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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2004                     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 400
Phoenix, 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 þ No o 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. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act
Rule 12b-2). Yes o No þ The aggregate market value of common stock held by nonaffiliates of the registrant (2,181,986
shares) based on the closing price of the common stock as reported on the Nasdaq SmallCap Market on
June 30, 2004, which was the last business day of the registrants most recently completed second
fiscal quarter, was $10,102,595. 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 25, 2005, there were outstanding 3,715,062 shares of the registrants common stock,
$.001 par value, which excludes 32,402 treasury shares. Documents incorporated by reference None.




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VODAVI TECHNOLOGY, INC.
ANNUAL REPORT ON FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 2004
TABLE OF CONTENTS PagePART IITEM 1.
    
    BUSINESS
    
    
    1ITEM 2.
    
    PROPERTIES
    
    
    18ITEM 3.
    
    LEGAL PROCEEDINGS
    
    
    18ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    18PART IIITEM 5.
    
    MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
    
    
    19ITEM 6.
    
    SELECTED FINANCIAL DATA
    
    
    20ITEM 7.
    
    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    21ITEM 7A.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    27ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
    
    
    27ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
    
    
    27ITEM 9A.
    
    CONTROLS  AND PROCEDURES
    
    
    27ITEM 9 B.
    
    OTHER INFORMATION
    
    
    27PART IIIITEM 10.
    
    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    
    
    28ITEM 11.
    
    EXECUTIVE COMPENSATION
    
    
    31ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
    
    
    41ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    
    43ITEM 14.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    44PART IVITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES
    
    
    45SIGNATURES
    
    
    
    
    47INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
    
    
    F-1EXHIBIT 10.58EXHIBIT 10.59EXHIBIT 21EXHIBIT 23.1EXHIBIT 23.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  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 2005 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, converged, and IP-based telephone systems and telephony
applications, as well as traditional and IP-based commercial grade telephones, that address a wide
variety of business applications. Our telephone systems incorporate sophisticated features such as
automatic call distribution, scalable networking, Internet Protocol, or IP, as well as wireless
solutions. Our telephony applications include Internet messaging, automated attendant, voice and
fax mail and computer-telephony products that 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,
telephony applications, and commercial grade telephones;
    focus on IP telephony product developments that provide more Voice over IP, or
VoIP, functionality for our legacy products and our 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 Officers, 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, telephony applications, and commercial grade telephones
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 applications 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 applications, 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:  
    telephone systems, which include traditional digital and IP-based key telephone
systems;
    telephony applications, which include voice messaging, automated attendant,
automatic call distribution, as well as advanced messaging products that include fax
mail, and unified messaging 2




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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; and
    commercial grade telephones, which include single-line and multi-line traditional
and IP-based telephones. Telephony Systems Sales of telephone systems represented approximately 83% of our revenue during 2004, 81% in
2003, and 72% in 2002. 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 with progressive features for use in conjunction with each of our
telephone systems. We currently market various lines of telephone systems under our STARPLUS and Vodavi brand
names for businesses requiring as few as eight stations up to 492 stations (a 600-port system).
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 applications. In addition, our XTS system can be IP-enabled with the addition of a VoIP Gateway, or LAN
card. An IP-enabled XTS, together with our IP networking software package allows up to 32 XTS
systems to communicate as one large system using an IP infrastructure. This configuration allows
companies with multiple locations or remote workers 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 our
systems than to switch to a competitors system. We believe that the cost savings and flexibility
we provide our customers through this migration strategy provides us with a competitive advantage. Our flagship IP-based telephone system, the Telenium, 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. Telephony Applications Telephony applications include a combination of various software and hardware solutions
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.
Some of our telephony applications may be integrated with telephone systems sold by competing
manufacturers while other applications only integrate with our telephone systems sold by to
differentiate them from our competitors products and to provide a value-added basis for increased
sales and profit margins. Sales of telephony applications accounted for approximately 11% of our
revenue during 2004, 13% during 2003, and 17% during 2002. 3




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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 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. 4




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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 market CTI products that use an open architecture to integrate computer and telephone
systems into a user-friendly information processing and storage system. Our CTI products allow 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. Commercial Grade Telephones We market several models of commercial grade telephones 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% of our revenue during 2004, 5% of our
revenue during 2003, and 7% during 2002. 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 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 opportunities for our growth and profitability on an
ongoing basis. We are currently focusing our product development efforts on new products and
enhancements that will address broader market applications, sophistication, and value to our
current product offerings. In addition, through new developments, we are targeting specific market
segments that we do not currently serve. Examples of our current developments include the
following:  
    An IP software based telephone for mobile worker and remote contact center
applications.
    Advanced IP Interface PCB that provides higher densities, cover cost, and advanced
IP feature set for the XTS.
    a wireless IP product that will offer complete mobility for users of the XTS
telephone system; 5




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
    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,
    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 Authorized Dealers and wholesale
distributors, who resell our products to general sales and installation companies and to Authorized
Vodavi Dealers that do not buy directly from our company. 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 have in the past and may in the future market our products on
a private label basis to original equipment manufacturers, or OEMs. Authorized Vodavi Dealers We have approximately 300 Authorized Dealers that sell our products. Approximately 200
Authorized Dealers buy our products directly from our company and approximately 100 Authorized
Dealers buy our products through our wholesale distributors. Our Authorized Dealers generally must
commit to minimum purchases of our products and must be trained and certified through our formal
product and sales training program. Our goal is to encourage Authorized Dealers to promote our
products to their customers as the preferred line of telecommunications equipment. We provide
Authorized Dealers with marketing, sales, and product support services as well as incentive
programs to encourage the sale of our products. 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 products.
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. We believe that the principal advantages of having an authorized dealer program include
greater control over the application and installation of our products and the ability to obtain
market feedback on product pricing, quality, and technology. Purchases from our Authorized Dealers
represented approximately 60% of our total revenue in 2004, whether those purchases were made
directly from our company or through our wholesale distributors. Wholesale Distributors We have a select number of wholesale distributors that resell our full line of products to
Authorized Dealers and our STARPLUS line and commercial grade telephones to general telephone
sales and installation companies and independent telephone companies. Our STARPLUS line of
products consists of our STS, DHS, DHSE, and DHSL telephone systems. We provide ongoing support
and training to enable our wholesale distributors to sell more effectively our products and to
provide their customers with technical assistance in installation, maintenance, and customer
support. We believe that sales through wholesale 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; 6




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
    availability of products in over 600 locations throughout the United States;
    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 dealers. Wholesale distributors that currently resell our products include Graybar Electric Co., Inc.,
Alltel Supply, Inc., Sprint/North Supply, Famous Telephone Supply, ADI, Target Distributing, Inc,
and Power & Telephone Supply Company. Graybar accounted for 26% of our revenue during 2004, and
27% during each of 2003 and 2002. Target, our second largest distributor, accounted for 17% of our
revenue during 2004, 14% in 2003 and 12% in 2002. Vodavi Direct We have a direct sales office that sells our products and provides 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 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 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. In-house Sales Staff We have an in-house sales support staff of eight employees who provide Authorized Dealers and
wholesale 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. 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 7




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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 telephone systems, some of our telephony applications, and our 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 telephone systems, voice mail products and IP-based commercial
grade telephones 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 $20.8 million, $20.0
million, and $15.9 million of product from LGE in 2004, 2003, and 2002, which represented 82%, 82%,
and 74%, of our total purchases, respectively. LGE currently owns approximately 23% of 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 traditional commercial grade telephones and replacement parts for such
telephones from LG Information and Communications Thailand, or LGICTH, a joint venture between LGE
and Srithai Group, a Thailand-based entity. Under an agreement with our company, LGICTH granted us
the right to distribute and sell throughout the United States and Canada the products that LGICTH
manufactures for us in Thailand. Our agreement with LGICTH 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 $1.4 million, $1.1 million, and $2.6 million of product from LGICTH in 2004, 2003, and
2002, which represented 6%, 5%, 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. 8




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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. 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, including Avaya, NEC and Nortel. 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. 9




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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 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, 2004, we employed a total of 114 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 28 persons in engineering and product development; 61 in sales,
marketing, and technical support; 10 in warehouse and distribution functions; and 15 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. 10




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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 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 26% of our sales during 2004, and 27% during each of 2003 and 2002.
Accounts receivable from Graybar comprised approximately 32% of total accounts receivable at
December 31, 2004. Our second largest distributor in each of the respective years accounted for
17% of our sales during 2004, 14% of our sales during 2003 and 12% during 2002. Accounts
receivable from our second largest distributor comprised approximately 25% of total accounts
receivable at December 31, 2004. 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: 11




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
    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 rely upon 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 $22.2 million, $21.1
million, and $18.5 million of product LGE and LGITCH, constituting approximately 88%, 87%, and 86%
of our total purchases in 2004, 2003, and 2002, respectively. Although we have executed as
manufacturing agreement with LGE to supply our products, we cannot be assured that LGE will
continue to support our business or operations. In January 2005, LGE announced that it plans to establish a joint venture with a division of
Nortel Networks Corporation to provide telecommunications networking solutions. Based on the
announcement, the proposed joint venture is intended to support the strategy of both companies for
ongoing development of telecommunications equipment and networking solutions. LGE management has
informed us that the proposed joint venture should not have any adverse effect on our ongoing
relationship and, in March 2005, entered into a new five-year agreement with us. The long-term
impacts to our business as a result of this joint venture are not known at the present time. 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 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 12




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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. 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 13




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for any significant period against an interruption of supply, particularly if we were required to
locate and use alternative sources of supply. 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. 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; 14




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
    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 with Gregory K. Roeper, our President and Chief Executive
Officer; and David A. Husband, our Vice-President  Finance and Chief Financial Officer. 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. 15




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Certain conflicts of interest may arise as a result of LGEs ownership interest in our company. LGE currently owns approximately 23% 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 LGICTH, an affiliate
of LGE. See Item 1, Business  Manufacturing and Risk Factors  LGEs proposed joint venture
with Nortel to develop telecommunications equipment and networking solutions may have a material
adverse effect on our business. 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 LGICTH. 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. Rights to acquire our common stock could result in dilution to other holders of our common stock. As of March 25, 2005, we had outstanding options to acquire 753,875 shares of our common stock
at a weighted average exercise price of $3.10 per share. An additional 488,750 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 16




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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;--
    ur entering into contracts with our stockholders or directors;--
    ur 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 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. 17




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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 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 Not applicable. 18




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PART II 
  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, 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
    
    
    Low2003:First quarter
    
    $
    1.95
    
    
    $
    1.36Second quarter
    
    
    2.60
    
    
    
    1.71Third quarter
    
    
    3.66
    
    
    
    2.20Fourth quarter
    
    
    9.46
    
    
    
    2.792004:First quarter
    
    $
    8.27
    
    
    $
    5.52Second quarter
    
    
    6.66
    
    
    
    4.15Third quarter
    
    
    6.07
    
    
    
    4.56Fourth quarter
    
    
    8.00
    
    
    
    5.272005:First quarter (through March 25, 2005)
    
    $
    7.55
    
    
    $
    5.86
 On March 25, 2005, the closing sales price of our common stock was $6.92 per share. As of
March 25, 2005 , 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 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. 19




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##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data presented below as of and for the years ended
December 31, 2004, and 2003 are derived from our consolidated financial statements, which have
been audited by Mayer Hoffman McCann P.C., independent registered public accounting firm. 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,
which have been audited by Deloitte & Touche LLP, independent auditors. The selected consolidated
financial data presented below as of and for year ended December 31, 2000 are derived from our
consolidated financial statements, 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:
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Revenue
    
    $
    43,791
    
    
    $
    41,270
    
    
    $
    37,328
    
    
    $
    34,153
    (1)
    
    $
    47,705Gross margin
    
    
    15,431
    
    
    
    14,285
    
    
    
    13,449
    
    
    
    11,170
    (2)
    
    
    17,503Operating expenses
    
    
    12,451
    
    
    
    12,082
    
    
    
    12,164
    
    
    
    13,183
    (3)
    
    
    16,041Operating income (loss)
    
    
    2,980
    
    
    
    2,203
    
    
    
    1,285
    
    
    
    (2,013
    )
    
    
    1,462Interest expense
    
    
    6
    
    
    
    128
    
    
    
    97
    
    
    
    406
    
    
    
    705Income (loss) before income
taxes and change in accounting
principle
    
    
    2,974
    
    
    
    2,075
    
    
    
    1,188
    
    
    
    (2,419
    )
    
    
    757Provision for (benefit from)
income taxes
    
    
    1,144
    
    
    
    804
    
    
    
    471
    
    
    
    (863
    )
    
    
    309Income (loss) before change in
accounting principle
    
    
    1,830
    
    
    
    1,271
    
    
    
    717
    
    
    
    (1,556
    )
    
    
    448Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (1,263
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    1,830
    
    
    $
    1,271
    
    
    $
    (546
    )
    
    $
    (1,556
    )
    
    $
    448Net income (loss) per share,
diluted
    
    $
    0.44
    
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.37
    )
    
    $
    0.10Weighted average shares
outstanding, diluted
    
    
    4,120
    
    
    
    4,170
    
    
    
    4,428
    
    
    
    4,235
    
    
    
    4,305
 As of December 31,(in thousands)Balance Sheet Data:
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Assets:Current assets
    
    $
    16,687
    
    
    $
    16,240
    
    
    $
    14,829
    
    
    $
    14,861
    
    
    $
    20,959Property and equipment, net
    
    
    1,363
    
    
    
    1,453
    
    
    
    1,631
    
    
    
    1,581
    
    
    
    2,033Goodwill, net
    
    
    725
    
    
    
    725
    
    
    
    725
    
    
    
    1,638
    
    
    
    1,772Other
    
    
    50
    
    
    
    105
    
    
    
    203
    
    
    
    193
    
    
    
    417$
    18,825
    
    
    $
    18,523
    
    
    $
    17,388
    
    
    $
    18,273
    
    
    $
    25,181Liabilities:Current liabilities
    
    $
    6,480
    
    
    $
    7,634
    
    
    $
    6,748
    
    
    $
    7,045
    
    
    $
    12,176Other long-term obligations
    
    
    24
    
    
    
    700
    
    
    
    18
    
    
    
    200
    
    
    
    421Total liabilities
    
    
    6,504
    
    
    
    8,334
    
    
    
    6,766
    
    
    
    7,245
    
    
    
    12,597Stockholders equity
    
    
    12,321
    
    
    
    10,189
    
    
    
    10,622
    
    
    
    11,028
    
    
    
    12,584$
    18,825
    
    
    $
    18,523
    
    
    $
    17,388
    
    
    $
    18,273
    
    
    $
    25,181
   (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. 20




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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 Distributing, Inc. As of
December 31, 2004, Graybar accounted for 32% and Target accounted for 25% 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. 21




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##### Table of Contents



Excess and Obsolete Inventory We record our inventory at the lower of cost or market value. Our assessment of market value
is determined by, among other things, historical and forecasted sales activity, the condition of
specific inventory items, and competitive pricing considerations. When the assessed market value
is less than the historical cost, provision is made in the financial statements to write-down the
carrying amount of the respective inventory items to market value. If actual results are less
favorable than our original assumptions for determining market value, additional inventory
write-downs may be required. The above listing is not intended to be a comprehensive list of our accounting policies. See
our audited consolidated financial statements and notes thereto, 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. 2004
    
    
    2003
    
    
    2002Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    64.8
    
    
    
    65.4
    
    
    
    64.0Gross margin
    
    
    35.2
    
    
    
    34.6
    
    
    
    36.0Operating expenses:Engineering and product development.
    
    
    4.3
    
    
    
    5.0
    
    
    
    6.3Selling, general, and administrative
    
    
    24.1
    
    
    
    24.3
    
    
    
    26.328.4
    
    
    
    29.3
    
    
    
    32.6Operating income
    
    
    6.8
    
    
    
    5.3
    
    
    
    3.4Interest expense, net
    
    
    .0
    
    
    
    .3
    
    
    
    .2Income before taxes and
accounting change
    
    
    6.8
    
    
    
    5.0
    
    
    
    3.2Income tax expense
    
    
    2.6
    
    
    
    1.9
    
    
    
    1.3Income before accounting change
    
    
    4.2
    
    
    
    3.1
    
    
    
    1.9Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (3.4
    )Net income (loss)
    
    
    4.2
    %
    
    
    3.1
    %
    
    
    (1.5
    )%
 Year Ended December 31, 2004 Compared with Year Ended December 31, 2003 Revenue Revenue for the year ended December 31, 2004 totaled $43.8 million, an increase of 6.1%, from
revenue of $41.3 million for the same period of 2003. Sales of our telephone systems increased
8.8% to $36.4 million during fiscal 2004 compared to $33.4 million in fiscal 2003. The increase in
telephone system sales is attributed to an increase in unit sales of our STS product line and the
sale of larger systems within the XTS product line. Sales of commercial grade single line
telephones declined 8.1% to $2.1 million during 2004 compared to $2.2 million in 2003. During the
third quarter of 2004, we discontinued our 2700 Series of single line telephones and in June 2004
we introduced the 2800 Series. We expect sales of single line telephones to accelerate in 2005.
Sales of telephony applications, including voice processing, computer telephony integration, and
unified messaging decreased to $4.8 million from $5.2 million between the respective years of 2004
and 2003. The decline in telephony applications is a direct result of selling more embedded voice
mail applications, which are reported in telephone system sales. 22




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Sales through our direct sales office in the Phoenix Metropolitan area totaled $2.1 million
during fiscal 2004 compared with $1.3 million in fiscal 2003. The increase in sales through our
direct sales office is attributable to the expansion of our sales force and the positive impact of
a focused sales and marketing program. Our reported revenue includes shipping and handling charges and is recorded net of reserves
for sales returns, discounts and customer incentive programs. These items resulted in a net reduction to revenue of $1.4
million in 2004 compared with a net reduction of $905,000 in 2003. Gross Margin Our gross margin was approximately $15.4 million in 2004 compared with $14.3 million in 2003.
Our gross margin as a percentage of total revenue increased to 35.2% during 2004 from 34.6% during
2003. The increase in our gross margin percentage during 2004 is a direct result of the mix of
product sales, a higher volume of sales to cover the fixed component of cost of sales, and
increased sales at our direct sales office. Engineering and Product Development Engineering and product development expenditures decreased to $1.9 million during 2004 from
$2.1 million in 2003. As a percentage of revenue, engineering and product development expenditures
decreased to 4.3% of total revenue during fiscal 2004 from 5.0% during fiscal 2003. This reduction
reflects a slight decrease in headcount and outsourced development costs primarily related to a
specific development that was completed in 2003. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased to $10.6 million in 2004 compared to
$10.0 million in 2003. Factors that increased our expenses include increased compensation and
additional marketing and promotional activity. As a percentage of revenue, selling, general, and
administrative expenses declined to 24.1% compared with 24.3% in 2003. Interest Expense Interest expense decreased to $6,000 during 2004 compared with $128,000 during 2003. The
reduction in interest expense is a direct result of the elimination of interest-bearing debt in the
first half of 2004. Income Taxes We provided for federal and state income taxes using an effective rate of 38.5% in 2004
compared with 38.7% for the same period in 2003. 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 23




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##### Table of Contents



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 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. Liquidity and Capital Resources Our net working capital position was approximately $10.2 million at December 31, 2004 compared
with $8.6 million at December 31, 2003. We had a cash balance of $4.0 million at December 31, 2004
compared with a cash balance of $2.9 million at December 31, 2003. Sources of cash included
positive income from operations, a reduction in inventory of $546,000 and other current assets of
$249,000, and $322,000 from the exercise of stock options. Uses of cash during 2004 included an
increase in accounts receivable of $245,000 and the pay down of accounts payable and accrued
liabilities of $752,000 and $202,000, respectively. We also used approximately $381,000 in 2004
for the purchase of property and equipment, $152,000 to repurchase 32,402 shares of our common
stock , and $900,000 to pay off our term loan. 24




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##### Table of Contents



Our accounts receivable days sales outstanding, calculated on a quarterly basis, were
approximately 59 days during each of 2004 and 2003. The timing of payments received from our
largest distributors greatly influence our days sales outstanding. Our two largest distributors
comprised 57% of our total accounts receivable as of December 31, 2004 and 51% as of December 31,
2003. Our inventory turnover, measured in terms of days outstanding on a quarterly basis, was 59
days as of December 31, 2004 compared to 67 days as of December 31, 2003. The decrease in inventory
days outstanding is a direct result of our efforts to rationalize our product lines and an increase
in sales. Trade payables and accrued liabilities, including payables to third-party and related-party
manufacturers, were approximately $6.5 million as of December 31, 2004 compared with $7.4 million
as of December 31, 2003. The level of our trade payables and accrued liabilities between periods
is largely influenced by the timing of payments we make to our largest suppliers for inventory
items and payments to cover payroll, income taxes, and customer rebates. We generally pay trade
payables within 45 days from the invoice date, except for payments to our largest supplier, which
are 60 days from the invoice date. We had a $15.0 million credit facility with General Electric Capital Corporation that expired
in April 2003. The line of credit bore interest at 2.5% over the 30-day commercial paper rate.
Advances under the line of credit were based upon eligible accounts receivable and inventory of our
wholly owned subsidiary, Vodavi Communications Systems, Inc., and were secured by substantially all
of our assets. The revolving line of credit contained covenants that are customary for similar
credit facilities and also prohibited our operating subsidiaries from paying dividends to us
without the consent of GE Capital. In April 2003, we entered into a credit agreement with Comerica Bank (Comerica) of a size that
is more reflective of the operational requirements of our business. The credit agreement
established a $5.0 million revolving line of credit and a $1.0 million term loan. Advances under
the credit facility are based upon eligible accounts receivable and inventory of our wholly owned
subsidiary, Vodavi Communications Systems, Inc., and are secured by substantially all of our
assets. The credit facility contains covenants that are customary for similar credit facilities and
also prohibits our operating subsidiaries from paying dividends to us without the consent of
Comerica. As of December 31, 2004, we had no outstanding borrowings on our line of credit and $5.0
million available for future advances. The $5.0 million revolving line of credit bears interest at Comericas prime rate, or 5.25% at
December 31, 2004, and requires monthly payments of interest only with all unpaid principal and
accrued interest due at its expiration in April 2005. In March 2005, we entered into a
modification agreement with Comerica extending the expiration date to April 2006. The $1.0 million term loan was available to us only for the purpose of acquiring our common
stock. Borrowings on the term loan bore interest at Comericas prime rate plus 0.5%. In April
2004, we repaid the amount outstanding on our term loan. 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, 2004 and the year in which those commitments
become due or are expected to be settled (in thousands): 25




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##### Table of Contents



Payment due by periodContractual
    
    
    
    
    
    Less than
    
    
    
    
    
    
    
    
    
    
    More thanObligations
    
    Total
    
    
    1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsOperating Lease
Obligations
    
    $
    5,604
    
    
    $
    866
    
    
    $
    1,597
    
    
    $
    1,570
    
    
    $
    1,571Purchase Obligations
    
    
    4,555
    
    
    
    4,555
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    10,159
    
    
    $
    5,421
    
    
    $
    1,597
    
    
    $
    1,570
    
    
    $
    1,571
 From time to time we are subject to certain asserted and unasserted claims encountered in the
normal course of business. We believe that the resolution of these matters will not have a
material adverse effect on our financial position or results of operations. However, we cannot
provide assurance that damages resulting from the resolution of these matters, if any, will not
have a material adverse effect on our financial position or results of operations. We believe that our cash flows from operations, working capital, and credit facilities are
sufficient to fund our capital needs during the next 12 months. We intend to continue to explore
business acquisition opportunities as they arise and may be required to seek additional financing
in the future to meet such opportunities. International Manufacturing Sources We currently obtain a substantial majority of our products under various manufacturing
arrangements with third-party manufacturers in South Korea and Thailand, including LGE who owns
approximately 23% 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 Financial Accounting Standards Board (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
required 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 continue
to be amortized over those periods. Amortization of goodwill and intangible assets with indefinite
lives have ceased. 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 November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4(SFAS 151). SFAS 151 clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage) by requiring those items to be
recognized currently in earnings. SFAS 151 is effective for inventory costs incurred during fiscal
periods beginning after June 15, 2005. The company believes the adoption of this statement will
not have a material impact on our financial condition or results from operations. In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets, an amendment
of APB Opinion No. 29(SFAS 153). SFAS 153 amends APB Opinion No. 29 to eliminate certain
exceptions to the principle that exchanges of nonmonetary assets should be measured based on fair
value. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The company believes that adoption of this statement will not have a
material impact on our financial condition or results from operations. 26




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In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. This
Statement replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R requires
companies to recognize the grant date fair value of stock options and other equity-based
compensation issued to employees in the income statement. The statement becomes effective for
interim or annual periods beginning after June 15, 2005. The Company has not determined the
financial impact that the adoption of SFAS No. 123R may have on its financial statements. 
 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, 2004, we had no
outstanding borrowings on the line of credit or term loan. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA Reference is made to the consolidated financial statements, the report thereon, and the notes
thereto commencing at page F-1 of this Report, which consolidated 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, 2004.
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have each
concluded that our disclosure controls and procedures are effective to ensure that we record,
process, summarize, and report information required to be disclosed by us in our quarterly reports
filed under the Securities Exchange Act within the time periods specified by the Securities and
Exchange Commissions rules and forms. During the quarterly period covered by this report, there
have not been any changes in our internal controls over financial reporting that have materially
affected, or is reasonably likely to materially affect, our internal control over financial
reporting. Subsequent to the date of their evaluation, there have not been any significant changes in our
internal controls or in other factors that could significantly affect these controls, including any
corrective action with regard to significant deficiencies and material weaknesses. 
 ITEM 9B. OTHER INFORMATION In March 2005 we entered into an exclusive supply and distribution agreement with LG.
Pursuant to the terms of the agreement, LG granted us exclusive rights to sell our current products
manufactured by LG and any future products jointly developed by LG and us, in the United States,
Canada, and the Caribbean Islands (except Cuba) and non-exclusive rights to sell certain products
in Mexico. The agreement expires in December 2009. 27




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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 (2)
    
    
    59
    
    
    Chairman of the BoardGregory K. Roeper
    
    
    44
    
    
    President, Chief Executive Officer, and DirectorDavid A. Husband
    
    
    36
    
    
    Vice President-Finance, Chief Financial Officer,
Secretary, and TreasurerStephen L. Borcich
    
    
    58
    
    
    Vice President  Distribution SalesJack A. Henry(1) (2)(3)
    
    
    61
    
    
    DirectorEmmett E. Mitchell (1)(2)(3)
    
    
    49
    
    
    DirectorJong Dae An
    
    
    45
    
    
    DirectorPaul D. Sonkin (1)(3)
    
    
    36
    
    
    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. 28




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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 White Electronic Designs
Corporation and Tickets.com, Inc. Mr. Henry previously served on the boards of directors of
Simula, Inc., and SOS Staffing Services, Inc., both public companies. Mr. Henry attended the U.S.
Naval Academy and holds both a Bachelors and Masters of Business Administration from the University
of Michigan. Jong Dae Anhas served as a director of our company since August 2004. Mr. An has served as a
group leader of the export business within the Network Division of LG Electronics Inc. where his
career began in 1986. During most of this tenure with LGE, Mr. An managed the export of
telecommunications equipment, establishing considerable market share in North America and Europe
through relationships with leading distributors and world-class telecom service providers. Mr. An
received a Master of Business Administration degree from the Helsinki School of Economy. 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. 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 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, 2004, 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 as follows: (1) Mr. Sonkin filed a late Form 3 regarding his initial beneficial ownership
and grant of options upon becoming a director of our company, as well as a late Form 4 covering a
grant of options from our company; and (2) each of Messrs. Borcich, Francis, Henry, Mitchell, and
Roeper filed one late Form 4 covering the grant of options from our company. 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. 29




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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. Mitchell, Henry, and Hinz. Messrs. Mitchell
and Henry are independent directors 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.
Mr. Hinz is not considered an independent director under such rules and is participating as a
member of our Audit Committee on a temporary basis pursuant to the exemption provided in NASDAQ
MarketPlace Rule 4350(d)(2)(B). The board of directors has determined that each of Messrs. Henry
and Mitchell qualify as an audit committee financial expert in accordance with applicable rules
and regulations of the SEC. 30




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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 two other executive officers who received cash compensation in
excess of $100,000 during fiscal 2004. The table also sets forth certain information regarding one
former officer of our company. SUMMARY COMPENSATION TABLE Long TermCompensationAwardsSecuritiesAnnual Compensation
    
    
    
    Underlying
    
    
    
    All OtherName and Principal Position(1)
    
    Year
    
    
    Salary($)
    
    
    Bonus ($)
    
    
    
    Options(#)(2)
    
    
    
    Compensation($)Gregory K. Roeper
    
    
    2004
    
    
    $
    200,000
    
    
    $
    98,957
    
    
    
    
    8,750
    
    
    
    $
    7,579
    (3)President and Chief Executive
    
    
    2003
    
    
    $
    182,500
    
    
    $
    114,068
    
    
    
    
    35,000
    
    
    
    $
    7,329
    (4)Officer
    
    
    2002
    
    
    $
    165,000
    
    
    $
    25,000
    
    
    
    
    
    
    
    
    $
    4,329
    (5)David A. Husband
    
    
    2004
    
    
    $
    150,000
    
    
    $
    41,791
    
    
    
    
    5,000
    
    
    
    $
    1,000
    (6)Vice President  Finance,
    
    
    2003
    
    
    $
    135,500
    
    
    $
    59,412
    
    
    
    
    25,000
    
    
    
    $
    750
    (6)Chief Financial Officer,
    
    
    2002
    
    
    $
    135,000
    
    
    $
    25,000
    
    
    
    
    
    
    
    
    $
    750
    (6)Secretary, and TreasurerStephen L. Borcich
    
    
    2004
    
    
    $
    130,000
    
    
    $
    31,631
    
    
    
    
    5,000
    
    
    
    $
    1,000
    (6)Vice President  Distribution
    
    
    2003
    
    
    $
    125,000
    
    
    $
    54,780
    
    
    
    
    
    
    
    
    $
    750
    (6)Sales
    
    
    2002
    
    
    $
    125,000
    
    
    $
    
    
    
    
    
    
    
    
    
    $
    750
    (6)Steven R. Francis
    
    
    2004
    
    
    $
    98,000
    
    
    $
    
    
    
    
    
    5,000
    
    
    
    $
    Former Vice President 
    
    
    2003
    
    
    $
    125,000
    
    
    $
    32,540
    
    
    
    
    25,000
    
    
    
    $
    750
    (6)Dealer Sales
    
    
    2002
    
    
    $
    102,000
    
    
    $
    
    
    
    
    
    50,000
    
    
    
    
    750
    (6)
   (1)
    
    We consider Messrs. Roeper, Husband and Borcich to be our executive officers. Mr. Francis ,
our former Vice President  Dealer Sales, resigned from our company in August 2004.(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 $1,000.(4)
    
    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.(5)
    
    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.(6)
    
    Represents a 401(k) plan matching contribution. 31




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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, 2004. OPTION GRANTS IN LAST FISCAL YEAR Individual GrantsPotential RealizableValue at AssumedAnnual RatesNumber of
    
    
    Percentage 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.
    
    
    8,750
    
    
    
    11.9
    %
    
    $
    7.05
    
    
    
    2/9/14
    
    
    $
    38,795
    
    
    $
    98,314David A. Husband
    
    
    5,000
    
    
    
    6.8
    %
    
    $
    7.05
    
    
    
    2/9/14
    
    
    $
    22,169
    
    
    $
    56,179Stephen L. Borcich
    
    
    5,000
    
    
    
    6.8
    %
    
    $
    7.05
    
    
    
    2/9/14
    
    
    $
    22,169
    
    
    $
    56,179Steven R. Francis.
    
    
    5,000
    
    
    
    6.8
    %
    
    $
    7.05
    
    
    
    2/9/14
    
    
    $
    22,169
    
    
    $
    56,179
   (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 2004 by the
officers listed and the value of each such officers unexercised options of December 31, 2004. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES Number of securities
    
    
    Value of Unexercised In-the-Shares
    
    
    
    
    
    
    Underlying Unexercised
    
    
    Money Options at FiscalAcquired on
    
    
    Value
    
    
    Options at Fiscal Year-End (#)
    
    
    Year-End ($) (1)Name
    
    Exercise (#)
    
    
    Realized ($)
    
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableGregory K. Roeper
    
    
    12,500
    
    
    $
    46,625
    
    
    
    227,500
    
    
    
    26,250
    
    
    $
    969,425
    
    
    $
    162,050David A. Husband
    
    
    
    
    
    
    
    
    
    
    65,000
    
    
    
    31,250
    
    
    $
    382,950
    
    
    $
    195,900Stephen L. Borcich
    
    
    
    
    
    
    
    
    
    
    57,500
    
    
    
    7,500
    
    
    $
    267,125
    
    
    $
    45,000Steven R. Francis (2)
    
    
    31,250
    
    
    $
    139,938
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    
   (1)
    
    Calculated based upon the closing price of our common stock as reported on the Nasdaq
SmallCap Market on December 31, 2004 of $7.51 per share.(2)
    
    Mr. Francis resigned as an officer of our company during August 2004. Pursuant to his
employment agreement, all of his unvested options were cancelled at that time and his
vested options that were not exercised were terminated during September 2004. 32




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Employment Agreements William J. Hinz We had an employment agreement with William J. Hinz that expired in September 2004. The
agreement provided for Mr. Hinz to serve as our Chairman of the Board and to receive a base salary
of $75,000 per annum. See Director Compensation and Other Information. 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 provided for Mr. Roeper to receive a base salary of $200,000
during fiscal 2004. 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 provided for Mr. Husband to receive a base salary of
$150,000 per annum. 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. 33




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Steven R. Francis Effective January 1, 2004 we entered into a new employment agreement with Mr. Francis. The
agreement had an initial term through December 31, 2004, and automatically renewed for successive
one-year terms unless either party terminated by giving the other party at least 30 days written
notice. The employment agreement provided for Mr. Francis to serve as Vice President  Dealer
Sales for a base salary of $135,000 per annum. During
August 2004, Mr. Francis resigned as an officer of our company. Under the terms of his
employment agreement, Mr. Francis was not entitled to receive any further compensation upon his
resignation and all of his unvested options were cancelled. Any vested options held by Mr. Francis
that were not exercised were terminated during September 2004. 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. 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 2004,
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 The 1994 Stock Option Plan, as amended, provided for  
    the granting of incentive stock options or nonqualified options to acquire our common stock;
    the granting of stock appreciation rights; 34




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
    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 provided for automatic grants of stock options to non-employee directors of our
company under an automatic program. Under the automatic program, each newly elected non-employee
member of our Board of Directors received 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 were automatically granted
to each non-employee director at the meeting of our Board of Directors held immediately after each
annual meeting of stockholders. We were authorized to issue 1,600,000 shares of Common Stock under the 1994 Plan. As of March
25, 2005, 405,625 shares of common stock have been issued upon exercise of options granted under
the plan, and there were outstanding options to acquire 642,625 shares of our common stock under
the plan. The 1994 Plan expired in April 2004 and all remaining options available for grant were
cancelled. We may not grant additional awards under the 1994 Plan. Any awards outstanding on the
expiration date were not 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 cancelled in favor of the new shares available under the 2003 Plan. 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 25, 2005, no shares of common stock have been issued upon exercise of options
granted under the 2003 Plan, and there were outstanding options to acquire 111,250 shares of our
common stock under the 2003 Plan. As of March 25, 2005, an additional 488,750 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. 35




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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 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 36




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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. 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. 37




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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. 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 38




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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 reimbursement for reasonable expenses incurred in attending
meetings of our Board of Directors.- Committee members 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. Our Chairman, William J. Hinz, receives a quarterly retainer fee of $4,688 payable on the
first day of each quarter. Mr. Hinz also receives a $625 fee for each meeting attended by
telephone or in person and reimbursement for reasonable expenses incurred in attending board
meetings. Mr. Hinz also receives a $625 fee for his attendance at Audit 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 2004 were made by the
Compensation Committee of our Board of Directors, which consisted of Messrs. Henry, Mitchell, and
Sonkin. During fiscal 2004, Mr. Stephen A McConnell, a former director of our company, also served
on our Compensation Committee. Mr. McConnells term as a director of our company expired during
May 2004 and he did not stand for re-election. None of such persons had any contractual or other
relationships with us during fiscal 2004 except as directors. See Item 11, Executive
CompensationDirector Compensation and Other Information. 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. 39




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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. 40




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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, 2004 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
    
    
    75,000
    (3)
    
    
    2.0
    %Gregory K. Roeper
    
    
    238,225
    (4)
    
    
    6.0
    %David A. Husband
    
    
    84,850
    (5)
    
    
    2.2
    %Stephen L. Borcich
    
    
    57,500
    (6)
    
    
    1.5
    %Steven R. Francis
    
    
    100,000
    
    
    
    2.7
    %Jong Dae An
    
    
    
    
    
    
    *Jack A. Henry
    
    
    15,900
    (7)
    
    
    *Emmett E. Mitchell
    
    
    15,300
    (8)
    
    
    *Paul D. Sonkin
    
    
    510,414
    (9)
    
    
    13.7
    %All directors and officers as a group (9 persons)
    
    
    1,097,189

    
    
    26.3
    %Non-management 5% Stockholders:LG Electronics, Inc.
    
    
    862,500
    (10)
    
    
    23.2
    %Hummingbird Management, LLC
    
    
    500,414
    (9)
    
    
    13.5
    %Barclays Global Investors,
NA
    
    
    200,272
    (11)
    
    
    5.4
    %
   *
    
    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 3,715,062 shares of our common stock
outstanding on December 31, 2004. The percentages shown include the shares of common stock
that each named stockholder has the right to acquire within 60 days of December 31, 2004. 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, 2004 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 75,000 shares of common stock issuable upon exercise of options.(4)
    
    Includes 10,725 shares of common stock and 227,500 shares of common stock issuable upon
exercise of options, but excludes 26,250 shares of common stock issuable upon exercise of
unvested stock options.(5)
    
    Includes 19,850 shares of common stock and 65,000 shares of common stock issuable upon
exercise of options, but excludes 31,250 shares of common stock issuable upon exercise of
unvested stock options.(6)
    
    Includes 57,500 shares of common stock issuable upon exercise of options, but excludes 7,500
shares of common stock issuable upon exercise of unvested stock options.(7)
    
    Includes 900 shares of common stock and 15,000 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. 41




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(8)
    
    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.(9)
    
    Mr. Sonkin is a control person of Humingbird Management, LLC. Amounts listed for Hummingbird
represent 500,414 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 460 Park Avenue,
12th Floor, 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 5,000 shares issuable
upon exercise of options, neither of which is included in the beneficial ownership of
Hummingbird Management.(10)
    
    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.(11)
    
    Represents shares of common stock beneficially owned by Barclays Global Investors, NA.
Barclays has sole voting power and sole dispositive power over all of such shares. The
address of Barclays is 45 Fremont Street, San Francisco, California 94105. 42




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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, 2004. (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
    
    
    738,625
    
    
    $
    2.84
    
    
    
    531,250Equity Compensation
Plans Not Approved
by Stockholders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    738,625
    
    
    $
    2.84
    
    
    
    531,250
 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS LG Electronics Inc., our principal supplier, owns approximately 23% of our outstanding common
stock. Jong Dae An, a director of our company since August 2004 and Jong Hwa Choi, a director of
our company from February 2003 until August 2004, are officers of LGE or its affiliates. We
purchased approximately $22.2 million of key telephone systems, commercial grade telephones, and
voice mail products from LGE and an affiliate of LGE during 2004. 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 $4.0 million for product purchases as of December 31, 2004. 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. 43




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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Audit Fees Aggregate fees billed to our company for the fiscal years ended December 31, 2004 and 2003 by
our principal accounting firm are as follows: 2004
    
    
    2003Audit Fees (1)
    
    $
    80,000
    
    
    $
    74,500Audit-Related Fees (2)
    
    $
    7,000
    
    
    $
    15,650Tax Fees (3)
    
    $
    21,404
    
    
    $
    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. 44




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PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.  (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)
    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)10.13A
    
    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)10.35
    
    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)10.47
    
    Sublease Agreement dated August 8, 2001, between Vodavi Communications Systems, Inc. and SpeedFam-IPEC, Inc. (5)10.49
    
    Second Amended and Restated 1994 Stock Option Plan (amended through May 13, 2002) (6)10.53
    
    Credit Agreement dated as of April 10, 2003 by and between Vodavi Communication Systems, Inc. and Comerica Bank  California. (7)10.54
    
    Vodavi Technology, Inc. 2003 Incentive Compensation Plan (8)10.55
    
    Employment Agreement, effective October 1, 2003, between Gregory K. Roeper and Vodavi Technology, Inc. (8)10.56
    
    Employment Agreement, effective January 1, 2004, between David A. Husband and Vodavi Technology, Inc. (8)10.57
    
    Employment Agreement, effective January 1, 2004, between Steven R. Francis and Vodavi Technology, Inc. (8)10.58
    
    Modification to Credit Agreement,
dated February 15, 2005, between Vodavi Communications Systems, Inc. and Comerica Bank10.59
    
    Vodavi Key System Agreement, dated January 1, 2005, between Vodavi Communications Systems, Inc. and LG Electronics, Inc.21
    
    List of Subsidiaries (8)23.1
    
    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.
 45




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ExhibitNumber
    
    Exhibit32.2
    
    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, 2001, as filed on November 13, 2001.(6)
    
    Incorporated by reference to Registration Statement on Form S-8 (No. 333-98819) as filed by
the Registrant on August 27, 2002.(7)
    
    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.(8)
    
    Incorporated by reference to the Registrants Annual Report on Form 10-K for the fiscal year
ended December 31, 2003, as filed on March 12, 2004. 46




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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 29, 2005
    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 29, 2005/s/ Gregory K. Roeper

Gregory K. Roeper
    
    President, Chief Executive Officer,
and Director
(Principal Executive Officer)
    
    March 29, 2005/s/ David A. Husband

David A. Husband
    
    Vice President  Finance, Chief Financial
Officer, Secretary, and Treasurer
(Principal Financial and Accounting Officer)
    
    March 29, 2005/s/ Jong Dae An

Jong Dae An
    
    Director
    
    March 29, 2005/s/ Jack A. Henry

Jack A. Henry
    
    Director
    
    March 29, 2005/s/ Emmett E. Mitchell

Emmett E. Mitchell
    
    Director
    
    March 29, 2005/s/ Paul D. Sonkin

Paul D. Sonkin
    
    Director
    
    March 29, 2005
 47




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VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES Index to Consolidated Financial Statements and Schedule
 PageReport of Independent Registered Public Accounting Firm  Mayer Hoffman McCann P.C
    
    
    F-2Report of Independent Registered Public Accounting Firm  Deloitte & Touche LLP
    
    
    F-3Consolidated Balance Sheets as of December 31, 2004 and 2003
    
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2004, 2003, and 2002
    
    
    F-5Consolidated Statements of Changes in Stockholders Equity for the Years Ended December 31, 2004, 2003, and 2002
    
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003, and 2002
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Report of
Independent Registered Public Accounting Firm on Schedule  Mayer Hoffman McCann P.C.
    
    
    S-1Report of
Independent Registered Public Accounting Firm  Deloitte & Touche LLP
    
    
    S-2Schedule II  Valuation and Qualifying Accounts
    
    
    S-3
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders of VODAVI TECHNOLOGY, INC. We have audited the accompanying consolidated balance sheets of Vodavi Technology, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of
operations, changes in stockholders equity and cash flows for the years 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
audits. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits 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, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Vodavi Technology, Inc. and subsidiaries as of
December 31, 2004 and 2003, and the results of their operations and their cash flows for the years
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 10, 2005 F-2




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders
Vodavi Technology, Inc.: We have audited the accompanying consolidated balance sheet of Vodavi Technology and subsidiaries
(the Company) as of December 31, 2002, and the related consolidated statements of operations,
changes in stockholders equity, and cash flows for the year 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 audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). 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, such consolidated financial statements present fairly, in all material respects,
the financial position of the Company as of December 31, 2002, and the results of its operations
and its cash flows for the year then ended, in conformity with accounting principles generally
accepted in the United States of America. As discussed in Note 1. j. to the consolidated financial statements, on January 1, 2002, the
Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible
Assets. 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 31,2004
    
    
    2003AssetsCurrent AssetsCash
    
    $
    4,000
    
    
    $
    2,924Accounts receivable, net of reserves for doubtful accounts
and sales returns of $387 in 2004 and $345 in 2003
    
    
    7,145
    
    
    
    6,988Inventories
    
    
    4,569
    
    
    
    5,115Deferred income taxes
    
    
    454
    
    
    
    445Prepaid expenses and other
    
    
    519
    
    
    
    768Total current assets
    
    
    16,687
    
    
    
    16,240Property and equipment, net
    
    
    1,363
    
    
    
    1,453Goodwill
    
    
    725
    
    
    
    725Deferred Income Taxes
    
    
    
    
    
    
    34Other Long-Term Assets, net
    
    
    50
    
    
    
    71$
    18,825
    
    
    $
    18,523Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    497
    
    
    $
    1,031Accrued liabilities
    
    
    1,352
    
    
    
    1,568Accrued rebates
    
    
    641
    
    
    
    627Trade accounts payable to stockholder
    
    
    3,990
    
    
    
    4,208Current maturities of long-term debt
    
    
    
    
    
    
    200Total current liabilities
    
    
    6,480
    
    
    
    7,634Deferred Income Taxes
    
    
    24
    
    
    
    Long-Term Debt, net of current maturities
    
    
    
    
    
    
    700Commitments and Contingencies (Note 4)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;
3,747,464 and 3,610,464 shares issued at December 31, 2004
and 2003, respectively
    
    
    4
    
    
    
    4Additional paid-in capital
    
    
    11,495
    
    
    
    11,041Retained earnings (deficit)
    
    
    974
    
    
    
    (856
    )Treasury stock, 32,402 shares at cost
    
    
    (152
    )
    
    
    12,321
    
    
    
    10,189$
    18,825
    
    
    $
    18,523
 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 31,2004
    
    
    2003
    
    
    2002Revenue, net
    
    $
    43,791
    
    
    $
    41,270
    
    
    $
    37,328Cost of Goods Sold
    
    
    28,360
    
    
    
    26,985
    
    
    
    23,879Gross Margin
    
    
    15,431
    
    
    
    14,285
    
    
    
    13,449Operating Expenses:Engineering and product development
    
    
    1,889
    
    
    
    2,071
    
    
    
    2,333Selling, general, and administrative
    
    
    10,562
    
    
    
    10,011
    
    
    
    9,83112,451
    
    
    
    12,082
    
    
    
    12,164Operating Income
    
    
    2,980
    
    
    
    2,203
    
    
    
    1,285Interest Expense
    
    
    6
    
    
    
    128
    
    
    
    97Income Before Income Taxes and Change
in Accounting Principle
    
    
    2,974
    
    
    
    2,075
    
    
    
    1,188Provision for Income Taxes
    
    
    1,144
    
    
    
    804
    
    
    
    471Income Before Change in Accounting Principle
    
    
    1,830
    
    
    
    1,271
    
    
    
    717Change in Accounting Principle, net of taxes
    
    
    
    
    
    
    
    
    
    
    (1,263
    )Net Income (Loss)
    
    $
    1,830
    
    
    $
    1,271
    
    
    $
    (546
    )Basic earnings per share:Income before change in accounting principle
    
    $
    0.50
    
    
    $
    0.33
    
    
    $
    0.16Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.29
    )Net Income (Loss)
    
    $
    0.50
    
    
    $
    0.33
    
    
    $
    (0.13
    )Diluted earnings per share:Income before change in accounting principle
    
    $
    0.44
    
    
    $
    0.30
    
    
    $
    0.16Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.29
    )Net Income (Loss)
    
    $
    0.44
    
    
    $
    0.30
    
    
    $
    (0.13
    )Weighted Average Shares Outstanding:Basic
    
    
    3,651
    
    
    
    3,906
    
    
    
    4,331Diluted
    
    
    4,120
    
    
    
    4,170
    
    
    
    4,428
 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 Additional
    
    
    RetainedCommon Stock
    
    
    Paid-In
    
    
    Earnings
    
    
    Treasury StockShares Issued
    
    
    Amount
    
    
    Capital
    
    
    (Deficit)
    
    
    Shares
    
    
    Amount
    
    
    TotalBalance, 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    218Stock Option Tax Benefit
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136Stockholder Contribution
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5Balance, December 31, 2003
    
    
    3,929,164
    
    
    
    4
    
    
    
    11,800
    
    
    
    (856
    )
    
    
    (318,700
    )
    
    
    (759
    )
    
    
    10,189Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,830
    
    
    
    
    
    
    
    
    
    
    
    1,830Stock Repurchase
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,402
    )
    
    
    (152
    )
    
    
    (152
    )Retire Treasury Stock
    
    
    (318,700
    )
    
    
    
    
    
    
    (759
    )
    
    
    
    
    
    
    318,700
    
    
    
    759
    
    
    
    Options Exercised
    
    
    137,000
    
    
    
    
    
    
    
    322
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    322Stock Option Tax Benefits
    
    
    
    
    
    
    
    
    
    
    132
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    132Balance, December 31, 2004
    
    
    3,747,464
    
    
    $
    4
    
    
    $
    11,495
    
    
    $
    974
    
    
    
    (32,402
    )
    
    $
    (152
    )
    
    $
    12,321
 The accompanying notes are an integral part of these consolidated financial statements. F-6




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VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES Consolidated Statements of Cash FlowsIn thousands Years ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from Operating Activities:Net income (loss)
    
    $
    1,830
    
    
    $
    1,271
    
    
    $
    (546
    )Adjustments to reconcile net income (loss) to
net cash provided by operating activities:Depreciation and amortization
    
    
    492
    
    
    
    467
    
    
    
    635Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    1,263Tax benefit on stock option exercises
    
    
    132
    
    
    
    136
    
    
    
    Provision for doubtful accounts and
sales returns
    
    
    88
    
    
    
    146
    
    
    
    256Deferred taxes
    
    
    49
    
    
    
    117
    
    
    
    397Changes in working capital:Accounts receivable
    
    
    (245
    )
    
    
    (463
    )
    
    
    69Inventories
    
    
    546
    
    
    
    435
    
    
    
    (199
    )Income tax receivable
    
    
    
    
    
    
    300
    
    
    
    539Prepaid expenses and other
    
    
    249
    
    
    
    (37
    )
    
    
    (148
    )Other long-term assets
    
    
    
    
    
    
    (47
    )
    
    
    3Accounts payable
    
    
    (534
    )
    
    
    (219
    )
    
    
    (204
    )Trade accounts payable to stockholder
    
    
    (218
    )
    
    
    243
    
    
    
    2,981Accrued liabilities and accrued rebates
    
    
    (202
    )
    
    
    644
    
    
    
    (543
    )Net cash provided byoperating activities
    
    
    2,187
    
    
    
    2,993
    
    
    
    4,503Cash flows from Investing Activities:Cash paid to acquire property and equipment
    
    
    (381
    )
    
    
    (270
    )
    
    
    (485
    )Cash paid to acquire DataSpeak Systems, Inc.
    
    
    
    
    
    
    
    
    
    
    (624
    )Net cash used in investing activities
    
    
    (381
    )
    
    
    (270
    )
    
    
    (1,109
    )Cash Flows from Financing Activities:Payments on revolving credit facility, net
    
    
    
    
    
    
    
    
    
    
    (2,593
    )Borrowings on term loan
    
    
    
    
    
    
    1,000
    
    
    
    Repayments on term loan
    
    
    (900
    )
    
    
    (100
    )
    
    
    Purchase of common stock
    
    
    
    
    
    
    (2,063
    )
    
    
    Purchase of treasury Stock
    
    
    (152
    )
    
    
    
    
    
    
    Stock options exercised
    
    
    322
    
    
    
    218
    
    
    
    Stockholder contribution
    
    
    
    
    
    
    5
    
    
    
    Net cash used in financing
activities
    
    
    (730
    )
    
    
    (940
    )
    
    
    (2,593
    )Change in Cash
    
    
    1,076
    
    
    
    1,783
    
    
    
    801Cash, beginning of period
    
    
    2,924
    
    
    
    1,141
    
    
    
    340Cash, end of period
    
    $
    4,000
    
    
    $
    2,924
    
    
    $
    1,141
 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, 2004, 2003 and 2002  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
26% of total revenue in 2004 and 27% during each of 2003 and 2002. During the same periods,
sales to the Companys second largest distributor accounted for an additional 17%, 14%, and
12% of total revenue, respectively. Accounts receivable from the two largest distributors
comprise 57% and 51% of total accounts receivable as of December 31, 2004 and 2003,
respectively. No other customers accounted for more than 10% of the Companys revenue.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. and Vodavi Direct, Inc.
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.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 F-8




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##### Table of Contents



revisions are reflected in the consolidated financial statements in the period they are
determined to be necessary.e.     InventoriesInventories consist of finished products purchased 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 purchased 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, 2004 and 2003, respectively. Useful LifeType of Asset
    
    In Years
    
    2004
    
    
    2003(in thousands)Office and computer equipment
    
    3-5
    
    $
    2,913
    
    
    $
    3,027Furniture and fixtures
    
    7-10
    
    
    494
    
    
    
    579Tooling and test equipment
    
    5-8
    
    
    1,925
    
    
    
    1,8795,332
    
    
    
    5,485Less  accumulated depreciation
    
    
    
    
    (3,969
    )
    
    
    (4,032
    )$
    1,363
    
    
    $
    1,453
  Depreciation expense was $471,00, $448,000, and $485,000 for the years ended December 31,
2004, 2003, and 2002, respectively.g.     GoodwillGoodwill represents the cost in excess of the estimated fair values of assets and
liabilities acquired. On January 1, 2002, the Company changed its method of accounting for
goodwill. See note j below.h.     Other Long-Term AssetsOther long-term assets consists principally of bank commitment fees and the cash surrender
value of key man life insurance. Amortization of bank commitment fees is recognized as a
component of interest expense and totaled $21,000, $19,000, and $0 in 2004, 2003, and 2002
respectively. F-9




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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 continue to be amortized over those periods. Amortization of goodwill and
intangible assets with indeterminate lives have ceased.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.In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4(SFAS 151). SFAS 151 clarifies the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage) by requiring those
items to be recognized currently in earnings. SFAS 151 is effective for inventory costs
incurred during fiscal periods beginning after June 15, 2005. The company believes the
adoption of this statement will not have a material impact on our financial condition or
results from operations.In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets, an amendment
of APB Opinion No. 29(SFAS 153). SFAS 153 amends APB Opinion No. 29 to eliminate certain
exceptions to the principle that exchanges of nonmonetary assets should be measured based on
fair value. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The company believes that adoption of this statement
will not have a material impact on our financial condition or results from operations.In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. This
Statement replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R requires
companies to recognize the grant date fair value of stock options and other equity-based
compensation issued to employees in the income statement. The statement becomes effective
for interim or annual periods beginning after June 15, 2005. The Company has not determined
the financial impact that the adoption of SFAS No. 123R may have on its financial
statements.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 F-10




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##### Table of Contents



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 Recognition  The 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.
Revenue is recorded net of discounts, allowances for sales returns, and volume rebates.  m.
    Engineering and Product Development  All costs associated with internal engineering and product development activities are
expensed as incurred.  n.
    Stock Option Plans  Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based
Compensation, encourages entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows
entities to continue to apply the provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees, and provide pro forma earnings per share disclosures for employee
stock option grants as if the fair-value-based method as defined in SFAS No. 123 had been
applied. The Company applies the intrinsic value method under APB No. 25 and provides the
pro forma disclosure provisions of SFAS No. 123.No stock-based employee compensation cost is reflected in net income as all options granted
under the Companys stock-based compensation plans 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 plans 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 31,2004
    
    
    2003
    
    
    2002(in thousands, except per share amounts)Net income (loss):As reported
    
    $
    1,830
    
    
    $
    1,271
    
    
    $
    (546
    )Employee compensation included in net income (loss)
    
    
    
    
    
    
    
    
    
    
    Fair value of options granted, net of taxes (1)
    
    
    (198
    )
    
    
    (105
    )
    
    
    (131
    )Pro forma
    
    $
    1,632
    
    
    $
    1,166
    
    
    $
    (677
    )Earnings (loss) per share:As reported  basic
    
    $
    0.50
    
    
    $
    0.33
    
    
    $
    (0.13
    )As reported  diluted
    
    $
    0.44
    
    
    $
    0.30
    
    
    $
    (0.13
    )Pro forma  basic
    
    $
    0.45
    
    
    $
    0.30
    
    
    $
    (0.16
    )Pro forma  diluted
    
    $
    0.40
    
    
    $
    0.28
    
    
    $
    (0.16
    )
  (1) The fair value of options granted was determined by 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 31,2004
    
    
    2003
    
    
    2002Risk free interest rate
    
    
    3.20
    %
    
    
    3.05
    %
    
    
    3.05
    %Expected dividends
    
    None
    
    None
    
    NoneExpected lives in years
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0Expected volatility
    
    
    86.4
    %
    
    
    76.1
    %
    
    
    76.1
    %
  o.
    Earnings Per Share  In 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: 2004
    
    
    2003
    
    
    2002(In thousands, except per share data)Income before change in accounting principle
    
    $
    1,830
    
    
    $
    1,271
    
    
    $
    717Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (1,263
    )Net income (loss)
    
    $
    1,830
    
    
    $
    1,271
    
    
    $
    (546
    )Weighted average common shares for basic
earnings per share
    
    
    3,651
    
    
    
    3,906
    
    
    
    4,331Effect of dilutive stock options(1)
    
    
    469
    
    
    
    264
    
    
    
    97Weighted average common shares for diluted
earnings per share
    
    
    4,120
    
    
    
    4,170
    
    
    
    4,428Basic earnings per share:Income before change in accounting principle
    
    $
    0.50
    
    
    $
    0.33
    
    
    $
    0.16Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.29
    )Net income (loss)
    
    $
    0.50
    
    
    $
    0.33
    
    
    $
    (0.13
    )Diluted earnings per share:Income (loss) before change in accounting
principle
    
    $
    0.44
    
    
    $
    0.30
    
    
    $
    0.16Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.29
    )Net income (loss)
    
    $
    0.44
    
    
    $
    0.30
    
    
    $
    (0.13
    )
 (1)       Dilutive securities are calculated using the treasury stock method and the average market price
during the period. Options on 87,000, 243,000, and 625,000 shares had an exercise price greater
than the average market price during the years ended December 31, 2004, 2003, and 2002,
respectively, and therefore did not enter into the earnings per share calculation.  p.
    Fair Value of Financial Instruments  The carrying value of cash, accounts receivable, accounts payable, trade accounts payable to
stockholder, 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. F-12




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##### Table of Contents



q.
    Segments  The 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.
    Reclassifications  Certain reclassifications have been made to the financial statements for the year ended
December 31, 2003 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 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.
    Revolving Credit FacilityIn April 2003, the Company entered into a credit agreement with Comerica Bank (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 the Companys operating subsidiaries from paying dividends to the Company
without the consent of Comerica. As of December 31, 2004, the Company had no outstanding
borrowings on its line of credit and $5.0 million available for future advances.The $5.0 million revolving line of credit bears interest at Comericas prime rate (5.25% as
of December 31, 2004) and requires monthly payments of interest only with all unpaid
principal and accrued interest due at its expiration in April 2005. In March 2005, the
Company entered into a modification agreement with Comerica extending the expiration of the
credit agreement to April 2006.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 bore interest at Comericas prime rate plus
0.5%. The term loan was repaid in 2004.4.
    Commitments and Contingencies  a.
    Legal Matters  The Company was involved in a legal dispute related to a strategic alliance agreement. In
October 2002, the parties settled the dispute. As a result, the Company paid $250,000 for
the settlement and incurred an F-13




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##### Table of Contents



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.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 Leases  The 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
    
    
    Total2005
    
    
    867
    
    
    
    (15
    )
    
    
    8522006
    
    
    811
    
    
    
    
    
    
    
    8112007
    
    
    785
    
    
    
    
    
    
    
    7852008
    
    
    785
    
    
    
    
    
    
    
    7852009
    
    
    785
    
    
    
    
    
    
    
    785Thereafter
    
    
    1,571
    
    
    
    
    
    
    
    1,571Total minimum lease commitments
    
    $
    5,604
    
    
    $
    (15
    )
    
    $
    5,589
  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, $1.1 million, and $1.2 million for the years ended December 31, 2004, 2003,
and 2002 respectively. The difference between rent expensed and rent paid was $9,000,
$9,000, and $23,000 for the years ended December 31, 2004, 2003, and 2002, respectively.  c.
    401(k) Profit Sharing Plan  The 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 $72,000, $58,000 and $64,000 for the years ended December 31,
2004, 2003, and 2002, respectively.6.
    Stockholders Equity  a.
    Treasury Stock  The Company has a stock repurchase program under which the Company may purchase up to $1.0
million of its common stock through March 31, 2005. As of December 31, 2004, the Company
had purchased 32,402 shares of common stock for $152,000.  b.
    Self Tender Offer  Stock Repurchase  In 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 F-14




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##### Table of Contents



million, which included offering costs of approximately $73,000, was recorded as a reduction
to common stock and additional paid in capital in the accompanying consolidated balance
sheets  c.
    Vodavi Technology, Inc. 1994 Stock Option Plan (the 1994 Plan)  The 1994 Plan, as amended, provided 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 were issued to key personnel of the Company.
The options issued were incentive stock options and nonqualified stock options. The 1994
Plan also included an automatic program under which nonqualified options were automatically
granted to the Companys nonemployee directors. The 1994 Plan expired in April 2004. All
outstanding options granted under the 1994 Plan prior to its expiration shall remain
outstanding until the expiration date of the individual option grants and all remaining
options available for grant at the expiration date were cancelled.  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 shares. 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-15




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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, 2004
    
    
    December 31, 2003
    
    
    December 31, 2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageNumber of
    
    
    Exercise
    
    
    Number of
    
    
    Exercise
    
    
    Number of
    
    
    ExerciseOptions
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    PriceOptions outstanding at
beginning of period
    
    
    863,125
    
    
    $
    2.46
    
    
    
    880,500
    
    
    $
    2.89
    
    
    
    804,500
    
    
    $
    3.08Granted
    
    
    73,750
    
    
    
    6.19
    
    
    
    185,000
    
    
    
    1.81
    
    
    
    112,500
    
    
    
    1.70Forfeited
    
    
    (61,250
    )
    
    
    7.00
    
    
    
    (112,500
    )
    
    
    4.84
    
    
    
    (36,500
    )
    
    
    3.42Exercised
    
    
    (137,000
    )
    
    
    2.35
    
    
    
    (89,875
    )
    
    
    2.43
    
    
    
    
    
    
    
    Options outstanding at end
of period
    
    
    738,625
    
    
    $
    2.84
    
    
    
    863,125
    
    
    $
    2.46
    
    
    
    880,500
    
    
    $
    2.89Options available for grant
    
    
    531,250
    
    
    
    
    
    
    
    1,094,500(1)
    
    
    
    
    
    
    
    567,000Exercisable at end of
period
    
    
    532,250
    
    
    $
    2.79
    
    
    
    517,000
    
    
    $
    3.00
    
    
    
    530,875
    
    
    $
    3.52Weighted average fair
value of options granted
    
    
    
    
    
    $
    4.28
    
    
    
    
    
    
    $
    0.82
    
    
    
    
    
    
    $
    1.08
 (1) Options available for grant at December 31, 2003 included 494,500 under the 1994
Plan and 600,000 under the 2003 Plan. The Company canceled all remaining options available for
grant under the 1994 Plan when it expired in April 2004. Options Outstanding
    
    
    Options ExercisableWeighted-Number
    
    
    Average
    
    
    
    
    
    
    NumberOutstanding at
    
    
    Remaining
    
    
    Weighted-
    
    
    Exercisable at
    
    
    Weighted-Range of
    
    December 31,
    
    
    Contractual
    
    
    Average
    
    
    December 31,
    
    
    AverageExercise Prices
    
    2004
    
    
    Life (in years)
    
    
    Exercise Price
    
    
    2003
    
    
    Exercise Price$0.71 - $2.81
    
    
    537,375
    
    
    
    6.0
    
    
    $
    1.94
    
    
    
    399,750
    
    
    $
    2.13$2.82 - $4.93
    
    
    99,500
    
    
    
    4.3
    
    
    $
    4.16
    
    
    
    84,500
    
    
    $
    4.08$4.94 - $7.05
    
    
    101,750
    
    
    
    5.5
    
    
    $
    6.29
    
    
    
    48,000
    
    
    $
    6.00738,625
    
    
    
    
    
    
    $
    2.84
    
    
    
    532,250
    
    
    $
    2.79
  7.
    Income TaxesThe Company files a consolidated federal income tax return. The income tax provision
(benefit) is comprised of the following: 2004
    
    
    2003
    
    
    2002(in thousands)Current
    
    $
    1,095
    
    
    $
    687
    
    
    $
    74Deferred
    
    
    49
    
    
    
    117
    
    
    
    397$
    1,144
    
    
    $
    804
    
    
    $
    471
 F-16




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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, 2004 and 2003, were as follows: 2004
    
    
    2003(in thousands)Current deferred tax assets:Receivable reserves
    
    $
    73
    
    
    $
    72UNICAP adjustment
    
    
    79
    
    
    
    80Other reserves and accruals
    
    
    262
    
    
    
    209Research and development credits
    
    
    40
    
    
    
    84$
    454
    
    
    $
    445Long-term deferred tax assets (liabilities):Depreciation and amortization differences (1)
    
    $
    (24
    )
    
    $
    34
  (1) The Company had a valuation allowance of $127,000 on certain
long-term deferred tax assets as of December 31, 2004 and 2003.  A reconciliation of the federal income tax rate to the Companys effective income tax rate
is as follows: 2004
    
    
    2003
    
    
    2002Federal statutory tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %State taxes, net
    
    
    3.6
    
    
    
    3.3
    
    
    
    3.3Research and development and other tax credits
    
    
    (0.5
    )
    
    
    (1.6
    )
    
    
    (2.8
    )Non-deductible expenses, reserves, and other
permanent differences
    
    
    1.4
    
    
    
    3.0
    
    
    
    5.138.5
    %
    
    
    38.7
    %
    
    
    39.6
    %
  8.
    Related Party TransactionsLG Electronics Inc. (LGE), the Companys principal supplier, owned approximately 23% of the
Companys outstanding common stock at December 31, 2004 and has a designated member on the
Companys board of directors. The Company purchased approximately $22.2 million, $21.1
million, and $18.5 million of key telephone systems, commercial grade telephones, and voice
mail products from LGE and an affiliate of LGE during 2004, 2003, and 2002, respectively.
The Company owed LGE and its affiliate a total of $3,990,000 and $4,208,000 for product
purchases at December 31, 2004 and 2003, 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 $0 in 2004, $24,000 in 2003 and $183,500 in 2002 for work performed
under the development agreement using the percentage of completion method. The project was
completed in 2003. F-17




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##### Table of Contents



9.
    Supplemental Cash Flow InformationCash paid for interest and income taxes for the years ended December 31, 2004, 2003, and
2002 was as follows: 2004
    
    
    2003
    
    
    2002(in thousands)Interest
    
    $
    15
    
    
    $
    128
    
    
    $
    97Income taxes
    
    $
    1,232
    
    
    $
    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, 2004 or 2003.10.
    Summary of Quarterly Results (unaudited): (in thousands, except per share amounts) First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Year2004Revenue, net
    
    $
    9,787
    
    
    $
    11,240
    
    
    $
    11,690
    
    
    $
    11,074
    
    
    $
    43,791Gross margin
    
    
    3,380
    
    
    
    3,944
    
    
    
    4,161
    
    
    
    3,946
    
    
    
    15,431Income before income taxes
    
    
    350
    
    
    
    736
    
    
    
    1,068
    
    
    
    820
    
    
    
    2,974Provision for income taxes
    
    
    134
    
    
    
    283
    
    
    
    411
    
    
    
    316
    
    
    
    1,144Net income
    
    $
    216
    
    
    $
    453
    
    
    $
    657
    
    
    $
    504
    
    
    $
    1,830Diluted earnings per share
    
    $
    0.05
    
    
    $
    0.11
    
    
    $
    0.16
    
    
    $
    0.12
    
    
    $
    0.442003Revenue, 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
    
    
    212
    
    
    
    552
    
    
    
    747
    
    
    
    564
    
    
    
    2,075Provision for income taxes
    
    
    85
    
    
    
    219
    
    
    
    295
    
    
    
    205
    
    
    
    804Net income
    
    $
    127
    
    
    $
    333
    
    
    $
    452
    
    
    $
    359
    
    
    $
    1,271Diluted earnings per share
    
    $
    0.03
    
    
    $
    0.08
    
    
    $
    0.12
    
    
    $
    0.09
    
    
    $
    0.30
 F-18




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SCHEDULE To the Stockholders VODAVI TECHNOLOGY, INC. We have audited the consolidated financial statements of Vodavi Technology, Inc. and subsidiaries
as of and for the years ended December 31, 2004 and 2003 and have issued our report thereon dated
February 10, 2005 (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
years ended December 31, 2004 and 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 10, 2005 S-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SCHEDULE 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 for the year 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 audit also
included the consolidated financial statement schedule for 2002 of Vodavi Technology, Inc. and
subsidiaries, listed in the Index to Consolidated Financial Statements and Schedule. The financial
statement schedule is the responsibility of the Companys management. Our responsibility is to
express an opinion based on our audits. In our opinion, such 2002 consolidated financial statement
schedule, when considered in relation to the basic 2002 consolidated financial statements taken as
a whole, presents 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, 2004, 2003, and 2002 In thousands 2004
    
    
    2003
    
    
    2002Reserves for doubtful accounts and sales returns:Balance at beginning of year
    
    $
    345
    
    
    $
    422
    
    
    $
    730Provision charged to expense
    
    
    88
    
    
    
    146
    
    
    
    256Write-offs
    
    
    (46
    )
    
    
    (223
    )
    
    
    (564
    )Balance at end of year
    
    $
    387
    
    
    $
    345
    
    
    $
    422Reserves for excess and obsolete inventory:Balance at beginning of year
    
    $
    321
    
    
    $
    344
    
    
    $
    621Provision charged to expense
    
    
    240
    
    
    
    310
    
    
    
    290Write-offs
    
    
    (149
    )
    
    
    (333
    )
    
    
    (567
    )Balance at end of year
    
    $
    412
    
    
    $
    321
    
    
    $
    344
 S-3