##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 Commission File No. 0-26912 Vodavi Technology, Inc. 
  Delaware
    
    86-0789350(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 4717 East Hilton Avenue, Ste. 400, Phoenix, Arizona
    
    85034(Address of principal executive offices)
    
    (Zip Code)
 (480) 443-6000 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).  The number of shares outstanding of registrants Common Stock, $.001 par value
per share, as of October 27, 2004 was 3,688,937.




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VODAVI TECHNOLOGY, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004 TABLE OF CONTENTS  
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets  September 30, 2004 and December 31, 2003
    
    
    3Consolidated Statements of Operations  Three and Nine Months Ended September 30, 2004 and 2003
    
    
    4Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    14Item 4. Controls and Procedures
    
    
    15PART II. OTHER INFORMATION
    
    
    16SIGNATURES
    
    
    17EX-31.1EX-31.2EX-32.1EX-32.2
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS VODAVI TECHNOLOGY, INC. 
 CONSOLIDATED BALANCE SHEETS
 In thousands, except share and per share amounts
 Sept. 30, 2004
    
    December 31,(Unaudited)
    
    2003CURRENT ASSETS:Cash
    
    $
    2,787
    
    
    $
    2,924Accounts receivable, net of reserves for doubtful accounts
and sales returns of $450 and $345, respectively
    
    
    8,213
    
    
    
    6,988Inventory
    
    
    4,653
    
    
    
    5,115Deferred income taxes
    
    
    445
    
    
    
    445Prepaid and other current assets
    
    
    611
    
    
    
    768Total current assets
    
    
    16,709
    
    
    
    16,240PROPERTY AND EQUIPMENT, net
    
    
    1,396
    
    
    
    1,453GOODWILL
    
    
    725
    
    
    
    725DEFERRED INCOME TAXES
    
    
    34
    
    
    
    34OTHER LONG-TERM ASSETS
    
    
    55
    
    
    
    71$
    18,919
    
    
    $
    18,523CURRENT LIABILITIES:Trade accounts payable
    
    $
    958
    
    
    $
    1,031Accrued liabilities
    
    
    2,097
    
    
    
    2,195Trade accounts payable to stockholder
    
    
    4,177
    
    
    
    4,208Current portion of long-term debt
    
    
    
    
    
    
    200Total current liabilities
    
    
    7,232
    
    
    
    7,634Long-term debt
    
    
    
    
    
    
    700COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred stock, $.001 par value; 1,000,000 shares
authorized, no shares issued
    
    
    
    
    
    
    Common stock, $.001 par value; 10,000,000 shares
authorized; 3,721,339 and 3,610,464 shares issued
    
    
    4
    
    
    
    4Additional paid-in capital
    
    
    11,365
    
    
    
    11,041Retained earnings (deficit)
    
    
    470
    
    
    
    (856
    )Treasury stock, 32,402 shares at cost
    
    
    (152
    )
    
    
    11,687
    
    
    
    10,189$
    18,919
    
    
    $
    18,523
 The accompanying notes are an integral part of these consolidated balance sheets. 3




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VODAVI TECHNOLOGY, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 In thousands except per share amounts
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003REVENUE, net
    
    $
    11,690
    
    
    $
    11,397
    
    
    $
    32,717
    
    
    $
    30,678COST OF GOODS SOLD
    
    
    7,529
    
    
    
    7,456
    
    
    
    21,232
    
    
    
    20,110GROSS MARGIN
    
    
    4,161
    
    
    
    3,941
    
    
    
    11,485
    
    
    
    10,568OPERATING EXPENSES:Engineering and product development
    
    
    447
    
    
    
    499
    
    
    
    1,460
    
    
    
    1,569Selling, general and administrative
    
    
    2,649
    
    
    
    2,655
    
    
    
    7,860
    
    
    
    7,3933,096
    
    
    
    3,154
    
    
    
    9,320
    
    
    
    8,962OPERATING INCOME
    
    
    1,065
    
    
    
    787
    
    
    
    2,165
    
    
    
    1,606INTEREST EXPENSE (INCOME)
    
    
    (3
    )
    
    
    40
    
    
    
    11
    
    
    
    93INCOME BEFORE INCOME TAXES
    
    
    1,068
    
    
    
    747
    
    
    
    2,154
    
    
    
    1,513INCOME TAX PROVISION
    
    
    411
    
    
    
    295
    
    
    
    828
    
    
    
    598NET INCOME
    
    $
    657
    
    
    $
    452
    
    
    $
    1,326
    
    
    $
    915EARNINGS PER COMMON SHARE:Basic
    
    $
    0.18
    
    
    $
    0.13
    
    
    $
    0.36
    
    
    $
    0.23Diluted
    
    $
    0.16
    
    
    $
    0.12
    
    
    $
    0.32
    
    
    $
    0.22WEIGHTED AVERAGE SHARES OUTSTANDING:Basic
    
    
    3,658
    
    
    
    3,521
    
    
    
    3,635
    
    
    
    4,021Diluted
    
    
    4,087
    
    
    
    3,766
    
    
    
    4,106
    
    
    
    4,192
 The accompanying notes are an integral part of these consolidated financial statements. 4




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VODAVI TECHNOLOGY, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 In thousands
 Nine Months EndedSeptember 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    1,326
    
    
    $
    915Adjustments to reconcile net income to net cash
flows provided by operating activities:Depreciation and amortization
    
    
    366
    
    
    
    347Tax benefit on stock option exercises
    
    
    97
    
    
    
    Changes in working capital:Accounts receivable, net
    
    
    (1,225
    )
    
    
    (407
    )Inventory
    
    
    462
    
    
    
    1,004Income tax receivable
    
    
    
    
    
    
    300Prepaid and other current assets
    
    
    157
    
    
    
    226Other long-term assets and deferred taxes
    
    
    (3
    )
    
    
    (38
    )Trade accounts payable
    
    
    (104
    )
    
    
    (963
    )Accrued liabilities
    
    
    (98
    )
    
    
    301Net cash flows provided by operating activities
    
    
    978
    
    
    
    1,685CASH FLOWS FROM INVESTING ACTIVITIES:Cash paid to acquire property and equipment
    
    
    (290
    )
    
    
    (262
    )Net cash flows used in investing activities
    
    
    (290
    )
    
    
    (262
    )CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings on term loan
    
    
    
    
    
    
    961Repayments on term loan
    
    
    (900
    )
    
    
    Stock repurchase
    
    
    (152
    )
    
    
    (2,063
    )Stock options exercised
    
    
    227
    
    
    
    Net cash flows used in financing activities
    
    
    (825
    )
    
    
    (1,102
    )CHANGE IN CASH
    
    
    (137
    )
    
    
    321CASH, beginning of period
    
    
    2,924
    
    
    
    1,141CASH, end of period
    
    $
    2,787
    
    
    $
    1,462SUPPLEMENTAL CASH FLOW INFORMATION:Cash paid for interest
    
    $
    14
    
    
    $
    82Cash paid for income taxes
    
    $
    823
    
    
    $
    162
 The accompanying notes are an integral part of these consolidated financial statements. 5




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VODAVI TECHNOLOGY, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 September 30, 2004
 (a) INTERIM FINANCIAL REPORTING The accompanying unaudited Consolidated Financial Statements have been prepared
by Vodavi Technology, Inc. and subsidiaries (Vodavi or the Company)
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC) and, in the opinion of management, include all adjustments (consisting
of normal recurring accruals and adjustments) necessary for a fair presentation
of results of operations, financial position, and cash flows as of and for the
periods presented. The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and revenue and expenses
during the period reported. Actual results could differ from those estimates.
Estimates are used in accounting for, among other things, customer incentive
programs, allowances for bad debts and sales returns, inventory obsolescence,
product warranty, depreciation, taxes and other contingencies. Estimates and
assumptions are reviewed periodically and the effects of revisions are
reflected in the Consolidated Financial Statements in the period they are
determined to be necessary. The results for the nine months ended September 30, 2004 are not necessarily
indicative of financial results for the full fiscal year. These financial
statements should be read in conjunction with the audited Consolidated
Financial Statements and notes thereto included in Vodavis Annual Report on
Form 10-K for the year ended December 31, 2003. [SPACE INTENTIONALLY LEFT BLANK] 6




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(b) CALCULATION OF EARNINGS PER SHARE The Company presents basic and diluted earnings per share (EPS). Basic EPS is
determined by dividing net income by the weighted average number of common
shares outstanding. The basic weighted average number of common shares
outstanding excludes all dilutive securities. Diluted EPS is determined by
dividing net income by the
weighted average number of common shares and dilutive securities outstanding. A reconciliation of the numerator and denominator (weighted average number of
shares outstanding) of the basic and diluted EPS computation is as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Net income
    
    $
    657
    
    
    $
    452
    
    
    $
    1,326
    
    
    $
    915Weighted average common shares:Basic
    
    
    3,657
    
    
    
    3,521
    
    
    
    3,635
    
    
    
    4,021Effect of dilutive stock options (1)
    
    
    430
    
    
    
    245
    
    
    
    470
    
    
    
    171Diluted
    
    
    4,087
    
    
    
    3,766
    
    
    
    4,105
    
    
    
    4,192Anti-dilutive stock options (2)
    
    
    111
    
    
    
    241
    
    
    
    106
    
    
    
    592
  (1)
    
    Dilutive securities are calculated using the treasury stock
method and the average market price during the period.(2)
    
    Options having an exercise price greater than the average
market price during the reporting period are anti-dilutive, and
therefore do not enter into the diluted earnings per share
calculation. (c) STOCK OPTION PLANS Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for
Stock-Based Compensation, encourages entities to recognize as expense over the
vesting period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 allows entities to continue to apply the provisions
of APB Opinion No. 25, Accounting for Stock Issued to Employees, and provide
pro forma earnings per share disclosures for employee stock option grants as if
the fair-value-based method as defined in SFAS No. 123 had been applied. The
Company applies the intrinsic value method under APB No. 25 and provides the
pro forma disclosure provisions of SFAS No. 123. No stock-based employee compensation cost is reflected in net income as all
options granted under the Plan had an exercise price equal to or greater than
the market price of the underlying common stock on the date of grant. If the
Company had accounted for its stock-based compensation plan using a fair value
based method of accounting as prescribed in SFAS No. 123, the Companys net
income and earnings per share would have been reported as follows: 7




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Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share amounts)Net income:As reported
    
    $
    657
    
    
    $
    452
    
    
    $
    1,326
    
    
    $
    915Options expense, net of taxes
    
    
    50
    
    
    
    23
    
    
    
    141
    
    
    
    83Pro forma net income
    
    $
    607
    
    
    $
    429
    
    
    $
    1,185
    
    
    $
    832Earnings per share:As reported  Basic
    
    $
    0.18
    
    
    $
    0.13
    
    
    $
    0.36
    
    
    $
    0.23As reported  Diluted
    
    $
    0.16
    
    
    $
    0.12
    
    
    $
    0.32
    
    
    $
    0.22Pro forma  Basic
    
    $
    0.17
    
    
    $
    0.12
    
    
    $
    0.33
    
    
    $
    0.21Pro forma  Diluted
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.29
    
    
    $
    0.20
 During the nine-month period ended September 30, 2004, 68,750 options were
granted at a weighted average exercise price of $6.26. Also during the
nine-month period ended September 30, 2004, 110,875 options were exercised with
total proceeds of approximately $227,000 that resulted in a tax benefit of
$97,000. (d) STOCK REPURCHASES In June 2003, the Company repurchased 829,199 shares of its common stock for
$2.40 per share pursuant to a tender offer. The purchase was funded through
advances on a revolving line of credit and borrowings on a term loan. As of
September 30, 2004, there were no outstanding balances on the revolving line of
credit or term loan. The repurchased shares were retired. In May 2004, the Company commenced a stock repurchase program to purchase up to
$1.0 million of the Companys common stock through October 2004. In October
2004, the Company extended the expiration of the repurchase program to March
31, 2005. As of September 30, 2004, the Company repurchased 32,402 shares at a
total cost of $152,000. The Company did not repurchase any shares during the
most recent quarter. The repurchased shares are held in treasury. (e) RECLASSIFICATIONS In June 2004, the Company retired 318,700 shares of treasury stock that had
been repurchased pursuant to a stock repurchase plan that expired in 1999. The
treasury stock along with the repurchase cost of $759,000 has been reclassified
on the December 31, 2003 balance as a reduction to the number of shares
outstanding and additional paid-in capital, respectively. (f) SEGMENT REPORTING The Company operates in one reportable segment, the distribution and support of
business telecommunications products. Accordingly, the Company has only
presented financial information for its one reportable segment. (g) COMMITMENTS AND CONTINGENCIES The Company is subject to certain asserted and unasserted claims encountered in
the normal course of business. The Company believes that the resolution of
these matters will not have a material adverse effect on its financial position
or results of operations. However, the Company cannot provide assurance that
damages resulting from the resolution of these matters, if any, will not have a
material adverse effect on the Companys financial position or results of
operations. 8




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Business Overview We design, develop, market, and support a broad range of business
telecommunications solutions, including traditional and IP telephony products,
voice processing products, as well as computer telephony products, that address
a wide variety of business applications. Our telecommunications solutions
incorporate sophisticated features such as automatic call distribution,
scalable networking, Internet protocol, or IP, and wireless solutions. Our
voice processing products include Internet messaging, automated attendant, and
voice and fax mail. Our computer telephony products enable users to integrate
the functionality of their telephone systems with their computer systems. We
market our products primarily in the United States as well as in foreign
countries through a distribution model consisting primarily of wholesale
distributors and direct dealers. Critical Accounting Policies and Estimates Managements Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and expenses
during the reporting period. On an on-going basis, we evaluate our estimates
and judgments, including those related to customer incentives, bad debts, sales
returns, excess and obsolete inventory, and contingencies and litigation. We
base our estimates and judgments on historical experience and on various other
factors that are reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements: Customer Incentives We record reductions to revenue for customer incentive programs, including
special pricing agreements, price protection for our distributors, promotions,
and other volume-related rebate programs. Such reductions to revenue are
estimates, which are based on a number of factors, including our assumptions
related to customer redemption rates, sales volumes, and inventory levels at
our distributors. If actual results differ from our original assumptions,
revisions are made to our estimates that could result in additional reductions
to our reported revenue in the period the revisions are made. Additionally, if
market conditions were to decline, we may take actions to increase the level of
customer incentive offerings that could result in an incremental reduction of
revenue in the period in which we offer the incentive. Bad Debts We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If
the financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required. Additionally, we have a significant concentration of accounts
receivable with our two largest distributors, Graybar Electric Company, Inc.
and Target Distributing Company. As of September 30, 2004, Graybar accounted
for 31% and Target accounted for 30% of our total accounts receivable. If
either Graybar or Targets financial condition were to deteriorate, resulting
in their inability to make payments to us, it could have a material adverse
impact on our financial condition and
results of operations. 9




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Sales Returns We maintain allowances for estimated sales returns. While we have
distribution agreements with our largest distributors that limit the amount of
sales returns on active products, we generally allow returns of products that
we discontinue. Accordingly, the timing and amount of revisions to our
estimates for sales returns is largely influenced by our decisions to
discontinue product lines and our ability to predict the inventory levels of
such products at our largest distributors. Revisions to these estimates have
the effect of increasing or decreasing the reported amount of revenue in the
period in which the revisions are made. We generally do not accept product
returns from our direct dealers unless the product is damaged. Excess and Obsolete Inventory We record our inventory at the lower of cost or market value. Our
assessment of market value is determined by, among other things, historical and
forecasted sales activity, the condition of specific inventory items, and
competitive pricing considerations. When the assessed market value is less
than the historical cost, provision is made in the financial statements to
write-down the carrying amount of the respective inventory items to market
value. If actual results are less favorable than our original assumptions for
determining market value, additional inventory write-downs may be required. The above listing is not intended to be a comprehensive list of our
accounting policies. See our audited Consolidated Financial Statements and
notes thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2003, which contains accounting policies and other disclosures
required by generally accepted accounting principles in the United States of
America. Results of Operations The following table sets forth, for the periods indicated the percentage
of total revenue represented by certain revenue and expense items. The table
and the discussion below should be read in conjunction with the consolidated
financial statements and notes thereto that appear elsewhere in this report. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    64.4
    
    
    
    65.4
    
    
    
    64.9
    
    
    
    65.6Gross margin
    
    
    35.6
    
    
    
    34.6
    
    
    
    35.1
    
    
    
    34.4Operating expenses:Engineering and product development
    
    
    3.8
    
    
    
    4.4
    
    
    
    4.5
    
    
    
    5.1Selling, general, and administrative
    
    
    22.7
    
    
    
    23.3
    
    
    
    24.0
    
    
    
    24.126.5
    
    
    
    27.7
    
    
    
    28.5
    
    
    
    29.2Operating income
    
    
    9.1
    
    
    
    6.9
    
    
    
    6.6
    
    
    
    5.2Interest expense, net
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    0.3Pretax income
    
    
    9.1
    
    
    
    6.5
    
    
    
    6.6
    
    
    
    4.9Income tax expense
    
    
    3.5
    
    
    
    2.6
    
    
    
    2.5
    
    
    
    1.9Net income (loss)
    
    
    5.6
    %
    
    
    3.9
    %
    
    
    4.1
    %
    
    
    3.0
    %
 10




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Quarter Ended September 30, 2004 Compared With Quarter Ended September 30,
2003 Revenue Revenue for the three-month period ended September 30, 2004 totaled $11.7
million, an increase of 2.6%, from revenue of $11.4 million for the same period
of 2003. Sales of our telephone systems increased 5.1% to $9.6 million during
the third quarter of 2004 compared to $9.2 million in 2003. The increase in
telephone system sales is attributed to an increase in unit sales of our STS
product line and the sale of larger systems within the XTS product line. Sales
of commercial grade single line telephones declined from $602,000 in the third
quarter of 2003 to $535,000 in the most recent quarter. During the third
quarter of 2004, we discontinued our 2700 Series of single line telephones and
in June 2004 we introduced the 2800 Series. We expect sales of single line
telephones to accelerate in the latter part of 2004. Sales of telephony
applications, including voice processing, computer telephony integration, and
unified messaging decreased to $1.2 million in the third quarter of 2004 from
$1.4 million in the third quarter of 2003. The decline in telephony
applications is a direct result of selling more embedded voice mail
applications, which are reported in telephone system sales. Sales through our direct sales office in the Phoenix Metropolitan area
totaled $645,000 during the third quarter of 2004 compared with $345,000 during
the same period of 2003. The increase in sales through our direct sales office
is attributable to the expansion of our sales force and the positive impact of
a focused sales and marketing program. Our revenue is reported net of reserves for sales returns, discounts,
customer incentive programs, and inter-company eliminations, and includes
shipping and handling charges. These items resulted in a net reduction to
revenue of $365,000 in the third quarter of 2004 compared with a reduction of
$112,000 in the third quarter of 2003. Gross Margin Our gross margin was approximately $4.2 million and $3.9 million for the
quarterly periods ended September 30, 2004 and 2003, respectively. Our gross
margin as a percentage of total revenue increased to 35.6% during 2004 from
34.6% during 2003. The increase in our gross margin percentage during 2004 is
a direct result of the mix of product sales, a higher volume of sales to cover
the fixed component of cost of sales, and increased sales at our direct sales
office. Engineering and Product Development Engineering and product development expenditures decreased slightly to
$447,000 during the third quarter of 2004 from $499,000 in the same period of
2003. We continue to invest in the development of our next generation IP
telephone systems, the convergence of and enhancements to our traditional
telephone systems, and enhancements to our voice processing and other telephony
applications. Selling, General, and Administrative Expenses Selling, general, and administrative expenses were approximately $2.7
million for each of the quarterly periods ended September 30, 2004 and 2003,
respectively. As a percentage of revenue, selling, general and administrative
expenses were approximately 23% for each of the quarterly periods ended
September 30, 2004 and 2003. Interest Expense (Income) Interest expense (income) decreased from $40,000 in 2003 to ($2,500) in
2004. The reduction in interest expense reflects the pay down of interest
bearing debt in 2004 and interest earned on short-term investments. Income Taxes We provided for federal and state income taxes using an effective rate of
38.5% during the third quarter of 2004 compared to 39.5% during the third
quarter of 2003. Our effective tax rate in the third quarter of 2004 is 11




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consistent with our effective tax rate that we reported for the full fiscal
year in 2003. Nine Months Ended September 30, 2004 Compared With Nine Months Ended
September 30, 2003 Revenue Revenue for the nine-month period ended September 30, 2004 totaled $32.7
million, an increase of 6.5%, from revenue of $30.7 million for the same period
of 2003. Sales of our telephone systems increased 9.3% to $27.0 million during
the first nine months of 2004 compared to $24.8 million in 2003. The increase
in telephone system sales is attributed to an increase in unit sales of our STS
product line and the sale of larger systems within the XTS product line. Sales
of commercial grade single line telephones declined 4.1% to $1.6 million during
the 2004 period compared to the first three quarters of 2003. During the third
quarter of 2004, we discontinued our 2700 Series of single line telephones and
in June 2004 we introduced the 2800 Series. We expect sales of single line
telephones to accelerate in the latter part of 2004. Sales of telephony
applications, including voice processing, computer telephony integration, and
unified messaging decreased slightly to $3.7 million from $4.0 million during
the respective periods of 2004 and 2003. The decline in telephony applications
is a direct result of selling more embedded voice mail applications, which are
reported in telephone system sales. Sales through our direct sales office in the Phoenix Metropolitan area
totaled $1.5 million during the first nine months of 2004 compared with
$962,000 during the same period of 2003. The increase in sales through our
direct sales office is attributable to the expansion of our sales force and the
positive impact of a focused sales and marketing program. Our revenue is reported net of reserves for sales returns, discounts,
customer incentive programs, and inter-company eliminations, and includes
shipping and handling charges. These items resulted in a net reduction to
revenue of $1.2 million in the first three quarters of 2004 compared with a
reduction of $712,000 in the first three quarters of 2003. Gross Margin Our gross margin was approximately $11.5 million in 2004 compared with
$10.6 million in 2003. Our gross margin as a percentage of total revenue
increased to 35.1% during 2004 from 34.4% during 2003. The increase in our
gross margin percentage during 2004 is a direct result of the mix of product
sales, a higher volume of sales to cover the fixed component of cost of sales,
and increased sales at our direct sales office. Engineering and Product Development Engineering and product development expenditures decreased slightly to
$1.5 million during the first nine months of 2004 from $1.6 million for the
same period in 2003. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased to $7.9 million in
2004 compared to $7.4 million in the first nine months of 2004. Factors that
increased our expenses include increased compensation and additional marketing
and promotional activity. As a percentage of revenue, selling, general, and
administrative expenses remained relatively unchanged at 24% for the respective
periods. Interest Expense Interest expense decreased to $11,000 for the first nine months of 2004
from $93,000 for the same period in 2003. The reduction in interest expense is
a direct result of the elimination of interest bearing debt in the first half
of 2004. Income Taxes We provided for federal and state income taxes using an effective rate of
38.5% during the first three quarters of 2004 compared with 39.5% for the same
period in 2003. Our effective tax rate in 2004 is expected to be consistent
with the effective tax rate that we reported for the full fiscal year in 2003. 12




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Liquidity and Capital Resources Our net working capital position was approximately $9.5 million at
September 30, 2004 compared with $8.6 at December 31, 2003. We had a cash
balance of $2.8 million at September 30, 2004 compared with a cash
balance of $2.9 million at December 31, 2003. Factors that decreased our
cash position during the first nine months of 2004 included an increase in
accounts receivable of $1.2 million and the pay down of accounts payable and
accrued liabilities of $104,000 and $98,000, respectively. We also used
approximately $290,000 during the first nine months of 2004 for the purchase of
property and equipment, $152,000 to repurchase 32,402 shares of our common

stock during the second fiscal quarter, and $900,000 to pay off our term loan.
Sources of cash included positive income from operations, a reduction in
inventory of $462,000 and other current assets of $157,000, and $227,000 from
the exercise of stock options. Our accounts receivable days sales outstanding, calculated on a quarterly
basis, were approximately 65 days as of September 30, 2004 compared to 59 days
as of December 31, 2003. The timing of payments received from our largest
distributors greatly influence our days sales outstanding. Our two largest
distributors comprised 61% of our total accounts receivable as of September 30,
2004 and 51% as of December 31, 2003. An increase in concentration from our
two largest distributors has the effect of increasing our days sales
outstanding. Our inventory turnover, measured in terms of days outstanding on a
quarterly basis, was 57 days as of September 30, 2004 compared to 67 days as of
December 31, 2003. The decrease in inventory days outstanding is a direct
result of our efforts to rationalize our product lines and an increase in
sales. Trade payables and accrued liabilities, including payables to third-party
and related-party manufacturers, were approximately $7.2 million as of
September 30, 2004 compared with $7.4 million as of December 31, 2003. The
level of our trade payables and accrued liabilities between periods is largely
influenced by the timing of payments we make to our largest suppliers for
inventory items and payments to cover payroll, income taxes, and customer
rebates. We generally pay trade payables within 45 days from the invoice date,
except for payments to our largest supplier, which are 60 days from the invoice
date. We had a $15.0 million credit facility with General Electric Capital
Corporation that expired in April 2003. The line of credit bore interest at
2.5% over the 30-day commercial paper rate. Advances under the line of credit
were based upon eligible accounts receivable and inventory of our wholly owned
subsidiary, Vodavi Communications Systems, Inc., and were secured by
substantially all of our assets. The revolving line of credit contained
covenants that are customary for similar credit facilities and also prohibited
our operating subsidiaries from paying dividends to us without the consent of
GE Capital. In April 2003, we entered into a credit agreement with Comerica
Bank-California (Comerica) of a size that is more reflective of the current
capital requirements of our business. The credit agreement established a $5.0
million revolving line of credit and a $1.0 million term loan. Advances under
the credit facility are based upon eligible accounts receivable and inventory
of our wholly owned subsidiary, Vodavi Communications Systems, Inc., and are
secured by substantially all of our assets. The credit facility contains
covenants that are customary for similar credit facilities and also prohibits
our operating subsidiaries from paying dividends to us without the consent of
Comerica. As of September 30, 2004, we had no outstanding borrowings on our
line of credit and $5.0 million available for future advances. The $5.0 million revolving line of credit bears interest at Comericas
prime rate, or 4.0% at September 30, 2004, and requires monthly payments of
interest only with all unpaid principal and accrued interest due at its
expiration in April 2005. If we are unable to reduce the principal balance on
the line of credit to zero for at least 30 consecutive days during any fiscal
year, then any remaining balance will be converted into a term loan, or term
balance, as defined in the agreement. In addition to interest on the term
balance, we will be required to make monthly payments of principal in an amount
sufficient to fully amortize the term balance over a thirty-six month period. The $1.0 million term loan was available to us only for the purpose of
acquiring our common stock. Borrowings on the term loan bore interest at
Comericas prime rate plus 0.5%. In April 2004, we repaid the amount
outstanding on our term loan with currently available funds. In May 2003, we commenced a self-tender offer to purchase up to 1,000,000
shares of our common stock 13




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for $2.40 per share. On June 13, 2003, we
repurchased 829,199 shares of our common stock at $2.40 per share pursuant to
the tender offer. The repurchase was funded through advances on our revolving
line of credit and term loan. We have certain long-term operating lease agreements for our office and
warehouse facilities and short-term purchase commitments to our third-party
suppliers. We have no special purpose entities or off balance sheet financing
arrangements, commitments, or guarantees. The following table sets forth all
known commitments as of September 30, 2004 and the year in which those
commitments become due or are expected to be settled (in thousands): Payment due by periodContractual
    
    
    
    
    
    Less than
    
    
    
    
    
    
    
    
    
    More thanObligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 yearsLong-Term Debt
Obligations
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating Lease
Obligations
    
    
    5,898
    
    
    
    940
    
    
    
    1,621
    
    
    
    1,570
    
    
    
    1,767Purchase Obligations
    
    
    6,426
    
    
    
    6,426
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    12,324
    
    
    $
    7,366
    
    
    $
    1,621
    
    
    $
    1,570
    
    
    $
    1,767
 From time to time we are subject to certain asserted and unasserted claims
encountered in the normal course of business. We believe that the resolution
of these matters will not have a material adverse effect on our financial
position or results of operations. However, we cannot provide assurance that
damages resulting from the resolution of these matters, if any, will not have a
material adverse effect on our financial position or results of operations. We believe that our working capital and credit facilities are sufficient
to fund our capital needs during the next 12 months. We intend to continue to
explore business acquisition opportunities as they arise and may be required to
seek additional financing in the future to meet such opportunities. International Manufacturing Sources We currently obtain a substantial majority of our products under various
manufacturing arrangements with third-party manufacturers in South Korea and
Thailand, including LGE who owns approximately 24% of our outstanding common
stock. We face risks associated with international manufacturing sources. For
a more detailed discussion of these risks, please see Item 1, Business 
Risk Factors  We face risks associated with international manufacturing
sources included in our annual report on Form 10-K for the year ended December
31, 2003. CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS This report contains forward-looking statements, including statements
regarding our business strategies, our business, and the industry in which we
operate. These forward-looking statements are based primarily on our
expectations and are subject to a number of risks and uncertainties, some of
which are beyond our control. Actual results could differ materially from the
forward-looking statements as a result of numerous factors, including those set
forth in our Form 10-K for the year ended December 31, 2003, as filed with the
Securities and Exchange Commission. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not participate in any activities involving derivative financial
instruments or other financial and commodity instruments. We do not hold
investment securities that would require disclosure of market risk. Our market
risk exposure is limited to interest rate risk associated with our credit
facility. We incur interest at a variable rate of prime on advances made under
our revolving line of credit and prime plus 0.5% on our term loan. At September
30, 2004, we had no outstanding borrowings on the line of credit or term loan. 14




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ITEM 4. CONTROLS AND PROCEDURES We have evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of September 30, 2004. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer have each concluded that our
disclosure controls and procedures are effective to ensure that we record,
process, summarize, and report information required to be disclosed by us in
our quarterly reports filed under the Securities Exchange Act within the time
periods specified by the Securities and Exchange Commissions rules and forms.
During the quarterly period covered by this report, there have not been any
changes in our internal controls over financial reporting that have materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. Subsequent to the date of their evaluation, there have not been any
significant changes in our internal controls or in other factors that could
significantly affect these controls, including any corrective action with
regard to significant deficiencies and material weaknesses. 15




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PART II - OTHER INFORMATION Item 1.
    
    Legal ProceedingsNot applicable.Item 2.
    
    Unregistered Sales of Equity Securities and Use of ProceedsNot applicable.Item 3.
    
    Defaults Upon Senior SecuritiesNot applicable.Item 4.
    
    Submission of Matters to a Vote of Security HoldersNot applicable.Item 5.
    
    Other InformationNot applicable.Item 6.
    
    Exhibits and Reports on Form 8-K
  (a)
    
    Exhibits:31.1
    
    Certification of Chief Executive Officer pursuant
to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant
to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.(b)
    
    Reports on Form 8-K:Not applicable 16




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. VODAVI TECHNOLOGY, INC.Dated: October 27, 2004
    
    /s/ Gregory K. RoeperGregory K. RoeperPresident and Chief Executive Officer(Principal Executive Officer)Dated: October 27, 2004
    
    /s/ David A. HusbandDavid A. HusbandChief Financial Officer and Vice President  Finance(Principal Financial and Accounting Officer)
 17