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 March 31, 1996
[ ] 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)
(415) 424-0500
Issuer's telephone number
State 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 18, 1996
---------------------------- -----------------------------
Common Stock, $.01 par value 29,016,145 Shares
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TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
Item 1 Unaudited Financial Statements
Consolidated Balance Sheets as of March 31, 1996
and December 31, 1995 ............................................ 3
Consolidated Statements of Operations for the
three months ended March 31, 1996 and 1995 ....................... 5
Consolidated Statements of Cash Flows for the
three months ended March 31, 1996 and 1995 ....................... 6
Notes to Unaudited Consolidated Financial Statements ............. 7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations .................... 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................ 12
Item 5. Other Information ................................................ 12
Item 6. Exhibits and Reports on Form 8-K ................................. 13
Signatures ....................................................... 14
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PART I. FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
Item 1. FINANCIAL STATEMENTS
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
(Unaudited)
March 31, December 31,
1996 1995
-------------------- ---------------------
Current assets:
Cash and cash equivalents $ 1,179,190 $ 962,724
-------------------- ---------------------
Receivables:
Customer - billed, net of allowance of $10,000 1,119,854 1,303,581
Customer - unbilled 83,382 17,361
Others 33,805 34,436
-------------------- ---------------------
Total receivables 1,237,041 1,355,378
-------------------- ---------------------
Deposits and prepaid expenses 60,648 56,704
-------------------- ---------------------
Total current assets 2,476,879 2,374,806
-------------------- ---------------------
Capitalized software, net of accumulated
amortization of $1,077,491
($1,063,733 - December 31, 1995) 202,138 180,974
-------------------- ---------------------
Equipment and improvements, at cost
Computer and other equipment 2,232,644 2,193,790
Leasehold improvements 744,315 744,315
-------------------- ---------------------
2,976,959 2,938,105
Less accumulated depreciation and amortization (2,737,620) (2,694,888)
-------------------- ---------------------
Net equipment and improvements 239,339 243,217
-------------------- ---------------------
Total assets $ 2,918,356 $ 2,798,997
==================== =====================
The accompanying notes are an integral part of these financial statements.
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TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS (CONT'D)
LIABILITIES AND STOCKHOLDERS' EQUITY
(Unaudited)
March 31, December 31,
1996 1995
-------------------- ---------------------
Current liabilities:
Accounts payable $ 204,673 $ 181,507
-------------------- ---------------------
Accrued liabilities:
Payroll and bonuses 351,135 435,667
Provision for contract charges 100,567 100,567
Provision for discontinued operations 145,413 135,615
Technology purchase 75,000 100,000
Other 341,141 344,414
-------------------- ---------------------
Total accrued liabilities 1,013,256 1,116,263
-------------------- ---------------------
Total current liabilities 1,217,929 1,297,770
-------------------- ---------------------
Long-term liabilities:
Provision for discontinued operations 54,432 88,704
Restructuring obligations 36,610 36,610
-------------------- ---------------------
Total long-term liabilities 91,042 125,314
-------------------- ---------------------
Total liabilities 1,308,971 1,423,084
-------------------- ---------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value, shares authorized
2,500,000, Series A, Convertible, none issued - -
Common stock, $.01 par value, shares authorized
50,000,000, issued 26,040,145 and 25,923,674
at March 31, 1996 and December 31, 1995, respectively 260,397 259,232
Additional paid-in capital (after (i) reduction of
$57,962,379 for elimination of accumulated deficit
at December 31, 1992, as a result of quasi-reorganization;
and (ii) increase of $18,306, $105,706 and $1,001,310 in
1995, 1994 and 1993, respectively as a result of reversal
of portions of 1992 loss provisions) 1,968,993 1,968,719
Deferred compensation (60,086) (120,173)
Accumulated deficit since January 1, 1993
(following quasi-reorganization) (556,919) (728,865)
-------------------- ---------------------
1,612,385 1,378,913
Treasury stock, at cost, 24,000 shares (3,000) (3,000)
-------------------- ---------------------
Total stockholders' equity 1,609,385 1,375,913
-------------------- ---------------------
Total liabilities and stockholders' equity $ 2,918,356 $ 2,798,997
==================== =====================
The accompanying notes are an integral part of these financial statements.
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TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended March 31,
----------------------------
1996 1995
---- ----
Revenues $ 1,670,779 $ 1,317,026
---------------- ----------------
Costs and expenses:
Cost of revenues 972,986 720,520
Selling and marketing 26,835 19,651
General and administrative 554,427 487,944
---------------- ----------------
Total costs and expenses 1,554,248 1,228,115
---------------- ----------------
Operating income 116,531 88,911
Interest income and expense 11,170 4,907
Other income, net 46,870 55,464
---------------- ----------------
Income before tax 174,571 149,282
Provision for income tax 2,625 -
---------------- ----------------
Net income $ 171,946 $ 149,282
================ ================
Net income per share $ 0.01 $ 0.01
================ ================
Weighted average common and
common equivalent shares outstanding 30,063,311 27,734,736
================ ================
The accompanying notes are an integral part of these financial statements.
6
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,
----------------------------
1996 1995
---- ----
Cash flows from operating activities:
Net income $ 171,946 $ 149,282
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of capitalized software 13,758 50,575
Depreciation 42,732 34,313
Stock compensation expense 60,086 60,086
Gain on sale of fixed assets (100) (4,459)
Changes in assets and liabilities:
Receivables 118,337 (70,665)
Deposits and prepaid expenses (3,944) 23,943
Accounts payable 23,166 (61,621)
Accrued liabilities (133,679) 66,296
------------- ------------
Net cash provided by operating activities 292,302 247,750
------------- ------------
Cash flows from investing activities:
Capitalization of software costs (34,922) (8,334)
Purchase of fixed assets (38,854) (43,687)
Proceeds from sale of fixed assets 100 4,459
------------- ------------
Net cash used for investing activities (73,676) (47,562)
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,439 471
Payments of capital lease obligations (3,599) (5,127)
------------- ------------
Net cash used for financing activities (2,160) (4,656)
------------- ------------
Net increase in cash and cash equivalents 216,466 195,532
Cash and cash equivalents at beginning of period 962,724 809,169
------------- ------------
Cash and cash equivalents at end of period $ 1,179,190 $ 1,004,701
============= ============
The accompanying notes are an integral part of these financial statements.
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TEKNOWLEDGE CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1996
1. Interim Statements
The interim statements are unaudited and should be read in conjunction
with the statements and notes thereto contained in the Company's Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1995. 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 are not necessarily
indicative of results which may be achieved for the entire fiscal year
ending December 31, 1996.
2. Net Income Per share
The number of shares of common stock used in the computation of per
share earnings for the quarters ended March 31, 1996 and 1995,
respectively, is the weighted average number of shares of common and
common shares equivalent outstanding during the applicable periods.
Common stock options which are common stock equivalents are included
for both quarters ended March 31, 1996 and 1995 because they are
dilutive. The difference between primary and fully diluted earnings per
share is immaterial, therefore only primary earnings per share is
presented in the financial statements.
3. Contingencies - Litigation
On December 8, 1994, a lawsuit was filed in the United States District
Court for the Northern District of California by Trilogy Development
Group, Inc. ("Trilogy") against the Company. The subject matter of the
case involves a configuration systems patent owned by the Company
(Bennett et al. U.S. Patent 4,591,983) and a sales configuration
product of Trilogy. Trilogy is seeking a judgment against Teknowledge
that it does not infringe any claim of the Bennett et al. patent, and
for actual and punitive damages and attorney fees for alleged unfair
competition under the Lanham Act and common law for misrepresenting
Teknowledge and Trilogy's products. The Company is vigorously
contesting these matters, and has filed countersuits against Trilogy
for patent infringement and for unfair competition under the Lanham Act
and common law for alleged false and misleading statements disparaging
the Bennett et al. patent. The court is currently reviewing a motion
for summary judgment asserting that the Bennett et al. patent is
invalid because the invention was allegedly "on sale" more than one
year prior to the filing date of the patent. Teknowledge contests this
claim. A court decision on this motion is currently pending.
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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.
Forward looking statements made in this section relating to recruiting of
additional employees, increase in demand for new employees, expected growth and
revenues, competition for expected new government contracts, development and
announcement of commercial products, and expected legal expenditures are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. All forward looking statements involve risks and
uncertainties, and actual results could differ materially from those set forth
in the forward looking statements contained herein.
Certain Factors That May Affect Future Results of Operations and/or Stock Price
Currently, agencies of the U.S. Government sponsor most of the Company's
revenues. In recent years, the portion of the Company's revenues attributed to
government business has risen from 95% in fiscal 1995 to 99% for the quarter
ended March 31, 1996. Competition for government funding is increasing, but this
factor is offset by the strength of the Company's market niche in open,
distributed systems and its growing technology leadership position. Teknowledge
has operated as both a prime contractor and subcontractor. Depending on specific
contract opportunities, it may team with other contractors to compete for
exceptionally large contracts. Government contracts are potentially more risky
than commercial contracts because they are subject to agency funding
limitations, congressional appropriation, and the political agenda of the
current administration in Washington, D.C. The Company has not been affected by
recent stalemates between Congress and the President regarding the 1996 budget;
however, there can be no assurance that the Company will not be affected in the
future. In general, however, the next generation, joint services, command and
control system for international wartime and disaster relief operations is a
priority for both political parties.
The typical cost-type government contract performed by the Company has a
negotiated fee limit which inhibits the Company from improving profit margins on
the government contract part of the business beyond what is permitted in
government regulations. Additionally, almost all the Company's contracts contain
termination clauses which permit contract termination upon the Company's default
or at the contracting party's discretion. The Company has not experienced any
material cancellations to date; however there can be no assurance that such
cancellations will not occur in the future.
The indirect costs and expenses accumulated in the performance of government
contracts are allocated to the customer in the form of overhead (indirect)
rates. These rates, which are periodically reviewed by government auditors,
fluctuate based on the relationship between the overhead costs and direct costs
incurred in the performance of the contract. Excluded from these rates, and not
subject to reimbursement, are certain costs which are prescribed as unallowable
by the government, such as entertainment and advertising, and a considerable
portion of litigation costs. In addition, the government has established
compensation limits which expressly reduce the amount of employee compensation
and related expenses, such as bonuses and stock options, that can be passed on
to the government through the rates. In recent years, the Company has
experienced a decline in the fees on new government contracts due to government
cost saving efforts. The limitation on potential government contract fees
coupled with the increase in the expenses not eligible for reimbursement from
the government, limits the Company's ability to improve profit margins on
government contracts in the future; therefore, the Company has increased its
emphasis on commercial Internet software development.
The Company recognizes that the continued success of the business is dependent
on key management and technical personnel, the loss of one or more of whom could
adversely affect the Company's business. The Company relies on its executives
and senior technical managers for the selection and negotiation of government
awards, preparation of proposals, and the general direction and management of
9
the Company. The Company believes that its future success depends on attracting
and retaining highly qualified technical, administrative, and management
personnel.
The market for software and services related to Associate Systems, as well as
the market for Internet products generally is rapidly evolving. It is
characterized by an increasing number of market entrants who have introduced
their products and services for communication and commerce over the Internet and
in private networks. As is typical in the case of a new and rapidly evolving
industry, demand and market acceptance for recently introduced products and
services are subject to a high level of uncertainty. The industry is young and
has few proven products. Moreover, critical issues concerning the commercial use
of the Internet (including profitability, security, reliability, ease of use and
access, and quality of service) remain unresolved and may impact the growth of
Internet use. Management believes that the technical issues above will
eventually be addressed and resolved.
There can be no assurance that commerce and communication over the Internet or
private networks will grow as quickly as expected, or that any products
developed or marketed by the Company will achieve market acceptance for these
purposes. The Company's products may be subject to price erosion and marketing
risks due to free client software distributed by on-line service providers,
Internet access providers, and others. There can also be no assurance that any
products developed by the Company for such new markets, even if accepted, will
generate any significant profits for the Company. Management believes that the
market for Internet software is a significant new opportunity for growing the
Company rapidly. Further, management believes that Teknowledge is in an
excellent position to exploit its government sponsored Internet software
research contracts into commercial products. However, if the Internet market
fails to develop, develops more slowly than expected, becomes saturated with
competitors, or if the Company's products for the Internet market do not achieve
market acceptance, the Company's business, financial condition, and results of
operations may be materially and adversely affected.
Generally, the Company's operating results are affected by a wide variety of
factors, including successful commercialization of the Company's products,
competition from larger companies, staffing and recruiting competition, general
economic conditions, and the possibility of a favorable or unfavorable outcome
in pending litigations (see Part II Item 1. Legal Proceedings.)
Results of Operations
Revenues
Revenues for the quarter ended March 31, 1996 were $1,670,779, an increase of
27% over the amount reported in the first quarter of 1995 of $1,317,026. This
increase of revenues was primarily attributed to the addition of technical
employees who performed on government contracts awarded in 1994 and 1995. The
Company continues to recruit for a number of open positions on existing
contracts and anticipates an increase in demand for new employees in fiscal 1996
if new contracts are awarded. Revenues from government contracts represent 99%
and 94%, respectively, of total revenues for the quarter ended March 31, 1996
and 1995. The Company expects the mix of revenues between government and
commercial services and products to remain about the same in 1996, unless new
commercial opportunities are realized.
Costs and Expenses
Costs of revenues were $972,986 and $720,520 for the quarters ended March 31,
1996 and 1995, respectively. Costs and expenses rose 35% over the previous year
due to the aforementioned increase in the technical workforce and related
expenses. Cost of revenues as a percentage of revenues was 58% and 55%,
respectively, for the quarters ended March 31, 1996 and 1995.
Combined selling and marketing costs and general and administrative costs for
10
the quarter ended March 31, 1996 were $581,262, a 15% increase over $507,595 for
the same period in 1995. The increase was due to the addition of two
administrative staff and the cost of implementing a shareholder Rights Agreement
in January.
The Company recorded no material charges for research and development ("R&D") in
either quarter ended March 31, 1996 or 1995. Most of its resources for research
and development were diverted to the litigation matter as discussed in Part II
Item 1, Legal Proceedings. Much of the Company's research and development
efforts are funded initially as a government project which the Company generally
believes it will be able to transform into a Company funded R&D project for
commercialization at a later date. The Company plans to increase its investments
in R&D as growth permits.
The Company has capitalized software development costs from the point at which
technological feasibility was determined through general availability of the
product. For the quarter ended March 31, 1996, capitalized software development
costs were $34,922 as compared to $8,334 in the same period last year. The
increase reflects a concerted effort by the Company towards building software
for the commercial marketplace.
Interest income was $11,170 and $5,179, respectively, for quarters ended March
31, 1996 and 1995. Other income was $46,870 and $55,464, respectively, for the
quarters ended March 31, 1996 and 1995. The majority of this other income in
both quarters was from the previous sale of a product line. The product line was
sold in exchange for a note and a royalty agreement in 1990. Because of the
uncertainty surrounding the eventual collection of the note, the Company has
elected to recognize the proceeds as other income only when cash is received.
Net income for the quarter ended March 31, 1996 was $171,946, or $.01 per share,
compared to $149,282, or $.01 per share, for the quarter ended March 31, 1995.
Net income was 10.3% and 11.3% as a percentage of revenues for the quarter ended
March 31, 1996 and 1995, respectively.
Bookings and Backlog
At March 31, 1996, the expected order backlog was approximately $10 million,
which consisted of (i) new orders for which work has not yet begun, and (ii)
revenue remaining to be recognized on work in progress. 100% of the backlog was
from government customers. 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. The Company's order backlog at December
31, 1995 was approximately $10.5 million.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1996, unused sources of liquidity of the Company consisted of
$1,179,190 of cash and cash equivalents, an increase of $216,466 from December
31, 1995. Included in the increase was $292,302 provided by operating
activities, $73,676 used for investing activities, and $2,160 used for financing
activities. Net income for the quarter ended March 31, 1996 of $171,946, after
adjustments for non-cash items such as depreciation, amortization and stock
compensation expense, provided $288,522 in cash to the Company. These proceeds
coupled with $118,337 from the realization of accounts receivable were then used
to pay off a net of $133,679 in accrued liabilities (including $220,207 in
executive bonuses), finance $34,922 in software development, and purchase
$38,854 in machinery and equipment.
The Company believes that the present level of cash and cash equivalents is
adequate to service the liquidity needs of the Company in 1996. The Company
relies principally on the collection of receivables to generate internal cash
reserves. The partial shutdown of the government in 1995 due to a budget
stalemate has not had an adverse effect on the Company's cash flow; however, the
government is capable of temporarily disrupting the flow of cash to the Company
11
at any time, usually as a result of the annual budget process. In addition, a
judgment adverse to the Company in the legal proceedings described in Part II
Item 1 could have a negative material impact on the Company's liquidity if the
Company is subject to penalties or other assessments.
The Company has an unsecured line of credit from a financial institution in the
amount of $400,000. The Company may borrow up to a maximum of 50% of the
receivable base or $400,000, whichever is lower. The line is subject to certain
covenants and maintenance requirements, which have been fulfilled. The line
expires on May 10, 1996 but is expected to be renewed. The Company had not
utilized the credit line through the quarter ended March 31, 1996.
Management believes the Company will be able to operate in 1996 without
additional financing, whether in the form of borrowings or equity capital.
Successful operations in the long term will require growth in revenues and
profitability which may require additional financing.
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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 defenses and certain counterclaims
against Mr. Robusto based upon his actions while in office. The
litigation process is continuing.
On December 8, 1994, a lawsuit was filed in the United States
District Court for the Northern District of California by Trilogy
Development Group, Inc. ("Trilogy") against the Company. The
subject matter of the case involves a configuration systems patent
owned by the Company (Bennett et al. U.S. Patent 4,591,983) and a
sales configuration product of Trilogy. Trilogy is seeking a
judgment against Teknowledge that it does not infringe any claim
of the Bennett et al. patent, and for actual and punitive damages
and attorney fees for alleged unfair competition under the Lanham
Act and common law for misrepresenting Teknowledge and Trilogy's
products. The Company is vigorously contesting these matters, and
has filed countersuits against Trilogy for patent infringement and
for unfair competition under the Lanham Act and common law for
alleged false and misleading statements disparaging the Bennett et
al. patent. The court is currently reviewing a motion for summary
judgment asserting that the Bennett et al. patent is invalid
because the invention was allegedly "on sale" more than one year
prior to the filing date of the patent. Teknowledge contests this
claim. A court decision on this motion is currently pending.
On September 19, 1995, Trilogy filed a suit in the Delaware
Superior Court alleging breach of contract by the Company in
relation to $125,000 in deferred payments under a 1987 agreement
between BMW Vision Associates Limited Partnership ("BMW") and
American Cimflex Corporation ("ACC"), a predecessor to the
Company. The agreement provided for the sale of technology by BMW
to ACC for a consideration including certain deferred payments. In
July 1995, Trilogy acquired by assignment for $276,786 BMW's right
to the remaining deferred payments and then demanded payment of
$525,000 from the Company. In September 1995, the Company paid
Trilogy $400,000 in full satisfaction of the $525,000, disclaiming
the obligation to pay the balance of $125,000 which the Company
believes to be barred by statute of limitation. Trilogy filed a
suit seeking the $125,000, subsequent deferred payments, interest
and attorney fees. The Company has responded to the initial
complaint and the litigation is now in the discovery stage.
Item 5. OTHER INFORMATION
Trilogy informed the Company in a Schedule 13D/A filing dated
April 1, 1996 that it had purchased 545,031 shares of Teknowledge
stock from Framatome S.A. in a private transaction at $.295 a
share. This purchase increased Trilogy's ownership of Teknowledge
stock to 3,508,453 shares or 13.5% of the Company.
13
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Index to Exhibits:
Exhibit No. Description
---------- -----------
3.2 Amended and Restated Bylaws of Teknowledge
Corporation
27 Financial Data Schedule
b) Reports on Form 8-K:
Current Report on Form 8-K dated February 12, 1996, related to the
adoption of a 12(g) Shareholder Rights Agreement dated January 29,
1996.
14
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 April 18, 1996
- ------------------------ of Directors and Chief
Frederick Hayes-Roth Executive Officer
(Principal Executive
Officer)
/s/ Neil A. Jacobstein President and Chief April 18, 1996
- ------------------------ Operating Officer
Neil A. Jacobstein
/s/ Dennis A. Bugbee Director of Finance, April 18, 1996
- ------------------------ Treasurer and Secretary
Dennis A. Bugbee (Principal Financial and
Accounting Officer)