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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934 [Fee Required]
For the fiscal year ended DECEMBER 31, 1995
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from ______ to ______
Commission File Number 0-14793
TEKNOWLEDGE CORPORATION
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(Name of small business issuer as specified in its charter)
Delaware 94-2760916
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1810 EMBARCADERO ROAD, PALO ALTO, CALIFORNIA 94303
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (415)424-0500
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 par value per share
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year. $5,566,053
The aggregate market value of Common Stock, $.01 par value per share, held by
non-affiliates of the registrant was $6,313,369 on March 20, 1996 (based on the
average bid and ask price per share of Common Stock on that date as reported
over-the-counter by the National Quotation Bureau).
On March 20, 1996, there were 25,953,105 shares of Common Stock, $.01 par value
per share, of the registrant outstanding.
Documents Incorporated by Reference:
Proxy Statement for 1996 Annual Meeting of Stockholders Part III
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PART I
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Item 1. Business
Teknowledge Corporation (the "Company") provides consulting services and
software products for commercial and government applications. The principal
lines of business are focused on distributed intelligent systems, associate
systems, and knowledge-based software. The Company was incorporated on July 8,
1981 under the laws of the State of Delaware. The Company's principal executive
offices are located at 1810 Embarcadero Road, Palo Alto, California 94303.
The Company is the surviving corporation of the merger (the "Merger") of
American Cimflex Corporation ("American Cimflex") and Teknowledge, Inc.
("Teknowledge") which was consummated in 1989. Since the Merger, the Company has
discontinued or divested certain of its business units. Ongoing operations of
the Company consist primarily of the former operations of Teknowledge's
Knowledge Systems Division ("KSD") located in Palo Alto and two satellite field
offices located near San Diego, California and Washington, D.C., established in
1995. At the 1994 Annual Meeting of Stockholders, the Company's name was changed
from "Cimflex Teknowledge Corporation" to "Teknowledge Corporation."
The Company's proprietary software products can be operated on individual
computers and integrated into customer networks. The Company maintains an active
intellectual property program, and currently holds eight U.S. software patents.
The application software developed by the Company includes knowledge-based
expert systems for configuration and sales support, systems to manage webs of
networked information, a customer requirements management package, and systems
that improve network information utilization on the Internet. The Company's
products and services are primarily marketed to the United States Government and
commercial companies, although the Company has several international customers.
Overview
During 1995 the Company experienced a substantial growth in revenues and
income over the previous fiscal year. Net income increased $304,615 to $450,670
and revenues increased $2,148,389 to $5,566,053, or 209% and 63%, respectively.
Because of the increased business, the Company hired a number of new employees
and opened two new business offices in Washington, D.C. and San Diego,
California. The Company is involved in a number of legal proceedings which are
reviewed in Item 3 on page 7. The Board of Directors approved a Shareholder
Rights Plan on January 29, 1996, as reported in a current report, Form 8-K,
filed on February 12, 1996.
Knowledge-based systems are computer software programs that capture,
represent, distribute, and apply knowledge to solve specific applications
problems. The Company develops software architectures and implementations that
integrate conventional software and knowledge systems in distributed,
heterogeneous network applications. These architectures are embodied in products
and services to support distributed intelligent systems integration and
applications.
Computer software applications provide maximum value when integrated into
networked operations, both within and between enterprises. Integration of these
various functions is facilitated if object-oriented software is designed with an
"open architecture." This allows the same applications software and user
interfaces to be distributed via a client-server protocol across many different
types of computers. The Company's products and services are designed to maximize
software integration flexibility and the ability to process and distribute
application knowledge.
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Since the U.S. Department of Defense and many commercial businesses plan
to conduct large-scale operations over international computer networks such as
the Internet, much of the Company's current and future project focus is in
providing associate systems to make it possible to delegate knowledge intensive
tasks to network savvy computer software. Teknowledge plans to commercialize
software that amplifies human productivity through the use of associate systems.
Operations
The Company operates principally from its headquarters located in Palo
Alto, California; however, the Company also has new branch offices located near
Washington, D.C. and San Diego, California.
Distributed Intelligent Systems
The Company is a leader in the architecture, design, and development of
distributed computer systems that exhibit some properties of intelligence such
as situation assessment, adaptive control, domain knowledge representation, and
cooperative problem solving with heterogeneous elements. Projects in this area
include the Defense Advanced Research Projects Agency ("DARPA") sponsored Domain
Specific Software Architecture project for semiautomatic construction of
software systems in distributed control applications, a DARPA sponsored project
to provide an architecture for the Joint Task Force Advanced Technology Program
("JTF-ATD"), and several industrial projects focusing on integrating diverse
software elements in an enterprise.
Associate Systems
Associate Systems provide the ability to delegate tasks to a network
computer-based software associate. These associate systems may accomplish
routine tasks, accelerate information gathering or dissemination over computer
networks, and improve resource utilization. Projects providing technology
infrastructure in this area include the DARPA-sponsored WebMan project to
provide capabilities to the JTF-ATD to create, edit, view, and manage the
structured "webs" of documents and objects that underlie effective collaboration
and planning. The Briefing Associate sponsored by this project supports briefers
in constructing Internet accessible briefings and customizing them for specific
audiences. The DARPA sponsored HIBURST project focuses on the design and
implementation of high-performance information bases using real-time scalable
technology in time-critical applications. This project will produce an associate
for situation assessments, and an accelerator to improve access to information
stored in computer networks. The DARPA sponsored Computer Assisted Education and
Training Initiative is sponsoring Teknowledge's GlobalEdNet project, which will
produce a Parents Associate to enable parents to get advice on parenting and
access to Internet based educational resources, and a Student Associate to
provide a computer-based coach or peer to help guide students in getting the
most from education resources available to them.
Knowledge-based Software
M.4 is a software tool produced by the Company and sold to customers to
build their own knowledge-based problem-solving systems. M.4 and its
predecessors have been sold and supported as shrink-wrapped software since 1985.
It is used primarily as a tool that allows users to embed expertise into other
software systems. M.4 is sold principally on PC platforms, and it includes
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interfaces to Visual BasicTM1, Visual C++TM1, and ToolbookTM2.
The Company has developed application software systems for several
customers to design and check hardware configurations. This configuration
software is in daily use at Applied Materials and Motorola Corporation. The
Company has been building configuration systems for a decade, and has codified
some of that experience in reusable configuration software.
ProductTrackTM is an open system, client-server software product that
enables companies to capture, distribute, track and evaluate product
requirements in order to shorten the time needed to get new products to market.
ProductTrackTM was developed in conjunction with work performed by the Company
for DARPA, and then enhanced with internal development funds.
Enterprise DXTM is available by technology license. It incorporates
best-in-class techniques for solving complex diagnostic problems. Enterprise
DXTM runs primarily on UNIX workstations in a client-server configuration.
Sales and Marketing
Company systems and products are marketed primarily by the Company's
employees, including the Chief Executive Officer, the President, and program
managers, supported by senior technical engineers. Teknowledge is currently
experimenting with marketing its products and services with the use of the
Internet and the World Wide Web (www.teknowledge.com). Each program area offers
consulting services to help prospective customers define their problems and
projects. Some of these consulting assignments are funded by customers and
others are performed at the Company's expense. Except for funded consulting
assignments, customers do not pay directly for any proposal work, unless
agreement is reached in advance.
The customer base for the Company's products and services consists, for
the most part, of government related projects and large domestic corporations.
For the year ended December 31, 1995, the Company's direct revenue mix from
continuing operations by industry was approximately 95% defense and 5% other. In
1994, the Company's mix was approximately 88% defense, 5% computer/electronics,
and 7% other. The Company's business is currently concentrated in the United
States. Less than 1% of the Company's sales in 1995 and 1994 were to customers
outside the United States.
Backlog
At December 31, 1995, the expected order backlog was approximately $10.5
million, which consisted of (i) new orders for which work has not yet begun, and
(ii) revenue remaining to be recognized on work in progress. 100% of the
December 31, 1995 backlog is from government customers. Approximately 34% of the
backlog consists of government-sponsored programs that are awarded but not yet
authorized for funding. The government normally funds a contract in incremental
amounts for the tasks that are currently in production. Backlog is an estimate
and is subject to a number of risks (see Item 6. Management's Discussion &
Analysis or Plan of Operation - Certain Factors That May Affect Future Results
of Operations and/or Stock Price). The portion of the overall backlog that is
reasonably expected to be filled in the current fiscal year is approximately
59%.
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1Visual BasicTM and Visual C++TM are trademarks of Microsoft Corporation.
2ToolbookTM is a trademark of Asymetrix Corporation.
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Research and Development
The Company elected to commercialize government sponsored research and
development, rather than expend additional internal funds on research and
development in 1995. Almost all of the Company's research and development
activities were funded externally, mostly by the Federal government. Generally,
the Company retains the exclusive right to market the government sponsored
research and development commercially.
In accordance with SFAS 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed," the Company incurred software
development costs which were capitalized. These capitalized software development
costs were $103,676 and $382,602, for the periods ended December 31, 1995 and
1994, respectively.
Competition
A number of companies provide consulting services and software that
compete with aspects of the Company's business. Many of these companies are
substantially larger and have greater financial resources than the Company.
Distributed intelligent systems services are provided by Bolt, Beranek, Newman,
ISX, ISI, Battele Labs, Perceptronics, and SAIC. Associate systems are a
relatively new area, but related network agent software is provided by General
Magic Corp., IBM, AT&T, and EIT Corp. Knowledge-based systems are provided by
Carnegie Group, Inference Corp., Neuron Data Corp., Intellicorp, Inc., and
Trinzic Corp.
The major part of the Company's business consists of performing
cost-plus-fixed-fee contracts. The Company also offers licenses for the use of
its software products with installation, maintenance and support services
offered separately. The sales process is traditionally characterized by long
lead times from first contact to sale, substantial up-front sales costs and
significant competition. Contract awards are generally made on the basis of the
concept and quality of the technical proposal, the track record of the bidder,
the quality and experience of project management and technical personnel, and
price.
Proprietary Rights
The Company has relied on a combination of patent, copyright, trade secret
and trademark laws, as well as contractual provisions, to protect its
proprietary technology. The Company has required employees, customers, vendors,
and others who have access to proprietary technology to sign nondisclosure
agreements. The Company retains a proprietary right to commercially market most
of the development that was sponsored by government agencies. The government may
not distribute proprietary information that was developed by the Company to any
third party without first receiving permission from the Company.
The Company provides its software products to end users under
non-exclusive, non-transferable licenses which typically have a perpetual term
unless terminated for breach. The Company protects the source code of its
software products as trade secrets and unpublished copyrighted works.
Additionally, the Company holds patents for the knowledge processing and systems
engineering technologies that form the basis for many of the products and
configuration services that the Company markets.
The Company has registered DELTATM, COPERNICUSTM and ProductTrackTM as
trademarks in the United States. The COPERNICUSTM trademark is also registered
in many foreign jurisdictions. As use of any product name becomes consistent and
established, formal registration of the product name as a trademark will be
obtained in the United States and any applicable foreign jurisdictions.
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Government Contracts
In 1995, approximately 95% of the Company's revenues were from cost-type
government contracts, and 100% of its December 31, 1995 backlog was from
government contracts. Accordingly, the Company's business is dependent upon
successful bidding for government contracts. The Company applies for contracts
in the form of a proposal by responding to Requests for Proposals and Broad
Agency Announcements issued by the United States Federal Government or by prime
contractors under contract to the Federal Government. Proposals include
discussion of the technical approach to be taken to satisfy government or prime
contractor requirements and a detailed presentation of costs expected to be
incurred. The proposal is reviewed and evaluated by technical and administrative
personnel employed by the government or the prime contractor. If the procurement
method is "competitive bid," the contract is awarded to the company which would
best satisfy government or prime contractor requirements. If the procurement
method is a "negotiated award," the government or the prime contractor would
enter into negotiations to determine a price for the contract; upon successful
conclusion to negotiations, a contract is awarded. Government contracts contain
termination clauses which permit contract termination upon the Company's default
or at the contracting party's discretion. (See Part II Item 6. Management's
Discussion and Analysis or Plan of Operation Certain Factors That May Affect
Future Results of Operations and/or Stock Price)
Employees
Including contract engineers and temporaries, the Company had a total of
39 full time employees at December 31, 1995. All of the employees were employed
in the continental United States. The majority of employees, including
management, are technical and they perform direct billable work on contracts, or
software products. A core group of administrative staff performs general and
administrative functions. Much of the company's ability to perform in consulting
or product development is based on the technical expertise of its employees. The
future success of the Company will depend, in part, on the Company's ability to
continue to retain, attract, and motivate highly qualified technical, marketing,
and management personnel. The Company has never had a work stoppage, and it is
not a party to a collective bargaining agreement with any of its employees.
Item 2. Properties
The Company's principal executive offices are located at 1810 Embarcadero
Road, Palo Alto, California. On December 1, 1995 a new lease was signed with the
landlord for 12,919 square feet of office space at an average price of $1.40 a
square foot for a period of three years commencing April 5, 1996. The Company
has an option to extend the new lease for an additional three years at the same
terms and conditions.
On February 19, 1996, the Company signed a five-year lease for a business
office located in Washington, D.C. Over the term of the lease, base rent is
scheduled to rise approximately 3% per annum on the 3,014 square feet of leased
space. The Company will pay an average rent of $1.95 a square foot per month
over the term of the lease.
In January 1994, The Company entered into a settlement agreement with the
landlord for the Company's former Franklin, Massachusetts location. Under the
terms of this agreement, the lease scheduled to expire in May 1999 was
terminated for a total consideration, including accrued interest, of $131,760
which is to be paid in escalating payments over a five-year period. Payments are
due January 31 of each year. As of December 31, 1995, a total of $21,664 in
payments have been made and the remaining liability was included in the
"Provision for Discontinued Operations" (see Part II Item 7: Financial
Statements).
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In September 1993, the Company entered into a settlement agreement with
the landlord at the former Bridgeville, Pennsylvania location. Under the terms
of the agreement, the Company will not have to pay an annual settlement amount
of $18,306 unless there exists a differential in rent between what the new
tenant pays and what the Company was expected to pay during the term of the
original lease. The settlement agreement provides for a maximum payment of
$18,306 by the Company per annum until 1998. There was no such rent assessment
to date. As of December 31, 1995, current and long-term possible assessments
totaling $54,915 were included in "Current Accrued Liabilities - Other " and
"Long-Term Restructuring Obligations", respectively (see Part II Item 7:
Financial Statements).
Item 3. Legal Proceedings
On or about August 2, 1994, Daniel R. Robusto, a former executive of the
Company, filed a suit in the Court of Common Pleas of Allegheny County,
Pennsylvania, pursuant to Pennsylvania Wage Payment and Collection Law, alleging
breach by the Company of an employment settlement agreement and the nonpayment
of severance wages of $107,307 plus liquidated damages of $26,827, attorney fees
and other court costs. The Company has responded to the initial complaint and
asserted certain counterclaims against Mr. Robusto based upon his actions while
in office. A decision against the Company for the full amount claimed could have
an adverse effect on the Company's short-term liquidity, however, the Company is
unable to predict the probability of a favorable or unfavorable outcome because
of the early stage of proceedings.
On December 8, 1994, a lawsuit was filed in the United States District
Court for the Northern District of California by Trilogy Development Group, Inc.
("Trilogy") against the Company. The subject matter of the case involves a
configuration systems patent owned by the Company (Bennett et al. U.S. Patent
4,591,983) and a sales configuration product of Trilogy. Trilogy is seeking a
judgment against Teknowledge that it does not infringe any claim of the Bennett
et al. patent, and for actual and punitive damages and attorney fees for alleged
unfair competition under the Lanham Act and common law for misrepresenting
Teknowledge and Trilogy's products. The Company is vigorously contesting these
matters, and has filed countersuits against Trilogy for patent infringement and
for unfair competition under the Lanham Act and common law for alleged false and
misleading statements disparaging the Bennett et al. patent. The court is
currently reviewing a motion for summary judgment asserting that the Bennett et
al. patent is invalid because the invention was allegedly "on sale" more than
one year prior to the filing date of the patent. Teknowledge contests this
claim. A court decision on this motion is currently pending. Due to the early
stage of the litigation and the nature of the counterclaims, an evaluation
cannot presently be made of the likelihood of a favorable or unfavorable outcome
nor can the Company estimate the amount or range of potential gain or loss. A
favorable or unfavorable outcome could have a substantial impact on the
financial condition of the Company.
On September 19, 1995, Trilogy filed a suit in the Delaware Superior Court
alleging breach of contract by the Company in relation to $125,000 in deferred
payments under a 1987 agreement between BMW Vision Associates Limited
Partnership ("BMW") and American Cimflex Corporation ("ACC"), a predecessor to
the Company. The agreement provided for the sale of technology by BMW to ACC for
a consideration including certain deferred payments. In July 1995, Trilogy
acquired by assignment for $276,786 BMW's right to the remaining deferred
payments and then demanded payment of $525,000 from the Company. In September
1995, the Company paid Trilogy $400,000 in full satisfaction of the $525,000,
disclaiming the obligation to pay the balance of $125,000 which the Company
believes to be barred by statute of limitation. Trilogy filed a suit seeking the
$125,000, subsequent deferred payments, interest and attorney fees. The Company
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believes that it has defenses to the suit and intends to defend itself actively.
The Company has responded to the initial complaint and the litigation is now in
the discovery stage. Due to the early stage of the litigation, an evaluation
cannot presently be made of the likelihood of a favorable or unfavorable
outcome.
Management of the Company believes the above suits are without merit and
intends to defend itself vigorously. Management also believes the ultimate
resolution of the above matters will not have an adverse material impact on the
Company's financial position and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of 1995.
PART II
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Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY & RELATED STOCKHOLDER MATTERS
On September 10, 1993, the Company's Common Stock, par value $.01 per
share ("Common Stock"), was delisted from NASDAQ National Market System ("NASDAQ
NMS") because the Company no longer met NASDAQ NMS minimum qualifications. The
Common Stock continues to be traded, however, in the "bulletin board," an
over-the-counter listing service provided by the National Quotation Bureau. The
price of the stock is updated periodically when a trade is made. As of March 20,
1996, the Common Stock was selling ("bid") for $.31 a share.
The following table sets forth the range of high and low bid information
for the Common Stock in the pink sheets for the quarterly periods indicated. The
bid information reflects inter-dealer prices, without retail mark-up, mark-down
or commission and may not represent actual transactions. The Company has never
paid dividends on its capital stock.
1995 High Low
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First quarter, ended March 31, 1995 $ .25 $ .11
Second quarter, ended June 30, 1995 .35 .10
Third quarter, ended September 30, 1995 .72 .10
Fourth quarter, ended December 31, 1995 .38 .10
1994 High Low
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First quarter, ended March 31, 1994 $ .04 $ .01
Second quarter, ended June 30, 1994 .22 .02
Third quarter, ended September 30, 1994 .21 .09
Fourth quarter, ended December 31, 1994 .32 .08
As of March 11, 1996 there were 2,063 holders of record of Common Stock of
the Company.
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Item 6. Management's Discussion and Analysis or Plan of Operation
Overview of Significant Matters
Forward looking statements made in this section relating to recruiting of
additional employees, increase in demand for new employees, expected growth and
revenues, competition for expected new government contracts, development and
announcement of commercial products, and expected legal expenditures are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. All forward looking statements involve risks and
uncertainties, and actual results could differ materially from those set forth
in the forward looking statements contained herein as a result of competition,
agency funding limitations, other factors relating to government contracting,
ability to attract and retain technical and management personnel, and other
factors described in "Certain Factors That May Affect Future Results of
Operations and/or Stock Price."
Year Ended December 31, 1995
Quarterly Results Summary
(in thousands except for per share data)
First Second Third Fourth Total
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Revenues $1,317 $1,181 $1,480 $1,588 $5,566
Costs and Expenses 1,228 1,138 1,400 1,574 5,340
Other and Tax Provision 60 54 62 49 225
Net Income 149 97 142 63 451
Net Income per share .01 .00 .01 .00 .02
Management believes the Company has entered fiscal 1996 in a favorable
position to compete for new business in both the commercial and government
markets. During 1995, the government restructured its research agencies which
provided a number of new opportunities in areas such as situation assessment,
computer-based education and training, and large scale simulation. The Company
has a track record of success in these areas. Many of the Company's current
projects: Hiburst, WebMan, and GlobalEdNet, directly relate to the activities
planned by the government in their future operations, which opens the
possibility that the Company may be able to convert this experience into
additional awards in 1996. In addition, the Company continues to build software
for the commercial Internet market.
The Company plans on converting the experience gained on government
contracts to commercial opportunities in fiscal 1996. The Company intends to
focus initially on opportunities for new products in the rapidly growing market
for commercial Internet software. The Company anticipates diverting an
increasing amount of resources to the development of new products for web
technology and other commercial applications. Development and presentation of
one new commercial product is expected by the end of the year.
Certain Factors That May Affect Future Results of Operations and/or Stock Price:
Currently, agencies of the U.S. Government sponsor most of the Company's
revenues. In recent years, the portion of the Company's revenues attributed to
government business has risen from 88% in 1994 to 95% in 1995. Competition for
government funding is increasing, but this factor is offset by the strength of
the Company's market niche in open, distributed systems and its growing
technology leadership position. Teknowledge has operated as both a prime
contractor and subcontractor. Depending on specific contract opportunities, it
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may team with other contractors to compete for larger awards. Government
contracts are potentially more risky than commercial contracts because they are
subject to agency funding limitations, congressional appropriation, and the
political agenda of the current administration in Washington, D.C. In addition,
the typical cost-type government contract performed by the Company has a
negotiated fee limit which inhibits the Company from improving profit margins on
the government contract part of the business beyond what is permitted in
government regulations. Federal Acquisition Regulations (FAR) exclude from
reimbursement some "unallowable" expenses which the Company considers a regular
part of the business. Additionally, almost all the Company's contracts contain
termination clauses which permit contract termination upon the Company's default
or at the contracting party's discretion. The Company has not experienced any
material cancellations to date; however there can be no assurance that such
cancellations will not occur in the future.
The indirect costs and expenses accumulated in the performance of
government contracts are allocated to the customer in the form of overhead
(indirect) rates. These rates, which are periodically reviewed by government
auditors, fluctuate based on the relationship between the overhead costs and
direct costs incurred in the performance of the contract. Excluded from these
rates, and not subject to reimbursement, are certain costs which are prescribed
as unallowable by the government, such as entertainment and advertising, and a
considerable portion of litigation costs. In addition, the government has
established compensation limits which expressly reduce the amount of employee
compensation and related expenses, such as bonuses and stock options, that can
be passed on to the government through the rates. In recent years, the Company
has experienced a decline in the fees on new government contracts due to
government cost saving efforts. The limitation on potential government contract
fees coupled with the increase in the expenses not eligible for reimbursement
from the government, limits the Company's ability to improve profit margins on
government contracts in the future; therefore, the Company has increased its
emphasis on commercial Internet software development.
The Company has not been affected by recent stalemates between Congress
and the President regarding the 1996 budget; however, there can be no assurance
that the Company will not be affected in the future.
The Company recognizes that the continued success of the business is
dependent on key management and technical personnel, the loss of one or more of
whom could adversely affect the Company's business. The Company relies on its
executives for the selection and negotiation of government awards, preparation
of proposals, and the general direction and management of the Company. The
Company believes that its future success depends on attracting and retaining
highly skilled technical personnel and other employees (See Item 1. Business -
Employees). Towards this end, Teknowledge hired four additional senior technical
managers in 1995.
The market for software and services related to Associate Systems, as well
as the market for Internet products generally has begun to develop, and is
rapidly evolving. It is characterized by an increasing number of market entrants
who have introduced their products and services for communication and commerce
over the Internet and in private networks. As is typical in the case of a new
and rapidly evolving industry, demand and market acceptance for recently
introduced products and services are subject to a high level of uncertainty. The
industry is young and has few proven products. Moreover, critical issues
concerning the commercial use of the Internet (including profitability,
security, reliability, ease of use and access, and quality of service) remain
unresolved and may impact the growth of Internet use. Management believes that
the technical issues above will eventually be addressed and resolved. The issue
of profitability depends on a variety of business factors, particularly
competition and product acceptance.
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There can be no assurance that commerce and communication over the
Internet or private networks will grow as quickly as expected, or that any
products developed or marketed by the Company will achieve market acceptance for
these purposes. The Company's products may be subject to price erosion and
marketing risks due to free client software distributed by on-line service
providers, Internet access providers, and others. There can also be no assurance
that any products developed by the Company for such new markets, even if
accepted, will generate any significant profits for the Company. Management
believes that the market for Internet software is a significant new opportunity
for growing the company rapidly. Further, management believes that Teknowledge
is in an excellent position to exploit its government network software research
contracts into commercial products. However, if the Internet market fails to
develop, develops more slowly than expected, becomes saturated with competitors,
or if the Company's products for the Internet market do not achieve market
acceptance, the Company's business, financial condition, and results of
operation may be materially and adversely affected.
The Company's operating results are affected by a wide variety of factors,
including successful commercialization of the Company's products, competition
from larger companies, staffing and recruiting competition, general economic
conditions, and the possibility of a favorable or unfavorable outcome in pending
litigations (see Part I Item 3. Legal Proceedings.)
Results of Operations
1995 compared to 1994
Revenues increased $2,148,389, or 63%, to $5,566,053 in fiscal 1995,
compared to a decrease of $1,094,607 from the previous year. Increases in
revenues were primarily attributed to an increase in service revenues from
government contracts which were awarded in late 1994 and early 1995. In response
to the new contracts, the Company hired a number of technical employees which
contributed substantially to the growth in revenues during the period. During
1995, the workforce grew by approximately 34%. The Company continues to recruit
for a number of open positions on existing contracts and anticipates an increase
in demand for new employees in fiscal 1996 as new contracts are awarded.
Management does not expect that the Company will be able to sustain a 63% growth
in revenues during 1996 unless there is a significant improvement in the supply
of qualified technical candidates and new contracts.
Costs of revenues were $3,409,703 and $1,977,498 in 1995 and 1994,
respectively. The increase was attributed to the aforementioned increase in the
technical workforce which supported both existing and new projects. In 1995,
many of the employees hired were placed in either senior or lead positions,
further contributing to the increase. The write down of the remaining value of
the ProductTrack development work, as a result of diminished demand of the
product, contributed $147,128 in additional costs during the period. Cost of
revenues as a percentage of revenue was 61% for 1995 and 58% for 1994.
Combined selling and marketing costs and general and administrative costs
for 1995 were $1,930,239 as compared to $1,562,095 in 1994. The increase was
mainly attributed to a $259,523 increase in legal fees associated with the
patent litigation with Trilogy (see Part I, Item 3. Legal Proceedings) and
additional stock compensation expense of $120,173, pertaining to Common Stock
options granted to executive officers of the Company in a previous period (see
Note 8 of the Notes to Consolidated Financial Statements).
The Company recorded no material charges for research and development
("R&D") in either 1995 or 1994. The Company's annual budget for independent R&D
was diverted to the defense of the patent in both 1995 and 1994. Much of the
<PAGE>
-Page 12-
Company's research and development efforts are funded initially as a government
project which the Company may transform into a Company funded R&D project at a
later date. The Company's future growth plans include increasing investments in
R&D.
The Company had capitalized software development costs from the point at
which technological feasibility was determined through general availability of
the product. In 1995, capitalized software development costs were $103,676 as
compared to $382,602 in the previous year. In 1995, costs were curtailed in the
development of ProductTrack which contributed substantially to the decline in
capitalized software development. M.4 development expenditures accounted for
most of the remaining activity during the year.
Interest income was $41,747 for 1995 as compared to $16,656 for 1994. The
increase was primarily due to a combined effect of better cash management and an
overall increase in the average cash position of the Company. Other income
decreased in 1995 to $199,205 from $253,655 in the previous year. The majority
of this income in 1995 was from the previous sale of a product line. The product
line was sold in exchange for a note and a royalty agreement in 1990. Because of
the uncertainty surrounding the eventual collection of the note, the Company has
elected to recognize the proceeds as other income only when cash is received or
subsequent receipt is certain.
Net income in 1995 was $450,670, or $.02 per share, compared to income of
$146,055, or $.01 per share, in 1994.
Inflation
During the foregoing periods, the Company did not experience any
significant effect from inflation.
Liquidity and Capital Resources
As of December 31, 1995, unused sources of liquidity of the Company
consisted of $962,724 of cash and cash equivalents, an increase of $153,555 from
$809,169 at December 31, 1994. Of this increase, a net of $425,062 was generated
from operating activities, $264,577 was used for investing activities, and
$6,930 was used for financing activities. Net income for 1995 of $450,670, after
adjustments for non-cash outlays such as depreciation and amortization, provided
$1,193,131 in cash to the Company. These proceeds were in turn used to finance
the growth in receivables of $423,261, and to pay off accrued liabilities of
$332,678, which includes a $450,000 payment to Trilogy for the old BMW debt (see
Note 9 of the Notes to Consolidated Financial Statements). As an investment in
future business, the Company used $103,676 in cash for commercial software
development which was capitalized. This amount, and $165,460 used for the
purchase of computer equipment, constituted the majority of investing activities
of the Company in 1995.
The Company believes that the present level of cash and cash equivalents
is adequate to service the liquidity needs of the Company in 1996. The Company
relies principally on the collection of receivables to generate internal cash
reserves. The partial shutdown of the government due to a budget stalemate has
not had an adverse effect on the Company's cash flow; however, the government is
capable of temporarily disrupting the flow of cash to the Company at any time.
In the past, such delays were tied to the annual budget process. A judgment
adverse to the Company in the legal proceedings described in Part I, Item 3
could have a negative material impact on the Company's liquidity if the Company
is subject to penalties or other assessments.
The Company has an unsecured line of credit from a financial institution
in the amount of $400,000. The Company may borrow up to a maximum of 50% of the
<PAGE>
-Page 13-
receivable base or $400,000, whichever is lower. The line is subject to certain
covenants and maintenance requirements, which have been fulfilled. The line
expires on May 10, 1996 but is expected to be renewed. The Company did not
utilize the credit line in 1995.
Item 7. Financial Statements and Supplementary Data
The response to this item is incorporated by reference in a separate
section of this report. See Exhibits and Reports on Form 8-K, Item 13(a)(1) and
(2).
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 9. Directors and Executive Officers of the Registrant
The information required by Item 9 regarding directors and executive
officers of the Company is incorporated herein by reference to the sections
entitled "Election of Directors" and "Executive Compensation - Employment and
Consulting Agreements" included in the definitive proxy statement for the
Company's 1996 Annual Meeting of Stockholders (the "1996 Annual Meeting Proxy
Statement").
Item 10. Executive Compensation
The information required by Item 10 is incorporated herein by reference
to the section entitled "Executive Compensation" included in the 1996 Annual
Meeting Proxy Statement.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 11 is incorporated herein by reference
to the section entitled "Security Ownership" included in the 1996 Annual Meeting
Proxy Statement.
Item 12. Certain Relationships and Related Transactions
The information required by Item 12 is incorporated herein by reference
to the sections entitled "Election of Directors" and "Executive Compensation"
included in the 1996 Annual Meeting Proxy Statement.
Item 13. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) and (2): Financial Statements and Financial Statement Schedules
Reference is made to the Index to Financial Statements preceding the
consolidated financial statements included in response to Part II, Item 7 of
this annual report for a list of all financial statements filed.
(a)(3): Exhibits
Set forth below is a list of all exhibits filed herewith or
incorporated by reference as part of this Annual Report on Form 10-KSB.
<PAGE>
-Page 14-
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certificate of Incorporation of
Teknowledge Corporation (6)
3.2 Amended and Restated Bylaws of Teknowledge Corporation (8)
3.3 Certificate of Designation, Preferences and Rights of the Terms of
the Series A Preferred Stock (8)
4.1 Rights Agreement dated January 29, 1996 between the Company and
Registrar and Transfer Company as Rights Agent (8)
10.1 Teknowledge Corporation 1989 Stock Option Plan
10.2 Development Agreement Amendment, dated December 22, 1987, between
American Cimflex Corporation and Ford Motor Company (1)
10.3 License Agreement, dated February 11, 1987, between American
Cimflex Corporation and BMW Technologies, Inc. (1)
10.4 Technology Sale and Stock Purchase Agreement, dated February 11,
1987, between American Cimflex Corporation and BMW Vision
Associates Limited Partnership (1)
10.5 Stock Option Agreement, effective as of September 1, 1988, between
American Cimflex Corporation and Romesh T. Wadhwani (1)
10.6 Amendment to Stock Option Agreement, dated November 30, 1988,
between American Cimflex Corporation and Romesh T. Wadhwani (1)
10.7 Lease, dated March 30, 1989, between American Automated Factories,
Inc. and Third Copley-Franklin Trust (2)
10.8 Purchase and Sales Agreement, dated September 13, 1990, between
Cimflex Teknowledge Corporation, PaineWebber R&D Partners L.P.
and Applied Diagnostics, Inc. (3)
10.9 Employment Agreement, dated as of December 13, 1990, between
Cimflex Teknowledge Corporation and Daniel R. Robusto (3)
10.10 Asset Purchase Agreement, dated December 14, 1990, between American
Automated Factories, Inc. and Control Automation, Inc. (3)
10.11 Lease, dated June 10, 1991, between Cimflex Teknowledge Corporation
and Pittsburgh Great Southern Company (3)
10.12 Amended Employment Agreement, dated as of January 21, 1992,
between Cimflex Teknowledge Corporation and Daniel R. Robusto (3)
10.13 Settlement Agreement, General Release, and Waiver of Claims, dated
November 21, 1992, between Daniel R. Robusto and Cimflex
Teknowledge Corporation (4)
10.14 Settlement Agreement, dated May 21, 1993, between Cimflex
Teknowledge Corporation and Third Copley-Franklin Trust (5)
10.15 Settlement Agreement, dated September 1, 1993, between Cimflex
Teknowledge Corporation and Pittsburgh Great Southern Company (5)
<PAGE>
-Page 15-
Exhibit No. Description
- ----------- -----------
10.16 Settlement Agreement, dated December 15, 1993, between Cimflex
Teknowledge Corporation and Heitman Michigan Trustee I
Corporation (5)
10.17 Change of Control Agreement, dated November 21, 1994, between
Teknowledge Corporation and Frederick Hayes-Roth and Neil
Jacobstein (7)
10.18 Executive Incentive Compensation Plan, dated January 16, 1996,
between Teknowledge Corporation and Frederick Hayes-Roth and
Neil Jacobstein
23.1 Consent of Arthur Andersen LLP, independent public accountants
27 Financial Data Schedule
References
(1) Filed as an Exhibit to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1989.
(2) Filed as an Exhibit to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1990.
(3) Filed as an Exhibit to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1991.
(4) Filed as an Exhibit to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1992.
(5) Filed as an Exhibit to the Company's Annual Report on Form
10-KSB, as amended, for the fiscal year ended December 31, 1993.
(6) Filed as an Exhibit to the Company's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1994.
(7) Filed as an Exhibit to the Company's Annual Report on Form
10-KSB, for the fiscal year ended December 31, 1994.
(8) Filed as an Exhibit to the Company's Current Report on Form 8-K
dated February 12, 1996, related to the adoption of a 12(g)
Shareholder Rights Agreement dated January 29, 1996.
(b) Reports on Form 8-K
Current Report on Form 8-K dated February 12, 1996, related to the
adoption of a 12(g) Shareholder Rights Agreement dated January 29, 1996.
(c) Exhibits
Reference is made to the response to Item 13(a)(3) above for a list of all
exhibits filed herewith or incorporated by reference as part of this Annual
Report on Form 10-KSB. Reference is also made to the Exhibit Index forming part
of this Annual Report on Form 10-KSB.
<PAGE>
-Page 16-
(d) Financial Statement Schedules
Reference is made to the response to Item 13(a)(1) and (2) above with
regard to the financial statement schedules filed as part of this Annual Report
on Form 10-KSB.
For the purposes of complying with the amendments to the rules governing
Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the
undersigned registrant hereby undertakes as follows, which undertaking shall be
incorporated by reference into registrant's Registration Statements on Form S-8
Nos. 33-27291, 33-77874, 33-78984, 33-82720, and 333-00261.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
<PAGE>
-Page 17-
SIGNATURES
In accordance with 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.
Teknowledge Corporation
Date: March 29, 1996 By: /s/ Frederick Hayes-Roth
------------------------
Frederick Hayes-Roth
Chairman of the Board of
Directors
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 and on the dates indicated.
NAME CAPACITY DATE
/s/ Frederick Hayes-Roth Chairman of the Board March 29, 1996
- --------------------------- of Directors and
Frederick Hayes-Roth Chief Executive Officer
(Principal Executive
Officer)
/s/ Neil A. Jacobstein President, Chief March 29, 1996
- --------------------------- Operating Officer and
Neil A. Jacobstein Director
/s/ Dennis A. Bugbee Director of Finance, March 29, 1996
- ---------------------------
Dennis A. Bugbee Treasurer and Secretary
(Principal Financial and
Accounting Officer)
/s/ General Robert T. Marsh Director March 29, 1996
- ---------------------------
General Robert T. Marsh
/s/ William G. Roth Director March 29, 1996
- ---------------------------
William G. Roth
/s/ James C. Workman Director March 29, 1996
- ---------------------------
James C. Workman
<PAGE>
-Page 18-
ANNUAL REPORT ON FORM 10-KSB
ITEM 7, ITEM 13(a)(1) and (2), (c) and (d)
LIST OF FINANCIAL STATEMENTS
CERTAIN EXHIBITS
FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1995 AND FOR THE TWO YEARS ENDED DECEMBER 31, 1995
TEKNOWLEDGE CORPORATION
PALO ALTO, CALIFORNIA
<PAGE>
-Page 19-
TEKNOWLEDGE CORPORATION
FORM 10-KSB - ITEM 13(a)(1) and (2)
LIST OF CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of Teknowledge Corporation are
included in Item 7:
Page
Report of Independent Public Accountants .............................. 20
Consolidated Balance Sheet - December 31, 1995 ........................ 21 - 22
Consolidated Statements of Operations - Years ended
December 31, 1995 and 1994 ............................................ 23
Consolidated Statements of Stockholders' Equity - Years ended
December 31, 1995 and 1994 ............................................ 24
Consolidated Statements of Cash Flows - Years ended
December 31, 1995 and 1994 ............................................ 25
Notes to Consolidated Financial Statements ............................ 26 - 36
<PAGE>
-Page 20-
Report Of Independent Public Accountants
To Teknowledge Corporation:
We have audited the accompanying consolidated balance sheet of Teknowledge
Corporation (a Delaware Corporation) and subsidiaries as of December 31, 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the years ended December 31, 1995 and 1994. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Teknowledge Corporation and
subsidiaries as of December 31, 1995, and the results of their operations and
their cash flows for the years ended December 31, 1995 and 1994 in conformity
with generally accepted accounting principles.
/s/ Arthur Andersen LLP
San Jose, California
February 12, 1996
<PAGE>
-Page 21-
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEET
As Of December 31, 1995
ASSETS
Current assets:
Cash and cash equivalents $ 962,724
---------------
Receivables:
Customer - billed, net of allowance of $10,000 1,303,581
Customer - unbilled 17,361
Others 34,436
---------------
Total receivables 1,355,378
---------------
Deposits and prepaid expenses 56,704
---------------
Total current assets 2,374,806
---------------
Capitalized software, net of accumulated
amortization of $1,063,733 180,974
---------------
Equipment and improvements, at cost
Computer and other equipment 2,193,790
Leasehold improvements 744,315
---------------
2,938,105
Less accumulated depreciation and amortization (2,694,888)
---------------
Net equipment and improvements 243,217
---------------
Total assets $ 2,798,997
===============
The accompanying notes are an integral part of these financial statements.
<PAGE>
-Page 22-
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEET (CONT'D)
As Of December 31, 1995
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 181,507
---------------
Accrued liabilities:
Payroll and bonuses 435,667
Provision for contract charges 100,567
Provision for discontinued operations 135,615
Technology purchase 100,000
Other 344,414
---------------
Total accrued liabilities 1,116,263
---------------
Total current liabilities 1,297,770
---------------
Long-term liabilities:
Provision for discontinued operations 88,704
Restructuring obligations 36,610
---------------
Total long-term liabilities 125,314
---------------
Total liabilities 1,423,084
---------------
Commitments and contingencies (Notes 3 and 11)
Stockholders' equity:
Preferred stock, $.01 par value, shares
authorized 2,500,000, Series A,
Convertible, none issued -
Common stock, $.01 par value, shares
authorized 50,000,000, issued 25,923,674 259,232
Additional paid-in capital (after (i)
reduction of $57,962,379 for
elimination of accumulated deficit
at December 31, 1992, as a result of
quasi-reorganization; and (ii) increase
of $18,306, $105,706 and $1,001,310 in 1995,
1994 and 1993, respectively as a result of
reversals of portions of 1992 loss provisions) 1,968,719
Deferred compensation (120,173)
Accumulated deficit since January 1, 1993
(following quasi-reorganization) (728,865)
---------------
1,378,913
Treasury stock, at cost, 24,000 shares (3,000)
---------------
Total stockholders' equity 1,375,913
---------------
Total liabilities and stockholders' equity $ 2,798,997
===============
The accompanying notes are an integral part of these financial statements.
<PAGE>
-Page 23-
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
------------------------
1995 1994
---- ----
Revenues $ 5,566,053 $ 3,417,664
--------------- ---------------
Costs and expenses:
Cost of revenues 3,409,703 1,977,498
Selling and marketing 53,049 99,716
General and administrative 1,877,190 1,462,379
--------------- ---------------
Total costs and expenses 5,339,942 3,539,593
--------------- ---------------
Operating income (loss) 226,111 (121,929)
Interest income 41,747 16,656
Interest expense (468) (2,327)
Other income, net 199,205 253,655
--------------- ---------------
Income before tax 466,595 146,055
Provision for income tax 15,925 -
--------------- ---------------
Net income $ 450,670 $ 146,055
=============== ===============
Net income per share $ 0.02 $ 0.01
=============== ===============
Weighted average common and common
equivalent shares outstanding 29,901,487 27,853,077
=============== ===============
The accompanying notes are an integral part of these financial statements.
<PAGE>
-Page 24-
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Two years ended December 31, 1995
<TABLE>
<CAPTION>
Common Stock
------------ Additional
Shares Par Paid-in Deferred Accumulated Treasury
Issued Value Capital Compensation Deficit Stock Total
------ ----- ------- ------------ ------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance,
January 1, 1994 23,044,471 $ 230,440 $ 1,329,714 $ - $ (1,325,590) $ (3,000) $ 231,564
Exercise of
stock options 2,672,400 26,724 31,286 - - - 58,010
Net income - - - - 146,055 - 146,055
Stock compensation expense - - 480,691 (360,518) - - 120,173
Reversal of portions
of provisions made
prior to quasi-
reorganization for:
Restructuring
reserve - - 36,980 - - - 36,980
Discontinued
operations - - 68,726 - - - 68,726
----------- ---------- ------------ ---------- ------------ -------- -----------
Balance,
December 31, 1994 25,716,871 257,164 1,947,397 (360,518) (1,179,535) (3,000) 661,508
Exercise of
stock options 206,803 2,068 3,016 - - - 5,084
Net income - - - - 450,670 - 450,670
Stock compensation expense - - - 240,345 - - 240,345
Reversal of portions
of provisions made
prior to quasi-
reorganization for:
Restructuring
reserve - - 18,306 - - - 18,306
----------- ---------- ------------ ---------- ------------ -------- -----------
Balance,
December 31, 1995 25,923,674 $ 259,232 $ 1,968,719 $ (120,173) $ (728,865) $ (3,000) $ 1,375,913
=========== ========== ============ ========== ============ ======== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-Page 25-
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended December 31,
------------------------
1995 1994
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 450,670 $ 146,055
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Amortization and writedown of capitalized software 330,510 125,325
Depreciation 128,511 131,527
Provision for contract charges 47,653 25,000
Stock compensation expense 240,346 120,173
Gain on sale of fixed assets (4,559) (1,820)
Changes in assets and liabilities:
Receivables (423,261) (239,436)
Deposits and prepaid expenses 2,067 34,678
Accounts payable (14,197) (28,332)
Accrued liabilities (332,678) (598,968)
---------- -----------
Net cash provided by (used for) operating activities 425,062 (285,798)
---------- -----------
Cash flows from investing activities:
Capitalization of software costs (103,676) (382,602)
Purchase of fixed assets (165,460) (74,558)
Proceeds from sale of fixed assets 4,559 5,504
---------- -----------
Net cash used for investing activities (264,577) (451,656)
---------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 5,084 58,010
Payments of capital lease obligations (12,014) (19,269)
---------- -----------
Net cash (used for) provided by financing activities (6,930) 38,741
---------- -----------
Net increase (decrease) in cash and cash equivalents 153,555 (698,713)
Cash and cash equivalents at beginning of year 809,169 1,507,882
---------- -----------
Cash and cash equivalents at end of year $ 962,724 $ 809,169
========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year:
Interest paid $ 468 $ 2,327
Income taxes paid $ 5,666 $ 2,456
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
-Page 26-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. History and Business
Teknowledge Corporation (the "Company") consists of the former
Knowledge Systems Division (KSD) of Cimflex Teknowledge Corporation
("Cimflex"). Prior to 1993, Cimflex restructured and divested a
significant part of its operations. Reserves for discontinued operations
and restructuring obligations were established for those events. In
December 1992, the Board of Directors approved a quasi-reorganization,
which had the effect of eliminating the accumulated deficit at December
31, 1992 of approximately $58 million by reducing paid-in-capital.
Adjustments to previously established reserves and realization of tax
benefits subsequent to the quasi-reorganization will be recorded as
adjustments to additional paid-in-capital in the future. As of December
31, 1995, there remained approximately $224,000 of accrued liabilities for
discontinued operations, of which approximately $110,000 is scheduled to
be paid out over the next three years and the remainder of $114,000
represents potential future payments.
The Company provides software architecture and distributed
intelligent systems to both the U.S. Government and commercial customers.
Most of the Company's government business involves cost-plus-fixed-fee
contracts which are judged to be riskier than commercial contracts because
they are subject to agency funding limitations, congressional
appropriation, and the political agenda of the current administration in
Washington, D.C. The sales cycle is characterized by long lead times,
substantial sales costs and significant competition. The typical cost-type
government contract awarded to the Company has a fee limit prescribed by
government regulations. The Company has experienced a decline in
negotiated fees due to economic factors in recent years. The drop in
potential fees coupled with the fact that Federal Acquisition Regulations
(FAR) exclude from reimbursement certain "unallowable" expenses continues
to erode the Company's ability to maintain or improve profit margins in
the future. The partial shutdown of the government due to a budget
stalemate has not had an adverse effect on the Company's cash flow;
however, the government is capable of temporarily disrupting the flow of
cash to the Company at any time. Additionally, almost all the Company's
contracts contain clauses which allow contract termination at the
government's discretion. The Company has not experienced any material
cancellations to date but there is no assurance that they will not occur
in the future.
Many of the Company's current government projects focus on providing
network associate systems to make information access easier, faster and
more cost-effective for large scale operations over international computer
networks. The Company plans on commercializing its business by applying
this expertise to the development of commercial applications on the
Internet. However, critical issues concerning the commercial use of the
Internet (including profitability, security, reliability, ease of
use and access, and quality of service) remain unresolved and
may impact the growth of Internet use. There can be no assurance
<PAGE>
-Page 27-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. History and Business (cont'd)
that commerce and communication over the Internet or private
networks will become as widespread and grow as quickly as expected, or
that any products developed by the Company will achieve market acceptance.
Moreover, there is no guarantee that the Company's products, even if
accepted, will generate significant profits for the Company, due to free
client software distributed by on-line service providers, Internet access
providers and others, and widespread competition for these services.
The Company recognizes that the continued success of the business is
dependent on key management and technical personnel, the loss of one or
more of whom could adversely affect the Company's business. The Company is
also subject to risks inherent in companies at a similar stage of
development, including the successful commercialization of the Company's
products, competition from larger companies with financial resources
greater than the Company, the ability to retain and attract employees,
capital and financing needs, and the possibility of an unfavorable
resolution of the litigation matters discussed in Note 11.
2. Summary of Significant Accounting Policies
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from the
estimates.
Consolidated financial statements
The consolidated financial statements include the accounts of
Teknowledge Corporation and its wholly owned subsidiaries. All significant
intercompany transactions and balances have been eliminated.
Cash and cash equivalents
Teknowledge considers all highly liquid investments, with original
maturity dates of less than 90 days, as cash equivalents. As of December
31, 1995, the Company's funds were invested almost entirely in money
market instruments at various institutions.
Effective January 1, 1994 the Company adopted Statement of
Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). SFAS 115
<PAGE>
-Page 28-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
2. Summary of Significant Accounting Policies (cont'd)
addresses the accounting and reporting of investments in equity securities
that have readily determinable fair values and requires all investments in
debt securities to be classified as held-to-maturity securities, trading
securities or as available-for-sale securities. The adoption of SFAS 115
did not have a material impact on the Company's financial statements.
Unbilled Receivables
Unbilled receivables represent differences between billings and
revenues recognized on cost-type contracts. The unbilled amounts mainly
represent (i) amounts which are recognized as revenue but not billed
pending receipt of the next funding authorization, (ii) timing differences
between incurred costs and billed costs, and (iii) differences between
actual indirect rates and government-approved billing rates which are not
billable until the final overhead rates are audited and approved by the
Defense Contract Audit Agency. The Company has received final overhead
rate approval for costs incurred through December 31, 1993.
Concentration of credit risk
The Company performs periodic credit evaluations of the financial
condition of commercial customers and generally does not require
collateral. Historically, the Company has experienced only minimal
write-offs from commercial receivables. The Company has not experienced a
credit loss from a government customer nor does it anticipate such losses.
Capitalized software
Teknowledge capitalizes software development costs from the point
technological feasibility is determined through the general availability
of the product. During 1995 and 1994, software development costs of
$103,676 and $382,602 were capitalized, respectively.
The Company's policy is to amortize capitalized software costs by
the greater of (a) the ratio that current gross revenues for a product
bear to the total of current and anticipated future gross revenues for
that product, or (b) the straight-line method over the remaining estimated
economic life of the product including the period being reported on. It is
reasonably possible that those estimates of anticipated future gross
revenues, the remaining estimated economic life of the product, or both
will be reduced significantly in the near term due to competitive
pressures. As a result, the carrying amount of the capitalized software
costs may be reduced materially in the near term.
<PAGE>
-Page 29-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
2. Summary of Significant Accounting Policies (cont'd)
Equipment and improvements
Equipment and improvements, which include assets under capital
leases, are depreciated using the straight-line method over their
estimated useful lives ranging from three to five years. Maintenance and
repairs are charged to expense as incurred. Leasehold improvements are
amortized over the shorter of the useful life or the remaining lease term.
Revenue Recognition
(a) Government contracts
The Company's revenues are primarily generated from U.S. Government
contracts where the Company may be either a prime contractor or
subcontractor. The Company principally uses the percentage-of-completion
method of accounting for contract revenues. The percentage-of-completion
method is based on total costs incurred to date compared with estimated
total costs upon completion of contracts. The Company charges all losses
on contracts to operations in the period when the loss is known.
In 1995, approximately 95% of the Company's revenues were recorded
in connection with cost-type U.S. Government contracts, principally
cost-plus-fixed-fee. These contracts are predominantly funded by the
Defense Advanced Research Projects Agency and administered by various
government agencies. In 1994, cost-type government contracts represented
over 88% of the revenues.
For the year ended December 31, 1995, the Naval Command, Control and
Ocean Surveillance Center was the sponsor of the Company's three largest
government contracts, accounting for approximately 74% of total revenues.
It was also the sponsor of the Company's second largest government contract
in 1994, accounting for approximately 24% of the Company's revenues in that
year. The Armament Research, Development and Engineering Center was the
sponsor of the largest government contract in 1994, accounting for
approximately 33% of the Company's total revenues in that year.
(b) Commercial contracts
Revenues earned under software license agreements with end users are
generally recognized when the software has been shipped and there are no
significant obligations remaining. Revenue from post-contract customer
support is recognized ratably over the period the customer support
services are provided and software services revenue is recognized as
services are performed.
<PAGE>
-Page 30-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
2. Summary of Significant Accounting Policies (cont'd)
Revenues from professional services provided principally under
technology contracts are recognized as costs for time and materials are
incurred.
Net income per share
The number of shares of common stock used in the computation of per
share earnings for the years ended December 31, 1995 and 1994 is the
weighted average number of common and common shares equivalent outstanding
during the applicable periods. Common stock options which are common stock
equivalents are included in 1995 and 1994 because they are dilutive. The
difference between primary and fully diluted earnings per share is
immaterial, therefore only primary earnings per share is presented in the
financial statements.
SFAS 123 Accounting for Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation." The Company is not required to adopt the
provisions of this statement until its fiscal year 1996. The Company
believes the effect on its financial position and results of operations
upon adoption will not be significant, since the Company will retain the
provisions of APB No. 25 to account for stock-based compensation. In
addition, the Company plans to adopt the disclosure provisions of this
statement in 1996.
3. Commitments
Teknowledge leases its facilities and certain equipment under
operating leases. As of December 31, 1995, the Palo Alto location had the
only active facility lease. The remaining obligations under this lease are
as follows:
Year Ending
December 31,
-----------
1996 $208,000
1997 215,000
1998 223,000
1999 59,000
--------
$705,000
========
Net rental expense for December 31, 1995 and 1994 totaled $279,844
and $254,110, respectively.
<PAGE>
-Page 31-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
4. Line of Credit
The Company has a $400,000 unsecured line of credit agreement with a
bank. The line expires on May 10, 1996 and can be extended from year to
year. The Company can borrow up to 50% of eligible receivables or
$400,000, whichever is lower. The maximum rate that may be charged is
prime plus 2.25%. The agreement includes certain financial reporting and
disclosure requirements that were met during the year. The line was not
utilized in 1995 but may be utilized in the future.
5. Tax Loss Carryforwards
In January 1993, the Company adopted on a prospective basis
Statement of Financial Accounting Standards No. 109 (SFAS 109),
"Accounting for Income Taxes." SFAS 109 is an asset and liability approach
for computing deferred income taxes based on enacted tax laws and rates
applicable to the period in which the taxes become payable.
The provision for income taxes differs from the statutory U.S.
Federal income tax rate due to the following:
1995
----
Provision at U.S. statutory rate 34.0%
State income taxes, net of Federal benefit 6.1
Permanent differences 20.6
Tax benefit of net operating loss carryforwards (57.3)
------
Provision for income taxes 3.4%
======
At December 31, 1995, the Company has accumulated net operating loss
carryforwards of approximately $86 million for federal tax purposes. The
availability and timing of the amount of prior losses to be used to
offset taxable income in future years will be limited due to various
provisions, including any change in ownership interest of the Company
resulting from significant stock transactions. Additionally, these loss
carryforwards expire through the year 2009.
The components of the net deferred income tax asset as of December
31, 1995 were as follows:
1995
----
Net operating loss carryforwards $29,379,000
Cumulative temporary differences 495,000
Tax credit carryforwards 1,758,000
-----------
31,632,000
Valuation Allowance (31,632,000)
-----------
Net deferred income tax asset $ 0
===========
<PAGE>
-Page 32-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
5. Tax Loss Carryforwards (cont'd)
The valuation allowance consisted of net operating losses,
cumulative temporary differences and tax credit carryforwards which may
expire before the Company can use them. The Company believes sufficient
uncertainty exists regarding the realizability of these items, and
accordingly, a valuation allowance has been established.
6. Defined Contribution Plan
Teknowledge has a 401(k) plan covering all of the Company's regular
employees. Participants in the plan may make a contribution as a
percentage of their gross wages subject to the applicable government
limits. Effective January 1, 1996, the Board of Directors amended the Plan
to include a matching provision whereby the Company would match
dollar-for-dollar up to 3 percent of employee contributions.
7. Executive Compensation Plan
The Chief Executive Officer and the President of the Company each
have an employment agreement that provides for annual base salaries and an
incentive compensation plan with target objectives established in the five
strategic areas of cash flow, profitability, new bookings, working capital
and recruiting, which were determined and assessed by the Board of
Directors to a maximum payout of 100% of base salary. As of December 31,
1995, $218,847 in incentive compensation was accrued for these executives
and was included in accrued liabilities.
8. Stock Options
Under the Company's 1989 Stock Option Plan, 10,250,000 shares of
Common Stock have been reserved for issuance. The Board of Directors has
granted options to employees that are either incentive stock options (ISO)
or non-statutory stock options (NSO). For ISO, the exercise price of the
common stock options granted under the 1989 Plan may not be less than the
fair market price on the date of grant. For NSO, the exercise price of the
common stock may not be less than 85% of the fair market price of the
common stock on the date of grant. Options that have been granted,
normally vest in quarterly increments over a term of one to four years and
expire ten years after the grant date.
On April 1, 1994 options were granted to the Chief Executive Officer
and the President of the Company for an aggregate of 4,005,760 shares of
Common Stock at $.03 per share. These options vest quarterly over two
years, starting September 30, 1994. The fair market value of the Common
Stock on June 30, 1994, the date the stockholders of the Company ratified
an amendment to the plan to permit the grants, or the measurement date,
was $.15 per share. The Company recorded compensation expense of
<PAGE>
-Page 33-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
8. Stock Options (cont'd)
approximately $240,000 and $120,000 related to the above options in 1995
and 1994, respectively, and anticipates recording compensation expense
of $120,000 in 1996.
A summary of option activities for the two years ended December 31,
1995 were as follows:
Options Option Price
Outstanding-Shares Per Share
------------------ ---------
Outstanding, December 31, 1993 3,599,401 $ .01-$3.53
Granted 4,928,520 $ .02-$ .20
Exercised (2,672,400) $ .01-$ .03
Canceled (135,649) $ .01-$ .94
--------- ------------
Outstanding, December 31, 1994 5,719,872 $ .01-$3.53
Granted 521,000 $ .19-$ .50
Exercised (206,803) $ .01-$ .25
Canceled (153,167) $ .01-$2.63
--------- ------------
Outstanding, December 31, 1995 5,880,902 $ .01-$3.53
========= ============
At December 31, 1995, options for approximately 4,336,087 shares
were vested at prices from $.01 to $3.53 and 1,061,395 shares were
available for future grant.
The Company has a Stock Option Plan for Non-Employee Directors. The
aggregate number of shares which may be issued under the Plan may not
exceed 250,000 shares of Common Stock. 165,000 shares were available for
future grant as of December 31, 1995. Under this plan, non-employee
directors are entitled to receive annual option grants to purchase 15,000
shares of Common Stock on their initial election to the Board and
thereafter on the anniversary date of their election to the Board.
Options, which are granted at fair market value, are exercisable one year
after the grant date. Options to purchase a total of 85,000 shares were
outstanding as of December 31, 1995 at $.15 to $.66 per share. Options for
40,000 shares at $.15 to $.66 per share were vested at December 31, 1995.
No options have been exercised.
As of December 31, 1995, the following number of shares of Common
Stock have been reserved for future issuance:
Teknowledge Corporation 1989 Stock Option Plan 6,942,297
Stock Option Plan for Non-Employee Directors 250,000
---------
7,192,297
=========
<PAGE>
-Page 34-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
9. Technology Purchase
In the early 1980's, Teknowledge entered into an agreement to
provide research and development for machine vision systems with Bavarian
Motor Works A.G. ("BMW"). BMW owned the technology funded under this
development agreement, and granted Teknowledge an option to enter into a
license to market the resultant technology and products. However, because
of changes in its own strategy, Teknowledge purchased all rights in the
technology in 1987 in exchange for stock valued at approximately $780,000
and deferred payments totaling at least $1,000,000 over a period of ten
years, which were to be paid in quarterly increments. In 1990, the Company
accrued all future deferred amounts and charged them against earnings when
the vision systems product line was disposed. Regular minimum quarterly
payments were suspended at that time and the deferred liability remained
unchanged on the books at $675,000 until 1995.
In July 1995, Trilogy Development Group entered into a Stock
Purchase and Assignment Agreement with BMW to purchase all of its holding
of Teknowledge shares and the remaining technology purchase obligation for
$550,000. Trilogy immediately billed the Company $525,000 for the portion
of the obligation that they believed was in arrears. Teknowledge
subsequently paid $400,000 in settlement of this obligation after having
deducted $125,000 for amounts that were barred by the statute of
limitations (See Part I Item 3. Legal Proceedings). The Company continues
to make regular quarterly installment payments of $25,000 on the current
portion of the obligation, which expires on December 31, 1996. The unpaid
balance as of December 31, 1995 was $100,000.
10. Other Income/Expense
The composition of other income is as follows:
1995 1994
---- ----
Revenue for sale of product line $141,530 $183,385
Insurance dividend - 27,374
Other 57,675 42,896
-------- --------
Total $199,205 $253,655
======== ========
11. Contingencies
Litigation
On December 8, 1994, a lawsuit was filed in the United States
District Court for the Northern District of California by Trilogy
Development Group, Inc. ("Trilogy") against the Company. The subject
matter of the case involves a configuration systems patent owned by the
Company (Bennett et al. U.S. Patent 4,591,983) and a sales configuration
<PAGE>
-Page 35-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
11. Contingencies (cont'd)
product of Trilogy. Trilogy is seeking a judgment against Teknowledge that
it does not infringe any claim of the Bennett et al. patent, and for
actual and punitive damages and attorney fees for alleged unfair
competition under the Lanham Act and common law for misrepresenting
Teknowledge and Trilogy's products. The Company is vigorously contesting
these matters, and has filed countersuits against Trilogy for patent
infringement and for unfair competition under the Lanham Act and common
law for alleged false and misleading statements disparaging the Bennett et
al. patent. The court is currently reviewing a motion for summary judgment
asserting that the Bennett et al. patent is invalid because the invention
was allegedly "on sale" more than one year prior to the filing date of the
patent. Teknowledge contests this claim. A court decision on this motion
is currently pending. Due to the early stage of the litigation and the
nature of the counterclaims, an evaluation cannot presently be made of the
likelihood of a favorable or unfavorable outcome nor can the Company
estimate the amount or range of potential gain or loss. A favorable or
unfavorable outcome could have a substantial impact on the financial
condition of the Company. Management of the Company believes the above
suit is without merit and intends to defend itself vigorously.
In December 1994, the Company entered into an agreement with its
legal counsel which was engaged for the Trilogy litigation. Under the
terms of the agreement, should the litigation be terminated as a result of
a merger of Trilogy and the Company, or if Trilogy acquires a majority
interest in the Company who then instructs its legal counsel to
discontinue litigation with Trilogy, then the Company or its successor
would become liable for four times the legal counsel's ordinary and
customary hourly rates plus all expenses incurred.
The Company is also subject to other legal proceedings and claims,
either asserted or unasserted, which arise in the ordinary course of
business. While the outcome of these claims cannot be predicted with
certainty, management does not believe that the outcome of any of these
legal matters will have a material adverse effect on the Company's
consolidated results of operations or consolidated financial position.
Change of Control - Severance Benefits
In the event of a change of control, defined as any consolidation or
merger of the Company in which the Company is not the continuing or
surviving corporation, the Chief Executive Officer and President of the
Company will be entitled to severance benefits to include: (i) full
accrued salaries and vacation pay, (ii) accrued incentive compensation
awarded or determined to be awarded by the Board of Directors, (iii)
insurance coverage, (iv) retirement benefits, (v) a lump sum severance
payment equal to two times their most recent respective annual salaries
<PAGE>
-Page 36-
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
11. Contingencies (cont'd)
and (vi) accelerated vesting of their stock options to purchase a total of
4,005,760 shares of Common Stock at $.03 per share.
Rights Agreement
On January 29, 1996 the Company's Board of Directors approved a
Rights Agreement ("the Plan"). The Adoption of the Plan is intended as a
means to guard against takeover tactics designed to gain control of
Teknowledge without paying all stockholders full and fair value.
Under the Plan, stockholders will receive a Right to purchase one
one-hundredth of a share of a new series of Preferred Stock for each
outstanding share of Teknowledge Common Stock of record held at the close
of business on February 12, 1996.
The Rights, which will initially trade with the Common Stock, become
exercisable to purchase one one-hundredth of a share of the new Preferred
Stock, at $2.00 per Right, when someone acquires 15 percent or more of
Common Stock or announces a tender offer which could result in such person
owning 15 percent or more of Common Stock. Each one one-hundredth of a
share of the new Preferred Stock has terms designed to make it
substantially the economic equivalent of one share of Common Stock. Prior
to someone acquiring 15 percent, the Rights can be redeemed for $.001 each
by action of the Board. Under certain circumstances, if someone acquires
15 percent or more of Common Stock, the Rights permit the holders to
purchase Teknowledge Common Stock having a market value of twice the
exercise price of the Rights, in lieu of the Preferred Stock. In addition,
in the event of certain business combinations, the Rights permit purchase
of the Common Stock of an acquirer at a 50 percent discount. In either
case, Rights held by the acquirer will become null and void.
<PAGE>
-Page 37-
Exhibit 10.1
TEKNOWLEDGE CORPORATION
1989 STOCK OPTION PLAN
(As Amended December 14, 1995)
1. Purpose of the Plan
The purpose of the Teknowledge Corporation 1989 Stock Option Plan (the
"Plan") is to encourage ownership of the Company's stock by eligible employees
of the Company and to provide an increased incentive for such employees to put
forth maximum effort for the success of the business. For purposes of the Plan,
references to the "Company" shall include where appropriate subsidiaries of the
Company.
2. Administration
The Plan shall be administered by the Compensation Committee of the Board
of Directors (the "Committee") which shall consist of not less than three
disinterested directors of the Company who are appointed by the Board of
Directors. For purposes hereof, "disinterested" shall have the meaning set forth
in Rule 16b-3 or any successor rule ("Rule 16b-3") promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Committee
is authorized to interpret the Plan, to prescribe, amend and rescind rules and
regulations to further the purposes of the Plan, and to make all other
determinations necessary for its administration. All such actions by the
Committee shall be final and binding.
3. Shares Subject to the Plan
Up to 10,250,000 shares of the Common Stock of the Company, par value $.01
per share (the "Common Stock"), shall be available for award under the Plan.
Except as otherwise provided in Paragraph 12, if any option shall cease to be
exercisable in whole or in part for any reason, the shares which were covered by
such option but as to which the option had not been exercised shall again be
available under the Plan. Shares shall be made available from authorized and
unissued or reacquired Common Stock.
4. Incentive Stock Options; Nonqualified Stock Options
Awards under the Plan may be in the form of options which qualify as
"incentive stock options" ("Incentive Stock Options") within the meaning of
Section 422 or any successor provision of the Internal Revenue Code of 1986, as
amended (the "Code"), or options which do not qualify ("Nonqualified Stock
Options"). Each award of an option shall be designated in the applicable option
agreement as an Incentive Stock Option, or a Nonqualified Stock Option, as
appropriate.
Exb 10.1-1
<PAGE>
-Page 38-
Exhibit 10.1
5. Participants
The Committee shall determine and designate from time to time those
employees of the Company who shall be eligible to become participants in the
Plan. The Committee may delegate to the Chief Executive Officer of the Company
the right to allocate a specified number of options among employees who are not
officers or directors of the Company within the meaning of the Exchange Act.
Directors of the Company who are not otherwise employees of the Company shall
not be eligible to participate in the Plan.
6. Allotment of Shares
Subject to Paragraph 3, the Committee shall determine from time to time
the number of options to be granted under the Plan, and subject to any
delegation of authority to the Chief Executive Officer pursuant to Paragraph 5,
the number of shares to be covered by each option. In making its determinations,
the Committee shall take into account the present and potential contributions of
the respective participants to the success of the Company, and such other
factors as the Committee shall deem relevant in connection with accomplishing
the purposes of the Plan.
7. Fair Market Value
For all purposes under the Plan, the "Fair Market Value" means, as of any
date, the closing sales price of the Common Stock as reported on the NASDAQ
National Market System or, if appropriate, the National Quotation Bureau "pink
sheets" on the applicable day or, if no sale of the Common Stock shall have
occurred on that day, on the next preceding day on which a sale occurred;
provided, however, that if the Common Stock is not listed on the NASDAQ National
Market System, the Fair Market Value of a share of Common Stock shall be
determined by the Committee, in its sole discretion, or by the Company, in its
sole discretion, if such determination is expressly allocated to the Company
herein.
8. Option Price
Incentive Stock Options shall be granted at an option price of not less
than 100% of the Fair Market Value on the date of grant. Options granted to a
participant who at the time of such grant owns (within the meaning of Section
424(d) of the Code) more than ten percent of the voting power of all classes of
stock of the Company (a "10% Holder") shall be granted at an option price of not
less than 110% of the Fair Market Value on the date of grant. Nonqualified Stock
Options shall be granted at an option price determined by the Committee,
provided, however, that such option price shall not be less than 85% of the Fair
Market Value on the date of grant.
Exb 10.1-2
<PAGE>
-Page 39-
Exhibit 10.1
9. Option Period
The Committee shall determine the period or periods of time within which
options may be exercised by participants, in whole or in part, provided that (i)
the term of an option shall not exceed ten years from the date of grant; (ii)
the term of an option granted a 10% Holder shall not exceed five years from the
date of grant; and (iii) the aggregate Fair Market Value (determined on the date
of grant) of Common Stock with respect to which Incentive Stock Options granted
a participant become exercisable for the first time in any single calendar year
shall not exceed $100,000; and (iv) options shall become exercisable at a rate
of at least 20% per year over five years from the date the options are granted.
10. Other Terms and Conditions
The Committee shall have the discretion to determine other terms and
conditions applicable to options granted under the Plan. Stock options granted
to the same or different employees, or at the same or different times, need not
contain similar provisions.
11. Repurchase Rights
Shares issued under the Plan may be subject to one or more repurchase
options or other conditions and restrictions as determined by the Committee in
its sole discretion at the time the option is granted. The Company shall have
the right to assign at any time any repurchase right it may have, whether or not
such right is then exercisable, to one or more persons as may be selected by the
Company. Upon request by the Company, each participant shall execute any
agreement evidencing such transfer restrictions prior to the receipt of shares
of Common Stock hereunder and shall promptly present to the Company any and all
certificates representing shares of Common Stock acquired hereunder for the
placement on such certificates of appropriate legends evidencing any such
transfer restrictions.
12. Surrender of Options
The Committee may authorize, upon such conditions and restrictions as it
deems advisable and at any time during the period an option is outstanding, the
surrender of the right to exercise an option, or any portion thereof, and the
payment by the Company in exchange therefor of an amount equal to the excess of
the Fair Market Value of the shares covered by the option, or portion thereof,
surrendered, over the aggregate option price of such shares. Such payment may be
made in shares of Common Stock valued at Fair Market Value, or in cash, or
partly in cash and partly in shares of Common Stock as the Committee deems
advisable. If the Committee determines to make part or all of such payment in
shares, such shares shall not be charged against the number of shares of Common
Stock available to be awarded under the Plan. In the event the Committee
Exb 10.1-3
<PAGE>
-Page 40-
Exhibit 10.1
authorizes any surrender of options by an officer or director of the Company (as
such terms are defined in the Exchange Act), such surrender cannot occur less
than six months after the date the Committee authorizes such surrender, and
shall be in accordance with all requirements of the Exchange Act and the rules
and regulations promulgated thereunder, including without limitation any
applicable window period requirements under Rule 16b-3. The shares of Common
Stock covered by an option, or portion thereof, as to which the right to
exercise shall have been surrendered pursuant to this paragraph 12 shall not
again be available for grant under the Plan.
13. Payment for Stock
Full payment for shares purchased shall be made at the time an option is
exercised in whole or in part. Payment of the purchase price shall be made in
cash or in such other form as the Committee may approve, including shares of
Common Stock valued at the Fair Market Value on the date of purchase. No shares
shall be issued until full payment therefor has been made and a participant
shall have none of the rights of a stockholder with respect to options held
except to the extent such options have been exercised.
14. Termination of Options
Unless otherwise determined by the Committee, all rights to exercise or
surrender options shall terminate thirty days following termination of
employment if such termination results from any cause other than death,
disability, or retirement with the consent of the Company after the employee has
reached age of sixty-five ("retirement").
15. Rights in the Event of Retirement
If a participant retires prior to termination of an option without having
fully exercised such option, the participant shall, as may be provided in the
option agreement, have the right within up to one year (or, in the case of
Incentive Stock Options, three months) after such retirement, but only prior to
the expiration of the term of the option, to exercise such option, to the extent
it is exercisable within such period, in whole or from time to time in part.
Exb 10.1-4
<PAGE>
-Page 41-
Exhibit 10.1
16. Rights in the Event of Death
If a participant dies prior to termination of an option without having
fully exercised or surrendered such option, the executors or administrators or
legatees or distributees of his estate shall, as may be provided in the option
agreement, have the right within up to one year after the option holder's death,
but only prior to the expiration of the term of the option, to exercise such
option, to the extent it is exercisable within such period, in whole or from
time to time in part.
17. Rights in the Event of Disability
If a participant becomes totally and permanently disabled within the
meaning of Section 22(e)(3) of the Code or any successor provision, the
participant shall, as may be provided in the option agreement, have the right
within one year after such disability is first determined, but only prior to the
expiration of the term of the option, to exercise such option, to the extent it
is exercisable within such period, in whole or from time to time in part.
18. Effect of Change in Stock Subject to the Plan
In the event of any subdivision or combination of the outstanding shares
of Common Stock, stock dividend, recapitalization, reclassification of shares,
sale, lease or transfer of all or a material portion of the assets of the
Company, substantial distributions to stockholders or other corporate
transactions which would result in a substantial dilution or enlargement of the
rights or economic benefits inuring to participants hereunder, the Committee
shall make such equitable adjustments as it may deem appropriate in the Plan and
the outstanding options, including, without limitation, any adjustment in the
total number of shares of Common Stock which may be available under the Plan.
In the event of: (1) a dissolution or liquidation of the Company; (2) a
merger or consolidation in which the Company is not the surviving corporation;
or (3) a reverse merger in which the Company is the surviving corporation but
the shares of the Common Stock outstanding immediately preceding the merger are
converted by virtue of the merger into other property, whether in the form of
securities, cash or otherwise, then to the extent permitted by applicable law
(i) any surviving corporation shall assume any options outstanding under the
Plan or shall substitute similar options for those outstanding under the Plan,
or (ii) such options shall continue in full force and effect. In the event any
surviving corporation refuses to assume or continue such options, or to
substitute similar options for those outstanding under the Plan, then the
options shall terminate if not exercised prior to such event.
Exb 10.1-5
<PAGE>
-Page 42-
Exhibit 10.1
19. Nonassignability
Options shall not be transferable other than by will or by the laws of
descent and distribution, and during a participant's lifetime are exercisable
only by the participant.
20. Annual Report
The Company shall make available to the holder of any option and the
purchaser of shares of Common Stock upon the exercise of an option, at least
annually, copies of the Company's balance sheet and income statement for the
just completed fiscal year. The Company shall not be required to provide such
information to persons whose duties in connection with the Company assure them
access to equivalent information.
21. Amendment
The Board of Directors may by resolution amend or revise the Plan, except
that any such amendment or revision shall not be effective until the
stockholders shall have approved it, (i) if such amendment or revision would
increase the number of shares which may be awarded under the Plan, materially
increase the benefits accruing to participants in the Plan, or modify the
requirements for eligibility for participation in the Plan, or (ii) if such
approval is required for continued applicability of Rule 16b-3. The Board may
not alter or impair any options previously granted under the Plan without the
consent of the holders thereof, except in accordance with the provisions of
Paragraph 18.
22. Effective Date; Termination of Plan
The Plan shall become effective on the effective date of the merger of
Teknowledge, Inc. and American Cimflex Corporation into the Company. The Plan
shall terminate on December 31, 1998, unless it is earlier terminated by the
Board of Directors of the Company. Termination of the Plan shall not affect
options previously granted under the Plan.
23. Continuation of Prior Plan as to outstanding Options
Any other provision of the Plan to the contrary notwithstanding, the terms
of the Plan in effect prior to its amendment on December 14, 1995 (the "Prior
Plan") shall remain in effect and apply to all options granted pursuant to the
Prior Plan.
Exb 10.1-6
<PAGE>
-Page 43-
Exhibit 10.18
CONFIDENTIAL MEMORANDUM
TO: Compensation Committee of the Board of Directors
FROM: Rick Hayes-Roth
SUBJECT: 1996 Objectives and Executive Incentive Compensation (v2, Final)
DATE: January 16, 1996
I have revised the earlier Memo dated Nov 27 to reflect the changes discussed in
our board meeting today. Here is a list of changes from the earlier version:
1. Various typos fixed.
2. The budget has been modified to incorporate $100K for the Rights Plan,
there by reducing the profit target to 4.5%.
3. The upper end of the profit performance factor has been adjusted to be
8.5%, representing a constant step increment over the budget target.
4. Any net profit improvement potentially resulting from our losing and
dropping the litigation, reducing continuing expenses, and reducing our
government reimbursement rates accordingly will be excluded from eventual
measurement for compensation purposes.
5. Clarified that the additional value of long-term booking awards beyond the
original 18-months' value credited in the initial year of the award are
eventually credited in subsequent years to "new bookings" as the
additional revenues are earned. (Not discussed at the board, but fixes a
problem in earlier language that leaves large portions of long-term awards
without incentive compensation.)
SITUATION:
- - The turnaround is complete. We are no longer merely a "start over." We
have shown quick growth and some profitability.
- - We are suddenly a strong and almost wholly ARPA contractor.
Unfortunately, this puts about a 6-7% ceiling on our profitability, since our
recent contracts have been negotiated with a Government "fee" (profit) of
6-7%.
- - We do not have enough cash for elbow room or speculation.
- - Trilogy has aggressively pursued us on several fronts. The outcome is a
crap shoot. We have modest downside, and moderate upside.
Exb 10.18-1
<PAGE>
-Page 44-
Exhibit 10.18
- - In 1996, given our objectives, NJ and RHR will need to spend more time on the
growth requirements of the company. We will need to launch a commercial business
line.
GOALS FOR 1996:
- - Be profitable.
- - Increase our strength in ARPA/DOD. Try to become the solution provider for
information logistics, in which we save people money by providing high quality
object sharing with reduced communication bandwidth (as in two of our current
contracts). In particular, focus on situation assessment and its role in
decision making. - Launch a commercial business line that exploits the company's
technology portfolio. - We need to free up NJ and RHR to spend more time on
commercial development and corporate development. Thus, our objective is to hire
several key personnel.
OBJECTIVES:
0. Cash gating factor constraint. Cash on hand at end of year (12/31/96)
must exceed $500K.
[15%] 1. Profit. Aim for 4.5% profitability.
[12.5%] 2. Bookings. Overall aim for $7M in new bookings which are earnable
within 18 months of notice of award.
[12.5%] 3. Launch new commercial line. Land several customers in a new
focused business line.
[10%] 4. Fill key company positions. Hire several people capable of
high-performance and independent success, relieving RHR and NJ in at least half
of these key areas: (1) commercial business development, (2) ARPA engineering
management, (3) administration, (4) CAETI EAGIL cluster leadership, (5-7) JTF
ATD architecture, schema and engineering board leadership roles.
BASE COMPENSATION:
I am recommending that we raise base compensation for executives by 5% in 1996,
rounded to nearest $5K. No change was made to the base compensation for
executives in the last three years. This is a minimal increase in light of
expanded responsibilities. The base plan would be:
Basic Contract RHR NJ
--- --
Base salary: $190,000 $125,000
Severance: 12 months 12 months
Change of control: 24 months 24 months
Exb 10.18-2
<PAGE>
-Page 45-
Exhibit 10.18
SPECIFIC GATING FACTOR AND PERFORMANCE FACTORS:
As in the last few years, I suggest adopting a gating factor based on "cash on
hand" at 12/31/96. This gating factor (GF) can scale from 0 to 1 and is a
multiplier on each individual performance factor. We are currently running
between a high of approximately $1300K and a low of approximately $800K. The
proposed gating factor would be 0 below $500K, and then scale linearly from 0.2
at $500K to 1.0 at $900K (or above). To assure that bonuses are not paid in the
case of significant losses, the gating factor would be forced to zero unless we
generate a positive operating cash flow. This includes all items in the budget
but excludes any potential extraordinary financing or board-authorized expenses.
Profit: Target factor would be 15% at 4.5% profit. It would scale linearly
from 0% at 0 profit or below to 15% at 4.5% profit, and then from 15% at 4.5%
profit to 25% at 8.5% profit or higher. If the Trilogy suit is lost and
abandoned, legal expenses would be discontinued, leading to a reduction in
expenses and a corresponding increase in profitability, modulated somewhat by
the decrease in government reimbursement rates. These effects, should they
arise, will be eliminated in determining the actual profits achieved for the
purposes of calculating executive compensation.
Bookings: Target factor would be 12.5% for $7M backlog for business awarded
in 1996 which is earnable within 18 months after award. Revenues produced from
earlier year awards not previously considered part of "bookings" for calculating
this factor would be considered bookings for this purpose. Target factor would
scale linearly from 5% at $4M to 12.5% at $7M, and then linearly from 12.5% at
$7M to 25% at $11M or higher.
New business line. Target factor would be 12.5% for booking three contracts
(at least $100K each) with new customers for new products/services in focus
area. It would scale linearly from 2.5% for 1 customer to 12.5% for 3 customers,
and would scale linearly from 12.5% for 3 customers to 25% for 5 new customers.
Hire key personnel. Target factor would be 10% for hiring three leaders that
could relieve NJ and RHR of substantial technical management duties by July 31,
1996. Management will consult with the Chairman of the Compensation Committee in
advance on candidates for these positions. The factor would scale in accordance
with the date at which these new leaders assume responsibilities for key
responsibilities now requiring major personal efforts by RHR or NJ. The
following positions are available for these new leaders: (1) commercial business
development, (2) ARPA engineering management, (3) administration, (4) CAETI
EAGIL cluster leadership, (5-7) JTF ATD architecture, schema and engineering
board leadership roles. If four key hires have assumed leadership
Exb 10.18-3
<PAGE>
-Page 46-
Exhibit 10.18
responsibilities for four or more of these responsibilities by July 1, the
performance factor will be 20%. If only two people have assumed leadership
responsibilities by December 1, the performance factor will be 0%. Hires who do
not remain in significant leadership roles continuously through December 31 will
not be counted. All other combinations of 1 and 4 people between these dates
will be associated with the following performance factors:
Second person Performance factor increment
hired not later for first two hires
than
November 1 1.25%
October 1 2.50%
September 1 3.75%
August 1 5.00%
July 1 6.25%
Third person Additional performance factor
hired not later increment for third hire
than
December 1 1.25%
November 1 2.00%
October 1 2.75%
September 1 3.75%
August 1 5.00%
July 1 6.25%
Fourth person Additional performance factor
hired not later increment for fourth hire
than
December 1 1.25%
November 1 2.50%
October 1 3.75%
September 1 5.00%
August 1 6.25%
July 1 7.50%
Exb 10.18-4
<PAGE>
-Page 47-
Exhibit 10.18
RESOLUTION OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS:
We agree to implement the 1996 Exec Compensation plan as described in this
January 16, 1996 memorandum from Rick Hayes-Roth.
Signed:
/s/ Bill Roth 1/16/96
------------------------ ------------------------
Bill Roth, Chairman Date
/s/ Tom Marsh 1/16/96
------------------------ ------------------------
Tom Marsh Date
/s/ James Workman 1/16/96
------------------------ ------------------------
James Workman Date
Exb 10.18-5
<PAGE>
-Page 48-
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-KSB, into the Company's previously filed
Registration Statements File Nos. 33-27291, 33-77874, 33-78984, 33-82720 and
333-00261 on Form S-8.
/s/ Arthur Andersen LLP
San Jose, California
March 29, 1996
Exb 23.1-1
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
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0
0
<OTHER-SE> 1,116,681
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<SALES> 0
<TOTAL-REVENUES> 5,566,053
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<INCOME-TAX> 15,925
<INCOME-CONTINUING> 450,670
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<EXTRAORDINARY> 0
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