1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000, 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 0-3035 COGNITRONICS CORPORATION (Exact name of registrant as specified in its charter) NEW YORK 13-1953544 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3 Corporate Drive, Danbury, Connecticut 06810 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (203) 830-3400 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 $0.20 per share American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None 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 and (2) has been subject to such filing requirements for at least 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. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 1, 2001: Common Stock, par value $0.20 per share -- $38,113,000 The number of shares outstanding of each of the issuer's classes of common stock as of March 1, 2001: Common Stock, par value $0.20 per share --5,519,378 shares Documents incorporated by reference: Portions of the Proxy Statement for the annual meeting of stockholders to be held on May 17, 2001 are incorporated by reference into Part III. 2 TABLE OF CONTENTS PART I Item Page 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . 5 4. Submission of Matters to a Vote of Security Holders. . . . . . 5 Executive Officers of the Company. . . . . . . . . . . . . . . 6 PART II 5. Market for Company's Common Equity and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . 7 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . 7 7a. Market Risk. . . . . . . . . . . . . . . . . . . . . . . . . .10 8. Financial Statements and Supplementary Data. . . . . . . . . .10 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. . . . . . . . . . . . . . . . . . .24 PART III 10. Directors and Executive Officers of the Company. . . . . . . .24 11. Executive Compensation . . . . . . . . . . . . . . . . . . . .24 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . . . . . . . . . . . . . . .24 13. Certain Relationships and Related Transactions . . . . . . . .24 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 McIAS is a trademark of Cognitronics Corporation. UNIX is a registered trademark of Santa Cruz Operation, Inc. 3 PART I Item 1. Business (a) Cognitronics Corporation (the "Company") was incorporated in January 1962 under the laws of the State of New York. The Company designs, manufactures and markets voice processing systems. (b) The Company operates in two segments of the voice processing industry. In the United States, the Company designs, manufactures and sells equipment for use in telephone central offices. In Europe, the Company distributes equipment for use on customers' premises. (c) (i) A description of the fields of voice processing in which the Company operates and its products are as follows: Domestic Operations. These products are sold directly to telecommunication service providers or through switch manufacturers who distribute the Company's products. Intelligent Announcers. The Company's McIAS(TM) 16xx product family has been primarily used by Incumbent Local Exchange Carriers (ILECs) and Competitive Local Exchange Carriers (CLECs) to provide voice announcements in connection with custom calling features (CLASS), such as selective call forwarding and caller originator trace. Number change intercept is another important feature provided. The 16xx is available in two versions: a lower cost configuration which provides network announcement functionality, is available as a 1607/68 (1 T-1 span capacity) and a 1610/68 (3 T-1 span capacity). The second version of this series is a UNIX(R)-based platform which utilizes many of the same components as the /68 series and is known as McIAS 16xx/IP. "IP" designates an Intelligent Peripheral, indicating the ability to serve as a voice peripheral to any manufacturer's switch and delivering multiple application capability. The McIAS 16xx/IP is available as a 1607/IP, a 1610/IP, and a 1623/IP. Features include an open architecture, scalable processing power and disk drives, and centralized administration. Application examples include number change with call completion, automated attendant, voice mail and time and temperature announcements. A new product line, the CX Series, was announced and sales began in 1999. This family of products provides greater capacity and increased functionality to meet telecommunication service providers' network needs in Advanced Intelligent Network ("AIN") and packet switched environments. Included in the CX capabilities are a new MultiResource Line Card and support for several key AIN protocols such as SS7, SR-3511, GR-1129-CORE and ISDN-PRI. The CX is also designed and planned to be IP Telephony and ATM ready by providing key packet switched network support such as MGCP, MEGACO, RTP/RTCP, H. 323, SIP and others. Passive Announcers. These announcers are used by the ILECs and CLECs to inform callers about network conditions or procedures to invoke the use of a service. The Company has been a major supplier to the industry of passive announcers and incorporates these features in products such as the Model 688 Automatic Number Announcer, McIAS 950, and the McIAS 16xx product family. 4 Call Processors. The Company's McIAS 950 is also an automated attendant and audiotext system with the flexibility to offer the caller various choices (dial an extension, revert to an operator, etc.). The system also offers a wide variety of menu-selected information to callers. The McIAS 950 is designed for use in both telephone network environments and the commercial business market. European Distributorship Operations. Dacon Electronics Plc., based in Hertfordshire, England, distributes call management and voice processing products, including products manufactured by the Company, in Europe. (ii) Status of publicly announced new products or industry segments requiring material investment. Inapplicable. (iii) The Company has adequate sources for obtaining raw materials, components and supplies to meet production requirements and did not experience difficulty during 2000 in obtaining such materials, supplies and components. (iv) 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 registered trademarks and names which the Company considers important in promoting the business of the Company and its products. (v) Seasonality. Inapplicable. (vi) The discussion of liquidity and sources of capital as set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations is included in Item 7 of this Annual Report on Form 10-K and is incorporated herein by reference. (vii) In 2000, revenues included sales of $12.6 million to Siemens Carrier Networks LLC. and $2.8 million to Nortel Inc. The Company's U.K. operations had sales of $3.7 million to British Telecommunications Plc in 2000. Over the past several years, a major portion of the revenues of the domestic operations has come from two or three large customers, and a significant portion of the revenues of the UK operations has come from one customer. Accordingly, the loss of any of these customers could have a material adverse impact on the Company's results of operations. (viii) The dollar amount of orders believed by the Company to be firm as of December 31, 2000 and 1999, amounted to $1.1 million and $.5 million, respectively. Substantially all of the orders as of December 31, 2000, can reasonably be expected to be filled during 2001. (ix) Business subject to renegotiation. Inapplicable. (x) 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. Future research and development expenditures will be based, in part, on future results of operations. There are 5 no assurances that the Company will be able to successfully develop and market new products and applications. (xi) Expenditures for research and development activities, as determined in accordance with generally accepted accounting principles, amounted to $2.4 million in 2000, $2.1 million in 1999 and $2.0 million in 1998. In addition, the estimated dollar amount spent on the improvement of existing products or techniques was $.2 million in each of the years. (xii) Material effects of compliance with Federal, State or local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. Inapplicable. (xiii) At December 31, 2000, the Company and its subsidiaries employed 103 people. (d) Sales to foreign customers primarily represent sales of Dacon Electronics Plc. (incorporated in the United Kingdom) of $7.3 million in 2000, $7.2 million in 1999 and $8.3 million in 1998. Additional information about foreign operations is included in Note K to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K and is incorporated herein by reference. Further, there were export-type sales (primarily North America) of approximately $.2 million in 2000, $3.5 million in 1999 and $2.4 million in 1998. Export sales do not involve any greater business risks than do sales to domestic customers and, in certain instances, the Company obtains an irrevocable letter of credit or payment prior to shipment of products to the customer. Selling prices and gross profit margins on export-type sales are comparable to sales to domestic customers. Item 2. Properties The facilities of the Company and its subsidiaries are located as follows: LOCATION DESCRIPTION FEET DATE -------- ----------- ------ ---------------- Danbury, Connecticut: Office, engineering, 40,000 10/31/03 3 Corporate Drive production and service facility Hemel Hempstead Office, distribution 12,000 7/31/01 Hertfordshire, and service facility United Kingdom 1 Enterprise Way The Company considers each of these facilities to be in good condition and adequate for the Company's business. Item 3. Legal Proceedings There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject. Item 4. Submission of Matters to a Vote of Security Holders Inapplicable. 6 Executive Officers of the Company The executive officers of the Company, their positions with the Company and ages as of March 1, 2001 are as follows: NAME POSITION(S) AND OFFICE(S) AGE ---- ------------------------- --- Brian J. Kelley President and Chief Executive Officer; Director 49 Kenneth G. Brix Vice President 54 Harold F. Mayer Secretary 71 Michael N. Keefe Vice President 45 Roy A. Strutt Vice President; Director 44 Garrett Sullivan Treasurer and Chief Financial Officer 55 Emmanuel A. Zizzo Vice President 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 his successor shall have been elected and qualified. Mr. Kelley has been President and Chief Executive Officer of the Company since 1994. Prior to that he held senior management positions with TIE/Communications, Inc. from 1986 to 1994. Mr. Brix has been a Vice President of the Company since 1994 with responsibility for U.S. sales and marketing. Prior to that he held senior management positions from 1987 to 1994. Mr. Mayer has been Secretary of the Company since 1975. He was Treasurer from 1974 to 1989 and a Vice President of the Company from 1986 to 1996. Mr. Keefe has been a Vice President of the Company since 1993 with responsibility for engineering, prior to which he was Manager of Software Planning and Development from 1992 until 1993 and senior engineer for more than five years. He has been employed by the Company since 1980. Mr. Strutt has been a Vice President of the Company since 1994 with responsibility for European operations. Since 1992, he has been Managing Director of Dacon Electronics Plc, which was acquired by the Company in 1992, and Director of Sales and Operations from 1990 to 1992. Prior to that he was Managing Director of Automatic Answering Ltd. for four years. Mr. Sullivan has been Treasurer and Chief Financial Officer of the Company since 1989. Prior to that he was Treasurer and Chief Financial Officer of Fundsnet, Inc., an electronic funds transfer company, from 1986 until 1989. He was employed by The Singer Co. from 1977 to 1986, where his most recent position was Vice President-Finance, Asia Division. Mr. Zizzo has been a Vice President of the Company since 1995 with responsibility for operations, primarily manufacturing, purchasing and physical facilities, prior to which he had been Director of Operations since 1994. He was an independent consultant from 1993 to 1994. Prior to that he held senior management positions with TIE/Communications, Inc.for more than five years. 7 PART II Item 5. Market for Company's Common Equity and Related Stockholder Matters (a) and (b) Cognitronics' Common Stock is traded on the American Stock Exchange under the symbol CGN. On March 1, 2001, there were 711 stockholders of record; the Company estimates that the total number of beneficial owners was approximately 3,200. Information on quarterly stock prices is set forth in Item 8 of this Annual Report on Form 10-K and is incorporated herein by reference. (c) The Company has never paid a cash dividend on its Common Stock and has used its cash for the development of its business. In 1998, 2000 and 2001, the Company announced its intention to repurchase up to 300,000, 200,000 and 500,000 shares, respectively, of its Common Stock. The Company repurchased 150 shares of its Common Stock in 1998, 105,750 in 1999 and 331,000 in 2000. The Company has no present intention of paying a cash dividend, and payment of any future dividends will depend upon the Company's earnings, financial condition and other relevant factors. Item 6. Selected Financial Data Year ended December 31, (in thousands except per share data) OPERATING RESULTS 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Revenues $31,836 $31,693 $28,917 $29,521 $17,343 Net income 4,530 5,346 4,689 3,622 1,099 Net income per share: Basic $.79 $.94 $.85 $.69 $.22 Diluted .74 .88 .78 .62 .20 Weighted average number of basic shares outstanding 5,754 5,670 5,543 5,233 5,074 Weighted average number of diluted shares outstanding 6,092 6,048 5,993 5,840 5,378 FINANCIAL POSITION Working capital $25,830 $24,130 $18,281 $13,112 $ 8,745 Total assets 32,998 35,102 27,080 23,123 17,511 Stockholders' equity 26,988 25,729 20,033 15,014 10,612 Stockholders' equity per share $4.85 $4.40 $3.58 $2.73 $2.04 Cash dividends paid None None None None None Included in 1997 is $956,000 (net of tax $598,000 or $.11 per basic share and $.10 per diluted share) of settlement costs and legal fees related to class action litigation. 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 Operations The Company reported net income of $4.5 million, $5.3 million and $4.7 million for 2000, 1999 and 1998, respectively. 8 In 2000, sales value of the Company's domestic operations and its UK distributorship operations were essentially the same as 1999. The unit volume in the domestic operations increased approximately 20% while the sales value increased only $.1 million. This was due to unfavorable distribution channel mix and a volume discount given for a large purchase of McIAS 1623/IPs ($5.9 million) in the fourth quarter of 2000. The increased sales due to this large purchase were offset by lack of sales to Mexico in 2000 ($2.9 million in 1999) and lower shipments to CLEC's. The Company's backlog at December 31, 2000 was $1.1 million versus $.5 million in 1999. Recently, there have been reductions in telecommunication infrastructure buildout, as reported by major telecommunication equipment suppliers, and this is reflected in the Company's sales order flow. In both 2000 and 1999, a major portion of the Company's domestic revenue came from one customer and a significant portion of its UK distributorship revenue came from one customer. The loss of either of these customers would have a material adverse impact on the Company. Consolidated gross margin decreased 4% to 52% in 2000 from 56% in 1999 primarily due to a decrease of 4% in the domestic operation's gross margin attributable to channel mix and a discount given on a large purchase. In 1999, sales increased 10% to $31.7 million due to increased sales of $3.9 million (19%) by the Company's domestic operations, offset by decreased sales of $1.1 million (13%) in its UK distributorship operations. The increased sales in the U.S. operations were due to increased direct sales of $3.0 million and $.9 million of indirect sales. The increase in direct sales was primarily attributable to two customers and the increase in indirect sales was attributable to increased sales of $5.7 million to three customers, offset by a decrease of $4.9 million sales to another customer. In 1999, primarily in the third quarter, the Company sold $2.9 million to Alcatel Indetel Industria de Telecomunicacion S.A. de C.V., up from $2.0 million in the fourth quarter of 1998. This completed the project which began in the fourth quarter of 1998. The decreased sales in UK distributorship operations were due to decreased demand from its primary customer, reflecting increased competition faced by this customer and obsolescence of certain products distributed by the Company. In 1999, consolidated gross margin percentage improved 1% to 56% from 55% in 1998, primarily due to an increase of 2.7% in the domestic operations' gross margin attributable to improved product mix and higher volume. This was offset, in part, by a 3.5% decrease in the UK distributorship's gross margin due to unfavorable product mix and exchange rates. In 2000 and 1999, research and development increased $.3 million (15%) and $.1 million (7%), respectively, in each year versus the prior year due to higher personnel costs. The Company anticipates an acceleration in the rate of increase in spending for research and development. Selling, general and administrative expenses for 2000 was approximately the same as the prior year. In 1999, these costs increased $.9 million (13%) due to an increase of $.7 million (20%) in the domestic operations and $.1 million (5%) in the UK distributorship operations. The increase in the domestic operations was due to higher sales commissions and bonuses. Other income of $.6 million in 2000 and $.4 million in 1999 and 1998 is primarily interest income. The increase in 2000 from 1999 is due to higher interest rates and higher balances of cash and marketable securities. The Company's effective tax rate for 2000 was 34% versus 36% for 1999 and 9 1998. The reduction in the effective rate in 2000 from 1999 is attributable to a reversal of a $156,000 tax reserve. The provision for income taxes is discussed in Note G to Consolidated Financial Statements. Under Financial Accounting Standards Board ("FASB") Statement No. 109, the Company has recognized future tax benefits that management believes will be realized. In order to realize these benefits, the Company, exclusive of the results of Dacon Electronics Plc, will have to generate pretax income of $4.1 million. The current deferred tax benefit of $.7 million is primarily attributable to inventory provisions, the recognition of such loss, for tax purposes, is, in large measure, within the control of the Company. The non-current tax benefit, $.8 million, primarily relates to deferred compensation and benefit plans and, as such, would be recognized over a long period of time. The Company's U.S. pretax income was $7.4 million, $8.4 million and $6.0 million in 2000, 1999 and 1998, respectively. Based on this, management anticipates that the Company will generate sufficient taxable income in the future to realize these benefits. The effect of inflation has not had a major impact on the operating results of the Company over the past few years. Technological advances and productivity improvements are continually being applied to reduce costs, thus reducing inflationary pressures on the operating results of the Company. Exchange rate changes will impact the reported dollar sales and cost of sales of the Company's UK distributorship operations. In addition, at December 31, 2000, the Company's UK distributorship operations had net assets of $1.9 million, which would be impacted by changes in foreign exchange rates. However, the impact of such rate change would be reflected in the translation adjustment recorded in the equity section of the balance sheet. The Company does not hedge this foreign currency net asset exposure. Liquidity and Sources of Capital Net cash provided by operations was $3.5 million, $3.0 million and $3.7 million in 2000, 1999 and 1998, respectively, primarily due to the results of operations. In 2000, cash provided by operating activities increased from 1999 due to a smaller net increase in working capital accounts. In 1999, cash provided by operating activities decreased from 1998 due to increased accounts receivable, inventories and tax payments, offset, in part, by increases in accounts payable. Cash used by investing activities was $.7 million, $6.1 million and $1 million in 2000, 1999 and 1998, respectively. Cash used for investing activities included additions to property, plant and equipment of $.5 million in all years. Also included in 2000 were loans to officers of $.7 million. The Company had net sales of marketable securities of $.6 million in 2000 and net purchases of $5.6 million and $.5 million in 1999 and 1998, respectively. Cash used by financing activities of $3.2 million in 2000 primarily relates to the repurchase of the Company's common stock. Cash provided by financing activities was $.1 million in 1999 and 1998. Working capital increased to $25.8 million at December 31, 2000 from $24.1 million at December 31, 1999 and $18.3 million at December 31, 1998. The ratio of current assets to current liabilities was 7.6:1 at December 31, 2000 versus 4.4:1 at December 31, 1999 and 4.9:1 at December 31, 1998. The increase in 2000 is due to the results of operations and the reduction in accounts payable, offset, in part, by the repurchase of Company shares and reduction in inventory levels. The decrease in 1999 was due to a volume purchase of inventory items at a favorable price occurring in the last quarter of 1999. The Company anticipates making capital expenditures of approximately $1 million, incurring increased research and development expenditures and the 10 repurchase of up to 563,100 shares of its Common Stock in 2001. Management believes that the cash and cash equivalents at December 31, 2000 and the cash flow from operations in 2001 will be sufficient to meet its needs. Certain Factors That May Affect Future Results From time to time, information provided by the Company, statements made by its employees or information included in its filings with the Securities and Exchange Commission (including this Form 10-K) may contain statements which are not historical facts, so-called "forward-looking statements". These forward- looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company's actual future results may differ significantly from those stated in any forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, including, but not limited to: Product demand fluctuations in the timing and volume of customer requests for our products. Telecommunication systems industry and general economic conditions. Competitive pressure on selling prices. Market acceptance of our products and our customer's products. Costs associated with possible litigation or settlement, including those related to the use of ownership of intellectual property. Loss of a major customer. A few customers account for a major portion of the Company sales. A loss of such a customer would have a major adverse impact on the Company's results. Third party suppliers increase the risk that we may not have adequate supply to meet demand. Introduction of new products. Our markets are subject to technological change, so our success depends on our ability to develop and introduce new products. The markets in which we compete are highly competitive. Some of our competitors have significantly greater financial and other resources than us. Our future success is dependent on our ability to attract and retain our key design engineering, sales and executive personnel. There is intense competition for qualified personnel, in particular, design engineers, and we may not be able to attract and train engineers and other qualified personnel necessary for the development and introduction of new products or to replace engineers or other qualified personnel that may leave our employ. Our expense levels, in the short term, are fixed. Sales variances from quarter to quarter would have a significant effect on the results of operations. Other risk factors detailed in this Annual Report on Form 10-K and in the Company's other Securities and Exchange Commission Filings. 11 Item 7.a Market Risk The Company does not use derivative financial instruments. The Company is exposed to changes in interest rates. The Company's marketable securities consist of short-term and/or variable rate instruments and therefore a change in interest rates would not have a material impact on the value of these securities. Item 8. Financial Statements and Supplementary Data QUARTERLY FINANCIAL DATA (UNAUDITED) (in thousands except per share amounts) 2000 FIRST SECOND THIRD FOURTH ---- ----- ------ ----- ------ Sales $5,925 $8,437 $8,404 $9,070 Gross profit 3,083 4,827 4,630 3,876 Net income 475 1,516 1,505 1,034 Net income per share: Basic $.08 $.26 $.26 $.18 Diluted $.08 $.25 $.25 $.18 Common Stock price range: High $27.25 $15.00 $15.50 $11.51 Low 11.13 8.63 10.75 8.00 1999 FIRST SECOND THIRD FOURTH ---- ----- ------ ----- ------ Sales $7,804 $8,334 $9,662 $5,893 Gross profit 4,401 4,738 5,560 3,095 Net income 1,283 1,512 1,873 678 Net income per share: Basic $.23 $.27 $.33 $.12 Diluted $.22 $.25 $.31 $.11 Common Stock price range: High $6.20 $12.17 $14.38 $18.63 Low 4.88 5.42 9.38 9.75 The gross margin percentage in the fourth quarter of 2000 was 43% versus 55% for the nine months ended September 30, 2000 and 53% in the fourth quarter of 1999 primarily due to channel mix and a discount given on a large purchase. The effective tax rates for the fourth quarter of 2000 and 1999 were 24.5% and 25.2%, respectively, versus the estimated effective rates of 36.7% and 37.3% for the first nine months of 2000 and 1999, respectively. The above financial information should be read in conjunction with the Consolidated Financial Statements, including the notes thereto. 12 Report of Independent Auditors Stockholders and Board of Directors Cognitronics Corporation We have audited the accompanying consolidated balance sheets of Cognitronics Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income and comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cognitronics Corporation and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Stamford, Connecticut March 2, 2001 13 CONSOLIDATED BALANCE SHEETS COGNITRONICS CORPORATION AND SUBSIDIARIES (dollars in thousands) December 31, 2000 1999 ---- ---- ASSETS CURRENT ASSETS Cash and cash equivalents $ 3,499 $ 3,992 Marketable securities 9,400 10,000 Accounts receivable, less allowances of $53 and $37 7,760 6,752 Inventories 6,557 9,079 Deferred income taxes 746 889 Other current assets including loans to officers of $1,062 and $377 1,783 591 ------- ------- TOTAL CURRENT ASSETS 29,745 31,303 PROPERTY, PLANT AND EQUIPMENT, net 1,373 1,370 GOODWILL, less amortization of $2,726 and $2,394 651 983 DEFERRED INCOME TAXES 762 685 OTHER ASSETS, less amortization of $148 and $11 467 761 ------- ------- $32,998 $35,102 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 1,560 $ 4,312 Accrued compensation and benefits 1,128 1,176 Income taxes payable 532 734 Current maturities of debt 43 49 Other accrued expenses 652 902 ------- ------- TOTAL CURRENT LIABILITIES 3,915 7,173 LONG-TERM DEBT 47 90 OTHER NON-CURRENT LIABILITIES 2,048 2,110 COMMITMENTS AND CONTINGENCIES (Note I) STOCKHOLDERS' EQUITY Common Stock, par value $.20 a share; authorized 10,000,000 shares; issued 5,863,829 and 5,841,153 shares 1,173 1,168 Additional paid-in capital 14,123 14,050 Retained earnings 15,218 10,688 Cumulative other comprehensive income/(loss) (182) 66 Unearned compensation (332) (243) ------- ------- 30,000 25,729 Less cost of 300,550 common shares in treasury in 2000 (3,012) ------- ------- TOTAL STOCKHOLDERS' EQUITY 26,988 25,729 ------- ------- $32,998 $35,102 ======= ======= The accompanying notes to consolidated financial statements are an integral part of these statements. 14 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME COGNITRONICS CORPORATION AND SUBSIDIARIES (in thousands except per share data) Year ended December 31, 2000 1999 1998 ---- ---- ---- SALES $31,836 $31,693 $28,917 COSTS AND EXPENSES Cost of products sold 15,420 13,899 13,083 Research and development 2,445 2,132 1,997 Selling, general and administrative 7,351 7,422 6,564 Amortization of goodwill 332 333 332 Other (income) expense, net (619) (441) (404) ------- ------- ------- 24,929 23,345 21,572 ------- ------- ------- Income before income taxes 6,907 8,348 7,345 PROVISION FOR INCOME TAXES 2,377 3,002 2,656 ------- ------- ------- NET INCOME 4,530 5,346 4,689 Currency translation adjustment (248) (100) 142 ------- ------- ------- COMPREHENSIVE INCOME/(LOSS) $ 4,282 $ 5,246 $ 4,831 ======= ======= ======= NET INCOME PER SHARE: Basic $.79 $.94 $.85 Diluted $.74 $.88 $.78 15 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended December 31, 1998, 1999 and 2000 (dollars in thousands) Common Stock Additional Compre- Unearned Treasury Shares Paid-In Retained hensive Compensa- Shares Issued Amount Capital Earnings Income tion Amount ------ ------ ---------- -------- -------- --------- -------- Balance at January 1, 1998 5,500,861 $1,100 $13,209 $ 700 $ 24 $ (19) Shares issued pursuant to employee stock plans 48,501 10 369 (3) (260) Shares returned to pay statutory withholding tax (5,800) (1) (29) (23) Repurchase of common shares $ (1) Exercise of Warrants 54,307 11 79 (4) Currency translation adjustment 142 Net income 4,689 40 --------- ------ ------- ------- ----- ----- ------- Balance at December 31, 1998 5,597,869 1,120 13,628 5,359 166 (239) (1) Shares issued pursuant to employee stock plans 243,284 48 422 (17) (188) 589 Repurchase of common shares (588) Currency translation adjustment (100) Net income 5,346 184 --------- ------ ------- ------- ----- ----- ------- Balance at December 31, 1999 5,841,153 1,168 14,050 10,688 66 (243) 0 Shares issued pursuant to employee stock plans 22,676 5 73 (235) 294 Repurchase of common shares (3,306) Currency translation adjustment (248) Net income 4,530 146 --------- ------ ------- ------- ----- ----- ------- Balance at December 31, 2000 5,863,829 $1,173 $14,123 $15,218 $(182) $(332) $(3,012) ========= ====== ======= ======= ====== ====== ======= The accompanying notes to consolidated financial statements are an integral part of these statements. 16 CONSOLIDATED STATEMENTS OF CASH FLOWS COGNITRONICS CORPORATION AND SUBSIDIARIES (in thousands) Year ended December 31, 2000 1999 1998 ---- ---- ---- OPERATING ACTIVITIES Net income $4,530 $5,346 $4,689 Adjustments to reconcile net income to net cash provided by operating activities: Income tax expense 2,377 3,002 2,656 Depreciation and amortization 943 802 769 (Gain) loss on disposition of assets (5) (15) 6 Shares issued as compensation 146 185 40 Net (increase) decrease in: Accounts receivable (1,108) (1,820) (605) Inventories 2,363 (4,111) (569) Other assets 215 (169) 284 Net increase (decrease) in: Accounts payable (2,698) 2,738 (802) Accrued compensation and benefits (107) 34 (60) Other accrued expenses (217) (62) (793) ------ ------ ------ 6,439 5,930 5,615 Income taxes paid (2,971) (2,760) (1,956) NET CASH PROVIDED BY OPERATING ACTIVITIES ------ ------ ------ 3,468 3,170 3,659 ------- ------ ------ INVESTING ACTIVITIES Purchase of marketable securities (2,800) (11,200) (3,700) Sale of marketable securities 3,400 5,600 3,200 Loans to officers (712) (127) Proceeds from disposition of assets 20 10 24 Additions to property, plant and equipment (534) (483) (539) Purchase of software licenses (50) ------ ------ ------ NET CASH USED BY INVESTING ACTIVITIES (676) (6,200) (1,015) ------ ------ ------ FINANCING ACTIVITIES Principal payments on debt (49) (111) (174) Issuance of debt 196 Shares issued pursuant to employee stock plans 107 783 22 Shares issued pursuant to warrants 86 Shares repurchased for treasury,331,000, 105,750 and 150 (3,306) (588) (1) Shares returned to pay statutory withholding tax upon vesting of restricted stock (53) ------ ------ ------ NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (3,248) 84 76 ------ ------ ------ EFFECT OF EXCHANGE RATE DIFFERENCES (37) (53) 83 ------ ------ ------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (493) (2,999) 2,803 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 3,992 6,991 4,188 ------ ------ ------ CASH AND CASH EQUIVALENTS - END OF YEAR $3,499 $3,992 $6,991 ====== ====== ====== The accompanying notes to consolidated financial statements are an integral part of these statements. 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS COGNITRONICS CORPORATION AND SUBSIDIARIES NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization. The Company designs, manufactures and markets voice processing products in the United States and, through a subsidiary, distributes call management and voice processing equipment in Europe. Risks and Uncertainties. A major portion of the Company's domestic revenues is generated by sales to two customers, and a significant portion of its European distributorship revenue comes from one customer. The loss of any of these customers would have a material adverse impact on the Company. The Company's receivables are primarily from major, well-established companies in the telecommunications industry, and at December 31, 2000, one such company accounted for 75% of the Company's accounts receivable. 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. Principles of Consolidation. The 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. Revenue. Revenue is recognized when earned. The Company generally recognizes revenue from product sales upon shipment and in certain instances upon acceptance by the customer. 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. Fair Value of Financial Instruments. The carrying amounts of the Company's financial instruments (trade receivables/payables and other short-term and long-term debt) due to their terms and maturities approximate fair value. 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, 2000, essentially all of the Company's cash and cash equivalent balances were with two financial institutions. Marketable Securities. Marketable securities are classified as available for sale and are reported at cost. Due to their short maturities and/or reset provisions, their carrying value approximates fair value. Inventories. Inventories are stated at the lower of cost (first-in, first-out method) or market. Property, Plant and Equipment. Property, plant and equipment is carried at cost less allowances for depreciation, computed in accordance with the straight- line method based on estimated useful lives. The estimated lives for machinery and equipment are 5 to 12 years and for furniture and fixtures are 4 to 10 years. Repairs and maintenance are expensed when incurred. 18 Foreign Exchange. Results of operations for the Company's foreign subsidiary were translated into U.S. dollars using average exchange rates during the period, while assets and liabilities were translated using current rates at the end of the period. Stock Based Compensation. The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and therefore recognizes no compensation expense for stock options granted. Income Per Share. In computing basic earnings per share, the dilutive effect of stock options and warrants are excluded, whereas for diluted earnings per share they are included. The shares used in the basic earnings per share calculations were 5,753,734, 5,670,023 and 5,542,804 and in the diluted earnings per share were 6,091,964, 6,047,636 and 5,993,077 for 2000, 1999 and 1998, respectively. Goodwill. The Company has classified as goodwill the cost in excess of fair value of the net assets of companies acquired in purchase transactions. Goodwill is amortized using the straight-line method over its estimated useful life (10 years). Goodwill in excess of associated expected operating cash flows is considered to be impaired and is written down to fair value. Stock Split. All share and per share amounts have been restated to give retroactive effect to a 3 for 2 split in the form of a dividend declared in July 1999. The par value of the additional shares of common stock issued in connection with the stock split was credited to common stock and charged to retained earnings. NOTE B. VALUATION AND QUALIFYING ACCOUNTS The allowance for doubtful accounts was increased by $16,000, $10,000 and $24,000 in 2000, 1999 and 1998, respectively, by charges to costs and expenses. The Company wrote off uncollectible accounts, net of recoveries, of $10,000 and $18,000 in 1999 and 1998, respectively. NOTE C. INVENTORIES (IN THOUSANDS): 2000 1999 ---- ---- Finished and in process $4,320 $3,947 Materials and purchased parts 2,237 5,132 ------ ------ $6,557 $9,079 ====== ====== NOTE D. PROPERTY, PLANT AND EQUIPMENT (IN THOUSANDS): 2000 1999 ---- ---- Machinery and equipment $1,995 $1,768 Furniture and fixtures 2,110 2,100 ------ ------ 4,105 3,868 Less allowances for depreciation 2,732 2,498 ------ ------ $1,373 $1,370 ====== ====== 19 NOTE E. OTHER NON-CURRENT LIABILITIES (IN THOUSANDS): 2000 1999 ---- ---- Accrued officers' supplemental pension $ 553 $ 593 Accrued deferred compensation 291 305 Accrued pension 568 607 Accrued postretirement benefit 825 800 ------ ------ 2,237 2,305 Less current portion 189 195 ------ ------ $2,048 $2,110 ====== ====== NOTE F. DEBT AND CREDIT ARRANGEMENTS Dacon Electronics Plc has a bank line of credit of $145,000 expiring in 2001. During 2000 and 1999, no amounts were borrowed under this facility. Long term debt (in thousands): 2000 1999 ---- ---- Installment finance agreements, interest at 8% to 12% per annum expiring through 2003 $90 $139 Less current maturities of debt 43 49 --- ---- $47 $ 90 === ==== Payments on the installment finance agreements in each of the three years in the period ending December 31, 2003 are $43,000, $35,000 and $12,000, respectively. Interest of $31,000, $30,000 and $42,000 was paid in 2000, 1999 and 1998, respectively. NOTE G. INCOME TAXES At December 31, 2000, consolidated retained earnings included approximately $1.1 million of retained earnings applicable to Dacon Electronics Plc, a foreign subsidiary. If the undistributed earnings were remitted, any resulting federal tax would be substantially reduced by foreign tax credits. 20 The components of the provision (benefit) for income taxes for the years ended December 31 are as follows (in thousands): 2000 1999 1998 ---- ---- ---- Current: Federal $1,989 $2,428 $1,565 Foreign (24) 62 377 State 346 419 370 ------ ------ ------ Total current 2,311 2,909 2,312 ------ ------ ------ Deferred: Federal 55 84 344 State 11 9 ------ ------ ------ Total deferred 66 93 344 ------ ------ ------ $2,377 $3,002 $2,656 ====== ====== ====== Not reflected in the 2000, 1999 and 1998 tax provisions are $29,000, $73,000 and $94,000, respectively, of income tax benefits related to employee stock plans; such amounts were credited to additional paid-in capital. The provision for 2000 reflects the reversal of a $156,000 tax reserve. Domestic and foreign pretax income (loss) for the years ended December 31 are as follows (in thousands): 2000 1999 1998 ---- ---- ---- Domestic operations $7,439 $8,484 $6,357 Foreign Operations (532) (136) 988 ------ ------ ------ $6,907 $8,348 $7,345 ====== ====== ====== Deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 2000 and 1999 are as follows (in thousands): 2000 1999 ---- ---- Deferred tax liabilities $ 187 $ 238 ------ ------ Deferred tax assets: Inventory valuation 504 701 Accrued liabilities and employee benefits 445 380 Accrued deferred compensation 309 333 Other postretirement benefits 312 304 Separate return federal operating loss carryforwards expiring in 2008 and 2009 445 445 Other 125 94 ------ ------ Total deferred tax assets 2,140 2,257 Valuation allowance (445) (445) ------ ------ 1,695 1,812 ------ ------ Net deferred tax assets $1,508 $1,574 ====== ====== 21 No amounts have been credited or charged to tax expense for the valuation allowance in 2000 or 1999. A reconciliation of the statutory federal income tax rate to the effective tax rate on income for the years ended December 31, is as follows: 2000 1999 1998 ---- ---- ---- Statutory federal income tax rate 34.0% 34.0% 34.0% State income taxes, net of federal tax benefit 3.4 3.4 3.6 Lower foreign tax rate (0.1) (1.0) Research & Development Credit (0.3) (1.0) (1.6) Nontaxable interest income (1.7) (1.2) (0.7) Goodwill amortization 1.2 1.0 1.5 Other (2.2) (.1) 0.4 ---- ---- ---- 34.4% 36.0% 36.2% ==== ==== ==== NOTE H. OTHER (INCOME) EXPENSE, NET (IN THOUSANDS): Year Ended December 31, 2000 1999 1998 ---- ---- ---- Interest expense $ 50 $ 49 $ 73 Interest income (669) (490) (477) ----- ----- ----- $(619) $(441) $(404) ===== ===== ===== NOTE I. COMMITMENTS Leases. Total rental expense amounted to $500,000 in 2000, $532,000 in 1999 and $465,000 in 1998. Future annual payments for long-term noncancellable leases for each of the five years in the period ending December 31, 2006 are approximately $424,000, $327,000,$253,000, $4,000 and $0, respectively, and no amounts thereafter. Pension Plan. The Company and its domestic subsidiaries have a defined benefit pension plan covering substantially all employees. 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. 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 components of net cost of the plan for the years ended December 31 are as follows (in thousands): 2000 1999 1998 ---- ---- ---- Interest cost on projected benefit obligation $116 $117 $115 Actual (return)/loss on plan assets 25 (50) (120) Net amortization and deferral (123) (44) 31 ---- ---- ---- Net periodic pension cost $ 18 $ 23 $ 26 ==== ==== ==== 22 The following table sets forth the plan's funded status and the accrued pension liability recognized in the Company's Consolidated Balance Sheets at December 31 (in thousands): 2000 1999 ---- ---- Projected benefit obligation for services rendered to date Beginning of year $1,586 $1,773 Gain due to change in estimates (33) (152) Interest cost 116 116 Less benefits paid (102) (151) ------ ------ End of year 1,567 1,586 ------ ------ Plan assets at fair value Beginning of year 1,220 1,258 Actual return on plan assets (25) 50 Contribution 56 63 Less benefits paid (102) (151) ------ ------ End of year 1,149 1,220 ------ ------ Plan assets less than projected benefit obligation (418) (366) Unrecognized net asset, less accumulated amortization of $172 and $164 (8) (17) Unrecognized net gain (142) (224) ------ ------ Accrued pension liability (included in other non-current liabilities) $ (568) $ (607) ====== ====== The discount rates used in determining the projected benefit obligation were 7.5 % in 2000 and 7.75% in 1999. The expected long-term rate of return on plan assets used in determining the net periodic pension cost was 7% for all years presented. The plan assets at December 31, 2000 and 1999 were principally invested in corporate debt and equity securities. 401(k) Retirement Plan. The Company has a defined contribution plan covering substantially all domestic employees. The Company's contribution is based upon the participants' contributions. The expense was $54,000, $53,000 and $52,000 in 2000, 1999 and 1998, respectively. Officers' Supplemental Pension Plan. The Company has an unfunded, noncontributory defined benefit pension plan covering certain retired officers. The components of net pension cost of the plan for the years ended December 31 are as follows (in thousands): 2000 1999 1998 ---- ---- ---- Interest cost on projected benefit obligation $32 $34 $35 Amortization of actuarial gains (3) (2) (3) --- --- --- Net periodic pension cost $29 $32 $32 === === === 23 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 (in thousands): 2000 1999 ---- ---- Projected benefit obligations Balance at beginning of period $508 $543 Interest expense 32 34 Less benefits paid (68) (69) ---- ---- Balance at end of period 472 508 Unrecognized net gain 81 85 ---- ---- Accrued pension liability (included in other non-current liabilities) $553 $593 ==== ==== The discount rate used in determining the projected benefit obligation was 6.75% for all three years presented. All participants are retired and receiving benefits under the Plan and therefore future increases in compensation are not applicable. Other Postretirement Benefit Plans. In addition to the Company's pension plans, the Company has a contributory, unfunded defined benefit plan providing certain health care benefits for domestic employees who retired prior to March 31, 1996. The participants' contributions are adjusted periodically and are based on age and length of service at time of retirement. The assumed rate of increase in the per capita cost of covered benefits used for 1999 was 9% decreasing to 5% after 8 years and for 2000 was 10% decreasing to 5% after 10 years. Increasing the health care cost trend rate by one percentage point each year would increase the accumulated postretirement benefit obligation by $83,000 at December 31, 2000 and the aggregate service and interest cost component of net periodic postretirement benefit cost for 2000 by $6,000. The corresponding impact for a 1% decrease are $73,000 and $5,000, respectively. The weighted average discount rates used in determining the net periodic postretirement benefit cost and accumulated benefit obligation were 7.5% and 7.75% for 2000 and 1999, respectively. The following sets forth the plan's status and accrued postretirement benefit liability recognized in the Company's Consolidated Balance Sheets at December 31 (in thousands): 2000 1999 ---- ---- Actuarial present value of accumulated postretirement benefit obligation: $834 $733 Unrecognized net gain/(loss) (9) 67 ---- ---- Accrued postretirement benefit liability (included in other non-current liabilities) $825 $800 ==== ==== The components of postretirement benefit cost for the years ended December 31, are as follows (in thousands): 2000 1999 1998 ---- ---- ---- Interest cost $61 $53 $42 Net amortization (8) --- --- --- Net periodic cost $61 $53 $34 === === === 24 Deferred Compensation. At December 31, 2000 and 1999, the liability relating to a deferred compensation arrangement between the Company and a director and former officer of the Company was $291,000 and $305,000, respectively. NOTE J. STOCK PLANS At December 31, 2000, the Company has reserved 176,575 shares of its common stock for grant to key employees under the 1990 Stock Option Plan. The plan provides for the grant, at fair market value on the date of grant, of nonqualified stock options and incentive stock options. Options generally become exercisable in three equal annual installments on a cumulative basis commencing six months from the date of grant and expire five years (ten years for awards granted after 1999) after the date granted. The Company also has the 1967 Employee Stock Purchase Plan under which 52,478 shares were reserved for grant at December 31, 2000 The purchase price is 85% of the fair market value of the stock on the date offered. Generally, rights to purchase shares under this plan expire 12 months (maximum 27 months) after the date of grant. The Company also has a time accelerated restricted stock plan ("Restricted Stock Plan") under which 14,687 shares are available for grant. The plan 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. Vesting may be accelerated based on the achievement of certain financial performance goals. Share information pertaining to these plans is as follows: Restricted Option Purchase Stock Plan Plan Plan ------ -------- ---------- Outstanding at January 1, 1998 521,826 0 22,950 Granted 175,725 28,603 39,000 Cancelled or expired (2,000) Vested (20,550) Exercised (9,501) ------- ------ ------ Outstanding at December 31, 1998 686,050 28,603 41,400 Granted 142,875 21,000 Cancelled or expired (4,101) (913) Vested (12,480) Exercised (300,497) (27,690) ------- ------ ------ Outstanding at December 31, 1999 524,327 0 49,920 Granted 202,900 26,000 Cancelled or expired (5,225) (600) Vested (8,280) Exercised (27,126) ------- ------ ------ Outstanding at December 31, 2000 694,876 0 67,040 ======= ====== ====== The exercise price for options granted in 1998 was $6.67, for options granted in 1999 was $9.00 and for options granted in 2000 ranged from $9.06 to $9.70. 25 The weighted average exercise price for the 694,876 options outstanding under the Option Plan is $6.73 with expiration dates ranging from 2001 to 2010. Options were exercised under the Option Plan at weighted average exercise prices of $1.98, $2.08 and $3.95 in 1998, 1999 and 2000, respectively. Shares exercisable under the Option Plan at December 31, 1998, 1999 and 2000 were 419,577, 316,027 and 457,943, respectively. Rights were granted under the Purchase Plan at an exercise price of $5.67 in 1998. Shares were exercised under the Purchase Plan at a weighted average price of $5.67 in 1999. Under the Restricted Stock Plan compensation expense was $146,000, $184,000 and $30,000 in 2000, 1999 and 1998, respectively. During 1998, the Company established a stock option plan for non-employee directors and officers. The plan provided for an initial grant of options to purchase 3,000 shares to each participant (18,000 in total) at $5.50, the fair market value on the date of grant, and additional grants of 1,500 shares for each participant on August 1st of subsequent years at the then fair market value. Effective August 1, 1999, an additional 1,500 shares were granted to each participant (9,000 in all) at an exercise price of $11.17. In 2000, an additional grant of 3,000 shares (18,000 in all) was awarded at an exercise price of $12.63. Through December 31, 2000, no grants under this plan have been exercised. At December 31, 2000, the Company has reserved 7,500 shares of its Common Stock for grant. The Company has elected to follow APB No. 25 and related interpretations in accounting for its stock option plans, and has adopted the disclosure-only provisions of SFAS No. 123. If the Company had elected to recognize compensation expense for the 1990 Stock Option Plan and the 1967 Stock Purchase Plan based on the fair value at the grant date , consistent with the method presented by SFAS No. 123, the pro forma net income and net income per share would be as follows (in thousands except per share information): 2000 1999 1998 ---- ---- ---- Net income As reported $4,530 $5,346 $4,689 ====== ====== ====== Pro forma $3,928 $4,859 $4,442 ====== ====== ====== Net income per share As reported Basic $.79 $.94 $.85 ==== ==== ==== Diluted $.74 $.88 $.78 ==== ==== ==== Pro forma Basic $.68 $.86 $.80 ==== ==== ==== Diluted $.65 $.81 $.75 ==== ==== ==== The estimated weighted average fair value per share of stock options granted were $4.82, $5.16 and $3.21 for 2000, 1999 and 1998, 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 2000, 1999 and 1998, respectively: risk-free interest rates of 5.1%, 5.5% and 4.5%; no dividend yields; volatility factors of the expected market price of the Company's common stock of .74 in 2000, .61 in 1999 and .64 in 26 1998; and a weighted average expected life of the option of 3.8 in all years, and 5 years for the Directors and Officers Plan. 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 employee 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 employee stock options. In 1998, warrants to purchase 54,307 shares of common stock at $1.58 per share were exercised and 20,693 expired. 27 NOTE K. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREAS The Company operates in two segments of the voice processing industry. In the United States, the Company designs, manufactures and sells equipment for use in telephone central offices. In Europe (United Kingdom), the Company distributes equipment for use in customers' premises. Information about the Company's operations by segment and geographic area for the years ended December 31, is as follows (in thousands): 2000 1999 1998 ---- ---- ---- Net sales United States: Unaffiliated customers (North America) $24,511 $24,462 $20,603 Intercompany transfers 55 194 98 ------- ------- ------- 24,566 24,656 20,701 Europe 7,325 7,231 8,314 Eliminations (55) (194) (98) ------- ------- ------- $31,836 $31,693 $28,917 ======= ======= ======= Operating profit United States $ 8,139 $ 9,433 $ 7,247 Europe (529) (138) 878 Intercompany eliminations 8 (10) 18 ------- ------- ------- 7,618 9,285 8,143 General corporate expenses 1,330 1,378 1,202 Other (income) expense, net (619) (441) (404) ------- ------- ------- Income before income taxes $ 6,907 $ 8,348 $ 7,345 ======= ======= ======= Total assets United States $29,262 $31,238 $21,461 Europe 3,779 3,919 5,670 Intercompany eliminations (43) (55) (51) ------- ------- ------- $32,998 $35,102 $27,080 ======= ======= ======= Long-lived assets United States $ 1,545 $ 1,718 $ 1,531 Europe 973 1,432 1,757 Intercompany eliminations (27) (36) (16) ------- ------- ------- $ 2,491 $ 3,114 $ 3,272 ======= ======= ======= Expenditures for long-lived assets United States $ 486 $ 300 $ 384 Europe 98 246 155 Intercompany eliminations 0 (63) 0 ------- ------- ------- $ 584 $ 483 $ 539 ======= ======= ======= Depreciation and amortization United States $ 452 $ 279 $ 261 Europe 494 540 525 Intercompany eliminations (3) (17) (17) ------- ------- ------- $ 943 $ 802 $ 769 ======= ======= ======= 28 Gross profit margin on intercompany transfers are comparable to sales to third parties. The United States operations had net sales of $2.8 million, $1.9 million and $6.8 million in 2000, 1999 and 1998, respectively, to one major customer; sales of $12.6 million, $7.3 million and $5.2 million in 2000, 1999 and 1998, respectively, to another major customer; sales of $2.9 million in 1999 to another customer and export sales of $2.9 million and $2.0 million in 1999 and 1998, respectively, to another customer. The European operations had sales of $3.7 million, $4.6 and $5.2 million in 2000, 1999 and 1998, respectively, to one customer. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant 1. (a) The identification of the directors of the Company as of March 1, 2001 and persons nominated to become directors set forth under the caption Information Concerning Nominees in the Proxy Statement for the annual meeting of stockholders to be held on May 17, 2001 is incorporated herein by reference. (b) The identification of the executive officers of the Company and their positions with the Company and ages as of March 1, 2001 is set forth under the caption Executive Officers of the Company in Part I of this Annual Report on Form 10-K. 2. The information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 set forth under the caption Section 16(a) Beneficial Ownership Reporting Compliance in the Proxy Statement for the annual meeting of stockholders to be held on May 17, 2001 is incorporated herein by reference. Item 11. Executive Compensation The information on executive compensation set forth under the caption Executive Compensation in the Proxy Statement for the annual meeting of stockholders to be held on May 17, 2001 is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management (a) and (b) Security ownership of certain beneficial owners and management set forth under the caption Security Ownership in the Proxy Statement for the annual meeting of stockholders to be held on May 17, 2001 is incorporated herein by reference. (c) Changes in Control. None. Item 13. Certain Relationships and Related Transactions The information on certain relationships and related transactions set forth under the caption Certain Relationships and Related Transactions in the Proxy Statement for the annual meeting of stockholders to be held on May 17, 2001 is incorporated herein by reference. 29 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) and (2) and (d) The response to this portion of Item 14 is submitted as a separate section beginning on page 26 of this Annual Report on Form 10-K. (a)(3) and (c) The response to this portion of Item 14 is submitted as a separate section beginning on page 27 of this Annual Report on Form 10-K. (b) There were no reports filed on Form 8-K during the fourth quarter of 2000. 30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and 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 23, 2001. COGNITRONICS CORPORATION Registrant by /s/ Garrett Sullivan ------------------------- Garrett Sullivan 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 23, 2001. Signature Title --------- ----- Chief Executive Officer: /s/ Brian J. Kelley ------------------- President and Chief Brian J. Kelley Executive Officer Chief Financial and Accounting Officer: /s/ Garrett Sullivan Treasurer -------------------- Garrett Sullivan A Majority of the Board of Directors: /s/ John T. Connor Director ------------------ John T. Connor /s/ Edward S. Davis Director ------------------- Edward S. Davis /s/ William A. Merritt Director ---------------------- William A. Merritt /s/ Timothy P. Murphy Director --------------------- Timothy P. Murphy /s/ David H. Shepard Director --------------------- David H. Shepard 31 Form 10-K -- Item 14 (a) (1) and (2) and (d) (a) (1) Financial Statements The following financial statements of the Company are included in Item 8. Financial Statements Covered by Report of Independent Auditors: PAGE Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . 11 Consolidated Balance Sheets, December 31, 2000 and December 31, 1999 . . . 12 Consolidated Statements of Income and Comprehensive Income for each of the three years in the period ended December 31, 2000. . . . . . . . . 13 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2000 . . . . . . . . . . . . 13 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2000. . . . . . . . . . . . . . . . . . . . 14 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . 15 (2) and (d) Financial Statement Schedules Schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, are inapplicable, or the information has been included in the Company's financial statements. and, therefore, have been omitted. 32 Item 14(a)(3) and (c) INDEX TO EXHIBITS Exhibit 3.1 Certificate of Incorporation as filed on January 2, 1962 (Exhibit 3-1-A to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference). 3.2 Amendment, dated June 28, 1965 (Exhibit 3-1-B to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference). 3.3 Amendment, dated October 3, 1966 (Exhibit 3-1-C to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference). 3.4 Amendment, dated October 30, 1967 (Exhibit 3-1-D to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference). 3.5 Amendment, dated July 27, 1981 (Exhibit 3.5 to Annual Report on Form 10-K for the fiscal year ended December 31, 1983 and incorporated herein by reference). 3.6 Amendment, dated September 27, 1984 (Exhibit 3.6 to Annual Report on Form 10-K for the fiscal year ended December 31, 1984 and incorporated herein by reference). 3.7 Amendment dated June 13, 1988 (Exhibit 3.7 to Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference). 3.8 Amendment dated November 3, 1994 (Exhibit 3.8 to Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference). 3.9 Amendment, dated July 25, 2000 (Exhibit 3.1 to Quarterly Report on Form 10-Q for the period ended June 30, 2000 and incorporated herein by reference) 3.10 By-laws of the Company (Exhibit 3.9 to Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference). 4. Specimen Certificate for Common Stock (Exhibit 4-1 to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference). 10.1 1990 Stock Option Plan, as amended (Exhibit 10.1 to Quarterly Report on Form 10-Q for the period ended June 30, 2000 and incorporated herein by reference). 10.2 Lease, dated April 30, 1993, between Seymour R. Powers and 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). 33 EXHIBIT 10.3 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). 10.4 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). 10.5 2000 Executive Bonus Plan (attached as Exhibit 10.5 to this Annual Report on Form 10-K). 10.6 Cognitronics Corporation Restricted Stock Plan (Exhibit 10.2 to Quarterly Report on Form 10-Q for the period ended June 30, 2000 and incorporated herein by reference). 10.7 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). 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 The Directors' Stock Option Plan, as amended (attached as Exhibit 10.3 to Quarterly Report on Form 10-Q for the period ended June 30, 2000 and incorporated herein by reference). 22. List of subsidiaries of the Company as of December 31, 2000 (attached as Exhibit 22 to this Annual Report on Form 10-K). 23. Consent of Independent Auditors, dated April 2, 2001 (attached as Exhibit 23 to this Annual Report on Form 10-K). Copies of the Exhibits to this Annual Report on Form 10-K are available upon written request to the Secretary of the Company at 3 Corporate Drive, Danbury, CT 06810-4130 and payment of $35.00 for a complete set of the Exhibits or $.25 per page for any part thereof (minimum $5.00).