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, 1996 Commission File Number 0-26912
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VODAVI TECHNOLOGY, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 86-0789350
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(State or other jurisdiction of (I.R.S. Employer
incorporation or Identification No.)
organization)
8300 EAST RAINTREE DRIVE
SCOTTSDALE, ARIZONA 85260
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(Address of principal executive offices) (Zip Code)
(602) 443-6000
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Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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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. [x]
At March 24, 1997, there were outstanding 4,342,238 shares of the registrant's
Common Stock, $.001 par value. The aggregate market value of Common Stock held
by nonaffiliates of the registrant (2,733,708 shares) based on the closing price
of the Common Stock as reported on the Nasdaq National Market on March 24, 1997,
was $9,567,978. 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.
Documents incorporated by reference: Portions of the registrant's definitive
Proxy Statement for the 1997 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Report.
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VODAVI TECHNOLOGY, INC.
ANNUAL REPORT ON FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
<TABLE>
PART I Page
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<S> <C> <C> <C>
ITEM 1. BUSINESS........................................................................... 1
ITEM 2. PROPERTIES......................................................................... 24
ITEM 3. LEGAL PROCEEDINGS.................................................................. 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................ 25
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS...................................................... 26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA............................................... 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................................. 28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................ 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.............................................. 31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................. 31
ITEM 11. EXECUTIVE COMPENSATION............................................................. 31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT................................................................... 31
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................... 31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K...................................................................... 32
SIGNATURES.................................................................................................... 34
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PART I
ITEM 1. BUSINESS
INTRODUCTION
The Company designs, develops, markets, and supports a broad range of
telephone systems, commercial grade telephones, voice processing products, and
computer-telephony products for a wide variety of business applications. The
Company's telephone systems incorporate sophisticated features, such as
automatic call distribution and caller ID, and its voice processing products
include interactive voice response systems, automated attendant, and voice and
fax mail. The Company's computer-telephony products allow users to combine the
functionality of telephones and desktop computers through applications such as
integrated PC telephones, desktop video conferencing systems, and call
accounting systems. The Company markets its products primarily in the United
States as well as in Canada, Mexico, and other foreign countries through a
distribution network consisting of wholesale distributors, direct dealers, and
its own sales personnel.
The Company's business strategy includes (i) expanding the Company's
historical business of supplying telephone systems and commercial grade
telephones; (ii) emphasizing its new voice processing and computer-telephony
integration products for use in connection with telephone systems supplied by it
and by others; (iii) entering the expanding markets for wireless telephone
systems and desktop video conferencing systems; (iv) pursuing its strategic
relationship with LG Electronics Inc. ("LGE"), a member of the multi-billion
dollar, Korean-based LG Group with which management has had a long-term
relationship; and (v) expanding its technological expertise through business
acquisitions, license arrangements and other strategic relationships, and
increased internal research and development efforts in order to enhance existing
products, introduce new products, and expand product lines.
Unless the context indicates otherwise, all references to the "Company"
refer to Vodavi Technology, Inc., its predecessors and its subsidiaries,
including Vodavi Communications Systems, Inc. ("VCS"), Enhanced Systems, Inc.
("Enhanced"), and Arizona Repair Services, Inc. ("ARSI"). The Company's
corporate headquarters are located at 8300 East Raintree Drive, Scottsdale,
Arizona 85260, and its telephone number is (602) 443-6000.
BUSINESS
Industry Overview
Virtually every business today relies upon its business communications
system as an essential tool to speed and enhance the effectiveness of
communications among employees, customers, and vendors; to contact decision
makers regardless of their location; to increase employee productivity; to
provide better customer service; and to reduce operating costs. Many factors
have stimulated the growth of the telecommunications industry, including
successive technological developments that have resulted in enhanced features
and services, advances in telephone and computer hardware and software, and
regulatory changes. These factors have resulted in continual development of
full-featured business communications systems designed for use by small- and
medium-sized businesses and offered at affordable prices.
Since the late 1980s, the telecommunications industry has undergone a
significant transition from products based on proprietary hardware and software
systems to more flexible open architecture based products. The use of open
architecture systems has enabled product developers to combine technological
advances created by third-party developers with standardized or proprietary
hardware, operating systems, and software in order to reduce development time,
lower product cost, and expand product functionality. The availability of open
architecture based platforms and flexible, user-programmable software modules
has made affordably priced, full-featured communications systems available to
small businesses with limited resources as well as to larger, more established
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organizations and has prompted users to replace older systems and equipment or
to enhance their existing systems after the introduction of newer designs,
technologies, and features.
Accelerated technological advances in recent years have enabled
telecommunications system providers to develop sophisticated systems that offer
a wide variety of applications in addition to traditional call switching
functions. Businesses of all sizes now demand affordable telecommunications
systems that provide the capacity for (i) voice and text processing systems,
which automate call answering, provide voice mail and automated call
distribution functions, and provide the capacity to manage facsimile messages;
(ii) interactive voice response, which enables businesses to provide a wide
range of additional services at lower cost by providing access to the
organization's computer system from any touchtone telephone; and (iii)
computer-telephony integration, which greatly enhances efficiency and
productivity by providing access to and control of telephone system functions
from individual computer terminals. Recent developments in wireless telephone
systems, computer-telephony integration technologies, and desktop video
conferencing technologies represent significant opportunities for sales of new
product lines and features to further increase employee mobility and efficiency.
The Company also believes that international sales of telecommunications systems
that include productivity enhancing products will increase substantially in the
future as cultural resistance to features such as voice mail and interactive
voice response declines, improvements in installed telephone infrastructures in
other countries are made, and regulatory differences between countries are
eliminated.
Products
The Company currently designs, develops, markets, and supports a broad
range of (i) telephony products, which include digital and electronic key
telephone systems and commercial grade telephones; (ii) voice processing
products, including interactive voice response systems, automated attendant,
automatic call distribution, voice mail and fax mail, and an advanced telephony
software development language; and (iii) computer-telephony products, including
Windows-based application products (such as PC telephones and attendant
consoles), local area network ("LAN") to PBX connection packages, unified
messaging servers utilizing the Internet, call accounting systems, and desktop
video conferencing systems. The Company currently is developing a new line of
digital communications systems and wireless digital telephone systems for
introduction in 1997. The Company also is developing additional
computer-telephone integration programs, voice activated command products, and
unified messaging systems.
Key Telephone Systems
Sales of key telephone systems represented approximately 72.4% and
70.0% of the Company's revenue during 1995 and 1996, respectively. A key
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 or modems, located at individual "stations."
Telephone systems are designed to accommodate the number of "ports" (the total
number of incoming lines, or "trunks," and stations) required to handle the
communications needs of businesses of varying sizes. The switching unit routes
calls on one or more incoming trunks from the local or long distance telephone
company central office equipment to the appropriate station located within the
business. The switching unit also routes calls from one station within the
business to other stations within the business or out to the telephone company
central office for switching to other local or long distance telephone numbers.
The Company currently markets various lines of key telephone systems,
under its STARPLUS and infinite brand names, for businesses requiring as few as
two incoming trunks and four stations up to 96 trunks and 120 stations (a
216-port system). The Company sells the STARPLUS line through large wholesale
distributors known as "Supply Houses" and the infinite line through telephone
sales and installation companies known as "Direct Dealers." See Item 1,
"Business - Sales, Marketing, and Distribution." Each of the infinite telephone
systems incorporates the base platform and software of the corresponding
STARPLUS system, with certain modifications that differentiate the infinite
system from the STARPLUS system in function and cosmetic appearance.
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The Company supplies several models of key telephone sets with
progressive features for use in conjunction with each of its telephone systems,
including a model with PC Interface for use with the Company's computer-
telephony integration products. Many of the feature buttons on the Company's key
telephones are user-programmable to enable users to custom-tailor their
telephone systems for maximum efficiency in specific applications.
The Company markets both fully digital and electronic (analog) key
telephone systems and related products. The Company's digital telephone systems
employ a digital architecture in order to provide digital voice transmission and
system control, while the Company's electronic telephone systems employ a
microprocessor-based architecture and solid state switching for voice
transmission and system control. Most of the Company's 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. The Company's 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. The Company designs its key telephone systems to readily
permit expansion or customization for specific business applications by
installation of a variety of voice processing or computer-telephony integration
products. See Item 1, "Business - Products - Voice Processing Products" and Item
1, "Business - Products - Computer-Telephony Integration Products."
The Company intends to take advantage of the expected replacement of
the entire installed base of electronic telephone equipment as digital and
wireless systems become better defined, more cost effective, and more widely
accepted. The digital technology incorporated into the Company's digital
telephone systems provides clearer voice reproduction and a state-of-the-art
interface to data applications that enables better data compression and more
accurate data transmission than can be provided by electronic systems. The
Company also believes that the growing acceptance and utilization of the
Integrated Services Digital Network ("ISDN"), which provides the capacity to
simultaneously transmit voice, data, and video information over the same
telephone, will significantly stimulate sales of digital telephone systems that
include high-speed data transmission and other technology necessary to fully
implement ISDN capabilities.
The Company's digital systems enable customers to upgrade their
telephone systems as their businesses grow and technology advances by adding or
replacing components in stages without replacing their entire systems. As a
result, it is generally more economical for the end users to expand their
STARPLUS or infinite systems than to switch to a competitor's system. In
addition, the wireless telephone systems currently being developed by the
Company are designed to be incorporated with the Company's digital systems
without requiring significant modification to existing equipment. The Company
believes that the economy and flexibility provided to its customers by this
migration strategy offers a competitive advantage to the Company.
Commercial Grade Telephones
The Company markets several lines of commercial grade telephones
through Supply Houses and Direct Dealers for ultimate sale to home office or
business users that require a business telephone with multiple features; for use
with PBX installations in hotels, motels, and resorts; and for use with
electronic or digital key systems, PBX systems, or telephone company central
office ("Centrex") switching systems when the customer prefers telephone sets
that provide multiple features. Sales of commercial grade telephones represented
approximately 17.7% of the Company's revenue during each of 1995 and 1996. All
of the Company's commercial grade telephones meet industry standards for
commercial telephone units and may be used with telephone systems sold by the
Company or by competing manufacturers. The Company's 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. The Company's more advanced commercial grade
telephones contain a central processing unit, built-in memory, built-in data
jacks, built-in speakerphones, and the capability to utilize custom calling
features provided by local telephone companies.
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Voice Processing Products
Voice processing includes functions designed to reduce labor costs
while providing faster, more efficient routing of incoming calls and speeding
and simplifying message delivery and storage. A caller communicates with the
system by pressing appropriate keys on a touchtone telephone or by giving spoken
commands. The system listens for this input and then makes an appropriate
response. The Company's voice processing systems also provide extensive
reporting capabilities, including data used to analyze mailbox usage or caller
routing patterns. The flexible design of these systems permits operating
personnel to access system programming and administration functions via a
keyboard and monitor or from remote locations via touchtone telephone.
The Company designs its voice processing systems by using a
microprocessor-based open architecture platform, which enables the Company to
significantly enhance product development by utilizing standardized hardware and
operating systems software and by supplementing its own software development
expertise with additional software systems developed in conjunction with or
acquired through licensing arrangements with independent third-party developers.
The Company packages this platform with increasingly sophisticated combinations
of software application modules in order to create several lines of voice
processing products that offer a wide array of features designed to meet the
needs of business organizations depending upon the size of their telephone
systems and required complexity of voice processing functions. The Company's
voice processing platforms utilize a modular software application design that
permits users to configure their systems to meet current needs and to
accommodate system growth as their businesses expand.
The Company designs its voice processing products to integrate with
telephone systems sold by the Company as well as competing manufacturers and
frequently markets its voice processing products independently of its telephone
systems. The Company, however, cultivates the expansion of its existing base of
telephone systems by offering voice processing products that differentiate its
products from those of its competitors and that provide a value-added basis for
increased sales and profit margins. The Company also markets an advanced
software development language, which enables independent developers to create
custom telephony applications.
Interactive Voice Response
The Company's interactive voice response ("IVR") system connects the
business user's telephone system to the user's host computer in order to permit
the use of any touchtone telephone as a computer terminal to access and store
information in the business's database. This interactive connectivity permits
callers to conduct transactions, such as placing orders, checking inventory,
tracking order shipments, or querying account information, from any touchtone
telephone. IVR converts callers' touchtone key presses into data for storage on
the computer system and uses synthesized human speech to give the caller
instructions regarding how to access the database and to communicate the
requested information to the caller. The open architecture design of the
Company's IVR system provides unlimited scalability by permitting users to
increase the number of ports or voice storage capacity simply by plugging in
more voice cards or disk drives and by linking multiple devices into networks to
create virtually unlimited configurations. Users may enhance the system by
adding independent off-the-shelf software modules that can be seamlessly
integrated to provide additional features, such as call routing, voice
messaging, fax store-and-forward, and audiotext.
Voice Mail and Fax Mail Systems
The Company's traditional DOS-based voice mail systems automatically
route unanswered calls to a preprogrammed destination or the recipient's voice
mailbox. 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 telephones. 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 certain of
the Company's voice mail systems enable business users to program the systems to
create custom, multi-level menus
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that permit callers to automatically access organizational departments or
product, service, or event information by dialing menu choices.
Fax mail provides the ability to receive, store, retrieve, and forward
facsimile messages in the same manner that voice mail handles voice messages.
The Company's 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-command" 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.
The Company's Microsoft Corp. ("Microsoft") Windows NT-based messaging
systems combine traditional voice and facsimile messaging capabilities with the
ability to share messages with other voice messaging systems over the Internet.
The new system utilizes Company developed extensions to existing 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. 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. In addition, by adding the Company's new Unified Messaging server, users
may retrieve voice, facsimile, paging, e-mail, or Internet mail messages from a
consolidated desktop computer screen. See Item 1, "Business - Products -
Computer-Telephony Integration Products."
Automatic Call Distribution
The Company markets its ACD System Software and ACD Reporting Package
(the "ACD System") for use with digital key telephone systems. The automatic
call distribution functions provided by the ACD System enable businesses that
receive a large volume of customer calls (such as catalog sales operations) to
manage incoming calls efficiently by directly routing them to the proper person
or group. The ACD System reduces 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, the ACD System
plays a custom "hold" message for the caller and connects the call to the first
available person or sales agent. The ACD System saves employee time by
eliminating the necessity of continually answering and transferring calls to the
same groups. The ACD System 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. The ACD
Reporting Package component of the ACD System provides real-time information and
comprehensive historical reports on calling activity for review by management.
Automated Attendant
The Company's automated attendant routes incoming calls automatically
to the intended person or department during and after business hours by
instructing the caller to press on his or her touch-tone telephone the numbers
of the recipient's extension or the letters of the recipient's name, which
provides front-end automated call processing for small key telephone systems and
PBX systems that support standard commercial telephones. Automated attendant
features ensure that each caller has the ability to contact the intended person
and enable the business to eliminate or reduce operators or attendants or to
assign other responsibilities to attendants or operators when not answering
calls. The business user also can program the system so that callers always have
the option of speaking with an operator.
Computer-Telephony Integration Products
The Company designs, develops, and markets computer-telephony
integration ("CTI") products that combine the communications technologies of
business telephone systems with the information storage and processing
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capabilities of personal computers. The Company's CTI products utilize an open
system architecture to integrate computers and telephone systems into a
user-friendly information storage, processing, and transmitting device. The
Company believes that developing more value-added CTI applications for its
telephone systems will enhance the appeal of its product lines and enable it to
sell more key telephone systems, full-featured telephones, and other software
packages and add-on peripheral products. The Company markets CTI products that
enable a user to (i) utilize the Internet to access voice, facsimile, and e-mail
messages via personal computer; (ii) incorporate telephone functions with
computer software to speed call handling and permit the user to personalize
telephone functions; (iii) identify incoming callers and immediately access
computer files relating to the caller; (iv) connect Windows-based local area
networks to the user's telephone system; and (v) quickly and inexpensively
access and analyze call accounting information. The Company has recently
incorporated an application provider interface into its digital telephone
systems that will be compatible with Microsoft's Telephony Application
Programming Interface.
PC Phone
The Company's PC Phone product lines include software applications
designed to operate in conjunction with Microsoft's Windows operating systems
software in order to unite personal computers and telephones to help business
users better manage their communications and information systems. The PC Phone
package includes the PC Phone software, which is ready to be loaded onto the
computer workstation, and a PC Interface Telephone, which is a digital telephone
keyset with RS-232C serial port for connection to the user's computer. PC Phone
incorporates the fixed and flexible feature buttons of the Company's digital
telephones (such as the dial pad, call status display, directory window, and
dial display) onto the computer screen. The user can then access all telephone
features, place calls, and process incoming calls from either the telephone or
the computer. For instance, the user can click on the directory icon to access
the desired telephone directory, type in the name of the person to be called,
and click on the "dial out" icon to automatically dial the telephone number. The
system also permits the user to answer incoming calls without having to exit a
Windows application.
PC Phone enables users to customize and enhance message handling
efficiency by using programmable feature buttons to create user-specific
functions, such as conference calling or speed dial numbers. PC Phone also
permits users to access voice mail and activate voice mail options, such as
fast-forward, rewind, or delete by using the mouse, computer keyboard, or
telephone keypad. PC Phone permits users to create multiple directories with up
to 1,000 names in each directory. PC Phone also provides connections to readily
available personal information managers and contact management software
packages, such as "ACT!," "TeleMagic," and "Gold Mine."
Incoming Caller ID
The Company's Incoming Caller ID product lines provide system users
with instant identification of the caller's name and telephone number prior to
answering the incoming call. When connected to the business's computer system
via the Company's PC Phone products, the Incoming Caller ID systems facilitate
instant access to customer database information, such as account activity notes,
prior purchases, or billing and payment history, which the system's "Screen Pop"
feature displays at the user's personal computer screen before the call is
answered. Other Incoming Caller ID features permit faster transfer of calls to
the appropriate system user, simplify the process of returning unanswered calls
by enabling the user to scroll through the table of unanswered calls shown on
the telephone display and press the speed dial button on the highlighted number
to return the call, and record incoming caller information, including name,
telephone number, time and date of call, call duration, and the number of the
station that answered the call.
Callsort Pro for Windows
The Company's Callsort Pro for Windows ("Callsort") combines call
accounting software with a graphical interface designed to enable business
managers quickly and inexpensively to access and analyze call accounting
information. Reports generated by Callsort enable business users to allocate
expenses by department or project, bill customers for calls made on their
behalf, evaluate productivity of individual employees, verify telephone bills,
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and identify long-distance call abusers. Callsort seamlessly blends a call
collecting and pricing software module, a system management software module, and
a reporting software module to form a single application that may be used in
conjunction with stand-alone computers or local area networks. Telephony systems
managers can program Callsort to control the collection and distribution of
system information and to grant or restrict access to specific data according to
the user's telephone extension, department, account, or other criteria. Callsort
provides over 30 predefined report formats that can be accessed and executed
from any Windows-based PC on the network and also enables users to customize
reports by selecting from various combinations of selection and sorting
criteria. In addition, users can create and save their own reporting formats.
Callsort includes a hotel module, which enables hotels and motels to charge
guests automatically for local and long-distance calls made from their rooms.
Unified Messaging
The Company's unified messaging system utilizes Microsoft's "Exchange"
technology to enable 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.
Internet Fax Delivery
The Company's Windows NT-based Internet fax delivery systems provide
the ability to send and receive facsimile messages via the Internet. The
Company's 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. The Company's
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.
Desktop Video Conferencing
The Company recently introduced a full-featured Windows 95-based
desktop ISDN video conferencing system that is designed to enable users to place
and receive video calls with ease. The system features a full duplex
speakerphone with echo cancellation and "picture-in-picture" to show both ends
of the call. Users can assemble video conferences with up to five parties by
using an external video conferencing service. The system also supports
application sharing and permits all parties on the call to collaborate in data
sharing.
New Product Development
The Company engages in an on-going program to develop enhancements to
its existing product lines and to develop new products that address the
increasing demands of business organizations for low-cost productivity enhancing
communications tools. The Company believes that continuous development of new
products and features will be necessary to enable it 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 growth and profitability of the Company on an
on-going basis.
Digital Communications Systems
In conjunction with LGE, the Company currently is developing a new line
of digital communications systems, which will support up to 384 ports. The
Company anticipates that the line will be ready for distribution beginning in
mid-1997. Upon introduction of the line, the Company will compete for sales of
the approximately 3.6 million stations currently sold annually to the 50 to 400
station market segment, which will significantly expand the Company's
addressable market for telephone systems and related products. The Company
intends to target its systems towards the small-installation segment of the PBX
market, with particular emphasis on key vertical market
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segments, such as hotels and motels, educational institutions, service
organizations, and general business organizations.
The Company is designing its new digital systems to combine the
sophistication and high-end capabilities of traditional PBX systems with the
ease of use of key telephone systems that are integrated for both voice and data
applications. The systems will be fully modular and will utilize a universal
slot orientation capable of supporting a wide variety of terminals, trunks, and
data interfaces. In addition to the new digital systems' productivity enhancing
features and capabilities, the Company anticipates that the larger digital
communications systems will provide users of the Company's products with the
ability to expand their telephone systems beyond the capacities of the Company's
current telephone systems, while retaining their installed base of STARPLUS or
infinite telephone sets, voice processing systems, and computer telephony
products. The Company currently is developing enhancements to its platform that
will provide support for multi-cell, multi-user wireless communications systems,
computer-telephony integration products, ISDN functions, and voice activated
commands.
Wireless Telephone Systems
The Company and NovAtel Wireless, Inc. ("NovAtel") currently are
jointly developing a single cell, multi-user wireless telephone system for use
with smaller telephone systems and a multi-cell, multi-user wireless system for
use with the Company's digital communications systems and PBX systems. The
low-powered, lightweight, portable wireless telephone handset units are designed
to operate as a stand-alone telephone system or to work in conjunction with all
industry-standard telephone systems marketed by the Company or its competitors
and will incorporate multiple key system feature buttons in order to provide
access to many of the system features currently provided by such telephone
systems. The Company's wireless telephone systems will use a 900 megahertz
digital spread-spectrum frequency hopping technology. The Company anticipates
that the handsets will operate at a range of up to 200 feet from a wireless
transmitting station.
Benefits of the Company's wireless telephone systems will include
greater mobility, reduced need for external paging equipment, reduced need for
voice mail, and reduced secretary workload as well as ease of installation and
lower initial installation costs resulting from the elimination of wiring to
individual stations. The Company believes that its wireless telephone systems
will provide increased productivity in business situations in which managers or
employees spend a large portion of their time away from a fixed office or
telephone location, such as sales clerks working on the floor of a large retail
store, order processing clerks in warehouse operations, or production
supervisors inspecting a large manufacturing plant. The Company currently plans
to introduce its first wireless communication products in 1997.
Under the agreement between the Company and NovAtel (the "Wireless
Agreement"), the Company and NovAtel share product development costs and the
Company pays the costs associated with obtaining necessary government approvals.
NovAtel has granted the Company the exclusive right to market and distribute the
wireless telephone systems in the United States and Canada. The Wireless
Agreement requires the Company to purchase from NovAtel, on a purchase order
basis, minimum quantities of wireless base units and handsets. The Wireless
Agreement establishes the minimum purchase obligations for the first year of the
agreement and gives NovAtel the right to change the Company's exclusive
distribution right to a non-exclusive right in the event that the Company and
NovAtel are unable to agree upon the Company's minimum purchase obligations for
subsequent years. The Wireless Agreement will expire five years after the first
delivery of wireless telephone products ordered by the Company. Steven A.
Sherman, the Company's Chairman of the Board, is the Chairman of the Board and
President and a significant shareholder of NovAtel. See Item 1, "Special
Considerations - Control by Management; Stockholders' Agreement; Conflicts of
Interest."
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CTI Development Programs
The Company currently is developing products to embrace the new
Telephony Application Programming Interface ("TAPI") computer-telephony
integration standard. TAPI is a programming interface that works in conjunction
with software standards developed by Microsoft to enable third-party software
developers to design CTI software that permits computer applications to
communicate with telephone systems without being written for a particular
telephone system vendor's hardware.
Sales, Marketing, and Distribution
The Company currently markets its products in all 50 states and Puerto
Rico through a distribution network consisting primarily of large wholesale
distributors known as "Supply Houses" and telephone sales and installation
companies known as "Direct Dealers." The Company also maintains an in-house
sales staff that makes direct sales of certain of its products to large
commercial organizations and public access providers, such as local telephone
companies and cellular telephone system providers. From time to time, the
Company may also market its products on a private label basis to original
equipment manufacturers ("OEMs"). The Company derived approximately 81.5% and
12.1% of its total revenue from sales to Supply Houses and Direct Dealers,
respectively, in 1996.
Supply Houses (Wholesale Distributors)
The Company designs and markets its STARPLUS brand of key telephone
systems, commercial grade telephones, and related products for sale through
Supply Houses. The Supply Houses resell the Company's products primarily to
small local interconnect companies and independent telephone companies, which in
turn resell the Company's products to end users, install the systems at the end
users' businesses, and provide service and technical support following the sale.
The Company provides ongoing training to Supply House employees to enable them
to sell more effectively the Company's products and to provide the interconnects
and independent telephone companies with technical assistance in installation,
maintenance, and customer support.
The Company believes that sales through Supply Houses offers several
advantages, including (i) established distribution systems and access to a large
number of customer accounts; (ii) maintenance of customer credit facilities and
an established inventory of the Company's products; (iii) prompt payment of
receivables; (iv) reduced needs for direct training by the Company; (v)
effective promotion of the Company's products at trade shows; (vi)
geographically dispersed sales forces that can reach customers more effectively
than the Company would otherwise be able to do; (vii) lower support and carrying
costs compared with the costs associated with direct sales to a large number of
Direct Dealers; and (viii) the absence of conflict with the Company's sales to
medium and larger interconnects through Direct Dealers.
Supply Houses that currently resell the Company's products include
Graybar Electric Co., Inc. ("Graybar"), Sprint/North Supply, Anixter Brothers,
Inc., G.T.E. Supply Co., Famous Telephone Supply, Power & Telephone Supply
Company, Inc., Alltel Supply, Inc., Ademco Distribution, Inc., and Ingram Micro,
Inc. Graybar accounted for 45% and 44% of sales during 1995 and 1996,
respectively. The Company's sales and marketing personnel stimulate demand for
its products with the smaller interconnects and independent telephone companies
that purchase the Company's products from Graybar, Sprint/North Supply, and
other Supply Houses and install these products at the end users' premises. These
interconnects and independent telephone companies provide the "pull through"
demand for the Company's products from Graybar and other Supply Houses. As a
result, the Company believes that a decrease in purchases by Graybar or other
Supply Houses would result in only a temporary adverse effect on the Company's
operations if interconnects and independent telephone companies would continue
to demand the Company's products from other Supply Houses, which in turn would
increase their purchases of the Company's products.
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Direct Dealers
The Company developed its infinite line of telephone systems and
related products for sales to Direct Dealers. These Direct Dealers are medium
and large interconnect companies or local dealers that resell the Company's
products directly to end users. The Company believes that the principal
advantages of this distribution channel are higher gross margins on product
sales, greater visibility of the Company's product lines, and the ability to
exert additional control over factors such as pricing of the Company's products.
Sales to Direct Dealers, however, generally involve longer credit terms for the
Company, the necessity to provide increased direct marketing and technical
support, and additional costs associated with developing and training the
independent commissioned sales staff of the various Direct Dealers to enable
them to solicit purchases of the Company's products. The Company has increased
the number of Direct Dealers that sell its infinite products from 15 at December
31, 1992 to approximately 77 at December 31, 1996 and continues to seek
additional Direct Dealers for its infinite products.
In-house Sales Staff
The Company maintains an in-house sales staff that makes direct sales
of certain of its products to large commercial organizations and governmental
agencies in the United States and foreign countries. The Company's in-house
sales force also develops relationships with value-added resellers, which
purchase certain of the Company's products as a base platform, enhance the
platform with specialized software that they have developed, and then resell the
combined systems.
International Sales
To date, sales of the Company's products in foreign countries have not
represented a significant portion of the Company's revenue. The Company,
however, believes that sales of its telephone systems and other products in
international markets may increase in the future as cultural resistance to
features such as voice mail and interactive voice response declines, as
touchtone technologies and cellular telephone service become more available and
other installed communications infrastructures are improved, and as regulatory
differences between countries are eliminated. All of the Company's sales in
foreign countries are denominated in United States dollars.
Research and Development; Strategic Alliances with LGE and Other Companies
The Company believes that the continued development of telephone system
software that distinguishes the functions and features of the Company's products
from those of its competitors represents a critical factor in determining the
Company's ongoing success. The Company's 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 the Company's facilities in Arizona and Georgia provides the
Company 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. The Company utilizes 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.
The Company conducts joint development activities with LGE for the
design and development of hardware incorporated into certain of the Company's
existing or planned telephone system and commercial grade telephone product
lines. Under its joint development projects with LGE, the Company provides
market analysis, product management, functional and performance standards,
software development, quality control program development, sales and
distribution, and customer service and support, while LGE provides hardware
research, design and development, development of components such as integrated
circuits and semiconductor chips, and manufacturing and production engineering.
Generally, LGE contributes the ongoing research and development costs for the
product hardware in return for an arrangement under which LGE produces the
finished goods developed under the
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alliance. See Item 1, "Business - Manufacturing" and "Special Considerations -
Dependence on LGE." The Company has successfully engaged in such projects with
LGE in the past and believes that it will continue to have access to LGE's
advanced hardware research and development capabilities as the Company develops
new product lines in such areas as wireless communications, digital key
telephone systems, digital PBX systems, large-scale integrated circuits,
multi-layer printed circuit boards, and surface mount technologies.
The Company also enhances its software development expertise through
acquisitions of or licensing arrangements and other strategic alliances with
independent third-party developers. The Company and NovAtel are parties to an
agreement to jointly develop wireless communications systems. See Item 1,
"Business - Products - New Product Development" and "Special Considerations -
Control by Management; Stockholders' Agreement; Conflicts of Interest." The
acquisition of Enhanced has provided the Company with significant technical
resources related to speech recognition, interactive voice response,
computer-telephony integration, and voice mail systems. The Company has active
strategic alliance relationships with other companies that possess expertise in
automatic call distribution, small digital key telephone systems, and digital
wireless technologies. The Company intends 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
The Company obtains its key telephone systems and full-featured
commercial grade telephones under manufacturing arrangements with various
third-party manufacturers, including LGE. The Company owns a significant portion
of the tooling used by the third-party manufacturers to manufacture its
products. The Company's agreements with the third-party manufacturers generally
require the manufacturers to produce the Company's products according to the
Company's technical specifications, to perform quality control functions or
otherwise meet the Company's quality standards for manufacturing, and to test or
inspect the products prior to shipment. Pursuant to the manufacturing
agreements, the manufacturers provide the Company 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 with the warranties within specified periods. The Company
performs final assembly, systems integration, and testing of certain of its
automated call distribution, voice mail, automated attendant, interactive voice
response, and computer-telephony integration products at its Arizona and Georgia
facilities.
The Company obtains certain of its electronic telephone systems and
certain of its digital telephones from LGE, which owns the rights to produce
such equipment. LGE owns approximately 18.7% of the Company's outstanding Common
Stock. Pursuant to an agreement with LGE (the "LGE Agreement"), LGE granted the
Company the right to distribute and sell throughout the United States and Canada
products covered by the agreement that LGE manufactures in South Korea. The term
of the LGE Agreement expires on April 12, 1997. The Company currently is engaged
in discussions with LGE regarding extending the current agreement or entering
into a new manufacturing agreement for the products that the Company obtains
from LGE. The Company makes all purchases pursuant to the LGE Agreement on a
purchase order basis. See Item 1, "Special Considerations - Dependence on LGE"
and "Special Considerations - Control by Management; Stockholders' Agreement;
Conflicts of Interest."
The Company obtains certain of its electronic telephone systems and
most of its commercial grade telephones and replacement parts for such
telephones from LG Srithai, Ltd. ("LGST"), a joint venture between LGE and
Srithai Group, a Thailand-based entity. Pursuant to an agreement with LGST (the
"LGST Agreement"), LGST granted the Company the right to distribute and sell
throughout the United States and Canada such products manufactured by LGST in
Thailand. The LGST Agreement prohibits the Company from purchasing the products
covered by the LGST Agreement from any other manufacturer during the term of the
agreement, which expires on April 12, 1997. The Company currently is engaged in
discussions with LGST regarding extending the current agreement or entering into
a new manufacturing agreement for the products that the Company obtains from
LGST.
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<PAGE>
The Company makes all purchases pursuant to the LGST Agreement on a purchase
order basis. See Item 1, "Special Considerations - Dependence on LGE" and
"Special Considerations - Control by Management; Stockholders' Agreement;
Conflicts of Interest."
The Company currently obtains certain of its digital key telephone
systems and related digital products from Wong's Electronics Co., Ltd.
("Wongs"), a Hong Kong company, pursuant to an agreement with Wong's (the
"Wong's Agreement"). The Wong's Agreement will remain in effect until either
party gives the other party at least three months' advance notice of
termination. The Company makes all purchases pursuant to the Wong's Agreement on
a purchase order basis. Executone Information Systems, Inc. ("Executone") owns
certain rights to the products that the Company purchases pursuant to the Wong's
Agreement and licenses to the Company the right to use Executone's technology
incorporated into such products. See Item 1, "Business - Patents, Trademarks,
and Licenses."
The Company also obtains certain of its digital key telephone systems
from Tecom Co., Ltd., ("Tecom") a Republic of China company. Pursuant to an
agreement with Tecom (the "Tecom Agreement"), Tecom granted the Company the
exclusive right to sell and distribute throughout all of North and South America
such products manufactured by Tecom. The initial term of the Tecom Agreement
expires in June 1999, at which time the agreement will automatically renew and
continue until either party gives the other party not less than 120 days'
advance notice of termination. The Company makes all purchases pursuant to the
Tecom Agreement on a purchase order basis. The Tecom Agreement requires the
Company to use its best efforts to purchase from Tecom products with an
aggregate minimum purchase price of $3.5 million and $4.25 million during 1997
and 1998, respectively. In the event that the Company fails to purchase at least
75% of such purchase obligations, Tecom has the right to either designate the
Company as a non-exclusive distributor of the products purchased under the Tecom
Agreement or increase the prices of such products by up to 5%.
The countries in which certain of the Company's products are
manufactured have been subject to natural disasters and civil disturbances in
the past. These circumstances could affect the Company's ability to obtain
certain of its products from its overseas manufacturers. Except for a fire that
interrupted production at one plant in China during late 1993 and the first part
of 1994, the Company has not experienced any significant interruptions of
shipments to date. The termination of any of the agreements with its
manufacturers or the inability of the Company to obtain products pursuant to
such agreements, even for a relatively short period of time, could have a
material adverse effect on the Company's operations. See Item 1, "Special
Considerations - Dependence on Third Parties for Manufacturing; International
Manufacturing Sources."
Quality Control
The Company recognizes that product quality and reliability are
critical factors in distinguishing its products from those of its competitors.
The Company designs its products to include components meeting specified quality
standards in order to ensure reliable performance. The Company also requires its
third-party manufacturers to comply with specified quality standards regarding
materials and assembly methods used in manufacturing the Company's products. See
Item 1, "Business - Manufacturing." In addition, the Company maintains a
rigorous quality assurance program designed to ensure that the manufacture of
its products conforms with specified standards and to detect substandard
products before shipment. As part of this program, the Company maintains, on a
full-time or part-time basis, personnel at the factories in which its products
are manufactured. These quality assurance personnel inspect incoming raw
materials and components, audit in-process controls at the factories, and
participate in finished goods acceptance inspections. The Company inspects
products as they arrive at its warehouse in Arizona.
Support Services
The Company provides limited warranties against defective materials and
workmanship on each of the products that it sells. The Company provides a
complete support service for all of its products by maintaining a
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24-hour toll-free telephone number that system users or their service
representatives can contact for trouble shooting and diagnostic assistance. The
Company maintains an operating set-up of each of its telephone systems, key
telephone units, and peripheral systems at its headquarters facility, supported
by a staff of technicians trained to handle service assistance calls. When a
customer calls with a question relating to performance malfunctions or an
operational system question, the Company's personnel attempt to replicate any
problem the customer is encountering, diagnose the cause, and provide a solution
to the customer via telephone. If the Company's technicians cannot determine the
cause of the malfunction over the telephone, the Company dispatches a service
representative to the customer's place of business in order to locate the source
of the problem and take corrective measures.
The Company also operates a repair facility that performs repairs on
the Company's telephone systems, commercial grade telephones, and related
products. The Company believes that operating its own repair center provides it
with savings on repair expenses as well as increased customer satisfaction as a
result of faster turn-around time, improved quality of repairs, and reduced need
for repeat repairs.
Competition
Markets for key telephone systems, commercial grade telephones, and
other communications products are extremely competitive. The Company currently
competes principally on the basis of the technical innovation and performance of
its telephone systems, commercial grade telephones, and other products,
including their ease of installation and use, reliability, cost, and the
technical support both before and after sales to end users. The Company's
competitors in the sale of telephone systems and telephones include Comdial,
Nitsuko, Panasonic Communications & Systems Co., and Toshiba Information
Systems, Inc. Competitors in the supply of voice processing systems include
Active Voice Corporation and Applied Voice Technology as well as PBX and key
system telephone manufacturers that offer integrated voice processing systems of
their own design and under various original equipment manufacturer agreements.
Competition in the interactive voice response market includes Brite Voice
Systems, Intellivoice Communications, Inc., and Glenayre. In the computer
telephony market, the Company competes with many of the same companies indicated
above as well as large software development companies, including Microsoft
Corp., Lotus Development Corporation, and Novell, Inc. Most of the Company's
competitors are large companies that have greater name recognition and greater
financial, technical, marketing, manufacturing, distribution, and personnel
resources than the Company. The revenue, profitability, and success of the
Company depends substantially upon its ability to compete with other providers
of telephone systems and other telephony products. No assurance can be given
that the Company will continue to be able to successfully complete with such
organizations.
Certain of the Company's product lines compete with products and
services provided by the regional Bell operating companies, ("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 such as ICLID through equipment
located in the telephone company's central switching offices. The RBOCs from
time to time have proposed the modification or repeal of statutes and
regulations, which currently prohibit them from conducting telephone equipment
manufacturing activities and from providing certain other services that may
directly compete with the Company's product lines. There can be no assurance
that such regulations will remain in effect or unchanged indefinitely. Any
modification or repeal of such regulations that would permit the RBOCs to
compete with the Company by directly or indirectly manufacturing or distributing
telephone systems and equipment and/or "bundling" telephone equipment sales with
other calling services provided by the RBOCs may have a material adverse effect
on the Company's operating results.
Patents, Trademarks, and Licenses
As of December 31, 1996, the Company owned six United States patents
expiring on various dates beginning in 2000 and ending in 2008. The Company
intends to continue to seek patents on its inventions used in its products. The
process of seeking patent protection can be expensive and can consume
significant management
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resources. The Company believes that its patents strengthen its negotiating
position with respect to future disputes that may arise regarding its
technology. However, the Company believes that its continued success depends
primarily on such factors as the technological skills and innovative abilities
of its personnel rather than on its patents. There can be no assurance that
patents will issue from pending or future applications or that any patents that
are issued will provide meaningful protection or other commercial advantage to
the Company.
The Company acquired the registered and unregistered trademarks for
"STARPLUS," "First Class," and "infinite" from Executone as part of the
acquisition of the assets of the Company from Executone in April 1994. The
Company's ability to compete may be enhanced by its ability to protect its
proprietary information, including the issuance of patents, copyrights, and
trademarks. The Company also has taken steps to protect its proprietary
information through a "trade secrets" program that includes copy protection of
its software programs and obtaining confidentiality agreements with its
employees. There can be no assurance, however, that such efforts will be
effective to prevent misappropriation, reverse engineering, or independent
development of the Company's proprietary information by its competitors. While
no intellectual property right of the Company has been invalidated or declared
unenforceable, there can be no assurance that such rights will be upheld in the
future. Accordingly, the Company believes that, due to the rapid pace of
technological change in the telecommunications industry, the technical and
creative skills of its engineers and other personnel will be extremely important
in determining the Company's future technological success.
Pursuant to an agreement with Executone (the "License Agreement"), the
Company possesses a non-exclusive license to use Executone's technology related
to certain of the STARPLUS and infinite digital telephone systems. Under the
License Agreement, the Company has granted to Executone a cross-license that
enables Executone to utilize improvements that the Company develops for the
technology covered by the License Agreement. The License Agreement prohibits the
Company from modifying the technology so that the Company's telephone systems
can be used with Executone's products. The License Agreement requires Executone
to provide certain technical support necessary for the Company to utilize the
technology covered by the agreement. Pursuant to the License Agreement, the
Company purchases all of the proprietary components for its STARPLUS and
infinite digital telephone systems at Executone's cost plus 5%, and the Company
pays Executone a royalty fee of 5.3% of the manufactured cost of all of its
products that utilize the technology covered by the agreement. The License
Agreement expires on March 30, 2014, but automatically renews for a 20-year
period unless either party gives written notice of termination within 60 days
prior to March 30, 2014. The Company and Executone in the past have disputed the
extent to which the License Agreement applies to products sold by the Company
and the amount of the royalty fee that the Company must pay to Executone.
In December 1996, the Company entered into an agreement with Syntellect
Technology Corp. ("Syntellect") under which the Company may make and sell
products utilizing Syntellect's portfolio of approximately 20 patents, so long
as the Company obtains certain components used in those products from Dialogic
Corporation, which has a license agreement for the technology incorporated in
those products. See Item 2, "Legal Proceedings."
The telecommunications industry is characterized by rapid technological
development and frequent introduction of new products and features. In order to
remain competitive, the Company 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, the Company receives notices from time
to time alleging possible infringement of patents and other intellectual
property rights of others. To date, the Company has been able to successfully
defend such claims or to negotiate settlements to such claims on terms that it
believes 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 the Company's operations.
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Government Regulation
In recent years, the United States government has imposed anti-dumping
duties on certain telephone products manufactured in certain of the countries in
which the Company's products are manufactured. There can be no assurance that
similar duties will not be imposed in the future on telephone products,
including the Company's products, manufactured in these or other foreign
countries. The imposition of such additional duties on the Company's products
could have a material adverse effect on the Company's operating results.
The wireless telephone systems currently being developed by the Company
will be subject to extensive regulation by the Federal Communications Committee
("FCC") and government agencies of foreign countries. Such regulations have been
designed, among other things, to allocate the radio frequency spectrum among
different types of users, avoid interference among users of radio equipment, and
permit interconnection of equipment. As a result, the Company must design its
wireless telephone systems so as to comply with such regulations in order to
obtain governmental approvals necessary to permit it to market these systems in
the United States and other countries. Furthermore, the FCC and foreign
regulatory agencies continually are adopting new or changed standards and
regulations governing wireless communications products. Changed or new
regulations may require the Company to modify its then-existing wireless
telephone products or to develop new products that will comply with regulations
then in effect. To the extent that foreign countries maintain wireless
communications standards and regulations that are different from those in effect
in the United States, the Company may be required to modify its wireless
telephone systems in order to market such systems in those countries. Delays in
obtaining governmental approvals or the inability to design or modify its
wireless telephone systems to meet governmental regulations could have a
material adverse effect on the Company's operating results related to its
proposed wireless telephone systems.
Employees
As of December 31, 1996, the Company employed a total of 160 persons,
consisting of 159 full-time employees and 1 part-time employee at its facilities
in Scottsdale, Arizona and Norcross, Georgia. This number includes 33 persons in
engineering and product development, 68 in sales, marketing and technical
support, 14 in warehouse and distribution functions, 20 in equipment repair, and
25 in administration, including executive personnel. The Company considers its
relationship with its employees to be good, and none of its employees currently
are represented by a union in collective bargaining with the Company.
Various third-party manufacturers provide the personnel engaged in the
manufacture and assembly of the Company's products in South Korea, Thailand,
Malaysia, Hong Kong, Republic of China, and the Peoples' Republic of China
pursuant to the agreements between the Company and the respective manufacturers.
Executive Officers
The following table sets forth information concerning each of the
executive officers of the Company:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Steven A. Sherman........................ 51 Chairman of the Board
Glenn R. Fitchet......................... 49 President, Chief Executive Officer, and Director
Kent R. Burgess.......................... 50 Senior Vice President -- Operations and
Secretary; President of Enhanced Systems, Inc.
Gregory K. Roeper........................ 36 Vice President -- Finance, Chief Financial
Officer, and Treasurer
Larry L. Steinmetz....................... 40 President of Vodavi Communications Systems,
Inc.
</TABLE>
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Steven A. Sherman has served as Chairman of the Board of the Company
since March 1994. Mr. Sherman has served as Chairman of the Board and President
of NovAtel Wireless, Inc. since August 1996. Mr. Sherman has served as a
director of Main Street and Main Incorporated ("Main Street"), the world's
largest franchisee of TGI Friday's restaurants, since June 1990, and served as
Chairman of the Board of Main Street from June 1990 to August 1996 and as the
Chief Executive Officer of Main Street from June 1990 until January 1996. Mr.
Sherman is a principal of the Sherman Capital Group, L.L.C., a merchant banking
organization which he founded in July 1988. Mr. Sherman was a founder and served
as the Chairman of the Board of Vodavi Technology Corporation, a predecessor of
the Company, from 1983 until his resignation in July 1988 and served as a
director of Executone from July 1988 until his resignation in January 1990. Mr.
Sherman also currently serves as a director of GlobalCenter, Inc., a privately
held Internet services provider.
Glenn R. Fitchet has served as President and a director of the Company
since April 1994 and as Chief Executive Officer of the Company since May 1996.
Mr. Fitchet was Vice President and General Manager of the Vodavi Division of
Executone from January 1990 until April 1994. Mr. Fitchet served as Vice
President - Marketing and Manufacturing of Executone from July 1988 until
January 1990 and as Vice President of Vodavi Technology Corporation from
September 1984 to July 1988. Mr. Fitchet also served as Vice President - Sales
and Marketing for Valcom, Inc. from December 1981 to August 1984 and as National
Sales Manager for Siemens Information Systems from July 1976 until December
1981.
Kent R. Burgess has served as Senior Vice President - Operations and
Secretary of the Company since April 1994 and as President of Enhanced since
September 1996. Mr. Burgess served as Senior Vice President - Business
Operations for Main Street and Main Incorporated from November 1992 until March
1994. Mr. Burgess served as Vice President - Production of Executone from
December 1989 to November 1992, with responsibilities for materials,
manufacturing, quality assurance, distribution, and warehousing. Mr. Burgess was
Executive Vice President of Vodavi Technology Corporation prior to the formation
of Executone.
Gregory K. Roeper has served as Vice President - Finance, Chief
Financial Officer, and Treasurer of the Company since November 1994. From 1982
to 1994, Mr. Roeper was employed by Arthur Andersen LLP, most recently as a
Senior Manager. Mr. Roeper is a Certified Public Accountant in the state of
Arizona.
Larry L. Steinmetz has served as President of VCS since July 1996. Mr.
Steinmetz served as Vice President - Sales of VCS from July 1995 to June 1996
and served as Vice President - Distribution Sales of VCS from April 1994 to June
1995. Mr. Steinmetz was Director of Distribution Sales of the Vodavi Division of
Executone from July 1988 to April 1994, Director of Distribution Sales of Vodavi
Technology Corporation from April 1987 until July 1988, and National Accounts
Manager of Vodavi Technology Corporation from November 1983 until April 1987.
Mr. Steinmetz also served as Director of Sales, Eastern Region, of Inter-Tel,
Incorporated from 1982 until November 1983 and held various sales and marketing
positions for Sprint United Telephone from 1979 until 1982.
History of the Company
The Company was incorporated in Delaware on March 10, 1994. On April
11, 1994, the Company acquired the operating assets of the Vodavi Communications
Systems Division (the "Vodavi Division") of Executone. The Company's current
management team includes individuals who conducted the operations and
development of the Vodavi Division and its predecessor since 1983.
In July 1995, the Company, through its wholly owned subsidiary, ARSI,
acquired from an affiliate of LGE certain of the assets and liabilities of a
telecommunications equipment repair business located in Scottsdale, Arizona.
In October 1995, Enhanced merged with a wholly owned subsidiary of the
Company. Enhanced develops and markets voice processing, interactive voice
response, desktop video conferencing, and call accounting software products for
small, medium, and large businesses, universities, and government organizations
in the United States
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and internationally. The Company issued to the shareholders of Enhanced an
aggregate of 666,662 shares of Common Stock and $3.0 million in cash upon the
consummation of the merger.
SPECIAL CONSIDERATIONS
Certain Factors Affecting Operating Results
The Company's operating results are affected by a wide variety of
factors that could adversely impact its net sales and profitability. These
factors, many of which are beyond the control of the Company, include the
Company's ability to identify market segments that have significant growth
potential and to successfully market its products and services to those market
segments; its ability to maintain the product design and production capabilities
necessary to design and produce innovative and desirable product lines on a
timely and cost-effective basis; the Company's success in maintaining customer
satisfaction with its products; market acceptance of new products or
technological innovations; the Company's ability to establish and maintain
strong and long-lasting relationships with the wholesale distributors and direct
dealers that distribute its products; the Company's success in encouraging its
distributors and dealers to promote the Company's products ahead of those of its
competitors; the level and timing of orders placed by customers that the Company
can complete in a quarter; customer order patterns and seasonality; changes in
product mix; the performance and reliability of the telephone systems, voice
processing systems, and computer-telephony products designed and marketed by the
Company; the life cycles of its products; the ability of the Company and its
third-party manufacturers to produce the Company's products and product
components in an efficient, timely, and high-quality manner; the availability
and cost of raw materials, equipment, and supplies; the timing of expenditures
in anticipation of orders; the cyclical nature of the businesses, industries,
and markets served by the Company; technological changes; the introduction of
new products by competitors; and competition and competitive pressures on prices
which, among other things, may decrease gross margins.
The Company's ability to increase its design capacity and enter into
manufacturing arrangements in order to meet customer demand and maintain
satisfactory delivery schedules will be an important factor in its long-term
prospects. A slowdown in demand for the Company's products as a result of
economic or other conditions in markets served by the Company or other
broad-based factors would adversely affect the Company's operating results.
Dependence on Third Parties for Manufacturing; International Manufacturing
Sources
The Company depends upon third parties to manufacture its key telephone
systems and commercial grade telephones. Although the Company owns most of the
equipment, tools, dies, and molds utilized in the manufacturing process, the
Company has limited control over the manufacturing processes. As a result, any
difficulties encountered by the third-party manufacturers that result in product
defects, production delays, cost overruns, or inability to fulfill orders on a
timely basis could have a material adverse effect on the Company.
The Company currently obtains certain of its products under various
manufacturing arrangements with third-party manufacturers in South Korea,
Thailand, Malaysia, Hong Kong, Republic of China, and the Peoples' Republic of
China. See Item 1, "Business - Manufacturing" for a description of the material
terms of certain of these arrangements. The Company's reliance on the
third-party manufacturers to provide personnel and facilities in these
countries, the Company's maintenance of equipment and inventories abroad, and
the potential imposition of quota limitations on imported goods from certain Far
East countries expose it to certain economic and political risks, including the
business and financial condition of the third-party manufacturers; political
uncertainty; the possibility of expropriation, supply disruption, currency
controls, and exchange fluctuations; and changes in tax laws, tariffs, and
freight rates. Except for a fire that interrupted production at one plant in
China during late 1993 and the first part of 1994, the Company has not
experienced any significant interruptions to date in obtaining its products from
third-party manufacturers. The Company believes that production of its product
lines overseas enables the Company to obtain these items on a cost basis that
enhances the ability of the Company to market them profitably.
17
<PAGE>
The Company purchased approximately $17.4 million and $17.9 million,
respectively, of key telephone systems and commercial grade telephones from LGE
and LGST, an affiliate of LGE, during fiscal 1995 and fiscal 1996, constituting
approximately 68.0% and 69.6%, respectively, of total purchases of such products
during these periods. The Company made such purchases pursuant to agreements
that expire in April 1997. See Item 1, "Business - Manufacturing" and "Special
Considerations - Control by Management; Stockholders' Agreement; Conflicts of
Interest." Although the Company currently is engaged in discussions with LGE and
LGST to extend the current agreements or to enter into new agreements, there can
be no assurance that it will be able to secure long-term manufacturing
arrangements for the products it currently obtains from LGE and LGST. The
Company's operations would be adversely affected if it lost its relationship
with any of its current suppliers or if any of its current suppliers' operations
or overseas or air transportation were disrupted or terminated even for a
relatively short period of time. The Company does not maintain an inventory of
sufficient size to provide protection for any significant period against an
interruption of supply, particularly if it were required to locate and utilize
alternative sources of supply.
Dependence on LGE
The Company depends on LGE, which owns approximately 18.7% of the
Company's outstanding Common Stock, for the supply of key telephone systems and
commercial grade telephones as well as on LGE's engineering, hardware and
circuit development, and manufacturing capabilities. See Item 1, "Business -
Manufacturing" and "Special Considerations - Control by Management;
Stockholders' Agreement; Conflicts of Interest." Except for certain product
supply agreements, LGE has no commitments to support the business or operations
of the Company.
Competition
The business in which the Company engages is intensely competitive and
has been characterized by price erosion, rapid technological change, and foreign
competition. The Company competes with major domestic and international
companies, many of which have greater market recognition and substantially
greater financial, technical, marketing, distribution, and other resources than
the Company possesses. Principal competitors include Comdial Corporation,
Nitsuko, Panasonic Communications & Systems Co., Toshiba Information Systems,
Inc., Active Voice Corporation, Applied Voice Technology, and Brite Voice
Systems. The Company anticipates that major computer software development
companies, including Microsoft Corp., Lotus Development Corporation, and Novell,
Inc., may enter the market for computer-based telephone products. Emerging
companies also may increase their participation in the telephone systems and
peripherals markets.
The ability of the Company to compete successfully depends on a number
of factors both within and outside its control, including the quality,
performance, reliability, features, ease of use, pricing, and diversity of its
product lines; the quality of its customer services; its ability to address the
needs of its customers; its 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; its efficiency of production; the rate at which end users upgrade or
expand their existing telephone systems, applications, and services; new product
introductions by the Company's competitors; the number, nature, and success of
its competitors in a given market; and general market and economic conditions.
The Company currently competes principally on the basis of the technical
innovation and performance of its telephone systems, commercial grade
telephones, voice processing products, and computer-telephony products,
including their ease of use, reliability, cost, timely introduction, delivery
schedules, and after-sale service and technical support. There is no assurance
that the Company will continue to be able to compete successfully in the future.
See Item 1, "Business - Competition."
Dependence on New Products and Technologies
The Company operates in an industry that is increasingly characterized
by fast-changing technology. As a result, the Company 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
18
<PAGE>
additional engineering and other technical personnel. Any failure by the Company
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
the Company's operations.
The Company's future operating results will depend to a significant
extent on its 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 introduction, cost, and
performance with the product lines offered by 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 its products. Because of
the complexity of the design and manufacturing processes required by the
Company's products, the Company may experience delays from time to time in
completing the design and manufacture of improvements to existing product lines
or the introduction of new product lines. In addition, there can be no assurance
that any new product lines will receive or maintain customer or market
acceptance. If the Company were unable to design and implement enhancements to
existing product lines or introduce new products on a timely and cost-effective
basis, its future operating results would be adversely affected. See Item 1,
"Business - Products."
Complex software programs, such as those developed by the Company or
other software sources and incorporated into the Company's 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 the Company conducts extensive testing of the software
programs included in its products, there can be no assurance that the Company
will successfully detect and eliminate all such errors in its 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 the Company's
goodwill as well as on its operating results.
Reliance on Independent Distribution Network
The Company currently markets its products through a distribution
network consisting primarily of large wholesale distributors known as "Supply
Houses" and telephone sales and installation companies known as "Direct
Dealers." Supply Houses and Direct Dealers generally stock inventories only in
quantities deemed sufficient to fill anticipated short-term orders. As a result,
orders generally can be cancelled and volume levels changed or delayed on short
notice to the Company. The timely replacement of cancelled, delayed, or reduced
orders cannot be assured.
The Company depends upon independent Supply Houses and Direct Dealers
to sell its 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 Supply Houses and
Direct Dealers, most of which carry products that compete directly with the
Company's products. There can be no assurance that the Company will be able to
maintain favorable relationships with the Supply Houses and Direct Dealers that
currently carry its product lines in order to encourage them to promote and sell
its products instead of those of its competitors or that the Company will be
able to develop such relationships with additional distributors and dealers in
the future. See "Business - Sales, Marketing, and Distribution."
Graybar accounted for 45% and 44%, respectively, of sales during 1995
and 1996. Accounts receivable from Graybar comprised approximately 44% of total
accounts receivable at December 31, 1996.
Patents, Licenses, and Intellectual Property Claims
The Company's success depends in part upon its ability to protect its
proprietary technology. The Company relies on a combination of copyright,
trademark, and trade secret laws, nondisclosure and other contractual
19
<PAGE>
agreements, and technical measures to protect its proprietary technology. There
can be no assurance that the steps taken by the Company to protect its
proprietary rights will be adequate to protect misappropriation of such rights
or that third parties will not independently develop equivalent or superior
technology. In addition, the Company has acquired certain patents and patent
licenses and intends to continue to seek patents on its inventions and
manufacturing processes. The process of seeking patent protection can be long
and expensive, and there can be no assurance that patents will issue from future
applications or that the Company's existing patents or any new patents that are
issued will be of sufficient scope or strength to provide meaningful protection
or any commercial advantage to the Company. The Company 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. As is typical in the
telecommunications industry, the Company from time to time has received, and in
the future may receive, communications alleging possible infringement of patents
or other intellectual property rights of others. See Item 3, "Legal
Proceedings." Based on industry practice, the Company believes that in most
cases it could obtain any necessary licenses or other rights on commercially
reasonable terms, but no assurance can be given that licenses would be available
on acceptable terms, that litigation would not ensue, or that damages for any
past infringements would not be assessed. Litigation, which could result in
substantial cost to and diversion of effort by the Company, may be necessary to
enforce patents or other intellectual property rights of the Company or to
defend the Company against claimed infringement of the rights of others. The
failure to obtain necessary licenses or other rights or litigation arising out
of infringement claims could have a material adverse effect on the Company. See
Item 1, "Business - Patents, Trademarks, and Licenses."
Management of Growth
The Company's ability to manage its growth effectively in the future
will require it to enhance its operational, financial, and management systems;
to expand its facilities and equipment; and to successfully hire, train, and
motivate additional employees, including the technical personnel necessary to
design the software used in the Company's telephone systems, voice processing
products, computer-telephony products, and wireless telephone products, and to
integrate new software systems with evolving hardware technologies. The failure
of the Company to manage its growth on a effective basis could have a material
adverse effect on the Company's operations.
The Company may be required to increase staffing and other expenses as
well as its capital expenditures in order to meet the demand for its products
and services. Customers, however, generally do not commit to firm purchase
orders for more than a short time in advance. The Company's profitability would
be adversely affected if the Company increases its expenditures in anticipation
of future orders that do not materialize. The development of new products or
product enhancements or unexpected customer orders also may require rapid
increases in design and production services that place excessive short-term
burdens on the Company's resources.
The Telecommunications Industry; Cyclicity and Capital Requirements
The telecommunications industry has experienced economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production overcapacity. The Company has sought
to reduce its exposure to industry downturns by targeting its product lines
towards small to medium-sized businesses, which the Company believes 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, the Company 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,
although the Company has not experienced significant quarterly sales
fluctuations in the past, the size and timing of sales of its new voice
processing and computer-telephony products may be expected to vary from quarter
to quarter to a greater extent. The expanding importance of these new products
could result in significant variations in the Company's overall operating
results on a quarterly basis.
20
<PAGE>
To remain competitive, the Company 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 capital
expenditures, the Company's operating results may be adversely affected if its
net sales do not increase sufficiently to offset the increased costs. The
Company from time to time may seek additional equity or debt financing to
provide for the capital expenditures required to maintain or expand the
Company's design and production facilities and equipment. The timing and amount
of any such capital requirements cannot be predicted at this time. There can be
no assurance that any such financing will be available or, if available, will be
available on terms satisfactory to the Company. If such financing is not
available on satisfactory terms, the Company may be unable to expand its
business or develop new products at the rate desired and its operating results
may be adversely affected. Debt financing increases expenses and must be repaid
regardless of 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."
Shortage of Raw Materials and Supplies
The principal raw materials and components used in producing the
Company's products consist of semiconductor components, unfinished printed
circuit boards, molded plastic parts, metals, and packaging materials. The
third-party manufacturers of the Company's products acquire these raw materials
primarily from Asian sources, which indirectly subjects the Company to certain
risks, including supply interruptions and currency price fluctuations.
Purchasers of these materials, including the Company and its third-party
manufacturers, experience difficulties from time to time in obtaining such
materials. The suppliers of these materials currently are adequately meeting the
requirements of the Company. The Company also believes that there are alternate
sources of supplies for most of these materials.
Voice processing boards that are used in certain of the Company's voice
processing and interactive voice response products currently are available from
a limited number of sources. The Company currently purchases most of its
requirements for voice processing boards from Dialogic on a purchase order
basis. Furthermore, the Company's license agreement with Syntellect permits the
Company to make and sell products utilizing Syntellect's portfolio of
approximately 20 patents, so long as the Company obtains certain components used
in those products from Dialogic, which has a license agreement for the
technology incorporated in those products. See Item 2, "Legal Proceedings." The
Company's ability to deliver certain of its product lines could be adversely
affected if it is unable to obtain voice processing boards from Dialogic at any
time that alternative sources of similar components are not readily available.
Dependence on Management and Other Key Personnel
The Company's development and operations to date have been, and its
proposed operations will be, substantially dependent upon the efforts and
abilities of its senior management and technical personnel. The Company does not
have employment agreements with any of its executive officers other than Kent R.
Burgess, the President of Enhanced. The Company, however, maintains agreements
with each of its officers and employees that prohibit such persons from
disclosing confidential information obtained while employed with the Company.
The loss of existing key personnel or the failure to recruit and retain
necessary additional personnel would adversely affect the Company's business
prospects. There can be no assurance that the Company will be able to retain its
current personnel or to attract and retain necessary additional personnel. The
Company's internal growth and the expansion of its product lines will require
additional expertise in such areas as software development, operational
management, and marketing. Such growth and expansion activities will increase
further the demand on the Company's resources and require the addition of new
personnel and the development of additional expertise by existing personnel.
The failure of the Company to attract and retain personnel with the requisite
expertise or to develop internally such expertise could adversely affect the
prospects for the Company's success. The Company currently maintains key person
insurance in the amount of $1.0 million covering Glenn R. Fitchet, its
President. The terms of the revolving line of credit facility between VCS and
General Electric Capital Corporation ("GE
21
<PAGE>
Capital") currently require that Steven Sherman or a successor that is
acceptable to GE Capital must serve as Chairman of the Board of VCS. See Item 1,
"Business - Executive Officers."
Control by Management; Stockholders' Agreement; Conflicts of Interest
The directors, executive officers, and certain other management
personnel of the Company and their affiliates own approximately 38.5% of the
outstanding shares of Common Stock, including approximately 18.7% owned by LGE
(excluding shares issuable to such persons upon exercise of outstanding
options). The Company, LGE, Steven A. Sherman, Glenn R. Fitchet, and certain
other stockholders of the Company are parties to a stockholders' agreement (the
"Stockholders' Agreement"). At any time that the Company issues shares of its
Common Stock in an amount representing 1% or more of its outstanding Common
Stock, the Stockholders' Agreement gives LGE the right to purchase from the
Company a sufficient number of shares as may be required to enable LGE to
maintain the percentage of ownership of Common Stock that existed immediately
prior to such issuance. The Stockholders' Agreement also requires Mr. Sherman
and Mr. Fitchet to vote their shares of Common Stock to elect as directors of
the Company that number of persons designated by LGE that comprises a percentage
of the Board of Directors equal to LGE's then percentage of ownership of the
Company's Common Stock, provided that so long as LGE owns 8% or more of the
Company's outstanding Common Stock, Messrs. Sherman and Fitchet will vote their
shares to the elect at least one designee of LGE as a director.
The Company obtains a substantial portion of the hardware utilized in
its telephone systems and commercial grade telephones from LGE and obtains
certain of its electronic telephone systems and most of its commercial grade
telephone and replacement parts for such telephones from LGST, an affiliate of
LGE. The terms of the Company's manufacturing agreement with LGST require the
Company to purchase $5.5 million of product from LGST during 1997. See Item 1,
"Business - Manufacturing" and "Special Considerations - Dependence on LGE." As
a result of LGE's ownership interest in the Company, an inherent conflict of
interest exists in establishing the volume and terms and conditions of such
purchases. In order to mitigate such conflicts, all decisions with respect to
such purchases will be made by officers of the Company and reviewed by directors
of the Company who have no relationship with LGE.
Steven A. Sherman, the Company's Chairman of the Board, is the Chairman
of the Board and President and a significant shareholder of NovAtel, with which
the Company has an agreement to develop wireless telephone systems. See Item 1,
"Business - New Product Development - Wireless Telephone Systems."
Possible Volatility of Stock Price
The trading price of the Company's Common Stock in the public
securities market could be subject to wide fluctuations in response to quarterly
variations in operating results of the Company or its competitors, actual or
anticipated announcements of technological innovations or new product
developments by the Company or its competitors, changes in analysts' estimates
of the Company's financial performance, developments or disputes concerning
proprietary rights, regulatory developments, general industry conditions,
worldwide economic and financial conditions, and other events and factors. The
trading volume of the Company's Common Stock has been limited, which may
increase the volatility of the market price for such stock or reduce the
liquidity of an investment in shares of the Company's 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 the Company's Common Stock.
Rights to Acquire Shares
A total of 850,000 shares of Common Stock have been reserved for
issuance upon exercise of options granted or which may be granted under the
Company's stock option plan. Options to acquire 648,500 shares of Common Stock
at a weighted average exercise price of $4.83 per share currently are
outstanding under the stock
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<PAGE>
option plan. In addition, the Company sold to the underwriter of its initial
public offering warrants to purchase 133,333 shares of Common Stock. The
warrants have an exercise price per share of $7.20 and are exercisable until
October 2000. During the terms of such options and warrants, the holders thereof
will have the opportunity to profit from an increase in the market price of the
Common Stock. The existence of such options and warrants may adversely affect
the terms on which the Company can obtain additional financing, and the holders
of such options and warrants can be expected to exercise such options or
warrants at a time when the Company, in all likelihood, would be able to obtain
additional capital by offering shares of its Common Stock on terms more
favorable to the Company than those provided by the exercise of such options or
warrants.
Shares Eligible for Future Sale
Sales of Common Stock in the public market could adversely affect
prevailing market prices. Approximately 1,817,000 shares of Common Stock
currently are eligible for sale in the public market, subject to compliance with
the requirements of Rule 144 under the Securities Act of 1933, as amended (the
"Securities Act"). As a result of recent changes to Rule 144, an additional
854,162 shares of Common Stock will become eligible for sale pursuant to Rule
144 in April 1997. Shares issued upon the exercise of stock options issued under
the Company's Stock Option Plan generally will be eligible for sale in the
public market. The Company also has 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 result in the dilution of the voting power of the currently
outstanding shares of Common Stock and could have a dilutive effect on earnings
per share.
Change in Control Provisions
The Company's Amended Certificate of Incorporation (the "Amended
Certificate") and Bylaws and the Delaware General Corporation Law (the "Delaware
GCL") contain provisions that may have the effect of making more difficult or
delaying attempts by others to obtain control of the Company, even when these
attempts may be in the best interests of stockholders.
The Company is subject to the provisions of Section 203 of the Delaware
GCL. In general, this statute prohibits a publicly held Delaware corporation
from engaging, under certain circumstances, in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person becomes an interested stockholder, unless either
(i) prior to the date at which the stockholder became an interested stockholder,
the Board of Directors approved either the business combination or the
transaction in which the person becomes an interested stockholder, (ii) upon
consummation of the transaction in which the stockholder becomes an interested
stockholder, the stockholder owned at least 95% of the outstanding voting stock
of the corporation (excluding shares held by directors who are officers or held
in certain employee stock plans), or (iii) the business combination is approved
by the Board of Directors and by two-thirds of the outstanding voting stock of
the corporation (excluding shares held by the interested stockholder) at a
meeting of stockholders held on or subsequent to the date of the business
combination. An "interested stockholder" is a person that, together with
affiliates and associates, owns (or at any time within the prior three years did
own) 15% or more of the corporation's voting stock. Section 203 defines a
"business combination" to include, without limitation, mergers, consolidations,
stock sales and asset based transactions, and other transactions resulting in a
financial benefit to the interested stockholder.
The Company's Amended Certificate and Bylaws contain a number of other
provisions relating to corporate governance and to the rights of stockholders.
These provisions include (a) the authority of the Board of Directors to fill
vacancies on the Board of Directors; (b) the authority of the Board of Directors
to issue preferred stock in series with such voting rights and other powers as
the Board of Directors may determine; and (c) the requirement that any of the
following actions be approved by the affirmative vote of two-thirds of the
directors then in office: (1) a public offering of the capital stock of the
Company; (2) the merger with or the acquisition of another business or the
acquisition of a significant amount of the assets of another business; (3) the
sale of a significant amount of the assets of the Company; (4) the Company
entering into contracts with stockholders or directors of the Company;
23
<PAGE>
(5) the assumption or acquisition by the Company of debt in excess of
$1,000,000; and (6) any amendment of the Amended Certificate of Incorporation
and Bylaws of the Company or VCS.
Lack of Dividends
The Company has never paid any cash dividends on its Common Stock and
does not anticipate that it will pay dividends in the foreseeable future.
Instead, the Company intends to retain any earnings to provide funds for use in
its business. Furthermore, the terms of the revolving line of credit facility
between VCS and GE Capital prohibit VCS from paying dividends to the Company
without the consent of GE Capital. This restriction could limit the Company's
ability to pay dividends in the future. There currently are no restrictions that
would prohibit Enhanced from paying dividends to the Company.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements and information contained in this Report under the
headings "Business," "Special Considerations," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" concerning future,
proposed, and anticipated activities of the Company, certain trends with respect
to the Company's revenue, operating results, capital resources, and liquidity or
with respect to the markets in which the Company competes or the
telecommunications industry in general, and other statements contained in this
Report regarding matters that are not historical facts are forward-looking
statements, as such term is defined in the Securities Act. Forward-looking
statements, by their very nature, include risks and uncertainties, many of which
are beyond the Company's 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 elsewhere under this Item 1, "Special Considerations."
ITEM 2. PROPERTIES
The Company leases, for a term expiring in December 2001, approximately
60,000 square feet of space in Scottsdale, Arizona, where it maintains
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. The Company also leases approximately 16,200 square feet of
space in Norcross, Georgia, for a term expiring in August 2002. The Company
maintains software development facilities, engineering and design laboratories,
product development facilities, product assembly and testing facilities,
warehouse and distribution areas, and sales, marketing, and administrative
offices at this location. The Company leases, for a term ending in December
2004, approximately 19,500 square feet of space in Scottsdale, Arizona, for its
telecommunications equipment repair operations. The Company believes its
facilities are adequate for its reasonably anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
In March 1996, Syntellect Technology Corp. ("Syntellect") filed suit
against the Company, Enhanced, and an unaffiliated third party, alleging
infringement of six United States patents held by Syntellect. In December 1996,
the Company reached an agreement with Syntellect under which it obtained (i) a
full release of all claims that formed the basis for the lawsuit, and (ii) a
license to make and sell products utilizing Syntellect's portfolio of
approximately 20 patents, including patents that were not the subject of the
lawsuit, so long as the Company obtains certain components used in those
products from a third-party supplier that has a license agreement with
Syntellect for that technology. See Item 1, "Business - Patents, Trademarks, and
Licenses."
On September 20, 1996, the Company and Enhanced filed a lawsuit in the
United States District Court for the District of Arizona (No. CIV 96-2184 PHX
SMM) against Michael Mittel and Fereydoun Taslimi, former
24
<PAGE>
officers and directors of Enhanced. The lawsuit alleges, among other things,
that Messrs. Mittel and Taslimi violated federal and Arizona securities laws and
engaged in fraudulent activities in connection with the Company's acquisition of
Enhanced in 1995; breached certain terms of their respective employment
contracts with Enhanced; and breached their fiduciary duties to Enhanced,
including converting certain corporate assets of Enhanced and misappropriating
certain corporate opportunities for their own benefit. The Company and Enhanced
are seeking compensatory and punitive damages against Messrs. Mittel and
Taslimi.
On September 24, 1996, Messrs. Mittel and Taslimi filed a lawsuit in
the United States District Court for the Northern District of Georgia, Atlanta
Division (No. 196-CV-2563), against the Company and Enhanced. The lawsuit
alleges that Enhanced breached Messrs. Mittel's and Taslimi's respective
employment agreements by terminating their employment. The Company intends to
proceed with its lawsuit against Messrs. Mittel and Taslimi and to vigorously
defend the lawsuit filed by them against the Company and Enhanced.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
25
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been quoted in the Nasdaq National
Market under the symbol "VTEK" since October 6, 1995. The following table sets
forth the high and low closing sales prices of the Company's Common Stock on the
Nasdaq National Market for the periods indicated.
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1995:
Fourth quarter (from October 6, 1995 to December 31, 1995).............. $ 7.50 $ 5.25
1996:
First quarter........................................................... $ 7.38 $ 5.25
Second quarter.......................................................... 8.88 5.88
Third quarter........................................................... 8.13 5.25
Fourth quarter.......................................................... 5.88 2.88
1997:
First quarter (through March 24, 1997).................................. $ 5.00 $ 3.50
</TABLE>
On March 24, 1997, the closing sales price of the Common Stock was
$3.50 per share. As of March 24, 1997, there were 42 holders of record and
approximately 660 beneficial owners of the Company's Common Stock.
26
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes certain selected consolidated financial
data of the Company and its predecessor, the Vodavi Division. The results of
operations for the three months ended March 31, 1994 are not necessarily
indicative of the results of operations for a full fiscal year. The selected
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 the Company and related
notes thereto. No dividends were paid during the periods presented.
<TABLE>
<CAPTION>
Vodavi Division(1) The Company
------------------------------------- --------------------------------------------
Period From
Three Inception
Months (Aug. 3, 1993)
Ended through
Year Ended December 31, March 31, December 31, Year Ended December 31,
----------------------- --------- ------------ -----------------------
1992 1993 1994 1993 1994(2) 1995 1996
---- ---- ---- ---- ------- ---- ----
(In thousands, except share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Operating Data:
Revenue................. $26,556 $31,571 $8,587 $ -- $29,140 $ 39,601 $ 46,154
Gross margin............ 6,812 8,172 2,418 -- 8,613 12,404 15,312
Operating expenses...... 6,071 6,591 1,872 7 6,291 10,399 13,749
Asset impairment and
restructuring charges. -- -- -- -- -- -- 4,805(3)
Operating income (loss). 741 1,581 546 (7) 2,322 2,055 (3,242)
Interest & other expenses 47 11 -- 6 576 1,130 840
Pretax income (loss).... 694 1,570 546 (13) 1,746 875 (4,082)
Income taxes............ -- -- -- -- 693 417 327
Net income (loss)....... 694 1,570 546 (13) 1,053 458 (4,409)
Net income (loss) per share N/A N/A N/A $ (0.02) $ 0.55 $ 0.17 $ (1.02)
Weighted average
shares outstanding.... N/A N/A N/A 849,999 1,917,346 2,769,434 4,342,238
<CAPTION>
As of December 31, As of March 31, As of December 31,
------------------------ --------------- ----------------------------------------------
1992 1993 1994 1993 1994 1995 1996
---- ---- ---- ---- ---- ---- ----
Balance Sheet Data:
Assets:
Current assets........ $10,953 $10,544 $12,034 $130 $14,122 $17,719 $16,591
Property and
equipment.......... 424 397 452 -- 635 1,731 2,465
Goodwill.............. -- -- -- -- 2,833 7,089 2,547
Other................. -- -- -- 280 357 931 815
--------- --------- --------- ----- -------- -------- --------
$11,377 $10,941 $12,486 $410 $17,947 $27,470 $22,418
======= ======= ======= ==== ======= ======= =======
Liabilities:
Current liabilities... $2,800 $2,390 $3,128 $406 $5,316 $5,776 $7,240
Long-term debt........ -- -- -- -- 8,574 7,884 5,588
Other long-term
obligations........ -- -- -- -- -- 69 189
Due to parent......... 4,040 2,444 2,705 -- -- -- --
------- ------- ------- ----- -------- -------- --------
Total liabilities....... 6,840 4,834 5,833 406 13,890 13,660 13,017
Stockholders' equity.... 4,537 6,107 6,653 4 4,057 13,810 9,401
------- ------- ------- ----- ------- ------- -------
$11,377 $10,941 $12,486 $410 $17,947 $27,470 $22,418
======= ======= ======= ==== ======= ======= -------
</TABLE>
(1) Prior to the acquisition by the Company, the Vodavi Division operated as a
separate division within a publicly held company. See Item 1, "Business --
History of the Company." As a result, share information is not applicable.
(2) Excludes the results of operations of the Vodavi Division prior to April 1,
1994, the effective date of the acquisition.
(3) Represents a $4.8 million charge to write down goodwill associated with the
acquisition of Enhanced and to set up restructuring charges related to
Enhanced. See Item 7, "Managements Discussion and Analysis of Financial
Condition and Results of Operations."
27
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Basis of Presentation
In April 1994, the Company acquired substantially all of the operating
assets of the Vodavi Division. See Item 1, "Business - History of the Company."
The acquisition was accounted for using the purchase method of accounting for
business combinations. Prior to the acquisition, the Vodavi Division operated as
a separate division within a publicly held company, with stand-alone financial
results.
Results of Operations
Annual Results
The following table summarizes the operating results of the Company for
the periods indicated. The table and the discussion below should be read in
conjunction with the Consolidated Financial Statements and Notes thereto, which
appear elsewhere in this Report.
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------------------------------------------------
1994 - Pro Forma(1) 1995 1996
-------------------------- ------------------------- ------------------------
(Dollar amounts in thousands)
$ % $ % $ %
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Revenue...................................... $37,727 100.0% $39,601 100.0% $46,154 100.0%
Cost of goods sold........................... 26,696 70.8% 27,197 68.7% 30,842 66.8%
------ ----- ------ ----- ------ -----
Gross margin............................... 11,031 29.2% 12,404 31.3% 15,312 33.2%
Operating expenses
Engineering and product
development.............................. 1,834 4.9% 1,942 4.9% 2,161 4.7%
Selling, general, and administrative....... 6,410 17.0% 8,457 21.3% 11,588 25.1%
Asset impairment and restructuring charges. --- --- --- --- 4,805 10.4%
-------- ------ ------- ------ ------ -----
Operating income (loss)...................... 2,787 7.3% 2,005 5.1% (3,242) (7.0)%
Other income (expense), net.................. (766) 2.0% (1,130) 2.9% (840) 1.8%
------- ------ ------ ----- -------- ------
Pretax income (loss)......................... 2,021 5.3% 875 2.2% (4,082) (8.8)%
Income tax expense........................... 798 2.1% 417 1.0% 327 0.7%
------- ------ ------- ----- ------- ------
Net income (loss)............................ $ 1,223 3.2% $ 458 1.2% $(4,409) (9.5)%
======= ====== ======== ===== ======= =======
</TABLE>
(1) Includes the pro forma results of the Vodavi Division for the first quarter
of 1994.
Revenue
Revenue was approximately $46.2 million in 1996, an increase of $6.6
million, or 16.7%, over 1995 revenue of approximately $39.6 million. Revenue in
1995 increased approximately $1.9 million, or 5.0%, over pro forma revenue for
1994 of approximately $37.7 million. The increase in 1996 can be attributed to
the annualized impact of the 1995 acquisitions of Enhanced and ARSI as well as
new product introductions and the addition of new customers. The increase in
1995 can be attributed to the acquisitions of ARSI and Enhanced (approximately
$900,000) as well as increased sales of the Company's digital telephone systems.
Cost of Goods Sold
Gross margins increased to approximately 33.2% of revenue in 1996 as
compared with 31.3% and 29.2% in 1995 and 1994, respectively. The improvement in
1996 reflects the October 1995 acquisition of Enhanced, which sells products
with significantly higher gross margins than other products sold by the Company.
The increased margins also reflect the Company's ongoing efforts to reduce the
costs of products obtained from its contract manufacturers as well as price
increases implemented during the periods presented.
28
<PAGE>
Engineering and Product Development
Expenditures related to engineering and product development remained
relatively stable at approximately $2.2 million, $1.9 million, and $1.8 million
in 1996, 1995, and 1994, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were approximately $11.6
million, $8.5 million, and $6.4 million in 1996, 1995, and 1994, respectively.
The $3.1 million, or 36.5%, increase in 1996 can be attributed primarily to the
annualized impact of the 1995 acquisitions of Enhanced and ARSI (approximately
$1.9 million of the increase) as well as increased sales and marketing expenses
and increased costs associated with being a publicly traded company.
The increase in 1995 of approximately $2.1 million, or 32.8%, can be
attributed to numerous factors, including the acquisitions of ARSI and Enhanced
(approximately $600,000 of the increase) and the expansion of the Company's
infrastructure in order to accommodate the separation of the operations of the
Vodavi Division from the operations of Executone and for anticipated growth.
Such increases included an increase in facilities expense related to the lease
entered into in January 1995, which significantly increased the space available
to the Company after Executone vacated the premises at the end of 1994, and an
increase in personnel of approximately 40%, primarily for warehouse, quality
assurance, systems integration, marketing, human resources, and finance
functions, all of which were previously shared with Executone.
Asset Impairment and Restructuring Charges
In 1996, the Company recorded a $4.2 million write-down of the goodwill
associated with the acquisition of Enhanced in accordance with Statement of
Financial Accounting Standard No. 121, Accounting for the Impairment of
Long-Lived Assets and for Assets to be Disposed Of. The Company determined that
the write-down was appropriate after evaluating the impact of several events
that occurred in the latter part of 1996, including communications from a
customer that purchase levels to which the customer had previously committed
would not be met. The write-down of the goodwill of Enhanced will result in a
reduction of goodwill amortization of approximately $460,000 annually.
The Company also accrued approximately $600,000 in restructuring
reserves related to the operations of Enhanced. These reserves included the
costs of relocating new management to Atlanta, costs related to the Company's
lawsuit against the former owners of Enhanced, costs related to the settlement
of an outstanding legal matter, and other expenses related to the management
change.
Other Income (Expense), Net
Other income (expense), net consists principally of interest expense.
Interest expense was approximately $840,000, $1.1 million, and $766,000, in
1996, 1995, and 1994, respectively. The $289,000, or 25.6%, decrease in 1996 can
be attributed primarily to the reduction in debt as a result of improved asset
management. The increase in 1995 reflects the additional borrowings by the
Company in 1995 to finance increased inventory levels and capital expenditures.
The increase also reflects higher interest rates in 1995 as compared to 1994.
The Company believes that the trend towards reduced interest expense will
continue during 1997, primarily as a result of the new terms under its extended
credit facility with GE Capital. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
29
<PAGE>
Income Taxes
The effective rate of the Company's income tax provision was (8.0)%,
47.7%, and 39.5% in 1996, 1995, and 1994, respectively. The effective tax rate
for the Company has been significantly impacted by the purchase of Enhanced and
the subsequent charges taken related to Enhanced. The goodwill generated by the
acquisition was non-deductible. This was the primary cause of the increased
effective rate in 1995 as compared with 1994. The asset impairment and a portion
of the restructuring charges in 1996 were also non-deductible, thus resulting in
the negative effective rate for 1996. The Company expects that the effective
rate in the future will be in the 40-42% range.
Liquidity and Capital Resources
The Company's cash and cash equivalents were approximately $1.2 million
at December 31, 1996. The Company's cash accounts are swept regularly and
applied against the Company's operating line of credit, as described below. The
Company's borrowings against its available operating line of credit at December
31, 1996 were approximately $5.4 million, which represents a $2.5 million
reduction from its borrowings of $7.9 million at December 31, 1995. The
reduction is attributed to several factors, including cash generated from
operations, improved asset management, and utilization of capital leases to
finance capital expenditures, as described below. At December 31, 1996, the
Company had approximately $4.0 million available to it under its operating line
of credit.
The Company maintains a $12.0 million revolving line of credit with GE
Capital. The line of credit extends through April 1997 and bears interest,
payable monthly, at 4.5% over the 30-day commercial paper rate, or a total of
10.45% at December 31, 1996. The Company has recently reached an agreement in
principal to extend the facility through April 2000. The terms of the extension
will lower the interest rate to 2.5% over the 30-day commercial paper rate, or a
total of 8.45% at December 31, 1996. Advances under the line of credit are based
upon the accounts receivable and inventories of VCS and are secured by
substantially all of the assets and all of capital stock of VCS. The revolving
line of credit contains covenants that are customary for similar credit
facilities and also prohibits VCS from paying dividends to the Company without
the consent of GE Capital. See Item 1, "Special Considerations - Lack of
Dividends." At December 31, 1996, the Company was in violation of two financial
covenants contained in the original agreement. The Company anticipates that
these covenants will be eliminated when its line of credit with GE Capital is
extended.
In 1996, the Company entered into leasing facilities in order to
finance capital expenditures. The facilities provide the Company with up to
$800,000 at rates tied to Treasury notes (approximately 9.0% at December 31,
1996). As of December 31, 1996, the Company had utilized approximately $435,000
of these facilities and had commitments outstanding for an additional $200,000.
As of December 31, 1996, the Company had commitments in connection with
its new product developments. Such commitments aggregate approximately $300,000
and are payable through December 31, 1997. The commitments include payments to
NovAtel in connection with the development of the Company's wireless product and
payments to develop new tooling for its existing and future digital products.
The Company believes that its working capital and credit facilities
will be sufficient to finance its internal growth for the foreseeable future.
Although the Company currently has no acquisition targets, it intends to
continue to explore acquisition opportunities as they arise and may be required
to seek additional financing in the future to meet such opportunities.
30
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Reference is made to the financial statements, the report thereon, and
the notes thereto commencing at page F-1 of this Report, which financial
statements, report, and notes are incorporated by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item relating to directors of the
Company is incorporated herein by reference to the definitive Proxy Statement to
be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") for the Company's 1997 Annual Meeting of
Stockholders. The information required by this Item relating to executive
officers of the Company is included in Item 1, "Business - Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1997 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1997 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1997 Annual Meeting of Stockholders.
31
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules
(1) Financial Statements are listed in the Index to Consolidated
Financial Statements on page F-1 of this Report.
(2) No Financial Statement Schedules are included because such
schedules are not applicable, are not required, or because
required information is included in the consolidated financial
statements or notes thereto.
(b) Reports on Form 8-K.
On October 15, 1996, the Company filed a Current Report on Form 8-K
dated September 20, 1996, reporting the election of Kent R. Burgess as
the President and a director of Enhanced, the removal of the former
President and Vice President of Enhanced, and certain lawsuits between
the Company and Enhanced on the one hand and the former President and
Vice President of Enhanced on the other.
(c) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
- ------ -------
<S> <C>
2.1 Asset Purchase Agreement dated as of November 5, 1993 among V Technology Acquisition Corp.,
Executone Information Systems, Inc., and Vodavi, Inc., with Amendment dated February 18, 1994(1)
2.2 Agreement and Plan of Reorganization dated as of May 9,1995 among the Registrant, VOD, Inc.,
Enhanced Systems, Inc., Michael Mittel, Fereydoun Taslimi, Nahid Taslimi, Scott Kelly, and Earl
Alexander, with letter amendment dated May 22, 1995(1)
3.1 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)
4.2 Form of Underwriter's Warrant(l)
9 Voting Trust Agreement dated as of May 9, 1995 among Enhanced Systems, Inc., Michael Mittel,
Fereydoun Taslimi, Nahid Taslimi, Scott Kelly, Earl Alexander, and Glenn R. Fitchet(1)
10.1 Credit Agreement dated as of April 11, 1994 between Vodavi Communications Systems, Inc. and General
Electric Capital Corporation(l)
10.2 Security Agreement dated as of April 11, 1994 between Vodavi Communications Systems, Inc. and
General Electric Capital Corporation(l)
10.3 Stock Pledge and Security Agreement dated as of April 11, 1994 between the Registrant and General
Electric Capital Corporation(l)
10.7 Patent Collateral Assignment Agreement dated as of April 11, 1994 between V Technology Acquisition
Corp. and General Electric Capital Corporation(l)
10.8 Trademark Security Agreement dated as of April 11, 1994 between V Technology Acquisition Corp. and
General Electric Capital Corporation(l)
10.9 Vodavi Technology, Inc. Amended and Restated 1994 Stock Option Plan(2)
10.10 Stockholders' Agreement among the Registrant, V Technology Holdings Corp., GoldStar
Telecommunication Co., Ltd., The Sherman Group, The Opportunity Fund, Steven A. Sherman, and
Glenn R. Fitchet, dated March 28, 1994, and Amendment Agreement dated April 5, 1995(1)
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
- ------ -------
<S> <C>
10.11 Escrow Agreement dated as of March 28, 1994 between the Registrant, GoldStar Telecommunication Co.,
Ltd., Steven Sherman, Glenn R. Fitchet and STKK Service Company, as Escrow Agent(l)
10.12 Vodavi Key System Agreement dated April 4, 1994 between GoldStar Telecommunication Co., Ltd., and
Vodavi Communication Systems, a division of Executone Information Systems, Inc.(l)
10.13 Vodavi Single Line Telephone Agreement dated April 4,1994 between Srithai GoldStar Co., Ltd., and
Vodavi Communication Systems, Inc., a division of Executone Information Systems, Inc.(l)
10.14 License Agreement dated as of March 31, 1994 between Executone Information Systems, Inc. and V
Technology Acquisition Corp.(l)
10.15 Assignment and Assumption Agreement dated April 11, 1994 between Executone Information Systems,
Inc. and V Technology Acquisition Corp.(l)
10.16 Supply Agreement dated December 1, 1994 between NovAtel Communications Ltd., and Vodavi
Communications Systems, Inc.(l)
10.17 Escrow Agreement dated as of May 9, 1995 among the Registrant, VOD, Inc., Michael Mittel,
Fereydoun Taslimi, Nahid Taslimi, Scott Kelly, Earl Alexander, Glenn R. Fitchet, Enhanced Systems,
Inc., and Arizona Escrow & Financial Corporation.(l)
10.18 Asset Purchase Agreement dated June 30, 1995 among the Registrant, Arizona Repair Services, Inc.,
Goldstar Products Company, Ltd., and LG Electronics, U.S.A., Inc.(l)
10.19 OEM Agreement dated as of June 19, 1995, between Tecom Co., Ltd. and Vodavi Communications
Systems, Inc.(3)
10.20 Agreement dated June 14, 1995 between Wong's Electronics Co., Ltd. and Vodavi Communications
Systems, Inc.(3)
10.21 Master Lease Agreement dated May 31, 1996, between Matrix Funding Corporation and Vodavi
Communications Systems, Inc.(2)
10.22 Master Lease Agreement dated October 7, 1996, between Matrix Funding Corporation and Vodavi
Communications Systems, Inc.(4)
11 Computation of Per Share Earnings
21 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP
27 Financial Data Schedule
</TABLE>
- ---------------------
(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, 1996, as filed on August 14, 1996.
(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 September 30, 1996, as filed on November 14, 1996.
33
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities 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 28, 1997 By: /s/ Glenn R. Fitchet
----------------------
Glenn R. Fitchet
President
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the date indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ STEVEN A. SHERMAN Chairman of the Board March 28, 1997
- ----------------------------------------
Steven A. Sherman
/s/ GLENN R. FITCHET President and Director March 28, 1997
- ----------------------------------------
Glenn R. Fitchet
/s/ GREGORY K. ROEPER Vice President --- Finance, Chief March 28, 1997
- ----------------------------------------
Gregory K. Roeper Financial Officer (Principal
Financial and Accounting Officer)
Director March __, 1996
- ----------------------------------------
Nam K. Woo
/s/ GILBERT H. ENGELS Director March 28, 1997
- ----------------------------------------
Gilbert H. Engels
/s/ STEPHEN A MCCONNELL Director March 28, 1997
- ----------------------------------------
Stephen A McConnell
</TABLE>
<PAGE>
VODAVI TECHNOLOGY, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Public Accountants --------------------------------- F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996 ------------- F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1994, 1995, and 1996 ------------------------------------- F-4
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1994, 1995, and 1996 --------------------- F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1994, 1995, and 1996 ------------------------------------- F-6
Notes to Consolidated Financial Statements ------------------------------- F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vodavi Technology, Inc.:
We have audited the accompanying consolidated balance sheets of VODAVI
TECHNOLOGY, INC. (a Delaware corporation) and subsidiaries as of December 31,
1995 and 1996, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. 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 audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Vodavi Technology, Inc. and
subsidiaries as of December 31, 1995 and 1996, and the results of their
operations and cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Phoenix, Arizona,
January 31, 1997.
F-2
<PAGE>
VODAVI TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------------
1995 1996
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,944,120 $ 1,151,713
Accounts receivable, net of allowances of
$163,000 in 1995 and $234,000 in 1996 6,427,123 7,789,832
Inventories, net 8,546,384 7,229,325
Prepaid expenses and other 801,333 420,455
------------ ------------
Total current assets 17,718,960 16,591,325
PROPERTY AND EQUIPMENT, net 1,730,514 2,465,214
GOODWILL, net 7,089,140 2,546,465
OTHER LONG-TERM ASSETS, net 931,367 814,620
------------ ------------
$ 27,469,981 $ 22,417,624
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ -- $ 258,000
Payable to related parties 1,646,656 2,291,581
Accounts payable 1,978,032 2,172,042
Accrued liabilities 1,710,903 2,224,427
Accrued income taxes 371,063 293,840
------------ ------------
Total current liabilities 5,706,654 7,239,890
------------ ------------
LONG-TERM DEBT 7,884,326 5,588,209
------------ ------------
OTHER LONG-TERM OBLIGATIONS 68,813 189,100
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 1,000,000 shares
authorized, no shares issued -- --
Common stock, $.001 par value, 10,000,000 shares
authorized; 4,342,238 shares issued
and outstanding 4,342 4,342
Additional paid-in capital 12,307,739 12,307,739
Retained earnings (deficit) 1,498,107 (2,911,656)
------------ ------------
13,810,188 9,400,425
------------ ------------
$ 27,469,981 $ 22,417,624
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
F-3
<PAGE>
VODAVI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1994 1995 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
REVENUES, net $ 29,139,730 $ 39,600,726 $ 46,154,174
COSTS OF GOODS SOLD (including
products acquired from related parties
(LGE) of $12.1 million, $15.6 million,
and $17.8 million, respectively 20,526,701 27,196,571 30,842,422
--------------- --------------- ---------------
Gross margin 8,613,029 12,404,155 15,311,752
OPERATING EXPENSES:
Engineering and product development 1,375,850 1,941,503 2,161,306
Selling, general and administrative 4,915,409 8,457,641 11,587,971
Asset impairment and restructuring
charges (Notes 1 and 4) - - 4,804,717
--------------- --------------- ---------------
OPERATING INCOME (LOSS) 2,321,770 2,005,011 (3,242,242)
INTEREST EXPENSE 575,952 1,129,604 840,830
--------------- --------------- ---------------
INCOME (LOSS) BEFORE INCOME TAXES 1,745,818 875,407 (4,083,072)
PROVISION FOR INCOME TAXES 692,725 417,599 326,691
--------------- --------------- ---------------
NET INCOME (LOSS) $ 1,053,093 $ 457,808 $ (4,409,763)
=============== =============== ===============
NET INCOME (LOSS) PER SHARE $ 0.55 $ 0.17 $ (1.02)
======== ======== =======
WEIGHTED AVERAGE SHARES
OUTSTANDING 1,917,346 2,769,434 4,342,238
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE>
VODAVI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock
------------------------- Additional Retained
Par Paid-in Earnings
Shares Value Capital (Deficit) Total
------------ ---------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993 849,999 $ 850 $ 16,150 $ (12,794) $ 4,206
Private sale of shares 1,033,994 1,034 2,563,966 - 2,565,000
Issuance of shares to
repay related party
indebtedness 116,000 116 434,884 - 435,000
Net income - - - 1,053,093 1,053,093
------------ ---------- ------------- -------------- --------------
BALANCE, December 31, 1994 1,999,993 2,000 3,015,000 1,040,299 4,057,299
Warrant conversion 187,500 187 (187) - -
Initial public offering 1,488,083 1,488 7,293,593 - 7,295,081
Issuance of shares to
acquire Enhanced 666,662 667 1,999,333 - 2,000,000
Net income - - - 457,808 457,808
------------ ---------- ------------- -------------- --------------
BALANCE, December 31, 1995 4,342,238 4,342 12,307,739 1,498,107 13,810,188
Net loss - - - (4,409,763) (4,409,763)
------------ ---------- ------------- -------------- --------------
BALANCE, December 31, 1996 4,342,238 $ 4,342 $ 12,307,739 $ (2,911,656) $ 9,400,425
============ ========== ============= ============== ==============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE>
VODAVI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,053,093 $ 457,808 $ (4,409,763)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization 287,423 561,048 903,741
Asset impairment -- -- 4,174,717
Rent levelization -- 68,813 68,246
Loss on retirement of fixed assets 2,796 -- 63,081
Changes in working capital, net of assets and liabilities acquired
in business combinations:
Accounts receivable 404,831 326,370 (1,310,669)
Inventories (920,352) (2,305,470) 1,302,059
Prepaid expenses and other (367,552) (377,344) 380,878
Other long-term assets (141,919) (156,742) 36,615
Accounts payable and payables to related parties 32,709 648,547 838,935
Accrued liabilities 815,452 (183,170) 619,003
Accrued income taxes -- (109,023) (77,223)
------------ ------------ ------------
Net cash flows provided by (used in) operating activities 1,166,481 (1,069,163) 2,589,620
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid to acquire assets through business combinations (9,583,427) (2,351,524) --
Accrued acquisition costs paid (943,956) (309,932) (217,894)
Cash paid to acquire fixed assets (313,515) (1,185,328) (556,664)
------------ ------------ ------------
Net cash flows used in investing activities (10,840,898) (3,846,784) (774,558)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the sale of common stock 2,565,000 8,928,598 --
Equity offering costs paid -- (1,633,517) --
Borrowings from related parties 35,000 -- --
Financing costs paid (175,000) -- --
Repayment of notes payable -- (1,200,000) --
Payments on capital leases -- -- (109,760)
Borrowings on revolving credit facility 37,798,136 41,127,236 41,369,367
Payments on revolving credit facility (29,224,464) (41,816,582) (43,867,070)
------------ ------------ ------------
Net cash flows provided by (used in) financing activities 10,998,672 5,405,735 (2,607,463)
------------ ------------ ------------
CHANGES IN CASH AND CASH EQUIVALENTS 1,324,255 489,788 (792,407)
CASH AND CASH EQUIVALENTS, beginning of period 130,077 1,454,332 1,944,120
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 1,454,332 $ 1,944,120 $ 1,151,713
============ ============ ============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
<PAGE>
VODAVI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES:
Nature of Business
Vodavi Technology, Inc. (VTI), a Delaware corporation, designs, develops,
markets, and supports a broad range of telecommunications systems, commercial
grade telephones, computer-telephony products, and voice processing products,
including voice mail, fax mail, Internet messaging, and interactive voice
response systems for a wide variety of commercial applications.
Principles of Consolidation
The consolidated financial statements include the accounts of VTI and its wholly
owned subsidiaries Vodavi Communication Systems, Inc. (VCS), Arizona Repair
Services, Inc. (ARSI), and Enhanced Systems, Inc. (Enhanced) (together referred
to as the Company) for the periods indicated in Note 2. All material
intercompany transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles 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.
Cash and Cash Equivalents
Cash and cash equivalents include funds on hand and short-term investments.
Inventory
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
F-7
<PAGE>
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method. Property and equipment and the related useful lives
consist of the following as of December 31, 1995 and 1996, respectively:
<TABLE>
<CAPTION>
Useful Life
Type of Asset in Years 1995 1996
- ------------------------------------------------- --------------- ------------- -------------
<S> <C> <C> <C>
Office and computer equipment 5 $ 439,628 $ 671,869
Furniture and fixtures 10 232,310 219,063
Tooling and manufacturing equipment 5-8 613,080 1,060,387
Assets under capital lease 5-12 - 574,982
Construction in progress - 758,422 502,976
------------- -------------
2,043,440 3,029,277
Less: Accumulated depreciation (312,926) (564,063)
------------- -------------
$ 1,730,514 $ 2,465,214
============= =============
</TABLE>
Construction in progress relates to the manufacture of new tooling and test
fixtures.
Goodwill
Goodwill represents the cost in excess of the estimated fair value of tangible
assets acquired in business combinations and is being amortized on the
straight-line method over the estimated life of the asset.
During 1996, the Company adopted Statement of Financial Accounting Standards
121, Accounting for the Impairment of Long-Lived Assets and For Long-Lived
Assets to be Disposed Of, which requires that long-lived assets be reviewed for
impairment whenever events or circumstances indicate that the carrying amount of
the asset may not be recoverable.
During 1996, certain events occurred which required the Company to re-evaluate
the realizability of the goodwill recorded in connection with the acquisition of
Enhanced. One of the events involved a significant customer of Enhanced
informing the Company that a previously communicated level of purchases from
Enhanced would not be met. As a result of the impact of this event on the
projected cash flows of Enhanced, the Company concluded that the goodwill was
impaired and recorded a $4.2 million impairment loss.
Income Taxes
The Company utilizes the liability method of accounting for income taxes as set
forth in Statement of Financial Accounting Standards 109, Accounting for Income
Taxes. Under the liability method, deferred taxes are provided based on the
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and liabilities.
F-8
<PAGE>
Revenue Recognition
Revenue, net of an allowance for product returns, is generally recognized upon
shipment to the customer. When the Company has an installation obligation,
revenue is recognized upon installation. Revenue from extended maintenance
contracts is recognized over the lives of the respective contracts.
Net Income (Loss) Per Share
Net income per share for the years ended December 31, 1994 and 1995, were
determined by dividing net income by the weighted average number of common and
common equivalent shares outstanding. The weighted average number of common
equivalent shares for the year ended December 31, 1994, assumes the conversion
of the warrants described in Note 5 and the exercise of all outstanding options
and the corresponding repurchase of shares using the treasury stock method on
April 1, 1994, the date of the acquisition of VCS. The weighted average number
of common equivalent shares for the year ended December 31, 1995, assumes the
conversion of the warrants described in Note 5 and the exercise of all
outstanding options and the corresponding repurchase of shares and retirement of
debt using the treasury stock method on January 1, 1995.
Net loss per share for the year ended December 31, 1996, was determined by
dividing the net loss by the weighted average number of common shares
outstanding. Common stock equivalents were not included as the effect would have
been anti-dilutive.
Fully diluted earnings per share are not presented as the effect would not be
materially different.
Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of Statement of Financial Accounting
Standards No. 107, Disclosures About Fair Value of Financial Instruments. The
estimated fair value amounts have been determined by the Company at December 31,
1996, using available market information. Considerable judgment is required in
interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented below may not be indicative of the amounts that the
Company could realize in a current market exchange. The use of different market
assumptions and valuation methodologies could have a material effect on the
estimated fair value amounts.
The carrying value of cash and cash equivalents, accounts receivable, accounts
payable, payable to related party, accrued liabilities, and the revolving credit
facility approximate fair values due to the short-term maturities of these
instruments.
F-9
<PAGE>
(2) BUSINESS COMBINATIONS:
In April 1994, VCS acquired the operating assets of the Vodavi Communication
Systems Division (the Vodavi Division) of Executone Information Systems, Inc.
(Executone). The acquisition was accounted for under the purchase method. The
purchase price of the Vodavi Division was approximately $12.0 million and was
allocated as follows:
Net current assets $ 8,600,000
Fixed assets 400,000
Goodwill 3,000,000
---------------
$ 12,000,000
===============
The accompanying financial statements include the results of the Vodavi Division
since April 1, 1994.
In July 1995, ARSI acquired certain operating assets of Goldstar Products
Company, Ltd. (GPC), an affiliate of LGE. The operations acquired consisted of a
repair facility utilized by GPC to repair telecommunications equipment primarily
sold by VCS. The purchase price was $440,000, including other direct
acquisition-related costs. The acquisition was accounted for under the purchase
method. The purchase price was allocated as follows:
Current assets $ 80,000
Fixed assets 90,000
Goodwill 270,000
-----------
$ 440,000
===========
Concurrently with the Company's initial public offering (IPO) in October 1995,
Enhanced, a Norcross, Georgia-based provider of voice processing technology,
merged with a wholly owned subsidiary of the Company. The total purchase price
of Enhanced was approximately $5,250,000, including other direct
acquisition-related costs, and consisted of $3,000,000 in cash and the issuance
of 666,662 restricted shares of VTI common stock.
The acquisition of Enhanced was accounted for under the purchase method. The
purchase price of Enhanced was allocated as follows:
Net current assets $ 500,000
Long-term assets 250,000
Goodwill 4,500,000
-------------
$ 5,250,000
=============
F-10
<PAGE>
The following table presents the unaudited pro-forma results of operations for
the years ended December 31, 1994 and 1995, assuming the transactions described
above had taken place as of January 1, 1994:
1994 1995
---------------- ---------------
Revenue $ 40,929,000 $ 41,938,000
Net income 1,398,000 272,000
Net income per share 0.33 .06
(3) LONG-TERM DEBT:
Long-term debt consists of the following as of December 31, 1995 and 1996:
1995 1996
------------- -------------
Revolving credit facility $ 7,884,326 $ 5,386,623
Capital lease obligations - 459,586
------------- -------------
7,884,326 5,846,209
Less: Current portion - 258,000
------------- -------------
$ 7,884,326 $ 5,588,209
============= =============
The Company has a $12.0 million revolving credit facility with a financial
institution, which expires in April 1997. Borrowings under the facility, which
are based on inventory and accounts receivable, carry interest payable monthly
at a variable rate based on commercial paper plus 4-1/2% (10.31% and 10.45% at
December 31, 1995 and 1996, respectively). The credit facility is secured by
substantially all of the assets and all of the common stock of VCS.
The credit agreement contains certain financial covenants relative to net worth,
cash flow, capital expenditures, and other ratios. At December 31, 1996, the
Company was not in compliance with two of such covenants. The Company has
recently negotiated a three-year extension of this facility. Under the new
terms, the Company will pay interest monthly at a variable rate based on
commercial paper plus 2-1/2% (8.45% at December 31, 1996). The extension also
eliminates certain fees and eliminates certain financial covenants, including
the two covenants with which the Company was not in compliance at December 31,
1996.
The Company has entered into several capital lease agreements with interest
rates ranging from 7.5% to 9%. These agreements generally have terms of 24
months.
F-11
<PAGE>
(4) COMMITMENTS AND CONTINGENCIES:
Operating Leases
The Company has entered into long-term lease agreements for all of its office
and warehouse facilities. Minimum payments under the Company's lease agreements
are as follows:
Total
----------------
1997 $ 1,061,403
1998 1,090,731
1999 1,120,707
2000 1,160,679
2001 1,201,335
Thereafter 486,465
Rent expense is recognized on a straight-line basis and was approximately
$315,000, $825,000, and $1,115,000 for the years ended December 31, 1994, 1995,
and 1996, respectively. For the year ended December 31, 1994, the Company
operated in facilities shared with Executone.
Royalties
VCS acquires certain proprietary components from Executone under the terms of a
20-year license agreement. Under the terms of the agreement, VCS will pay a 5.3%
royalty over the manufactured cost of all products utilizing the proprietary
components. Total royalties to Executone were $250,000, $492,000, and $502,000
in 1994, 1995, and 1996, respectively.
Supply Agreements
VCS has entered into various supply agreements with its vendors to purchase
products through 1998. Minimum required purchases in 1997 and 1998 total
approximately $11.5 million and $4.3 million, respectively.
401(k) Profit Sharing Plan
In April 1994, the Company adopted a profit sharing plan (the 401(k) Plan)
pursuant to Section 401(k) of the Internal Revenue Code of 1986. 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 approximately $26,000, $40,000, and $67,500
for the years ended December 31, 1994, 1995, and 1996, respectively.
Legal Matters
The Company is currently involved in a lawsuit with the former owners of
Enhanced, who were dismissed from their positions as executive management of
Enhanced in the third quarter of 1996. In September 1996, the Company sued the
former owners alleging securities fraud, fraudulent activities, breach of
employment agreements, breach of fiduciary duties, and other
F-12
<PAGE>
charges. The former owners countersued the Company claiming the Company breached
their employment agreements and owes them approximately $500,000. The Company
intends to vigorously pursue its action and defend against the countersuit. In
connection with the fourth quarter charges for the asset impairment and other
restructuring charges, the Company reserved approximately $250,000 to pursue
this matter.
(5) STOCKHOLDERS' EQUITY:
Warrants
In connection with the private sale of common stock in April 1994, the Company
issued warrants to acquire an additional 1,125,000 shares of common stock at
$4.00 per share. In September 1995, the Company issued 187,500 shares of its
common stock in a cashless exchange for these warrants.
In connection with the IPO, the Company sold to its underwriter warrants to
purchase up to 133,333 shares of its common stock at a price of $7.20 per share.
The warrants are exercisable during a four-year period from October 12, 1996 to
October 12, 2000.
Vodavi Technology, Inc. Stock Option Plan
The Vodavi Technology, Inc. Stock Option Plan (the Plan), as amended, provides
for the granting of options to purchase up to 850,000 shares of VTI's common
stock. Under the Plan, options may be issued to key personnel of the Company.
The options issued may be incentive stock options or nonqualified stock options.
If any option terminates or expires without having been exercised in full, stock
not issued under such option will again be available for the purposes of the
Plan.
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 of 1986. The
maximum number of shares of common stock with respect to which options can be
granted to any one employee, including officers, during the term of the plan may
not exceed 50% of the shares of common stock covered by the Plan.
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
upon grant of the options. The exercise prices of options are determined by the
plan administrator, but 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 VTI
stock) of the fair market value of the common stock at the time of the grant.
F-13
<PAGE>
The following summarizes the activity for the Plan:
<TABLE>
<CAPTION>
December 31, 1994 December 31, 1995 December 31, 1996
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
--------- -------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of period: - $ 4.00 240,000 $ 4.00 237,500 $ 4.00
Granted 240,000 - 295,000 $ 6.07
Canceled - (2,500) $ 4.00 (34,000) $ 6.00
Exercised - - -
--------- -------- --------
Options outstanding
at end of period 240,000 $ 4.00 237,500 $ 4.00 498,500 $ 5.08
========= ======== =========
Options available
for grant 72,500 75,000 351,500
========= ======== =========
Exercisable at end
of period - 59,375 $ 4.00 118,750 $ 4.00
========= ======== ===========
Weighted average fair
value of options granted N/A $ 2.69
====== ======
</TABLE>
Of the 498,500 options outstanding at December 31, 1996, 237,500 have an
exercise price of $4.00 and a weighted average remaining contractual life of
eight years. Of these options, 118,750 are exercisable. The remaining 261,000
options have exercise prices between $6.00 and $7.00, with a weighted average
exercise price of $6.07 and a weighted average remaining contractual life of
nine years. None of these options are exercisable at December 31, 1996.
The Company accounts for the Plan under APB Opinion No. 25, under which no
compensation cost has been recognized. Had compensation cost for these plans
been determined consistent with FASB Statement No. 123, the Company's 1996 pro
forma net loss and pro forma loss per share would have been $4,607,000 and $1.06
per share, respectively. There were no options granted in 1995.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1996: risk-free interest rates of 5.47%; expected
dividend yields of zero; expected lives at 5 years; expected volatility of
47.86%.
In February 1997, the Company's Board of Directors granted an additional 150,000
options at an exercise price of $4.00 per share.
(6) MAJOR CUSTOMERS:
The Company's sales efforts have been concentrated on major supply houses as
well as a dealer network. During 1994, 1995, and 1996, sales to the Company's
largest customer accounted for 49%, 45%, and 44% of total revenues,
respectively.
F-14
<PAGE>
Accounts receivable from this supply house comprise 46% and 44% of total
accounts receivable at December 31, 1995 and 1996, respectively. Generally, the
Company does not require collateral from its customers. The Company believes its
credit evaluation procedures substantially reduce its credit risk.
(7) INCOME TAXES:
The Company files a consolidated federal income tax return. The income tax
provision is comprised of the following:
1994 1995 1996
------------- ------------- -------------
Current $ 816,376 $ 531,448 $ 311,490
Deferred (123,651) (113,889) 15,201
------------- ------------- -------------
$ 692,725 $ 417,599 $ 326,691
============= ============= =============
The Company provides for deferred income taxes resulting from temporary
differences between amounts reported for financial accounting and income tax
purposes. The components of net deferred income tax asset at December 31, 1995
and 1996, were as follows:
1995 1996
------------- -------------
Deferred tax assets:
Inventory and receivable reserves $ 133,945 $ 180,139
UNICAP adjustment 232,083 120,096
Other accruals 311,778 344,791
------------- -------------
677,806 645,026
------------- -------------
Deferred tax liabilities:
Depreciation differences (25,276) (38,901)
Amortization differences (25,075) (86,882)
------------- -------------
(50,351) (125,783)
------------- -------------
Net long-term deferred tax asset $ 627,455 $ 519,243
============= =============
The net long-term deferred tax asset is included in other long-term assets in
the accompanying consolidated balance sheet.
Reconciliation of the federal income tax rate to the Company's effective income
tax rate is as follows:
1994 1995 1996
------ ------ ------
Federal statutory tax rate 34.0% 34.0% 34.0%
State taxes, net 4.2 4.7 4.6
Non-deductible expenses 1.7 9.0 (46.6)
Utilization of NOLC reversal of
valuation reserve (.3) -- --
------ ------ ------
39.6% 47.7% (8.0)%
====== ====== ======
F-15
<PAGE>
The Copmany's effective income tax rate has been impacted by the acquisition of
Enhanced and the subsequent asset impairment and restructuring charges
recognized in 1996, as the goodwill generated by the acquisition is
non-deductible.
(8) RELATED PARTIES TRANSACTIONS:
LG Electronics Inc. (LGE), the Company's principal supplier, owns approximately
19.0% of the Company's outstanding Common Stock at December 31, 1996. During
1994, 1995, and 1996, the Company purchased approximately $12.7 million, $17.4
million, and $17.9 million of key telephone systems and commercial grade
telephones from LGE.
During 1994 and 1995, LGE provided the Company with a $3.5 million line of
credit for use in inventory purchases. During 1995, VCS utilized approximately
$2.5 million of this line. The Company utilized a portion of the proceeds from
the IPO to repay the line of credit in full, along with approximately $175,000
in interest, in October 1995.
(9) SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest and income taxes for the years ended December 31, 1994,
1995, and 1996, is as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------------- ------------- -------------
<S> <C> <C> <C>
Interest paid $ 892,000 $ 1,130,000 $ 840,000
Income taxes paid $ 642,000 $ 435,000 $ 22,000
The following information relates to business combinations made by the Company.
1994 1995 1996
------------- --------------- --------------
Fair value of assets acquired $ 15,124,000 $ 5,690,000 $ -
Value of stock issued - (2,000,000) -
Cash paid, net of cash acquired (3,000,000) (2,351,524) -
-------------- --------------- --------------
Liabilities assumed or incurred $ 12,114,000 $ 1,338,476 $ -
============== =============== ==============
</TABLE>
During the year ended December 31, 1996, the Company acquired approximately
$575,000 of property and equipment using capital leases.
F-16
EXHIBIT 11
VODAVI TECHNOLOGY, INC.
COMPUTATION OF EARNINGS PER COMMON SHARE
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $ 1,053,093 $ 457,808 $ (4,409,763)
Interest savings from assumed retirement of
debt, net of tax -- -- --
------------- ------------ -----------
Pro forma net income (loss) $ 1,053,093 $ 457,808 $ (4,409,763)
============= ============ ============
Weighted average number of common shares
outstanding 1,716,267 2,690,267 4,342,238
Additional shares assuming conversion of
stock options and warrants 201,079 79,167 --
------------- ------------ -----------
1,917,346 2,769,434 4,342,238
============= ============ ============
Primary earnings (loss) per common share $ 0.55 $ 0.17 $ (1.02)
============= ============ ============
</TABLE>
EXHIBIT 21
----------
LIST OF SUBSIDIARIES
--------------------
Name of Subsidiary State of Incorporation
- ------------------ ----------------------
Vodavi Communications Systems, Inc. Arizona
Enhanced Systems, Inc. Arizona
Arizona Repair Services, Inc. Arizona
ARTHUR ANDERSEN LLP
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed
Registration Statement on Form S-8 (No. 333-08437).
ARTHUR ANDERSEN LLP
Phoenix, Arizona,
March 27, 1997.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Exhibit contains summary financial
information extracted from the Registrant's
unaudited consolidated financial statements for
the period ended December 31, 1996 and is
qualified in its entirety by reference to such
financial statements. This Exhibit shall not be
deemed filed for purposes of Section 11 of the
Securities Act of 1933 and Section 18 of the
Securities Act of 1934, or otherwise subject to
the liability of such Sections, nor shall it be
deemed a part of any other filing which
incorporates this report by reference, unless
such other filing expressly incorporates this
Exhibit by reference.
</LEGEND>
<CIK> 949491
<NAME> Vodavi Technology, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollar
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 1,152
<SECURITIES> 0
<RECEIVABLES> 8,024
<ALLOWANCES> 234
<INVENTORY> 7,229
<CURRENT-ASSETS> 16,591
<PP&E> 3,029
<DEPRECIATION> 564
<TOTAL-ASSETS> 22,418
<CURRENT-LIABILITIES> 7,240
<BONDS> 5,777
0
0
<COMMON> 4
<OTHER-SE> 9,396
<TOTAL-LIABILITY-AND-EQUITY> 22,418
<SALES> 46,154
<TOTAL-REVENUES> 46,154
<CGS> 30,842
<TOTAL-COSTS> 30,842
<OTHER-EXPENSES> 18,554
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 841
<INCOME-PRETAX> (4,083)
<INCOME-TAX> 327
<INCOME-CONTINUING> (4,410)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,410)
<EPS-PRIMARY> (1.02)
<EPS-DILUTED> (1.02)
</TABLE>
