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 June 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from to
Commission File Number 0-14793
TEKNOWLEDGE CORPORATION
(Exact name of small business issuer as specified in its charter)
Delaware 94-2760916
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1810 Embarcadero Road, Palo Alto, California 94303
(Address of principal executive offices)
(650) 424-0500
Issuer's telephone number
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days:
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at July 28, 1998
---------------------------- -----------------------------
Common Stock, $.01 par value 24,534,824 Shares
2
TABLE OF CONTENTS
Page No.
PART I.FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1998
and December 31, 1997...................................... 3
Consolidated Statements of Operations for the three months
and six months ended June 30, 1998 and 1997................ 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 1998 and 1997............................... 5
Notes to Unaudited Consolidated Financial Statements....... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. ................................ 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................... 11
Item 4. Submission of Matters to a Vote of Security Holders........ 11
Item 6. Exhibits and Reports on Form 8-K........................... 12
Signatures................................................................ 14
3
PART I. FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
Item 1. FINANCIAL STATEMENTS
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
Unaudited
June 30, December 31,
1998 1997
------------ ------------
Current assets:
Cash and cash equivalents $ 1,892,481 $ 2,172,235
------------ ------------
Receivables:
Customer - billed, net of allowance of $10,000 2,308,339 1,949,476
Customer - unbilled 414,209 339,277
------------ ------------
Total receivables 2,722,548 2,288,753
------------ ------------
Deferred tax asset, short-term 400,000 400,000
Deposits and prepaid expenses 104,268 97,905
------------ ------------
Total current assets 5,119,297 4,958,893
------------ ------------
Capitalized software, net of accumulated
amortization of $554,998 and $623,215 19,705 27,398
------------ ------------
Fixed assets, at cost
Computer and other equipment 2,899,501 2,758,384
Furniture and fixtures 110,860 103,909
Leasehold improvements 835,913 829,904
------------ ------------
3,846,274 3,692,197
Less accumulated depreciation and amortization (3,236,822) (3,093,603)
------------ ------------
Net fixed assets 609,452 598,594
------------ ------------
Deferred tax asset, long-term 500,000 500,000
------------ ------------
Total assets $ 6,248,454 $ 6,084,885
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 566,337 $ 702,898
Payroll and related 671,652 744,934
Other accrued liabilities 392,262 477,012
------------ ------------
Total current liabilities 1,630,251 1,924,844
------------ ------------
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 50,000,000
shares, issued 24,418,824 and 23,982,714 shares 244,184 239,823
Additional paid-in capital 1,265,468 1,217,055
Retained earnings since January 1, 1993
(following quasi-reorganization) 3,108,551 2,703,163
------------ ------------
Total stockholders' equity 4,618,203 4,160,041
------------ ------------
Total liabilities and stockholders' equity $ 6,248,454 $ 6,084,885
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
4
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
3 Months Ended June 30, 6 Months Ended June 30,
----------------------- -----------------------
1998 1997 1998 1997
---- ---- ---- ----
Revenues $ 3,080,854 $ 2,481,827 $ 6,150,784 $ 4,287,129
------------- ------------ ------------- -------------
Costs and expenses:
Cost of revenues 1,997,250 1,735,054 3,965,000 2,844,595
General and administrative 559,685 499,766 1,165,350 972,569
Sales and marketing 291,658 197,661 504,171 305,898
Research and development 82,473 24,113 163,616 24,113
------------- ------------ ------------- -------------
Total costs and expenses 2,931,066 2,456,594 5,798,137 4,147,175
------------- ------------ ------------- -------------
Operating income 149,788 25,233 352,647 139,954
Interest income 21,990 23,122 46,138 39,910
Other income and expense, net (649) 1,109,458 (649) 1,109,247
------------- ------------ ------------- -------------
Income before tax 171,129 1,157,813 398,136 1,289,111
Provision for income tax (14,452) 2,984 (7,252) 9,131
------------- ------------ ------------- -------------
Net income $ 185,581 $ 1,154,829 $ 405,388 $ 1,279,980
============= ============ ============= =============
Net income per share:
- Basic $ 0.01 $ 0.05 $ 0.02 $ 0.05
============= ============ ============= =============
- Diluted $ 0.01 $ 0.04 $ 0.01 $ 0.04
============= ============ ============= =============
Shares used in computing
net income per share:
- Basic 24,347,570 24,973,604 24,233,528 25,544,633
============= ============ ============= =============
- Diluted 29,061,658 29,179,184 28,642,559 29,708,107
============= ============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
5
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
6 Months Ended June 30,
-----------------------
1998 1997
Cash flows from operating activities: ---- ----
Net income $ 405,388 $ 1,279,980
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 150,913 113,319
Noncash portion of other income from Trilogy Settlement - (1,005,757)
Changes in assets and liabilities:
Receivables (433,795) (661,797)
Deposits and prepaid expenses (6,363) (45,026)
Accounts payable (136,561) 166,204
Accrued liabilities (158,032) (1,613)
------------ ------------
Net cash used for operating activities (178,450) (154,690)
------------ ------------
Cash flows from investing activities:
Capitalization of software costs - (9,090)
Purchase of fixed assets (154,077) (162,070)
------------ ------------
Net cash used for investing activities (154,077) (171,160)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock 52,773 9,990
------------ ------------
Net cash provided by financing activities 52,773 9,990
------------ ------------
Net decrease in cash and cash equivalents (279,754) (315,860)
Cash and cash equivalents at beginning of period 2,172,235 1,797,892
------------ ------------
Cash and cash equivalents at end of period $ 1,892,481 $ 1,482,032
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
6
TEKNOWLEDGE CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
1. Interim Statements
The interim statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. However,
the Company believes that the disclosures are adequate to make the
information presented not misleading. These interim statements should be
read in conjunction with the financial statements and the notes thereto
included in the Company's annual report on Form 10-KSB for the fiscal
year ended December 31, 1997. In the opinion of management, these
interim statements include all adjustments, consisting of normal,
recurring adjustments, which are necessary for a fair presentation of
results for such periods. The results of operations for any interim
period presented herein are not necessarily indicative of results that
may be achieved for the entire fiscal year ended December 31, 1998.
2. Net Income Per Share
Net income per share is calculated in accordance with the
provision of Statement of Financial Accounting Standard (SFAS) No. 128,
"Earnings per Share," adopted by the Company in the fourth quarter of
1997. SFAS No. 128 requires companies to compute net income per share
under two different methods, basic and diluted. Basic earning per share
is calculated by dividing net income by the weighted average shares of
common stock outstanding during the period. Diluted earning per share is
calculated by dividing net income by the weighted average shares of
outstanding common stock and common stock equivalents during the period.
Common stock equivalents consist of dilutive shares issuable upon the
exercise of outstanding common stock options.
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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.
Teknowledge Corporation (the "Company") is in the distributed knowledge
management business. The central value of this business is to help customers
manage their knowledge assets for competitive advantage, both inside corporate
intranet, and distributed on the Internet. Teknowledge is in a unique position
to apply its core competencies in knowledge-based systems and large-scale,
distributed object-oriented software to the expanding opportunities presented by
the Internet and the World Wide Web. These core competencies have developed
through a strong software talent base, a rapidly evolving technology and
intellectual property portfolio, and a 17-year history of solving business
problems for customers. Teknowledge provides software products and consulting
services for government and commercial applications. The Company's key business
lines are: Distributed Systems Engineering, Situation Assessment & Data Fusion,
Education & Training Technologies, C4I & Information Security, and Electronic
Commerce ("E-Commerce") products and services. Teknowledge was incorporated on
July 8, 1981 under the laws of the State of Delaware.
Results of Operations
Revenues
Revenues for the three months and six months ended June 30, 1998
improved to $3,080,854 and $6,150,784, an increase of 24% and 43%, respectively,
over the comparable periods in 1997. During the interim periods, the company
began technical work on several new government contracts, which was the primary
cause of increased revenues. Approximately 98% of the revenues earned thus far
in 1998 is attributed to contracts with agencies of the Federal Government,
however, Teknowledge is focusing increasing resources and attention on
commercial revenue sources, particularly in E-Commerce.
Costs and Expenses
Cost of revenues were $1,997,250 and $3,965,000 for the three months
and six months ended June 30, 1998, increases of 15% and 39%, respectively, over
the comparable periods in 1997. The increase in cost of revenues was primarily
due to increases in labor and subcontractor costs. The Company experienced a
significant increase in labor and related costs as it continued to expand its
technical workforce on new government contracts. Subcontractor costs related to
the new contracts also increased significantly by 42% and 103%, to $582,928 and
$1,163,341 for the three and six months ended June 30, 1998, from the same
periods in 1997. Cost of revenues as a percentage of total costs declined from
71% and 69% for the three months and six months ended June 30, 1997, to 68% each
for the three months and six months ended June 30, 1998, as human resources were
diverted from performance of government contract work to commercial research and
development.
Sales and marketing costs for the three months and six months ended
June 30, 1998 increased to $559,685 and $1,165,350, or 12% and 20% over the
comparable periods in 1997. The increase was primarily due to an expanded
E-Commerce sales and marketing staff. Sales and marketing costs as a percentage
of total costs, however, decreased from 20% and 23% for the three months and six
months ended June 30, 1998 to 19% and 20% for the same periods in the previous
year.
General and administrative costs for the three months and six months
ended June 30, 1998 were $291,658 and $504,171, increases of 48% and 65% over
the comparable periods in 1997. The increased expenses were primarily due to
recruiting in a competitive labor market. General and administrative costs for
the three months and six months ended June 30, 1998 were 10% and 9% of total
costs, versus 8% and 7% for the same periods in the previous year.
8
Research and development costs for the three months and six months
ended June 30, 1998 were $82,473 and $163,616, increases of 242% and 579% over
the comparable periods in 1997. The increased expenses were primarily
concentrated in the development of commercial products for the Internet.
Research and development costs for the three months and six months ended June
30, 1998 were 3% of total costs, versus 1% for the same periods in the previous
year. These figures do not include the large amount of R&D conducted under
contract for our customers.
Interest income was $21,990 and $46,138 for the three months and six
months ended June 30, 1998, versus $23,122 and $39,910 for the comparable
periods of the previous year. The Company decreased its cash reserves in the
second quarter of 1998, due to aging of receivables and purchase of computer
equipment. There was no significant other income and expense for the three
months and six months ended June 30, 1998, but a settlement between the Company
and Trilogy Development Group, Inc. contributed $1,109,458 and $1,109,247 to
other income and expense for the three months and six months ended June 30,
1997.
Net income for the three and six months ended June 30, 1998 was
$185,581 and $405,388, or $.01 per share each, versus $1,154,829 and $1,279,980,
or $.04 per share each, for the same periods in 1997. Net income represented 6%
and 7% of revenue for the three and six months ended June 30, 1998 and 47% and
30% for the comparable periods in 1997. During the second quarter of 1997, the
Company recorded approximately $1.1M income as a result of a patent settlement
and licensing agreement with Trilogy Development Group, Inc. for Teknowledge's
Hierarchical Knowledge System Patent #4,591,983.
Bookings and Backlog
At June 30, 1998, the expected multi-year contract commitments (order
backlog) from government customers was approximately $26M, which consisted of
(i) new orders for which work has not yet begun and (ii) revenue remaining to be
recognized on work in progress. Approximately 78% of the backlog consists of
programs that are awarded but not yet authorized for funding. The government
normally funds a contract in incremental amounts for the tasks that are
currently in production. The Company's order backlog at December 31, 1997 was
approximately $25M.
Two of the Company's projects under the JFACC program were closed at
the government's convenience, pending a reassessment of the government's
priorities. Until the future of these projects is settled, the Company reduced
its multi-year backlog by $5M to the $26M figure shown above for June 30, 1998.
Any effect on revenue of the reduction in backlog is expected to be spread over
approximately 36 months. The Company is attempting to build its backlog further
with additional proposals for new government and commercial projects.
Liquidity and Capital Resources
As of June 30, 1998, unused sources of liquidity consisted of
$1,892,481 in cash and cash equivalents, a decrease of $279,754 from December
31, 1997. The decrease consisted of $178,450 used for operating activities,
$154,077 used for investing in fixed assets, and $52,773 provided by financing
activities.
The Company believes that the present level of cash and cash
equivalents is adequate to service the liquidity needs of the Company in the
next twelve months. The Company relies principally on the collection of
receivables to generate internal cash reserves. The Company may experience
periodic cashflow shortages as a result of delays associated with the
government's annual budget process.
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 and
expires in June 1999. The Company has not utilized the credit line through June
30, 1998.
9
Management believes the Company will be able to operate in the next
twelve months without additional financing, whether in the form of borrowings or
equity capital. As the Company's commercial business expands it may require
additional financing to sustain growth. There can be no assurance that such
financing will be available on satisfactory terms.
Year 2000
The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium ("year 2000" or "Y2K")
approaches. The key issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Most of the hardware
and software currently in use at the Company are relatively new and Y2K
compliant. No significant reprogramming efforts and Y2K compliance expenses
inside the Company are expected to be necessary. The Company is currently
addressing its exposure related to suppliers and customers and plans to complete
its initial evaluation of all Y2K related issues and solutions by end of 1998.
Risks and Uncertainties
Teknowledge's service revenue is currently derived primarily from
government R&D contracts, 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. Another uncertainty in
providing services under government contracts is the Company's ability to
attract and retain sufficient technical staff to meet the demands of new orders.
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 in headcount growth, billable efficiency,
and costs may vary from original estimates and necessitate periodic adjustments
to overhead rates and revenues. Such adjustments are made on a cumulative basis
whereby the resulting revenue and income effects are recognized in the period of
the adjustments.
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.
Furthermore, 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 believes the Internet and intranet software market offers a
significant new opportunity for growth and Teknowledge is in a good position to
convert Internet-based software developed under its government R&D contracts
into new commercial products. However, if the Company's E-Commerce related sales
develop more slowly than expected, or the market becomes saturated with
competitors, or if the Company's products do not achieve market acceptance, the
Company's commercial business, financial condition, and results of operations
may eventually be adversely affected.
Forward-Looking Statements
Forward-looking statements made in this section relating to recruiting
of additional employees, increase in demand for new employees, expected growth
in revenues, mix of revenues between government and commercial, anticipated new
government contracts, year 2000 issues, and the development and announcement of
commercial products involve risks and uncertainties, and actual results could
differ materially from that set forth in the forward looking statements
contained herein as a result of difficulties in recruiting, risks relating to
the development of the Internet and intranet software market, market acceptance
of the the Company's products, risks in government contracting, risks relating
to commercialization of products, and other risks set forth under "Risks and
10
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.
11
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. LEGAL PROCEEDINGS
The Company is still in litigation with a former employee. There has
been no change since March 31, 1998.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders was held on June 25, 1998.
A proposal to elect two directors of the Company to serve for a
three-year term was approved by stockholders. This proposal received the
following votes:
For Withheld
Dr. Larry E. Druffel 20,467,419 213,607
James C. Workman 20,462,560 217,466
The following directors continue:
Dr. Frederick Hayes-Roth
Neil A. Jacobstein
Gen. Robert T. Marsh (ret.)
William G. Roth
A second proposal to ratify Arthur Andersen LLP as the Company's
independent public accounts for the fiscal year ending December 31, 1998 was
approved by stockholders. This proposal received the following votes:
For Against Abstain
20,531,397 40,761 108,868
A third proposal to adopt the 1998 Stock Option Plan was approved by
stockholders. This proposal received the following votes:
Broker
For Against Abstain Non-Vote
11,292,708 847,504 292,606 8,248,208
A fourth proposal to amend the Company's Stock Option Plan for
Non-Employee Directors was approved by stockholders. This proposal received the
following votes:
Broker
For Against Abstain Non-Vote
11,202,414 1,368,395 240,432 7,869,785
A fifth proposal to permit a one-for-five reverse stock split and a
reduction in the number of authorized shares from 50,000,000 to 25,000,000 was
approved by stockholders. This proposal received the following votes:
Broker
For Against Abstain Non-Vote
18,884,819 1,206,633 208,579 380,995
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Set forth below is a list of all exhibits filed herewith or incorporated by
reference as part of this Quarterly Report on Form 10-QSB.
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certificate of Incorporation of Teknowledge
Corporation (5)
3.2 Amended and Restated Bylaws of Teknowledge Corporation (8)
3.3 Certificate of Designation, Preferences and Rights of the Terms of
the Series A Preferred Stock (7)
4.1 Rights Agreement dated January 29, 1996 between the Company and
Registrar and Transfer Company as Rights Agent (7)
10.1 Teknowledge Corporation 1989 Stock Option Plan
10.2 Amendment to Stock Option Agreement, dated November 30, 1988,
between American Cimflex Corporation and Romesh T. Wadhwani (1)
10.3 Amended Employment Agreement, dated as of January 21, 1992, between
Cimflex Teknowledge Corporation and Daniel R. Robusto (2)
10.4 Settlement Agreement, General Release, and Waiver of Claims, dated
November 21, 1992, between Daniel R. Robusto and Cimflex
Teknowledge Corporation (3)
10.5 Settlement Agreement, dated May 21, 1993, between Cimflex
Teknowledge Corporation and Third Copley-Franklin Trust (4)
10.6 Settlement Agreement, dated September 1, 1993, between Cimflex
Teknowledge Corporation and Pittsburgh Great Southern Company (4)
10.7 Change of Control Agreement, dated November 21, 1994, between
Teknowledge Corporation and Frederick Hayes-Roth and Neil
Jacobstein (6)
27 Financial Data Schedule
13
References
(1) Filed as an Exhibit to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1989.
(2) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1991.
(3) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1992.
(4) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB, as
amended, for the fiscal year ended December 31, 1993.
(5) Filed as an Exhibit to the Company's Quarterly Report on Form 10-QSB for
the quarter ended June 30, 1994.
(6) Filed as an Exhibit to the Company's Annual Report on Form 10-KSB, for
the fiscal year ended December 31, 1994.
(7) Filed as an Exhibit to the Company's 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.
(8) Filed as an Exhibit to the Company's Quarterly Report on Form 10-QSB for
the quarter ended March 31, 1996.
(b) The registrant did not file a report on Form 8-K during the quarter ended
June 30, 1998.
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 July 30, 1998
- ------------------------ of Directors and Chief
Frederick Hayes-Roth Executive Officer
(Principal Executive
Officer)
/s/ Neil A. Jacobstein President and Chief July 30, 1998
- ------------------------ Operating Officer
Neil A. Jacobstein
/s/ Dennis A. Bugbee Director of Finance, July 30, 1998
- ------------------------ Treasurer and Secretary
Dennis A. Bugbee (Principal Financial and
Accounting Officer)