<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
[ ] TRANSITION REPORT UNDER 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
(Exact 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
(Address of principal executive offices)
(650) 424-0500
Issuer's telephone number
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 [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at April 28, 1998
---------------------------- -----------------------------
Common Stock, $.01 par value 24,350,494 Shares
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2
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997 3
Consolidated Statements of Operations for the three months
ended March 31, 1998 and 1997 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1998 and 1997 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 10
Item 6. Exhibits and Reports on Form 8-K 10
Signatures 12
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3
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
(Unaudited)
March 31, December 31,
1998 1997
---------- ----------
Current assets:
Cash and cash equivalents $ 2,259,702 $ 2,172,235
---------- -----------
Receivables:
Customer - billed, net of allowance of $10,000 1,440,940 1,949,476
Customer - unbilled 746,795 339,277
---------- -----------
Total receivables 2,187,735 2,288,753
---------- -----------
Deferred tax asset, short-term 400,000 400,000
Deposits and prepaid expenses 125,595 97,905
---------- -----------
Total current assets 4,973,032 4,958,893
---------- -----------
Capitalized software, net of accumulated
amortization of $553,046 and $623,215 22,567 27,398
---------- -----------
Fixed assets, at cost
Computer and other equipment 2,827,866 2,758,384
Furniture and fixtures 107,026 103,909
Leasehold improvements 836,943 829,904
---------- -----------
3,771,835 3,692,197
Less accumulated depreciation and amortization (3,163,913) (3,093,603)
---------- -----------
Net fixed assets 607,922 598,594
---------- -----------
Deferred tax asset, long-term 500,000 500,000
---------- -----------
Total assets $ 6,103,521 $ 6,084,885
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 652,292 $ 702,898
Payroll and related 640,678 744,934
Other accrued liabilities 418,774 477,012
---------- -----------
Total current liabilities 1,711,744 1,924,844
---------- -----------
Commitments and contingencies (Note 3)
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 24,240,670 and
23,982,714 shares 242,402 239,823
Additional paid-in capital 1,226,405 1,217,055
Retained earnings since January 1, 1993
(following quasi-reorganization) 2,922,970 2,703,163
---------- -----------
Total stockholders' equity 4,391,777 4,160,041
---------- -----------
Total liabilities and stockholders' equity $ 6,103,521 $ 6,084,885
========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
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4
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
3 Months Ended March 31,
------------------------
1998 1997
----------- ---------
Revenues $ 3,069,930 $ 1,805,302
----------- ---------
Cost of revenues 1,967,750 1,109,541
General and administrative 605,665 472,803
Sales and marketing 212,513 108,237
Research and development 81,143 -
----------- ---------
Total costs and expenses 2,867,071 1,690,581
----------- ---------
Operating income 202,859 114,721
Interest Income 24,148 16,788
Other Income and Expense, net - (211)
----------- ---------
Income before tax 227,007 131,298
Provision for income tax 7,200 6,147
----------- ---------
Net Income $ 219,807 $ 125,151
=========== =========
Net Income per share:
- Basic $ 0.01 $ 0.00
=========== =========
- Diluted $ 0.01 $ 0.00
=========== =========
Shares used in computing net income per share:
- Basic 24,119,486 26,115,661
=========== ==========
- Diluted 28,223,459 30,237,029
=========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
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5
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
3 Months Ended March 31,
------------------------
1998 1997
----------- ----------
Cash flows from operating activities:
Net income $ 219,807 $ 125,151
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 75,141 63,957
Changes in assets and liabilities:
Receivables 101,018 312,883
Deposits and prepaid expenses (27,690) (10,664)
Accounts payable (50,606) (100,905)
Accrued liabilities (162,494) (378,192)
----------- ----------
Net cash provided by operating activities 155,176 12,230
----------- ----------
Cash flows from investing activities:
Capitalization of software costs - (2,253)
Purchase of fixed assets (79,638) (46,902)
----------- ----------
Net cash used for investing activities (79,638) (49,155)
----------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock 11,929 9,989
----------- ----------
Net cash provided by financing activities 11,929 9,989
----------- ----------
Net increase (decrease) in cash and cash equivalents 87,467 (26,936)
Cash and cash equivalents at beginning of period 2,172,235 1,797,892
----------- ----------
Cash and cash equivalents at end of period $2,259,702 $1,770,956
=========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
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6
TEKNOWLEDGE CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1998
1. Interim Statements
The interim statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. However, the
Company believes that the disclosures are adequate to make the information
presented not misleading. These interim statements should be read in
conjunction with the financial statements and the notes thereto included
in the Company's annual report on Form 10-KSB for the fiscal year ended
December 31, 1997. In the opinion of management, these interim statements
include all adjustments, consisting of normal, recurring adjustments,
which are necessary for a fair presentation of results for such periods.
The results of operations for any interim period presented herein are not
necessarily indicative of results that may be achieved for the entire
fiscal year ended December 31, 1998.
2. Net Income Per Share
Net income per share is calculated in accordance with the provision
of Statement of Financial Accounting Standard (SFAS) No. 128, "Earnings
per Share," adopted by the Company in the fourth quarter of 1997. SFAS No.
128 requires companies to compute net income per share under two different
methods, basic and diluted. Basic earning per share is calculated by
dividing net income by the weighted average shares of common stock
outstanding during the period. Diluted earning per share is calculated by
dividing net income by the weighted average shares of outstanding common
stock and common stock equivalents during the period. Common stock
equivalents consist of dilutive shares issuable upon the exercise of
outstanding common stock options.
3. Commitments and contingencies
Refer to Part II Item 1. Legal Proceedings.
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7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
unaudited consolidated financial statements and notes thereto.
Teknowledge Corporation (the "Company") is in the distributed knowledge
management business. The central value of this business is to help customers
manage their knowledge assets for competitive advantage, both inside corporate
intranets, and distributed on the Internet. Teknowledge is in a unique position
to apply its core competencies in knowledge-based systems and large scale,
distributed object-oriented software to the expanding opportunities presented by
the Internet and the World Wide Web. These core competencies have developed
through a strong software talent base, a rapidly evolving technology and
intellectual property portfolio, and a 16 year history of solving challenging
problems for customers. Teknowledge provides software products and consulting
services for government and commercial applications. The Company's key business
lines are: Distributed Systems Engineering, Situation Assessment & Data Fusion,
Education & Training Technologies, C4I & Information Security Systems, and
Electronic Commerce ("E-Commerce") Systems. Teknowledge was incorporated on July
8, 1981 under the laws of the State of Delaware.
Results of Operations
Revenues
Revenues for the first quarter of 1998 rose to $3,069,930, an increase of
70% over the comparable quarter of 1997. Most of the growth in revenues was
attributed to an increase in the billable workforce on government-sponsored
contracts initiated in 1998 and 1997. Expenditures on government contracts are
generally reimbursed in the period in which they are incurred and are reported
as revenues in that period. The growth in the workforce has slowed from 1997's
rate of increase as the Company approaches targeted staffing levels. Included in
the revenue for the first quarter was the Company's first commercial sale of a
product license for Sales Associate(TM) for $50,000. The Company also
experienced increased usage of billable subcontractors and consultants who
complement the Company's internal skill set. Combined subcontractor and
consultant costs were $580,413 and $170,890 for the first quarter of 1998 and
1997, respectively.
Costs and Expenses
Cost of revenues for the first quarter of 1998 was $1,967,750, an increase
of 77% from the first quarter in 1997. The Company experienced a significant
increase in labor and related costs as it continued to expand its technical
workforce. Subcontractor and consultant costs also increased significantly but
so did revenue from these activities. As a percent of revenues, cost of revenues
rose from 61% for the first quarter of 1997 to 64% for the first quarter of
1998.
Combined sales and marketing and general and administrative costs for the
same quarter of 1998 were $818,178, compared to $581,040 for the comparable
period of the previous year, an increase of 41%. The increase in costs was
primarily attributed to the expansion of the E-Commerce sales and marketing
workforce and expenses related to the recruitment of non-technical employees.
Combined sales and marketing and general and administrative costs for the first
quarter of 1998 were 27% of revenues, versus 32% of revenues for the same period
of 1997. As revenues continue to increase, the percentage of costs attributable
to technical versus administrative activities is expected to increase. Research
and development costs were $81,143 and $0 for the first quarter of 1998 and
1997, respectively.
Interest income was $24,148 for the first quarter of 1998, versus $16,788
for the same period of the previous year. The Company increased its cash
reserves in the first quarter of 1998. There was no significant other income and
expense for the first quarter of 1998 and 1997.
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8
Net income for the first quarter of 1998 was $219,807, or $.01 per share,
versus $125,151, or $.00 per share, for the first quarter of 1997. Net income
represented 7% of revenue for the first quarter of both 1998 and 1997.
Bookings and Backlog
At March 31, 1998, the expected multi-year contract commitments (order
backlog) from government customers was approximately $34 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. Approximately 79% of the backlog
consists of 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. The Company's order backlog at December 31, 1997
was approximately $25 million.
Liquidity and Capital Resources
As of March 31, 1998, unused sources of liquidity consisted of $2,259,702
in cash and cash equivalents, an increase of $87,467 from December 31, 1997. The
increase consisted of $155,176 provided by operating activities, $79,638 used
for investing in fixed assets, and $11,929 provided by financing activities. The
decrease in billed receivables is partially offset by the increase in unbilled
receivables, due in part to a positive difference between the booked and billed
overhead rates for the quarter. The Company anticipates recovering the related
unbilled amounts in the near term, pending approval of a rate increase from the
government.
The Company believes that the present level of cash and cash equivalents
is adequate to service the liquidity needs of the Company in the next twelve
months. The Company relies principally on the collection of receivables to
generate internal cash reserves. The government is capable of temporarily
disrupting the flow of cash to the Company at any time, for example, as a result
of delays associated with the annual budget process.
The Company has an unsecured line of credit from a financial institution
in the amount of $1,500,000. The Company may borrow up to the lower of 60% of
the receivable base or $1,500,000, at a rate of one percent over the prime rate.
The line is subject to certain covenants and maintenance requirements, which
have been fulfilled. The line expires in June 1998. The Company has not utilized
the credit line through March 31, 1998.
Management believes the Company will be able to operate in the next twelve
months without additional financing, whether in the form of borrowings or equity
capital. Successful operations in the long term should produce growth in
revenues and profitability, which may require additional financing.
Year 2000
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("year 2000") approaches. The key
issue is whether computer systems will properly recognize date-sensitive
information when the year changes to 2000. Most of the hardware and software
currently in use at the Company are relatively new and year 2000 compliant. No
significant reprogramming efforts and year 2000 compliance expenses inside the
Company are expected to be necessary.
Risks and Uncertainties
Teknowledge's service revenue currently derives primarily from government
R&D contracts, and the Company has historically been profitable in that
business. Dependence on government contracts carries risk; however,
Teknowledge's particular government customers have fared well over the past
decade of budget cutbacks in Washington. The primary uncertainty in providing
services under government contracts has been the Company's ability to attract
and retain sufficient technical staff to meet the demands of new orders.
Teknowledge's track record of profitability, excellent employee benefits, and
exciting new technical projects, have helped to ease the recruiting problem.
<PAGE>
9
Management believes the Company has many competitive advantages which mitigate
the risks of the typical startup company. In recent years, government services
have provided Teknowledge with a consistent base of profits and a strong
technology portfolio upon which to build an internal software product
development program. The Company believes it will continue to develop and market
test new software products without a material adverse impact on its financial
position or results of operations. The Company screens potential products for
user and market acceptance before they are released. While this does not
guarantee success, it does minimize the exposure to the Company. A marketplace
success could result in further investments and additional products.
The Company believes the Internet and intranet software market offers a
significant new opportunity for growth and Teknowledge is in a good position to
convert Internet-based software developed under its government R&D contracts
into new commercial products. However, if the Internet or intranet market
develops more slowly than expected, becomes saturated with competitors, or if
the Company's products do not achieve market acceptance, the Company's
commercial business, financial condition, and results of operations may
eventually be adversely affected.
All of the Company's government contracts are the cost-plus-fixed-fee
type. Revenues, costs and earnings on government contracts are determined based
on estimated overhead rates derived from forecasted annual costs. The Company's
actual experience in headcount growth, billable efficiency, and costs may vary
from original estimates and necessitate periodic adjustments to overhead rates.
Such adjustments are made on a cumulative basis whereby the resulting revenue
and income effects are recognized in the period of the adjustments.
Forward-Looking Statements
Forward-looking statements made in this section relating to recruiting of
additional employees, increase in demand for new employees, expected growth in
revenues, mix of revenues between government and commercial, anticipated new
government contracts, Year 2000 issues, and the development and announcement of
commercial products involve risks and uncertainties, and actual results could
differ materially from that set forth in the forward looking statements
contained herein as a result of difficulties in recruiting, risks in government
contracting, risks relating to commercialization of products, and other risks
set forth under "Risks and Uncertainties."
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10
PART II. OTHER INFORMATION
- ------------------------------------------------------------------------------
Item 1. 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. Management of the Company
believes this suit is without merit and intends to defend itself vigorously.
Management believes the ultimate resolution of this suit will not have an
adverse material impact on the Company's financial position and results of
operations.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Set forth below is a list of all exhibits filed herewith or incorporated by
reference as part of this Quarterly Report on Form 10-QSB.
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certificate of Incorporation of Teknowledge
Corporation (5)
3.2 Amended and Restated Bylaws of Teknowledge Corporation (9)
3.3 Certificate of Designation, Preferences and Rights of the Terms of
the Series A Preferred Stock (7)
4.1 Rights Agreement dated January 29, 1996 between the Company and
Registrar and Transfer Company as Rights Agent (7)
10.1 Teknowledge Corporation 1989 Stock Option Plan (8)
10.2 Amendment to Stock Option Agreement, dated November 30, 1988,
between American Cimflex Corporation and Romesh T. Wadhwani (1)
10.3 Amended Employment Agreement, dated as of January 21, 1992, between
Cimflex Teknowledge Corporation and Daniel R. Robusto (2)
10.4 Settlement Agreement, General Release, and Waiver of Claims, dated
November 21, 1992, between Daniel R. Robusto and Cimflex
Teknowledge Corporation (3)
10.5 Settlement Agreement, dated May 21, 1993, between Cimflex
Teknowledge Corporation and Third Copley-Franklin Trust (4)
10.6 Settlement Agreement, dated September 1, 1993, between Cimflex
Teknowledge Corporation and Pittsburgh Great Southern Company (4)
10.7 Change of Control Agreement, dated November 21, 1994, between
Teknowledge Corporation and Frederick Hayes-Roth and Neil
Jacobstein (6)
23.1 Consent of Arthur Andersen LLP, independent public accountants
27 Financial Data Schedule
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11
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, 1991.
(3) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1992.
(4) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB, as
amended, for the fiscal year ended December 31, 1993.
(5) Filed as an Exhibit to the Company's Quarterly Report on Form 10-QSB for
the quarter ended June 30, 1994.
(6) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB, for
the fiscal year ended December 31, 1994.
(7) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB, for
the fiscal year ended December 31, 1995.
(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.
(9) Filed as an Exhibit to the Company's Quarterly Report on Form 10-QSB for
the quarter ended March 31, 1996.
(b) The registrant did not file a report on Form 8-K during the quarter ended
March 31, 1998.
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12
SIGNATURES
Pursuant to the requirements of the Exchange Act, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TEKNOWLEDGE CORPORATION
-----------------------
(Registrant)
/s/ Frederick Hayes-Roth Chairman of the Board May 4, 1998
- ------------------------ of Directors and Chief
Frederick Hayes-Roth Executive Officer
(Principal Executive
Officer)
/s/ Neil A. Jacobstein President and Chief May 4, 1998
- ------------------------ Operating Officer
Neil A. Jacobstein
/s/ Dennis A. Bugbee Director of Finance, May 4, 1998
- ------------------------ Treasurer and Secretary
Dennis A. Bugbee (Principal Financial and
Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-END> Mar-31-1998
<CASH> 2,259,702
<SECURITIES> 0
<RECEIVABLES> 2,197,735
<ALLOWANCES> 10,000
<INVENTORY> 0
<CURRENT-ASSETS> 4,973,032
<PP&E> 3,771,835
<DEPRECIATION> 3,163,913
<TOTAL-ASSETS> 6,103,521
<CURRENT-LIABILITIES> 1,711,744
<BONDS> 0
0
0
<COMMON> 242,402
<OTHER-SE> 4,149,375
<TOTAL-LIABILITY-AND-EQUITY> 6,103,521
<SALES> 0
<TOTAL-REVENUES> 3,069,930
<CGS> 0
<TOTAL-COSTS> 1,967,750
<OTHER-EXPENSES> 899,321
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 227,007
<INCOME-TAX> 7,200
<INCOME-CONTINUING> 219,807
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 219,807
<EPS-PRIMARY> 0.01
<EPS-DILUTED> 0.01
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