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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
_____________
FORM 10-K
_____________
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2006,
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number 1-8496
THINKENGINE NETWORKS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 20-8058881
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Nickerson Road, Marlborough, MA 01752
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (508) 624-7600
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Common Stock, par value $0.001 per share American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [_] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [_] No [X]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [_] Accelerated filer [_] Non-Accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [_] No [X]
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As of June 30, 2006, which is the last business day of the registrant's most
recently completed second fiscal quarter, the aggregate market value of the
registrant's common stock held by non-affiliates of the registrant was
$11,577,106 based on the closing price as reported on AMEX. This calculation
does not reflect a determination that persons are affiliates for any other
purpose.
As of March 1, 2007, there were 6,779,327 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held on May 10, 2007
are incorporated by reference into Part III.
TABLE OF CONTENTS
PART I
Item Page
---- ----
1. Business............................................................. 4
1A. Risk Factors......................................................... 7
1B. Unresolved Staff Comments............................................ 10
2. Properties........................................................... 10
3. Legal Proceedings.................................................... 10
4. Submission of Matters to a Vote of Security Holders.................. 10
Executive Officers of the Registrant................................. 12
PART II
5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities ................... 13
6. Selected Financial Data.............................................. 15
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 15
7A. Quantitative and Qualitative Disclosures about Market Risk........... 19
8. Financial Statements and Supplementary Data.......................... 19
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................. 36
9A. Controls and Procedures.............................................. 36
9B. Other Information.................................................... 37
PART III
10. Directors, Executive Officers and Corporate Governance............... 39
11 Executive Compensation............................................... 40
12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters........................... 40
13 Certain Relationships and Related Transactions, and
Director Independence................................................ 40
14 Principal Accountant Fees and Services............................... 40
PART IV
15. Exhibits and Financial Statement Schedules........................... 41
3
PART I
Certain statements in this report, other than purely historical information,
including estimates, projections, statements relating to the Company's business
plans, objectives and expected operating results, and the assumptions upon which
those statements are based, are "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995, Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
(the "Exchange Act"). These forward-looking statements generally are identified
by the words "believe," "project," "expect," "anticipate," "estimate," "intend,"
"strategy," "plan," "may," "should," "will," "would," "will be," "will
continue," "will likely result," and similar expressions. Forward-looking
statements are based on current expectations and assumptions that are subject to
risks and uncertainties which may cause actual results to differ materially from
the forward-looking statements. A detailed discussion of these and other risks
and uncertainties that could cause actual results and events to differ
materially from such forward-looking statements is included in the section
entitled "Risk Factors" (refer to Item 1A). the Company undertakes no obligation
to update or revise publicly any forward-looking statements, whether as a result
of new information, future events or otherwise.
For purposes of the following, the terms "ThinkEngine", "we", "us", and "our"
refer to ThinkEngine Networks, Inc. and its consolidated subsidiaries.
Item 1. Business
------------------
ThinkEngine Networks, Inc. (the "Company") designs, manufactures and sells voice
processing systems, consisting of media servers and application servers, for use
in telephone networks, audio call conferencing networks, and cable and non-cable
VoIP networks. The Company's products are utilized by telecommunications service
providers, cable broadband service providers, audio call conferencing service
providers, switch manufacturers, IP-based communications systems manufacturers
and systems integrators in order to implement network announcements, interactive
voice response (IVR), intelligent peripherals, audio conferencing, intelligent
call routing, pre/post-paid calling cards and automatic speech recognition
(ASR). The Company's primary products are the CX4000 network media server, and
the VSR1000, a multi-function voice services router.
BACKGROUND OF THE BUSINESS
The Company was incorporated in December 2006 under the laws of the State of
Delaware. It was formerly known as Cognitronics Corporation, a New York state
chartered corporation incorporated in January 1962, which was reincorporated in
Delaware and changed its name pursuant to a merger with and into the newly
created Delaware corporation in December 2006.
On November 18, 2005, the Company, then Cognitronics Corporation, acquired
ThinkEngine Networks, Inc. for consideration of 1,149,705 shares of the
Company's common stock, $1,250,000 in cash, and notes in the aggregate amount of
$300,000. In 2006, the acquired ThinkEngine Networks, Inc. subsidiary was
renamed TE Networks, Inc. ("TE Networks"). TE Networks was a provider of time
division multiplexer (TDM) and Internet Protocol (IP) capable conferencing
bridges and media servers to the telecommunications industry. In January 2007,
TE Networks was merged with and into the Company.
PRINCIPAL PRODUCTS AND SERVICES
The Company's two primary products are the CX4000 network media server and the
VSR1000, a multi-function voice services router.
The CX4000 network media server is capable of simultaneous operations in
traditional TDM networks and advanced intelligent networks ("AIN") and the most
advanced VoIP networks as well as in hybrid network environments. In an
economical package, the CX4000 holds up to 6 next generation media server
boards, each with its own stand alone onboard processing capabilities. The
CX4000 is built to open industry architecture standards, adheres to NEBS
standards, is built on a next generation internal switching platform and has an
industry standard switching bus. The CX4000 is built to the highest level of
reliability, delivering 99.999% availability, utilizing redundant hot swappable
components, and a redundant systems architecture to avoid downtime.
4
The VSR1000 is an advanced call processing platform with highly integrated call
treatment capabilities. The VSR1000 can provide speech recognition, advanced
call routing, and conferencing service to 672 simultaneous VoIP or TDM channels.
The VSR1000 was designed specifically for carrier networks. The VSR1000 adheres
to NEBS standards and includes carrier class features such as a dedicated
management coprocessor, -48v DC power, and standard Telco style alarms. When
deployed in redundant configurations the VSR1000 can provide 99.999% service
availability. The system's solid state design (no spinning media within the
platform) contributes to its high reliability and ease of management. System
management, including rolling upgrades, can be performed remotely.
In addition to the VSR1000 and CX hardware based products, the Company also
develops software solutions. ThinkEngine's reservationless conferencing solution
utilizes the VSR1000 platform to implement audio conferencing services widely
deployed by service providers. The system is capable of scaling from hundreds of
participants to tens of thousands of participants. Reservationless conferencing
is the most widely deployed application for the VSR1000.
In order to ease development burden and speed time-to-service deployment,
ThinkEngine provides two powerful tools. The ThinkEngine Remote Control Toolkit
eases the burden of Session Initiation Protocol ("SIP") application development
by abstracting complicated call state models into an easy to use SIP application
server toolkit. This toolkit is tightly integrated with the VSR1000 and allows
non-experts to build both PSTN and VoIP applications. The ThinkEngine Call Flow
Designer suite takes the level of abstraction one level further by allowing
programmers to utilize a graphical "drag and drop" programming model. Both of
these tools have been instrumental in lowering the barrier of entry when
customers are contemplating new service development and deployment.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS, EXPORT SALES AND DOMESTIC AND
FOREIGN OPERATIONS
The Company operates in one segment, voice processing. The Company designs,
manufactures and sells equipment for use in telecommunication and cable
broadband networks.
The discussion of liquidity and sources of capital set forth in Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in Item 7 of this Annual Report on Form 10-K is incorporated herein by
reference.
Sales to foreign customers primarily represent export-type sales (primarily
North America and Europe) of approximately $0.9 million in 2006, $0.8 million in
2005, and $0.5 million in 2004. Export sales generally do not involve any
greater business risks than do sales to domestic customers. Selling prices and
gross profit margins on export-type sales are comparable to sales to domestic
customers.
CUSTOMERS
The Company's customers are telecommunications service providers, cable
broadband service providers, audio call conferencing service providers, switch
manufacturers, IP-based communications systems manufacturers, systems
integrators, and value added resellers (VAR) who distribute the Company's
products. In 2006, revenues included sales of $3.3 million to Verizon
Communications Inc., $2.0 million to Comcast Corporation, $1.1 million to Free
Conferencing Corporation of America, and $0.8 million to Telcordia Technologies,
Inc. In 2005, revenues included sales of $2.3 million to Telcordia Technologies,
Inc., $1.3 million to Verizon Communications Inc., and $1.1 million to Comcast
Corporation. Over the past several years, a major portion of our revenues has
come from a few large customers. Accordingly, the loss of any of these customers
could have a material adverse impact on the Company's results of operations.
SALES AND SUPPORT
The Company sells and markets its products through our direct sales force and
through distribution partners. The Company believes that a broad range of
support services is critical to the successful installation and ongoing support
of our products, the development of long-term relationships with customers and
the generation of additional sales of our products. The Company provides its
customers with service and support primarily through our internal support
organization and to a lesser extent through the service organizations of
distribution partners. The Company offers a complete range of technical and
operational support services to support our customers throughout the product
lifecycle ranging from basic customer service and support, to planning, design
and installation services.
5
COMPETITION
The Company competes, and expects to compete, in fields noted for rapid
technological advances and the frequent introduction of new products and
services. The Company's products are similar to those manufactured, or capable
of being manufactured, by a number of companies, some of which are
well-established corporations with financial, personnel and technical resources
substantially larger than those of the Company. The Company's ability to compete
in the future depends on its ability to maintain the technological and
performance advantages of its current products and to introduce new products and
applications that achieve market acceptance. There are no assurances that the
Company will be able to successfully develop and market new products and
applications. The Company also believes that the key competitive differentiators
in these markets include product quality and functionality, ease-of-use,
integration capabilities, price performance, cost of ownership, speed of
deployment and installation and technical support and service. Current third
party competitors in the markets in which we sell our products include IBM
Corporation, Avaya, Inc., Compunetix, Inc., PolyCom, Inc., Radisys Corporation,
Cantata Technology, and Iperia, Inc., among others.
INTELLECTUAL PROPERTY
The Company relies on technological expertise, responsiveness to users' needs
and innovations and believes that these are of greater significance in its
industry than patent protection. There can be no assurance that patents owned or
controlled by others will not be encountered and asserted against the Company's
voice processing products, or that licenses or other rights under such patents
would be available, if needed. The Company has trademarks and names which the
Company considers important in promoting the business of the Company and its
products.
MANUFACTURING
The Company has outsourced the production of certain subassemblies and finished
goods to contract manufacturers. It performs final assembly, integration and
test functions for its products at its facilities in Connecticut and
Massachusetts.
RAW MATERIALS AND SUPPLIERS
The Company has adequate sources for obtaining raw materials, components and
supplies to meet production requirements, consisting primarily of electronic
components and subassemblies, and did not experience difficulty during 2006 in
obtaining such materials, supplies and components.
SEASONALITY
The Company traditionally has experienced its heaviest order volume during the
fourth quarter of each year which is primarily due to the budget and related
procurement cycles of its customers.
RESEARCH AND DEVELOPMENT
Expenditures for research and development activities, as determined in
accordance with U. S. generally accepted accounting principles, amounted to $5.2
million in 2006, $3.9 million (including purchased research and development of
$0.7 million) in 2005, and $2.5 million in 2004.
BACKLOG
The dollar amount of orders in backlog believed by the Company to be firm as of
December 31, 2006 and 2005, amounted to $0.5 million and $3.1 million,
respectively. All of the orders in backlog as of December 31, 2006 can
reasonably be expected to be filled during 2007. the Company does not believe
that its backlog, as of any particular date, is necessarily indicative of actual
revenue for any future period.
EMPLOYEES
At December 31, 2006, the Company and its subsidiaries employed 42 people, all
of whom are located in the United States. None of the Company's employees are
represented by a labor union.
6
ENVIRONMENTAL MATTERS
The Company may from time to time be subject to various state, federal and
international laws and regulations governing the environment, including those
restricting the presence of certain substances in electronic products and making
manufacturers of those products financially responsible for the collection,
treatment, recycling and disposal of certain products. For example, the European
Union ("EU") has adopted the RoHS and WEEE directives. RoHS prohibits the use of
certain substances, including mercury and lead, in certain products placed on
the market after July 1, 2006. The WEEE directive obligates parties that place
electrical and electronic equipment onto the market in the EU to put a clearly
identifiable mark on the equipment, register with and report to EU member
countries regarding distribution of the equipment, and provide a mechanism to
take back and properly dispose of the equipment. Each EU member country has
enacted, or is expected soon to enact, legislation clarifying what is and what
is not covered by the WEEE directive in that country. The Company is presently
investigating what actions may be necessary on our part in order to meet the
requirements of the RoHS and WEEE directives. Similar laws and regulations have
been or may be enacted in other regions.
Item 1A. Risk Factors
----------------------
The Company operates in a rapidly changing economic and technological
environment that presents numerous risks, many of which are driven by factors
that the Company cannot control or predict. The following discussion, as well as
the "Critical Accounting Policies and Estimates" discussion in Item 7 highlights
some of these risks.
IF THE COMPANY CONTINUES TO INCUR OPERATING LOSSES, IT MAY BE UNABLE TO CONTINUE
OPERATIONS.
The Company has incurred losses in each of its five most recent fiscal years. If
the Company continues to incur operating losses and fails to become a profitable
company, it may be unable to continue its operations. The extent of the
Company's future losses and the timing of its potential profitability are highly
uncertain. The Company's future growth and profitability depends on its ability
to successfully market the VSR1000 product. We must continue to enhance the
features and functionality of our products to meet customer requirements and
competitive demands. In addition, the failure of these planned product
enhancements to operate as expected could delay or prevent future sales of our
products. If our target customers do not adopt, purchase and successfully deploy
our products and our planned product enhancements, our revenues could be
adversely impacted.
THE COMPANY'S OPERATING RESULTS FLUCTUATE AND ARE DIFFICULT TO PREDICT, WHICH
COULD CAUSE OUR STOCK PRICE TO DECLINE.
The Company's revenues in any particular period may be lower than revenues in a
preceding or comparable period. Factors contributing to fluctuations, some of
which are beyond our control, include:
o fluctuations in our customers' businesses;
o our customers' budgets and the related procurement cycles;
o timing and market acceptance of new products or enhancements introduced by
us or our competitors;
o availability of components from our suppliers and the manufacturing capacity
of our subcontractors;
o timing and level of expenditures for sales, marketing and product
development;
o changes in the prices of our products or of our competitors' products; and
o general industry trends.
In addition, the Company has historically operated with no significant backlog.
Any significant deferral of orders for its products would cause a shortfall in
revenues for the quarter. The Company may receive one or more large orders in
one quarter from a customer and then receive no orders from that customer in the
next quarter. As a result, the Company's revenues may vary significantly from
quarter to quarter. If the Company's quarterly revenue or operating results fall
below the expectations of investors or public market, our stock price could be
adversely impacted.
7
THE COMPANY MAY BE UNABLE TO OBTAIN THE CAPITAL NECESSARY TO FUND ITS
OPERATIONS.
The Company may need to raise additional capital through debt or equity
financing to fund operations. As of December 31, 2006, the Company had $2.8
million in cash and cash equivalents to fund its operations and continue its
product development. Although the Company raised an additional $1.5 million
through debt financing in January 2007, if operations do not become profitable,
it will need to raise additional capital in order to have sufficient capital to
fund its operations beyond 2007. The Company may not get funding when it needs
it or on favorable terms. In addition, the amount of capital that a company such
as ThinkEngine is able to raise often depends on variables that are beyond its
control, such as the share price of its stock and its trading volume. As a
result, the Company may not be able to secure financing on terms attractive to
it, or at all. If the Company is able to consummate a financing arrangement, the
amount raised may not be sufficient to meet its future needs and may be highly
dilutive. If the Company cannot raise adequate funds to satisfy its capital
requirements, it may have to delay, scale-back or eliminate operations.
A SMALL NUMBER OF THE COMPANY'S CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF
ITS REVENUES, AND MOST OF ITS RECEIVABLES. THE LOSS OF A MAJOR CUSTOMER OR
REDUCED SPENDING OF THESE SERVICE PROVIDERS COULD SIGNIFICANTLY REDUCE THE
COMPANY'S REVENUES, PROFITABILITY AND CASH FLOW.
A few large telecommunications, audio conferencing and cable service providers
account for a substantial portion of the Company's revenues. These industries
have recently experienced significant consolidation due to mergers and
acquisitions. As service providers increase in size, it is possible that an even
greater percentage of the Company's revenues will be attributable to a smaller
number of large service providers going forward.
THE COMPANY'S RECENT ACQUISITION HAS A HISTORY OF LOSSES.
In November 2005, the Company, as the former Cognitronics Corporation, acquired
ThinkEngine Networks, Inc. which in 2006 was renamed TE Networks, Inc. ("TE
Networks"). The operations of TE Networks have never made a profit and will
continue to generate losses and require funding until sales of the VSR1000
product can be increased to sufficient levels, of which there can be no
assurance. In January 2007, the TE Networks, Inc. subsidiary was merged into the
Company and ceased to exist as a separate entity.
THE COMPANY OPERATES IN HIGHLY COMPETITIVE INDUSTRIES WITH MANY PARTICIPANTS.
The Company operates in a highly competitive environment, competing on the basis
of product offerings, technical capabilities, quality, service and pricing.
Competition for next generation service providers as well as for new
infrastructure deployments is particularly intense. The Company has a number of
existing competitors, some of which are very large, with significantly greater
technological and financial resources, brand recognition, and established
relationships with telecommunications service providers. In addition, new
competitors may enter the industry as a result of shifts in technology. The
Company does not offer any assurances that it will be able to compete
successfully against existing or future competitors.
TECHNOLOGY DRIVES THE COMPANY'S PRODUCTS AND SERVICES. IF THE COMPANY FAILS TO
KEEP PACE WITH TECHNOLOGICAL ADVANCES IN ITS INDUSTRY, OR IF IT PURSUES
TECHNOLOGIES THAT DO NOT BECOME COMMERCIALLY ACCEPTED, CUSTOMERS MAY NOT BUY ITS
PRODUCTS OR USE ITS SERVICES.
The telecommunications and cable industries use numerous and varied technologies
and large service providers often invest in several and, sometimes, incompatible
technologies. The industry also demands frequent and, at times, significant
technology upgrades. The Company does not have the resources to invest in all of
these existing and potential technologies. As a result, the Company concentrates
its resources on those technologies it believes have or will achieve substantial
customer acceptance and in which it has appropriate technical expertise.
However, existing products often have short product life cycles. In addition,
the Company's choices for developing technologies may prove incorrect if
customers do not adopt the products it develops or if those technologies
ultimately prove to be unviable. The Company's operating results depend to a
significant extent on the market acceptance of its products and its ability to
enhance its existing products, to continue to introduce new products
successfully and on a timely basis, and to develop new or enhance existing tools
for its services offerings.
8
THE COMPANY MAY BE UNABLE TO ATTRACT AND RETAIN HIGHLY QUALIFIED PERSONNEL.
The Company's future success is dependent on its ability to attract and retain
engineering, sales and executive personnel. There is intense competition for
qualified personnel, and the Company may not be able to attract and retain
qualified personnel necessary for the development and introduction of new
products or to replace qualified personnel that may leave its employ. Part of
our compensation program includes stock options. If our stock price performs
poorly it may adversely affect our ability to retain or attract key employees.
THE TELECOMMUNICATIONS MARKET FLUCTUATES AND IS IMPACTED BY MANY FACTORS,
INCLUDING DECISIONS BY SERVICE PROVIDERS REGARDING THEIR DEPLOYMENT OF
TECHNOLOGY AND THEIR TIMING OF PURCHASES, AS WELL AS DEMAND AND SPENDING FOR
COMMUNICATIONS SERVICES BY BUSINESSES AND CONSUMERS.
Although the Company believes the overall market will continue to grow, the rate
of growth could vary geographically and across different technologies, and is
subject to substantial fluctuations. The specific market segments in which the
Company participates may not experience the growth of other segments. As a
result, our revenues are difficult to forecast and our quarterly operating
results can fluctuate significantly.
THE COMPANY MAY BE SUBJECT TO INTELLECTUAL PROPERTY LITIGATION AND INFRINGEMENT
CLAIMS, WHICH COULD CAUSE IT TO INCUR SIGNIFICANT EXPENSES OR PREVENT THE
COMPANY FROM SELLING ITS PRODUCTS.
Intellectual property litigation can be costly and time-consuming and can divert
the attention of management and key personnel from other business issues. The
complexity of the technology involved and the uncertainty of intellectual
property litigation increase these risks. A successful claim by a third party of
patent or other intellectual property infringement by the Company could compel
it to enter into costly royalty or license agreements or force it to pay
significant damages and could even require it to stop selling certain products.
IF THE COMPANY'S AMORTIZABLE INTANGIBLE ASSETS BECOME IMPAIRED IT MAY BE
REQUIRED TO RECORD A SIGNIFICANT CHARGE TO EARNINGS.
Under U. S. generally accepted accounting principles, we review our amortizable
intangible assets for impairment when events or changes in circumstances
indicate the carrying value may not be recoverable. The Company's intangible
assets are required to be tested for impairment at least annually. Factors that
may be considered a change in circumstances indicating that the carrying value
of the Company's amortizable intangible assets may not be recoverable include a
decline in stock price and market capitalization, reduced future cash flow
estimates, and slower growth rates in our industry. The Company may be required
to record a significant charge to earnings in its financial statements during
the period in which any impairment of its amortizable intangible assets is
determined, negatively impacting our results of operations.
CHANGES IN ACCOUNTING MAY AFFECT THE COMPANY'S REPORTED EARNINGS AND OPERATING
INCOME.
U. S. generally accepted accounting principles and accompanying accounting
pronouncements, implementation guidelines, and interpretations for many aspects
of the Company's business, such as revenue recognition for software, accounting
for investments, and treatment of goodwill or amortizable intangible assets, are
highly complex and involve subjective judgments. Changes in these rules or their
interpretation or changes in the Company's products or business could
significantly change the Company's reported earnings and operating income and
could add significant volatility to those measures, without a comparable
underlying change in cash flow from operations. See "Item 8. Financial
Statements and Supplementary Data", and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Critical Accounting
Policies and Estimates" of this report.
ACQUISITIONS AND JOINT VENTURES MAY HAVE AN ADVERSE EFFECT ON THE COMPANY'S
BUSINESS.
The Company may make acquisitions or enter into joint ventures as part of its
long-term business strategy. Any such transaction involves significant
challenges and risks including that the transaction does not advance the
Company's business strategy, that the company doesn't realize a satisfactory
return on the investment it makes, or that the Company may experience difficulty
in the integration of new employees, business systems, and technology, or
diversion of management's attention from its other business activities. These
factors could adversely affect the Company's operating results or financial
condition.
9
THE COMPANY RELIES ON THIRD PARTY SUPPLIERS TO PRODUCE SUBASSEMBLIES AND CERTAIN
FINISHED PRODUCTS.
The Company has outsourced the production of certain subassemblies and finished
goods. If a contract manufacturer terminates its relationship with the Company
or is unable to fill its orders on a timely basis, or if the Company does not
accurately forecast its requirements, the Company may be unable to deliver the
affected products to meet its customers' orders, which may adversely impact our
revenue and operating results in a quarter.
Item 1B. Unresolved Staff Comments
-----------------------------------
None.
Item 2. Properties
--------------------
Our properties consist of the following leased facilities:
SQUARE LEASE EXPIRATION
LOCATION DESCRIPTION FEET DATE
-------- ----------- ------ ----------------
Danbury, Connecticut Sales, engineering, production 27,600 10/31/08
3 Corporate Drive and service facility
Marlborough, Massachusetts Corporate office, engineering 11,405 8/31/09
100 Nickerson Road and service facility
The Company considers each of these facilities to be in good condition and
adequate for the Company's business.
Item 3. Legal Proceedings
---------------------------
In the normal course of business, the Company periodically becomes involved in
litigation. As of December 31, 2006, in the opinion of management, the Company
had no pending litigation that would have a material adverse effect on the
Company's financial position, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
-------------------------------------------------------------
At the 2006 annual meeting of stockholders of the Company, held on December 14,
2006, seven proposals were voted upon and approved by the Company's
stockholders. A brief discussion of each proposal voted upon at the annual
meeting and the number of votes cast for, against or withheld, as well as the
number of abstentions to each proposal and broker non-votes are set forth below,
as applicable.
1) A vote was taken for the election of six directors of the Company to hold
office until their respective successors shall have been duly elected. The
aggregate numbers of shares of common stock voted in person or by proxy were as
follows:
Nominee For Withheld
------- --- --------
Robert C. Fleming 5,709,859 302,720
William A. Merritt 5,745,476 267,103
Michael G. Mitchell 5,716,864 295,715
Robert H. Scott 5,716,854 295,915
William J. Stuart 5,768,175 244,404
John E. Sweeney 5,717,464 295,115
2) A vote was taken on the proposal to approve the reincorporation of the
Company into the State of Delaware through a merger with a newly formed,
wholly-owned Delaware subsidiary and the terms of the definitive agreements
related thereto. The aggregate numbers of shares of common stock voted in person
or by proxy were as follows:
10
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
4,234,122 273,359 18,723 1,486,375
3) A vote was taken on the proposal to amend the Company's certificate of
incorporation to change the Company's name from "Cognitronics Corporation" to
"ThinkEngine Networks, Inc." (in the event the reincorporation was not duly
adopted and approved). The aggregate numbers of shares of common stock voted in
person or by proxy were as follows:
For Against Abstain
--- ------- -------
5,723,567 264,852 24,160
4) A vote was taken on the proposal to approve the Company's 1990 Stock Option
Plan, as amended, including an increase in the number of shares reserved for
issuance thereunder by 550,000. The aggregate numbers of shares of common stock
voted in person or by proxy were as follows:
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
3,664,360 762,225 99,619 1,486,375
5) A vote was taken on the proposal to approve the Company's Restricted Stock
Plan, as amended, including an increase in the number of shares reserved for
issuance thereunder by 300,000. The aggregate numbers of shares of common stock
voted in person or by proxy were as follows:
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
3,641,691 778,105 106,408 1,486,375
6) A vote was taken on the proposal to approve the Company's Directors' Stock
Option Plan, as amended, including an increase in the number of shares reserved
for issuance thereunder by 150,000. The aggregate numbers of shares of common
stock voted in person or by proxy were as follows:
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
3,534,127 883,213 108,864 1,486,375
7) A vote was taken to ratify the selection of Carlin, Charron & Rosen, LLP, an
independent registered public accounting firm, as independent auditors for the
Company for the year ending December 31, 2006. The aggregate numbers of shares
of Common Stock voted in person or by proxy were as follows:
For Against Abstain
--- ------- -------
5,954,586 30,271 27,722
The foregoing proposals are described more fully in the Company's proxy
statement filed with the Securities and Exchange Commission on November 13, 2006
pursuant to Section 14 (a) of the Securities Act of 1934, as amended, and the
rules and regulations promulgated thereunder.
11
Executive Officers of the Registrant
------------------------------------
The executive officers of the Registrant, their positions with the Company and
ages as of March 1, 2007 are as follows:
NAME POSITION(S) AND OFFICE(S) AGE
---- ------------------------- ---
Michael G. Mitchell President and Chief Executive Officer; Director 46
Paul J. Gagne Vice President and Chief Technology Officer 54
John E. Steinkrauss Vice President, Treasurer and Chief Financial Officer 60
No family relationships exist between the executive officers of the Company.
Each of the executive officers was elected to serve until the next annual
meeting of the Board of Directors or until their successor shall have been
elected and qualified.
Mr. Mitchell has been President and Chief Executive Officer of the Company since
August 2006. Since 2001, he had been President and Chief Executive Officer for
ThinkEngine Networks, Inc. which was acquired by the Company in November 2005,
and he subsequently served as Executive Vice President of the Company's
ThinkEngine Networks subsidiary until April 2006. Prior to joining ThinkEngine
Networks, Inc., he held senior management positions at several technology firms.
Mr. Gagne has been a Vice President and Chief Technology Officer of the Company
since May 2006 with responsibility for engineering. Since 2001, he had been Vice
President of Engineering for ThinkEngine Networks, Inc. Prior to that he held
senior engineering positions at several technology firms.
Mr. Steinkrauss has been Vice President, Treasurer and Chief Financial Officer
of the Company since November 2006. Prior to that, he provided financial
consulting services to a number of companies, or held senior financial
management positions as follows: from September 2006 to October 2006 Director of
Finance at The Software MacKiev Company; from September 2004 to July 2006 as
Senior Vice President, Treasurer, Secretary and Chief Financial Officer of
IntelliReach Corporation; from April 2004 to July 2004, as Vice President,
Treasurer, Secretary and Chief Financial Officer of Stargus Communications,
Inc.; and from April 2002 to October 2002 as Vice President - Division
Controller of Digimarc ID Systems.
12
PART II
Item 5. Market for Registrant's Common Equity Related Stockholder Matters and
-------------------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
The Company's Common Stock is traded as ThinkEngine Networks, Inc. on the
American Stock Exchange under the symbol THN, which became effective on January
4, 2007. It was previously traded on the American Stock Exchange as Cognitronics
Corporation under the symbol CGN. On March 1, 2007, there were 522 stockholders
of record; the Company estimates that the total number of beneficial owners was
approximately 1,700. Information on quarterly stock prices during the two most
recent fiscal years is set forth below.
2006 FIRST SECOND THIRD FOURTH
---- ----- ------ ----- ------
Common Stock price range
High $3.37 $3.15 $2.55 $3.09
Low $2.49 $2.20 $1.75 $1.90
2005 FIRST SECOND THIRD FOURTH
---- ----- ------ ----- ------
Common Stock price range
High $5.00 $4.05 $3.58 $3.10
Low $2.92 $2.80 $2.25 $2.12
The Company has never paid a cash dividend on its Common Stock and has used its
cash for the development of its business. The Company has no present intention
of paying a cash dividend. Payment of any future dividends will depend upon the
Company's earnings, financial condition and other relevant factors.
13
Performance Graph
-----------------
The following graph compares the cumulative total return on the Company's
Common Stock with the cumulative total return of the S&P 500 Index and the
Hemscott Telecommunications Processing Systems and Products Industry Group for
the five years ended December 31, 2006.(1)
[PERFORMANCE GRAPH]
2001 2002 2003 2004 2005 2006
------ ------ ------ ------ ------ ------
THINKENGINE NETWORKS, INC. 100.00 53.47 70.53 86.11 50.74 65.05
S & P 500 100.00 77.90 100.24 111.15 116.61 135.03
TELECOMMUNICATIONS PROCESSING SYSTEMS & PRODUCTS 100.00 26.16 59.41 58.17 46.49 47.00
(1) Assumes that the value of the investment in the Company's Common Stock and
each index was $100 on December 31, 2001 and that all dividends were reinvested.
14
Item 6. Selected Financial Data
---------------------------------
The following table sets forth selected financial data of the Company for the
last five years. This selected financial data should be read in conjunction with
the consolidated financial statements and related notes included in Item 8 of
this Form 10-K.
Year ended December 31,
(in thousands except per share data)
-----------------------------------------------------------------------------------------------------------------------------------
Operating Results 2006 2005 2004 2003 2002
-----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 9,633 $ 7,750 $ 8,699 $ 5,096 $ 5,535
Loss from continuing operations (5,631) (2,591) (341) (3,482) (6,361)
Loss from discontinued operations -- (1,555) (213) (68) (83)
Cumulative effect of change in accounting principle,
net of tax 36 -- -- -- --
Net loss $ (5,595) $ (4,146) $ (554) $ (3,550) $ (6,444)
Loss per share
Continuing operations $ (0.82) $ (0.45) $ (0.06) $ (0.62) $ (1.17)
Discontinued operations -- (0.26) (0.04) (0.01) (0.02)
Cumulative effect of change in
accounting principle, net of tax 0.01 -- -- -- --
Net loss $ (0.81) $ (0.71) $ (0.10) $ (0.63) $ (1.18)
Weighted average number of common shares outstanding
6,899 5,879 5,781 5,615 5,438
-----------------------------------------------------------------------------------------------------------------------------------
Financial Position
-----------------------------------------------------------------------------------------------------------------------------------
Working capital $ 3,293 $ 7,251 $ 13,132 $ 12,851 $ 16,321
Total assets $ 10,646 $ 21,205 $ 18,956 $ 18,898 $ 22,812
Stockholders' equity $ 7,148 $ 14,015 $ 15,015 $ 15,268 $ 18,152
Stockholders' equity per share $ 1.04 $ 2.38 $ 2.60 $ 2.72 $ 3.34
Included in continuing operations is a provision for slow moving and obsolete
inventory of $640,000, $666,000, $434,000, and $951,000, for the years 2006,
2004, 2003, and 2002, respectively.
Included in continuing operations in 2005 is the expensing of purchased
in-process R&D of $678,000.
Included in continuing operations in 2002 is a provision for impairment of fixed
assets of $275,000.
The above Selected Financial Data should be read in conjunction with the
Consolidated Financial Statements of the Company, including the notes thereto,
and the unaudited quarterly financial data included in Item 8 of this Annual
Report on Form 10-K.
Item 7. Management's Discussion and Analysis of Financial Condition and
-------------------------------------------------------------------------
Results of Operation
--------------------
Executive Summary
-----------------
The Company designs, manufactures and sells voice processing equipment for use
primarily by telecommunications service providers. The Company's products
include media servers and application servers. These products facilitate the
deployment of voice resources in service providers' networks, both traditional
circuit-switched networks, as well as the next generation of packet-based
networks.
Established service providers are looking for ways to offer additional features
on their legacy networks while they institute a multi-year plan to transition to
internet protocol (IP) based multimedia services. To effectively compete, the
Company must expand its penetration in the market, increase the applications
available on its intelligent peripherals, media servers and application servers
and increase the capacity of its media servers.
15
Capital spending in the markets the Company serves can vary over time and change
rapidly. In addition, the Company faces intense competition from larger and
better financed competitors, and a few customers account for a significant
portion of the Company's revenue. As a result, the Company's performance is
subject to large fluctuations. Because of these uncertainties, it is difficult
for the Company to make accurate short and long-term projections of results of
operations and cash flows.
During 2005 the Company disposed of its UK subsidiary, Dacon Electronics, Plc
(see Note L), and the Company acquired ThinkEngine Networks, Inc. ("TE
Networks") (see Note K).
Results of Operations
---------------------
The Company reported losses from continuing operations of $5.6 million, $2.6
million and $0.3 million in 2006, 2005, and 2004, respectively.
In 2006, revenues increased $1.9 million (24%). Product sales increased $1.2
million of which $1.1 million was attributable to inclusion for a full fiscal
year of revenue from the VSR1000 product. Service revenues increased $0.7
million of which $0.5 million is due to the inclusion of VSR1000 related
revenues for a full fiscal year.
In 2005, revenues decreased $0.9 million (11%) primarily due to decreased sales
of the CX product of $1.3 million, offset, in part, by increased service revenue
of $0.4 million. The lower sales were primarily due to a decrease in sales of
$5.0 million to a large telecommunications service provider. This decrease was
offset by increased sales of $2.1 million to a telecommunication equipment
integrator, and $1.1 million and $0.7 million to two telecommunications service
providers. The acquisition of TE Networks contributed less than $0.1 million in
revenues in 2005. The Company's consolidated backlog at December 31, 2006 was
$0.5 million versus $3.1 million at December 31, 2005. A major portion of the
Company's revenue comes from a few customers. The loss of any of these customers
would have a material adverse impact on the Company.
Gross margin was 49% in 2006, 58% in 2005, and 59% in 2004. The 2006 decrease
from 2005 was due to an increase of $0.1 million resulting from inclusion of a
full year's amortization expense for the intangible assets acquired in the
November 2005 acquisition of TE Networks, and an increase in the provision for
inventory obsolescence of approximately $0.5 million. The decrease in gross
margin percentage in 2005 from 2004 was primarily due to decreased sales volume.
Included in cost of revenues were inventory obsolescence charges of $0.6 million
in 2006, and $0.7 million in 2004.
Research and development expense increased $1.3 million (33%) in 2006 from 2005,
and increased $1.5 million (60%) in 2005 from the prior year. The increase in
2006 is attributable to inclusion of a full fiscal year of research and
development spending of the TE Networks, an increase of $0.3 million resulting
from inclusion of a full year's amortization expense for the intangible assets
acquired in the November 2005 acquisition of TE Networks, the expensing of stock
options ($0.2 million), and severance costs ($0.2 million). The increase in 2005
primarily reflects the expensing of $0.7 million of purchased research and
development, and increased headcount and salaries due to the acquisition of TE
Networks.
Selling, general and administrative expense increased $2.1 million (60%) in
2006, and $0.3 million (11%) in 2005. In 2006, the increase is primarily due to
inclusion for a full fiscal year of TE Networks ($1.5 million), the expensing of
stock options ($0.2 million), and severance costs ($0.9 million), which were
offset, in part, by lower personnel costs. In 2005, $0.1 million of the increase
is due to the inclusion of TE Networks' operations from November 18, 2005. The
remaining increase in 2005 is primarily due to increased personnel costs.
Other income of $0.3 million in 2006, $0.3 million in 2005, and $0.1 million in
2004 is primarily interest income. The increase in 2005 primarily reflects
higher interest rates.
The Company's effective tax rate was 0% for 2006, 2% in 2005, and 19% in 2004.
Included in tax expense are deferred tax valuation allowances of $1.2 million in
2006, $0.8 million in 2005, and $0.2 million in 2004. Forming a conclusion that
such an allowance is not needed is difficult when there is evidence such as
cumulative losses in recent years. The provision for income taxes is discussed
in Note I to the Consolidated Financial Statements.
The effect of inflation has not had a significant impact on the operating
results of the Company over the past few years.
16
Total rental expense amounted to $376,000 in 2006, $220,000 in 2005, and
$190,000 in 2004. Future annual payments for long-term noncancellable leases for
each of the five years in the period ending December 31, 2011 are approximately
$391,000, $355,000, $129,000, $0 and $0, respectively.
Off-Balance Sheet Arrangements
------------------------------
None.
Liquidity and Sources of Capital
--------------------------------
Operations used net cash of $4.7 million in 2006, provided net cash of $2.1
million in 2005 and used $0.3 million in 2004. The cash used by operations in
2006 is primarily attributable to $5.6 million in losses from continuing
operations. The cash provided by operations in 2005 is primarily attributable to
$2.1 million of prepaid revenue related to equipment shipped in 2005. Cash
provided (used) by investing activities was $6.2 million in 2006 and ($2.5)
million in 2005. The Company in 2006 sold all of its investments in marketable
securities, had net purchases of $0.5 million in 2005 and net proceeds from
sales of $0.1 million in 2004, and in 2005 used $1.4 million for the acquisition
of TE Networks. There were purchases of property, plant and equipment and
software of $0.3 million, $0.5 million and, $0.1 million in 2006, 2005 and 2004,
respectively.
Working capital was $3.3 million at December 31, 2006, $7.3 million at December
31, 2005, and $13.1 million at December 31, 2004. The ratio of current assets to
current liabilities was 2.3:1 at December 31, 2006, 2.1:1 at December 31, 2005,
and 5.5:1 at December 31, 2004. The decreases in working capital in 2006 and
2005 from the prior year were primarily due to the net losses incurred in each
year.
The Company's contractual obligations at December 31, 2006 are as follows
(amounts in thousands):
Payments due by period
----------------------
Less than More than
Total 1 Year 1-3 Years 3-5 Years 5 Years
Operating leases $875 $391 $484 $0 $0
In 2007, the Company anticipates making capital expenditures of approximately
$0.2 million, and increasing the current level of expenditures for sales and
marketing. To ensure that the Company will have sufficient working capital to
execute its operating plan, the Company borrowed $1,500,000 in January 2007
under a three year term loan agreement (see Note Q). Management believes that
with the funds provided by this loan the Company will have sufficient funds to
meet the Company's cash requirements for 2007. However, if the Company's
operations deteriorate due to increased competition, loss of a large customer or
other adverse events, it may be required to obtain additional sources of funds
through asset sales, capital market transactions or financing from third parties
or a combination thereof. The Company cannot provide assurances that these
additional sources of funds will be available or, if available, what the terms
would be.
Critical Accounting Policies and Estimates
------------------------------------------
In the preparation of financial statements in conformity with accounting
principles generally accepted in the United States, management must make
critical decisions regarding accounting policies and judgments regarding their
application. Materially different amounts could be reported under different
circumstances and conditions.
REVENUE
The Company generally recognizes product revenue, net of sales discounts and
allowances, when persuasive evidence of an arrangement exists, shipment or
delivery (dependent upon the terms of the sale) has occurred, all significant
contractual obligations have been satisfied, the amount is fixed or determinable
and collection is considered probable. Sales of services and system support are
deferred and recognized ratably over the contract period.
17
INVENTORIES - SLOW-MOVING AND OBSOLETE
Due to a prolonged slow-down in spending by telecommunications service
providers, inventory turnover has slowed. The Company recorded charges of $0.6
million and $0.7 million in 2006 and 2004, respectively, to increase its
reserves for obsolete and slow-moving inventory.
DEFERRED TAX ASSETS
As of December 31, 2006, the Company has a valuation allowance for all $6.3
million of net deferred tax assets. In making such a determination, the Company
considers its current and past performance, the market environment in which it
operates, estimated future earnings, tax planning strategies and other factors.
In the future, as these factors change, a change in the valuation reserve may be
required. The Company will only recognize a deferred tax asset when, based upon
available evidence, realization is more likely than not and will provide a
valuation allowance as necessary.
PENSIONS
The Company's defined benefit pension plan is reported in accordance with SFAS
No. 158 "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and
132(R)" ("SFAS 158"), issued in September 2006. This statement requires balance
sheet recognition of the overfunded or underfunded status of pension and
postretirement benefit plans. Under SFAS 158, actuarial gains and losses, prior
service costs or credits, and any remaining transition assets or obligations
that have not been recognized under previous accounting standards must be
recognized in accumulated other comprehensive loss, net of tax effects, until
they are amortized as a component of net periodic benefit cost. In addition, the
measurement date, the date at which plan assets and the benefit obligation are
measured, is required to be the Company's fiscal year end. We adopted the
recognition and measurement provisions of SFAS 158 effective December 31, 2006.
The adoption of SFAS 158 did not have a material effect on the 2006 consolidated
financial statements since all future benefit accruals under the Company's
defined benefit plan were curtailed as of 1994.
In 2006 the Company applied to the Pension Benefit Guaranty Corporation and the
Internal Revenue Service for permission to terminate the Company's defined
benefit plan. While approval was received, the Company decided not to proceed
with the termination of the plan in 2006. The Company may reapply for permission
in 2007; reflecting this, the Company adjusted the discount rate used to
calculate plan liabilities to 4.7% for 2005 and 2006.
STOCK-BASED COMPENSATION
The Company grants stock options for a fixed number of shares to employees and
directors with an exercise price equal to the fair value at the date of grant.
Effective January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R) "Share-Based Payment", ("SFAS No.
123(R)"), which establishes accounting for equity instruments exchanged for
employee services. Under the provisions of SFAS No. 123(R), share-based
compensation cost is measured at the grant date, based on the fair value of the
award, and is recognized as an expense over the employee's requisite service
period (generally the vesting period of the equity grant). Prior to January 1,
2006, the Company accounted for share-based compensation to employees in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. The Company also
followed the disclosure requirements of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
The Company elected to adopt the modified prospective transition method as
provided by SFAS No. 123(R) and, accordingly, financial statement amounts for
the prior periods presented in this Form 10-K have not been restated to reflect
the fair value method of expensing share-based compensation.
The Company has recognized compensation expense for its restricted stock grants.
Upon adoption of SFAS 123(R), using the modified prospective method, the Company
recognized a benefit of $36,000 as a cumulative effect of a change in accounting
principle resulting from the requirement to estimate forfeitures of the
Company's restricted stock grants at the date of grant instead of recognizing
them as incurred. The estimated forfeiture rate was applied to the previously
recorded compensation expense of the Company's unvested restricted stock in
determining the cumulative effect of a change in accounting principle. The
cumulative benefit, net of tax, increased basic earnings per share by $0.01 for
the fiscal year ended December 31, 2006.
18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------
The Company does not use derivatives and has no financial instruments subject to
market rates.
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
19
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
ThinkEngine Networks, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of ThinkEngine
Networks, Inc. and subsidiaries (the "Company") as of December 31, 2006 and
2005, and the related consolidated statements of operations and comprehensive
loss, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 2006. 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of ThinkEngine
Networks, Inc. and subsidiaries as of December 31, 2006 and 2005, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2006 in conformity with accounting
principles generally accepted in the United States of America.
/s/ CARLIN, CHARRON & ROSEN, LLP
Glastonbury, Connecticut
March 15, 2007
20
CONSOLIDATED BALANCE SHEETS
THINKENGINE NETWORKS, INC. AND SUBSIDIARIES
(dollars in thousands)
December 31,
----------------------------
ASSETS 2006 2005
------------ ------------
Current assets
Cash and cash equivalents $ 2,764 $ 1,750
Marketable securities -- 6,370
Accounts receivable, net 1,354 3,565
Inventories, net 1,439 2,245
Other current assets 270 137
------------ ------------
Total current assets 5,827 14,067
Loans to officers 444 2,029
Property, plant and equipment, net 970 1,208
Intangible assets, net 3,356 3,824
Other assets, less amortization of $932 and $864 49 77
------------ ------------
Total assets $ 10,646 $ 21,205
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 114 $ 814
Notes payable -- 300
Accrued compensation and benefits 932 1,817
Deferred service revenues 522 2,976
Other accrued expenses 966 909
------------ ------------
Total current liabilities 2,534 6,816
Long-term debt 300 --
Other liabilities 664 374
Commitments and contingencies (Note M) -- --
Stockholders' equity
Common stock, par value $.001 per share; authorized 20,000,000 shares 7 7
Additional paid-in capital 14,938 16,609
Accumulated deficit (6,876) (1,281)
Accumulated other comprehensive loss (529) (580)
------------ ------------
7,540 14,755
Less cost of 179,356 and 52,272 common shares in treasury (392) (740)
------------ ------------
Total stockholders' equity 7,148 14,015
------------ ------------
Total liabilities and stockholders' equity $ 10,646 $ 21,205
============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
21
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
THINKENGINE NETWORKS, INC. AND SUBSIDIARIES
(in thousands except per share data)
Year ended December 31,
--------------------------------------------
2006 2005 2004
------------ ------------ ------------
Revenues
Sales $ 7,887 $ 6,666 $ 8,006
Service 1,746 1,084 693
------------ ------------ ------------
9,633 7,750 8,699
Cost of revenues 4,892 3,281 3,590
------------ ------------ ------------
Gross margin 4,741 4,469 5,109
Other costs and expenses
Research and development 5,171 3,895 2,438
Selling, general and administrative 5,497 3,432 3,097
Other (income) expense, net (296) (327) (140)
------------ ------------ ------------
10,372 7,000 5,395
------------ ------------ ------------
Pretax loss (5,631) (2,531) (286)
Provision for income taxes -- 60 55
------------ ------------ ------------
Loss from continuing operations (5,631) (2,591) (341)
Loss from discontinued operations, net of tax -- (1,555) (213)
Cumulative effect of change in accounting principle, net of tax 36 -- --
------------ ------------ ------------
Net loss (5,595) (4,146) (554)
Currency translation adjustment -- (170) 121
Unfunded pension liability 51 (185) (248)
------------ ------------ ------------
Comprehensive loss $ (5,544) $ (4,501) $ (681)
============ ============ ============
Loss per share - basic and diluted:
Continuing operations $ (0.82) $ (0.45) $ (0.06)
Discontinued operations -- (0.26) (0.04)
Cumulative effect of change in accounting principle, net of tax 0.01 -- --
Net loss $ (0.81) $ (0.71) $ (0.10)
The accompanying notes to consolidated financial statements are an integral part
of these statements.
22
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THINKENGINE NETWORKS, INC. AND SUBSIDIARIES
Years ended December 31, 2006, 2005 and 2004
(dollars in thousands) Common Stock Retained Accumulated
------------------------ Additional Earnings Compre- Treasury Total
Shares Paid-In (Accumulated hensive Shares Shareholders'
Issued Amount Capital Deficit) (Loss) Amount Equity
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2003 5,803,829 $ 6 $ 13,323 $ 3,419 $ (98) $ (1,382) $ 15,268
Shares issued pursuant to stock
plans 3,649 -- 90 -- -- 137 227
Shares issued to directors -- -- (290) -- -- 293 3
Directors' fees - common stock
to be issued -- -- 47 -- -- -- 47
Officers' awards - common stock
to be issued -- -- 151 -- -- -- 151
Currency translation adjustment -- -- -- -- 121 -- 121
Unfunded pension liability -- -- -- -- (248) -- (248)
Net loss -- -- -- (554) -- -- (554)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2004 5,807,478 6 13,321 2,865 (225) (952) 15,015
Shares issued pursuant to stock
plans -- -- (21) -- -- 212 191
Shares issued in conjunction
with acquisition 1,149,705 1 3,126 -- -- -- 3,127
Directors' fees - common stock
to be issued -- -- 20 -- -- -- 20
Officers' awards - common stock
to be issued -- -- 163 -- -- -- 163
Currency translation adjustment -- -- -- -- (170) -- (170)
Unfunded pension liability -- -- -- -- (185) -- (185)
Net loss -- -- -- (4,146) -- -- (4,146)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2005 6,957,183 7 16,609 (1,281) (580) (740) 14,015
Shares issued pursuant to stock
plans -- -- (1,522) -- -- 2,230 708
Shares issued to directors -- -- (149) -- -- 149 --
Repurchase of shares -- -- -- -- -- (2,031) (2,031)
Unfunded pension liability -- -- -- -- 51 -- 51
Net loss -- -- -- (5,595) -- -- (5,595)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2006 6,957,183 $ 7 $ 14,938 $ (6,876) $ (529) $ (392) $ 7,148
========== ========== ========== ========== ========== ========== ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
23
CONSOLIDATED STATEMENTS OF CASH FLOWS
THINKENGINE NETWORKS, INC. AND SUBSIDIARIES
(dollars in thousands) Year ended December 31,
--------------------------------------------
2006 2005 2004
------------ ------------ ------------
Operating Activities
Loss from continuing operations $ (5,631) $ (2,591) $ (341)
Adjustments to reconcile loss from continuing operations to net
cash provided (used) by operating activities:
Deferred income taxes -- 60 55
Depreciation and amortization 983 373 349
Expensing of purchased research and development -- 678 --
Loss (gain) on disposition of assets 56 1 (1)
Cumulative effect of change in accounting principle (36) -- --
Stock-based compensation 699 330 404
Net (increase) decrease in:
Accounts receivable 2,211 438 (3,512)
Inventories 806 189 527
Other assets (138) 99 2,205
Net increase (decrease) in:
Accounts payable (700) 550 (138)
Accrued compensation and benefits (544) (136) (95)
Other accrued liabilities (2,397) 2,123 282
------------ ------------ ------------
Net cash provided (used) by operating activities (4,691) 2,114 (265)
------------ ------------ ------------
Investing Activities
Purchases of marketable securities (4,753) (10,412) (7,646)
Sale of marketable securities 11,123 9,889 7,755
Acquisition (Note K) -- (1,442) --
Additions to property, plant and equipment (265) (512) (72)
Repayment of officers' loans 124 -- --
Purchase of software licenses -- (33) (51)
------------ ------------ ------------
Net cash provided (used) by investing activities 6,229 (2,510) (14)
------------ ------------ ------------
Financing Activities
Shares purchased for treasury (531) -- --
Shares issued pursuant to stock plans 7 45 24
------------ ------------ ------------
Net cash provided (used) by financing activities (524) 45 24
------------ ------------ ------------
Discontinued Operations -- (121) 257
Increase (decrease) in cash and cash equivalents 1,014 (472) 2
Cash and cash equivalents - beginning of year 1,750 2,222 2,220
------------ ------------ ------------
Cash and cash equivalents - end of year $ 2,764 $ 1,750 $ 2,222
------------ ------------ ------------
Supplemental Disclosures of Cash Flow Information
Cash (paid) received during the year for:
Interest $ (10) $ (25) $ (14)
------------ ------------ ------------
Income taxes, net $ (5) $ (5) $ (81)
------------ ------------ ------------
Non-cash activity:
Repayment of loans to officers and accumulated interest with
common stock $ 1,500 $ 0 $ 0
------------ ------------ ------------
Cashless exercise of stock options in satisfaction of due
from employee (other assets) $ 38 $ 0 $ 0
------------ ------------ ------------
The accompanying notes to consolidated financial statements are an integral part
of these statements.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THINKENGINE NETWORKS, INC. AND SUBSIDIARIES
(dollars in thousands except per share data)
NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION. The Company designs, manufactures and markets voice processing
products.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the
accounts of the Company and its subsidiaries, all of which are wholly-owned.
Intercompany accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES. The preparation of the financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
REVENUE RECOGNITION. The Company generally recognizes product sales, net of
sales discounts and allowances, when persuasive evidence of an arrangement
exists, shipment or delivery (dependent upon the terms of the sale) has
occurred, all significant contractual obligations have been satisfied, the
amount is fixed or determinable and collection is considered probable. Sales of
services and system support are deferred and recognized ratably over the
contract period.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses include the
costs of engineering, design, feasibility studies, outside services, personnel,
stock-based compensation and other costs incurred in development of the
Company's products. All such costs are charged to expense as incurred.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include the payroll, employee benefits, stock-based
compensation, and other headcount-related costs associated with sales and
marketing personnel and promotions, tradeshows, and other marketing-related
programs, as well as expenses associated with administrative and accounting
personnel and general corporate related expenses.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts of the Company's
financial instruments (trade receivables/payable, and other short-term and
long-term debt) approximate fair value due to their terms and maturities.
CASH, AND CASH EQUIVALENTS. The Company considers financial instruments with a
maturity of three months or less from the date of purchase to be cash
equivalents. At December 31, 2006, essentially all of the Company's cash and
cash equivalent balances were with two financial institutions.
RISKS AND UNCERTAINTIES. A major portion of the Company's revenues is generated
by sales to a small number of customers, such that the Company had net revenue
from two customers (56%), four customers (59%), and one customer (78%) in 2006,
2005, and 2004, respectively. The Company's receivables are primarily from
major, well-established companies in the telecommunications and cable
industries, and at December 31, 2006, three such companies accounted for 75% of
the Company's accounts receivable. The loss of any of these customers would have
a material adverse impact on the Company. The Company's markets are subject to
rapid technological change and frequent introduction of new products. The
Company's products are similar to those manufactured, or capable of being
manufactured, by a number of companies, some of which are well established with
financial, personnel and technical resources substantially larger than those of
the Company. The Company's ability to compete in the future depends on its
ability to maintain the technological and performance advantages of its current
products and to introduce new products and applications that achieve market
acceptance.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The allowance for doubtful accounts reflects
the Company's best estimate of probable losses inherent in the accounts
receivable balance. The Company determines the allowance based on known troubled
accounts, historical experience, and other currently available evidence.
INVENTORIES. Inventories are stated at the lower of cost (first-in, first-out
method) or market. Provisions for slow moving and obsolete inventories are
provided based on historical experience and anticipated product demand.
25
PROPERTY AND EQUIPMENT. Property and equipment is carried at cost less
allowances for depreciation, computed in accordance with the straight-line
method based on estimated useful lives ranging from 3 to 12 years. Computer
software developed or obtained for internal use is depreciated using the
straight-line method over the estimated useful life of the software, generally
three years or less. Repairs and maintenance are expensed when incurred.
INCOME TAXES. Income taxes are provided on all revenue and expense items
included in the consolidated statement of operations, regardless of the period
in which such items are recognized for income tax purposes, adjusted for items
representing permanent differences between pretax accounting income and taxable
income. Deferred income taxes result from the future tax consequences associated
with temporary differences between the carrying amounts of assets and
liabilities for tax and financial reporting purposes. A valuation allowance is
provided to the extent the Company cannot determine that the ultimate
realization of net deferred tax assets is more likely than not.
STOCK-BASED COMPENSATION. The Company grants stock options for a fixed number of
shares to employees and directors with an exercise price equal to the fair value
at the date of grant.
Effective January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R) "Share-Based Payment", ("SFAS No.
123(R)"), which establishes accounting for equity instruments exchanged for
employee services. Under the provisions of SFAS No. 123(R), share-based
compensation cost is measured at the grant date, based on the fair value of the
award, and is recognized as an expense over the employee's requisite service
period (generally the vesting period of the equity grant). Prior to January 1,
2006, the Company accounted for share-based compensation to employees in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. The Company also
followed the disclosure requirements of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
The Company elected to adopt the modified prospective transition method as
provided by SFAS No. 123(R) and, accordingly, financial statement amounts for
the prior periods presented in this Form 10-K have not been restated to reflect
the fair value method of expensing share-based compensation.
The Company has recognized compensation expense for its restricted stock grants.
Upon adoption of SFAS 123(R), using the modified prospective method, the Company
recognized a benefit of $36 as a cumulative effect of a change in accounting
principle resulting from the requirement to estimate forfeitures of the
Company's restricted stock grants at the date of grant instead of recognizing
them as incurred. The estimated forfeiture rate was applied to the previously
recorded compensation expense of the Company's unvested restricted stock in
determining the cumulative effect of a change in accounting principle. The
cumulative benefit, net of tax, increased both basic and diluted earnings per
share by $0.01 for the fiscal year ended December 31, 2006. If the Company had
elected in 2005 and 2004 to recognize compensation expense for the 1990 Stock
Option Plan, the 1967 Stock Purchase Plan and the Directors' Stock Option Plan
based on the fair value at the grant date, consistent with the method presented
by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock Based Compensation", as amended, the pro forma net loss and net loss per
share would be as follows:
2005 2004
------------ ------------
Net loss, as reported $ (4,146) $ (554)
Add: Stock-based compensation expense
included therein 330 404
Deduct: Total stock-based compensation
under fair valuation method (742) (707)
------------ ------------
Pro forma net loss $ (4,558) $ (857)
============ ============
Net loss per share
As reported - Basic and Diluted $ (0.71) $ (0.10)
============ ============
Pro forma - Basic and Diluted $ (0.78) $ (0.15)
============ ============
The estimated weighted average fair value per share of stock options granted
were $1.58 and $2.56 for 2005 and 2004, respectively. The fair value for the
stock options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions for 2005 and 2004,
respectively: risk-free interest rates of 4.4%, and 4.4%; no dividend yields;
volatility factors of the expected market price of the Company's common stock of
..55 in 2005, and .73 in 2004; and a weighted average expected life of the option
of 7.5 years in all years for the Option Plan and 5 years for the Directors'
Option Plan.
26
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
INCOME (LOSS) PER SHARE. In computing basic earnings (loss) per share, the
dilutive effect of stock options and warrants are excluded, whereas for diluted
earnings per share they are included, except in those fiscal periods when the
Company has incurred a loss. The weighted average number of common shares used
in both the basic and diluted earnings per share calculations were 6,899,399,
5,878,928, and 5,780,603 for 2006, 2005 and 2004, respectively.
INTANGIBLE ASSETS. Intangible assets are amortized using the straight-line
method over their estimated period of benefit, ranging from four to ten years.
The Company evaluates the recoverability of intangible assets periodically and
takes into account events or circumstances that warrant revised estimates of
useful lives or that indicate that impairment exists. All of the Company's
intangible assets are subject to amortization. No impairments of intangible
assets have been identified during any of the periods presented.
GOODWILL. The Company has classified as goodwill the cost in excess of fair
value of the identifiable net assets of companies acquired in purchase
transactions.
Goodwill is reviewed for impairment whenever events such as product
discontinuances, plant closures, product dispositions or other changes in
circumstances indicate that the carrying amount may not be recoverable. An
impairment charge is recognized if an asset's carrying amount exceeds its
implied fair value. In the third quarter of 2005, the Company, based on the
continuing losses of its UK subsidiary, determined that the related goodwill was
impaired and expensed $319 of goodwill. Such amount is included in the 2005 loss
from discontinued operations. The Company has no goodwill at December 31, 2006
and 2005.
RECLASSIFICATIONS. Certain prior year amounts have been reclassified to conform
to the current year presentation.
NEW ACCOUNTING PRONOUNCEMENTS. In September 2006, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 158 "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans", which amends SFAS No. 87
"Employers' Accounting for Pensions" (SFAS No. 87), SFAS No. 88 "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits" (SFAS No. 88), SFAS No. 106 "Employers' Accounting for
Postretirement Benefits Other Than Pensions" (SFAS No. 106), and SFAS No. 132R
"Employers' Disclosures about Pensions and Other Postretirement Benefits
(revised 2003)" (SFAS No. 132R). This Statement requires companies to recognize
an asset or liability for the over-funded or under-funded status of their
benefit plans in their financial statements. SFAS No. 158 also requires the
measurement date for plan assets and liabilities to coincide with the sponsor's
year end. The recognition of an asset and liability related to the funded status
provision is effective for fiscal years ending after December 15, 2006 and the
change in measurement date provisions is effective for fiscal years ending after
December 15, 2008. The adoption of SFAS 158 did not have a material effect on
the 2006 consolidated financial statements since all future benefit accruals
under the Company's defined plan were curtailed as of 1994.
In September 2006, the FASB issued SFAS No. 157 "Fair Value Measurements," which
provides a definition of fair value, establishes a framework for measuring fair
value and requires expanded disclosures about fair value measurements. The
measurement and disclosure requirements, which are applied prospectively, are
effective for the Company beginning in the first quarter of 2008. Management is
assessing the potential impact on the Company's financial condition and results
of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109" (SFAS
No. 109). The interpretation contains a two step approach to recognizing and
measuring uncertain tax positions accounted for in accordance with SFAS No. 109.
The first step is to evaluate the tax position for recognition by determining if
the weight of available evidence indicates it is more likely than not that the
position will be sustained on audit, including resolution of related appeals or
litigation processes, if any. The second step is to measure the tax benefit as
the largest amount which is more than 50% likely of being realized upon ultimate
settlement. The provisions are effective for the Company beginning in the first
quarter of fiscal 2007. The Company does not anticipate that adoption of this
statement will have any material impact on its financial statements.
27
NOTE B. MARKETABLE SECURITIES
The Company's marketable securities were sold during 2006 and consisted of
corporate and municipal bonds and auction rate preferred stock. Unrealized
gains/losses on marketable securities were immaterial in all years presented and
therefore have not impacted cumulative other comprehensive loss.
NOTE C. ACCOUNTS RECEIVABLE, NET:
Accounts receivable are presented net of an allowance for uncollectible accounts
of $20 and $73 at December 31, 2006 and 2005, respectively. The Company wrote
off uncollectible accounts, net of recoveries, of $39, $38, and $23 in 2006,
2005 and 2004, respectively. The Company determines the allowance based on known
troubled accounts, historical experience, and other currently available
evidence.
NOTE D. INVENTORIES, NET:
2006 2005
------------ ------------
Finished and in process $ 885 $ 1,571
Materials and purchased parts 554 674
------------ ------------
$ 1,439 $ 2,245
============ ============
Netted in the above amounts is the Company's reserve for slow moving and
obsolete inventories totaling $3,337 and $3,054 at December 31, 2006 and 2005,
respectively. The reserve for slow moving and obsolete inventories was increased
by $640 in 2006, and $666 in 2004, by charges to cost of revenues, and was
reduced in 2005 due to the sale of reserved items. Starting October 1, 2006, the
Company changed its policy for reserving for slow moving and obsolete
inventories to a policy that the Company believes more accurately reflects the
estimated future benefits inherent in its inventories and more accurately
reflects the pattern of consumption of those benefits. The Company has reflected
the change in estimate as a current period charge during the fourth quarter of
2006, the period in which the change in estimate occurred. The adjustment
resulted in increasing the Company's loss from continuing operations and net
loss by approximately $300 and increasing the related loss per share amounts by
approximately ($0.04).
NOTE E. PROPERTY AND EQUIPMENT, NET:
2006 2005
------------ ------------
Machinery and equipment $ 2,914 $ 2,870
Furniture and fixtures 885 1,174
------------ ------------
3,799 4,044
Less allowances for depreciation 2,829 2,836
------------ ------------
$ 970 $ 1,208
============ ============
The Company has recorded depreciation expense of $447, $269 and $277 in 2006,
2005 and 2004, respectively.
NOTE F. INTANGIBLE ASSETS, NET:
The Company's intangible assets consist of acquired technology (see Note K)
relating to higher level applications, an operating system and a board design.
Intangible assets have an original cost of $3,883 and are presented net of
accumulated amortization of $527 and $59 at December 31, 2006 and 2005,
respectively. The Company has recorded amortization expense of $468, $59, and $0
in 2006, 2005, and 2004, respectively.
NOTE G. BORROWINGS:
In November 2005, as part of the consideration paid for the acquisition of TE
Networks, Inc. (see Note K), the Company issued $300 in interest-free notes
payable in full in November 2006.
2006 2005
------------ ------------
Notes payable $ 0 $ 300
============ ============
In November 2006, without penalty, the holders of the above notes extended the
payment due date until April 2008.
28
2006 2005
------------ ------------
Long-term debt $ 300 $ 0
============ ============
NOTE H. OTHER LIABILITIES (SEE NOTE M):
2006 2005
------------ ------------
Accrued officers' supplemental pension $ 254 $ 313
Accrued deferred compensation 139 176
Accrued defined benefit pension plan 634 775
------------ ------------
1,027 1,264
Less current portion (included in accrued
compensation and benefits - see Note M) 363 890
------------ ------------
$ 664 $ 374
============ ============
NOTE I. INCOME TAXES
The components of the provision for income taxes for the years ended December 31
are as follows:
2006 2005 2004
------------ ------------ ------------
Current:
State $ 0 $ 60 $ 55
Deferred -- -- --
------------ ------------ ------------
Provision for income taxes $ 0 $ 60 $ 55
============ ============ ============
A reconciliation of the statutory federal income tax rate to the effective tax
rate on pretax loss for the years ended December 31, is as follows:
2006 2005 2004
---------- ---------- ----------
Statutory federal income tax rate (34.0)% (34.0)% (34.0)%
State income taxes, net of federal
tax benefit -- 1.4 12.7
Write-off of purchased research and
development -- 6.9 --
Nontaxable interest income -- (0.8) (1.0)
Amortization of intangibles 2.9 (1.0) (9.4)
Stock-based compensation expense 3.0 -- --
Valuation allowance 28.0 29.8 63.3
Other 0.1 0.1 (12.4)
---------- ---------- ----------
0% 2.4% 19.2%
========== ========== ==========
Deferred income taxes reflect the net tax effects of temporary differences
between carrying amounts of assets and liabilities and their tax bases, and are
stated at enacted tax rates expected to be in effect when taxes are actually
paid or recovered.
Significant components of the Company's deferred tax liabilities and assets as
of December 31, 2006 and 2005 are as follows:
2006 2005
------------ ------------
Deferred tax liabilities $ 77 $ 84
------------ ------------
Deferred tax assets:
Inventory valuation 1,262 1,174
Accrued liabilities and employee benefits 526 2,146
Accrued deferred compensation 134 167
Federal operating loss carryforward
expiring in 2026 3,853 1,007
Separate return federal operating loss
carryforwards expiring in 2008 and 2009 445 445
Other 148 222
------------ ------------
Total deferred tax assets 6,368 5,161
Valuation allowance (6,291) (5,077)
------------ ------------
77 84
------------ ------------
Net deferred tax assets $ 0 $ 0
============ ============
29
The Company has increased its valuation allowances by $1,214, $829, and $181 in
2006, 2005 and 2004, respectively, as the Company cannot determine that the
ultimate realization of its net deferred tax asset is more likely than not.
TAX CONTINGENCIES. The Company is subject to income taxes in the United States.
Significant judgment is required in determining its provision for income taxes
and recording the related assets and liabilities. In the ordinary course of its
business, there are many transactions and calculations where the ultimate tax
determination is uncertain. The Company is periodically subject to audit by tax
authorities. Accruals for tax contingencies are provided for in accordance with
the requirements of SFAS No. 5, ACCOUNTING FOR CONTINGENCIES.
Although the Company believes it has appropriate support for the positions taken
on its tax returns, it has recorded a liability for its best estimate of the
probable loss on certain of these positions. The Company believes that its
accruals for tax liabilities are adequate for all open years, based on its
assessment of many factors including past experience and interpretations of tax
law applied to the facts of each matter, which matters result primarily from the
amount of research and experimentation tax credits claimed, state income taxes,
and certain other matters. Although the Company believes its recorded assets and
liabilities are reasonable, tax regulations are subject to interpretation and
tax litigation is inherently uncertain; therefore its assessments can involve
both a series of complex judgments about future events and rely heavily on
estimates and assumptions. Although the Company believes that the estimates and
assumptions supporting its assessments are reasonable, the final determination
of tax audit settlements and any related litigation could be materially
different than that which is reflected in historical income tax provisions and
recorded assets and liabilities. If the Company were to settle an audit or a
matter under litigation, it could have a material effect on its income tax
provision, net income, or cash flows in the period or periods for which that
determination is made. Due to the complexity involved the Company is not able to
estimate the range of reasonably possible losses in excess of amounts recorded.
The Internal Revenue Service has completed and closed its audits of the
Company's consolidated federal income tax returns through 2004.
NOTE J. OTHER (INCOME) EXPENSE, NET:
Year ended December 31,
------------------------------------------
2006 2005 2004
------------ ------------ ------------
Interest expense $ 10 $ 25 $ 14
Interest income (306) (352) (154)
Loss on disposal of fixed assets 56 -- --
Income - payments recovered on note
receivable from Dacon (Note L) (75) -- --
Other 19 -- --
------------ ------------ ------------
$ (296) $ (327) $ (140)
============ ============ ============
NOTE K. ACQUISITION
On November 18, 2005, the Company, as the former Cognitronics Corporation,
acquired ThinkEngine Networks, Inc., subsequently renamed TE Networks, Inc., at
a cost of $4,869 including $1,442 in cash, 1,149,705 shares of common stock
valued at $3,127, and $300 in interest-free notes.
The acquisition was accounted for by the purchase method. The purchase price was
allocated to purchased in process research and development ($678), net current
and long term assets ($308) and the value of intangible assets ($3,883) with
estimated remaining useful lives of four to ten years. The following are
unaudited pro forma results of operations as if the acquisition had taken place
at the beginning of the respective year:
2005 2004
------------ ------------
Revenues $ 8,762 $ 9,348
============ ============
Loss from continuing operations $ (6,048) $ (4,708)
============ ============
Net loss $ (7,599) $ (5,048)
============ ============
Loss per share:
Loss from continuing operations $ (0.89) $ (0.68)
============ ============
Net loss $ (1.11) $ (0.71)
============ ============
30
NOTE L. DISCONTINUED OPERATIONS
On December 22, 2005, the Company sold its UK subsidiary, Dacon Electronics, Plc
("Dacon") in an arms length transaction to a company owned by the former Vice
President of European operations for $150 in cash and a $150 note. In addition,
Dacon issued a note for $275 for amounts previously advanced to Dacon by the
Company. A charge of $425 to reserve for these two notes was included in 2005 in
the loss on sale of discontinued operations, of which $75 was recovered and
recorded as other income during 2006. In 2005 the Company reclassified Dacon's
operations as discontinued operations and, accordingly, has segregated the
revenue and expenses of the discontinued operations in its 2005 and 2004
consolidated Statements of Operations and Comprehensive Loss and notes thereto.
Summary results for discontinued operations for the years ended December 31 are
as follows:
2005 2004
------------ ------------
Revenue $ 3,826 $ 5,526
Operating expenses 4,976 5,739
------------ ------------
Operating loss (1,150) (213)
Loss on impairment of goodwill (319) --
Loss on sale (86) --
------------ ------------
Loss from discontinued operations $ (1,555) $ (213)
============ ============
NOTE M. COMMITMENTS AND CONTINGENCIES
LEASES. Total rental expense amounted to $376 in 2006, $220 in 2005, and $190 in
2004. Future annual payments for long-term non-cancelable leases for each of the
five years in the period ending December 31, 2011 are approximately $391, $355,
$129, $0, and $0 respectively.
PENSION PLAN. The Company and its subsidiaries have a defined benefit pension
plan covering substantially all employees, except that employees joining the
Company after June 30, 1994 were not eligible to participate. The benefits are
based on years of service and the employee's compensation. No additional service
cost benefits were earned subsequent to June 30, 1994. Because of this
curtailment of the Plan in 1994, at this time the Projected Benefit Obligation
and Accumulated Benefit Obligation are the same. The Company's funding policy is
to contribute amounts to the plan sufficient to meet the minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974,
plus such additional amounts as the Company may determine to be appropriate from
time to time.
The following table sets forth the changes in benefit obligations and plan
assets, and reconciles amounts recognized in the Company's Consolidated Balance
Sheets at December 31:
2006 2005
------------ ------------
Projected and accumulated benefit obligation
for services rendered to date
Beginning of year $ 1,843 $ 1,681
Loss (gain) due to change in estimates 58 183
Interest cost 44 91
Less benefits paid (128) (112)
------------ ------------
End of year 1,817 1,843
------------ ------------
Plan assets at fair value
Beginning of year 1,068 941
Actual return on plan assets 78 33
Contribution 165 206
Less benefits paid (128) (112)
------------ ------------
End of year 1,183 1,068
------------ ------------
Plan assets less than benefit obligation $ (634) $ (775)
============ ============
31
The components of net cost of the plan for the years ended December 31 are as
follows:
2006 2005 2004
---------- ---------- ----------
Interest cost on projected benefit
obligation $ 44 $ 91 $ 92
Actual (return)/loss on plan assets (78) (33) (14)
Net amortization and deferral 108 (3) (33)
---------- ---------- ----------
Net periodic pension cost $ 74 $ 55 $ 45
========== ========== ==========
Other changes in plan assets and benefit obligations recognized in comprehensive
loss:
2006 2005
---------- ----------
SFAS 158 transition adjustment $ (709) *
New net loss 658 *
---------- ----------
Total recognized in other comprehensive loss $ (51) *
========== ==========
Total recognized in net periodic benefit cost
and other comprehensive loss $ 23 *
========== ==========
* not applicable due to adoption of SFAS No. 158 effective December 31, 2006.
The estimated amount of net loss that will be amortized from accumulated other
comprehensive loss into net periodic pension benefit cost in 2007 is $40.
Assumptions: 2006 2005
------------ ---------- ----------
Weighted-average assumptions used to determine
benefit obligation as of year-end:
Discount rate 4.69% 4.70%
Rate of compensation increase 0.00% 0.00%
Weighted-average assumptions used to determine
net benefit cost:
Discount rate 4.73% 4.70%
Rate of compensation increase 0.00% 0.00%
Expected return on plan assets 6.50% 6.50%
The plan's weighted-average asset allocations at
December 31, 2006 and 2005, by asset category, are
as follows:
Asset Category 2006 2005
-------------- ---------- ----------
Equity Securities 49% 51%
Debt Securities 20% 25%
Cash and cash equivalents 31% 24%
In 2006, the Company applied to the Pension Benefit Guaranty Corporation
("PBGC") and the Internal Revenue Service ("IRS") for permission to terminate
this Plan. While the permissions were received, the Company decided not to
terminate the Plan in 2006. Accordingly, the Company's accrual for its defined
benefit pension plan included a current liability of $245 and $0 at December 31,
2006 and 2005, respectively, and a long-term liability of $389 and $775 at
December 31, 2006 and 2005, respectively.
Cash Flows
----------
The Company may reapply in the future to the PBGC and the IRS for permission to
terminate this Plan. If permission is received during 2007 the Company expects
to contribute $630 to the pension plan and make $1,850 of benefit payments
relating to expected future service.
32
Effects of transition to SFAS 158 as of December 31, 2006:
Before Effect of After
SFAS 158 SFAS 158 SFAS 158
---------- ---------- ----------
Prepaid cost/(accrued liability) $ 24,000 $ (658,000) $ (634,000)
Accumulated other comprehensive loss $ (658,000) $ 0 $ (658,000)
401(K) RETIREMENT PLAN. The Company has a defined contribution plan covering
substantially all employees. The Company has not made any contributions to the
plan.
OFFICERS' SUPPLEMENTAL PENSION PLAN. The Company has an unfunded,
noncontributory defined benefit pension plan covering three retired officers.
The components of net pension cost of the plan for the years ended December 31
are as follows:
2006 2005 2004
---------- ---------- ----------
Interest cost on projected benefit
obligation $ 13 $ 16 $ 19
Amortization of actuarial gains (2) (1) (2)
---------- ---------- ----------
Net periodic pension cost $ 11 $ 15 $ 17
========== ========== ==========
The following table sets forth the plan's status and the accrued pension
liability recognized in the Company's Consolidated Balance Sheets at December
31:
2006 2005
---------- ----------
Projected benefit obligations
Balance at beginning of period $ 268 $ 322
Interest expense 13 16
Less benefits paid (70) (70)
---------- ----------
Balance at end of period 211 268
Unrecognized net gain 43 45
---------- ----------
Accrued pension liability $ 254 $ 313
========== ==========
The discount rate used in determining the projected benefit obligation was 5.5%
in 2006 and 2005. All participants are retired and receiving benefits under the
plan and therefore future increases in compensation are not applicable.
The following benefit payments and contributions are expected to be paid: $65 in
2007, $51 in 2008, $51 in 2009, $51 in 2010, $23 in 2011, and no amounts for the
five year period ending in 2016.
DEFERRED COMPENSATION. At December 31, 2006 and 2005, the liability relating to
a deferred compensation arrangement between the Company and a former director
and officer of the Company was $139 and $176, respectively, and is included in
other liabilities. The Company expects to make payments in 2007 totaling $49
under this contract.
NOTE N. STOCK PLANS
Effective January 1, 2006, the Company adopted SFAS No. 123(R), "Share-Based
Payment", using the modified prospective application transition method.
The 1990 Stock Option Plan provides for the grant, at fair market value on the
date of grant, of nonqualified stock options and incentive stock options.
Options generally expire ten years after the date granted.
The Company may, in certain circumstances, grant, at the fair market value on
the date of grant, nonqualified options as an inducement to enter into
employment with the Company ("Inducement Options"). Options generally become
vested in three equal annual installments on a cumulative basis generally
commencing six months after the date of grant and expire 10 years following the
grant date.
The Directors' Stock Option Plan, as amended, provides for an annual grant of
options to non-employee directors. This plan provides for the automatic award of
options to purchase 6,000 shares of common stock at the fair market value at the
date of grant to each person who is a participant on August 1 of each year and
pro-rated awards in certain cases. Options become vested one year after the date
of grant. The awards expire ten years following the grant date.
33
Share information pertaining to the option plans is as follows:
Weighted Weighted Weighted
Average 1990 Average Directors' Average
Inducement Exercise Option Exercise Option Exercise
Options Price Plan Price Plan Price
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at December 31, 2003 -- 1,131,300 $ 4.66 125,250 $ 4.15
Granted -- 3,000 $ 3.50 30,000 $ 3.50
Cancelled or expired -- (144,751) $ 8.88 (12,000) $ 8.74
Exercised -- (12,497) $ 1.65 (14,500) $ 10.27
---------- ---------- ----------
Outstanding at December 31, 2004 -- 977,052 $ 4.06 128,750 $ 3.68
Granted 705,000 $ 2.55 167,000 $ 2.70 30,000 $ 3.22
Cancelled or expired -- (27,416) $ 2.92 (12,000) $ 12.30
Exercised -- (27,166) $ 1.66 --
---------- ---------- ----------
Outstanding at December 31, 2005 705,000 $ 2.55 1,089,470 $ 3.95 147,750 $ 2.94
Granted 140,000 $ 2.92 657,500 $ 3.54 31,000 $ 2.08
Cancelled or expired (278,334) $ 2.58 (688,969) $ 4.30 (12,000) $ 2.05
Exercised -- (84,868) $ 1.69 --
---------- ---------- ----------
Outstanding at December 31, 2006 566,666 $ 2.62 973,133 $ 3.62 166,750 $ 2.84
========== ========== ==========
Available for future grant 0 590,733 182,750
========== ========== ==========
Average remaining term 8.9 yrs 5.6 yrs 7.1
Exercisable at December 31, 2006 225,832 $ 2.63 640,132 $ 4.03 147,750 $ 2.94
========== ========== ==========
Intrinsic Value:
Outstanding $ 288,000 $ 468,000 $ 103,000
========== ========== ==========
Exercisable $ 64,000 $ 385,000 $ 84,000
========== ========== ==========
The following table summarizes information relating to current outstanding and
exercisable stock options as of December 31, 2006:
Options Options Options
Outstanding Exercisable Exercisable
-------------------------------------- ---------- ----------
Weighted
Average
Remaining Weighted Weighted
Number of Contractual Average Average
Shares Life Exercise Number of Exercise
Exercise Price Outstanding (in years) Price Shares Price
-------------- ---------- ---------- ---------- ---------- ----------
Inducement Options:
$2.55 440,000 8.8 $ 2.55 182,500 $ 2.55
2.59 - 3.25 126,666 9.3 2.86 43,332 2.95
---------- ----------
566,666 8.9 2.62 225,832 2.63
========== ==========
1990 Option Plan:
1.55 145,667 5.8 1.55 145,667 1.55
2.20 140,333 6.8 2.20 140,333 2.20
2.70 110,333 8.8 2.70 92,332 2.70
2.85 315,000 10.0 2.85 -- --
5.00 142,000 4.5 5.00 142,000 5.00
9.06 - 9.70 119,800 3.4 9.07 119,800 9.07
---------- ----------
973,133 5.6 3.62 640,132 4.03
========== ==========
Directors Option Plan:
1.45 15,000 5.6 1.45 15,000 1.45
2.00 - 2.11 75,500 7.0 2.06 57,500 2.06
2.81 - 3.25 61,000 8.1 3.35 60,000 3.36
5.35 - 6.10 15,250 4.6 6.09 15,250 6.09
---------- ----------
166,750 7.1 2.84 147,750 2.94
========== ==========
34
The following table summarizes the status of the Company's non-vested stock
options for 2006:
Non-Vested Options
---------------------------
Weighted
Number Average
of Shares Fair Value
---------- ----------
Non-vested at December 31, 2005 905,158 $ 2.57
Granted 486,000 $ 2.81
Vested (386,823) $ 2.53
Forfeited (311,500) $ 2.57
----------
Non-vested at December 31, 2006 692,835 $ 2.69
==========
The Company also has a restricted stock plan ("Restricted Stock Plan") which
provides for the award of shares to key employees; generally, the awards vest in
five equal annual installments commencing two years after the date of the award.
In 2006, as an inducement to enter into employment with the Company, a total of
275,000 restricted common shares were granted to two key executives which vest
four years after the date of grant. Such rights are subject to immediate vesting
in the event of change of control of the Company or involuntary termination of
employment for reasons other than cause. The total value of the restricted
common shares on the dates of grant was $564, and was based on the fair market
value of $2.05 per share on the grant dates. Compensation expense recognized in
2006 was $43.
Information pertaining to restricted stock grants is as follows:
Restricted
Stock Plan Inducement
Shares Shares
---------- ----------
Outstanding at December 31, 2003 329,037 --
Granted -- --
Cancelled or expired -- --
Vested (53,550) --
---------- ----------
Outstanding at December 31, 2004 275,487 --
Granted -- --
Cancelled or expired (23,300) --
Vested (70,137) --
---------- ----------
Outstanding at December 31, 2005 182,050 --
Granted -- 275,000
Cancelled or expired (71,900) --
Vested (87,650) --
---------- ----------
Outstanding at December 31, 2006 22,500 275,000
========== ==========
Available for future grant 395,200 0
========== ==========
Average remaining term 1.4 years 3.7 years
In 2002, the Company granted to key executives the right to receive 395,000
common shares which vested on January 2, 2006. The total value of the rights at
the date of grant was $612 and was based on the market price of $1.55 per share.
Compensation expense recognized was $0, $153, and $153 for the years ended
December 31, 2006, 2005, and 2004, respectively. There were 60,000, and 395,000
shares outstanding at December 31, 2006 and 2005, respectively.
35
The following table summarizes the components and classification of stock-based
compensation expense included in the statements of operations:
Year ended December 31, 2006 2005 2004
---------- ---------- ----------
Stock options $ 521 $ -- $ --
Stock options - severance 132 -- --
Stock grants 46 306 357
Other -- 24 47
---------- ---------- ----------
Total stock-based compensation $ 699 $ 330 $ 404
---------- ---------- ----------
Cost of revenues $ 31 $ 25 $ 33
Selling, general and administrative 428 255 319
Research and development 240 50 52
---------- ---------- ----------
Total stock-based compensation $ 699 $ 330 $ 404
========== ========== ==========
As of December 31, 2006, approximately $500 and $500 of unrecognized stock
compensation (net of estimated forfeitures) related to unvested option awards
and unvested stock grants, respectively, are expected to be recognized over
weighted-average periods of 2.8 and 3.7 years, respectively.
The Company estimates the fair value of stock options using the Black-Scholes
valuation model. Key input assumptions used to estimate the fair value of stock
options include the exercise price of the award, the expected option term, the
expected volatility of the Company's stock over the option's expected term, the
risk-free interest rate over the option's expected term, and the Company's
expected annual dividend yield. The Company believes that the valuation
technique and the approach utilized to develop the underlying assumptions are
appropriate in calculating the fair values of the Company's stock options
granted during the year ended December 31, 2006. Estimates of fair value are not
intended to predict actual future events or the value ultimately realized by
persons who receive equity awards. The following table summarizes the
assumptions used to compute the weighted average fair value of stock option
grants of $0.84 during the year ended December 31, 2006:
Dividend yield 0.0%
Weighted average volatility 51.4%
Risk free interest rate 4.8%
Expected holding period 2.5 years
No dividend yield was assumed because the Company has never paid a cash
dividend.
The weighted average volatility for the current period was developed using
historical volatility.
The risk-free interest rate was developed using the U.S. Treasury yield for
periods equal to the expected life of the options on the grant date. An increase
in the risk-free interest rate will increase stock compensation expense.
The expected holding period was developed after considering vesting schedules,
life of the option, historical experience and estimates of future exercise
behavior patterns. An increase in this assumption would increase stock
compensation expense.
SFAS 123R requires the recognition of stock-based compensation for the number of
awards that are ultimately expected to vest. As a result, for most awards,
recognized stock compensation was reduced for estimated forfeitures prior to
vesting primarily based on historical annual forfeiture rates of approximately
5%. Estimated forfeitures will be reassessed in subsequent periods and may
change based on new facts and circumstances. Prior to January 1, 2006, actual
forfeitures were accounted for as they occurred for purposes of required pro
forma stock compensation disclosures.
In addition, for the purpose of the statement of cash flows, the realization of
tax benefits in excess of amounts recognized for financial reporting purposes
will be recognized as a financing activity rather than an operating activity as
in the past.
NOTE O. ACCUMULATED OTHER COMPREHENSIVE LOSS
Cumulative other comprehensive loss consists of the following at December 31:
36
2006 2005
-------- --------
Minimum pension liability net of tax of $129 $ (529) $ (580)
NOTE P. RELATED PARTY TRANSACTIONS
Prior to August 2002, the Company had advanced amounts to officers primarily for
personal income taxes related to various stock option grants. The amounts
outstanding at December 31, 2006 and 2005 were $444 and $2,029, respectively,
including interest accrued on the advances. This indebtedness bears interest at
rates approximating market rates and is payable upon demand. During 2006, former
officers of the Company repaid loans and accumulated interest, aggregating
approximately $1,630. Repayment consisted of $124 and 597,144 shares of the
Company's common stock, valued at the closing market price at the date of the
repayment of the loans. In February 2007, a former officer repaid loans and
accumulated interest of $431. Repayment consisted of 140,813 shares of the
Company's common stock, valued at the closing market price at the date of the
repayment of the loans.
In 2005, the Company sold its UK distributorship operations to a company owned
by its former Vice President of European Operations. See Note L.
Mr. Robert Fleming, chairman of the Company's Board of Directors, is the
designated representative on the Board of Prism Venture Partners ("Prism") which
owns 1,149,705 shares of the Company's common stock. The contractual terms in
connection with the acquisition of ThinkEngine Networks, Inc. in November 2005
provide that, so long as Prism or one of its affiliated funds holds 400,000 or
more shares of the Company's common stock, the Company shall cause an individual
designated by Prism and acceptable to the Company's Board to be elected a
director.
NOTE Q. SUBSEQUENT EVENTS
On January 16, 2007, the Company borrowed $1,500 under a term loan agreement.
The loan bears interest at the rate of 13% per annum, matures on February 10,
2010, and requires an additional $150 payment to the lender on the maturity
date. The loan is to be repaid in six interest-only monthly installments
followed by thirty monthly installments of principal and interest. The Company
pledged as collateral substantially all of its non-intellectual property
business. In connection with the loan agreement, the Company issued a ten-year
common stock warrant to the lender to purchase 35,000 shares of the Company's
common stock at an exercise price of $3.47 which was the closing market price on
January 16, 2007. The fair value of the warrants is estimated to be $49, based
on the assumption that they will be exercised at the termination of the loan and
thus have an estimated life of three years.
37
NOTE R. QUARTERLY FINANCIAL DATA (UNAUDITED)
2006 FIRST SECOND THIRD FOURTH
---- -------- -------- -------- --------
Revenues $ 3,465 $ 1,576 $ 1,899 $ 2,693
Gross profit 2,069 195 1,033 1,444
Loss from continuing operations (750) (2,572) (1,393) (917)
Cumulative effect of change in accounting principle 36 0 0 0
Net loss (714) (2,572) (1,393) (917)
Net loss per share:
Continuing operations $ (.11) $ (.36) $ (.20) $ (.14)
Cumulative effect of change in accounting principle .01 .00 .00 .00
Net loss (.10) (.36) (.20) (.14)
2005 FIRST SECOND THIRD FOURTH
---- -------- -------- -------- --------
Revenues $ 1,721 $ 1,054 $ 986 $ 3,989
Gross profit 1,051 353 388 2,675
Income (loss) from continuing operations (498) (1,241) (1,065) 213
Loss from discontinued operations (257) (454) (585) (259)
Net loss (755) (1,695) (1,650) (46)
Net income (loss) per share:
Continuing operations $ (.09) $ (.22) $ (.19) $ .03
Discontinued operations (.05) (.08) (.11) (.04)
Net loss (.13) (.30) (.29) (.01)
The gross profit percentage for the fourth quarter of 2006 was 54% versus 48%
for the first nine months of 2006 due to increased volume.
The Company expensed $678 of purchased in process research and development in
connection with the acquisition of ThinkEngine Networks, Inc. in the fourth
quarter of 2005. The gross profit percentage for the fourth quarter of 2005 was
67% versus 48% for the first nine months of 2005 due to increased volume.
Item 9. Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
Item 9A. Controls and Procedures
---------------------------------
QUARTERLY EVALUATION. The Company's management carried out an evaluation as of
December 31, 2006 of the effectiveness of the design and operation of the
Company's "disclosure controls and procedures," which the Company refers to as
the Company's disclosure controls. This evaluation was done under the
supervision and with the participation of Company management, including the
Chief Executive Officer and Chief Financial Officer. Rules adopted by the
Commission require that the Company present the conclusions of the Chief
Executive Officer and Chief Financial Officer about the effectiveness of the
Company's disclosure controls as of the end of the period covered by this annual
report.
DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROL OVER FINANCIAL
REPORTING. Disclosure controls and procedures are designed with the objective of
ensuring that information required to be disclosed in the Company's reports
filed or submitted under the Exchange Act, such as this Annual Report on Form
10-K, is recorded, processed, summarized and reported within the time periods
specified in the Commission's rules and forms. Disclosure controls and
procedures are also designed with the objective of ensuring that such
information is accumulated and communicated to Company management, including the
Company's Chief Executive Officer and Chief Financial Officer, as appropriate,
to allow timely decisions regarding required disclosure.
Internal control over financial reporting is a process designed by, or under the
supervision of, the Company's Chief Executive Officer and Chief Financial
Officer, and effected by the Company's Board of Directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:
38
o pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the Company's
assets;
o provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that the Company's receipts and
expenditures are being made only in accordance with authorizations of
management or the Company's Board of Directors; and
o provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company's assets that
could have a material adverse effect on the Company's financial statements.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. Management, including the
Company's Chief Executive Officer and its Chief Financial Officer, do not expect
that the Company's disclosure controls and procedures or internal control over
financial reporting will prevent all errors and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management's override of the
control. The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
SCOPE OF THE EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND PROCEDURES. An
evaluation of the Company's disclosure controls and procedures included a review
of the Company's internal control procedures, as well as discussions with
members of management and others in the Company, as appropriate. In the course
of the evaluation, the Company sought to identify data errors, control problems
or acts of fraud and to confirm that appropriate corrective action, including
process improvements were being undertaken. The overall goals of these various
evaluation activities are to monitor the Company's disclosure controls and
procedures and to make modifications as necessary. The Company's intent in this
regard is that the disclosure controls and procedures will be maintained as
systems that change (including with improvements and corrections) as conditions
warrant. Among other matters, the Company sought in this evaluation to determine
whether there were any "significant deficiencies" or "material weaknesses" in
the Company's internal control over financial reporting, or whether the Company
had identified any acts of fraud involving personnel who have a significant role
in the Company's internal control over financial reporting. The Company also
sought to deal with other control matters in the evaluation, and in any case in
which a problem was identified, management considered what revision, improvement
and/or correction was necessary to be made in accordance with the Company's
on-going procedures.
PERIODIC EVALUATION AND CONCLUSION OF DISCLOSURE CONTROLS AND PROCEDURES. As of
December 31, 2006, the Company carried out an evaluation, under the supervision
and with the participation of the Company's management, including its Chief
Executive Officer and its Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that such controls and procedures were effective as of December 31,
2006.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. During the three months
ended December 31, 2006, there were no changes in the Company's internal control
over financial reporting that have materially affected, or are reasonably likely
to materially affect, the Company's internal control for financial reporting.
Item 9B. Other Information
---------------------------
Not applicable.
39
PART III
Item 10. Directors, Executive Officers and Corporate Governance
---------------------------------------------------------------
The information required by this Item with respect to the directors and
compliance with Section 16(a) of the Securities and Exchange Act is incorporated
by reference from the information provided under the headings "Board of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance,"
respectively, contained in the Proxy Statement to be filed with the Securities
and Exchange Commission in connection with the solicitation of proxies for the
Annual Meeting of Stockholders to be held on May 10, 2007 (the "Proxy
Statement").
The information required by this Item with respect to the executive officers is
contained in Part I of this Annual Report on Form 10-K under the heading
"Executive Officers of the Registrant."
The information required by this Item with respect to the Company's audit
committee members and audit committee financial experts is incorporated herein
by reference from the information provided under the heading "The Audit
Committee" of the Proxy Statement.
The information required by this Item with respect to the Company's code of
business ethics is incorporated herein by reference from the information
provided under the heading "Statement on Corporate Governance--Employee Matters"
of the Proxy Statement.
The information required by this Item with respect to material changes to the
procedures by which the Company's stockholders may recommend nominees to the
Board of Directors is incorporated herein by reference from the information
provided under the heading "The Nominating Committee" of the Proxy Statement.
Item 11. Executive Compensation
-------------------------------
The information in the Proxy Statement set forth under the captions "Information
Regarding Executive Officer Compensation" and "Information about the Board and
its Committees - Director Compensation" is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
---------------------------------------------------------------------------
Related Shareholder Matters
---------------------------
The information in the Proxy Statement set forth under the captions "Equity
Compensation Plan Information" and "Information Regarding Beneficial Ownership
of Principal Shareholders, Directors, and Management" is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions, and Director
---------------------------------------------------------------------
Independence
------------
The information set forth under the captions "Certain Relationships and Related
Transactions" of the Proxy Statement is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
-----------------------------------------------
Information concerning principal accountant fees and services appears in the
Proxy Statement under the heading "Fees Billed by Carlin, Charron & Rosen, LLP"
and is incorporated herein by reference.
40
PART IV
Item 15. Exhibits and Financial Statement Schedules
---------------------------------------------------
(a) (1) Financial Statements
The following financial statements of the Company are included in Item 8.
Financial Statements Covered by Reports of Independent Registered Public Accounting Firm: PAGE
----------------------------------------------------------------------------------------- ----
Report of Independent Registered Public Accounting Firm...............................................................20
Consolidated Balance Sheets, December 31, 2006 and 2005...............................................................21
Consolidated Statements of Operations and Comprehensive Loss
for each of the three years in the period ended December 31, 2006....................................................22
Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2006.....23
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2006...............24
Notes to Consolidated Financial Statements............................................................................25
(a) (2) Financial Statement Schedule
The following financial statement schedule of the Company is required to be
filed by Item 8 hereof and paragraph (c)
below:
Report of Independent Registered Public Accounting Firm on Financial
Statement Schedule
Schedule II: Valuation and qualifying accounts
All other schedules for which provisions are made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are not applicable, and
have therefore been omitted.
(a) (3) (b) Exhibits
See Exhibit Index included as the last part of this report on Form
10-K, which Index is incorporated herein by this reference.
(a) (3) (c) Financial Statement Schedules
Refer to Item 15 (a) above for listing of financial statement schedules.
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on March 27, 2007.
THINKENGINE NETWORKS, INC.
Registrant
BY /S/JOHN E. STEINKRAUSS
-------------------
JOHN E. STEINKRAUSS
TREASURER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on March 27, 2007.
SIGNATURE TITLE
/S/ MICHAEL G. MITCHELL PRESIDENT AND CHIEF
-------------------------- EXECUTIVE OFFICER AND A DIRECTOR
MICHAEL G. MITCHELL
/S/ JOHN E. STEINKRAUSS TREASURER
-------------------------- (PRINCIPAL FINANCIAL AND
JOHN E. STEINKRAUSS ACCOUNTING OFFICER)
/S/ ROBERT C. FLEMING DIRECTOR
--------------------------
ROBERT C. FLEMING
/S/ WILLIAM A. MERRITT DIRECTOR
--------------------------
WILLIAM A. MERRITT
/S/ ROBERT H. SCOTT DIRECTOR
--------------------------
ROBERT H. SCOTT
/S/ WILLIAM J. STUART DIRECTOR
--------------------------
WILLIAM J. STUART
/S/ JOHN E. SWEENEY DIRECTOR
--------------------------
JOHN E. SWEENEY
42
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
FINANCIAL STATEMENT SCHEDULE
To the Shareholders and Board of Directors of
ThinkEngine Networks, Inc.
We have audited the consolidated financial statements of ThinkEngine Networks,
Inc. and subsidiaries as of December 31, 2006 and December 31, 2005, and for
each of the years in the three-year period ended December 31, 2006, and have
issued our report thereon dated March 15, 2007. Such consolidated financial
statements and report are included in the Company's annual report to
shareholders for the fiscal year ended December 31, 2006 and are incorporated
herein by reference. Our audit also included the financial statement schedule of
the Company, listed in item 15. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audit. In our opinion, such financial statement schedule,
when considered in relation to the basic consolidated financial statements as of
December 31, 2006 and December 31, 2005, and for each of the years in the
three-year period ended December 31, 2006, taken as a whole, presents fairly, in
all material respects, the information set forth therein.
/S/CARLIN, CHARRON & ROSEN, LLP
GLASTONBURY, CONNECTICUT
MARCH 15, 2007
43
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ThinkEngine Networks, Inc. and Subsidiaries
COL. A COL. B COL. C COL. C COL. D COL. E
Additions Additions
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Year Expenses Accounts Deductions Year
Year ended December 31, 2006:
Reserves and allowances deducted from asset accounts:
Allowance for doubtful accounts receivable $ 73,000 $ 0 $0(1) $ 53,000 $ 20,000
Allowance for excess and obsolete inventories 3,054,000 640,000 0(2) 357,000 3,337,000
Allowance for deferred tax assets 5,077,000(4) 1,214,000 0 0 6,291,000
Year ended December 31, 2005:
Reserves and allowances deducted from asset accounts:
Allowances for doubtful accounts receivable 46,000 65,000 0(1) 38,000 73,000
Allowance for excess and obsolete inventories 3,163,000 0 0(3) 109,000 3,054,000
Allowance for deferred tax assets 4,248,000(4) 829,000 0 0 5,077,000
Year ended December 31, 2004:
Reserves and allowances deducted from asset accounts:
Allowances for doubtful accounts receivable 35,000 34,000 0(1) 23,000 46,000
Allowance for excess and obsolete inventories 2,765,000 666,000 0(2) 268,000 3,163,000
Allowance for deferred tax assets 4,067,000(4) 181,000 0 0 4,248,000
(1) Write-off of specific accounts receivable, and $14,000 recovery of bad debts
in 2006 only.
(2) Disposition of inventory reserved against.
(3) Sale of reserved inventory items.
(4) Increases charged to income tax expense.
44
INDEX TO EXHIBITS
Exhibit
-------
2.1 Agreement and Plan of Merger, dated as of October 28, 2005, among
Cognitronics Corporation, TN Acquisition Corporation, ThinkEngine
Networks, Inc. and its Principal Security holders (Exhibit 2.1 to Form
8-K filed with the Securities and Exchange Commission on November 1,
2005 and incorporated herein by reference). Exhibits and schedules to
the Agreement and Plan of Merger (Form of Note, Form of Escrow
Agreement, Form of Registration Rights Agreement, Form of Employment
Agreement, Schedule 1.2(b) Allocation of Merger Consideration and
Schedule 4.1 Available Employees) have been omitted pursuant to Item
601(b)(2) of Regulation S-K. The Company will furnish supplementally a
copy of any omitted exhibit, schedule or similar attachment to the
Commission upon request.
2.2 Share Sale Agreement, dated as of December 22, 2005, among Cognitronics
Corporation, Garrett Sullivan and Silbury 307 Limited (Exhibit 2.1 to
Form 8-K filed with the Securities and Exchange Commission on December
27, 2005 and incorporated herein by reference).
2.3 Agreement and Plan of Merger, dated as of December 18, 2006, between
the Company and Cognitronics Corporation, a New York corporation
(Exhibit 2.1 to Form 8-K filed with the Securities and Exchange
Commission on January 4, 2007 and incorporated herein by reference).
3.1 Certificate of Incorporation as filed on December 15, 2006 (Exhibit 3.1
to Form 8-K filed with the Securities and Exchange Commission on
January 4, 2007 and incorporated herein by reference).
3.2 Bylaws of the Company (Exhibit 3.2 to Form 8-K filed with the
Securities and Exchange Commission on January 4, 2007 and incorporated
herein by reference).
4. Specimen Certificate for Common Stock (Exhibit 1 to Form 8-A filed by
the Company with the Securities and Exchange Commission on January 8,
2007 and incorporated herein by reference).
10.1 1990 Stock Option Plan, as amended (Exhibit D to Proxy Statement filed
by the Company with the Securities and Exchange Commission on November
13, 2006 and incorporated herein by reference).
10.2 Lease, dated April 30, 1993, between The Danbury Industrial
Corporation, landlord, and Cognitronics Corporation, tenant (Exhibit
10.3 to Annual Report on Form 10-K for the year ended December 31, 1993
and incorporated herein by reference).
10.3 Lease amendment, dated as of January 27, 2003, between the Danbury
Industrial Corporation and Cognitronics Corporation (Exhibit 10.3 to
Annual Report on Form 10-K for the year ended December 31, 2002 and
incorporated herein by reference).
10.4 Form of Indemnity Agreement, dated October 27, 1986, between each
Director (with equivalent form for each Officer) and Cognitronics
Corporation (Exhibit 10.7 to Annual Report on Form 10-K for the year
ended December 31, 1986 and incorporated herein by reference).
10.5 Supplemental Pension Plan for Officers, as amended November 2, 1993
(Exhibit 10.6 to Annual Report on Form 10-K for the year ended December
31, 1993 and incorporated herein by reference).
10.6 Restricted Stock Plan, as amended (Exhibit E to Proxy Statement filed
by the Company with the Securities and Exchange Commission on November
13, 2006 and incorporated herein by reference).
10.7.1 Form of Executive Severance Agreement between certain officers and
Cognitronics Corporation (Exhibit 10.8 to Annual Report on Form 10-K
for the year ended December 31, 1997 and incorporated herein by
reference).
45
Exhibit
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10.8 Addendum to Executive Severance Agreement between certain officers and
Cognitronics Corporation (Exhibit 10.8 to Annual Report on Form 10-K
for the year ended December 31, 1999 and incorporated herein by
reference).
10.9 Directors' Stock Option Plan, as amended (Exhibit F to the Proxy
Statement filed by the Company with the Securities and Exchange
Commission on November 13, 2006 and incorporated herein by reference).
10.10 Employment Agreement, dated August 16, 2006, between the Company and
Michael Mitchell (Exhibit 10.1 to Form 8-K filed with the Securities
and Exchange Commission on August 16, 2006 and incorporated herein by
reference).
10.11 Restricted Stock Agreement, dated August 16, 2006, between the Company
and Michael Mitchell (Exhibit 10.2 to Form 8-K filed with the
Securities and Exchange Commission on August 16, 2006 and incorporated
herein by reference).
10.12 Separation and Release Agreement, dated August 16, 2006, between the
Company and Brian J. Kelley (Exhibit 10.3 to Form 8-K filed with the
Securities and Exchange Commission on August 16, 2006 and incorporated
herein by reference).
10.13 Employment Agreement, dated November 21, 2006, between the Company and
John Steinkrauss (Exhibit 10.1 to Form 8-K filed with the Securities
and Exchange Commission on November 27, 2006 and incorporated herein by
reference).
10.14 Restricted Stock Agreement, dated November 21, 2006, between the
Company and John Steinkrauss (Exhibit 10.2 to Form 8-K filed with the
Securities and Exchange Commission on November 27, 2006 and
incorporated herein by reference).
10.15 Loan and Security Agreement, dated as of January 16, 2007, between the
Company and VenCore Solutions LLC (Exhibit 10.1 to Form 8-K filed with
the Securities and Exchange Commission on January 22, 2007 and
incorporated herein by reference).
10.16 Negative Pledge Agreement, dated January 16, 2007, by the Company
(Exhibit 10.2 to Form 8-K filed with the Securities and Exchange
Commission on January 22, 2007 and incorporated herein by reference).
10.17 Common Stock Purchase Warrant, dated January 16, 2007 issued to VenCore
Solutions LLC (Exhibit 10.3 to Form 8-K filed with the Securities and
Exchange Commission on January 22, 2007 and incorporated herein by
reference).
10.18 Form of Director and Officer Indemnification Agreement, dated February
15, 2007, between each Director (with equivalent form for each Officer)
and the Company (Exhibit 10.1 to Form 8-K filed with the Securities and
Exchange Commission on February 16, 2007 and incorporated herein by
reference).
21. List of subsidiaries of the Company.
23. Consent of Independent Registered Public Accounting Firm.
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
46
Exhibit
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32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2.1 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
47