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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, 1996
[ ] 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
(Name of small business issuer as specified in its charter)
Delaware 94-2760916
(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. $7,158,763
The aggregate market value of Common Stock, $.01 par value per share, held by
non-affiliates of the registrant was $13,675,134 on March 20, 1997 (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 26,205,643 shares of Common Stock, $.01 par value
per share, of the registrant outstanding.
Documents Incorporated by Reference:
Proxy Statement for 1997 Annual Meeting of Stockholders Part III
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PART I
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Item 1. Description of Business
Teknowledge Corporation (the "Company") is in the distributed knowledge
processing business. Teknowledge is leveraging its core competencies in
knowledge based systems and large scale, distributed object-oriented software
with the expanding opportunities presented by the Internet and the World Wide
Web. The Company provides software products and consulting services for
commercial and government applications. The Company's key business lines are:
Sales Associate Product, Education & Training Technologies, Command & Control,
Situation Assessment and Data Fusion, and Distributed Systems Engineering. 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 and Teknowledge, Inc., 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 located in Palo
Alto and three satellite engineering offices located in San Diego, California
(1995), Washington, D.C.(1995), and Orlando, Florida (1996).
The Company's commercial software products can be operated on
individual computers and integrated into the Internet or intranets. The Company
maintains an active intellectual property program, and currently holds eight
U.S. software patents. The application software developed by the Company
includes the Sales Associate(a) which interviews customers and configures sales
orders on the Internet, knowledge-based expert systems, and systems to manage
webs of networked information. The Company's products and services are primarily
marketed to domestic commercial companies and the United States Government,
although the Company has several international customers.
Overview
Knowledge-based systems are computer software programs that capture,
represent, distribute, and apply knowledge to solve specific applications
problems. The Company develops software architectures, designs, and operational
systems 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 the value of distributing and activating application
knowledge within flexible frameworks for software integration.
Since the U.S. Department of Defense and many commercial businesses are
now conducting large-scale operations over international computer networks such
as the Internet, much of the Company's current and future business focus is on
providing associate systems to make it possible to delegate knowledge-intensive
tasks to network-enabled computer software associates systems. These associate
systems may accomplish routine tasks, accelerate information gathering,
disseminate knowledge over computer networks, or improve resource utilization.
Teknowledge's strategic plans include commercializing software that amplifies
human productivity through the use of these associate systems. Teknowledge has
built six associate systems and commercialized one. These systems include:
Briefing Associate, the Parent's Associate, the Student's Associate, the Project
Center Associate, the Desktop Associate, and the commercial Sales Associate.
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Operations
Teknowledge headquarters is located in Palo Alto, California. The
Company continues to expand its technical staff at its headquarters and in the
Washington DC, San Diego, and Orlando branch offices. The Company has five
program areas that provide interrelated but distinct lines of business from the
commercial Sales Associate product to R&D on distributed object oriented systems
as discussed below.
Sales Associate Product
The Sales Associate is a commercial software product for providing
unassisted sales over the Internet. It incorporates rules of selling and
utilizes specific product knowledge to emulate the best practices of the most
productive sales person in a firm. The product goes beyond the typical browsing
interaction on the World Wide Web by engaging the customer in an interactive
dialog about products. The Sales Associate creates a unique profile of every
customer and specializes the sales presentation to each prospect. It never
forgets a customer's profile and preferences, and the Associate uses all
available information towards the next sale. The system can specialize its
visual form to match the user's profile, selecting among web text, audio, or 3D
renditions. The Sales Associate incorporates both generic and domain-specific
"rules of selling" to guide the sales process. It matches a customer profile
with the products in a product knowledge base. The Sales Associate delivers
up-to-the minute information on product features and availability, as well as
news of special discounts and other promotions. Sales are processed immediately
on-line through electronic credit or digital cash. Customer fulfillment comes
via mail or local delivery. The Sales Associate is a new product in a new market
category. There are uncertainties and risks associated with the introduction of
any new software product, but the Company is committed to making the Sales
Associate a commercial success.
The Company has also 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 over a decade, and has
codified some of that experience in reusable configuration software.
M.4 is a commercial software tool produced by the Company and sold to
customers who want to build their own knowledge-based problem-solving systems.
M.4 and its predecessors have been sold and supported by Teknowledge as
shrink-wrapped software since 1985. M.4 is used primarily as a tool that allows
users to embed expertise within other software systems. M.4 is sold principally
on PC platforms, and it includes interfaces to Visual BasicTM1, Visual C++TM1,
and ToolbookTM2. The market for expert systems tools is limited, but M.4
provides a useful infrastructure for developing knowledge based application
systems.
1 Visual Basic(a) and Visual C++(a) are trademarks of Microsoft Corporation.
2 Toolbook(a) is a trademark of Asymetrix Corporation.
Education and Training Technologies
The Internet and the World Wide Web have created a new opportunity for
formerly isolated desktop systems that provided computer-aided instruction. Not
only have the techniques of computer aided instruction improved dramatically in
recent years, but the means to distribute them have undergone a veritable
revolution. Now it is possible to provide distance learning via an interactive
course delivered through a standard World Wide Web browser or associated
application system. There are opportunities to deliver in-house corporate
training over intranets, K-12 education over the Internet, and just-in-time
adult training on the job or in the home. Teknowledge has been involved in
education and training since 1981, and in 1996 it created a program devoted
entirely to this growing opportunity. Teknowledge has served for the past two
years as the Cluster Leader for the US's largest multi-institution project on
Intelligent Tutors and Associates. The DARPA sponsored Computer Assisted
Education and Training Initiative is sponsoring Teknowledge's Parents Associate
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to enable parents to get advice on parenting and access to Internet based
educational resources, and a Center Associate to provide a computer-based coach
or peer to help guide users in getting the most from education resources
available to them. Teknowledge is actively developing distance learning
technology to provide cost effective industrial strength courseware over the
Internet.
Command and Control
Teknowledge's Command, Control, Communications, Computer, and
Intelligence ("C4I") program is focused on intelligent use of computers and
communications in command and control applications. These applications may be
used in times of natural disasters such as floods or hurricanes, humanitarian
interventions into war torn areas such as Bosnia, or external conflicts, such as
the Gulf War. A keystone of C4I systems is that they use all of the available
information provided by web servers, situation servers, and other specialized
servers. The resulting digital planning space is used to assess alternative
courses of action, to select action plans, and to monitor and control the
results of those plans. Teknowledge has contracts to provide architectures and
systems implementations for several command and control applications.
The Briefing Associate developed in this program supports briefers in
constructing Internet accessible command and control briefings and customizing
them for specific audiences.
Situation Assessment and Data Fusion
Complex problem solving in emergencies, competitive enterprises, or
external conflicts, typically requires the problem solver to access and combine
data from multiple sources, and to develop a dynamic assessment of an evolving
situation. Teknowledge's Situation Assessment and Data Fusion program focuses on
providing distributed tools and systems infrastructure to fuse data from
multiple sources and combine those data into a cogent and often shared
perception of a situation. An example of a project in this program includes the
DARPA sponsored HIBURST project which focuses on the design and implementation
of high performance information bases using real-time scaleable technology in
time critical applications. This project will produce a situation server, and an
accelerator to improve access to information distributed throughout computer
networks.
Distributed Systems Engineering
Operations that are globally distributed over the globe require
extensive object-oriented systems infrastructure. Currently, the World Wide Web
provides little of this systems infrastructure, and instead relies on the
distribution of multimedia documents. In the future, complex webs of objects and
knowledge will have to be distributed systematically. This requires the ability
to provide high performance, security of operations, maintainability, and
distribution by intelligent "push" and "pull" techniques. In addition, the types
and quantity of knowledge distributed will require new conceptual schemas and
new software for distributed knowledge processing tasks. Teknowledge's
Distributed Systems Engineering program focuses on providing precisely this type
of infrastructure.
Sales and Marketing
Company systems and products are marketed primarily by the Company's
employees, including the Chief Executive Officer, the President, and five
experienced program managers, supported by senior technical engineers. 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 fund proposal work, unless agreement is
reached in advance.
The customer base for the Company's products and services consist
primarily of government related projects and large industrial corporations. For
the year ended December 31, 1996, the Company's direct revenue mix from
continuing operations by industry was approximately 98% government and 2%
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commercial products and services. In 1995, the Company's mix was approximately
95% government and 5% commercial products and other services. The Company's
business is currently concentrated in the United States. Less than 1% of the
Company's sales in 1996 and 1995 were to customers outside the United States.
Backlog
At December 31, 1996, the expected order backlog was approximately
$18.5 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, 1996 backlog is from government customers. Approximately 76% 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 fulfilled in the current fiscal year
is approximately 38%.
Research and Development
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 R&D 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 $59,485 and $103,676 for the periods ended December 31,
1996 and 1995, 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.
Sales and configuration systems are provided by Trilogy Development Group,
Calico, Concentra, and others. Knowledge-based systems are provided by Carnegie
Group, Inference Corp., Neuron Data Corp., Intellicorp, Inc., and Trinzic Corp.
Distributed systems engineering, data fusion, and C4I services are provided by
Bolt, Beranek, Newman, ISX, ISI, Battele Labs, Perceptronics, Pacific Sierra
Research, and SAIC. Internet-based distance education and training technologies
are mostly in the R&D stage, with competitors still emerging in the commercial
marketplace.
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 market commercially 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 for commercial purposes without first receiving permission from the
Company.
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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 Sales AssociateTM as a trademark in the
United States. The COPERNICUSTM trademark is also registered in the US and many
foreign jurisdictions. As use of any product name becomes consistent and
established, the Company intends to apply for formal registration of the product
name as a trademark in the United States and any applicable foreign
jurisdictions.
Government Contracts
In 1996, approximately 98% of the Company's revenues were from
cost-type government contracts, and 100% of its December 31, 1996 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 the government's or
the prime contractor's 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 the government's or the prime contractor's
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 of negotiations, a contract is awarded.
Government contracts contain termination clauses which permit contract
termination upon the Company's default or at the government's discretion.
Currently, agencies of the U.S. Government sponsor most of the
Company's technical work. In recent years, the portion of the Company's revenues
attributed to government business has risen from 95% in 1995 to 98% in 1996.
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. However, the particular government customers that have
sponsored Teknowledge contract work have been unusually stable in recent years.
While there is no guarantee that this will continue to be the case, it is an
indication of the priority that the government has historically placed on this
type of contract R&D work.
The typical cost-type government contract performed by the Company has
a regulated fixed fee limit which inhibits the Company from improving profit
margins on the government contract part of the business beyond what is permitted
in the 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 (less than 5% of
total costs in `96) which are prescribed as unallowable by the government, such
as entertainment and advertising, and a considerable portion of patent
litigation costs. In addition, the government has established compensation
limits for employees which expressly reduce the amount of compensation and
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related expenses, such as bonuses and stock options, that can be passed on to
the government through the overhead rates. In recent years, the Company has
experienced a decline in the fees on new government contracts due to government
cost saving efforts. Some new contracts may not suffer this fee erosion.
However, the overall limitation on potential government contract fees coupled
with some increase in the expenses not eligible for reimbursement from the
government combine to limit the Company's ability to improve profit margins on
government contracts in the future. The Company's government-sponsored R&D is
most valuable as a technology incubator, development laboratory, and testbed.
The best software from this work becomes candidates for commercial software
products. This helps the government amortize the considerable cost of
maintenance, and it provides Teknowledge with the opportunity to compete in an
growing commercial marketplace.
Employees
Including contract engineers and temporaries, the Company had a total
of 49 full time employees at December 31, 1996. All the employees were employed
in the continental United States. The majority of employees, including top
management, are technical. They perform direct billable work on contracts or
develop and support software products. A core group of administrative staff
performs general and administrative functions. A large percentage of the
employees hold advanced degrees in technical disciplines. 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. This has become a particular challenge as increasing
demand for top quality software professionals has exceeded supply. 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. Description of Property
The Company's 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. Over the term of the lease the Company will pay an average rent of
$1.95 a square foot per month.
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, 1996, a total of $43,056 in
payments have been made and the remaining liability was included in "Long-term
liabilities - Provision for discontinued operations" and "Current liabilities -
Other" (see Part II Item 7: Financial Statements).
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 avoid 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 have been no such rent assessments to date. As of
December 31, 1996, current and long-term future possible assessments totaling
$36,610 were included in "Current liabilities - Other" and "Long-term
liabilities Restructuring obligation" (see Part II Item 7: Financial
Statements).
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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. The litigation process is continuing.
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 has filed
counterclaims 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.
On August 27, 1996, Teknowledge and Trilogy Development Group, Inc.
agreed to a settlement of their disputes. On August 29, 1996, Trilogy's
attorneys provided written notification to the Federal District Court that the
companies had reached a settlement. Under the agreement, Trilogy would provide
consideration to Teknowledge and Teknowledge would grant a license to Trilogy
to use the technology covered by the patent-in-suit. The agreement also
provided that all lawsuits between the parties would be dismissed and that all
previously existing debt between the parties would be canceled. The other
details of the agreement are to be kept confidential by both parties.
Nevertheless, on August 30, 1996, before formal documentation of the
settlement agreement was finalized, but after Trilogy's lawyers confirmed to
the Court in writing that the case had been settled, the U.S. District Court
entered an order granting Trilogy's motion for summary judgment invalidating
the patent. In view of the Court's order, Trilogy has taken the position that
no settlement yet exists and that it need not abide by the terms to which the
parties agreed and represented to the Court. The Company has informed Trilogy
that the Company intends to enforce the settlement agreement, and believes
that Trilogy has breached the settlement agreement. Accordingly, on September
20, 1996, the Company filed a motion to vacate the judgment in light of the
prior settlement. The Company and Trilogy engaged in discussions regarding the
settlement agreement in light of the Court's judgment; however, there is no
assurance that the parties will be able to resolve the issues without further
litigation, that the Company's motion to vacate and dismiss will be
successful, or that the Company will be able to enforce the settlement
agreement.
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. On
August 20, 1996, the Court denied the Company's motion for partial summary
judgment on the choice of law issue, deciding that California law, instead of
Pennsylvania law, should apply to the issue of accord and satisfaction. The
Company is preparing a motion for summary judgment on its statute of
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limitations defense. However, the final outcome of this litigation may be
decided by the ultimate enforceability of the settlement agreement between the
Company and Trilogy described in the preceding paragraph, which provides for
the dismissal of this lawsuit and the settlement of the underlying claim.
Management of the Company believes the above suits are without merit
and intends to defend itself vigorously. Management 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 1996.
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PART II
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Item 5. Market for Common Equity and Related Stockholder Matters
The Common Stock of Teknowledge is traded under the symbol TEKC on the
"Bulletin Board," an over-the-counter ("OTC") listing service provided by the
National Quotation Bureau. The price of the stock is updated periodically when a
trade is made. On March 25, 1997, the listed closing "bid" price of the stock
was $.51 a share.
The following table sets forth the range of high and low bid
information for the Common Stock on the OTC Bulletin Board 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.
1996 High Low
First quarter, ended March 31, 1996 $ .55 $ .25
Second quarter, ended June 30, 1996 .86 .46
Third quarter, ended September 30, 1996 .86 .56
Fourth quarter, ended December 31, 1996 .72 .40
1995 High Low
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
As of December 31, 1996 there were 1,992 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, 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, 1996
Quarterly Results Summary
(in thousands except for per share data)
First Second Third Fourth Total
Revenues $1,671 $1,662 $1,847 $1,979 $7,159
Costs and Expenses 1,554 1,551 1,705 1,882 6,692
Other and Tax Provision 55 42 47 61 205
Net Income 172 153 189 158 672
Net Income per share .01 .00 .01 .00 .02
The Company's revenues for the year ended December 31, 1996 increased
to $7,158,763, a 29% improvement over 1995. Sales to Federal Government entities
contributed 98% of total revenues for the year. Total revenues are expected to
increase further due to the 76% increase in backlog of $18.5M versus $10.5M as
of December 31, 1995. Of the $18.5M, $12.0M in new contracts were awarded to the
Company in late 1996 and are expected to contribute to an increase in revenues
by mid-1997, provided the Company is able to attract and retain additional
software engineers. The Company competes for software engineering professionals
in a highly dynamic industry against companies which often have more resources
and a higher visibility than the Company. Recruiting software engineers in
Silicon Valley has become particularly difficult in recent years as demand has
outpaced supply. However, the Company has had moderate success in recruiting new
technical employees for its branch facilities, particularly in Washington, D.C.,
and management believes future development of the technical staff may favor one
or more of the branch office locations.
Certain Factors That May Affect Future Results of Operations and/or Stock Price:
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 aspects of the Company's business. The hiring of
five senior program managers in the past two years will mitigate this risk. The
Company relies on its executives and program managers for the attainment 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.
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 utilize software
developed under R&D contracts into new 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
<PAGE>
- Page 12 -
do not achieve market acceptance, the Company's business, financial condition,
and results of operation may be materially and adversely affected. There can be
no assurance that commerce over the Internet or the demand for associate systems
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.
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, ability to staff and recruit employees,
general economic conditions, and the possibility of an unfavorable or favorable
outcome in pending litigation (see Part I Item 3. Legal Proceedings).
Results of Operations
1996 compared to 1995
Revenues increased $1,592,710, or 29%, to $7,158,763 in 1996, as
compared to a 63% growth in revenues in the previous year. This increase was
attributable primarily due to increased service revenues from additional
government contracts awarded in 1996 and ongoing service revenues on previously
awarded contracts. The Company continues to recruit and employ additional
technical employees to meet the needs of awarded contracts. Future revenue
growth is expected in 1997 due to the addition of several new government
contracts in the fourth quarter of 1996.
Cost of revenues were $4,541,823 and $3,409,703 in 1996 and 1995, to
63% and 61% of revenues, respectively, primarily due to an increase in the costs
associated with the growth in the technical workforce which support both new and
existing projects.
Combined selling and marketing costs and general and administrative
costs for 1996 were $2,150,659, or 30% of revenues, versus $1,930,239, or 35% of
revenues in 1995. The decrease is primarily due to a reduction in compensation
expenses of $120,000 associated with the grant of options to executives which
were fully vested in 1996, as well as overall cost control efforts.
The Company recorded no charges for research and development ("R&D") in
either 1996 or 1995. Much of the Company's research and development efforts are
funded through government projects, and the Company may transform results from
these efforts into Company-sponsored products at a later date.
Interest income was $57,612 in 1996 versus $41,747 for 1995. The
increase was primarily due to increased cash balances during the year. Other
income decreased by $25,606 to $173,131 in 1996. Other income in 1996 and 1995
primarily resulted from the cash receipts for the sale in 1990 of a product
line. In 1996, the Company received the final payment and there will be no other
income from this sale in the future.
Net income in 1996 was $672,374 versus $450,670 in 1995. Income per
common share was $.02 for each year.
Inflation
During the foregoing periods, the Company did not experience any
significant effect from inflation.
Liquidity and Capital Resources
As of December 31, 1996, unused sources of liquidity of the Company
were $1,797,892 in cash and cash equivalents, an increase of $835,168 over the
previous year. Cash totaling $1,148,976 was provided by operating activities.
<PAGE>
- Page 13 -
Cash was reduced by $317,713 in capital expenditures, which was invested
primarily in the development of the Sales Associate system, and the purchase of
computer equipment and other improvements for the new branch office located in
Washington D.C.
The Company believes that the present level of cash and cash
equivalents is adequate to service the liquidity needs of the Company in 1997.
The Company relies principally on the collection of receivables to generate
internal cash reserves.
The Company has an unsecured line of credit from a financial
institution in the amount of $1,000,000. The Company may borrow up to a maximum
of 60% of the receivable base or $1,000,000, whichever is lower. The line is
subject to certain covenants and maintenance requirements, which have been
fulfilled. The line expires on May 10, 1997 but is expected to be renewed. The
Company did not utilize the credit line in 1996.
Item 7. Financial Statements
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, Executive Officers, Promoters and Control Persons;Compliance
With Section 15(a) of the Exchange Act
- -------------------------------------------------------------------------------
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 1997 Annual Meeting of Stockholders (the "1997 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 1997 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 1997 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 1997 Annual Meeting Proxy Statement.
Item 13. Exhibits 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
<PAGE>
- Page 14 -
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.
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)
Exhibit No. Description
10.1 Cimflex 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)
10.10Asset Purchase Agreement, dated December 14, 1990, between
American Automated Factories, Inc. and Control Automation, Inc.
(3)
10.11Lease, dated June 10, 1991, between Cimflex Teknowledge
Corporation and Pittsburgh Great Southern Company (3)
10.12Amended Employment Agreement, dated as of January 21, 1992,
between Cimflex Teknowledge Corporation and Daniel R. Robusto (3)
10.13Settlement Agreement, General Release, and Waiver of Claims,
dated November 21, 1992, between Daniel R. Robusto and Cimflex
Teknowledge Corporation (4)
10.14Settlement Agreement, dated May 21, 1993, between Cimflex
Teknowledge Corporation and Third Copley-Franklin Trust (5)
10.15Settlement Agreement, dated September 1, 1993, between Cimflex
Teknowledge Corporation and Pittsburgh Great Southern Company (5)
<PAGE>
- Page 15 -
10.16Settlement Agreement, dated December 15, 1993, between Cimflex
Teknowledge Corporation and Heitman Michigan Trustee I
Corporation (5)
Exhibit No. Description
- ---------- -----------
10.17Change of Control Agreement, dated November 21, 1994, between
Teknowledge Corporation and Frederick Hayes-Roth and Neil
Jacobstein (7) 27 Financial Data Schedule
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
None.
(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.
(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
<PAGE>
- Page 16 -
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 27, 1997 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 27, 1997
- ---------------------------
Frederick Hayes-Roth of Directors and
Chief Executive Officer
(Principal Executive
Officer)
/s/ Neil A. Jacobstein President, Chief March 28, 1997
- --------------------------
Neil A. Jacobstein Operating Officer and
Director
/s/ Dennis A. Bugbee Director of Finance, March 28, 1997
- --------------------------
Dennis A. Bugbee Treasurer and Secretary
(Principal Financial and
Accounting Officer)
/s/ General Robert T. Marsh
- --------------------------- Director March 28, 1997
General Robert T. Marsh
/s/ William G. Roth Director March 28, 1997
- ---------------------------
William G. Roth
/s/ James C. Workman Director March 28, 1997
- ---------------------------
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, 1996 AND FOR THE TWO YEARS ENDED DECEMBER 31, 1996
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, 1996 21 - 22
Consolidated Statements of Operations - Years ended
December 31, 1996 and 1995 23
Consolidated Statements of Stockholders' Equity - Years ended
December 31, 1996 and 1995 24
Consolidated Statements of Cash Flows - Years ended
December 31, 1996 and 1995 25
Notes to Consolidated Financial Statements 26 - 33
<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 subsidiary as of December 31, 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for the years ended December 31, 1996 and 1995. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our 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
subsidiary as of December 31, 1996, and the results of their operations and
their cash flows for the years ended December 31, 1996 and 1995 in conformity
with generally accepted accounting principles.
San Jose, California
February 11, 1997
<PAGE>
- Page 21 -
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEET
As of December 31, 1996
ASSETS
Current assets:
Cash and cash equivalents $ 1,797,892
-----------------
Receivables
Customer - billed, net of allowance of $10,000 1,198,488
Customer - unbilled 80,695
Others 10,220
-----------------
Total receivables 1,289,403
Deposits and prepaid expenses 61,452
-----------------
Total current assets 3,148,747
Capitalized software, net of accumulated
amortization of $675,209 126,001
Equipment and improvements, at cost
Computer and other equipment 2,429,888
Leasehold improvements 766,545
-----------------
3,196,433
Less accumulated depreciation and amortization (2,877,020)
-----------------
Net equipment and improvements 319,413
-----------------
Total assets $ 3,594,161
=================
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
- Page 22 -
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEET (CONT'D)
As of December 31, 1996
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 209,762
Accrued liabilities 693,882
Other 423,510
-----------------
Total current liabilities 1,327,154
-----------------
Long-term liabilities:
Provision for discontinued operations 54,432
Restructuring obligation 18,305
-----------------
Total long-term liabilities 72,737
-----------------
Total liabilities 1,399,891
-----------------
Commitments and contingencies (Notes 4 and 11)
Stockholders' equity:
Preferred stock, $.01 par value, authorized 2,500,000
shares, Series A convertible, none issued -
Common stock, $.01 par value, authorized 50,000,000
shares, issued 26,096,770 260,963
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, $18,306, $105,706 and $1,001,310
in 1996, 1995, 1994 and 1993, respectively as a result
of reversals of portions of 1992 loss provisions) 1,992,798
Accumulated deficit since January 1, 1993
(following quasi-reorganization) (56,491)
-----------------
2,197,270
Treasury stock, at cost, 24,000 shares (3,000)
-----------------
Total stockholders' equity 2,194,270
------------------
Total liabilities and stockholders' equity $ 3,594,161
==================
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
- Page 23 -
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
1996 1995
Revenues $ 7,158,763 $ 5,566,053
----------------- -----------------
Costs and expenses:
Cost of revenues 4,541,823 3,409,703
Selling and marketing 95,961 53,049
General and administrative 2,054,698 1,877,190
----------------- -----------------
Total costs and expenses 6,692,482 5,339,942
----------------- -----------------
Operating income 466,281 226,111
Interest income 57,612 41,747
Other income, net 173,131 198,737
----------------- -----------------
Income before tax 697,024 466,595
Provision for income tax 24,650 15,925
----------------- -----------------
Net income $ 672,374 $ 450,670
================= =================
Net income per share $ 0.02 $ 0.02
================= =================
Weighted average common and common
equivalent shares outstanding 30,275,473 29,901,487
================= =================
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
- Page 24 -
<TABLE>
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<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, 1995 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
Exercise of
stock options 173,096 1,731 5,773 - - - 7,504
Net income - - - - 672,374 - 672,374
Stock compensation expense - - - 120,173 - - 120,173
Reversal of portions of provisions
made prior to quasi- reorganization for:
Restructuring
reserve - - 18,306 - - - 18,306
---------- ---------- ----------- ----------- --------- ----------- ------------
Balance,
December 31, 1996 26,096,770 260,963 $ 1,992,798 $ - $ (56,491) $ (3,000) $ 2,194,270
========== ========== =========== =========== ========= ============= ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
- Page 25 -
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
1996 1995
Cash flows from operating activities:
Net income $ 672,374 $ 450,670
Adjustments to reconcile net
income to net cash provided by operating
activities:
Depreciation and amortization 296,590 459,021
Stock compensation expense 120,173 240,346
Gain on sale of equipment (100) (4,559)
Changes in assets and liabilities:
Receivables 65,975 (423,261)
Deposits and prepaid expenses (4,748) 2,067
Accounts payable 28,255 (14,197)
Accrued liabilities (29,543) (285,025)
----------------- ----------------
Net cash provided by operating activities 1,148,976 425,062
----------------- ----------------
Cash flows from investing activities:
Capitalization of software costs (59,485) (103,676)
Purchase of equipment and improvements (258,328) (165,460)
Proceeds from sale of equipment 100 4,559
----------------- ----------------
Net cash used for investing activities (317,713) (264,577)
----------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of common stock 7,504 5,084
Payments of capital lease obligations (3,599) (12,014)
----------------- ----------------
Net cash provided by (used for)
financing activities 3,905 (6,930)
----------------- ----------------
Net increase in cash and cash equivalents 835,168 153,555
Cash and cash equivalents at beginning of year 962,724 809,169
----------------- ----------------
Cash and cash equivalents at end
of year $ 1,797,892 $ 962,724
================= ================
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
- Page 26 -
TEKNOWLEDGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. History and Business
Teknowledge Corporation (the "Company") is the surviving
corporation of the merger of American Cimflex Corporation ("Cimflex")
and Teknowledge Inc., which was consummated in 1989. 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, 1996, there remained
approximately $125,000 of accrued liabilities for discontinued
operations and restructuring obligations, which are scheduled to be
paid over the next two years.
The Company is in the distributed knowledge processing
business. Teknowledge is leveraging its core competencies in knowledge
based systems and large scale, distributed object-oriented software
with the expanding opportunities presented by the Internet and the
World Wide Web. The Company provides software products and consulting
services for commercial and government applications. The Company's key
business lines are: Sales Associate Product, Education & Training
Technologies, Command & Control, Situation Assessment and Data Fusion,
and Distributed Systems Engineering. The Company was incorporated on
July 8, 1981 under the laws of the State of Delaware.
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 these estimates.
Consolidated Financial Statements
The consolidated financial statements include the accounts of
Teknowledge Corporation and its wholly owned subsidiary, Teknowledge
Federal Systems, Inc. All significant intercompany transactions and
balances have been eliminated.
For certain income statement amounts, prior year balances have
been reclassified to conform to the current year presentation.
<PAGE>
- Page 27 -
Cash and Cash Equivalents
The Company considers all highly liquid investments, with
original maturity dates of less than 90 days, as cash equivalents. As
of December 31, 1996, the Company's funds were invested almost entirely
in money market instruments at various institutions.
Unbilled Receivables
Unbilled receivables represent differences between billings
and revenues recognized on cost-type contracts. The unbilled amounts
primarily 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, or (iii) a portion
of the earned fee held back as retention until the contract is
completed and the final indirect overhead rates have been determined. A
substantial portion of the retained fee may be billed to the government
after the final indirect rates are submitted to the government;
however, they are subject to future review and approval 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 1996 and 1995, software development
costs of $59,485 and $103,676 were capitalized, respectively.
Amortization costs were $114,458 in 1996 and $330,510 in 1995.
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.
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 the prime
contractor or a 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.
<PAGE>
- Page 28 -
In 1996, approximately 98% 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 1995 cost-type
government contracts represented approximately 95% of the revenues.
For the year ended December 31, 1996, the Naval Command, Control and
Ocean Surveillance Center was the sponsor of the Company's three
largest government contracts, accounting for approximately 85% of
total revenues. They were also the sponsor of the Company's thre
largest government contracts in 1995,accounting for approximately
74% of the Company's 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.
Revenues from professional services provided principally under
technology contracts are recognized when 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, 1996 and 1995 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 1996 and 1995 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
Effective January 1, 1996, the Company adopted the disclosure
provisions of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation." The adoption did not have a
significant effect on the Company's results of operations as the
Company continues to apply the principles of APB Opinion No 125 and
related interpretations in accounting for the Company's stock plans.
Note 9 to the Consolidated Financial Statements contains a summary of
the pro forma effects on reported net income and earnings per share for
1996 and 1995 based on the fair value of the options granted at grant
date as prescribed by SFAS 123.
3. Accrued Liabilities
Accrued liabilities as of December 31, 1996 consist of the
following:
Payroll and bonuses $516,941
Provision for contract charges 142,567
Provision for discontinued operations 34,374
--------
$693,882
========
<PAGE>
- Page 29 -
4. Commitments
Teknowledge leases its facilities and certain equipment under
operating leases. As of December 31, 1996, only the Palo Alto and
Washington, D.C. locations had active facility leases. The remaining
obligations under these leases are as follows:
Year Ending
December 31,
------------
1997 $ 282,000
1998 292,000
1999 130,000
2000 74,000
2001 & After 37,000
--------
$815,000
========
Net rental expense for the years ended December 31, 1996 and 1995
totaled $326,720 and $279,844, respectively.
5. Line of Credit
The Company has a $1,000,000 unsecured line of credit
agreement with a bank. The line expires on May 10, 1997 and can be
extended from year to year. The Company can borrow up to 60% of the
eligible receivables base or $1,000,000, whichever is lower. The
maximum rate that may be charged is prime plus 1.25%. The agreement
includes certain financial reporting and disclosure requirements that
were met during the year. The line was not utilized in 1996 but may be
utilized in the future.
6. Tax Loss Carryforwards
The Company accounts for income taxes in accordance with
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:
1996 1995
------ -----
Provision at U.S. statutory rate 34.0% 34.0%
State income taxes, net of Federal benefit 6.1 6.1
Permanent differences 7.0 20.6
Deferred tax assets and use of loss carryforwards (43.6) (57.3)
------ -----
Provision for income taxes 3.5% 3.4%
====== =====
At December 31, 1996, the Company had net operating loss
carryforwards of approximately $85 million available to offset future
Federal taxable income. These loss carryforwards expire through the
year 2009. The availability and timing of the amount of prior losses to
be used to offset taxable income in future years may be limited due to
various provisions, including any change in ownership interest of the
Company resulting from significant stock transactions.
The components of the net deferred income tax asset as of
December 31, 1996 was as follows:
Net operating loss carryforwards $29,100,000
Cumulative temporary differences 451,000
Tax credit carryforwards 1,758,000
31,309,000
Valuation allowance (31,309,000)
-----------
Net deferred income tax asset $ -
===========
<PAGE>
- Page 30 -
The valuation allowance consisted of net operating losses,
cumulative temporary differences and tax credit carryforwards which may
expire before they can be used. The Company believes sufficient
uncertainty exists regarding the realizability of these items, and
accordingly, a valuation allowance has been established.
7. 401(k) 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 gross wages. During 1996
the Company contributed $80,629 to the plan.
8. 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,
bookings, new commercial lines, 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, 1996, $168,098 in incentive
compensation was accrued for these executives and was included in
accrued liabilities.
9. Stock-Based Compensation Plans
The Company has a stock option plan for employees called the
Teknowledge Corporation 1989 Stock Option Plan (the "1989 Plan"). The
Company accounts for this plan under APB Opinion No. 25, under which no
compensation cost has been recognized.
Had compensation cost for this plan been determined consistent
with SFAS 123, the Company's net income and earnings per share would
have been reduced to the following pro forma amounts:
1996 1995
Net Income As Reported $672,374 $450,670
Pro Forma $575,043 $437,541
Primary EPS As Reported $.02 $.02
Pro Forma $.02 $.01
Because the SFAS 123 method of accounting has not been
applied to options granted prior to January 1, 1995, the resulting pro
forma compensation cost may not be representative of that to be
expected in future years.
The Company may grant options for up to 10,250,000 shares
under the 1989 Plan. The Company has granted options on 459,022 shares
($.25 - $.86 per share) and 521,000 shares ($.19 - .$.50 per share) in
1996 and 1995, respectively, and has reserved for issuance a total of
6,046,828 shares through December 31, 1996. 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
two to three years and expire ten years after the grant date.
<PAGE>
- Page 31 -
<TABLE>
A summary of the status of the Company's fixed stock option
plan as of December 31, 1996 and 1995, and changes during the years
ending is presented below:
<CAPTION>
1996 1995
---------------------------- --------------------------
Shares Wtd Avg Shares Wtd Avg
Ex Price Ex Price
---------------- ----------- ---------------- -----------
<S> <C> <C> <C> <C>
Outstanding at beg. of year 5,880,902 .30 5,719,872 .29
Granted 459,022 .55 521,000 .32
Exercised (173,096) .04 (206,803) .02
Forfeited (120,000) .17 (131,229) .29
Expired - (21,938) 1.15
--------------- --------------
Outstanding at end of year 6,046,828 .32 5,880,902 .30
--------------- ---------------
Exercisable at end of year 5,520,453 .31 4,336,087 .36
Weighted average fair value
of options granted $0.39 $0.22
</TABLE>
The following table summarizes information about fixed stock
options outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------- ------------------------
Number Wtd Avg Wtd Avg. Ex Number Wtd Avg
Range of Ex Prices Outstanding Remaining Price Excercisable at Ex Price
($'s) 12/31/96 Plan life ($'s) 12/31/96 ($'s)
# (years) #
------------------- -------------- --------- ---------- ---------------- -----------
<S> <C> <C> <C> <C> <C>
.01 - .03 4,236,952 7.5 $.03 4,205,702 $ .03
.13 - .86 1,017,397 8.6 .40 522,272 .32
1.00 - 3.53 792,479 1.8 1.80 792,479 1.80
------------- -------------
.01 - 3.53 6,046,828 6.9 .32 5,520,453 .31
------------- -------------
</TABLE>
The fair value of each option grant is estimated on the date
of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions used for grants in 1996 and
1995, respectively; risk-free interest rates of 6.1 and 6.2 percent;
expected lives of 3.4 and 3.8 years; expected volatility of 100% for
each year; and an expected dividend yield of 0%.
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. 120,000 shares were
available for future grant as of December 31, 1996. 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 and expire ten years after the grant
date. Options to purchase a total of 130,000 shares were outstanding as
of December 31, 1996 at $.15 to $.86 per share and a weighted average
of $.49 per share. Options for 85,000 shares at $.15 to $.66 per share
and a weighted average of $.35 per share were vested at December 31,
1996. No options have been exercised.
As of December 31, 1996, the following number of shares of
Common Stock have been reserved for future issuance under both Plans:
Teknowledge Corporation 1989 Stock Option Plan 6,769,201
Stock Option Plan for Non-Employee Directors 250,000
---------
7,019,201
=========
<PAGE>
- Page 32 -
10. Other Income
The composition of other income is as follows:
1996 1995
-------- --------
Income from sale of product line $148,998 $141,530
Other 24,133 57,207
-------- --------
Total $173,131 $198,737
======== =======
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 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 has
filed counterclaims 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.
On August 27, 1996, Teknowledge and Trilogy Development Group, Inc.
agreed to a settlement of their disputes. On August 29, 1996, Trilogy's
attorneys provided written notification to the Federal District Court
that the companies had reached a settlement. Under the agreement,
Trilogy would provide consideration to Teknowledge and Teknowledge
would grant a license to Trilogy to use the technology covered by the
patent-in-suit. The agreement also provided that all lawsuits between
the parties would be dismissed and that all previously existing debt
between parties would be canceled. The other details of the agreement
are to be kept confidential by both parties.
Nevertheless, on August 30, 1996, before formal documentation
of the settlement agreement was finalized, but after Trilogy's lawyers
confirmed to the Court in writing that the case had been settled, the
U.S. District Court entered an order granting Trilogy's motion for
summary judgment invalidating the patent. In view of the Court's order,
Trilogy has taken the position that no settlement yet exists and that
it need not abide by the terms to which the parties agreed and
represented to the Court. The Company has informed Trilogy that the
Company intends to enforce the settlement agreement, and believes that
Trilogy has breached the settlement agreement. Accordingly, on
September 20, 1996, the Company filed a motion to vacate the judgment
in light of the prior settlement. The Company and Trilogy have been
engaged in discussions regarding the settlement agreement in light of
the Court's judgment; however, there is no assurance that the parties
will be able to resolve the issues without further litigation, that the
Company's motion to vacate and dismiss will be successful, or that the
Company will be able to enforce the settlement agreement.
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 change in control of the Company, 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
<PAGE>
- Page 33 -
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
the 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 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 a third party 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 a third party acquiring 15 percent, the
Rights can be redeemed for $.001 each by action of the Board. Under
certain circumstances, if a third party 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 34-
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 28, 1997
Exb 23.1-1
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,797,892
<SECURITIES> 0
<RECEIVABLES> 1,289,403
<ALLOWANCES> 10,000
<INVENTORY> 0
<CURRENT-ASSETS> 3,148,747
<PP&E> 3,196,433
<DEPRECIATION> 2,877,020
<TOTAL-ASSETS> 3,594,161
<CURRENT-LIABILITIES> 1,327,154
<BONDS> 0
<COMMON> 260,963
0
0
<OTHER-SE> 2,194,270
<TOTAL-LIABILITY-AND-EQUITY> 3,594,161
<SALES> 0
<TOTAL-REVENUES> 7,158,763
<CGS> 0
<TOTAL-COSTS> 4,541,823
<OTHER-EXPENSES> 2,150,659
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 697,024
<INCOME-TAX> 24,650
<INCOME-CONTINUING> 672,374
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 672,374
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
