<PAGE>
1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 FORM 10-QSB
(MarkOne)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
[ ] 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 June 30, 2000
Common Stock, $.01 par value 5,494,381 Shares
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2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
<C>
Consolidated Balance Sheets as of June 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations and Comprehensive Income
for the three months and six months ended June 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 2000 and 1999 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 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 16
</TABLE>
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3
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS
As of June 30, 2000
ASSETS
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
2000 1999
--------------- -----------------
Current assets:
<S>
<C> <C>
Cash and cash equivalents $ 1,281,954 $ 1,951,393
----------------- -----------------
Receivables:
Customer - billed, net of allowance of $95,000 3,156,208 2,028,953
Customer - unbilled 774,750 1,234,189
----------------- -----------------
Total receivables 3,930,958 3,263,142
Deferred tax asset, short-term 400,000 400,000
Deposits and prepaid expenses 159,119 75,692
------------------ -----------------
Total current assets 5,772,031 5,690,227
------------------ -----------------
Capitalized software development costs, net of accumulated
amortization of $97,780 and $104,485, respectively 1,011,564 359,743
------------------ -----------------
Fixed assets, at cost
Computer and other equipment 3,241,709 3,078,647
Furniture and fixtures 117,897 112,647
Leasehold improvements 838,398 838,398
------------------ -----------------
4,198,004 4,029,692
Less accumulated depreciation and amortization (3,783,054) (3,652,857)
------------------ -----------------
414,950 376,835
------------------ -----------------
Investment in Global Stake 1,064,463 211,765
Deferred tax asset, long-term 500,000 500,000
Other Assets, long-term 30,067 29,397
------------------ -----------------
Total assets $ 8,793,075 $ 7,167,967
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,524,953 $ 747,404
Payroll and related liabilities 807,978 659,752
Short-term loan obligations 500,000
Other accrued liabilities 124,255 221,159
------------------ -----------------
Total current liabilities 2,957,186 1,628,315
------------------ -----------------
Stockholders' equity:
Preferred stock, $.01 par value, authorized 2,500,000 shares, Series A,
Convertible, none issued
Common stock, $.01 par value, authorized 25,000,000
shares, issued and outstanding 5,494,381 shares 54,944 53,025
at June 30, 2000
Additional paid-in capital 1,800,463 1,614,305
Retained earnings since January 1, 1993
(following quasi-reorganization) 3,980,482 3,872,322
------------------ -----------------
Total stockholders' equity 5,835,889 5,539,652
------------------ -----------------
Total liabilities and stockholders' equity $ 8,793,075 $ 7,167,967
================== =================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
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4
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
(Unaudited)
3 Months Ended June 30, 6 Months Ended June 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Revenues $ 4,019,593 $ 2,776,623 $ 6,774,397 $ 5,567,267
---------------- ---------------- ---------------- ----------------
Costs and expenses:
Cost of revenues 2,975,224 1,661,290 4,968,473 3,316,397
General and administrative 651,122 656,158 1,231,793 1,285,977
Sales and marketing 167,647 136,819 243,056 267,496
Research and development 130,162 118,282 177,969 266,958
---------------- ---------------- ---------------- ----------------
Total costs and expenses 3,924,155 2,572,549 6,621,291 5,136,828
---------------- ---------------- ---------------- ----------------
Operating income 95,438 204,074 153,106 430,439
Interest income, net 9,204 26,891 30,436 53,100
Other Expense - - (3,275) -
---------------- ---------------- ---------------- ----------------
Income before tax 104,642 230,965 180,267 483,539
Provision (benefit) for income tax 41,857 92,385 72,107 193,415
---------------- ---------------- ---------------- ----------------
Net income $ 62,785 $ 138,580 $ 108,160 $ 290,124
================ ================ ================ ================
Net income per share:
- Basic $ 0.01 $ 0.03 $ 0.02 $ 0.06
================ ================ ================ ================
- Diluted $ 0.01 $ 0.02 $ 0.02 $ 0.05
================ ================ ================ ================
Shares used in computing net income per share:
- Basic 5,444,399 4,975,963 5,376,351 4,968,566
================ ================ ================ ================
- Diluted 5,980,290 5,888,550 6,020,161 5,904,116
================ ================ ================ ================
* Amounts were reclassified to conform to current presentation.
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
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5
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
6 Months Ended June 30,
2000 1999
<S> <C> <C>
Cash flows from operating activities:
Net income $ 108,160 $ 290,124
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 227,977 186,092
Noncash portion of income tax provision 65,126 93,104
Changes in assets and liabilities:
Receivables (667,816) 134,112
Deposits and prepaid expenses (83,427) 6,189
Accounts payable 777,549 (12,156)
Accrued liabilities 51,322 (266,315)
---------------- -----------------------
Net cash provided by operating activities 478,890 431,150
---------------- -----------------------
Cash flows from investing activities:
Investment in GlobalStake.com (852,698) -
Capitalization of software development costs (749,601) (52,842)
Purchase of fixed assets (168,312) (39,481)
---------------- -----------------------
Net cash used for investing activities (1,770,611) (92,323)
---------------- -----------------------
Cash flows from financing activities:
Drawdown on line of Credit 500,000 -
Proceeds from issuance of common stock 122,281 151,793
Repurchase of common stock - (91,959)
---------------- -----------------------
Net cash provided by financing activities 622,281 59,834
---------------- -----------------------
Net increase (decrease) in cash and cash equivalents (669,439) 398,661
Cash and cash equivalents at beginning of period 1,951,393 2,378,390
---------------- -----------------------
Cash and cash equivalents at end of period $ 1,281,954 $ 2,777,051
================ =======================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
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6
TEKNOWLEDGE CORPORATION NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS June 30, 2000
1. Interim Statements
The unaudited consolidated financial statements included herein have
been prepared by the Company 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, 1999. 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, 2000.
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,
which 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. Reverse Stock Split
The Company effected a one-for-five reverse stock split on December 22,
1998. All share and per share data has been retroactively restated to reflect
the effect of the reverse stock split. Since there was no change in per share
par value, aggregate par value has also been retroactively adjusted to reflect
the reduction in the number of common stock.
4. Repurchase of Common Stock
On December 16, 1998, the Company adopted a program to repurchase up to
300,000 shares of the Company's common stock in the open market or in private
during the twelve-month period ending December 15, 1999 at prevailing prices.
Repurchases will be made periodically at management discretion using the
Company's own cash reserves. As of June 30, 2000, the Company has used $291,494
to repurchase 70,270 shares of the Company's Common Stock. Shares repurchased
may be reissued to employees pursuant to the Company's stock option plans, or
for other corporate purposes.
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7
5. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which
requires companies to value derivative financial instruments, including those
used for hedging foreign currency exposures, at current market value with the
impact of any change in market value being charged against earnings in each
period. In June 1999, the Financial Accounting Standards Board issued SFAS No.
137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS No. 133" to defer the effective date of SFAS No. 133
until fiscal years beginning after June 15, 2000. To date, the Company has not
entered into any derivative financial instrument contracts. Thus the Company
anticipates that SFAS No. 133 will not have a material impact on its
consolidated financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101 "Revenue Recognition in Financial Statements."
SAB 101 provides guidance on applying generally accepted accounting principles
to revenue recognition issues in financial statements. The implementation of SAB
101 is currently under review and will be adopted in the fourth quarter of 2000.
We do not expect the adoption of SAB 101 to have a material impact on our
consolidated results of operations and financial position.
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8
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 ("the Company") has increased its eCommerce focus on the
financial software and services business. The Company has been investing in
TekPortal(tm) software product development, testing, and sales. This investment
has begun to pay off. For the three months ended June 30, 2000, the percentage
of Teknowledge's commercial business has increased to 41% from 4% in the
comparable quarter in 1999. As a result of commitments and anticipated growth in
Internet-based financial services, the Company expects improved commercial
revenues in 2000.
Teknowledge's eCommerce business unit delivers TekPortal(tm) product
and service solutions. TekPortal software gives financial services companies,
such as Internet banks, the ability to provide customers with a single web site
to manage their financial portfolio of bank, brokerage, credit card, and
frequent flier accounts. TekPortal permits both information aggregation and
transactions between accounts. The customer provides all of the account and
transaction permissions. TekPortal is typically installed at the financial
institution, and the financial institution provides its security and privacy
policies. Teknowledge has several new Internet bank customers, and several
value-added resellers for TekPortal, including NCR, Vexis, and Financial Fusion
Inc.
Teknowledge's core business is products and services for intelligent
Internet transactions. These transactions provide flexible, secure, and
knowledge-based interactions with commercial and government customers.
Teknowledge sells solution and development services to support software and
services for the financial services industry, web-based training, knowledge
systems, Internet security, and distributed systems. These core competencies are
complementary, supporting the common focus on intelligent Internet transactions.
Virtually all of Teknowledge's government and commercial projects involve
processing application knowledge and distributing customer solutions over the
Internet. Teknowledge integrates its own proprietary software and third party
products into a total system solution for customers in industry or government.
Teknowledge's eCommerce team can deliver TekPortal combined with other
third party software solutions to financial services institution web sites. The
Teknowledge Information Assurance security team can provide PKI and Check Point
FireWall-1(tm) security expertise to banks and other financial institutions. The
Web-based Training team provides embedded training. The Knowledge Systems team
develops methods to represent an organization's specialized knowledge, and then
serves that knowledge over the web. Teknowledge adds value by solving
challenging business problems, and increasing its customer's quality, speed, and
efficiency of operations on the Internet.
The exponential increase in information flowing through the World Wide
Web has placed a premium on the ability to apply knowledge to enhance the value
of information. This trend leverages Teknowledge's expertise in knowledge
processing. Knowledge has become the key enabler to providing informed sales
advice on web sites as well as providing individualized training. Teknowledge's
Web-based Training and Knowledge Systems units are collaborating on building a
new knowledge-processing component that can be used by web servers and sales
advice software such as Sales Associate(. This new component is being developed
for speed and flexibility. Unlike stand-alone expert systems, Internet-based
knowledge systems enable new relationships between people and computers in
capturing, refining, distributing, and applying knowledge to solve business
application problems. Knowledge that was once held only by people can now be
processed consistently by a computer and distributed via a web server to
millions of customers 7 days a week, 24 hours a day. This type of "activated"
knowledge can also be used by Teknowledge's customers to serve advice, assess
situations rapidly in a crisis, defend web sites from attack, or ensure the
distribution of messages to the right people at the right time.
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9
Teknowledge has been in business for nineteen years. It has reported
twenty-four consecutive profitable quarters (six years). The Company maintains
an aggressive intellectual property program and is defending actively its nine
U.S. software patents. In a time of increasing scarcity of top technical talent,
the Company recently recruited an outstanding five person technical team from
the University of Southern California's Information Sciences Institute.
Teknowledge continues to recruit top talent by providing a challenging and
collaborative technical environment with many employee rewards. These rewards
include advanced education and training, incentive stock options, performance
bonuses, competitive salary, and an attractive benefits program. Teknowledge is
headquartered in Palo Alto, California with offices in Fairfax, Orlando,
Cleveland, Los Angeles and San Diego. The Company's stock is traded on the
NASDAQ SmallCap Market under the symbol TEKC. Teknowledge was incorporated on
July 8, 1981 under the laws of the State of Delaware.
Results of Operations
Revenues
Revenues for the three months ended June 30, 2000 and 1999 were
$4,019,593, and $2,776,623, respectively, a 45% improvement between periods.
Approximately 41% of the revenues earned in the second quarter of 2000 were
attributed to commercial customers, and 59% were with agencies of the Federal
Government. Commercial revenues increased tenfold over the comparable quarter in
1999, when commercial revenues were 4% of total revenues. eCommerce revenues in
the first quarter of 2000 were 29%. $342,000, or 21%, of eCommerce revenue was
attributed to the sale of commercial software licenses associated with the
installation of the Company's proprietary TekPortal product on the web sites of
financial service providers. Government revenue between the first quarter and
the second quarter of 2000 improved 22% as the Company began working on several
new R&D contracts. Government revenue in the comparable quarter in 1999 was 11%
above the current quarter. The Company elected not to record about $275,000 of
net revenues at December 31, 1999 pending the outcome of an arbitration matter
with an eCommerce customer. A ruling is expected in the third quarter of 2000,
which could have a positive impact on the third quarter's results. The Company
recently announced that it hired a CTO, Dr. Robert Balzer, and several senior
technical people from the University of Southern California's Information
Sciences Institute. In addition to adding to Teknowledge's intellectual capital,
the group is expected to add $2M a year in DARPA and NSF project revenue. The
Company expects an increase in demand for its TekPortal(TM) financial products
for the remainder 2000 and is expanding its workforce to meet the expected
demand.
Costs and Expenses
Cost of revenues was $2,975,224 for the three months ended June 30,
2000, a 79% increase from the comparable period in 1999. The Company continues
to expand its workforce to meet the demands of the growing backlog of commercial
and government projects. The Company also uses billable consultants and
contractors to supplement its full-time employee workforce. During the second
quarter of 2000, the Company spent $1,475,248 on these services compared to
$686,714 in the comparable quarter of 1999. Subcontractor and consultant costs
increased 114% between 1999 and 2000, accounting for the bulk of the cost
increase between periods. 43% of the subcontractor costs incurred in the second
quarter are attributed to the eCommerce program, which did not begin full-scale
operations until the third quarter of 1999. Cost of revenues as a percentage of
total revenues was 74% for the three months ended June 30, 2000 compared to 60%
for the three months ended June 30, 1999.
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10
General and administrative costs for the three months ended June 30,
2000 were $651,122, a 1% decrease over the second quarter in 1999. In the second
quarter of 2000, the Company experienced less average headcount in
administrative and executive functions, and an increase in legal expenditures.
This was due in part to the decision to consolidate the President and CEO roles.
General and administrative costs for the three months ended June 30, 2000 were
16% of total revenues, versus 24% for the second quarter of last year.
Sales and marketing costs for the three months ended June 30, 2000
increased to $167,647, or 23% higher that the comparable period in 1999. Sales
and marketing costs rose in the second quarter of 2000 as the eCommerce unit
expanded its advertising and marketing activities and assigned more personnel to
sales production. Sales and marketing costs are expected to increase during 2000
as the Company expands its operations.
Research and development ("R&D") costs for the three months ended June
30, 2000 were $130,162, a 10% increase from the comparable period in 1999. These
figures do not include primary R&D conducted under contract for our government
customers nor do they include the aforementioned software development costs that
were capitalized during the period. The Company invested $397,533 in the
development of software for its TekPortal product that was capitalized in
anticipation of future revenue growth. Some of the employees who are qualified
to work on R&D projects were diverted to develop commercial financial software.
Internal R&D costs, excluding TekPortal development, were 3% of revenues for the
three months ended June 30, 2000 and 4% of revenues in the comparable quarter in
1999.
Interest income was $20,093 and $26,891 for the three months ended June
30, 2000 and 1999, respectively. Interest income reflects lower average cash
balances during the period. The Company accumulated $10,889 of interest expense
related to a bank loan during the quarter.
Income before taxes for the three months ended June 30, 2000 was
$104,642, which represented a 55% decrease over the comparable period in 1999.
The decrease was directly attributable to the continued expansion of the
business in the second quarter of 2000. The Company experienced lower net
margins on some eCommerce projects as it continues to transition from a mostly
government business. Income before taxes represented 3% and 8% of revenues, for
the three months ended June 30, 2000 and 1999, respectively.
The Company utilized essentially all tax losses generated subsequent to
the date of the quasi-reorganization, which were reflected as a reduction to the
effective tax rate and provision for income taxes, up to December 31, 1998.
Commencing 1999, realization of tax benefits existing at the date of the
quasi-reorganization is recorded as an adjustment to additional paid-in-capital.
Accordingly, the Company increased its effective tax rate and provision for
income taxes for the first quarter of 1999 and thereafter. However, even with
the increase in its effective tax rate for book purposes, the Company will
continue to realize full cash savings from its extensive tax loss benefits
existing at the date of the quasi-reorganization. In short, the Company has been
reporting increased tax expenses, but will not actually be required to pay such
taxes, and there will be no effect on the Company's cash resulting from the
reported increases.
Net income for the three months ended June 30, 2000 was $62,785, or
$.01 per diluted share, versus $138,580, or $.02 per diluted share, for the
comparable period in 1999. Because the eCommerce unit is relatively new, it has
not achieved its expected net margins in its first year of projects. While
government contracts continue to produce income, that income is constrained by
government regulations that limit the Company's ability to increase its net
margins on these contracts. The Company expects to achieve higher net margins on
its commercial contracts as volume increases and operating efficiencies improve.
Net income represented 2% and 5% of revenues, for the three months ended June
30, 2000 and 1999, respectively. <PAGE>
11
Bookings and Backlog
At June 30, 2000, the expected order backlog was approximately $18.3
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. 93% of June 30,
2000 backlog is from government customers. Approximately 35% of the backlog
consist 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. Teknowledge won
contracts totaling approximately $4,000,000 in Q2. Approximately 45% of the new
contract work is expected to be completed this year. The portion of the overall
backlog that expected to be fulfilled in the current fiscal year is
approximately 36%. The Company's backlog at December 31, 1999 was approximately
$18.6M.
Liquidity and Capital Resources
As of June 30, 2000, unused sources of liquidity of the Company were
$1,281,954 in cash and cash equivalents, a decrease of $1,495,097 over the
previous year. The Company generated cash of $478,890 from its operating
activities and $122,281 from issuance of common stock to employees exercising
their stock options. It invested $749,601 for developing capitalized software
and $168,312 for purchases of computer equipment and other improvements. The
Company invested $852,698 to GlobalStake.com during the first six months of the
year and has met 89% of its $1.2M investment agreement since GlobalStake.com was
spun out in November of 1999. Generally, the decline in the Company's cash
balance is attributed to the development of TekPortal(TM) software for sale and
the investment in GlobalStake.com.
The Company believes that the present level of cash and cash
equivalents and borrowing capacity is adequate to service the Company's
short-term liquidity needs in 2000. The Company is contractually committed to
provide an addition $135,000 of seed money to GlobalStake.com in 2000. It is
anticipated that this requirement will be fulfilled during the third quarter of
2000 with a small cash infusion and no future cash requirements are anticipated.
The Company borrowed $500,000 against its line of credit in March 2000 to
supplement its existing reserves and may have to borrow further to fund the
accelerated growth of its eCommerce operations. The Company is seeking
additional funding from third parties to supplement its existing cash reserves,
which have been reduced by the investment in GlobalStake.com and the demands of
the expanding eCommerce program. Compared to reliable government customers, the
Company has experienced slower collections, higher average receivable balances,
and a slower turnover of cash from its commercial customers. Because commercial
customers are judged to be a greater credit risk, the Company has tightened its
credit/collection process and going forward, is increasing its reserve for bad
debt. If the Company does not receive a substantial short-term infusion of cash,
the Company's business, financial condition, and results of operations may be
materially and adversely affected.
The Company has an unsecured line of credit from a financial
institution in the amount of $2,000,000. The Company may borrow up to the lower
of 60% of the receivable base or $2,000,000 at a rate of one percent over Prime.
The line is subject to certain covenants and maintenance requirements that have
been fulfilled. The line expires in December 2000 and is renewable. The Company
borrowed $500, 000 against its credit line in March.
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12
Risks and Uncertainties
Management believes that the market for TekPortal software is a
significant new opportunity for the Company and that its eCommerce services
business will expand rapidly. The market for financial aggregation software,
however, is rapidly evolving, and characterized by an increasing number of
market entrants who have introduced or are developing competing software
products and services. As is typical for a new and rapidly evolving industry,
demand and market acceptance for recently introduced products and services are
subject to a high level of uncertainty. Even after a correction in 2000, the
stock market for eCommerce and Internet companies has continued to experience a
large wave of speculative investment. Further, aspects of the Internet
(including security, privacy, reliability, cost, ease of use, and quality of
services) are undergoing rapid evolution that may affect the use of the Internet
in general, and Internet information aggregation software in particular. In
addition, for its new dot.com customers, Teknowledge is exposed to a higher risk
of bad debt and slower collections, compared to more reliable government
customers.
The demand for some new Internet software will depend upon broad
acceptance of new methods of conducting business and exchanging information over
the Internet. The demand for products developed by the Company cannot be
determined, nor can the viability of these products be determined at this time
due to the explosive growth and competitive nature of the market. As the market
continues to change, there can be no assurance that the Company will continue to
recruit or retain the technical staff to develop and bring to market products
that will gain market acceptance or generate significant revenue or profits. If
the TekPortal(TM) or other product markets develop more slowly than expected,
become saturated with competitors, or if the Company's products do not achieve
market acceptance, Teknowledge's business, financial condition, and results of
operations may be materially and adversely affected.
GlobalStake.com's ExploreRealty.com business did not get the capital
funding necessary to be competitive in the business-to-consumer real estate
market. The ExploreRealty.com business line of GlobalStake.com is pursuing third
party arrangements to accept its real estate lead stream. GlobalStake.com is
developing a new business-to-business model for continuing operations.
GlobalStake.com is a business with limited cash and all the associated risks and
uncertainties of a start-up business. Teknowledge owns 19.9% of GlobalStake.com.
Teknowledge's service revenue from government R&D contracts were 59% of
total revenue, and the Company has historically been profitable in that
business. However, dependence on government contracts can be risky because the
contracts are subject to administrative, legislative, and political
interruptions, which may jeopardize the flow of funds. The Company's revenues,
costs and earnings on government contracts are determined based on estimated
overhead rates derived from forecasted annual costs. The Company's actual
experience with fluctuations in the workforce, billable efficiency, and costs
may vary from original estimates and necessitate periodic adjustments to the
overhead rates until the actual costs have been tabulated and the year closed
out. Such adjustments are made on a cumulative basis whereby the resulting
revenue and income effects are recognized in the period of the adjustment.
The typical cost-type government contract performed by the Company has
a regulated fixed fee limit, which inhibits the Company from improving profit
margins beyond what is permitted in the government regulations. In addition,
Federal Acquisition Regulations exclude from reimbursement some "unallowable"
expenses, which the Company considers a regular part of the business. 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.
However, these clauses have been invoked infrequently.
Forward-Looking Statements
Forward-looking statements made in this section relate to the expected
growth of the commercial business, realizability of backlog, competition for
government and commercial contracts, the mix of revenues between government and
commercial, development of commercial products and services, the anticipated
growth of eCommerce, GlobalStake.com or ExploreRealty.com, and the possible
requirement for additional financing. 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,
commercial opportunities, cash collections, and other factors set forth under
"Risks and Uncertainties" above and the section entitled "Certain Factors Which
May Affect Future Results of Operations and/or Stock Price" in the Company's
Form 10-KSB. <PAGE>
13
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
In 1999 Teknowledge offered to sell SAP a license to use the technology
related to Teknowledge's Intelligent Configuration Patent Portfolio, a
collection of five patents relating to configuration technologies, including the
`983 patent. In response to this offer, on October 8, 1999, SAP America, Inc.
and SAP Aktiengesellschaft (collectively, "SAP") filed a lawsuit against the
Company in the United States District Court for the District of Delaware. The
subject matter of the case involves Teknowledge's configuration systems patent,
Bennett et al. U.S. Patent 4,591,983 (the "'983 patent") and the configuration
technology associated with the SAP R/3 System ("R/3 System"). SAP is seeking a
judgment against Teknowledge that the `983 patent is invalid and is not
infringed by the R/3 System; an award of attorney fees, costs of suit, and other
relief the court may deem just and proper.
On October 21, 1999 Teknowledge filed a counterclaim against SAP for
patent infringement of two of its patents. The subject of the counter suit is
the `983 patent entitled "Hierarchical Knowledge System" and U.S. Patent
4,783,752 entitled "Knowledge Based Processing for Application Programs Using
Conventional Data Processing Capabilities." On May 24, 2000 and June 30, 2000,
SAP filed motions for Summary Judgment on the `983 patent and the `752 patent,
respectively. Teknowledge responded to these motions on June 9, 2000 and July
17, 2000, respectively. The parties are awaiting notification from the Judge on
a hearing date or a ruling on the filed papers. The management of the Company
considers the suit brought by SAP to be without merit and intends to defend its
patents vigorously. Management believes the ultimate resolution of the above
matters may have a positive impact, and 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
The Annual Meeting of stockholders was held on July 19, 2000.
A proposal to elect one Class III Director to serve for a three-year
term was approved by stockholders. The proposal received the following votes:
For Withheld
Robert T. Marsh 4,796,100 33,320
The following directors continue:
Benedict O'Mahoney
Dr. Larry E. Druffel
Neil A. Jacobstein
James C. Workman
Proposal no. 2 to ratify the selection of Arthur Andersen LLP as
independent accountants for the fiscal year ending December 31, 2000 was
approved by the stockholders. This proposal received the following votes:
For Against Abstain
5,064,784 5,303 18,121
Proposal no. 3 to approve and adopt and amendment to the Company's 1998
Employee Stock Option Plan to increase the number of authorized shares from
1,595,101 to 2.345,101 was approved by stockholders. This proposal received the
following votes:
For Against Abstain Broker Non-votes
2,458,012 83,050 26,035 2,567,097
<PAGE>
14
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 (4)
3.2 Amended and Restated Bylaws of Teknowledge Corporation (4)
3.3 Certificate of Designation, Preferences and Rights of the
Terms of the Series A Preferred Stock (2)
4.1 Rights Agreement dated January 29, 1996 between the Company
and Registrar and Transfer Company as Rights Agent (2)
10.1 Stock Option Agreement between the Company and Frederick
Hayes-Roth, dated November 29, 1993 (5)
10.2 Stock Option Agreement between the Company and Neil
Jacobstein, dated November 29, 1993 (5)
10.3 Stock Option Agreement between the Company and Frederick
Hayes-Roth, dated April 1, 1994 (5)
10.4 Stock Option Agreement between the Company and Neil
Jacobstein, dated April 1, 1994 (5)
10.5 Change of Control Agreement, dated November 21, 1994, between
Teknowledge Corporation and Frederick Hayes-Roth and
Neil Jacobstein (1)
10.6 Stock Option Agreement between the Company and Frederick
Hayes-Roth, dated March 30, 1995 (5)
10.7 Stock Option Agreement between the Company and Neil
Jacobstein, dated March 30, 1995 (5)
10.8 Teknowledge Corporation 1998 Stock Option Plan (3)
10.9 Executive Compensation Plan, adopted by resolution of the
Company's Compensation Committee, dated November 22, 1999 (6)
10.10 Contract Agreement with GlobalStake.com, dated November 22,
1999 (6)
27 Financial Data Schedule
<PAGE>
15
References
(1) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB,
for the fiscal year ended December 31, 1994.
(2) 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.
(3) Filed as an Exhibit to the Company's Quarterly Report on Form
10-QSB, for the quarter ended March 31, 1998.
(4) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB,
for the fiscal year ended December 31, 1998.
(5) Filed as an Exhibit to the Company's Quarterly Report on Form
10-QSB, for the quarter ended June 30, 1999.
(6) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB,
for the fiscal year ended December 31, 1999.
(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, 333-00261, and 333-67623.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
<PAGE>
16
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/ Neil A. Jacobstein Chairman and Chief August 14, 2000
Neil A. Jacobstein Executive Officer
/s/ Dennis A. Bugbee Chief Financial Officer, August 14, 2000
Dennis A. Bugbee Vice President of Finance
Principal Financial and
Accounting Officer)
