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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K [X]            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2003
    
    Commission File Number 0-26912
 VODAVI TECHNOLOGY, INC. 
  Delaware
    
    86-0789350(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 4717 East Hilton Avenue, Suite 400Phoenix, Arizona
    
    85034-6402(Address of principal executive offices)
    
    (Zip Code)
 (480) 443-6000 
  Securities registered pursuant to Section 12(b) of the Act:
None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value 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. Yes [X] No [  ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [  ] No [X] The aggregate market value of common stock held by nonaffiliates of the
registrant (1,950,489 shares) based on the closing price of the common stock as
reported on the Nasdaq SmallCap Market on June 30, 2003, which was the last
business day of the registrants most recently completed second fiscal quarter,
was $4,778,698. For purposes of this computation, all officers, directors, and
10% beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed an admission that such officers, directors,
or 10% beneficial owners are, in fact, affiliates of the registrant. As of March 5, 2004, there were outstanding 3,610,464 shares of the
registrants common stock, $.001 par value, which excludes 318,700 treasury
shares. Documents incorporated by reference None.




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 6. SELECTED CONSOLIDATED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESPART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-KSIGNATURESIndex to Consolidated Financial Statements and ScheduleINDEPENDENT AUDITORS REPORTINDEPENDENT AUDITORS REPORTConsolidated Balance SheetsConsolidated Statements of OperationsConsolidated Statements of Changes in Stockholders EquityConsolidated Statements of Cash FlowsNotes to Consolidated Financial StatementsINDEPENDENT AUDITORS REPORT ON SCHEDULESINDEPENDENT AUDITORS REPORT ON SCHEDULESSCHEDULE II Valuation and Qualifying AccountsEX-10.54EX-10.55EX-10.56EX-10.57EX-21EX-23.1EX-23.2EX-31.1EX-31.2EX-32.1EX-32.2    Table of Contents  VODAVI TECHNOLOGY, INC. ANNUAL REPORT ON FORM 10-K FISCAL YEAR ENDED DECEMBER 31, 2003 TABLE OF CONTENTS PagePART IITEM 1.
    
    BUSINESS
    
    
    1ITEM 2.
    
    PROPERTIES
    
    
    19ITEM 3.
    
    LEGAL PROCEEDINGS
    
    
    19ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    19PART IIITEM 5.
    
    MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
    
    
    21ITEM 6.
    
    SELECTED CONSOLIDATED FINANCIAL DATA
    
    
    22ITEM 7.
    
    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    23ITEM 7A.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    30ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
    
    
    30ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
    
    
    30ITEM 9A.
    
    CONTROLS  AND PROCEDURES
    
    
    30PART IIIITEM 10.
    
    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    
    
    31ITEM 11.
    
    EXECUTIVE COMPENSATION
    
    
    34ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
    
    
    44ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    
    46ITEM 14.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    47PART IVITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
    
    
    48SIGNATURES
    
    
    50INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
    
    
    F-1
 Statement Regarding Forward-Looking Statements The statements contained in this report onForm 10-Kthat are not purely
historical are forward-looking statements within the meaning of applicable
securities laws. Forward-looking statements include statements regarding our
expectations, anticipation, intentions, beliefs, or strategies
regarding the future. Forward-looking statements also include statements
regarding revenue, margins, expenses, and earnings analysis for fiscal 2004 and
thereafter; technological developments; future products or product development;
our product and distribution channel development strategies; potential
acquisitions or strategic alliances; the success of particular product of
marketing programs; and liquidity and anticipated cash needs and availability.
All forward-looking statements included in this report are based on information
available to us as of the filing date of this report, and we assume no
obligation to update any such forward-looking statements. Our actual results
could differ materially from the forward-looking statements. Among the factors
that could cause results to differ materially are the factors discussed in Item
1, Business  Risk Factors. -i-




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PART I 
 ITEM 1. BUSINESS Introduction 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, as well as 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. Our goal is to develop, deliver, and support high-quality
telecommunications products and services that meet the demands of the markets
we serve. Key elements of our strategy to achieve that goal include the
following:  
    
    continued expansion of our core business of supplying
telephone systems, voice processing systems, and
computer-telephony integration, or CTI, products;
    
    focus on IP telephony product developments allowing Voice
over IP, or VoIP, connectivity for our legacy products and our
next generation IP local area network, or LAN, telephony system;
    
    emphasize sales of larger and more advanced systems
through our dealers;
    
    focus on the integration of existing and newly developed
products to provide complete, industry standard-based business
communications products to our customers;
    
    expand our strategic relationship with LG Electronics
Inc., or LGE, which is a member of the multi-billion dollar,
Korean-based LG Group; and
    
    enhance our existing products and expand our product
lines by expanding our technological expertise and distribution
channels through  
    internal research and development efforts, and
    business acquisitions, license arrangements, and other strategic relationships. Our corporate offices are located at 4717 East Hilton Avenue, Suite 400,
Phoenix, Arizona, and our telephone number is (480) 443-6000. All references to
our business operations in this report include the operations of Vodavi
Technology, Inc. and our subsidiaries. Our website is located at
www.vodavi.com. Through our website, we make available free of charge our
annual report on Form 10-K, our proxy statement, our quarterly reports on Form
10-Q, our current reports on Form 8-K, amendments to reports filed under the
Securities Exchange Act of 1934, and earnings press releases. These filings are
available as soon as reasonably practical after we electronically file them
with the Securities and Exchange Commission. We also post on our website the
charters of our Audit, Compensation, and Nomination and Corporate Governance
Committees; our Corporate Governance Guidelines, Code of Conduct, Code of
Ethics for the CEO and Senior Financial Officer, and any amendments and waivers
thereto; and any other corporate governance materials contemplated by SEC or
Nasdaq regulations. These documents are also available in print to any
stockholder requesting a copy from our corporate secretary at our principal
executive offices. Industry Overview The telecommunications industry encompasses a broad range of equipment and
service providers. We focus our efforts in the customer premise equipment, or
CPE, segment of the industry. Within the CPE segment, we 1




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provide business
telephone systems, voice processing systems, and adjunct equipment that help
small to medium sized businesses streamline operations, reduce costs, and
communicate more effectively. Many factors have influenced the telecommunications industry over the years, including the following:  
    
    successive technological developments that have resulted in enhanced features and services;
    
    optical networking technologies;
    
    broadband connectivity;
    
    wireless and mobile communications;
    
    emphasis on the use of communications systems to provide cost-effective customer service; and
    
    regulatory changes. Perhaps the most significant technological advancement in recent years has
been the evolution and acceptance of the Internet and other packet-switched
networks to carry voice and data traffic. This evolution is transforming the
way businesses communicate and allows equipment providers to develop
sophisticated systems that offer a wide variety of applications in addition to
traditional call switching functions. While utilizing packet-switched networks
to carry voice and data traffic can offer more efficiencies and value to
businesses, the traditional telephone network utilizing analog and digital
time-division-multiplexing, or TDM, technologies remains the standard for voice
communications today. Nevertheless, businesses of all sizes will increasingly
demand affordable telecommunications systems that provide the capacity for the
following:  
    
    IP-enabled telephone systems, which represent products based on
TDM technology that have been blended with IP technology, to create
IP capable business communications systems that retain certain TDM
functionality while taking advantage of newer IP technology for
certain applications;
    
    IP telephony, which represents products based exclusively on IP
technology for voice and data communications. These products take
advantage of a common infrastructure, provide scalability, and
integrate with data networks to simplify administration;
    
    Voice processing systems that automate call answering, provide voice
mail and automated call distribution functions, provide the capacity
to manage facsimile messages, and unified messaging applications,
which allow users to receive all message types (voice, e-mail, fax) to
be managed from their e-mail program;
    
    Computer-telephony integration, which greatly enhances
efficiency and productivity by integrating businesses voice and data
networks; and
    
    Contact Center applications, wireless offerings, and remote worker
applications to further increase employee mobility and efficiency. Our Products We currently design, develop, market, and support a broad range of
products that can be categorized as follows:  
    
    telephony products, which include traditional digital and
IP-based key telephone systems and commercial grade telephones; 2




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
    
    voice processing products, which include voice messaging,
automated attendant, automatic call distribution, as well as advanced
messaging products that include fax mail, and unified messaging
systems; and
    
    computer-telephony products, including Windows-based
application products such as PC telephones and attendant consoles,
local area network to PBX connection packages, IP gateways, and
Internet messaging systems. Telephony Products Telephone Systems Sales of telephone systems represented approximately 75% of our revenue
during 2003 and 74% of our revenue during 2002 and 2001. A telephone system
consists primarily of a sophisticated switching unit located at the users
place of business, along with the individual telephone sets and other devices,
such as facsimile machines and modems, located at individual stations. We
supply various models of telephone sets, several of which are CTI compatible,
with progressive features for use in conjunction with each of our telephone
systems. We currently market various lines of telephone systems under our STARPLUS,
Vodavi, Triad, and infinitebrand names for businesses requiring as few as
eight stations up to 492 stations (a 600-port system). We sell the STARPLUS
line to large wholesale distributors for resale to telephone sales and
installation companies known as dealers or interconnects. We also sell our
Triad line to large wholesale distributors for resale only to authorized
dealers. We sell our infiniteand Vodavi lines directly to authorized dealers. Our flagship digital telephone systems are the XTS (eXpandable Telephone
System) for larger applications and the STS for smaller businesses and
residences. These systems employ a digital architecture in order to provide
digital voice transmission and system control. Most of our digital telephone
systems feature flexible software combined with modular hardware and card slot
design, which allow cost-effective system customization and expansion to meet
the needs of individual users. Our digital telephone systems are fully
compatible with industry-standard commercial grade telephones and contain an
extensive array of standard features that add sophistication generally found
only in larger telephone systems. We design our telephone systems to permit
expansion or customization for specific business applications by the
installation of a variety of voice processing or computer-telephony integration
products. In addition, our XTS system is IP capable with the addition of a circuit
pack. In 2003, we introduced a robust IP networking package to the marketplace.
This package allows up to 32 XTS systems to communicate as one large system
using an IP infrastructure. This configuration allows companies with multiple
locations to communicate more efficiently and to reduce costs by utilizing a
common network to connect multiple locations together. Our digital systems enable customers to upgrade their telephone systems as
their businesses grow and as technology advances by adding or replacing
components in stages without replacing their entire systems. As a result, it
is generally more economical for the end users to expand their STARPLUS, Triad,
or infinitesystems than to switch to a competitors system. We believe that
the economy and flexibility we provide our customers through this migration
strategy provides us with a competitive advantage. We introduced our flagship IP-based telephone system, the Telenium, in
September 2002. The Telenium system is based exclusively on IP technology,
which allows a business local area network or wide area network to be utilized
as the communication medium. The Telenium system provides an extensive array of
standard features that operate in much the same manner as a traditional system.
The Telenium system also offers web-based administration, which simplifies
administration locally or from a remote location. The Telenium system
accommodates IP telephones, commercial grade telephones, and a variety of
incoming lines including traditional as well as ISDN types. Currently, the
Telenium system is only available to certified dealers who buy directly from
us. 3




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Commercial Grade Telephones We market several models of commercial grade telephones through wholesale
distributors for use with IP-based, analog or digital telephone systems, PBX
systems, or telephone company central office, or Centrex, switching systems.
Businesses, the hospitality industry, and school districts represent the
principal purchasers of our commercial grade telephones. All of our commercial
grade telephones meet industry standards for commercial telephone units and may
be used with telephone systems sold by us or by competing manufacturers. Our commercial grade telephones offer a myriad of features, functions, and
designs ranging from simple, traditionally styled desk and wall-mounted
telephones to programmable telephones with contemporary styling. Our more
advanced commercial grade telephones contain a central processing unit,
built-in memory, built-in data jacks, built-in speakerphones, built-in Caller
ID, and the capability to use custom calling features provided by local
telephone companies. Sales of commercial grade telephones represented
approximately 5.0% of our revenue during 2003, 7.5% of our revenue during 2002,
and 7.0% during 2001. Voice Processing Products Voice processing includes functions designed to improve customer service
and reduce labor costs while providing faster, more efficient routing of
incoming calls as well as speeding up and simplifying message delivery and
storage. We design our voice processing products to integrate with the
telephone systems we sell as well as those sold by competing manufacturers. We
also cultivate the expansion of our existing base of telephone systems by
offering digitally integrated voice processing systems for our Triad and
infiniteproduct lines to differentiate them from our competitors products and
to provide a value-added basis for increased sales and profit margins. Sales
of voice processing products accounted for approximately 20.0% of our revenue
during 2003, 18.5% during 2002, and 19.0% during 2001. Voice Mail Systems Voice mail enables callers to leave detailed messages and permits
recipients to retrieve messages when they return to their offices or by dialing
into the system from remote locations. Each voice mailbox can be customized to
the individual users needs. Voice messages can be stored, replayed, saved, or
erased as desired by the user. The menu routing functions included in some of
our voice mail systems enable business users to program the systems to create
custom, multi-level menus that permit callers to automatically access
organizational departments or product, service, or event information by dialing
menu choices. In addition to our larger voice processing systems, we market a line of
self-contained, competitively priced voice processing systems designed for
small- to medium-sized organizations. These systems, which work in conjunction
with telephone systems sold by us as well as other manufacturers, can be
expanded from two ports up to eight ports, feature a full range of automated
attendant and voice mail functions, and include a serial port for
administration via the users personal computer. Advanced Messaging Platform Our Pathfinder Microsoft® Windows based messaging systems, which provide
virtually unlimited port capacities, combine voice mail functions with
facsimile messaging capabilities (known as fax mail) as well as the ability to
share messages with other voice messaging systems over the Internet. Fax mail
provides the ability to receive, store, retrieve, and forward facsimile
messages in the same manner that voice mail handles voice messages. Our fax
mail system digitizes and stores facsimile messages and notifies the user that
messages have been received. The user can retrieve and print the facsimiles
from his or her office or remote locations (such as a hotel room) and can also
instruct the system to forward facsimiles to other recipients. Fax-on-demand
enables callers to access information stored by a business, such as sales and
marketing brochures, technical specifications, and pricing data, and request
the system to transmit the desired information to the callers facsimile
machine. Our Pathfinder system also uses Internet e-mail protocols to enable voice
messages to be transported over the Internet or other electronic fields for
efficient, low-cost information exchange between remote systems. In addition,
our Pathfinder Internet fax delivery systems connect the users telephone and
computer to enable the user 4




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to transmit facsimile messages or documents to
conventional facsimile machines via the Internet. These systems provide ease
of use and avoid problems associated with e-mail attachments, mismatched data
encryption techniques, or private or switched network costs. Our Internet fax
delivery systems provide spoken prompts that guide the user through the
transmission process and also transmit delivery confirmations to the users
mailbox. As a result, a business with
multiple offices can extend its voice messaging system so as to permit
employees in different locations to create, receive, answer, or forward voice
and facsimile messages via the Internet more quickly, efficiently, and
economically than traditional long-distance telephone calls. Our Pathfinder system also uses Microsoft® Exchange technology to
provide unified messaging. Unified messaging enables users to access e-mail,
voice mail, facsimiles, and paging messages in a single session at a personal
computer. The system displays a listing of all of the users messages and
enables the user to access and control all of his or her messages with a click
of the computer mouse. Automatic Call Distribution We market our automatic call distribution, or ACD, software systems and
ACD reporting packages for use with our digital key telephone systems. The
automatic call distribution functions enable businesses that receive customer
calls to manage incoming calls efficiently by directly routing them to the
proper person or group. Our ACD systems reduce the number of abandoned calls
by reducing the number of calls placed on hold and by minimizing the length of
time that calls are kept on hold. When all group member telephones are busy,
ACD plays a custom hold message for the caller and connects the call to the
first available person or sales agent. ACD saves employee time by eliminating
the necessity of continually answering and transferring calls to the same
groups. ACD enables agents with display telephones to see the number of calls
waiting in queue as well as the length of the longest waiting call in order to
speed call handling at times of heavy calling activity. Our ACD reporting package provides real-time statistics and comprehensive
reports on calling activity for review by the users management. These
statistics allow users to analyze and make informed decisions regarding their
business operations. Computer-Telephony Integration Products We design, develop, and market CTI products that use an open architecture
to integrate computer and telephone systems into a user-friendly information
processing and storage system. We believe that developing more value-added CTI
applications for our telephone systems will enhance the appeal of our product
lines and enable us to sell more telephone systems, full-featured telephones,
and other software packages and add-on peripheral products. We market CTI
products that enable a user  
    
    to use the Internet to access voice, facsimile, and e-mail
messages via personal computers;
    
    to incorporate telephone functions with computer software to
speed call handling and permit the user to personalize telephone
functions;
    
    to identify incoming callers and immediately access computer files relating to the caller;
    
    to connect Windows-based local area networks to the users telephone system; and
    
    to access and analyze call accounting information quickly and inexpensively. New Product Development We engage in an ongoing program to develop enhancements to our existing
product lines and to develop new products that address the increasing demands
of business organizations for low-cost productivity enhancing communication
solutions. We believe that continuous development of new products and features
will be necessary to enable us to continue to offer telephony systems, voice
processing products, computer-telephony products, and related business
communications products that will be in greatest demand and that will provide
the best 5




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opportunities for our growth and profitability on an ongoing basis. We
are currently focusing our new product development efforts on new products and
enhancements that will deliver greater features, sophistication, and value to
our current product offerings. In addition, through new developments, we are
targeting markets that we do not currently serve. Examples of our current
developments include the following:  
    
    A remote IP telephone for the XTS system to facilitate remote worker and small branch office applications.
    
    a wireless IP product that will offer complete in-building mobility to the XTS telephone system;
    
    The second phase of our IP telephony system, providing LAN telephony from 64 stations expanding to 300 stations, high speed
digital interfaces, transparent networking capabilities, remote worker solution, as well as voice compression enhancements;
    
    The third phase of our IP telephony system, providing a WiFi offering for mobility applications, softphone software that
allows computers and PDA devices to perform as a Telenium station, as well as CTI and contact center enhancements,
    
    The introduction of the IP equivalent of our Pathfinder that will provide IP connectivity to our Telenium IP system;
    
    a new In Skin PC platform that will provide enhanced voice
processing applications on the Starplus STS system; and
    
    a new In Skin PC platform for our XTS that will provide
software applications, such as voice processing, ACD, and CTI,
eliminating the need for external computer platforms on the XTS
System; We are expanding our strategic alliances with LGE and other third parties
related to the development of new products, product lines, or product features,
including new features on our Telenium IP system. We will continue to seek
additional strategic alliances for new product development in the future. Sales, Marketing, and Distribution We currently market our products in all 50 states and, to a limited
extent, internationally through a distribution network consisting primarily of
large wholesale distributors and telephone sales and installation companies
known as direct dealers. In March 2002, through our acquisition of Dataspeak
Systems, Inc., we began distributing our products and services directly to
end-users in the Phoenix metropolitan area. We also had an in-house sales
force that made direct sales of Interactive Voice Response products to
end-users. We discontinued our Interactive Voice Response business in March
2001. We have in the past and may in the future market our products on a
private label basis to original equipment manufacturers, or OEMs. The
following table sets forth, for the periods indicated the percentage of total
revenue represented by the respective distribution channels. Year Ended December 31,Distribution Channel
    
    2001
    
    2002
    
    2003Wholesale Distributors
    
    
    55
    %
    
    
    56
    %
    
    
    60
    %Direct Dealers
    
    
    41
    %
    
    
    41
    %
    
    
    39
    %Direct Sales Office
    
    
    
    
    
    
    3
    %
    
    
    1
    %IVR Customers
    
    
    4
    %
    
    
    
    
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 6




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The following diagram illustrates the current distribution channels for
our product lines. (VODAVI LOGO) Triad Distributors and Dealers We design and market our Triad line of telephone systems and related
products for sale through distributors to a limited number of authorized Triad
dealers. The Triad product line includes a full array of digital telephone
systems ranging from three lines and eight stations up to 600 ports, as well as
voice messaging, ACD, CTI, and other products. The authorized Triad dealers
must commit to minimum purchases of Triad products and must be trained and
certified through our formal product and sales training program. Our goal is
to encourage the Triad dealers to promote the Triad line to their customers as
the preferred line of telephone systems. We provide the authorized Triad
dealers with marketing, sales, and product support services. We had
approximately 156 authorized and active Triad dealers as of December 31, 2003. StarPlus Distributors and Dealers We design and market our STARPLUS brand of products for sale through
wholesale distributors. The distributors resell our products primarily to
small local interconnect companies and independent telephone companies, which
in turn resell our products to end users, install the systems at the end users
businesses, and provide service and technical support following the sale. We
provide ongoing support and training to enable distributors to sell more
effectively our products and to provide the interconnects and independent
telephone companies with technical assistance in installation, maintenance, and
customer support. Our STARPLUS line of products consists of commercial grade
telephones and STARPLUS, STS, DHS, DHSE, and DHSL telephone systems. We believe that sales through distributors offer several advantages, including the following:  
    
    established distribution systems and access to a large number of dealer and national customer accounts;
    
    maintenance of customer credit facilities and an established inventory of our products;
    
    availability of products in over 600 locations throughout the United States; 7




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
    
    security of receivables;
    
    reduced needs for direct training;
    
    effective promotion of our products at trade shows;
    
    geographically dispersed sales forces that can reach customers
more effectively than we would otherwise be able to do; and
    
    lower support and carrying costs compared with the costs
associated with direct sales to a large number of direct dealers. Distributors that currently resell our products include Graybar Electric
Co., Inc., Alltel Supply, Inc., Sprint/North Supply, Famous Telephone Supply,
ADI, Target, and Power & Telephone Supply Company. Graybar accounted for 27%
of our revenue during each of 2003, 2002 and 2001. Our second largest
distributor accounted for 14% of our revenue during 2003, 12% in 2002 and 9% in
2001. infinite Direct Dealers We developed our infiniteline of telephone systems and related products
for sales to a limited number of authorized direct dealers. These direct
dealers are medium and large interconnect companies that resell our products
directly to end-users. We believe that the principal advantages of this
distribution channel include greater control over the application and
installation of our products and the ability to obtain market feedback on
product pricing, quality, and technology. Sales to direct dealers, however,
generally involve greater credit risks, the necessity to provide increased
direct marketing and technical support, and additional costs associated with
developing and training the independent sales staff of the various direct
dealers to enable them to solicit purchases of our products. As of December 31, 2003, we had approximately 140 direct dealers that sell
our infiniteproducts. We maintain a program to focus on selling to fewer, but
larger and better-established, dealers. We secure arrangements with
large-volume, well-qualified dealers and have discontinued sales to dealers
that have not provided a sufficient level of sales or support for our infinite
line. We strive to secure dealers that maintain large customer bases and
possess the resources needed to provide quality sales presentations and support
to their customers. In-house Sales Staff We have an in-house sales support staff of eight employees who provide
dealers and distributors with order fulfillment, marketing, sales, and
technical support. We believe that our commitment to support dealers that sell
our products on a pre-sale and post-sale basis provides us with a competitive
advantage. Vodavi Direct We have a direct sales office of eight employees who sell our infinite
line of products and provide pre- and post-sales support services directly to
end-users in the Phoenix metropolitan area. We acquired this operation during
March 2002 through our acquisition of Dataspeak Systems, Inc. International Sales To date, sales of our products in foreign countries have not represented a
significant portion of our revenue. We believe, however, that sales of our
voice processing and other products in international markets may increase in
the future as demand for features, such as voice mail, advanced messaging, and
automatic call distribution increases, as touchtone technologies and cellular
telephone service become more available and other installed communications
infrastructures are improved, and as regulatory differences between countries
are eliminated. All of our sales in foreign countries are denominated in U.S.
dollars. 8




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Research and Development; Strategic Alliances with LGE and Other Companies We believe that the continued development of software that distinguishes
the functions and features of our products from those of our competitors
represents a critical factor in determining our ongoing success. Our
engineering staff consists of highly trained and experienced software
professionals who focus on providing and supporting high-quality, user-friendly
business communications systems and related products. The availability of
in-house software and systems development expertise at our facilities in
Arizona and Georgia provides us with product control, permits faster
turnaround and reaction time to changing market conditions, and provides a
solid base of maintenance and support services to end users. We use product
and market development groups that interact with customers in order to
anticipate and respond to customer needs through development of new product
programs and enhancement of existing product lines. We conduct joint development activities with LGE for the design and
development of hardware incorporated into some of our existing or planned
telephone systems and commercial grade telephone product lines. Under our
joint development projects with LGE, we provide market analysis, product
management, functional and performance standards, software development, quality
control program development, sales and distribution, and customer service and
support, while LGE provides hardware research, design, and development,
development of components such as integrated circuits and semiconductor chips,
and manufacturing and production engineering. Generally, LGE contributes the
ongoing research and development costs for the product hardware in return for
an arrangement under which LGE produces the finished goods developed under the
alliance. As a result of this arrangement, we have been able to obtain access
to LGEs research and development expertise and resources while controlling our
capital expenditures for much of our product development efforts. In addition,
our arrangement with LGE enables us to minimize the risks inherent in making
significant investments in research and development infrastructure or
personnel. To the extent that we develop new hardware in conjunction with LGE
or another development partner, the development partner typically retains
ownership rights to the new hardware and we retain the right to sell products
incorporating that hardware throughout North America and the Caribbean. See
Item 1, Business  Manufacturing and Item 1, Business  Risk
Factors  We rely on LGE as a strategic partner. We have successfully engaged in such
projects with LGE in the past and believe that we will continue to have access
to LGEs advanced hardware research and development capabilities as we develop
new product lines. We enhance our software development expertise through acquisitions of or
licensing arrangements and other strategic alliances with independent
third-party developers. We have active strategic alliance relationships with
other companies that possess expertise in automatic call distribution, small
digital key telephone systems, computer telephony, Internet telephony, and
certain voice mail applications. We believe that our strategic alliances with
other companies enable us to develop products and bring them to market more
quickly and at a lower cost than we would be able to achieve by developing the
products internally. We intend to pursue additional opportunities to enter
into strategic alliances with other companies that possess established
expertise in specific technologies in order to co-develop proprietary products,
or to acquire such companies in order to develop new products internally. Manufacturing We obtain our key telephone systems, some of our voice processing systems,
and our full-featured commercial grade telephones under manufacturing
arrangements with various third-party manufacturers, including LGE. We also
purchase certain voice processing products from third parties on an OEM basis.
Our agreements with the third-party manufacturers generally require the
manufacturers to produce our products according to our technical
specifications, to perform quality control functions or otherwise meet our
quality standards for manufacturing, and to test or inspect the products prior
to shipment. Under the manufacturing agreements, the manufacturers provide us
with warranties that the products are free of defects in material and
workmanship. The agreements also require the manufacturers to repair or
replace, at their expense, products that fail to conform to the warranties
within specified periods. All of the equipment and most of the tools and molds
used in the manufacturing process are owned by the third-party manufacturers. We obtain a majority of our key telephone systems and voice mail products
from LGE, which owns the rights to produce this equipment. We purchase
products manufactured by LGE in Korea on a purchase order basis. We purchased
$20.0 million, $15.9 million, and $13.0 million of product from LGE in 2003,
2002, and 2001, which represented 82%, 74%, and 67%, of our total purchases,
respectively. LGE currently owns approximately 24% of 9




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our outstanding common
stock. See Item 1, Business  Risk Factors  We rely on LGE as a strategic
partner and Business  Risk Factors  Certain conflicts of interest may
arise as a result of LGEs ownership interest in our company. We obtain all of our commercial grade telephones and replacement parts for
such telephones from LG Srithai, Ltd., or LGST, a joint venture between LGE and
Srithai Group, a Thailand-based entity. Under an agreement with our company,
LGST granted us the right to distribute and sell throughout the United States
and Canada the products that LGST manufactures for us in Thailand. Our
agreement with LGST prohibits us from purchasing the products covered by the
agreement from any other manufacturer during the term of the agreement. The
agreement renews automatically for successive one-year terms unless either
party provides notice to the other of its intent to cancel the agreement at
least three months prior to the end of the then-current term. We make all
purchases pursuant to the agreement on a purchase order basis. We purchased
$1.1 million, $2.6 million, and $2.4 million of product from LGST in 2003,
2002, and 2001, which represented 5%, 12%, and 12% of our total purchases,
respectively. See Item 1, Business  Risk Factors  We rely on LGE as a
strategic partner and Business  Risk Factors  Certain conflicts of
interest may arise as a result of LGEs ownership interest in our company. We also obtain some of our digital key telephone systems from Tecom Co.,
Ltd., a Republic of China company. Under an agreement with our company, Tecom
granted us the right to sell and distribute throughout all of North and South
America the products that Tecom manufactures for us. The term of the agreement
with Tecom will remain in effect until either party gives the other party at
least 120 days advance notice of termination. We make all purchases pursuant
to the agreement on a purchase order basis. We currently maintain a $5.0 million insurance policy to cover lost
revenue in the event of significant interruptions in purchases from our
overseas manufacturers. See Item 1, Business  Risk Factors  We depend on
third parties for manufacturing and Item 1, Business  Risk Factors 
We face risks associated with international manufacturing sources. Quality Control We recognize that product quality and reliability are critical factors in
distinguishing our products from those of our competitors. We design our
products to include components meeting specified quality standards in order to
assure reliable performance. We also require our third-party manufacturers to
comply with specified quality standards regarding materials and assembly
methods used in manufacturing our products. In addition, we maintain a
rigorous quality assurance program designed to assure that the manufacture of
our products conforms to specified standards and to detect substandard products
before shipment. We have an inspection program in which we examine varying
numbers of our products as they arrive at our warehouse in Arizona, depending
upon the manufacturer and the type of product. Support Services We provide limited warranties against defective materials and workmanship
on each of the products that we sell. We provide a complete support service
for all of our products by maintaining a 24-hour toll-free telephone number and
e-mail support that the dealers or interconnects service representatives can
contact for trouble shooting and diagnostic assistance. We also maintain a
technical support page on our Web site that includes frequently asked
questions, technical tips, and product-related notifications. We maintain an
operating set-up of each of our telephone systems, key telephone units, and
peripheral systems at our headquarters facility, supported by a staff of
technicians trained to handle service assistance calls. When a dealer or
interconnect calls with a question relating to performance malfunctions or an
operational system question, our personnel attempt to replicate any problem the
user is encountering, diagnose the cause, and provide a solution via telephone.
If our technicians cannot determine the cause of the malfunction over the
telephone, we dispatch a service representative to the users place of business
in order to locate the source of the problem and take corrective measures. We currently outsource the repair and refurbishment of our products. We
believe that this arrangement enables us to continue to provide fast
turn-around time and consistent quality of repairs without the overhead and
other expenses associated with operating a repair facility. 10




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Competition Markets for communications products are extremely competitive. We
currently compete principally on the basis of the technical innovation and
performance of our products, including their ease of installation and use,
reliability, cost, and the technical support both before and after sales to end
users. Our competitors for the sale of telephone systems and telephones
include Avaya, Inc., Comdial Corporation, Inter-Tel, Inc., Iwatsu, NEC
Corporation, Nortel Networks Corporation, Panasonic Technologies, Inc., and
Toshiba Information Systems. Competitors in the market for voice processing systems include Applied
Voice Technology and Key Voice as well as PBX and key system telephone
manufacturers that offer integrated voice processing systems of their own
design and under various OEM agreements. Competitors in the market for IP
telephony systems include 3Com Corporation, AltiGen Communications, Inc.,
Artisoft, Inc., and Cisco Systems, Inc., in addition to other PBX and key
system manufacturers that offer IP enabled systems. In the computer telephony market, we compete with many of the same
companies indicated above. Some of our product lines compete with products and
services provided by the regional Bell operating companies, or RBOCs, which
offer key telephone systems and commercial grade telephones produced by several
of the competitors named above as well as Centrex systems that provide
automatic call distribution facilities and features through equipment located
in the telephone companys central switching offices. Many competitors listed
above are larger than our company and therefore may have greater financial
resources at their disposal. Patents, Trademarks, and Licenses We own various U.S. patents. We intend to continue to seek patents on our
inventions used in our products. The process of seeking patent protection can
be expensive and can consume significant management resources. We believe that
our patents strengthen our negotiating position with respect to future disputes
that may arise regarding our technology. However, we believe that our
continued success depends primarily on such factors as the technological skills
and innovative abilities of our personnel rather than on our patents. We
cannot assure you that patents will issue from our pending or future
applications or that any patents that are issued will provide meaningful
protection or other commercial advantage. We own a number of registered and unregistered trademarks that we consider
to be an important factor in marketing our products. Our ability to compete
may be enhanced by our ability to protect our proprietary information,
including the issuance of patents, copyrights, and trademarks. We also have
taken steps to protect our proprietary information through a trade secrets
program that includes copy protection of our software programs and obtaining
confidentiality agreements with our employees. We cannot assure you, however,
that these efforts will be effective in preventing misappropriation, reverse
engineering or independent development of our proprietary information by our
competitors. While none of our intellectual property rights have been
invalidated or declared unenforceable, we cannot assure you that our rights
will be upheld in the future. Accordingly, we believe that, due to the rapid
pace of technological change in the telecommunications industry, the technical
and creative skills of our engineers and other personnel will be extremely
important in determining our future technological success. We license from third parties the rights to the software included in
certain of our products, including certain CTI and ACD products. These
licenses generally give us a non-exclusive right to use and sell the licensed
software included in our products during the term of the applicable agreement.
We pay the licensors fees based on the number of units that we purchase from
them. The telecommunications industry is characterized by rapid technological
development and frequent introduction of new products and features. In order
to remain competitive, we and other telecommunications manufacturers
continually find it necessary to develop products and features that provide
functions similar to those of other industry participants, often with
incomplete knowledge of whether patent or copyright protection may have been
applied for or obtained by other parties. As a result, we receive notices from
time to time alleging possible infringement of patents and other intellectual
property rights of others. To date, we have been able to successfully defend
these claims or to negotiate settlements to these claims on terms we believe to
be favorable. In the future, however, the defense of such claims, fees paid in
settlement of such claims, or costs associated with licensing rights 11




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to use the
intellectual property of others or to develop alternative technology may have a
material adverse impact on our operations. Government Regulation The U.S. government from time to time has imposed anti-dumping duties on
some telephone products manufactured in some of the countries where our
products are manufactured. Most recently, duties on certain of our products
were phased out between 1997 and 2000. We cannot assure you that similar
duties will not be imposed in the future on telephone products, including our
products, manufactured in these or other foreign countries. The imposition of
such additional duties on our products could have a material adverse effect our
operating results. Employees As of December 31, 2003, we employed a total of 106 persons, all of which
are full-time employees at our facilities in Phoenix, Arizona, and
Lawrenceville, Georgia. Our current number of full-time employees includes 30
persons in engineering and product development; 50 in sales, marketing, and
technical support; 10 in warehouse and distribution functions; and 16 in
administration, including executive personnel. We consider our relationship
with our employees to be good, and none of our employees currently are
represented by a union. Risk Factors You should carefully consider the following factors, in addition to those
discussed elsewhere in this report, in evaluating our company and our business.
Some of the statements and information contained in this report that are not
historical facts are forward-looking statements, as such term is defined in the
securities laws. These include statements concerning future, proposed, and
anticipated activities of our company; certain trends with respect to our
revenue, operating results, capital resources, and liquidity; and certain
trends with respect to the markets where we compete or the telecommunications
industry in general. Forward-looking statements, by their very nature, include
risks and uncertainties, many of which are beyond our control. Accordingly,
actual results may differ, perhaps materially, from those expressed in or
implied by such forward-looking statements. Factors that could cause actual
results to differ materially include those discussed under this Item 1,
Business  Risk Factors. Our reliance on our independent distribution network affects our inventory
levels, the timing and predictability of our revenue, and our overall operating
results. We currently market our products through a distribution network consisting
primarily of large wholesale distributors and telephone sales and installation
companies known as direct dealers. Distributors generally maintain
inventories in amounts that they consider sufficient to fill anticipated
orders. A decline in the volume of sales made by distributors could result in
their inventory levels exceeding their anticipated sales, which could delay
purchases of additional products from us until the distributors inventories
reach re-ordering levels. Direct dealers generally stock inventories only in
quantities they deem sufficient to fill anticipated short-term orders,
including orders related to support and maintenance. As a result, distributors
and direct dealers may cancel orders and delay or change volume levels on short
notice to us. Because the sale of key telephone systems, voice processing
products, and related products typically involves a long sales cycle, we may
not be able to accurately forecast our own inventory levels. Our reliance on
third-party distributors and dealers to sell our products could further
exaggerate any inventory shortages or excesses that we might experience,
particularly if our distributors or dealers are not able to give us adequate
notice of anticipated changes in demand for our products. Additionally, we offer our distributors price protection on their
inventory of our products. If we reduce the list price of our products, we
will compensate our distributors for the respective products that remain in
their inventory on the date the price adjustment becomes effective. If we do
not have sufficient cash resources to compensate distributors on terms
satisfactory to them or us, our price protection obligations may prevent us
from reacting quickly to competitive market conditions. We depend upon independent distributors and direct dealers to sell our
products to end users, to perform installation services, and to perform service
and support functions after the sale. Other telephone system manufacturers
compete intensely for the attention of the same distributors and direct
dealers, most of which carry 12




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products that compete directly with our products.
We may not be able to maintain favorable relationships with the distributors
and direct dealers that currently carry our product lines in order to encourage
them to promote and sell our products instead of those of our competitors. In
addition, we may not be able to develop such relationships with additional
distributors and dealers in the future. Graybar accounted for 27% of our sales during each of 2003, 2002 and 2001.
Accounts receivable from Graybar comprised approximately 28% of total accounts
receivable at December 31, 2003. Our second largest distributor in each of the
respective years accounted for 14% of our sales during 2003, 12% of our sales
during 2002 and 9% during 2001. Accounts receivable from our second largest
distributor comprised approximately 23% of total accounts receivable at
December 31, 2003. We face risks associated with international manufacturing sources. We currently obtain a substantial majority of our products under various
manufacturing arrangements with third-party manufacturers in South Korea,
Thailand, and Taiwan. We believe that production of our product lines overseas
enables us to obtain these items on a cost basis that enhances our ability to
market them profitably. Our reliance on third-party manufacturers to provide
personnel and facilities in these countries and the potential imposition of
quota limitations on imported goods from certain Far East countries expose us
to certain economic and political risks, including the following:  
    
    political instability in Asia, and in particular on the Korean Peninsula;
    
    the business and financial condition of our third-party manufacturers;
    
    the possibility of expropriation, supply disruption, currency
controls, and currency exchange fluctuations;
    
    changes in tax laws, tariffs, and freight rates; and
    
    strikes, work slow downs, or lockouts at any ports where our products arrive in the United States. The countries in which most of our products are manufactured also have
been subject to economic problems in the past. Although the economic situation
in Asia in recent years has not resulted in any adverse changes in our ability
to obtain products or the prices that we pay for our products, an extended
period of financial pressure on overseas markets or currency devaluations that
result in a financial setback to our overseas manufacturers could have an
adverse impact on our operations. Protectionist trade legislation in either the United States or foreign
countries, such as a change in the current tariff structures, export compliance
laws, or other trade policies, could adversely affect our ability to purchase
our products from foreign suppliers or the price at which we can obtain those
products. We depend on new products and technologies. We operate in an industry that is characterized by fast-changing
technology. As a result, we will be required to expend substantial funds for
and commit significant resources to the conduct of continuing product
development, including research and development activities and the engagement
of additional engineering and other technical personnel. Any failure on our
part to anticipate or respond adequately to technological developments,
customer requirements, or new design and production techniques, or any
significant delays in product development or introduction, could have a
material adverse effect on our operations. Our future operating results will depend to a significant extent on our
ability to identify, develop, and market enhancements or improvements to
existing product lines as well as to introduce new product lines that compare
favorably on the basis of time to market, cost, and performance with the
product lines offered by our competitors. The success of new product lines
depends on various factors, including proper market segment selection,
utilization of advances in technology, innovative development of new product
concepts, timely 13




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completion and delivery of new product lines, efficient and
cost-effective features, and market acceptance of our products. Because of the
complexity of the design and manufacturing processes required by our products,
we may experience delays from time to time in completing the design and
manufacture of improvements to existing product lines or the introduction of
new product lines. In addition, customers or markets may not accept new
product lines. Our failure to design and implement enhancements to existing
product lines or failure to introduce new products on a timely and
cost-effective basis would adversely affect our future operating results. Complex software programs, such as those we develop or those developed by
other software sources and incorporated into our products, occasionally contain
errors that are discovered only after the product has been installed and used
by many different customers in a variety of business operations. Although we
conduct extensive testing of the software programs included in our products, we
may not successfully detect and eliminate all such errors in our products prior
to shipment. Significant programming errors in product software could require
substantial design modifications that may create delays in product introduction
and shipment and that could result in an adverse impact on our reputation as
well as on our operating results. The telecommunications industry is cyclical. The telecommunications industry has experienced economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production overcapacity. We have sought to
reduce our exposure to industry downturns by targeting our product lines
towards small- and medium-sized businesses, which we believe will sustain
continued growth in the near and long-term, resulting in a steadily increasing
demand for enhanced and upgraded telephone systems and voice processing
products. However, we may experience substantial period-to-period fluctuations
in future operating results because of general industry conditions or events
occurring in the general economy. In addition, the size and timing of sales of
our new voice processing, IP systems, and
computer-telephony products may vary from quarter to quarter to a greater
extent in future periods. The expanding importance of these new products could
result in significant variations in our overall operating results on a
quarterly basis. We must finance the maintenance and expansion of our business and the
development of new products. To remain competitive, we must continue to make significant investments in
research and development, equipment, and facilities. As a result of the
increase in fixed costs and operating expenses related to these expenditures,
our failure to increase net sales sufficiently to offset the increased costs
may adversely affect our operating results. From time to time, we may seek
additional equity or debt financing to provide for the expenditures required to
maintain or expand our business. We cannot predict the timing and amount of
any such capital requirements. Such financing may not be available or, if
available, may not be available on terms satisfactory to us. If such financing
is not available on satisfactory terms, we may be unable to maintain or expand
our business or develop new products at the rate desired and our operating
results may be adversely affected. Debt financing increases expenses and must
be repaid regardless of our operating results. Equity financing could result
in additional dilution to existing stockholders. See Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Liquidity and Capital Resources. We depend on third parties for manufacturing. We depend upon third parties to manufacture our products. We do not own
most of the equipment, tools, and molds used in the manufacturing process, and
we have only limited control over the manufacturing processes. As a result,
certain difficulties could have a material adverse effect on our business,
including any difficulties encountered by the third-party manufacturers that
result in  
    
    product defects;
    
    production delays;
    
    cost overruns; or
    
    the inability to fulfill orders on a timely basis. 14




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Our operations would be adversely affected if we were to lose our relationship
with any of our suppliers, if any of our suppliers operations were interrupted
or terminated, or if overseas or air transportation services were disrupted
even for a relatively short period of time. We do not maintain an inventory of
sufficient size to provide protection for any significant period against an
interruption of supply, particularly if we were required to locate and use
alternative sources of supply. We rely on LGE as a strategic partner. We rely on LGE to supply most of our key telephone systems and voice mail
products and all of our commercial grade telephones. We also rely on LGEs
engineering, hardware and circuit development, and manufacturing capabilities.
We purchased approximately $21.1 million, $18.5 million, and $15.4 million of
product from LGE and LGST, constituting approximately 87%, 86%, and 79% of our
total purchases in 2003, 2002, and 2001, respectively. We currently obtain
products from LGE and LGST on a purchase order basis and cannot provide
assurance that we will be able to secure long-term manufacturing arrangements
for the products we currently obtain from LGE and LGST. LGE has no formal
commitments to support our business or operations. Markets for our products are intensely competitive, and we cannot assure you
that we will be able to compete successfully in the future. We engage in an intensely competitive business that has been characterized
by price erosion, rapid technological change, and foreign competition. We
compete with major domestic and international companies. Many of our
competitors have greater market recognition and substantially greater
financial, technical, marketing, distribution, and other resources than we
possess. Emerging companies also may increase their participation in the
telephone systems and peripherals markets. Our ability to compete successfully
depends on a number of factors both within and outside our control, including
the following:  
    
    the quality, performance, reliability, features, ease of use, pricing, and diversity of our product lines;
    
    the performance of our distributors and dealers;
    
    the quality of our customer services;
    
    our ability to address the needs of our customers;
    
    our success in designing and manufacturing new products,
including those implementing new technologies;
    
    the availability of adequate sources of raw materials, finished
components, and other supplies at acceptable prices;
    
    our suppliers efficiency of production;
    
    the rate at which end users upgrade or expand their existing
telephone systems, applications, and services;
    
    new product introductions by our competitors;
    
    the number, nature, and success of our competitors in a given market; and
    
    general market and economic conditions. We currently compete principally on the basis of the technical innovation and
performance of our products, including their ease of use and reliability, as
well as price, timely delivery, and after-sale service and technical support.
We may not continue to be able to compete successfully in the future. 15




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We face risks associated with patents, licenses, and intellectual property. Our success depends in part upon our ability to protect our proprietary
technology. We rely on a combination of copyright, trademark, and trade secret
laws, nondisclosure and other contractual agreements, and technical measures to
protect our proprietary technology. We have acquired certain patents and
patent licenses, and we intend to continue to seek patents on our inventions
and manufacturing processes. We face risks associated with our intellectual
property, including the following:  
    
    the steps we have taken to protect our proprietary rights may
be inadequate to protect misappropriation of such rights;
    
    third parties may independently develop equivalent or superior
technology;
    
    the process of seeking patent protection can be long and
expensive, and patents may not issue from future applications;
    
    existing patents or any new patents that are issued may not be
of sufficient scope or strength to provide us meaningful protection
or any commercial advantage;
    
    we may be subject to or may initiate interference proceedings
in the U.S. Patent and Trademark Office, which can demand significant
financial and management resources; and
    
    we may commence litigation to enforce patents or other
intellectual property rights, or to defend us against claimed
infringement of the rights of others, which could result in
substantial cost to us and diversion of our managements attention. As is typical in the telecommunications industry, we have received from
time to time, and in the future may receive, allegations of possible
infringement of patents or other intellectual property rights of others. Based
on industry practice, we believe that in most cases we could obtain any
necessary licenses or other rights on commercially reasonable terms. In the
event that a third party alleges that we are infringing its rights, we may not
be able to obtain licenses on commercially reasonable terms from the third
party, if at all, or the third party may commence litigation against us. The
failure to obtain necessary licenses or other rights or the occurrence of
litigation arising out of such claims could materially and adversely affect us,
our result of operations, or prospects. Our third-party manufacturers may experience shortages of raw materials and supplies. The principal raw materials and components used in producing our products consist of  
    
    semiconductor components;
    
    unfinished printed circuit boards;
    
    molded plastic parts; and
    
    metals. The third-party manufacturers of our products acquire these raw materials
primarily from Asian sources, which indirectly subjects us to certain risks,
including supply interruptions and currency price fluctuations. We and our
third-party manufacturers from time to time experience difficulties in
obtaining these materials. The suppliers of these materials currently are
adequately meeting our requirements and those of our third-party manufacturers.
We also believe that there are alternate suppliers for most of these
materials. We depend on management and other key personnel. Our development and operations to date have been, and our proposed
operations will be, substantially dependent upon the efforts and abilities of
our senior management and technical personnel. We have employment agreements
Gregory K. Roeper, our President and Chief Executive Officer; David A. Husband,
our Vice-President  16




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Finance and Chief Financial Officer; and Steven R.
Francis, our Vice President  Sales and Marketing. We maintain agreements with
each of our officers and employees that prohibit them from disclosing
confidential information obtained while employed with us. The loss of existing
key personnel or the failure to recruit and retain necessary additional
personnel would adversely affect our business prospects. We cannot provide
assurance that we will be able to retain our current personnel or that we will
be able to attract and retain necessary additional personnel. Our internal
growth and the expansion of our product lines will require additional
expertise in such areas as software development, operational management, and
sales and marketing. Such growth and expansion activities will increase
further the demand on our resources and require the addition of new personnel
and the development of additional expertise by existing personnel. Our failure
to attract and retain personnel with the requisite expertise or to develop
internally such expertise could adversely affect the prospects for our success. Certain conflicts of interest may arise as a result of LGEs ownership interest
in our company. LGE currently owns approximately 24% of our outstanding common stock. We
obtain most of our digital telephone systems, IP-based products, and voice mail
products from LGE and obtain all of our commercial grade telephones and
replacement parts for such telephones from LGST, an affiliate of LGE. See Item
1, Business  Manufacturing and Risk Factors  We rely on LGE as a
strategic partner. As a result of LGEs direct ownership interest in us, an
inherent conflict of interest exists in establishing the volume and terms and
conditions of our purchases from LGE and LGST. In order to mitigate such
conflicts, all decisions with respect to such purchases are made by our
officers and reviewed by directors who have no relationship with LGE. Our relationship with LGE may have the effect of making more difficult or
delaying attempts by others to obtain control of us, even when these attempts
may be in the best interests of stockholders. Through LGEs stockholder
interest and business interests in our company, LGE may have significant
influence over our business. Our stock price may be volatile. The trading price of our common stock in the public securities market
could be subject to a variety of factors, including the following:  
    
    wide fluctuations in response to quarterly variations in our
operating results or the operating results of our competitors;
    
    actual or anticipated announcements of technological
innovations or new product developments by us or our competitors;
    
    significant actual or anticipated expenditures for property or
equipment, research and development, sales and marketing activities,
or other planned or unanticipated events;
    
    changes in analysts estimates of our financial performance;
    
    developments or disputes concerning proprietary rights;
    
    regulatory developments;
    
    general industry conditions; and
    
    worldwide economic and financial conditions. The trading volume of our common stock in the past has been limited, which may
increase the volatility of the market price for our stock and reduce the
liquidity of an investment in shares of our common stock. During certain
periods, the stock markets have experienced extreme price and volume
fluctuations. In particular, prices for many technology stocks often fluctuate
widely, frequently for reasons unrelated to the operating performance of such
companies. These broad market fluctuations and other factors may adversely
affect the market price of our common stock. 17




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##### Table of Contents



The absence of an active trading market, which may occur if we are required to
delist our shares from NASDAQ SmallCap Market, would likely make our common
stock an illiquid investment. The NASDAQ Stock Market has certain rules that must be met in order for a
listed company to maintain its listing on NASDAQ. During fiscal 2001, we moved
the listing of our common stock from the NASDAQ National Market to the NASDAQ
SmallCap Market. We may be required to delist from the NASDAQ SmallCap Market
if we fail to comply with those rules. Should that occur, market makers may
choose to create a market for our common stock on the over-the-counter bulletin
board. If that does not occur, our stock could be traded in the pink sheets
maintained by the National Quotation Bureau. As a result, investors would
likely find it significantly more difficult to dispose of, or to obtain
accurate quotations as to the value of, our shares. Rights to acquire our common stock could result in dilution to other holders of
our common stock. As of March 5, 2004, we had outstanding options to acquire 894,375 shares
of our common stock at a weighted average exercise price of $2.65 per share.
An additional 494,500 shares remain available for grant under our 1994 Stock
Option Plan, and 561,250 shares remain available for grant under our 2003
Incentive Compensation Plan. During the terms of these options, the holders
thereof will have the opportunity to profit from an increase in the market
price of the common stock. Additionally, all outstanding options become fully
vested and exercisable upon a change of control of our company. The existence
of these options may adversely affect the terms on which we can obtain
additional financing, and the holders of these options can be expected to
exercise such options at a time when we, in all likelihood, would be able to
obtain additional capital by offering shares of our common stock on terms more
favorable to us than those provided by the exercise of these options. Sales of additional shares of our common stock could have a negative effect on
the market price of our common stock. Sales of substantial amounts of our common stock in the public market
could adversely affect prevailing market prices and could impair our ability to
raise capital through the sale of our equity securities. Most shares of common
stock currently outstanding are eligible for sale in the public market, subject
in certain cases to compliance with the requirements of Rule 144 under the
securities laws. Shares issued upon the exercise of stock options granted
under our stock option plan generally will be eligible for sale in the public
market. We also have the authority to issue additional shares of common stock
and shares of one or more series of preferred stock. The issuance of such
shares could dilute the voting power of the currently outstanding shares of our
common stock and could dilute earnings per share. It may be difficult for a third party to acquire us, even if the acquisition
would be in the best interest of stockholders. We are subject to provisions under Delaware corporate law that would
require us to obtain certain approvals from our board of directors or
stockholders in order to engage in a business combination with an interested
stockholder under certain circumstances. Our Amended Certificate of
Incorporation and Bylaws also contain a number of other provisions relating to
corporate governance and to the rights of stockholders. These provisions  
    
    authorize our board of directors to fill vacancies on our board
of directors;
    
    authorize our board of directors to issue preferred stock in
series with such voting rights and other powers as our board of
directors may determine; and
    
    require the affirmative vote of two-thirds of the directors then in office to approve:  
    
     a public offering of our capital stock;
    
     the merger with or the acquisition of another business or
the acquisition of a significant amount of the assets of another
business;
    
     the sale of a significant amount of our assets;
    
     our entering into contracts with our stockholders or directors; 18




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##### Table of Contents




    
    our assumption or acquisition of debt in excess of $1.0 million; and
    
    any amendment of our Amended Certificate of Incorporation
and Bylaws of our wholly owned subsidiary Vodavi Communications
Systems, Inc. These provisions in our Amended Certificate of Incorporation and Bylaws and
Delaware corporate law may have the effect of making more difficult or delaying
attempts by others to obtain control of us, even when these attempts may be in
the best interests of stockholders. We do not pay cash dividends. We have never paid any cash dividends on our common stock. Instead, we
have retained our earnings to provide funds for use in our business. Our board
of directors reviews our dividend policy from time to time and may elect to pay
dividends on our common stock in the future. However, the terms of the
revolving line of credit facility between our wholly owned subsidiary Vodavi
Communications Systems, Inc. and Comerica Bank-California prohibit our
subsidiary from paying dividends to us without the consent of Comerica. This
restriction could limit our ability to pay dividends in the future. 
 ITEM 2. PROPERTIES We sublease, for a ten year term expiring in December 2011, approximately
55,000 square feet of space in Phoenix, Arizona, where we maintain engineering
and design laboratories, a sound engineering laboratory, software development
facilities, testing laboratories, product development facilities, customer
service support facilities, an employee training facility, warehouse and
distribution areas, sales and marketing offices, and administrative and
executive offices. We also lease approximately 3,000 square feet of space in Norcross,
Georgia, for a term expiring in August 2006. We maintain software development
facilities, engineering and design laboratories, product development
facilities, product assembly and testing facilities. We lease, for a term ending in December 2004, approximately 19,500 square
feet of space in Scottsdale, Arizona. This space is sub-leased to a third
party. We also lease, for a term ending in May 2005, approximately 5,000
square feet of office and warehouse space in Tempe, Arizona. This space is
subleased to a third party. We believe our facilities are adequate for our reasonably anticipated needs. 
 ITEM 3. LEGAL PROCEEDINGS 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. We cannot provide assurance, however, that
damages that result in a material adverse effect on our financial position or
results of operations will not be imposed in these matters. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our 2003 Annual Meeting of Stockholders on October 29, 2003. The
following nominees were elected to our Board of Directors to serve until the
next annual meeting of stockholders, until their successors are elected or have
been qualified, or until their earlier resignation or removal: 19




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##### Table of Contents



Nominee
    
    Votes in Favor
    
    WithheldWilliam J. Hinz
    
    
    1,849,315
    
    
    
    613,306Gregory K. Roeper
    
    
    2,383,371
    
    
    
    79,250Jong Hwa Choi
    
    
    2,386,091
    
    
    
    76,530Jack A. Henry
    
    
    2,379,071
    
    
    
    83,550Stephen A McConnell
    
    
    1,849,015
    
    
    
    613,606Emmett E. Mitchell
    
    
    1,849,015
    
    
    
    613,606Frederick M. Pakis
    
    
    1,854,315
    
    
    
    608,306
 Additionally, our stockholders approved and ratified the Vodavi 2003
Incentive Compensation Plan. Votes in Favor
    
    Opposed
    
    Abstained
    
    Broker Non-Vote871,777
    
    
    171,601
    
    
    
    14,130
    
    
    
    1,405,113
 20




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##### Table of Contents



PART II 
 ITEM 5.
    
    MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES  Our common stock is listed on the NASDAQ SmallCap Market under the symbol
VTEK. The following table sets forth the high and low sales prices of our
common stock on the NASDAQ SmallCap Market for the periods indicated. High
    
    Low2002:First quarter
    
    $
    1.65
    
    
    $
    1.24Second quarter
    
    
    2.85
    
    
    
    1.43Third quarter
    
    
    3.33
    
    
    
    1.71Fourth quarter
    
    
    2.15
    
    
    
    1.312003:First quarter
    
    $
    1.95
    
    
    $
    1.36Second quarter
    
    
    2.60
    
    
    
    1.71Third quarter
    
    
    3.66
    
    
    
    2.20Fourth quarter
    
    
    9.46
    
    
    
    2.792004:First quarter (through March 5, 2004)
    
    $
    8.27
    
    
    $
    5.68
 On March 5, 2004, the closing sales price of our common stock was $6.82
per share. As of March 5, 2004, there were approximately 40 holders of record
of our common stock. Dividend Policy We have never paid any cash dividends on our common stock. Instead, we
have retained our earnings to provide funds for use in our business. Our board
of directors reviews our dividend policy from time to time and may elect to pay
dividends on our common stock in the future. However, the terms of the
revolving line of credit facility between our wholly owned subsidiary Vodavi
Communications Systems, Inc. and Comerica Bank-California prohibit our
subsidiary from paying dividends to us without the consent of Comerica. This
restriction could limit our ability to pay dividends in the future. 21




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##### Table of Contents



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below as of and for the
year ended December 31, 2003, are derived from our consolidated financial
statements (included herein), which have been audited by Mayer Hoffman McCann
P.C., independent auditors. The selected consolidated financial data presented
below as of and for each of the years in the two-year period ended December 31,
2002 are derived from our consolidated financial statements (included herein),
which have been audited by Deloitte & Touche LLP, independent auditors. The
selected consolidated financial data presented below as of and for each of the
years in the two-year period ended December 31, 2000 are derived from our
consolidated financial statements (not included herein), which have been
audited by Arthur Andersen LLP, independent public accountants. The selected
consolidated financial information provided below should be read in conjunction
with Item 7, Managements Discussion and Analysis of Financial Condition and
Results of Operations and the Consolidated Financial Statements of our company
and related notes thereto. No dividends were paid during the periods
presented. Years Ended December 31,(in thousands, except per share amounts)Statement of Operations Data:
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Revenue
    
    $
    41,270
    
    
    $
    37,328
    
    
    $
    34,153
    (1)
    
    $
    47,705
    
    
    $
    49,811Gross margin
    
    
    14,285
    
    
    
    13,449
    
    
    
    11,170
    (2)
    
    
    17,503
    
    
    
    17,886Operating expenses
    
    
    12,082
    
    
    
    12,164
    
    
    
    13,183
    (3)
    
    
    16,041
    
    
    
    15,252Operating income (loss)
    
    
    2,203
    
    
    
    1,285
    
    
    
    (2,013
    )
    
    
    1,462
    
    
    
    2,634Interest expense
    
    
    128
    
    
    
    97
    
    
    
    406
    
    
    
    705
    
    
    
    676Income
(loss) before income taxes and change in
accounting principle
    
    
    2,075
    
    
    
    1,188
    
    
    
    (2,419
    )
    
    
    757
    
    
    
    1,958Provision for (benefit from)income taxes
    
    
    804
    
    
    
    471
    
    
    
    (863
    )
    
    
    309
    
    
    
    718Income
(loss) before change in accounting principle
    
    
    1,271
    
    
    
    717
    
    
    
    (1,556
    )
    
    
    448
    
    
    
    1,240Change in accounting principle
    
    
    
    
    
    
    (1,263
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    1,271
    
    
    $
    (546
    )
    
    $
    (1,556
    )
    
    $
    448
    
    
    $
    1,240Net income
(loss) per share, diluted
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )
    
    $
    0.10
    
    
    $
    0.29Weighted
average shares outstanding, diluted
    
    
    4,170
    
    
    
    4,428
    
    
    
    4,235
    
    
    
    4,305
    
    
    
    4,344
 As of December 31,(in thousands)Balance Sheet Data:
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Assets:Current assets
    
    $
    16,240
    
    
    $
    14,829
    
    
    $
    14,861
    
    
    $
    20,959
    
    
    $
    20,570Property and equipment, net
    
    
    1,453
    
    
    
    1,631
    
    
    
    1,581
    
    
    
    2,033
    
    
    
    2,356Goodwill, net
    
    
    725
    
    
    
    725
    
    
    
    1,638
    
    
    
    1,772
    
    
    
    1,906Other
    
    
    105
    
    
    
    203
    
    
    
    193
    
    
    
    417
    
    
    
    726$
    18,523
    
    
    $
    17,388
    
    
    $
    18,273
    
    
    $
    25,181
    
    
    $
    25,558Liabilities:Current liabilities
    
    $
    7,634
    
    
    $
    6,748
    
    
    $
    7,045
    
    
    $
    12,176
    
    
    $
    13,208Other long-term obligations
    
    
    700
    
    
    
    18
    
    
    
    200
    
    
    
    421
    
    
    
    530Total liabilities
    
    
    8,334
    
    
    
    6,766
    
    
    
    7,245
    
    
    
    12,597
    
    
    
    13,738Stockholders equity
    
    
    10,189
    
    
    
    10,622
    
    
    
    11,028
    
    
    
    12,584
    
    
    
    11,820$
    18,523
    
    
    $
    17,388
    
    
    $
    18,273
    
    
    $
    25,181
    
    
    $
    25,558
   (1)
    
    Includes special charges of $432 related to price protection obligations.(2)
    
    Cost of goods sold includes special charges of $568 related to inventory
impairments.(3)
    
    Includes special charges of $761 related to severance, receivable reserves,
and exit costs. 22




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##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 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 revenues 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 historical and projected 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. As of December 31, 2003, Graybar accounted for 28% and Target
accounted for 23% 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. 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 unlimited 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, 23




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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, which begin on page F-1 of this Annual Report on Form 10-K,
which contain accounting policies and other disclosures required by generally
accepted accounting principles in the United States. 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. 2003
    
    2002
    
    2001Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    65.4
    
    
    
    64.0
    
    
    
    67.3Gross margin
    
    
    34.6
    
    
    
    36.0
    
    
    
    32.7Operating expenses:Engineering and product development
    
    
    5.0
    
    
    
    6.3
    
    
    
    5.9Selling, general, and administrative
    
    
    24.3
    
    
    
    26.3
    
    
    
    32.729.3
    
    
    
    32.6
    
    
    
    38.6Operating income (loss)
    
    
    5.3
    
    
    
    3.4
    
    
    
    (5.9
    )Interest expense, net
    
    
    .3
    
    
    
    .2
    
    
    
    1.2Income
(loss) before taxes and accounting change
    
    
    5.0
    
    
    
    3.2
    
    
    
    (7.1
    )Income tax expense (benefit)
    
    
    1.9
    
    
    
    1.3
    
    
    
    (2.5
    )Income (loss) before accounting change
    
    
    3.1
    
    
    
    1.9
    
    
    
    (4.6
    )Change in accounting principle
    
    
    
    
    
    
    (3.4
    )
    
    
    Net income (loss)
    
    
    3.1
    %
    
    
    (1.5
    )%
    
    
    (4.6
    )%
 2001 Special Charges During the first quarter of 2001, we implemented a restructuring plan
aimed at reducing our operating expenses to coincide with our revised sales
outlook. Pursuant to the restructuring plan, we reduced our workforce,
discontinued our Interactive Voice Response product group, and implemented
broad-based price reductions on certain product lines. These actions created
severance-related obligations of $168,000, estimated shut-down costs of
$265,000, and estimated distributor price protection obligations of $432,000. Additionally, in light of deteriorating economic and industry conditions
and planned introductions of new products in the first quarter of 2001, we
re-evaluated the carrying amount of certain receivables and inventory items
resulting in additional accounts receivable reserve requirements of $328,000
and inventory impairments of $568,000. The pre-tax financial impact of these initiatives during 2001 totaled
approximately $1.8 million consisting of both cash and non-cash charges. All
accrued cash charges were paid by December 31, 2002. The following table sets
forth the components of these special charges included in the accompanying
consolidated statement of operations for the year ended December 31, 2001: 24




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Inclusion inAmount($000)
    
    Statement of OperationsNon-cash Charges:Inventory impairments
    
    $
    568
    
    
    Cost of goods soldAllowance for bad debts
    
    
    328
    
    
    Selling, general & administrative expensesDistributor price protection
    
    
    151
    
    
    Revenue reductionProperty and equipment
    
    
    15
    
    
    Selling, general & administrative expenses1,062Cash Charges:Distributor price protection
    
    
    281
    
    
    Revenue reductionSeverance-related costs
    
    
    168
    
    
    Selling, general & administrative expensesOther shut-down costs
    
    
    250
    
    
    Selling, general & administrative expenses699$
    1,761
 Year Ended December 31, 2003 Compared With Year Ended December 31, 2002 Revenue Revenue for the year ended December 31, 2003 totaled $41.3 million, an
increase of $3.9 million, or 10.6%, from revenue of $37.3 million in 2002.
Sales to our supply house customers accounted for approximately $24.9 million
of our total revenue during 2003 compared with $20.8 million in 2002. The
increase in sales to our supply house customers in 2003 is related principally
to sales of our new STS telephone system that we introduced in January 2003.
The STS product line is a full-featured telephone system designed and priced to
capture a larger portion of the small business telephone system market. While
the STS telephone system has been accepted well into the marketplace, sales of
this product have had the effect of reducing the level of sales of similar
products that we sell through supply houses. Sales through our direct dealer program totaled $16.0 million in 2003
compared with $15.4 million in 2002. The increase in sales to our direct
dealers is reflective of our program to focus on selling to fewer, but larger
and better-established, dealers that are more effective at selling our larger
systems. During 2003, our direct dealers also purchased our new STS product
line directly from our supply house customers. Sales through our direct sales office in the Phoenix Metropolitan area
totaled $1.3 million during 2003 compared with $1.6 million in 2002. The
reduction in sales through our direct sales office from 2002 was directly
attributable to a large school system sale in 2002 that did not recur in 2003. Our revenue is reported net of reserves for sales returns, discounts,
customer incentive programs, inter-company eliminations, and shipping and
handling charges. These items resulted in a reduction to revenue of $905,000
in 2003 compared with a reduction of $400,000 in 2002. Gross Margin Our gross margin was approximately $14.3 million in 2003 compared with
$13.5 million in 2002. Our gross margin as a percentage of total revenue
decreased to 34.6% during 2003 from 36.0% during 2002. The decrease in our
gross margin percentage during 2003 was a direct result of the product mix of
sales to our supply house customers with a heavier emphasis of sales of our new
STS telephone system, which generates a lower overall gross margin percentage
than most of our other products. Engineering and Product Development Engineering and product development expenditures decreased to $2.1 million
during 2003 from $2.3 million in 2002. The expenditures in 2002 reflected
additional headcount and outsourced development costs associated with a
development project that we completed in 2002 pursuant to a development
agreement with LG
Electronics. While engineering and product development expenditures
decreased from a year ago, we continue to 25




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##### Table of Contents



invest in the development of our next
generation IP telephone system, the convergence of and enhancements to our
existing telephone systems, and enhancements to our voice processing products. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased to $10.0 million
in 2003 from $9.8 million in 2002. As percentage of revenue, such expenses
declined to 24.3% in 2003 compared with 26.3 % in 2002. The reduction in
selling, general and administrative expenses as a percentage of revenue
reflects improved operating leverage in 2003 and the impact of a $300,000
charge for the settlement of litigation in 2002 that did not recur in 2003. Interest Expense Interest expense increased to $128,000 during 2003 compared with $97,000
during 2002. Our interest expense increased in 2003 as a result of additional
borrowings on our revolving credit facility to repurchase our common stock in
June 2003 and the amortization of bank commitment fees and other costs
associated with the credit facility that we entered into with Comerica
Bank-California in April 2003. Income Taxes We provided for federal and state income taxes using an effective rate of
38.7% in 2003 compared with an effective rate of 39.6% in 2002. Our effective
tax rate was lower in 2003 as we incurred less non-deductible expenses as a
percentage of our taxable income in 2003 than we did in 2002. Year Ended December 31, 2002 Compared With Year Ended December 31, 2001 Revenue Revenue during 2002 increased $3.2 million, or 9.3%, to $37.3 million from
revenue of $34.2 million in 2001. Sales to our supply house customers
increased $1.9 million, or 10.0 %, to $20.8 million, or 56% of our total
revenue during 2002 compared with $18.9 million, or 55% of our total revenue in
2001. Our sales in this channel of distribution can fluctuate significantly
between periods as a result of fluctuations in the amount of inventory supply
houses carry of our product. We estimated that our supply house customers
reduced their inventory of our products by approximately $1.5 million during
2002 compared with a reduction of $5.8 million during 2001. Sales through our infinitedirect dealer program increased approximately
$700,000, or 5.0%, to $15.4 million, or 41% of our total revenue during 2002,
compared with $14.7 million, or 43% of our total revenue during 2001. The
increase in infiniteproduct sales can be attributed to selling to fewer, but
larger and better established dealers that are more effective at selling our
larger systems. Sales through our direct sales office, which we acquired in March 2002,
totaled approximately $1.0 million, after intercompany eliminations of
approximately $600,000, during 2002. Our revenue during 2002 was negatively impacted by our decision to exit
our Interactive Voice Response business in 2001. Revenue attributable to this
business totaled $135,000 during 2002 compared with revenue of $1.3 million in
2001. Gross Margin Our gross margin was $13.5 million in 2002 compared with $11.2 million in
2001. Our gross margin as a percentage of total revenue increased to 36.0%
during 2002 compared with 32.7% in 2001. The increase in gross margin
percentage during 2002 was a direct result of (a) inventory impairments and
price protection obligations of $1.0 million in 2001; (b) better leverage over
the fixed component of cost of goods sold, which includes labor and other
warehouse and distribution costs; and (c) higher margins associated with
our direct sales office. The increase in gross margin percentage between the
periods was slightly offset by our decision to sell certain discontinued
product lines in 2002 in a bulk sale transaction for $300,000 at no margin. 26




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Engineering and Product Development Engineering and product development expenditures increased 16.8% to $2.3
million in 2002 compared with $2.0 million in 2001. During 2002, we incurred
additional salaries and personnel costs associated with an increase in
headcount and field trial activities. During 2002 we also engaged third-party
consultants to a greater extent than 2001 to assist in the development of some
of our products. Selling, General, and Administrative Expenses Selling, general, and administrative expenses declined approximately $1.4
million, or 12.1%, to $9.8 million in 2002 compared with $11.2 million in 2001.
Excluding special charges of approximately $760,000 recorded in 2001, selling,
general, and administrative expense declined by approximately $594,000, or
5.7%, in 2002. The reduction was the net effect of a number of factors
including (a) the discontinuance of our Interactive Voice Response Business,
(b) decreased sales, marketing and promotional expenses, (c) a reduction in bad
debt expenses, and (d) a reduction in depreciation and amortization, including
the elimination of goodwill amortization of $134,000 associated with our
adoption of SFAS No. 142. These reductions were partially offset by additional
operating expenses of our direct sales office of approximately $632,000 during
2002 compared to zero in 2001 and the cost associated with the settlement of
litigation in 2002 of $300,000. Interest Expense Interest expense decreased to approximately $97,000 in 2002 compared with
$406,000 in 2001. The decrease in interest expense is a direct result of our
debt reduction efforts during 2002 and lower borrowing costs. Income Taxes We provided for federal and state income taxes using an effective rate of
39.6% during 2002 compared with and effective rate of 35.7% in 2001. The
change in effective rates between periods reflected the impact of permanent
book/tax differences in loss years versus years with positive pre-tax earnings. Liquidity and Capital Resources Our net working capital position was approximately $8.6 million at
December 31, 2003 compared with $8.1 million at December 31, 2002. We had a
cash balance of $2.9 million at December 31, 2003 compared with a cash balance
of $1.1 million at December 31, 2002. Factors that increased our cash position
during 2003 included positive income from operations, a reduction in inventory
of $435,000, an increase in accounts payable and accrued liabilities of
$668,000, the receipt of a $300,000 income tax refund, borrowings on our term
loan of $1.0 million, and $218,000 in proceeds from stock option exercises.
Factors that decreased our cash position in 2003 included an increase in
accounts receivable of $463,000 and repayments on our term loan of $100,000.
We also used approximately $270,000 in 2003 for the purchase of property and
equipment and $2.1 million for the repurchase of our common stock. Our accounts receivable days sales outstanding, calculated on a quarterly
basis, were approximately 59 days as of December 31, 2003 compared to 70 days
as of December 31, 2002. The timing of payments received from our largest
distributors and the linearity of our revenue streams during the quarter
significantly influenced our days sales outstanding and our liquidity. Our two
largest distributors accounted for 51% of our total accounts receivable as of
December 31, 2003 and 43% as of December 31, 2002. An increase in
concentration from our two largest distributors generally had the effect of
increasing our days sales outstanding while a more linear revenue stream during
the quarter had the effect of reducing our receivable days sales outstanding. Our inventory turnover, measured in terms of days sales outstanding on a
quarterly basis, was 67 days as of December 31, 2003 compared to 87 days as of
December 31, 2002. The decrease in inventory days outstanding was a direct
result of a higher volume of sales in the fourth quarter 2003 compared with the
fourth quarter of 2002 and our efforts to rationalize our product lines. 27




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Trade payables and accrued liabilities, including payables to third-party
and related-party manufacturers, were approximately $7.4 million as of December
31, 2003 compared with $6.8 million as of December 31, 2002. The level of our
trade payables and accrued liabilities between periods was largely influenced
by the timing of payments we make to our largest suppliers for inventory items
and payments to cover payroll 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 our Company 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 our Company without the
consent of Comerica. As of December 31, 2003, we had no outstanding borrowings
on our line of credit and $4.1 million available for future advances. The $5.0 million revolving line of credit bears interest at Comericas
prime rate, or 4.0% at December 31, 2003, 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 bear interest at
Comericas prime rate plus 0.5%, or 4.5% at December 31, 2003. In addition to
interest on the term loan, we are required to make monthly payments of
principal in an amount sufficient to fully amortize the term loan over a
60-month period with all unpaid principal and accrued interest due in 36
months, or by June 2006. In May 2003, we commenced a self-tender offer to purchase up to 1,000,000
shares of our common stock 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 purchase price of approximately $2.1 million, which
includes offering costs of approximately $73,000, is recorded as a reduction to
common stock and additional paid in capital in the accompanying consolidated
balance sheet as of December 31, 2003. The repurchase was funded through
advances on our revolving line of credit and term loan. We have no special purpose entities or off balance sheet financing
arrangements, commitments, or guarantees other than certain long-term operating
lease agreements for our office and warehouse facilities and short-term
purchase commitments to our third-party suppliers. The following table sets
forth all known commitments as of December 31, 2003 and the year in which those
commitments become due or are expected to be settled (in thousands): 28




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Payment due by periodContractual
    
    
    
    
    
    Less than
    
    
    
    
    
    
    
    
    
    More thanObligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 yearsLong-Term Debt
Obligations
    
    $
    900
    
    
    $
    200
    
    
    $
    700
    
    
    $
    
    
    
    $
    Operating Lease
Obligations
    
    
    6,720
    
    
    
    1,095
    
    
    
    1,699
    
    
    
    1,570
    
    
    
    2,356Purchase Obligations
    
    
    4,972
    
    
    
    4,972
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    12,592
    
    
    $
    6,267
    
    
    $
    2,399
    
    
    $
    1,570
    
    
    $
    2,356
 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. We cannot provide assurance, however, that
damages that result in a material adverse effect on our financial position or
results of operations will not be imposed in these matters. We believe that our working capital and credit facilities are sufficient
to fund our capital needs during the next 12 months. Although we currently
have no acquisition targets, we intend to continue to explore 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. Impact of Recently Issued Accounting Standards In 2001, the FASB issued SFAS No. 141, Accounting For Business
Combinations, and SFAS No. 142, Goodwill And Other Intangible Assets. These
statements modified accounting for business combinations after June 30, 2001
and affected the Companys treatment of goodwill and other intangible assets
effective January 1, 2002. The statements require that goodwill existing at
the date of adoption be reviewed for possible impairment and that impairment
tests be performed at least annually, with impaired assets written-down to fair
value. Additionally, existing goodwill and intangible assets must be assessed
and classified consistent with the statements criteria. Intangible assets
with estimated useful lives will continue to be amortized over those
periods. Amortization of goodwill and intangible assets with indefinite lives
will cease. We determined that upon adoption of these statements on January 1, 2002,
the $1.6 million carrying amount of the goodwill as of that date was impaired.
The goodwill impairment was recognized in 2002 as a change in accounting
principle, net of $375,000 of income taxes. In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements,
relating to consolidation of certain entities. This Interpretation was
subsequently revised by FIN 46 (revised 2003) (FIN 46®) issued in December
2003. This Interpretation states that consolidation of variable interest
entities will be required by the primary beneficiary if the entities do not
effectively disperse risks among the parties involved. The requirements are
effective for fiscal years beginning after December 15, 2003 for newly created
variable interest entities and for all variable interest entities for periods
ending after December 31, 2004. We do not believe that adoption of FIN 46®
will have any effect on our financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity.
This Statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer 29




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classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). This Statement is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of this Statement did not have a material impact on our financial
condition or results from operations. 
 ITEM 7A. 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 December
31, 2003 we had a term loan balance of $900,000 and had no outstanding
borrowings on the line of credit. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA Reference is made to the financial statements, the report thereon, and the
notes thereto commencing at page F-1 of this Report, which financial
statements, report, and notes are incorporated herein by reference. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE Not applicable. 
 ITEM 9A. 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 December 31, 2003. 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. 30




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PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information regarding our directors
and executive officers: Name
    
    Age
    
    PositionWilliam J. Hinz
    
    58
    
    Chairman of the BoardGregory K. Roeper
    
    43
    
    President, Chief Executive Officer, and DirectorDavid A. Husband
    
    34
    
    Vice President-Finance, Chief Financial Officer,Secretary, and TreasurerStephen L. Borcich
    
    57
    
    Vice President  Distribution SalesSteven R. Francis
    
    52
    
    Vice President  Dealer SalesJack A. Henry (2)(3)
    
    60
    
    DirectorJong Hwa Choi
    
    43
    
    DirectorStephen A McConnell (2)(1)
    
    51
    
    DirectorEmmett E. Mitchell (1)(2).
    
    48
    
    DirectorFrederick M. Pakis (1)(3).
    
    50
    
    DirectorPaul D. Sonkin
(3)
    
    35
    
    Director
   (1)
    
    Member of the Compensation Committee(2)
    
    Member of the Audit Committee(3)
    
    Member of the Nominating and Corporate Governance Committee William J. Hinzhas served as Chairman of the Board of our company since
October 1997 and as a director of our company since April 1997. From October
1999 until March 2004, Mr. Hinz served as Group President for the Triumph
Components Group, which is a group of seven divisional companies within Triumph
Group, Inc., a publicly held company. Mr. Hinz served as President of
Stolper-Fabralloy Company, a precision aerospace engine component manufacturer
that is a subsidiary of Triumph Group, Inc., from September 1997 until October
1999 and as Executive Vice President of Operations of Stolper-Fabralloy from
March 1996 until September 1997. Mr. Hinz served as Vice President of Global
Repair and Overhaul Operations for AlliedSignal Aerospace Company from June
1994 until March 1996. During this period, Mr. Hinz also was responsible for
aerospace aftermarket merger and acquisition activity. Gregory K. Roeperhas served as President of our company since December
1998 and as Chief Executive Officer and a director of our company since
December 1999. Mr. Roeper served as our Chief Operating Officer from June 1998
until December 1999. Between November 1994 and June 1998, Mr. Roeper held a
variety of other executive positions with our company, including Chief
Financial Officer; Executive Vice President - Finance, Administration, and
Operations; Secretary; and Treasurer. From 1982 until 1994, Mr. Roeper was
employed with Arthur Andersen LLP. David
A. Husbandhas served as our Vice President  Finance, Chief
Financial Officer, Secretary, and Treasurer since March 2001. Prior to joining
our company, Mr. Husband served in various capacities with Action Performance
Companies, Inc., a publicly held company engaged in the motorsports
merchandising business, from May 1998 until December 2000, most recently as
Executive Vice President and Chief Operating Officer. Mr. Husband was employed
as an accountant with Arthur Andersen LLP from July 1992 to May 1998, where he
was primarily engaged in auditing publicly held companies. Mr. Husband is a
Certified Public Accountant in the state of Arizona. Stephen
L. Borcichhas served as our Vice President  Distribution Sales
since June 2002. Prior to that, Mr. Borcich served as our Vice President -
Sales and Marketing since April 1999. Mr. Borcich served as Vice President -
Sales for Voice Technologies Group, a manufacturer and distributor of digital
integration technology from August 1998 until March 1999. From February 1997
until July 1998, Mr. Borcich served as Vice President  Sales and Marketing of
Q.SyS, Inc., a manufacturer of computer telephony applications. Mr. Borcich
also served as Vice President  Sales of Microlog Corporation from December
1990 until September 1995. 31




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Steven
R. Francishas served as our Vice President  Dealer Sales since
June 2002. From March 2002, when we acquired DataSpeak Systems, Inc. to June
2002, Mr. Francis served as our Vice President  Direct Sales. Mr. Francis
served as co-founder and president of DataSpeak Systems, Inc., an Arizona-based
interconnect company from January 1998 until March 2002. Prior to that time,
Mr. Francis served as the Vice President of Sales and Marketing of Enhanced
Systems, Inc. from October 1996 until December 1997. Mr. Francis previously
has served in the communications industry in various positions including
various sales and management positions at GTE, Stromberg-Carlson, and
Executone. Jack A. Henryhas served as a director of our company since November 2001.
Mr. Henry began his career in 1966 with Arthur Andersen LLP and held positions
in Detroit, Michigan, San Jose, California, Seattle, Washington and Phoenix,
Arizona. In 2000, Mr. Henry retired as Managing Partner of the Phoenix office
and formed Sierra Blanca Ventures LLC, a private advisory and investment firm.
Mr. Henry currently serves on the board of directors of Harris Bank Arizona and
American AgCredit, a member of the U.S. farm credit system. Mr. Henry
previously served on the boards of directors of Simula, Inc., and SOS Staffing
Services, Inc., both public companies. Mr. Henry has served in a variety of
community positions including chairman of the Arizona Chamber of Commerce and
Greater Phoenix Leadership. Mr. Henry attended the U.S. Naval Academy and
holds both a Bachelors and Masters of Business Administration from the
University of Michigan. Jong Hwa Choihas served as a director of our company since February 2003.
Mr. Choi has served in various capacities for LG InfoComm U.S.A., a major U.S.
mobile handset vendor and affiliate of LG Electronics, Inc. since 1987, and
since March 2000 has served as Vice President of Administration. During his
16-year tenure, Mr. Choi has managed international business planning and set up
overseas subsidiaries for various divisions of LGE. Mr. Chois global
assignments include Italy, Russia, and the United States. Mr. Chois
experiences in various industries include consumer electronics, semiconductors,
and mobile handsets. Stephen A McConnellhas served as a director of our company since January
1996. Mr. McConnell currently serves as the President of Solano Ventures, an
investment fund devoted to small- to mid-sized companies. Mr. McConnell also
currently serves as Chairman of G-L Industries, LLC, a manufacturer of wood
glue-lam beams used in the construction industry. Mr. McConnell served as
Chairman of the Board of Mallco Lumber & Building Materials from September 1991
to June 1997. Mr. McConnell currently serves as a director of Capital Title
Group, Inc., Mobile Mini, Inc., InnSuites Hospitality Trust, and Miracor
Diagnostics, Inc., all of which are publicly held companies. Emmett E. Mitchellhas served as a director of our company since February
1999. Mr. Mitchell has been employed with MS Howell & Co., a NASD broker
dealer and investment banking firm, as the Executive Vice President since
December 2000. Mr. Mitchell has also served as the Chief Financial Officer of
ICESoft Technologies, Inc., a privately held software company since December
2001. Prior to this, Mr. Mitchell was employed with Paradise Valley
Securities, Inc., since October 1991, most recently as the Chairman and Chief
Executive Officer. Frederick M. Pakishas served as a director of our company since November
2001. Mr. Pakis was a co-founder of JDA Software, Inc. in 1985 where he served
as Co-Chairman of the Board, President, and Co-Chief Executive Officer for
various periods of time through 1999. Since that time, Mr. Pakis formed and
serves as Managing Director of Clarendon Capital Management, LLC, a private
advisory and investment firm. Mr. Pakis previously served as a Retail
Consulting Manager with Touche Ross & Co. from 1981 to 1985, and as Director of
Corporate Planning for the Sherwin Williams Company, a home improvement
specialty store company from 1976 to 1981. Mr. Pakis also serves on the boards
of several not-for-profit entities, including Phoenix Childrens Hospital and
Phoenix Country Day School. Mr. Pakis attended the U.S. Military Academy at
West Point, received a Bachelor of Science degree in Operations Research from
Case Western Reserve University , and a Master of Business Administration
degree from the London School of Business, where he studied as a Sloan Fellow. Paul D. Sonkinhas served as a director of our company since February
2004. Mr. Sonkin has served as the portfolio manager of the Hummingbird Value
Fund, The Hummingbird Microcap Value Fund, and The Hummingbird Concentrated
Fund since June 1999. He also serves as an adjunct professor at Columbia
University Graduate School of Business, where he teaches courses on security
analysis and value investing. From May 1998 to June 1999, Mr. Sonkin served as
a senior analyst and portfolio manager at First Manhattan & Co., a firm that 32




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##### Table of Contents



specialized in mid- and large-cap value investing. Prior to that, from
April 1995 to May 1998 Mr. Sonkin served as an analyst and portfolio manager at
Royce & Associates, the investment advisor to the Royce Funds. Prior to
receiving an MBA from Columbia University, he worked at Goldman Sachs & Co. and
at the U.S. Securities and Exchange Commission. Mr. Sonkin is co-author of
Value Investing: From Graham to Buffet and Beyond. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act requires our directors, officers, and
persons who own more than 10% of a registered class of our equity securities to
file reports of ownership and changes in ownership with the SEC. Officers,
directors, and greater than 10% stockholders are required by SEC regulations to
furnish us with copies of all Section 16(a) forms they file. Based solely upon
our review of the copies of such forms we received during the fiscal year ended
December 31, 2003, and written representations that no other reports were
required, we believe that each person who, at any time during such fiscal year,
was a director, officer, or beneficial owner of more than 10% of our common
stock complied with all Section 16(a) filing requirements during such fiscal
year, except that Mr. McConnell filed one late Form 4 covering the exercise of
outstanding stock options. Code of Ethics and Committee Charters Our Board of Directors has adopted Corporate Governance Guidelines, a Code
of Conduct, a Code of Ethics for the CEO and Senior Financial Officers, an
amended and restated Audit Committee Charter, a Compensation Committee Charter,
a Nominating/Corporate Governance Charter, and any other corporate governance
materials contemplated by SEC or NASDAQ regulations. We post on our website at
www.vodavi.com, these corporate governance materials. These documents are also
available in print to any stockholder who requests by contacting our corporate
secretary at our executive offices. Information Relating to Our Audit Committee of the Board of Directors The purpose of the Audit Committee is to assist our board of directors in
the oversight of the integrity of the consolidated financial statements of our
company, our companys compliance with legal and regulatory matters, the
independent auditors qualifications and independence, and the performance of
our companys independent auditors. The primary responsibilities of the Audit
Committee are set forth in its charter, and include various matters with
respect to the oversight of our companys accounting and financial reporting
process and audits of the consolidated financial statements of our company on
behalf of our board of directors. The Audit Committee also selects the
independent certified public accountants to conduct the annual audit of the
consolidated financial statements of our company; reviews the proposed scope of
such audit; reviews accounting and financial controls of our company with the
independent public accountants and our financial accounting staff; and reviews
and approves transactions between us and our directors, officers, and their
affiliates. The Audit Committee currently consists of Messrs. McConnell, Henry, and
Mitchell, each of whom is an independent director of our company under
applicable NASDAQ rules as well as under rules adopted by the Securities and
Exchange Commission pursuant to the Sarbanes-Oxley Act of 2002. The board of
directors has determined that each member of our audit committee qualifies as
an audit committee financial expert in accordance with applicable rules and
regulations of the SEC. 33




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##### Table of Contents



ITEM 11. EXECUTIVE COMPENSATION Summary of Cash and Other Compensation The following table sets forth certain information with respect to the
compensation we paid to our Chief Executive Officer and each other executive
officer who received cash compensation in excess of $100,000 during fiscal
2003. SUMMARY COMPENSATION TABLE Long TermCompensationAwardsAnnual
Compensation
    
    SecuritiesUnderlying
    
    All OtherName and Principal Position(1)
    
    Year
    
    Salary($)
    
    Bonus ($)
    
    Options(#)(2)
    
    Compensation($)Gregory K. Roeper
    
    
    2003
    
    
    $
    182,500
    
    
    $
    17,500
    
    
    
    35,000
    
    
    $
    7,329
    (3)President and Chief Executive
    
    
    2002
    
    
    $
    165,000
    
    
    $
    25,000
    
    
    
    
    
    
    $
    4,329
    (4)Officer
    
    
    2001
    
    
    $
    155,000
    
    
    $
    15,000
    
    
    
    35,000
    
    
    
    8,451
    (5)David A.
Husband
    
    
    2003
    
    
    $
    135,500
    
    
    $
    10,000
    
    
    
    25,000
    
    
    $
    750
    (6)Vice President  Finance,
    
    
    2002
    
    
    $
    135,000
    
    
    $
    25,000
    
    
    
    
    
    
    $
    750
    (6)Chief Financial Officer,
    
    
    2001
    
    
    $
    94,000
    
    
    $
    
    
    
    
    75,000
    
    
    $
    Secretary and TreasurerStephen L. Borcich
    
    
    2003
    
    
    $
    125,000
    
    
    $
    
    
    
    
    15,000
    
    
    $
    750
    (6)Vice
President  Distribution
    
    
    2002
    
    
    $
    125,000
    
    
    $
    
    
    
    
    
    
    
    $
    750
    (6)Sales
    
    
    2001
    
    
    $
    125,000
    
    
    $
    
    
    
    
    
    
    
    
    750
    (6)Steven R. Francis
    
    
    2003
    
    
    $
    125,000
    
    
    $
    7,500
    
    
    
    25,000
    
    
    $
    750
    (6)Vice
President  Dealer Sales
    
    
    2002
    
    
    $
    102,000
    
    
    $
    
    
    
    
    50,000
    
    
    $
    750
    (6)
   (1)
    
    We consider Messrs. Roeper, Husband, Borcich, and Francis to be our
executive officers. David A. Husband became our Chief Financial Officer
during March 2001; Mr. Francis became our Vice President
 Direct Sales
during March 2002 and became our Vice President  Dealer Sales in June
2002.(2)
    
    The exercise price of all stock options granted were equal to the fair
market value of our common stock on the date of grant.(3)
    
    Represents premium payment of $3,579 for a long-term disability insurance
policy and $3,000 for a term life insurance policy paid by our company.
Also includes a 401(k) plan matching contribution in the amount of $750.(4)
    
    Represents premium payment of $3,579 for a long-term disability insurance
policy paid by our company and a 401(k) plan matching contribution in the
amount of $750.(5)
    
    Represents premium payment of $2,234 for a long-term disability insurance
policy and $5,467 for a term life insurance policy paid by our company.
Also includes a 401(k) plan matching contribution in the amount of $750.(6)
    
    Represents a 401(k) plan matching contribution. 34




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##### Table of Contents



Option Grants The following table sets forth certain information with respect to stock
options granted to the officers listed during the fiscal year ended December
31, 2003. OPTION GRANTS IN LAST FISCAL YEAR Individual GrantsPotential RealizableValue at AssumedPercentage
    
    
    
    
    
    
    
    
    
    Annual RatesNumber of
    
    of Total
    
    
    
    
    
    
    
    
    
    of Stock PriceSecurities
    
    Options
    
    
    
    
    
    
    
    
    
    Appreciation forUnderlying
    
    Granted to
    
    
    
    
    
    
    
    
    
    Option Term(2)Options
    
    Employees in
    
    Exercise
    
    ExpirationName
    
    Granted (#)(1)
    
    Fiscal Year
    
    Price
    
    Date
    
    5%
    
    10%Gregory K. Roeper
    
    
    35,000
    
    
    
    25.0
    %
    
    $
    1.51
    
    
    
    2/25/13
    
    
    $
    33,237
    
    
    $
    84,229David A. Husband
    
    
    25,000
    
    
    
    17.9
    %
    
    $
    1.51
    
    
    
    2/25/13
    
    
    $
    23,741
    
    
    $
    60,164Stephen L. Borcich
    
    
    15,000
    
    
    
    10.7
    %
    
    $
    1.51
    
    
    
    2/25/13
    
    
    $
    14,245
    
    
    $
    36,098Steven R. Francis
    
    
    25,000
    
    
    
    17.9
    %
    
    $
    1.51
    
    
    
    2/25/13
    
    
    $
    23,741
    
    
    $
    60,164
   (1)
    
    Each of the options granted vest ratably over a four-year period.(2)
    
    Potential gains are net of the exercise price, but before taxes
associated with the exercise. Amounts represent hypothetical gains that
could be achieved for the respective options if exercised at the end of
the option term. The assumed 5% and 10% rates of stock price appreciation
are provided in accordance with SEC rules and do not represent our
estimate or projection of the future price of our common stock. Actual
gains, if any, on stock option exercises will depend upon the future
market prices of our common stock. Aggregate Option Exercises and Fiscal Year-End Option Holdings The following table provides information on options exercised during
fiscal 2003 by the officers listed and the value of each such officers
unexercised options of December 31, 2003. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
 Number of securities
    
    Value of Unexercised In-the-Underlying Unexercised
    
    Money Options at FiscalSharesAcquired on
    
    Value
    
    Options at Fiscal Year-End (#)
    
    Year-End ($) (1)Name
    
    Exercise (#)
    
    Realized ($)
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    UnexercisableGregory K. Roeper
    
    
    
    
    
    
    
    
    
    
    205,000
    
    
    
    52,500
    
    
    $
    501,175
    
    
    $
    234,325David A. Husband
    
    
    8,750
    
    
    $
    41,029
    
    
    
    28,750
    
    
    
    62,500
    
    
    $
    135,488
    
    
    $
    284,825Stephen L. Borcich
    
    
    
    
    
    
    
    
    
    
    45,000
    
    
    
    15,000
    
    
    $
    142,875
    
    
    $
    64,350Steven R. Francis
    
    
    
    
    
    
    
    
    
    
    12,500
    
    
    
    62,500
    
    
    $
    55,625
    
    
    $
    274,125
   (1)
    
    Calculated based upon the closing price of our common stock as reported
on the Nasdaq SmallCap Market on December 31, 2003 of $5.80 per share.
The exercise price of certain of the options held by our executive
officers on December 31, 2003 were greater than $5.80 per share. 35




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Employment Agreements William J. Hinz Effective October 1, 1999, we entered into an employment agreement with
William J. Hinz. The agreement had an initial term through September 30, 2001,
and has automatically renewed through September 30, 2004. The agreement
automatically renews for successive one-year terms unless either party
terminates by giving the other party at least 30 days written notice. The
agreement provides for Mr. Hinz to serve as our Chairman of the Board and to
receive a base salary of $75,000 per annum. The employment agreement provides for Mr. Hinz to receive his fixed
compensation to the date of termination of his employment by reason of
resignation, death, or as a result of termination of employment for cause, as
defined the agreement. If we terminate the employment of Mr. Hinz, or if his
employment is terminated by reason of disability, the agreement provides for
the payment of fixed compensation to Mr. Hinz for the remaining term of the
agreement, payable in a lump sum within ten days of the date of termination.
In addition, Mr. Hinzs vested options as of the date of termination will
remain outstanding through the 90-day period following the then-current term of
the agreement . All unvested options as of the date of termination will be
cancelled. In the event of a change of control of our company, as defined in the
agreement, Mr. Hinz will receive a minimum bonus of $50,000. In addition, any
options that were granted to Mr. Hinz that remain unvested as of the date of
the change of control will become fully vested and exercisable on the effective
date of the change of control. If the employment of Mr. Hinz is terminated as
a result of a change of control, we will be required to pay Mr. Hinz, within
ten days of the date of termination, the greater of (a) his base salary and
benefits for the remaining term of the employment agreement, or (b) his annual
base salary. Gregory K. Roeper Effective October 1, 2003, we renewed and amended Mr. Roepers employment
agreement for a term expiring on December 31, 2004. The agreement
automatically renews for successive one-year terms unless either party
terminates by giving the other party at least 30 days written notice. The
employment agreement provides for Mr. Roeper to serve as our President and
Chief Executive Officer. The employment agreement provides for Mr. Roeper to
receive a base salary of $182,500 through December 31, 2003, and $200,000 per
annum thereafter. The agreement provides for Mr. Roeper to receive his fixed compensation to
the date of termination of his employment by reason of resignation, death, or
as a result of termination of employment for cause, as defined in the
agreement. If we terminate his employment, or if his employment is terminated
by reason of disability, the agreement provides for the payment of his base
salary and benefits for a period of one year, payable in a lump sum within ten
days of the date of termination. In addition, Mr. Roepers vested options as
of the date of termination will remain outstanding through the 120-day period
following the then-current term of the agreement. All unvested options as of
the date of termination will be cancelled. In the event of a change of control of our company, as defined in the
agreement, Mr. Roeper will receive a minimum bonus of $100,000. In addition,
any options that were granted to Mr. Roeper that remain unvested as of the date
of the change of control will become fully vested and exercisable on the
effective date of the change of control. If Mr. Roepers employment is
terminated as a result of a change of control, we will be required to pay him,
within ten days of the date of termination, his annual base salary and benefits
for a period of one year following the date of termination plus any earned
bonus through the date of termination. David A. Husband Effective January 1, 2004, we entered into a new employment agreement with
Mr. Husband. The agreement has an initial term of one year, and automatically
renews for successive one-year terms unless either party terminates by giving
the other party at least 30 days written notice. The employment agreement
provides for Mr. Husband to serve as our Vice President  Finance and Chief
Financial Officer. The employment agreement provides for Mr. Husband to
receive a base salary of $150,000 per annum. 36




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The agreement provides for Mr. Husband to receive his fixed compensation
to the date of termination of his employment by reason of resignation, death,
or as a result of termination of employment for cause, as defined the
agreement. If we terminate Mr. Husbands employment, or if his employment is
terminated by reason of disability, we will pay Mr. Husband his base salary and
benefits for a nine-month period. In addition, Mr. Husbands vested options as
of the date of termination will remain outstanding through the 120-day period
following the then-current term of the agreement. All unvested options as of
the date of termination will be cancelled. In the event of a change of control of our company, as defined in the
employment agreement, Mr. Husband will receive a bonus ranging from $25,000 to
$62,500, based on the value of the transaction. In addition, any options that
were granted to Mr. Husband that remain unvested as of the date of the change
of control will become fully vested and exercisable on the effective date of
the change of control. If Mr. Husbands employment is terminated as a result
of a change of control, we will be required to pay him his base salary and
benefits for a nine-month period following the date of termination plus any
earned bonus through the date of termination. Steven R. Francis Effective January 1, 2004 we entered into a new employment agreement with
Mr. Francis. The agreement has an initial term through December 31, 2004, and
automatically renews for successive one-year terms unless either party
terminates by giving the other party at least 30 days written notice. The
employment agreement provides for Mr. Francis to serve as Vice President 
Dealer Sales for a base salary of $135,000 per annum. In the event of a
change of control of our company, as defined in the agreement, any options
that were granted to Mr. Francis that remain unvested as of the date of the
change of control will become fully vested and exercisable on the effective
date of the change of control. If Mr. Francis employment is terminated as a
result of a change of control, we will be required to pay Mr. Francis his base
salary and benefits for the remaining term of the agreement plus any earned
bonus through the date of termination. The agreement provides for Mr. Francis to receive his fixed compensation
to the date of termination of his employment by reason of resignation, death,
or as a result of termination of employment for cause, as defined the
agreement. If we terminate the employment of Mr. Francis, or if his employment
is terminated by reason of disability, we will pay Mr. Francis his base salary
and benefits for a nine-month period. In addition, any vested options held by
Mr. Francis as of the date of termination will remain outstanding through the
120-day period following the then-current term of the agreement. All unvested
options as of the date of termination will be cancelled. Each employment agreement described above provides that the executive will
be eligible to receive discretionary bonuses in amounts determined by our Board
of Directors. In addition, each employment agreement generally requires us to  
    
    reimburse each executive for all travel, entertainment, and
other ordinary and necessary expenses incurred in connection with
our business and their duties under their respective employment
agreements; and
    
    provide such other fringe benefits that we make generally
available to all of our employees on a non-discriminatory basis. Each employment agreement also contains provisions that prohibit the
executive from  
    
    competing with us for a period of 12 months after the
termination of the executives employment with our company,
    
    taking certain actions intended to solicit other persons to
terminate their business relationship with us or to terminate his or
her employment relationship with us, and
    
    making unauthorized use or disclosure of our trade names,
fictitious names, or confidential information. 37




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Other Arrangements We maintain agreements with each of our other officers and employees that
prohibit such persons from disclosing confidential information obtained while
employed by us. We offer our employees medical, life, and disability insurance
benefits. Our executive officers and other key personnel (including directors
who also are employees of our company) are eligible to receive stock options
under our stock option plan. 401(k) Profit Sharing Plan In April 1994, we adopted a profit sharing plan pursuant to Section 401(k)
of the Internal Revenue Code of 1986. Pursuant to the 401(k) Plan, all
eligible employees may make elective contributions through payroll deductions.
In addition, we may make matching and discretionary contributions in such
amounts as may be determined by our Board of Directors. During fiscal 2003, we
expensed matching contributions pursuant to the 401(k) Plan to all executive
officers as a group in the amount of $3,000. 1994 Stock Option Plan Our Stock Option Plan was adopted by our Board of Directors in 1994 and
was approved by the stockholders in July 1995. Our Board of Directors amended
and restated the plan, and our stockholders approved the amended and restated
plan, in 1996. Our Board of Directors further amended the plan in October
1997. Those amendments did not require stockholder approval. Our Board of
Directors further amended the plan in April 2000, and our stockholders approved
the amendment during June 2000. Our Board of Directors further amended the
plan in May 2002, and our stockholders approved the amendment in July 2002.
The 1994 plan provides for  
    
    the granting of incentive stock options or nonqualified options to acquire our common stock;
    
    the granting of stock appreciation rights;
    
    the direct granting of shares of our common stock; and
    
    the granting of other cash awards to key employees of our
company and to consultants or independent contractors who provide
valuable services to us. The plan also provides for automatic grants of stock options to non-employee
directors of our company under an automatic program. We may issue 1,600,000 shares of Common Stock under the 1994 Plan. If any
option or award terminates or expires without having been exercised in full,
stock not issued under such award will again be available for the purposes of
the plan. As of March 5, 2004, 249,875 shares of common stock have been issued
upon exercise of options granted under the plan, and there were outstanding
options to acquire 855,625 shares of our common stock under the plan. As of
March 5, 2004, an additional 494,500 shares of common stock were available for
grant under the plan. The term of the 1994 Plan will continue through December
2004. We may not grant additional awards under the 1994 Plan unless granted
before the termination of the 1994 Plan. Any awards outstanding on that date
will not be terminated or otherwise affected by virtue of the expiration of the
1994 Plan. In approving the 2003 Plan discussed below, the Board considered
that the remaining shares available under the 1994 Plan would be canceled in
favor of the new shares available under the 2003 Plan. Options that are incentive stock options may only be granted to our key
personnel who are also employees of our company. To the extent that granted
options are incentive stock options, the terms and conditions of those options,
including the exercise price and expiration date, must be consistent with the
qualification requirements set forth in the Internal Revenue Code. The maximum
number of shares with respect to which options or awards may be granted to any
one employee (including officers) during the term of the plan may not exceed
50% of the shares of common stock authorized for issuance under the plan. Under the automatic program, each newly elected non-employee member of our
Board of Directors will receive an automatic initial grant of options to
acquire 5,000 shares of common stock on the date of his or her first
appointment or election to our Board of Directors. In addition, options to
acquire 5,000 shares of common stock 38




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will be automatically granted to each non-employee director at the meeting
of our Board of Directors held immediately after each annual meeting of
stockholders. A non-employee member of our Board of Directors will not be
eligible to receive the automatic annual grant if that option grant date is
within 90 days of such non-employee member receiving his or her automatic
initial grant. To exercise an option, the option holder will be required to deliver to us
full payment of the exercise price for the shares as to which the option is
being exercised. Generally, options may be exercised by delivery of cash, bank
cashiers check, or shares of our common stock. 2003 Incentive Compensation Plan Our Board of Directors approved the Vodavi 2003 Incentive Compensation
Plan in August 2003, and our stockholders approved the 2003 Plan during October
2003. The purpose of the 2003 Plan is to assist us in attracting, motivating,
retaining, and rewarding high-quality executives and other employees, officers,
directors, and consultants by enabling such persons to acquire or increase a
proprietary interest in our company in order to strengthen the mutuality of
interests between such persons and our stockholders, and providing such persons
with annual and long-term performance incentives to expend their maximum
efforts in the creation of stockholder value. General Terms of the 2003 Plan; Shares Available for Issuance The 2003 Plan provides for the granting of awards in the form of incentive
stock options, nonqualified stock options, stock appreciation rights, shares of
restricted common stock, bonus stock in lieu of obligations, or other
stock-based awards to employees, directors, and independent contractors who
provide valuable services to our company. The 2003 Plan authorizes the
issuance of 600,000 shares of stock, and no more than 500,000 shares may be
issued pursuant to incentive stock options. As of March 5, 2004, no shares of
common stock have been issued upon exercise of options granted under the 2003
plan, and there were outstanding options to acquire 38,750 shares of our common
stock under the 2003 plan. As of March 5, 2004, an additional 561,250 shares
of common stock were available for grant under the 2003 plan. The maximum
number of shares of common stock covered by awards granted to any individual in
any year may not exceed 200,000. If any award previously granted under the
2003 Plan is forfeited, terminated, canceled, surrendered, does not vest, or
expires without having been exercised in full, stock not issued under such
award will again be available for grant for purposes of the 2003 Plan. If any
change is made in the stock subject to the 2003 Plan, or subject to any award
granted under the 2003 Plan (through consolidation, spin-off, recapitalization,
stock dividend, split-up, combination of shares, exchange of shares, or
otherwise), the 2003 Plan provides that appropriate adjustments will be made as
to the aggregate number and type of shares available for awards, the maximum
number and type of shares that may be subject to awards to any individual, the
number and type of shares covered by each outstanding award, the exercise price
grant price, or purchase price relating to any award, and any other aspect of
any award that the Board of Directors or Committee determines appropriate. The 2003 Plan provides that it is not intended to be the exclusive means
by which we may issue options to acquire our common stock or any other type of
award. To the extent permitted by applicable law and the rules and regulations
of the NASDAQ SmallCap Market, we may issue other options, warrants, or awards
other than pursuant to the 2003 Plan without stockholder approval. Eligibility and Administration Employees, executive officers, directors, and independent contractors of
our company will be eligible to receive awards under the 2003 Plan. Options
that are incentive stock options may be granted only to employees of our
company. A committee designated by the Board of Directors will administer the 2003
Plan, however, the Board may exercise any power or authority granted to the
committee under the 2003 Plan. The Board may designate more than one committee
to administer the 2003 Plan as to various categories of eligible persons. The
committee will consist of at least two directors, and each member of which will
be (a) a non-employee director within the meaning of 39




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Rule 16b-3 under the Exchange Act, unless administration of the 2003 Plan
by non-employee directors is not then required in order for exemptions under
Rule 16b-3 to apply to transactions under the 2003 Plan, and (b) an outside
director within the meaning of Section 162(m) of the Internal Revenue Code,
unless administration of the 2003 Plan by outside directors is not then
required in order to qualify for tax deductibility under Section 162(m) of the
Internal Revenue Code. The Board and/or any committee that has been delegated
the authority to administer the 2003 Plan is referred to as the Plan
Administrator. Where appropriate, the Plan Administrator will satisfy the
then requirements of any stock exchange or automated quotation system upon
which our stock is listed or quoted. The Plan Administrator will have the authority, in its discretion, to
determine all matters relating to awards, including the selection of the
individuals to be granted awards, the type of awards, the number of shares of
common stock subject to an award, vesting conditions, and any and all other
terms, conditions, restrictions, and limitations, if any, of an award. The
Plan Administrator will also have the authority to construe and interpret the
2003 Plan, and to make all decisions and determinations as the Plan
Administrator may deem necessary or advisable for administration of the 2003
Plan. The Plan Administrator may delegate to officers or managers of our
company certain functions, in each case to the extent permitted by the Board,
under the 2003 Plan, and applicable law. Terms of Awards General Awards granted under the 2003 Plan may be granted either alone or in
addition to, in tandem with, or in substitution or exchange for, any other
award or any award granted under another plan of our company. Such additional,
tandem, and substitute or exchange award may be granted at any time. The term
of each award will be for such period as may be determined by the Plan
Administrator, provided that in no event will the term of any option or stock
appreciation right exceed a period of 10 years, or such shorter period as may
be required in the case of an incentive stock option. Options Options granted under the 2003 Plan may be either incentive stock options,
as defined under the Internal Revenue Code, or nonqualified options. The
expiration date, maximum number of shares purchasable, vesting provisions, type
of consideration to be paid upon exercise, and any other provisions of options
granted under the 2003 Plan will be established at the time of grant. The Plan
Administrator will set the term of each option, and in the case of incentive
stock options, such terms will be subject to compliance in all respects with
the Internal Revenue Code and the 2003 Plan. Options will vest and become
exercisable in whole or in one or more installments at such time as may be
determined by the Plan Administrator, including based on achievement of
performance goals or future service requirements. The exercise prices of options will be determined by the Plan
Administrator, provided that the exercise price of all options granted under
the 2003 Plan may not be less than 100% of the fair market value of the common
stock on the date of the grant (110% of the fair market value if the option
intended to be an incentive stock options granted to a stockholder who at the
time the option is granted owns stock possessing more than 10% of the total
combined voting power of all classes of stock of our company or of its
subsidiaries). The Plan Administrator will also have the discretion to grant options that
are immediately exercisable for restricted shares of stock that will vest over
a period of time or pursuant to certain performance criteria established by the
Plan Administrator. Should the optionees continuous service cease while
holding such unvested shares, we will have the right to repurchase, at the
exercise price paid per share, any or all of the unvested shares. The terms
upon which such repurchase right will be exercisable will be established by the
Plan Administrator and set forth in the document evidencing such repurchase
right. 40




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Stock Appreciation Rights The Plan Administrator is authorized to grant stock appreciation rights,
which provide the holder the right to receive, upon exercise thereof, the
excess of (a) the fair market value of one share of stock on the date of
exercise, over (b) the grant price of the stock appreciation right as
determined by the Plan Administrator. The grant price of a stock appreciation
right will not be less than the fair market value of a share of stock on the
date of grant, except under limited circumstances set forth in the 2003 Plan.
The Plan Administrator will determine at the date of grant the terms and
conditions of the stock appreciation right, including the form of consideration
payable in settlement. Stock appreciation rights may be either freestanding or
granted in tandem with other awards. The Plan Administrator may grant limited
stock appreciation rights, which may be exercised only in the event of a
change of control, as defined in the 2003 Plan. Restricted Stock The Plan Administrator is authorized to grant shares of restricted stock,
which will be subject to such restrictions on transferability, risk of
forfeiture, and other restrictions as the Plan Administrator will determine or
as otherwise provided in the 2003 Plan. The restrictions may lapse separately
or in combination at such times, under such circumstances, in such
installments, or otherwise, as the Plan Administrator may determine at the date
of grant or thereafter. A holder granted restricted stock will have all of the
rights of a stockholder, including the right to vote and receive dividends.
During the applicable restricted period, the shares may not be sold,
transferred, pledged, hypothecated, margined, or otherwise encumbered by the
holder. Except as otherwise determined by the Plan Administrator at the time of
the award, upon termination of a participants service during the applicable
restricted period, the participants restricted stock that is at that time
subject to restrictions will be forfeited and reacquired by us, provided that
the Plan Administrator may provide or determine that restrictions or forfeiture
conditions will be waived in whole or in part in the event of terminations
resulting from specified causes, and the Plan Administrator may in other cases
waive in whole or in part the forfeiture of restricted stock. As a condition to the grant of an award of restricted stock, the Plan
Administrator may require that any cash dividends paid on a share of restricted
stock be automatically reinvested in additional shares of restricted stock or
applied to the purchase of additional awards under the 2003 Plan, which will be
subject to restrictions and a risk of forfeiture to the same extent as the
restricted stock with respect to which such stock or other property has been
distributed. Bonus Stock and Awards in Lieu of Obligations The Plan Administrator is authorized to grant stock as a bonus, or to
grant stock or other awards in lieu of company obligations to pay cash or
deliver other property under the 2003 Plan or under other plans or compensatory
arrangements, subject to certain exceptions in the case of participants subject
to Section 16 of the Exchange Act or other terms as determined by the Plan
Administrator. Other Stock-Based Awards The Plan Administrator is authorized to grant participants such other
awards that may be denominated or payable in, valued in whole or in part by
reference to, or otherwise based on stock as deemed by the Plan Administrator
to be consistent with the purposes of the 2003 Plan. Such awards may be
convertible or exchangeable debt securities, other rights convertible or
exchangeable into stock, purchase rights for stock, awards with value and
payment contingent upon performance of our company or any other factors
designated by the Plan Administrator. The Plan Administrator will determine
the terms and conditions of such awards, including the nature of the right,
consideration to be paid upon exercise, vesting conditions, repurchase rights
for unvested shares, and the like. Cash awards, as an element of or supplement
to any other award under the 2003 Plan, may also be granted under the 2003
Plan. 41




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Automatic Grant Program The 2003 Plan includes an automatic grant program that automatically
grants options to our non-employee directors. The automatic grant program
under the 2003 Plan will begin upon the earlier of (a) the expiration of the
1994 Plan, (b) the date upon which there are no shares available for grant
under the 1994 Plan, or (c) the date upon which we voluntarily terminate the
1994 Plan. Under the automatic grant program, each newly elected non-employee
member of the Board will receive an option to purchase 5,000 shares of common
stock, if available, on the date of his or her first appointment or election to
the board of directors. In addition, an option to acquire 5,000 shares of
common stock, if available, will be granted to each non-employee director at
the meeting of the board of directors held immediately after each annual
meeting of stockholders. A non-employee member of the board of directors will
not be eligible to receive this annual grant if the grant date of such annual
grant would be within 90 days of the date on which the non-employee member
received his or her initial grant. Each initial grant will vest and become
exercisable immediately on the date of grant. The exercise price per share of common stock subject to automatic options
granted under the 2003 Plan will be equal to 100% of the fair market value of
our common stock on the date such option is granted. Each automatic option
will expire on the tenth anniversary of the date of grant. In the event the
non-employee director ceases to serve as a member of the board of directors,
the option holder may exercise the automatic options until the earlier of (1)
90 days after the cessation of service, or (2) the expiration of the term of
the automatic option. If the non-employee director dies while serving as a
director or within 90 days after ceasing to serve as a director, the option
holders estate or the persons to whom the automatic options are transferred
under the option holders will or the laws of descent and distribution may
exercise the automatic options until the earlier of (a) 90 days after the
cessation of service, or (b) the expiration of the term of the automatic
option. Other Provisions In the event of a proposed sale of all or substantially all of our assets
or any reorganization, merger, consolidation, or other form of corporate
transaction in which our company does not survive, or in which shares of stock
are exchanged for or converted into securities issued by another entity, then
the successor or acquiring entity may, with the consent of the committee or the
Board, assume each outstanding option or substitute an equivalent option or
right. If the successor or acquiring entity does not assume or substitute such
options, then (a) each option will terminate upon consummation of sale, merger,
consolidation, or other corporate transaction, and (b) the committee will have
the discretion and authority exercisable at any time to provide for the
automatic acceleration of vesting or exercisability of one or more awards
granted by it under the 2003 Plan. Duration and Modification The Plan will terminate at such time as no shares of stock remain
available for issuance under the 2003 Plan and we have no further rights or
obligations with respect to outstanding awards under the 2003 Plan. The Board
may amend, alter, suspend, discontinue, or terminate the 2003 Plan without the
consent of stockholders, except that any amendment or alteration to the 2003
Plan will be subject to stockholder approval no later than the next annual
meeting following such Board action if required by applicable law or the rules
or any applicable stock exchange or quotation system on which the stock may
then be listed or quoted. In addition, without the consent of an affected
participant, the Board may not amend or alter the 2003 Plan to affect the
rights of any participant under any previously granted and outstanding award. Despite the foregoing, the Board of Directors, in its sole discretion, may
bifurcate the 2003 Plan so as to restrict, limit, or condition the use of any
provision of the 2003 Plan to participants who are officers, directors, or
stockholders subject to Section 16 of the Exchange Act without so restricting,
limiting, or conditioning the 2003 Plan with respect to other participants. Director Compensation and Other Information Employees of our company do not receive compensation for serving as
members of our Board of Directors. Each independent director receives a
quarterly retainer fee of $3,750 payable on the first day of each quarter.
Each independent director also receives a $500 fee for each meeting attended by
telephone or in person and 42




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reimbursement for reasonable expenses incurred in attending meetings of
our Board of Directors, except that Mr. Hinz receives no cash compensation for
meetings attended. Mr. Hinz, the Chairman of our Board of Directors is
compensated as pursuant to an employment agreement. See Item 11, Executive
Compensation  Employment Agreements. During March 2003, we granted Mr. Hinz
options to purchase 15,000 shares of our common stock. Committee members other
than Mr. Hinz receive a $500 fee for attendance at committee meetings that are
held on days other than days on which a Board of Directors meeting is held.
Non-employees who serve as directors of our company also receive an annual
automatic stock option grant to purchase 5,000 shares of stock under our 2003
Incentive Compensation Plan. Each automatic grant under the 2003 Plan shall
vest and become exercisable on the earlier of (1) the first anniversary of the
date of grant, or (2) the day prior to the next regularly held annual meeting
of our stockholders. Compensation Committee Interlocks and Insider Participation Performance evaluation and compensation decisions relating to 2003 were
made by the Compensation Committee of our Board of Directors, which consisted
of Messrs. Mitchell, Hinz, and Pakis. Except for our employment agreement with
Mr. Hinz, which was effective during fiscal 2003, none of such persons had any
contractual or other relationships with us during fiscal 2003 except as
directors. See Item 11, Executive Compensation  Director Compensation and
Other Information. In February 2004, Mr. Hinzs position on the Compensation
Committee was replaced with the appointment of Mr. McConnell. Our Compensation
Committee is now composed entirely of independent directors. Limitation of Directors Liability and Indemnification Our certificate of incorporation provides that no director of our company
will be personally liable to our company or our stockholders for monetary
damages for breach of fiduciary duty as a director, except to the extent such
exemption or limitation of liability is not permitted under the Delaware
General Corporation law, or Delaware GCL. Under the Delaware GCL, a director
may be held liable  
    
    for any breach of the directors duty of loyalty to our
company or our stockholders;
    
    for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law;
    
    in respect of certain unlawful dividend payments or stock purchases; or
    
    for any transaction from which the director derived an improper personal benefit. The effect of this provision in our certificate of incorporation is to
eliminate the rights of our company and our stockholders (through stockholders
derivative suits on behalf of our company) to recover monetary damages from a
director for breach of the fiduciary duty of care as a director (including
breaches resulting from negligent or grossly negligent behavior) except in the
situations described above. In addition, our certificate of incorporation
provides that any repeal or modification of this provision by our stockholders
will not adversely affect any right or protection of a director of our company
existing at the time of such repeal or modification with respect to acts or
omissions occurring prior to such repeal or modification. These provisions do
not limit or eliminate the rights of our company or any stockholder to seek
non-monetary relief such as an injunction or recision in the event of a breach
of a directors duty of care. Our certificate of incorporation requires us to indemnify our directors,
officers, and certain other representatives of our company against expenses and
certain other liabilities arising out of their conduct on behalf of our company
to the maximum extent permitted by the Delaware GCL. Indemnification is not
available with respect to proceedings or claims initiated or brought
voluntarily by an officer, director, or other representative of our company
against us unless such proceeding or claim is approved by our Board of
Directors. 43




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##### Table of Contents



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 The following table sets forth certain information with respect to
beneficial ownership of our common stock as of December 31, 2003 by (i) each
director; (ii) the executive officers set forth in the Summary Compensation
Table under Item 11, Executive Compensation; (iii) all of our directors and
executive officers as a group; and (iv) each other person who is known by us to
beneficially own or to exercise voting or dispositive control over more than 5%
of our common stock. Number ofName and Address of Beneficial Owner (1)
    
    Shares (2)
    
    Percent (2)Directors and Executive Officers:William J. Hinz
    
    
    60,000
    (3)
    
    
    1.6
    %Gregory K. Roeper
    
    
    224,475
    (4)
    
    
    5.9
    %David A. Husband
    
    
    54,850
    (5)
    
    
    1.5
    %Stephen L. Borcich
    
    
    48,750
    (6)
    
    
    1.3
    %Steven R. Francis
    
    
    118,750
    (7)
    
    
    3.3
    %Jack A. Henry
    
    
    10,900
    (8)
    
    
    *Jong Hwa Choi
    
    
    5,000
    (9)
    
    
    *Stephen A McConnell
    
    
    38,900
    (10)
    
    
    1.1
    %Emmett E. Mitchell
    
    
    15,300
    (11)
    
    
    *Frederick M. Pakis
    
    
    10,000
    (12)
    
    
    *Paul D. Sonkin
    
    
    453,176
    (13)
    
    
    12.6
    %All directors and officers as a group (11 persons)
    
    
    1,036,801
    
    
    
    25.6
    %Non-management 5% Stockholders:LG Electronics, Inc.
    
    
    862,500
    (14)
    
    
    23.9
    %Hummingbird Management, LLC
    
    
    448,176
    (13)
    
    
    12.5
    %
   *
    
    Less than 1%  (1)
    
    Each person named in the table has sole voting and investment power with
respect to all common stock beneficially owned by him, subject to
applicable community property law, except as otherwise indicated. Except
as otherwise indicated, each person may be reached at 4717 East Hilton
Avenue, Suite 400, Phoenix, Arizona 85034.(2)
    
    The percentages shown are calculated based upon 3,610,464 shares of our
common stock outstanding on December 31, 2003. The percentages shown
include the shares of common stock that each named stockholder has the
right to acquire within 60 days of December 31, 2003. In calculating
ownership percentage, all shares of common stock that the named
stockholder has the right to acquire upon exercise of stock options within
60 days of December 31, 2003 are deemed to be outstanding for the purpose
of computing the percentage of common stock owned by such stockholder, but
are not deemed to be outstanding for the purpose of computing the
ownership percentage of any other stockholder. Percentages may be
rounded. Includes, when applicable, shares owned of record by such
persons children and spouse and by other related individuals and entities
over whose shares of common stock such person has sole or shared voting
control or power of disposition.(3)
    
    Includes 60,000 shares of common stock issuable upon exercise of options,
but excludes 15,000 shares of common stock issuable upon exercise of
unvested stock options.(4)
    
    Includes 10,725 shares of common stock and 213,750 shares of common stock
issuable upon exercise of options, but excludes 43,750 shares of common
stock issuable upon exercise of unvested stock options.(5)
    
    Includes 19,850 shares of common stock and 35,000 shares of common stock
issuable upon exercise of options, but excludes 56,250 shares of common
stock issuable upon exercise of unvested stock options.(6)
    
    Includes 48,750 shares of common stock issuable upon exercise of options,
but excludes 11,250 shares of common stock issuable upon exercise of
unvested stock options. 44




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##### Table of Contents



(7)
    
    Includes 100,000 shares of common stock and 18,750 shares of common stock
issuable upon the exercise of stock options, but excludes 56,250 shares of
common stock issuable upon exercise of unvested stock options.(8)
    
    Includes 900 shares of common stock and 10,000 shares of common stock
issuable upon exercise of stock options, but excludes 5,000 shares of
common stock issuable upon exercise of unvested stock options.(9)
    
    Includes 5,000 shares of common stock issuable upon exercise of stock
options, but excludes 5,000 shares of common stock issuable upon exercise
of unvested stock options.(10)
    
    Includes 13,900 shares of common stock and 25,000 shares issuable upon
exercise of options, but excludes 5,000 shares of common stock issuable
upon exercise of unvested stock options.(11)
    
    Includes 3,300 shares of common stock and 12,000 shares issuable upon
exercise of options, but excludes 5,000 shares of common stock issuable
upon exercise of unvested stock options.(12)
    
    Includes 10,000 shares of common stock issuable upon exercise of stock
options, but excludes 5,000 shares of common stock issuable upon exercise
of unvested stock options.(13)
    
    Mr. Sonkin is a control person of Humingbird Management, LLC. Amounts
listed for Hummingbird represent 448,176 shares of common stock
beneficially owned by Hummingbird Management, LLC (f/k/a Morningside Value
Investors, LLC), as investment manager to The Hummingbird Value Fund, L.P.
The managing member of Hummingbird Management is Paul D. Sonkin, who also
serves as the managing member of HVF Capital, the general partner of The
Hummingbird Value Fund and The Hummingbird Microcap Value Fund.
Hummingbird Management has sole voting and dispositive power over the
shares, and Hummingbird Management disclaims any economic interest or
beneficial ownership of the shares. The address of Hummingbird Management,
LLC is 153 East 53rd Street, New York, New York 10022. In addition to the
amounts listed for Hummingbird Management, Mr. Sonkins beneficial
ownership, for which Mr. Sonkin has sole voting and dispositive power,
includes 5,000 shares of common stock and such amount is not included in
the beneficial ownership of Hummingbird Management.(14)
    
    Represents shares of common stock beneficially owned by LG Electronics
Inc. LGE has sole voting power and sole dispositive power over such
shares. LGE acquired the shares of our common stock in connection with
the merger of its minority owned subsidiary, LGIC, with and into LGE
during September 2000. The address of LGE is LG Twin Towers, 20
Yoido-dong, Youngdungpo-gu, Seoul 150-721, Korea. 45




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Equity Compensation Plan Information The following table sets forth information with respect to our common
stock that may be issued upon the exercise of stock options under our 1994
Stock Option Plan and our 2003 Incentive Compensation Plan as of December 31,
2003. (c)Number of Securities(a)
    
    
    
    
    
    Remaining Available forNumber of Securities
    
    (b)
    
    Future Issuance Underto be Issued Upon
    
    Weighted Average
    
    Equity CompensationExercise of
    
    Exercise Price of
    
    Plans (ExcludingOutstanding Options,
    
    Outstanding Options,
    
    Securities Reflected inPlan Category
    
    Warrants, and Rights
    
    Warrants, and Rights
    
    Column (a))Equity Compensation
Plans Approved by
Stockholders
    
    
    863,125
    
    
    $
    2.46
    
    
    
    1,094,500Equity Compensation
Plans Not Approved
by Stockholders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    863,125
    
    
    $
    2.46
    
    
    
    1,094,500
 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS LG Electronics Inc., our principal supplier, owns approximately 24% of our
outstanding common stock. Kyeong Woo Lee, a director of our company from
January 2002 until February 2003 and Jong Hwa Choi, a director of our company
since February 2003, are officers of LGE or its affiliates. We purchased
approximately $21.1 million of key telephone systems, commercial grade
telephones, and voice mail products from LGE and an affiliate of LGE during
2003. We believe that the purchases from LGE and its affiliate approximate
terms that would be offered by non-related parties. We owed LGE and its
affiliate approximately $4.2 million for product purchases as of December 31,
2003. We also conduct joint development activities with LGE for the design and
development of hardware incorporated into some of our existing and planned
telephone systems and commercial grade telephones. Generally, LGE contributes
the ongoing research and development costs for the product hardware and
produces the finished goods developed under the alliance and we obtain the
right to sell such products throughout North America and the Caribbean. In July 2001, we entered into a development agreement with LGE under which
we developed for LGE certain advanced voice messaging technologies. We
recorded revenue of $24,000 in 2003, $183,500 in 2002 and $210,000 in 2001 for
work performed under the development agreement using the percentage of
completion method. As of December 31, 2003, LGE had paid us $417,500 pursuant
to the agreement. 46




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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Audit Fees We engaged Deloitte & Touche LLP as our independent public accountants
during the fiscal year ended December 31, 2002, and engaged Mayer Hoffman
McCann P.C. as our new independent public accountants for the fiscal year ended
December 31, 2003. Aggregate fees billed to our company for the fiscal years
ended December 31, 2002 and 2003 by our principal accounting firm are as
follows: 2002
    
    2003Audit Fees (1)
    
    $
    123,150
    
    
    $
    74,500Audit-Related Fees (2)
    
    $
    10,000
    
    
    $
    15,650Tax Fees (3)
    
    $
    18,571
    
    
    $
    16,255All Other Fees
    
    $
    
    
    
    $
    
   (1)
    
    Represents fees associated with the audit of our annual consolidated
financial statements, review of our quarterly consolidated financial
statements, and related consents.(2)
    
    Represents fees associated with the audit of our 401(k) benefit plan in
each of the years presented, and fees and expenses in 2003 associated with
the transition of our principal accounting firm from Deloitte & Touche LLP
to Mayer Hoffman McCann P.C. in 2003.(3)
    
    Represents fees associated with the preparation of our corporate, federal
and state income tax returns and assistance with our quarterly estimated
tax payments. Audit Committee Pre-Approval Policies The charter of our Audit Committee provides that the duties and
responsibilities of our Audit Committee include the pre-approval of all audit,
audit related, tax, and other services permitted by law or applicable SEC
regulations (including fee and cost ranges) to be performed by our independent
auditor. Any pre-approved services that will involve fees or costs exceeding
pre-approved levels will also require specific pre-approval by the Audit
Committee. Unless otherwise specified by the Audit Committee in pre-approving
a service, the pre-approval will be effective for the 12-month period following
pre-approval. The Audit Committee will not approve any non-audit services
prohibited by applicable SEC regulations or any services in connection with a
transaction initially recommended by the independent auditor, the purpose of
which may be tax avoidance and the tax treatment of which may not be supported
by the Internal Revenue Code and related regulations. To the extent deemed appropriate, the Audit Committee may delegate
pre-approval authority to the Chairman of the Board or any one or more other
members of the Audit Committee provided that any member of the Audit Committee
who has exercised any such delegation must report any such pre-approval
decision to the Audit Committee at its next scheduled meeting. The Audit
Committee will not delegate the pre-approval of services to be performed by the
independent audit to management. Our Audit Committee requires that our independent auditor, in conjunction
with our Chief Financial Officer, be responsible for seeking pre-approval for
providing services to us and that any request for pre-approval must inform the
Audit Committee about each service to be provided and must provide detail as to
the particular service to be provided. All of the services provided by our principal accounting firm described
above under the captions Audit-Related Fees and Tax Fees were approved by
our Audit Committee. 47




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PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K  (a)
    
    Financial Statements and Financial Statement Schedules  (1)
    
    Financial Statements are listed in the Index to Consolidated
Financial Statements on page F-1 of this report.(2)
    
    Financial Statement Schedules: Schedule II, Valuation and
Qualifying Accounts is set forth on page S-3 of this report.  (b)
    
    Reports onForm 8-K. On October 30, 2003, the Registrant filed a Form 8-K reporting the
financial results of its third quarter of fiscal 2003.  (c)
    
    Exhibits ExhibitNumber
    
    Exhibit3.1
    
    Amended Certificate of Incorporation of the Registrant (l)3.2
    
    Amended and Restated Bylaws of the Registrant (l)4.1
    
    Form of Certificate representing shares of Common Stock, par value $.001 per share (1)10.13
    
    A Vodavi Single Line Telephone Agreement Extension dated April 4, 1997
between Vodavi Communications Systems, Inc. and L.G. Srithai Electronics
Co., Ltd. (2)10.19
    
    OEM Agreement dated as of June 19, 1995, between Tecom Co., Ltd. and
Vodavi Communications Systems, Inc. (3)10.23
    
    Amended and Restated Credit Agreement dated as of April 11, 1994 between
Vodavi Communications Systems, Inc. and General Electric Capital
Corporation, as Amended and Restated as of June 11, 1997 (2)10.24
    
    First Amendment to Stock Pledge and Security Agreement dated as of June
11, 1997, between Vodavi Technology, Inc. and General Electric Capital
Corporation (2)10.25
    
    Security Agreement dated as of June 11, 1997 between Enhanced Systems,
Inc. and General Electric Capital Corporation (2)10.28
    
    Trademark Security Agreement, dated as of June 11, 1997, by and between
Vodavi Communications Systems, Inc. and General Electric Capital
Corporation (2)10.29
    
    Trademark Security Agreement dated as of June 11, 1997, by and between
Enhanced Systems, Inc. and General Electric Capital Corporation (2)10.35
    
    Repair and Refurbishment Agreement dated June 24, 1999, between Vodavi
Communication Systems, Inc. and Aztec International LLC (4)10.36
    
    License Agreement dated May 17, 1999, between Santa Barbara Connected
Systems Corporation and Vodavi Technology, Inc. (4)10.37
    
    Object Code Software License Agreement dated May 24, 1999, between D2
Technologies, Inc. and Vodavi Technology, Inc. (4)10.38
    
    Fourth Amendment to Credit Agreement between Vodavi Communications
Systems, Inc. and General Electric Capital Corporation (5)10.40
    
    Employment Agreement dated October 1, 1999, between William J. Hinz and
Vodavi Technology, Inc. (6)10.42
    
    Second Amendment to Amended and Restated Credit Agreement dated October
31, 1999, between Vodavi Communications Systems, Inc. and General Electric
Capital Corporation (6)10.43
    
    Third Amendment to Amended and Restated Credit Agreement dated October
9, 2000, between Vodavi Communications Systems, Inc. and General Electric
Capital Corporation (7)10.44
    
    Waiver and Amendment of Credit Agreement dated May 11, 2001, between
Vodavi Communications Systems, Inc. and General Electric Capital
Corporation (8)10.47
    
    Sublease Agreement dated August 8, 2001, between Vodavi Communications
Systems, Inc. and SpeedFam-IPEC, Inc. (9)
 48




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ExhibitNumber
    
    Exhibit10.49
    
    Second Amended and Restated 1994 Stock Option Plan (amended through May
13, 2002) (10)10.50
    
    Fourth Amendment to Amended and Restated Credit Agreement dated March 4,
2002, between Vodavi Communications Systems, Inc. and General Electric
Capital Corporation (11)10.51
    
    Employment Agreement, effective January 1, 2003, between David A.
Husband and Vodavi Technology, Inc. (11)10.52
    
    Employment Agreement, effective October 1, 2002 between Gregory K.
Roeper and Vodavi Technology, Inc. (11)10.53
    
    Credit Agreement dated as of April 10, 2003 by and between Vodavi
Communication Systems, Inc. and Comerica Bank  California (12)10.54
    
    Vodavi Technology, Inc. 2003 Incentive Compensation Plan10.55
    
    Employment Agreement, effective October 1, 2003, between Gregory K.
Roeper and Vodavi Technology, Inc.10.56
    
    Employment Agreement, effective January 1, 2004, between David A.
Husband and Vodavi Technology, Inc.10.57
    
    Employment Agreement, effective January 1, 2004, between Steven R.
Francis and Vodavi Technology, Inc.21
    
    List of Subsidiaries23.1
    
    Consent of Mayer Hoffman McCann P.C.23.2
    
    Consent of Deloitte & Touche LLP31.1
    
    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.
   (1)
    
    Incorporated by reference to Registration Statement on Form S-1 (No.
33-95926) and amendments thereto which became effective on October 6,
1995.(2)
    
    Incorporated by reference to the Registrants Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, as filed on August 11, 1997.(3)
    
    Incorporated by reference to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 31, 1995, as filed on April 1, 1996.(4)
    
    Incorporated by reference to the Registrants Quarterly Report on Form
10-Q for the quarter ended June 30, 1999, as filed on August 16, 1999.(5)
    
    Incorporated by reference to the Registrants Quarterly Report on Form
10-Q for the quarter ended September 30, 1999, as filed on November 12,
1999.(6)
    
    Incorporated by reference to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 31, 1999, as filed on March 27, 2000.(7)
    
    Incorporated by reference to the Registrants Quarterly Report on Form
10-Q for the quarter ended September 30, 2000, as filed on November 14,
2000.(8)
    
    Incorporated by reference to the Registrants Quarterly Report on Form
10-Q for the quarter ended March 31, 2001, as filed on May 15, 2001.(9)
    
    Incorporated by reference to the Registrants Quarterly Report on Form
10-Q for the quarter ended September 30, 2001, as filed on November 13,
2001.(10)
    
    Incorporated by reference to Registration Statement on Form S-8 (No.
333-98819) as filed by the Registrant on August 27, 2002.(11)
    
    Incorporated by reference to the Registrants Annual Report on Form 10-K
for the fiscal year ended December 31, 2002, as filed on March 31, 2003.(12)
    
    Incorporated by reference to the
Registrants Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 2003, as filed on
April 29, 2003. 49




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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.Date: March 5, 2004
    
    By:
    
    /s/ Gregory K. RoeperGregory K. RoeperPresident and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacity and on the dates indicated. Signature
    
    Title
    
    Date/s/ William J. Hinz

William J. Hinz
    
    Chairman of the Board
    
    March 5, 2004/s/ Gregory K. Roeper

Gregory K. Roeper
    
    President, Chief Executive Officer,
and Director
(Principal Executive Officer)
    
    March 5, 2004/s/ David A. Husband

David A. Husband
    
    Vice President  Finance, Chief Financial
Officer, Secretary, and Treasurer
(Principal Financial and Accounting Officer)
    
    March 5, 2004/s/ Jack A. Henry

Jack A. Henry
    
    Director
    
    March 5, 2004/s/ Jong Hwa Choi
Jong Hwa Choi
    
    Director
    
    March 5, 2004/s/ Stephen A McConnell

Stephen A McConnell
    
    Director
    
    March 5, 2004/s/ Emmett E. Mitchell

Emmett E. Mitchell
    
    Director
    
    March 5, 2004/s/ Frederick M. Pakis

Frederick M. Pakis
    
    Director
    
    March 5, 2004/s/ Paul D. Sonkin

Paul D. Sonkin
    
    Director
    
    March 5, 2004
 50




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VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements and Schedule PageIndependent
Auditors Report  Mayer Hoffman McCann P.C.
    
    
    F-2Independent
Auditors Report  Deloitte & Touche LLP
    
    
    F-3Consolidated Balance Sheets as of December 31, 2003 and 2002
    
    
    F-4Consolidated Statements of Operations for the Years Ended
December 31, 2003, 2002, and 2001
    
    
    F-5Consolidated Statements of Changes in Stockholders Equity for
the Years Ended December 31, 2003, 2002, and 2001
    
    
    F-6Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002, and 2001
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Independent
Auditors Report on Schedules  Mayer Hoffman McCann P.C.
    
    
    S-1Independent
Auditors Report on Schedules  Deloitte & Touche LLP
    
    
    S-2Schedule II  Valuation and Qualifying Accounts
    
    
    S-3
 F-1




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INDEPENDENT AUDITORS REPORT To the Board of Directors and Stockholders of Vodavi Technology, Inc. We have audited the accompanying consolidated balance sheet of Vodavi
Technology, Inc. and subsidiaries as of December 31, 2003, and the related
consolidated statements of operations, changes in stockholders equity and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit. The
consolidated financial statements of the Company as of December 31, 2002, and
for each of the two years in the period ended December 31, 2002, were audited
by other auditors whose report dated February 14, 2003, expressed an
unqualified opinion on those statements We conducted our audit in accordance with U.S. generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Vodavi Technology,
Inc. and subsidiaries at December 31, 2003, and the results of their operations
and their cash flows for the year then ended in conformity with U.S. generally
accepted accounting principles. /s/ Mayer Hoffman McCann P.C. MAYER HOFFMAN MCCANN P.C.
Phoenix, Arizona
February 9, 2004 F-2




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INDEPENDENT AUDITORS REPORT To the Board of Directors and Stockholders of Vodavi Technology, Inc. We have audited the accompanying consolidated balance sheets of Vodavi
Technology, Inc. and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of operations, changes in stockholders equity,
and cash flows for the years then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express
an opinion on these financial statements based on our audits. The Companys
consolidated financial statements for the year ended December 31, 2000 were
audited by other auditors who have ceased operations. Those auditors expressed
an unqualified opinion on those consolidated financial statements in their
report dated February 2, 2001. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2002 and
2001, and the results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America. As discussed above, the consolidated financial statements of the Company for
the year ended December 31, 2000 were audited by other auditors who have ceased
operations. As described in Note 1, these financial statements have been
revised to include the transitional disclosures required by Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets
(SFAS 142), which was adopted by the Company as of January 1, 2002. Our audit
procedures with respect to the disclosures in Note 1 with respect to 2000
included (1) comparing the previously reported net income to the previously
issued financial statements and the adjustments to reported net income
representing amortization expense (including any related tax effects)
recognized in those periods related to goodwill, intangible assets that are no
longer being amortized, deferred credits related to an excess over cost, equity
method goodwill, and changes in amortization periods for intangible assets that
will continue to be amortized as a result of initially applying SFAS 142
(including any related tax effects) to the Companys underlying analysis
obtained from management, and (2) testing the mathematical accuracy of the
reconciliation of adjusted net income to reported net income and the related
earnings-per-share amounts. In our opinion, the disclosures for 2000 in Note 1
are appropriate. However, we were not engaged to audit, review, or apply any
procedures to the 2000 financial statements of the Company other than with
respect to such disclosures and, accordingly, we do not express an opinion or
any other form of assurance on the 2000 financial statements taken as a whole. DELOITTE & TOUCHE LLP
Phoenix, Arizona
February 14, 2003 F-3




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##### Table of Contents



VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES 
 Consolidated Balance SheetsIn thousands except share and per share amounts December 31,2003
    
    2002AssetsCurrent AssetsCash
    
    $
    2,924
    
    
    $
    1,141Accounts receivable, net of reserves for doubtful accounts
and sales returns of $345 in 2003 and $422 in 2002
    
    
    6,988
    
    
    
    6,671Inventories
    
    
    5,115
    
    
    
    5,550Income tax receivable
    
    
    
    
    
    
    300Deferred income taxes
    
    
    445
    
    
    
    436Prepaid expenses and other
    
    
    768
    
    
    
    731Total current assets
    
    
    16,240
    
    
    
    14,829Property and equipment, net
    
    
    1,453
    
    
    
    1,631Goodwill
    
    
    725
    
    
    
    725Deferred Income Taxes
    
    
    34
    
    
    
    160Other Long-Term Assets, net
    
    
    71
    
    
    
    43$
    18,523
    
    
    $
    17,388Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    1,031
    
    
    $
    1,250Accrued liabilities
    
    
    1,568
    
    
    
    987Accrued rebates
    
    
    627
    
    
    
    564Accounts payable to stockholder
    
    
    4,208
    
    
    
    3,965Current maturities of long-term debt
    
    
    200
    
    
    
    Total current liabilities
    
    
    7,634
    
    
    
    6,766Long-Term Debt, net of current maturities
    
    
    700
    
    
    
    Commitments and Contingencies (Note 5)Stockholders Equity:Preferred stock, $.001 par value, 1,000,000 shares authorized;
no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $.001 par value, 10,000,000 shares authorized;
3,929,164 and 4,668,488 shares issued at December 31, 2003
and 2002, respectively
    
    
    4
    
    
    
    5Additional paid-in capital
    
    
    11,800
    
    
    
    13,503Accumulated deficit
    
    
    (856
    )
    
    
    (2,127
    )Treasury stock, at cost; 318,700 shares at December 31, 2003
and 2002
    
    
    (759
    )
    
    
    (759
    )10,189
    
    
    
    10,622$
    18,523
    
    
    $
    17,388
 The accompanying notes are an integral part of these consolidated financial statements. F-4




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VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES 
 Consolidated Statements of OperationsIn thousands except per share amounts Years Ended December 31,2003
    
    2002
    
    2001Revenue, net
    
    $
    41,270
    
    
    $
    37,328
    
    
    $
    34,153Cost of Goods Sold
    
    
    26,985
    
    
    
    23,879
    
    
    
    22,983Gross Margin
    
    
    14,285
    
    
    
    13,449
    
    
    
    11,170Operating Expenses:Engineering and product development
    
    
    2,071
    
    
    
    2,333
    
    
    
    1,998Selling, general and administrative
    
    
    10,011
    
    
    
    9,831
    
    
    
    11,18512,082
    
    
    
    12,164
    
    
    
    13,183Operating Income (Loss)
    
    
    2,203
    
    
    
    1,285
    
    
    
    (2,013
    )Interest Expense
    
    
    128
    
    
    
    97
    
    
    
    406Income (Loss) Before Income Taxes and Change
in Accounting Principle
    
    
    2,075
    
    
    
    1,188
    
    
    
    (2,419
    )Provision for (Benefit from) Income Taxes
    
    
    804
    
    
    
    471
    
    
    
    (863
    )Income (Loss) Before Change in Accounting Principle
    
    
    1,271
    
    
    
    717
    
    
    
    (1,556
    )Change in Accounting Principle, net of taxes
    
    
    
    
    
    
    (1,263
    )
    
    
    Net Income (Loss)
    
    $
    1,271
    
    
    $
    (546
    )
    
    $
    (1,556
    )Basic earnings per share:Income (loss) before change in accounting principle
    
    $
    0.33
    
    
    $
    0.16
    
    
    $
    (0.37
    )Change in accounting principle
    
    
    
    
    
    
    (0.29
    )
    
    
    Net Income (Loss)
    
    $
    0.33
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )Diluted earnings per share:Income (loss) before change in accounting principle
    
    $
    0.30
    
    
    $
    0.16
    
    
    $
    (0.37
    )Change in accounting principle
    
    
    
    
    
    
    (0.29
    )
    
    
    Net Income (Loss)
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )Weighted Average Shares Outstanding:Basic
    
    
    3,906
    
    
    
    4,331
    
    
    
    4,235Diluted
    
    
    4,170
    
    
    
    4,428
    
    
    
    4,235
 The accompanying notes are an integral part of these consolidated financial statements. F-5




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VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES 
 Consolidated Statements of
Changes in Stockholders EquityIn thousands except share amounts Common Stock
    
    Additional
Paid-In
    
    Accumulated
    
    Treasury StockShares Issued
    
    Amount
    
    Capital
    
    Deficit
    
    Shares
    
    Value
    
    TotalBalance, December 31, 2000
    
    
    4,553,488
    
    
    $
    5
    
    
    $
    13,363
    
    
    $
    (25
    )
    
    
    (318,700
    )
    
    $
    (759
    )
    
    $
    12,584Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,556
    )
    
    
    
    
    
    
    
    
    
    
    (1,556
    )Balance, December 31, 2001
    
    
    4,553,488
    
    
    
    5
    
    
    
    13,363
    
    
    
    (1,581
    )
    
    
    (318,700
    )
    
    
    (759
    )
    
    
    11,028Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (546
    )
    
    
    
    
    
    
    
    
    
    
    (546
    )Common stock issued
    
    
    115,000
    
    
    
    
    
    
    
    150
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150Tax effect of expired warrants
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Balance, December 31, 2002
    
    
    4,668,488
    
    
    
    5
    
    
    
    13,503
    
    
    
    (2,127
    )
    
    
    (318,700
    )
    
    
    (759
    )
    
    
    10,622Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,271
    
    
    
    
    
    
    
    
    
    
    
    1,271Stock Repurchase
    
    
    (829,199
    )
    
    
    (1
    )
    
    
    (2,062
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,063
    )Options Exercised
    
    
    89,875
    
    
    
    
    
    
    
    218
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    218Tax Benefit Exercised
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136Shareholder Contribution
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5Balance, December 31, 2003
    
    
    3,929,164
    
    
    $
    4
    
    
    $
    11,800
    
    
    $
    (856
    )
    
    
    (318,700
    )
    
    $
    (759
    )
    
    $
    10,189
 The accompanying notes are an integral part of these consolidated financial statements. F-6




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##### Table of Contents



VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES 
 Consolidated Statements of Cash FlowsIn thousands Years ended December 31,2003
    
    2002
    
    2001Cash flows from Operating Activities:Net income (loss)
    
    $
    1,271
    
    
    $
    (546
    )
    
    $
    (1,556
    )Adjustments to reconcile net income (loss) to
net cash provided by operating activities:Depreciation and amortization
    
    
    467
    
    
    
    635
    
    
    
    988Change in accounting principle
    
    
    
    
    
    
    1,263
    
    
    
    Tax benefit on stock option exercises
    
    
    136
    
    
    
    
    
    
    
    Provision for doubtful accounts and
sales returns
    
    
    146
    
    
    
    256
    
    
    
    839Deferred taxes
    
    
    117
    
    
    
    397
    
    
    
    16Changes in working capital:Accounts receivable
    
    
    (463
    )
    
    
    69
    
    
    
    3,962Inventories
    
    
    435
    
    
    
    (199
    )
    
    
    1,376Income tax receivable
    
    
    300
    
    
    
    539
    
    
    
    (839
    )Prepaid expenses and other
    
    
    (37
    )
    
    
    (148
    )
    
    
    296Other long-term assets
    
    
    (47
    )
    
    
    3
    
    
    
    (6
    )Accounts payable
    
    
    (219
    )
    
    
    (204
    )
    
    
    80Accounts payable to stockholder
    
    
    243
    
    
    
    2,981
    
    
    
    (1,398
    )Accrued liabilities and accrued rebates
    
    
    644
    
    
    
    (543
    )
    
    
    (144
    )Net cash provided by
operating activities
    
    
    2,993
    
    
    
    4,503
    
    
    
    3,614Cash flows from Investing Activities:Cash paid to acquire property and equipment
    
    
    (270
    )
    
    
    (485
    )
    
    
    (172
    )Cash paid to acquire DataSpeak Systems, Inc.
    
    
    
    
    
    
    (624
    )
    
    
    Net cash used in investing activities
    
    
    (270
    )
    
    
    (1,109
    )
    
    
    (172
    )Cash Flows from Financing Activities:Payments on revolving credit facility, net
    
    
    
    
    
    
    (2,593
    )
    
    
    (3,666
    )Borrowings on term loan
    
    
    1,000
    
    
    
    
    
    
    
    Repayments on term loan
    
    
    (100
    )
    
    
    
    
    
    
    Purchase of common stock
    
    
    (2,063
    )
    
    
    
    
    
    
    Stock options exercised
    
    
    218
    
    
    
    
    
    
    
    Shareholder contribution
    
    
    5
    
    
    
    
    
    
    
    Net cash used in financing
activities
    
    
    (940
    )
    
    
    (2,593
    )
    
    
    (3,666
    )Change in Cash
    
    
    1,783
    
    
    
    801
    
    
    
    (224
    )Cash, beginning of period
    
    
    1,141
    
    
    
    340
    
    
    
    564Cash , end of period
    
    $
    2,924
    
    
    $
    1,141
    
    
    $
    340
 The accompanying notes are an integral part of these consolidated financial statements. F-7




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VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES 
 Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001  1.
    
    Nature of Business and Summary of Significant Accounting Policiesa.     Nature of BusinessVodavi Technology, Inc., a Delaware corporation, and subsidiaries (the
Company), designs, develops, markets, and supports a broad range of
business telecommunications solutions, including digital and IP-based
telephone systems, voice processing systems, and computer-telephony
products for a wide variety of business applications. The Company
markets its products primarily in the United States through a
distribution network consisting of wholesale distributors, direct
dealers, and its own sales personnel.The Company currently obtains most of its products from manufacturers
located in South Korea and Thailand. While the Company believes that
production of its product lines overseas enhances its profitability,
these arrangements expose the Company to certain economic and political
risks. The Company does not own most of the equipment, tools and molds
used in the manufacturing process and has only limited control over the
manufacturing of its products. A majority of these purchases are made
from a stockholder (see Note 8).b.     ConcentrationsSales to the Companys largest distributor, Graybar Electric Company,
Inc., accounted for 27% of total revenues during each of 2003, 2002 and
2001. During the same periods, sales to the Companys second largest
distributor accounted for an additional 14%, 12%, and 9% of total
revenues, respectively. Accounts receivable from the two largest
distributors comprise 51% and 43% of total accounts receivable as of
December 31, 2003 and 2002, respectively. No other customers accounted
for more than 10% of the Companys revenues.Other financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash deposits in
bank accounts. Deposits in excess of amounts insured by the Federal
Deposit Insurance Corporation (FDIC) of $100,000 are exposed to loss in
the event of nonperformance by the institution. At times during the
year, the Company has had cash deposits in excess of the FDIC insurance
coverage.c.     Principles of ConsolidationThe consolidated financial statements include the accounts of Vodavi
Technology, Inc. and its wholly owned subsidiaries Vodavi Communications
Systems, Inc. (VCS), Vodavi Direct, Inc., and Vodavi-CT, Inc.
(Vodavi-CT), formerly known as Enhanced Systems, Inc. (together herein
referred to as the Company). In February 2002, Vodavi Direct, Inc. was
formed as a wholly owned subsidiary of VCS (see Note 2). As a result of
the discontinuance of the business operations of Vodavi-CT in 2001, this
entity was merged into its parent company in January 2003 and no longer
exists. All material intercompany transactions have been eliminated in
consolidation.d.     Use of EstimatesThe preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires the Companys
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 the reported
amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates. F-8




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Estimates are used in accounting for, among other things, customer
incentive programs, allowances for doubtful accounts and sales returns,
price protection, reserves for excess inventory and obsolescence, and
contingencies and litigation. 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.e.     InventoriesInventories consist of purchased finished products from a stockholder and
other third-party manufacturers and are stated at the lower of cost
(first-in, first-out method) or market. The Companys 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 reduce the carrying amount of the respective inventory
items to market value.The Company generally takes title to inventory upon shipment from the
manufacturer for international purchases and upon receipt for domestic
purchases.f.     Property and EquipmentProperty and equipment are stated at cost, less accumulated depreciation.
Depreciation is computed using the straight-line method over the
estimated useful lives of the respective assets. Leasehold improvements
are amortized on the straight-line method over the shorter of the
estimated useful lives of the assets or the term of the lease. When
property or equipment is sold or otherwise disposed of, the cost and
related accumulated depreciation are removed from the accounts and any
resulting gain or loss is reflected in operations for the period.Property and equipment and the related useful lives consist of the
following as of December 31, 2003 and 2002, respectively. Useful LifeType of Asset
    
    In Years
    
    2003
    
    2002($
    000
    )
    
    ($
    000
    )Office and computer equipment
    
    
    5
    
    
    $
    3,027
    
    
    $
    2,975Furniture and fixtures
    
    
    10
    
    
    
    579
    
    
    
    570Tooling and manufacturing equipment
    
    
    5-8
    
    
    
    1,879
    
    
    
    1,6705,485
    
    
    
    5,215Less  accumulated depreciation
    
    
    
    
    
    
    (4,032
    )
    
    
    (3,584
    )$
    1,453
    
    
    $
    1,631
  Depreciation expense was $448,000, $485,000, and $627,000, for the years
ended December 31, 2003, 2002, and 2001, respectively.g.     GoodwillGoodwill represents the cost in excess of the estimated fair values of
assets and liabilities acquired. In 2001, goodwill was being amortized
on the straight-line method over 20 years. Amortization expense was
$134,000 for the year ended December 31, 2001. On January 1, 2002, the
Company changed its method of accounting for goodwill. See note below.h.     Other Long-Term AssetsOther long-term assets consists principally of bank commitment fees, the
cash surrender value of key man life insurance, and acquired licensing
rights, including a licensing agreement the Company entered into in 1999
to acquire the licensing and manufacturing rights to certain voice mail
products for $500,000. This F-9




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agreement was being amortized utilizing a useful life of three years.
Amortization expense related to this asset was $0, $125,000 and $167,000
for the years ended December 31, 2003, 2002 and 2001, respectively. As
of December 31, 2002, all licensing-related assets were fully amortized.
Amortization of bank commitment fees is recognized as a component of
interest expense and totaled $19,000, $0 and $0 in 2003, 2002 and 2001
respectively.i.     Impairment of Long-Lived AssetsLong-lived assets, excluding goodwill and other intangible assets, are
reviewed for impairment whenever events or circumstances indicate that
the carrying amount of the assets may not be recoverable. If events or
changes in circumstances indicate that the carrying amount of the assets
may not be recoverable, the Company compares the carrying value of the
assets to the sum of the expected future cash flows (undiscounted and
without interest charges) to be generated by the assets and their
ultimate disposition. If the sum of the undiscounted cash flows is less
then the carrying value, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair
value of the assets. Assets to be disposed are valued at the lower of
carrying value or fair value, less costs to sell.j      Change in Accounting Principle and Recent Accounting PronouncementsIn 2001, the FASB issued Statement No. 141, Accounting For Business
Combinations, and Statement No. 142, Goodwill And Other Intangible
Assets. These statements modified accounting for business combinations
after June 30, 2001 and affected the Companys treatment of goodwill and
other intangible assets effective January 1, 2002. The Statements
require that goodwill existing at the date of adoption be reviewed for
possible impairment and that impairment tests be performed at least
annually, with impaired assets written-down to fair value. Additionally,
existing goodwill and intangible assets must be assessed and classified
consistent with the Statements criteria. Intangible assets with
estimated useful lives will continue to be amortized over those periods.
Amortization of goodwill and intangible assets with indeterminate lives
will cease.The Company had determined that upon adoption of these Statements on
January 1, 2002, the entire $1.6 million carrying amount of the goodwill
as of that date was impaired. This determination was based principally
on the total market value of the Companys issued and outstanding common
stock on January 1, 2002 of $5.5 million compared to the Companys book
value on December 31, 2001 of $11.0 million. The goodwill impairment was
recognized in 2002 as a change in accounting principle, net of $375,000
of income taxes.The following table sets forth, for the periods presented, pro forma net
income (loss) as if we had adopted SFAS Nos. 141 and 142 from the
earliest period presented: ($000s except per share amounts) Year Ended December 31,2003
    
    2002
    
    2001Amount
    
    EPS
    
    Amount
    
    EPS
    
    Amount
    
    EPSIncome (loss) before
change in accounting
principle, as reported
    
    $
    1,271
    
    
    $
    0.30
    
    
    $
    717
    
    
    $
    0.16
    
    
    $
    (1,556
    )
    
    $
    (0.37
    )Add back goodwill
amortization, net of
taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100
    
    
    
    0.02Adjusted net income (loss)
    
    $
    1,271
    
    
    $
    0.30
    
    
    $
    717
    
    
    $
    0.16
    
    
    $
    (1,456
    )
    
    $
    (0.35
    )
  In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which clarifies the
application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, relating to consolidation of certain entities.
This Interpretation was subsequently revised by FIN 46 (revised 2003)
(FIN 46(R)) issued in December 2003. This Interpretation states that
consolidation of variable interest entities will be required by the
primary beneficiary if the entities do not effectively disperse risks
among the parties involved. The requirements are effective for fiscal
years beginning after December 15, 2003 for newly created variable
interest entities and for all other variable F-10




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interest entities for periods ending after December 31, 2004. The
Company does not believe that adoption of FIN 46® will have any effect
on its financial statements.In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity. This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an
issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is
effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The adoption of this
Statement did not have a material impact on our financial condition or
results from operations.k.     Income TaxesIncome taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax basis, and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date. A valuation allowance is
recorded against deferred tax assets if it is unlikely that some or all
of the deferred tax assets will be realized.l.     Revenue RecognitionThe Company recognizes revenue when persuasive evidence of an arrangement
exists, delivery has occurred, the fee is fixed and determinable and
collectibility is probable. Generally, all of these conditions are met
at the time the Company ships products to customers. Additionally,
revenues from software sales were recognized when delivery had occurred,
the license fee was fixed and determinable, collectibility was reasonably
assured and evidence of an arrangement existed. Software maintenance and
support revenues were recognized ratably over the term of the contract,
generally twelve months. Revenues from professional services for
customization of software are generally recognized under two methods,
depending on contractual terms. Under the time and materials method,
revenue is based on a fee-per-hour basis and is recognized as hours are
completed. Under the fixed contract method, a pre-set fee is agreed upon
for a project, and revenue is recognized proportionately to the
percentage completion of the project. Revenues are recorded net of
discounts, allowances for sales returns, and volume rebates.m.     Engineering and Product DevelopmentAll costs associated with internal engineering and product development
activities are expensed as incurred.n.     Stock Option PlansStatement 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.The Company has computed, for pro forma disclosure purposes, the value of
all options granted during 2003, 2002, and 2001, using the Black-Scholes
option pricing model with the following weighted average assumptions: F-11




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##### Table of Contents



Years Ended December 31,2003
    
    2002
    
    2001Risk free interest rate
    
    
    3.05
    %
    
    
    3.05
    %
    
    
    5.03
    %Expected dividends
    
    None
    
    None
    
    NoneExpected lives in years
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0Expected volatility
    
    
    76.1
    %
    
    
    76.1
    %
    
    
    79.0
    %
  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: Years Ended December 31,2003
    
    2002
    
    2001(in thousands, except per share amounts)Net income (loss):As reported
    
    $
    1,271
    
    
    $
    (546
    )
    
    $
    (1,556
    )Fair Value of options granted, net of taxes
    
    
    (105
    )
    
    
    (131
    )
    
    
    (126
    )Pro forma
    
    $
    1,166
    
    
    $
    (677
    )
    
    $
    (1,682
    )Earnings (loss) per share:As reported
 basic
    
    $
    0.33
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )As reported
 diluted
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )Pro forma
 basic
    
    $
    0.30
    
    
    $
    (0.16
    )
    
    $
    (0.40
    )Pro forma
 diluted
    
    $
    0.28
    
    
    $
    (0.16
    )
    
    $
    (0.40
    )
  o.      Earnings Per ShareIn accordance with SFAS No. 128, Earnings Per Share, the Company
displays 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: F-12




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##### Table of Contents



2003
    
    2002
    
    2001(In thousands, except per share data)Income (loss) before change in
accounting principal
    
    $
    1,271
    
    
    $
    717
    
    
    $
    (1,556
    )Change in accounting principal
    
    
    
    
    
    
    (1,263
    )
    
    
    Net income (loss)
    
    $
    1,271
    
    
    $
    (546
    )
    
    $
    (1,556
    )Weighted average common shares for
basic earnings per share
    
    
    3,906
    
    
    
    4,331
    
    
    
    4,235Effect of dilutive stock options(1)
    
    
    264
    
    
    
    97
    
    
    
    Weighted average common shares for
diluted earnings per share
    
    
    4,170
    
    
    
    4,428
    
    
    
    4,235Basic earnings per share:Income (loss) before change in
accounting principle
    
    $
    0.33
    
    
    $
    0.16
    
    
    $
    (0.37
    )Change in accounting principle
    
    
    
    
    
    
    (0.29
    )
    
    
    Net income (loss)
    
    $
    0.33
    
    
    $
    (0.13
    )
    
    $
    0.37
    )Diluted earnings per share:Income (loss) before change in
accounting principle
    
    $
    0.30
    
    
    $
    0.16
    
    
    $
    (0.37
    )Change in accounting principle
    
    
    
    
    
    
    (0.29
    )
    
    
    Net income (loss)
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )
 (1) Dilutive securities are calculated using the treasury stock method and the
average market price during the period. Options on 243,000, 625,000, and
646,500 shares had an exercise price greater than the average market price
during the years ended December 31, 2003, 2002, and 2001, respectively, and
therefore did not enter into the earnings per share calculation.  p.     Fair Value of Financial InstrumentsThe carrying value of cash, accounts receivable, accounts payable,
payable to related parties, and accrued liabilities approximate fair
values due to the short-term maturities of these instruments. As the
revolving credit facility and term loan bear a variable interest rate
based on the prime rate, the carrying value approximates fair value.q.     SegmentsThe Company operates in one reportable segment, the distribution of
business telecommunications equipment. Accordingly, the Company has only
presented financial information for its one reportable segment.r.     ReclassificationsCertain reclassifications have been made to the financial statements for
the years ended December 31, 2002 and 2001 to conform to the current
years presentation.  2.
    
    AcquisitionsOn March 4, 2002, the Company, through its wholly owned subsidiary Vodavi
Direct, Inc., acquired substantially all of the assets and assumed
certain liabilities of DataSpeak Systems, Inc., an Arizona-based dealer
of the Companys products. Under the terms of the purchase agreement,
the Company paid cash of $624,000 and issued 100,000 shares of restricted
common stock valued at $135,000 based on the closing F-13




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##### Table of Contents



price of the Companys common stock on the date of the acquisition. The
purchase price was allocated as follows (in thousands): Inventory
    
    $
    20Prepaid assets
    
    
    9Property and equipment
    
    
    50Deferred Taxes
    
    
    9Goodwill
    
    
    725Accrued liabilities
    
    
    (54
    )$
    759
  3.
    
    Special ChargesDuring the first quarter of 2001, the Company implemented a restructuring
plan aimed at reducing its operating expenses to coincide with its then
current sales outlook. Pursuant to the restructuring plan, the Company
reduced its workforce by approximately 20 percent, discontinued its
Interactive Voice Response product group, and implemented broad-based
price reductions on certain voice mail products and single-line
telephones. These actions created severance-related obligations of
$168,000, estimated shut-down costs of $265,000, and estimated
distributor price protection obligations of $432,000.Additionally, in light of deteriorating economic and industry conditions
and planned introductions of new products in the first quarter of 2001,
the Company re-evaluated the carrying amount of certain receivables and
inventory items resulting in additional accounts receivable reserve
requirements of $328,000 and inventory impairments of $568,000.The pre-tax financial impact of these initiatives during 2001 totaled
approximately $1.8 million consisting of both cash and non-cash charges.
All accrued cash charges were paid by December 31, 2002. The following
table sets forth the components of these special charges included in the
accompanying consolidated statement of operations for the year ended
December 31, 2001: Amount
    
    Inclusion in($000)
    
    Statement of OperationsNon-cash Charges:Inventory impairments
    
    $
    568
    
    
    Cost of goods soldAllowance for bad debts
    
    
    328
    
    
    Selling, general & administrative expensesDistributor price protection
    
    
    151
    
    
    Revenue reductionProperty and equipment
    
    
    15
    
    
    Selling, general & administrative expenses1,062Cash Charges:Distributor price protection
    
    
    281
    
    
    Revenue reductionSeverance-related costs
    
    
    168
    
    
    Selling, general & administrative expensesOther shut-down costs
    
    
    250
    
    
    Selling, general & administrative expenses699$
    1,761
 F-14




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##### Table of Contents



The following table sets forth for the periods presented the total
revenue and operating income (loss) contributed by the Interactive Voice
Response product group that was discontinued in the first quarter of
2001: (in thousands) Year Ended December 31,2003
    
    2002
    
    2001Revenue
    
    $
    
    
    
    $
    135
    
    
    $
    1,331Operating income (loss)
    
    
    
    
    
    
    73
    
    
    
    (359
    )
  4.
    
    Revolving Credit FacilityIn April 2003, the Company entered into a credit agreement with Comerica
Bank-California (Comerica), which established a $5.0 million revolving
line of credit facility and a $1.0 million term loan (the Credit
Facility). Advances under the Credit Facility are based upon eligible
accounts receivable and inventory of the Companys wholly owned
subsidiary Vodavi Communications Systems, Inc. and are secured by
substantially all of the Companys assets. The Credit Facility contains
covenants that are customary for similar credit facilities and also
prohibits our operating subsidiaries from paying dividends to our Company
without the consent of Comerica. As of December 31, 2003, we had no
outstanding borrowings on our line of credit and $4.1 million available
for future advances.The $5.0 million revolving line of credit bears interest at Comericas
prime rate (4.0% as of December 31, 2003) and requires monthly payments
of interest only with all unpaid principal and accrued interest due at
its expiration in April 2005. If the Company is unable to reduce the
principal balance on the line of credit to zero for at least thirty
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, the Company 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 the Company only for the
purpose of acquiring its common stock. Borrowings on the term loan bear
interest at Comericas prime rate plus 0.5%, or 4.5% as of December 31,
2003. In addition to interest on the term loan, the Company is required
to make monthly payments of principal in an amount sufficient to fully
amortize the term loan over a sixty-month period with all unpaid
principal and accrued interest due in thirty-six months, or by June 2006.
The following table sets forth the scheduled payments under the term
loan as of December 31, 2003 (in thousands): Required PrincipalYear
    
    Payments2004
    
    $
    2002005
    
    
    2002006
    
    
    500$
    900
  5.
    
    Commitments and Contingenciesa.     Legal MattersThe Company was involved in a legal dispute with Paradygm Communications,
Inc. and R.C. Patel related to a strategic alliance agreement. In
October 2002, the parties settled the dispute. As a result, the Company
paid Paradygm and Patel $250,000 and incurred an additional $50,000 of
legal fees. The financial impact of the settlement is included in the
consolidated financial statements for the year ended December 31, 2002. F-15




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##### Table of Contents



From time to time the Company is subject to certain asserted and
unasserted claims encountered in the normal course of business. It is the
Companys belief 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 that result
in a material adverse effect on our financial position or results of
operations will not be imposed in these matters.b.     Operating LeasesThe Company has entered into long-term operating lease agreements for all
of its office and warehouse facilities and certain vehicles. Minimum
payments under the Companys lease agreements are as follows (in
thousands): SubleaseYears Ending December 31,
    
    Operating Leases
    
    Rentals
    
    Total2004
    
    $
    1,095
    
    
    $
    (215
    )
    
    $
    8802005
    
    
    881
    
    
    
    (15
    )
    
    
    8662006
    
    
    818
    
    
    
    
    
    
    
    8182007
    
    
    785
    
    
    
    
    
    
    
    7852008
    
    
    785
    
    
    
    
    
    
    
    785Thereafter
    
    
    2,356
    
    
    
    
    
    
    
    2,356Total minimum lease commitments
    
    $
    6,720
    
    
    $
    (230
    )
    
    $
    6,490
  Certain of the Companys lease agreements provide for initial periods of
free or discounted rental payments. Rent expense is recognized on a
straight-line basis and was approximately $1.1 million, $1.2 million and
$1.1 million for the years ended December 31, 2003, 2002, and 2001
respectively. The difference between rent expensed and rent paid (rent
equalization) was $9,000, $23,000 and $94,000 for the years ended
December 31, 2003, 2002, and 2001, respectively.c.     401(k) Profit Sharing PlanThe Company sponsors a profit sharing plan (the 401(k) Plan) pursuant to
Section 401(k) of the Internal Revenue Code. The 401(k) Plan covers
substantially all full-time employees who meet the eligibility
requirements and provides for a discretionary profit sharing contribution
by the Company and an employee elective contribution with a discretionary
Company matching provision. The Company expensed discretionary
contributions pursuant to the 401(k) Plan in the amounts of $58,000
$64,000, and $63,000 for the years ended December 31, 2003, 2002, and
2001, respectively.6.
    
    Stockholders Equitya.     Treasury StockIn the fourth quarter of 1999, the Company began acquiring shares of its
common stock in connection with a stock repurchase program authorized by
the Companys Board of Directors in October 1999. That program authorized
the Company to purchase up to 400,000 common shares over a six-month
period, which was subsequently extended through June 2001, on the open
market or pursuant to negotiated transactions at price levels the Company
deemed attractive. The Company purchased 318,700 shares at an aggregate
cost of $759,000 pursuant to the repurchase program.b.     Self Tender Offer  Stock RepurchaseIn May 2003, the Company commenced a self-tender offer to purchase up to
1,000,000 shares of its common stock for $2.40 per share. On June 13,
2003, the Company repurchased 829,199 shares of its common stock at $2.40
per share pursuant to the tender offer. The purchase price of
approximately $2.1 million, which includes offering costs of
approximately $73,000, is recorded as a reduction to common F-16




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##### Table of Contents



stock and additional paid in capital in the accompanying consolidated
balance sheet as of December 31, 2003.c.     Vodavi Technology, Inc. 1994 Stock Option Plan (the 1994 Plan)The 1994 Plan, as amended, provides for the granting of (a) options to
purchase shares of the Companys common stock, (b) stock appreciation
rights, (c) shares of the Companys common stock, or (d) other cash
awards related to the value of the Companys common stock. Under the 1994
Plan, options and other awards may be issued to key personnel of the
Company. The options issued may be incentive stock options or
nonqualified stock options. The 1994 Plan also includes an automatic
program under which nonqualified options are automatically granted to the
Companys nonemployee directors. If any options terminate or expire
without having been exercised in full, the stock underlying such options
will again be available for grant under the 1994 Plan. In July 2002,
stockholders approved an increase in the number of shares that may be
issued under the 1994 Plan from 1,100,000 to 1,600,000 shares. The 1994
Plan expires in April 2004. Upon expiration of the 1994 Plan, all
outstanding options granted under the 1994 Plan shall remain outstanding
until the expiration date of the individual option grants and all
remaining options available for grant with no longer be reserved for
issuance.d.     Vodavi Technology, Inc. 2003 Incentive Compensation Plan (the 2003 Plan)The 2003 Plan provides for the granting of awards in the form of
incentive stock options, nonqualified stock options, stock appreciation
rights, shares of restricted common stock, bonus stock in lieu of
obligations, or other stock-based awards to employees, directors, and
independent contractors who provide valuable services to our Company.
The 2003 Plan authorizes the issuance of 600,000 shares of stock, and no
more than 500,000 shares may be issued pursuant to incentive stock
options. The maximum number of shares of common stock covered by awards
granted to any individual in any year may not exceed 200,000. If any
award previously granted under the 2003 Plan is forfeited, terminated,
canceled, surrendered, does not vest, or expires without having been
exercised in full, stock not issued under such award will again be
available for grant for purposes of the 2003 Plan. If any change is made
in the stock subject to the 2003 Plan, or subject to any award granted
under the 2003 Plan (through consolidation, spin-off, recapitalization,
stock dividend, split-up, combination of shares, exchange of shares, or
otherwise), the 2003 Plan provides that appropriate adjustments will be
made as to the aggregate number and type of shares available for awards,
the maximum number and type of shares that may be subject to awards to
any individual, the number and type of shares covered by each outstanding
award, the exercise price, grant price, or purchase price relating to any
award, and any other aspect of any award that the Board of Directors or
Committee determines appropriate.To the extent that granted options are incentive stock options, the terms
and conditions of those options must be consistent with the qualification
requirements set forth in Section 422 of the Internal Revenue Code. The
expiration date, maximum number of shares purchasable, and the other
provisions of the options are established at the time of grant. Options
may be granted for terms of up to ten years and become exercisable in
whole or in one or more installments at such time as may be determined by
the plan administrator, but the exercise price may not be less than 100%
(110% if the option is granted to a stockholder who at the time the
option is granted owns stock representing more than ten percent of the
total combined voting power of all classes of the Companys stock) of the
fair market value of the common stock at the time of the grant. F-17




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##### Table of Contents



The following table sets forth the activity under the 1994 Plan and the
2003 Plan for each of the years presented: December 31, 2003
    
    December 31, 2002
    
    December 31, 2001Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Exercise
    
    Number of
    
    Exercise
    
    Number of
    
    ExerciseOptions
    
    Price
    
    Options
    
    Price
    
    Options
    
    PriceOptions outstanding at
beginning of period
    
    
    880,500
    
    
    $
    2.89
    
    
    
    804,500
    
    
    $
    3.08
    
    
    
    725,000
    
    
    $
    3.68Granted
    
    
    185,000
    
    
    
    1.81
    
    
    
    112,500
    
    
    
    1.70
    
    
    
    188,000
    
    
    
    1.04Forfeited
    
    
    (112,500
    )
    
    
    4.84
    
    
    
    (36,500
    )
    
    
    3.42
    
    
    
    (108,500
    )
    
    
    3.49Exercised
    
    
    (89,875
    )
    
    
    2.43
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options outstanding at end
of period
    
    
    863,125
    
    
    $
    2.46
    
    
    
    880,500
    
    
    $
    2.89
    
    
    
    804,500
    
    
    $
    3.08Options available for grant
    
    
    1,094,500
    (1)
    
    
    
    
    
    
    567,000
    
    
    
    
    
    
    
    143,000Exercisable at end of
period
    
    
    517,000
    
    
    $
    3.00
    
    
    
    530,875
    
    
    $
    3.52
    
    
    
    407,375
    
    
    $
    4.11Weighted average fair
value of options granted
    
    
    
    
    
    $
    0.82
    
    
    
    
    
    
    $
    1.08
    
    
    
    
    
    
    $
    0.69
 (1)  Options available for grant at December 31, 2003 include 494,500 under the
1994 Plan and 600,000 under the 2003 Plan. The Company has no intention on
granting new options under the 1994 Plan before it expires in April 2004.
Therefore, all remaining options available for grant under the 1994 Plan will
no longer be reserved for issuance when it expires. Options Outstanding
    
    Options ExercisableWeighted-Number
    
    Average
    
    
    
    
    
    NumberOutstanding at
    
    Remaining
    
    Weighted-
    
    Exercisable at
    
    Weighted-Range of
    
    December 31,
    
    Contractual Life
    
    Average
    
    at December 31,
    
    AverageExercise Prices
    
    2003
    
    Life (in years)
    
    Exercise Price
    
    2003
    
    Exercise Price$0.70 - $2.79
    
    
    687,125
    
    
    
    7.3
    
    
    $
    1.90
    
    
    
    366,000
    
    
    $
    2.24$2.80 - $4.89
    
    
    119,000
    
    
    
    4.7
    
    
    $
    3.95
    
    
    
    94,000
    
    
    $
    4.07$4.90 - $7.00
    
    
    57,000
    
    
    
    2.2
    
    
    $
    6.09
    
    
    
    57,000
    
    
    $
    6.09863,125
    
    
    
    
    
    
    $
    2.46
    
    
    
    517,000
    
    
    $
    3.00
  7.
    
    Income TaxesThe Company files a consolidated federal income tax return. The income
tax provision (benefit) is comprised of the following: 2003
    
    2002
    
    2001(in thousands)Current
    
    $
    687
    
    
    $
    74
    
    
    $
    (879
    )Deferred
    
    
    117
    
    
    
    397
    
    
    
    16$
    804
    
    
    $
    471
    
    
    $
    (863
    )
 F-18




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##### Table of Contents



The Company provides for deferred income taxes resulting from temporary
differences between amounts reported for financial accounting and income
tax purposes. The components of deferred income taxes at December 31,
2003 and 2002, were as follows: 2003
    
    2002(in thousands)Current deferred tax assets:Receivable reserves
    
    $
    72
    
    
    $
    73UNICAP adjustment
    
    
    80
    
    
    
    79Other accruals
    
    
    209
    
    
    
    200Research and development credits
    
    
    84
    
    
    
    84$
    445
    
    
    $
    436Long-term deferred tax assets:State net operating losses
    
    $
    
    
    
    $
    68Depreciation and amortization differences
    
    
    34
    
    
    
    92$
    34
    
    
    $
    160
  A reconciliation of the federal income tax rate to the Companys
effective income tax rate is as follows: 2003
    
    2002
    
    2001Federal statutory tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    (34.0
    )%State taxes, net
    
    
    3.3
    
    
    
    3.3
    
    
    
    (3.3
    )Research and development and other tax
credits
    
    
    (1.6
    )
    
    
    (2.8
    )
    
    
    (3.1
    )Non-deductible expenses and other permanent
differences
    
    
    3.0
    
    
    
    5.1
    
    
    
    4.738.7
    %
    
    
    39.6
    %
    
    
    (35.7
    )%
  8.
    
    Related Party TransactionsLG Electronics Inc. (LGE), the Companys principal supplier, owned
approximately 24% of the Companys outstanding common stock at December
31, 2003 and has a designated member on the Companys board of directors.
The Company purchased approximately $21.1 million, $18.5 million, and
$15.4 million of key telephone systems, commercial grade telephones, and
voice mail products from LGE and an affiliate of LGE during 2003, 2002,
and 2001, respectively. The Company owed LGE and its affiliate a total
of $4,208,000 and $3,965,000 for product purchases at December 31, 2003
and 2002, respectively. The Companys payment terms with LGE and its
affiliate are 60 days after shipment, except for shipments of single line
telephones, which are 30 days after shipment. Current balances are
non-interest bearing.The Company conducts joint development activities with LGE for the design
and development of hardware incorporated into some of the Companys
existing and planned telephone systems and commercial grade telephones.
Generally, LGE contributes the ongoing research and development costs for
the product hardware and produces the finished goods developed under the
alliance, and the Company obtains the right to sell such products
throughout North America and the Caribbean.In July 2001, the Company entered into a development agreement with LGE
under which the Company developed for LGE certain advanced voice
messaging technologies. The Company recorded revenue of $24,000 in 2003,
$183,500 in 2002 and $210,000 in 2001 for work performed under the
development agreement using the percentage of completion method. As of
December 31, 2003, LGE had made cash payments to the Company of $417,500
pursuant to the agreement. F-19




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##### Table of Contents



9.
    
    Supplemental Cash Flow InformationCash paid for interest and income taxes for the years ended December 31,
2003, 2002, and 2001 was as follows: 2003
    
    2002
    
    2001(in thousands)Interest
    
    $
    128
    
    
    $
    97
    
    
    $
    406Income taxes
    
    $
    195
    
    
    $
    401
    
    
    $
    
 Supplemental schedule of non-cash activities:
    
    2002(in thousands)Common Stock issued to acquire DataSpeak Systems, Inc.
    
    $
    135Common Stock issued in lieu of employee cash bonus
    
    $
    15Tax effect of expired warrants
    
    $
    (10
    )
  There were no non-cash activities during the years ended December 31,
2003 or 2001.10.
    
    Summary of Quarterly Results (unaudited): (in thousands, except per
share amounts) First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Year2003Revenue, net
    
    $
    9,063
    
    
    $
    10,214
    
    
    $
    11,397
    
    
    $
    10,596
    
    
    $
    41,270Gross margin
    
    
    3,179
    
    
    
    3,444
    
    
    
    3,941
    
    
    
    3,721
    
    
    
    14,285Income before income taxes
and change in accounting principle
    
    
    212
    
    
    
    552
    
    
    
    747
    
    
    
    564
    
    
    
    2,075Provision for income taxes
    
    
    85
    
    
    
    219
    
    
    
    295
    
    
    
    205
    
    
    
    804Income before change in accounting
principle
    
    
    127
    
    
    
    333
    
    
    
    452
    
    
    
    359
    
    
    
    1,271Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    127
    
    
    $
    333
    
    
    $
    452
    
    
    $
    359
    
    
    $
    1,271Diluted earnings per share
    
    $
    0.03
    
    
    $
    0.08
    
    
    $
    0.12
    
    
    $
    0.09
    
    
    $
    0.302002Revenue, net
    
    $
    8,790
    
    
    $
    9,459
    
    
    $
    10,541
    
    
    $
    8,538
    
    
    $
    37,328Gross margin
    
    
    3,151
    
    
    
    3,463
    
    
    
    3,941
    
    
    
    2,894
    
    
    
    13,449Income (loss) before income taxes and
change in accounting principle
    
    
    279
    
    
    
    499
    
    
    
    366
    
    
    
    44
    
    
    
    1,188Provision (benefit) for income taxes
    
    
    112
    
    
    
    197
    
    
    
    145
    
    
    
    17
    
    
    
    471Income before change in accounting
principle
    
    
    167
    
    
    
    302
    
    
    
    221
    
    
    
    27
    
    
    
    717Change in accounting principle
    
    
    (1,263
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,263
    )Net income (loss)
    
    $
    (1,096
    )
    
    $
    302
    
    
    $
    221
    
    
    $
    27
    
    
    $
    (546
    )Diluted earnings (loss) per share
    
    $
    (0.26
    )
    
    $
    0.07
    
    
    $
    0.05
    
    
    $
    0.01
    
    
    $
    (0.13
    )
 F-20




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##### Table of Contents



INDEPENDENT AUDITORS REPORT ON SCHEDULES To the Board of Directors and Stockholders of Vodavi Technology, Inc. We have audited the consolidated financial statements of Vodavi Technology,
Inc. and subsidiaries as of and for the year ended December 31, 2003 and have
issued our report thereon dated February 9, 2004 (included herein on page F-2
of this Form 10-K). Our audit was conducted for the purpose of forming an
opinion on the basic consolidated financial statements taken as a whole. The
information included in the accompanying Schedule II  Valuation and Qualifying
Accounts on page S-3 is presented for purposes of complying with the Securities
and Exchange Commissions rules and is not a required part of the basic
consolidated financial statements. Such information for the year ended December
31, 2003 has been subjected to the auditing procedures applied in the audit of
the basic consolidated financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic consolidated financial
statements taken as a whole. /s/ Mayer Hoffman McCann P.C. MAYER HOFFMAN MCCANN P.C.
Phoenix, Arizona
February 9, 2004 S-1




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##### Table of Contents



INDEPENDENT AUDITORS REPORT ON SCHEDULES To the Board of Directors and Stockholders of
Vodavi Technology, Inc.
Phoenix, Arizona We have audited the consolidated financial statements of Vodavi Technology,
Inc. and subsidiaries (the Company) as of December 31, 2002 and 2001 and for
the years then ended, and have issued our report thereon dated February 14,
2003; such financial statements and report are included elsewhere in this
annual report on Form 10-K of Vodavi Technology, Inc. and subsidiaries. Our
audits also included the consolidated financial statement schedules for 2002
and 2001 of Vodavi Technology, Inc. and subsidiaries, listed in the Index to
Consolidated Financial Statements and Schedule. The financial statement
schedules are the responsibility of the Companys management. Our
responsibility is to express an opinion based on our audits. In our opinion,
such 2002 and 2001 consolidated financial statement schedules, when considered
in relation to the basic 2002 and 2001 consolidated financial statements taken
as a whole, present fairly in all material respects the information set forth
therein. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP
Phoenix, Arizona
February 14, 2003 S-2




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##### Table of Contents



SCHEDULE II Valuation and Qualifying Accounts For the years ended December 31, 2003, 2002, and 2001 In thousands 2003
    
    2002
    
    2001Reserves for doubtful accounts and sales returns:Balance at beginning of year
    
    $
    422
    
    
    $
    730
    
    
    $
    1,582Provision charged to expense
    
    
    146
    
    
    
    256
    
    
    
    839Write-offs
    
    
    (223
    )
    
    
    (564
    )
    
    
    (1,691
    )Balance at end of year
    
    $
    345
    
    
    $
    422
    
    
    $
    730Restructuring reserve:Balance at beginning of year
    
    $
    
    
    
    $
    284
    
    
    $
    Provision charged to expense
    
    
    
    
    
    
    
    
    
    
    699Payments
    
    
    
    
    
    
    (284
    )
    
    
    (415
    )Balance at end of year
    
    $
    
    
    
    $
    
    
    
    $
    284Reserves for excess and obsolete inventory:Balance at beginning of year
    
    $
    344
    
    
    $
    621
    
    
    $
    741Provision charged to expense
    
    
    310
    
    
    
    290
    
    
    
    1,027Write-offs
    
    
    (333
    )
    
    
    (567
    )
    
    
    (1,147
    )Balance at end of year
    
    $
    321
    
    
    $
    344
    
    
    $
    621
 S-3