<PAGE>
1
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 September 30, 2000
[ ] 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 September 30, 2000
Common Stock, $.01 par value 5,496,256 Shares
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2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<C>
Item 1. Financial Statements
<S> <C>
Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations and Comprehensive Income
for the three months and nine months ended September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for the nine months ended
September 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 12
Item 6. Exhibits and Reports on Form 8-K 13
Signatures 15
</TABLE>
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3
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS
As of September 30, 2000
ASSETS
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
2000 1999
------------------ -------------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 698,058 $ 1,951,393
------------------ -------------------
Receivables:
Customer - billed, net of allowance of $155,000 3,762,576 2,028,953
Customer - unbilled 1,014,716 1,234,189
------------------ -------------------
Total receivables 4,777,292 3,263,142
------------------ -------------------
Deferred tax asset, short-term 400,000 400,000
Deposits and prepaid expenses 141,605 75,692
------------------ -------------------
Total current assets 6,016,955 5,690,227
------------------ -------------------
Capitalized software development costs, net of accumulated
amortization of $ 157,643 and $ 81,255, respectively 1,588,228 359,743
------------------ -------------------
Fixed assets, at cost
Computer and other equipment 3,347,286 3,078,647
Furniture and fixtures 117,898 112,647
Leasehold improvements 838,398 838,398
------------------ -------------------
4,303,582 4,029,692
Less accumulated depreciation and amortization (3,848,623) (3,652,857)
------------------ -------------------
Net fixed assets 454,959 376,835
------------------ -------------------
Investment in Global Stake 1,093,835 211,765
Deferred tax asset, long-term 500,000 500,000
Other Assets, L-T 30,066 29,397
------------------ -------------------
Total assets $ 9,684,043 $ 7,167,967
================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,697,457 $ 747,404
Payroll and related liabilities 660,155 659,752
Short term Loan Obligations 1,100,000 -
Other accrued liabilities 183,858 221,159
------------------ -------------------
Total current liabilities 3,641,470 1,628,315
------------------ -------------------
Commitments and contingencies
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 5,496,256 shares 54,970 53,025
Additional paid-in capital 1,882,121 1,795,402
Retained earnings since January 1, 1993
(following quasi-reorganization) 4,105,482 3,872,332
------------------ -------------------
Total stockholders' equity 6,042,573 5,539,662
------------------ -------------------
Total liabilities and stockholders' equity $ 9,684,043 $ 7,167,977
================== ===================
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 Sep 30, 9 Months Ended Sep 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Revenues $ 4,195,696 $ 2,901,267 $ 10,970,093 $ 8,468,534
------------------ --------------------- ------------------ -----------------
Costs and expenses:
Cost of revenues 3,068,667 1,978,308 8,037,140 5,294,705
General and administrative 666,124 636,309 1,897,917 1,922,286
Sales and marketing 110,815 101,486 353,871 368,982
Research and development 140,981 104,266 318,950 371,224
------------------ --------------------- ------------------ -----------------
Total costs and expenses 3,986,587 2,820,369 10,607,878 7,957,197
------------------ --------------------- ------------------ -----------------
Operating income 209,109 80,898 362,215 511,337
Interest income (4,097) 31,439 26,339 84,539
Other Expense 3,319 2,417 44 2,417
------------------ --------------------- ------------------ -----------------
Income before tax 208,331 114,754 388,598 598,293
Provision (benefit) for income tax 83,333 62,664 155,440 256,079
------------------ --------------------- ------------------ -----------------
Net income $ 124,998 $ 52,090 $ 233,158 $ 342,214
================== ===================== ================== =================
Net income per share:
- Basic $ 0.02 $ 0.01 $ 0.04 $ 0.07
================== ===================== ================== =================
- Diluted $ 0.02 $ 0.01 $ 0.04 $ 0.06
================== ===================== ================== =================
Shares used in computing net income per share:
- Basic 5,496,256 5,007,479 5,376,351 4,981,537
================== ===================== ================== =================
5,790,816
- Diluted 5,885,927 5,564,196 6,020,161 5,790,816
================== ===================== ================== =================
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)
9 Months Ended Sep 30,
2000 1999
<S> <C> <C>
Cash flows from operating activities:
Net income $ 233,158 $ 342,214
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 353,409 271,516
Allowance for doubtful accounts 145,000 10,000
Noncash portion of income tax provision 141,840 214,706
Changes in assets and liabilities:
Receivables (1,659,150) 14,673
Deposits and prepaid expenses (65,913) (14,270)
Accounts payable 950,053 31,404
Accrued liabilities (36,898) (95,651)
---------------- ----------------
Net cash provided by (used for) operating activities 61,499 774,592
---------------- ----------------
Cash flows from investing activities:
Investment in Globalstake (882,069) -
Capitalization of software development costs (1,386,797) (146,898)
Purchase of fixed assets (273,890) (69,721)
---------------- ----------------
Net cash used for investing activities (2,542,756) (216,619)
---------------- ----------------
Cash flows from financing activities:
Drawdown on Line of Credit 1,100,000 -
Proceeds from issuance of common stock 127,923 157,022
Repurchase of common stock - (241,334)
---------------- ----------------
Net cash provided by financing activities 1,227,923 (84,312)
---------------- ----------------
Net increase (decrease) in cash and cash equivalents (1,253,334) 473,661
Cash and cash equivalents at beginning of period 1,951,393 2,378,390
---------------- ----------------
Cash and cash equivalents at end of period $ 698,059 $ 2,852,051
================ ================
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
September 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. 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's discretion using the
Company's own cash reserves. As of September 30, 2000, the Company had 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.
4. 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.
<PAGE>
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 ("the Company") increased its financial software and
services business substantially in the third quarter of 2000. The Company has
been investing in TekPortal(TM) software product development, testing, and
sales. For the three months ended September 30, 2000, the percentage of
Teknowledge's commercial business has increased to 45% from 21% in the
comparable quarter in 1999. As a result of on-going work at banks currently
installing TekPortal, the current pipeline of banking opportunities, and
anticipated growth in Internet-based financial services, the Company expects
commercial revenues to continue to grow.
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 and brokerage accounts. TekPortal
permits both information aggregation and transactions between accounts. The
customer provides all of the account and transaction permissions. TekPortal is
typically installed on-premise at the financial institution. The financial
institution provides its own security and privacy policies, and if necessary,
Teknowledge's Information Assurance team can provide addition security software
and services. A recent Celent Communications report on Account Aggregators
recognized Teknowledge as the most experienced team leader in delivering
on-premise account aggregation solutions. The Company has several new Internet
bank customers, and several effective 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(TM) 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 software 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(TM). 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.
<PAGE>
8
Teknowledge has been in business for nineteen years. It has reported
twenty-five consecutive profitable quarters. 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, including CTO Dr.
Robert Balzer from the University of Southern California's Information Sciences
Institute. Teknowledge provides 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 September 30, 2000 and 1999 were
$4,195,696, and $2,901,267, respectively, a 45% improvement between periods.
Approximately 45%, or $1,885,744, of the revenue earned in the third quarter of
2000 was attributed to commercial customers, and 55%, or $2,309,952, was from
government contract R&D. In the comparable period in 1999, government and
commercial revenues were $2,049,080 and $852,187, respectively. In dollar terms,
commercial revenues more than doubled over the previous year.
Government-sponsored contract R&D revenues between comparable periods improved
13%. Commercial revenues for the nine months ended September 30, 2000 were 39%
of total revenues. $330,000, or 17.5%, of eCommerce revenue was attributed to
the sale of commercial software licenses associated with the installation of the
Company's proprietary TekPortal(TM) product on the web sites of financial
service providers. The Company's pipeline of potential eCommerce customers has
increased substantially in Q3. Because of the increased customer interest, the
Company anticipates an increase in demand for its TekPortal financial products
in the fourth quarter of 2000. Contract R&D revenues are expected to remain
approximately the same, depending on the results of new program decisions and
competitive contract awards.
Costs and Expenses
Cost of revenues was $3,068,667 for the three months ended September
30, 2000 compared to $1,978,308 in the comparable period in 1999. The Company
continues to expand its workforce to meet the demands of the growing commercial
business. The bulk of the increase between periods in attributed to the growth
in the demand for the TekPortal(TM) product and a corresponding increase in the
costs of delivering additional services and support for customers using the new
product. The Company also uses billable consultants and contractors to
supplement its full-time employee workforce. During the third quarter of 2000,
the Company spent $1,647,508 on these services compared to $1,105,320 in the
comparable quarter of 1999. Subcontractor and consultant costs increased 49%
between 1999 and 2000, roughly equivalent to the revenue growth between periods.
Cost of revenues as a percentage of total revenues for both the three months and
nine months ended September 30, 2000 was 73% of revenues, or $3,068,667 and
$8,307,140, respectively. In the comparable periods in 1999, cost of revenues
was $1,978,308 and $5,294,705, or 68% and 62.5%, respectively.
General and administrative costs for the three months ended September
30, 2000 were $666,124, a $29,815 increase over the third quarter in 1999. In
the third quarter of 2000, the Company experienced less average headcount in
administrative and executive functions, and an increase in legal expenditures.
General and administrative costs for the three months and nine months ended
September 30, 2000 were $666,124 and $1,897,917, or 16% of total revenues,
versus $636,309 and $1,922,286, or 22%, in the comparable periods in 1999.
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9
Sales and marketing costs for the three months ended September 30, 2000
were $110,815, a $9,329 or 9% increase over the comparable period in 1999. Sales
and marketing costs rose in the third quarter of 2000 as the eCommerce unit
expanded its advertising and marketing activities and assigned more personnel to
product sales. For the nine months ended September 30, 2000, sales and marketing
costs were $353,871, approximately 4% below the prior year. Sales and marketing
costs are expected to increase during 2000 as the Company expands its financial
services and product business.
Research and development ("R&D") costs for the three months ended
September 30, 2000 were $140,981, a 35% 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 software development costs that were
capitalized during the period. The Company expended $298,072 in the third
quarter in the development of software for its TekPortal product that was
capitalized in accordance with SFAS 86. For the year, the company has
capitalized $1,386,128 of TekPortal costs. Some of the employees who are
qualified to work on R&D projects were diverted to develop TekPortal software.
Internal R&D costs, excluding TekPortal development, were 3% of revenues for the
three months ended September 30, 2000 and 4% of revenues in the comparable
quarter in 1999.
Net interest income was $12,120 and $33,856 for the three months ended
September 30, 2000 and 1999, respectively. Interest income reflects lower
average cash balances during the period. The Company paid $16,217 of interest
expense related to a bank loan during the quarter.
Income before taxes for the three months and nine months ended
September 30, 2000 was $208,331 and $388,598, respectively, which represented an
81% increase and 35% decrease over the comparable period in 1999. Starting in
1999, the Company achieved very low or even negative margins on its start-up
eCommerce business, which was offset by the predictable returns from most
government contracts. Starting in mid 2000, the company experienced an increase
in revenue from commercial customers and products, but the emerging business
line has yet to achieve its expected margins. Income before taxes was 5% of
revenues from the three months ended September 30, 2000, and 4% of revenues in
the comparable period in 1999.
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 the
full amount of such taxes, and there will be only a minimal effect on the
Company's cash reserves resulting from the reported increase in its effective
tax rate.
Net income for the three months and nine months ended September 30,
2000 was $124,998 and $233,158, or $.02 and $.04 per diluted share, versus
$52,090 and $342,214, or $.01 and $.06 per diluted share, for the same periods
in 1999. Net income represented 3% and 2% of revenues for the three months and
nine months ended September 30, 2000; and 2% and 4% for the comparable periods
in 1999, respectively. Because the eCommerce unit is relatively new, it has not
achieved its expected net margins in its first year of operations. Government
contracts continue to produce steady income but at a rate that is typically well
below what one would expect from a successful commercial enterprise. This is
because contracts negotiated with the government are restricted by government
regulation from exceeding the fee limits established in the Federal Acquisition
Regulations. The Company expects to achieve higher net margins on its commercial
contracts as volume increases and operating efficiencies improve.
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10
Bookings and Backlog
At September 30, 2000, the expected multi-year order backlog was
approximately $18.4 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. 96% of September 30, 2000 backlog is from competitive awards for
government contract R&D projects. Approximately 35% 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. Approximately 67% of the new contract
work is expected to be completed within twelve months. The Company's backlog at
December 31, 1999 was approximately $18.6M.
Liquidity and Capital Resources
As of September 30, 2000, unused sources of liquidity of the Company
were $698,058 in cash and cash equivalents, a decrease of $2,154,169 over the
previous year. The Company generated cash of $61,499 from its operating
activities and $1,227,923 from financing activities, including $1,100,000 of
borrowings. It invested $1,386,128 for developing capitalized software and
$273,890 for purchases of computer equipment and other improvements. The Company
invested $882,069 in GlobalStake.com during the first nine months of the year
and has met 91% of its $1,200,000 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, but the Company believes it will need
additional cash to fund future growth. The Company is contractually committed to
provide an additional $106,000 of seed money to GlobalStake.com's new business
in future periods. It is anticipated that this requirement will be fulfilled
early in 2001 and no future cash requirements are anticipated. The Company
borrowed $600,000 against its line of credit in August 2000 and has borrowed a
total of $1,100,000 against the $2,000,000 bank line. The Company uses the money
to supplement its existing reserves and to fund the growth of its commercial
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 TekPortal business. 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
is increasing its reserve for bad debt.
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.
Risks and Uncertainties
Management believes that the market for TekPortal(TM) 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 financial aggregation software in particular. In addition, for
its "dot-com" customers, Teknowledge is exposed to a higher risk of bad debt and
slower collections, compared to more reliable government customers. If the
Company does not raise additional cash, the Company's business growth, financial
condition, and results of operations may be materially and adversely affected.
Management is investigating several opportunities to raise additional cash for
growth by selling technology licenses or stock. However, there is no guarantee
that these efforts will yield positive results. <PAGE>
11
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 long-term viability of these products be predicted in
advance of actual market experience. 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 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 made third-party
arrangements to accept its real estate lead stream. GlobalStake.com is
developing a viable business-to-business model for conducting commercial real
estate mortgages. This business is configured to be cash flow positive and
profitable. However, GlobalStake.com is a business with limited cash and all the
associated risks and uncertainties of a start-up business. Teknowledge continues
to own 19.9% of GlobalStake.com.
Teknowledge's service revenue from government R&D contracts was 55% of
total revenue in the third quarter, 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
program priority changes, 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. Federal
Acquisition Regulations exclude from reimbursement some "unallowable" expenses,
which the Company considers a regular part of the business. In addition, 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, cash and financing
requirements, and the anticipated growth of eCommerce and GlobalStake.com. 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>
12
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 September 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 may not have an adverse
material impact on the Company's financial position and results of operations.
<PAGE>
13
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>
14
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>
15
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 November 14 , 2000
Neil A. Jacobstein Executive Officer
/s/ Dennis A. Bugbee Chief Financial Officer, November 14, 2000
Dennis A. Bugbee Vice President of Finance
(Principal Financial and
Accounting Officer)
