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, 1999
[ ] 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 November 1, 1999
Common Stock, $.01 par value 5,263,367 Shares
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TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998 3
Consolidated Statements of Operations and Comprehensive Income
for the three months and nine months ended September 30, 1999 and 1998 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and 1998 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 12
Signatures 14
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PART I. FINANCIAL INFORMATION
- ------------------------------------------------------------------------------------------------
Item 1. FINANCIAL STATEMENTS
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
(Unaudited)
September 30, December 31,
1999 1998
-------------- ------------
Current assets:
Cash and cash equivalents $ 2,852,051 $ 2,378,390
-------------- ------------
Receivables:
Customer - billed, net of allowance of $10,000 1,045,177 2,471,242
Customer - unbilled 1,463,933 62,541
-------------- ------------
Total receivables 2,509,110 2,533,783
-------------- ------------
Deferred tax asset, short-term 400,000 400,000
Deposits and prepaid expenses 130,525 116,255
-------------- ------------
Total current assets 5,891,686 5,428,428
-------------- ------------
Capitalized software development costs, net of accumulated
amortization of $81,255 and $11,562, respectively 344,412 267,206
-------------- ------------
Fixed assets, at cost
Computer and other equipment 3,008,995 2,939,274
Furniture and fixtures 112,647 112,647
Leasehold improvements 838,398 838,398
-------------- ------------
3,960,040 3,890,319
Less accumulated depreciation and amortization (3,587,765) (3,385,942)
-------------- ------------
372,275 504,377
-------------- ------------
Deferred tax asset, long-term 500,000 500,000
-------------- ------------
Total assets $ 7,108,373 $ 6,700,011
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 692,725 $ 661,321
Payroll and related liabilities 732,628 678,514
Other accrued liabilities 118,099 267,863
-------------- ------------
Total current liabilities 1,543,452 1,607,698
-------------- ------------
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 5,318,262 and outstanding 5,261,192 shares at
September 30, 1999, issued and outstanding 4,954,954 shares
at December 31, 1998 53,183 49,550
Additional paid-in capital 1,922,075 1,553,980
Retained earnings since January 1, 1993
(following quasi-reorganization) 3,830,997 3,488,783
Less: Treasury stock at cost (241,334) -
-------------- ------------
Total stockholders' equity 5,564,921 5,092,313
-------------- ------------
Total liabilities and stockholders' equity $ 7,108,373 $ 6,700,011
============== ============
The accompanying notes are an integral part of these consolidated financial statements.
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TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Unaudited)
3 Months Ended Sep 30, 9 Months Ended Sep 30,
1999 1998 1999 1998
Revenues $ 2,901,267 $ 3,070,219 $ 8,468,534 $ 9,221,003
------------- ------------- ------------- -------------
Costs and expenses:
Cost of revenues 1,978,308 2,226,756 * 5,294,705 6,177,374 *
General and administrative 636,309 497,186 1,922,286 1,662,536
Sales and marketing 101,486 123,127 * 368,982 519,194 *
Research and development 104,266 (31,114)* 371,224 254,988 *
------------- ------------- ------------- -------------
Total costs and expenses 2,820,369 2,815,955 7,957,197 8,614,092
------------- ------------- ------------- -------------
Operating income 80,898 254,264 511,337 606,911
Interest income 33,856 26,405 86,956 71,894
------------- ------------- ------------- -------------
Income before tax 114,754 280,669 598,293 678,805
Provision (benefit) for income tax 62,664 7,200 256,079 (52)
------------- ------------- ------------- -------------
Net income $ 52,090 $ 273,469 $ 342,214 $ 678,857
============= ============= ============= =============
Net income per share:
- Basic $ 0.01 $ 0.06 $ 0.07 $ 0.14
============= ============= ============= =============
- Diluted $ 0.01 $ 0.05 $ 0.06 $ 0.12
============= ============= ============= =============
Shares used in computing
net income per share:
- Basic 5,007,479 4,906,482 4,981,537 4,866,631
============= ============= ============= =============
- Diluted 5,564,196 5,770,549 5,790,816 5,742,524
============= ============= ============= =============
* Amounts were reclassified to conform to current presentation.
The accompanying notes are an integral part of these consolidated financial statements.
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TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
9 Months Ended Sep 30,
1999 1998
Cash flows from operating activities:
Net income $ 342,214 $ 678,857
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 271,516 235,232
Noncash portion of income tax provision 214,706 -
Changes in assets and liabilities:
Receivables 24,673 229,683
Deposits and prepaid expenses (14,270) (46,058)
Accounts payable 31,404 (162,477)
Accrued liabilities (95,651) (233,674)
------------- -------------
Net cash provided by operating activities 774,592 701,563
------------- -------------
Cash flows from investing activities:
Capitalization of software development costs (146,898) (213,868)
Purchase of fixed assets (69,721) (183,620)
------------- -------------
Net cash used for investing activities (216,619) (397,488)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock 157,022 95,673
Repurchase of common stock (241,334) -
------------- -------------
Net cash provided by (used for) financing activities (84,312) 95,673
------------- -------------
Net increase in cash and cash equivalents 473,661 399,748
Cash and cash equivalents at beginning of period 2,378,390 2,172,235
------------- -------------
Cash and cash equivalents at end of period $ 2,852,051 $ 2,571,983
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
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TEKNOWLEDGE CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
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, 1998. 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, 1999.
2. Net Income Per Share
Net income per share is calculated in accordance with the
provision of Statement of Financial Accounting Standard (SFAS) No. 128,
"Earnings per Share," which requires companies to compute net income
per share under two different methods, basic and diluted. Basic earning
per share is calculated by dividing net income by the weighted average
shares of common stock outstanding during the period. Diluted earning
per share is calculated by dividing net income by the weighted average
shares of outstanding common stock and common stock equivalents during
the period. Common stock equivalents consist of dilutive shares
issuable upon the exercise of outstanding common stock options.
3. Reverse Stock Split
The Company effected a one-for-five reverse stock split on
December 22, 1998. All share and per share data has been retroactively
restated to reflect the effect of the reverse stock split. Since there
was no change in per share par value, aggregate par value has also been
retroactively adjusted to reflect the reduction in the number of common
stock.
4. Repurchase of Common Stock
On December 16, 1998, the Company adopted a program to
repurchase up to 300,000 shares of the Company's common stock in the
open market or in private during the twelve-month period ending
December 15, 1999 at prevailing prices. Repurchases will be made
periodically at management discretion using the Company's own cash
reserves. As of September 30, 1999, the Company has used $241,334 to
repurchase 57,070 shares of the Company's common stock at an average
price of $4.23 a share. Shares repurchased may be reissued to employees
pursuant to the Company's stock option plans, or for other corporate
purposes.
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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") has increased its focus on the
expanding Internet software and services business as planned. Teknowledge has
been investing in commercial software product development and is in the process
of converting the software technology and skills gained in the government R&D
business into commercial business. Teknowledge is investing actively in methods
to deploy its technology base directly, in web-based services. Teknowledge's
talented technical staff, its dual-purpose software technology base, and the
growing E-Commerce market make this a viable strategy with large potential.
Virtually all of Teknowledge's government and commercial projects involve
processing application knowledge and distributing customer solutions over the
Internet. In Q3 the Company has taken steps to accelerate its commercial growth
by investing talent in growing its commercial business. The Company transitioned
several of its technical people working on government technical contracts to
E-Commerce contracts that are now starting up. The Company has experienced early
success in implementing its strategy to move its primary customer base from
defense R&D to rapid-growth commercial applications, by increasing its
E-Commerce revenues. For the nine months ended September 30, 1999, the
percentage of commercial business has increased to 10% from 1% a year ago, and
we expect that percentage to continue to grow in Q4, as a result of commitments
and anticipated growth in Internet-based financial services.
Teknowledge's core competencies are in E-Commerce, web-based training,
information assurance, situation assessment, and distributed systems
engineering. These core competencies are complementary and inherently
"dual-use." They help Teknowledge integrate its own proprietary software and
third party products into a total system solution for customers in industry or
government. In the second quarter of 1999, Teknowledge began delivering a total
system solution to developing E-Commerce sites. The Teknowledge Information
Assurance security team in Washington provided the Check Point FireWall-1(TM)
security expertise. The Web-based Training team provided some of the recent
upgrades to Teknowledge's Sales Associate(TM) product. The E-Commerce team
supplied the IBM Net.Commerce(TM) E-commerce storefront expertise and the
component systems integration work. This type of web-enabled application system
supports the integration, processing, and systematic utilization of a customer's
knowledge assets to achieve its operational objectives. Teknowledge's business
now focuses on 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 an E-Commerce web site as well as providing the individualized lessons
in Teknowledge's Courseware Factory project for Web-based training. This year
several staff members began dual assignments in Web-based training and
E-Commerce. These two groups began building a knowledge processing component
that can be used by web servers. Unlike the stand-alone expert system,
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 other groups, for example, to 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.
During 1999, Teknowledge continued to invest in its own Sales
Associate(TM) software that acts as an electronic sales agent for selling
products on Internet E-Commerce web sites. In order to facilitate the
opportunity to install Sales Associate(TM) on major web sites, Teknowledge has
also invested in the capability to provide total customer solutions for
E-Commerce web sites. This includes E-Commerce strategy, web design, storefront
server, firewall, and database delivery. Teknowledge has become a Premier
Provider for IBM's E-Commerce web-site storefront product called
Net.Commerce(TM), and a value-added reseller of Check Point's security
Firewall-1(TM) product. Teknowledge is now a Microsoft Certified Solution
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Provider, which enables a closer coupling to the Microsoft NT platform for
component application solutions rather than being tied to Unix. Teknowledge's
customer base is expected to change significantly as E-Commerce related
investment and customer solution capabilities increase over the coming years.
Teknowledge has sustained its business for eighteen years. It has
reported twenty-one consecutive profitable quarters. The Company maintains an
aggressive intellectual property program and is defending actively its eight key
U.S. software patents. 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, 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 and nine months ended September 30, 1999
were $2,901,267 and $8,468,534, respectively, a decrease of 6% and 8% from
$3,070,219 and $9,221,003 for the comparable periods in 1998. Revenues in the
first nine months of 1999 were affected by three factors that contributed to
lower than expected revenues: 1) the overall demand for some government services
declined as a result of government-initiated cutbacks in the latter part of
1998, 2) Some of the Company's employees were diverted to non-revenue producing
functions, such as Sales Associate(TM) software development in anticipation of
an increase in demand for commercial services, and 3) the Company had incurred
non-revenue producing startup costs in Q3 as it geared up its transition from a
mostly government to commercial operation. Approximately 79% and 90% of the
revenues earned in the three months and nine months ended September 30, 1999
were attributed to contracts with agencies of the Federal Government, and the
remaining 21% and 10% of revenues were commercial. For the first nine months in
1999, commercial revenues have increased approximately ten-fold since 1998, when
commercial revenues were approximately 1% of total revenues.
Costs and Expenses
Cost of revenues was $1,978,308 and $5,294,705 for the three months and
nine months ended September 30, 1999, an 11% and 14% decrease from each of the
comparable periods in 1998. The cost of labor on government contracts declined
in relation to the reduced rate of production. This was partially offset by a
43% and 25% increase in billable subcontractor and consultant costs.
Subcontractor and consultant costs were $1,105,320 and $2,416,406 for the three
months and nine months ended September 30, 1999, compared to $773,641 and
$1,936,983 in the same periods last year. Cost of revenues as a percentage of
total revenues represented 68% and 63% for the three months and nine months
ended September 30, 1999; compared to 73% and 67% for each of the comparable
periods in 1998.
General and administrative costs for the three months and nine months
ended September 30, 1999 were $636,309 and $1,922,286, a 28% and 16% increase
over the same periods in 1998. The increase was mostly due to escalation of
office rents, insurance and legal expenses. General and administrative costs for
the three months and nine months ended September 30, 1999 were 22% and 23% of
total revenues, versus 16% and 18% for the same periods last year. Because
general and administrative costs are largely fixed in nature, they decline more
slowly over time, thereby accounting for a larger proportion of total costs
during a period in which overall revenues declined.
Sales and marketing costs for the three months and nine months ended
September 30, 1999 decreased to $101,486 and $368,982, or 18% and 29% from the
comparable periods in 1998. Sales and marketing costs were 3% and 4% each of
total revenues for the three months and nine months ended September 30, 1999;
and 4% and 6% for the comparable periods in 1998, respectively. Sales and
marketing costs are expected to increase in Q4 as the Company intensifies its
E-Commerce sales and marketing activities.
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Research and development ("R&D") costs for the three months and nine
months ended September 30, 1999 were $104,266 and $371,224, compared to
$(31,114) and $254,988 for the same periods last year. The negative amount for
the quarter ended September 30, 1998 was a result of a year-to-date adjustment
and a complementary general increase in capitalized software development
efforts. R&D costs were 4% each of revenues for the three months and nine months
ended September 30, 1999 and -1% and 3% for the comparable periods in 1998.
These figures are reported net of direct R&D expenditures conducted under the
NIST ATP contract that were reimbursed by the customer. In 1999, the Company
received $536,348 from NIST that the company used to offset R&D costs. There
were no comparable offsets in 1998.
Interest income were $33,856 and $86,956 for the three months and nine
months ended September 30, 1999; and $26,405 and $71,894 for the comparable
periods in 1998, respectively.
Income before taxes for the three months and nine months ended
September 30, 1999 were $114,754 and $598,293, respectively, which represented a
59% and 12% decrease from $280,669 and $678,805 for the comparable periods in
1998. Income before taxes represented 4% and 7% of revenues for the three months
and nine months ended September 30, 1999; and 9% and 7% each for the comparable
periods in 1998, respectively.
The Company has 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 has increased its effective tax rate
and provision for income taxes since the first quarter of 1999. 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 will
begin to report increased tax expenses, but will not actually pay such taxes,
and there will be no effect on the Company's cash.
Net income for the three months and nine months ended September 30,
1999 were $52,090 and $342,214, or $.01 and $.06 per diluted share, versus
$273,469 and $678,857, or $.05 and $.12 per diluted share, for the same periods
in 1998. Net income represented 2% and 4% of revenues, for the three months and
nine months ended September 30, 1999; and 9% and 7% for the comparable periods
in 1998, respectively. The decrease in net income as a percentage of revenues
was largely a result of the increase in the provision for income taxes as
discussed in the preceding paragraph. It is important to note that no actual
cash outlays were associated with such book increase.
Bookings and Backlog
At September 30, 1999, the expected multi-year contract commitments
(order backlog) from government customers were approximately $15 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, compared to $22 million at
September 30, 1998. The decrease resulted from the overall decline in demand for
some government services as a result of government-initiated cutbacks in the
latter part of 1998. Approximately 79% of the backlog consist 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, 1998 was approximately $15 million.
Liquidity and Capital Resources
As of September 30, 1999, unused sources of liquidity consisted of
$2,852,051 in cash and cash equivalents, an increase of $473,661 from December
31, 1998. The increase consisted of $774,592 provided by operating activities,
$157,022 provided by issuance of common stock related to employee option
exercises, offset by $216,619 used for investing in capital software development
and fixed assets, and $241,334 used to repurchase shares of the Company's Common
Stock.
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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 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 2000. The Company has not utilized the credit line through
September 30, 1999.
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. Future growth might require additional financing.
Year 2000
The Company is aware of and is addressing 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 treat
date-sensitive information correctly when the year changes to 2000. The
consequences of this issue may include system failures and business process
interruption that could have a material impact on the Company's ability to
conduct its business.
Although most of the hardware and software currently in use at the
Company is relatively new and expected to be Y2K compliant, the issue can affect
the Company's internal systems, including information technology (IT) and non-IT
systems. The Company has commenced a phased program to inventory, assess,
remediate, test, implement, and develop contingency plans for all
mission-critical systems potentially affected by Y2K All phases, except
developing contingency plans, have been substantially completed; contingency
plans will continue to be revised and updated through the end of the calendar
year, and other contingency plans will be prepared and updated as deemed
practicable and appropriate by the Company.
Most of the Company's revenues are currently generated from government
R&D service contracts, the deliverable of which is sometimes a software
prototype. Under some of the contracts, the government requires from the Company
a Y2K warranty within the contracts, which generally guarantees all software
delivered under government contracts to be able to process date-sensitive
information beyond Y2K accurately, to the extent other third party elements used
in combination are Y2K compliant. In the case of noncompliance discovered and
communicated to the Company within a prescribed timeframe, usually 90 days from
acceptance of an item, remedies in the form of repair or replacement will be
made available. The Company is exposed only on ongoing government contracts, and
believes that software developed under them is Y2K compliant. On the other hand,
the Department of Defense ("DoD") is confident that payments to its contractors,
among others, will continue uninterrupted in January 2000. The majority of the
Company's DoD payments are made by electronic funds transfer. These systems had
been tested successfully with the Federal Reserve System and several financial
institutions.
The Company has substantially completed its inventory of Y2K impacted
software related to its internal business processes, including its financial
information systems, assessing its centralized computer and embedded systems to
identify any potential Y2K issues, remediating, testing and implementing
solutions for any identified issues. The Company believes its financial
reporting systems are compliant. However, if implementation of replacement or
upgraded systems or software is delayed, or if significant new non-compliance
issues are identified, the Company's results of operations or financial
condition could be materially adversely affected.
The Company has contacted its critical suppliers and vendors to
determine whether their operations and the products and services that they
provide to the Company are Y2K compliant. The Company intends to continue
working directly with other material third parties to avoid any business
interruptions in Y2K. Where practicable, the Company will attempt to mitigate
its risks with respect to the failure of third parties to be Y2K ready,
including developing contingency plans. However, such failures, including
11
failures of any contingency plan, remain a possibility and could have a
materially adverse impact on the Company's results of operations or financial
condition.
Risks and Uncertainties
Teknowledge's service revenue is currently derived largely 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 with fluctuations in the workforce,
billable efficiency, and costs may vary from original estimates and necessitate
periodic adjustments to the overhead rates until the actual costs have been
tabulated and the year closed-out. Such adjustments are made on a cumulative
basis whereby the resulting revenue and income effects are recognized in the
period of the adjustment.
The typical cost-type government contract performed by the Company has
a regulated fixed fee limit, which inhibits the Company from improving profit
margins beyond what is permitted in the government regulations. In addition,
Federal Acquisition Regulations exclude from reimbursement some "unallowable"
expenses, which the Company considers a regular part of the business.
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 relate to the expected
growth of the commercial business, realizability of backlog, competition for
government contracts, mix of revenues between government and commercial,
development of commercial products and VAR services, the growth of E-Commerce,
deferred tax assets, year 2000 issues, and future growth and additional
financing. All forward-looking statements involve risks and uncertainties, and
actual results could differ materially from those set forth in the
forward-looking statements contained herein as a result of competition, agency
funding limitations, other factors relating to government contracting, ability
to attract and retain technical and management personnel, commercial
opportunities, 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.
12
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. LEGAL PROCEEDINGS
On October 8, 1999, a lawsuit was filed in the United States District
Court for the District of Delaware by SAP America, Inc. and SAP
Aktiengesellschaft (collectively, "SAP") against the Company. The subject matter
of the case involves the Company's configuration systems patent, Bennett et al.
U.S. Patent 4,591,983 (the "'983 patent") and the configurator technology
associated with the SAP R/3 System ("R/3 System"). SAP brought this action in
response to the Company's offer to sell SAP a license to use the technology
related to its Intelligent Configuration Patent Portfolio, a collection of five
patents relating to configuration technologies, including the `983 patent. SAP
is seeking a judgment against Teknowledge that the `983 patent is invalid and is
noninfringed by the R/3 System; an award of attorney fees, costs of suit and
other relief the court may deem just and proper.
Management of the Company believes the suit brought by SAP is without
merit and intends to defend its patents vigorously. On October 21, 1999 the
Company announced a countersuit against SAP for patent infringement of two of
its patents. The subject of the countersuit 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." Management believes the ultimate resolution of the above matters
will not have an adverse material impact on the Company's financial position and
results of operations.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Set forth below is a list of all exhibits filed herewith or incorporated by
reference as part of this Quarterly Report on Form 10-QSB.
Exhibit No. Description
3.1 Amended and Restated Certificate of Incorporation of
Teknowledge Corporation (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)
13
Exhibit No. Description
10.5 Change of Control Agreement, dated November 21, 1994, between
the Company 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)
27 Financial Data Schedule
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 June 30, 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.
(b) The registrant did not file a report on Form 8-K during the quarter ended
September 30, 1999.
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 November 12, 1999
- ------------------------ of Directors and Chief
Frederick Hayes-Roth Executive Officer
(Principal Executive
Officer)
/s/ Neil A. Jacobstein President and Chief November 12, 1999
- ------------------------ Operating Officer
Neil A. Jacobstein
/s/ Dennis A. Bugbee Director of Finance, November 12, 1999
- ------------------------ Treasurer and Secretary
Dennis A. Bugbee (Principal Financial and
Accounting Officer)