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, 2001
[ ] 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 August 09, 2001
---------------------------- ------------------------------
Common Stock, $.01 par value 5,695,668 Shares
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000 3
Consolidated Statements of Income and Comprehensive Income
for the three months and six months ended June 30, 2001 and 2000 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 2001 and 2000 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
2
PART I. FINANCIAL INFORMATION
TEKNOWLEDGE CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
(Unaudited)
June 30, December 31,
2001 2000
------------ -----------
Current assets:
Cash and cash equivalents $ 2,233,886 $ 1,049,052
----------- -----------
Receivables:
Billed, net of allowance of $197,194 and $515,000
as of June 30, 2001 and December 31, 2000, respectively 3,974,999 3,508,070
Unbilled 985,559 1,252,648
----------- -----------
Total receivables 4,960,558 4,760,718
Deferred tax asset, current 85,535 268,000
Deposits and prepaid expenses 64,659 38,373
----------- -----------
Total current assets 7,344,638 6,116,143
Capitalized software development costs, net of accumulated
amortization of $1,382,886 and $386,232 as of June 30, 2001
and December 31, 2000, respectively 3,055,180 2,291,661
Fixed assets, at cost
Computer and other equipment 3,418,671 3,437,440
Furniture and fixtures 122,834 121,577
Leasehold improvements 838,398 838,398
----------- -----------
4,379,903 4,397,415
Less: Accumulated depreciation (3,964,991) (3,911,255)
----------- -----------
414,912 486,160
Investment in GlobalStake 1,207,070 1,134,307
Deferred tax asset, noncurrent 500,000 500,000
Other assets, noncurrent 24,541 24,541
----------- -----------
Total assets $ 12,546,341 $10,552,812
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
(Unaudited)
June 30, December 31,
2001 2000
------------ -------------
Current liabilities:
Accounts payable $ 2,701,864 $ 2,098,095
Line of credit, current 1,630,328 1,350,000
Payroll and related liabilities 1,106,485 732,706
Other accrued liabilities 525,406 278,716
----------- -----------
Total current liabilities 5,964,083 4,459,517
Stockholders' equity:
Preferred stock, $.01 par value, authorized 2,500,000 shares,
Series A Convertible Preferred Stock, none issued -- --
Common stock, $.01 par value, authorized 25,000,000 shares,
5,691,835 and 5,690,835 shares issued and outstanding 56,918 56,908
at June 30, 2001 and December 31, 2000, respectively
Additional paid-in capital 1,774,638 1,772,048
Retained earnings since January 1, 1993
(following quasi-reorganization) 4,750,702 4,264,339
----------- -----------
Total stockholders' equity 6,582,258 6,093,295
----------- -----------
Total liabilities and stockholders' equity $12,546,341 $10,552,812
=========== ===========
The accompanying notes are an integral part of this consolidated financial statement.
3
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited) (Unaudited)
Three Months ended June 30, Six Months ended June 30,
--------------------------- -------------------------
2001 2000 2001 2000
---- ---- ---- ----
Revenues $ 4,634,414 $ 4,019,593 $ 9,881,821 $ 6,774,397
----------- ----------- ------------ -----------
Costs and expenses:
Cost of revenues 3,453,734 2,975,224 7,272,972 4,968,473
General and administrative 865,140 651,122 1,545,910 1,231,793
Sales and marketing 99,667 167,647 259,409 243,056
Research and development 11,888 130,162 80,761 177,969
----------- ----------- ------------ -----------
Total costs and expenses 4,430,429 3,924,155 9,159,052 6,621,291
----------- ----------- ------------ -----------
Operating income 203,985 95,438 722,769 153,106
Other income (expense), net (15,428) 9,204 (56,519) 27,161
----------- ----------- ------------ ------------
Income before tax 188,557 104,642 666,250 180,267
Provision for income tax 60,464 41,857 179,887 72,107
----------- ----------- ------------ ------------
Net income and
comprehensive income $ 128,093 $ 62,785 $ 486,363 $ 108,160
=========== =========== ============ ============
Net income and comprehensive
income per share:
- Basic $ 0.02 $ 0.01 $ 0.09 $ 0.02
=========== =========== ============ ============
- Diluted $ 0.02 $ 0.01 $ 0.08 $ 0.02
=========== =========== ============ ============
Shares used in computing
Net income and comprehensive
income per share:
- Basic 5,690,879 5,444,399 5,690,857 5,376,351
=========== =========== ============ ============
- Diluted 5,906,051 5,980,290 5,834,637 6,020,161
=========== =========== ============ ============
The accompanying notes are an integral part of these consolidated financial statements.
4
TEKNOWLEDGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months ended June 30,
-------------------------
2001 2000
----- ----
Cash flows from operating activities:
Net income $ 486,363 $ 108,160
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 550,935 227,977
Deferred income taxes 182,465 65,126
Provision for doubtful accounts 145,000 --
Changes in assets and liabilities:
Receivables (344,840) (667,816)
Deposits and prepaid expenses (26,286) (83,427)
Accounts payable 603,769 777,549
Payroll and related liabilities 373,779 148,226
Other accrued liabilities 246,690 (96,904)
---------- ----------
Net cash provided by operating activities 2,217,875 478,891
---------- ----------
Cash flows from investing activities:
Investment in GlobalStake (72,763) (852,698)
Capitalization of software development costs (1,197,193) (749,601)
Purchase of fixed assets (46,013) (168,312)
---------- ----------
Net cash used in investing activities (1,315,969) (1,770,611)
---------- ----------
Cash flows from financing activities:
Net drawdown on line of credit 280,328 500,000
Proceeds from issuance of common stock 2,600 122,281
---------- ----------
Net cash provided by financing activities 282,928 622,281
---------- ----------
Net increase (decrease) in cash and cash equivalents 1,184,834 (669,439)
Cash and cash equivalents at beginning of period 1,049,052 1,951,393
---------- ----------
Cash and cash equivalents at end of period $ 2,233,886 $ 1,281,954
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
5
TEKNOWLEDGE CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001
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 accounting principles generally accepted in the United States
of America 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, 2000. 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, 2001.
2. Net Income Per Share
Basic earnings per share is calculated by dividing net income by the
weighted average shares of common stock outstanding during the period.
Diluted earnings per share are calculated by dividing net income by the
weighted average shares of outstanding common stock and potentially dilutive
securities during the period. Potentially dilutive securities consist of
shares issuable upon the exercise of outstanding common stock options.
Diluted income per share for the three- and six-month periods ended
June 30, 2001 and 2000 excludes the effect of certain out-of-the-money stock
options as their inclusion would be anti-dilutive. The number of options
excluded for the three- and six-month periods ended June 30, 2001 and 2000
was 689,100 and 251,050, respectively.
A summary of the earnings per share calculation for the three- and
six-month periods ended June 30, 2001 and 2000 is as follows (in thousands,
except per share amounts).
Three Months Six Months
ended June 30, ended June 30,
2001 2000 2001 2000
---- ---- ---- ----
Basic earnings per share:
Net income $ 128 $ 63 $ 486 $ 108
-------- ------ ------ ------
Weighted average common shares 5,691 5,444 5,691 5,376
-------- ------ ------ ------
Basic earnings per share $ 0.02 $ 0.01 $ 0.09 $ 0.02
======== ====== ====== ======
Dilutive earnings per share:
Net income $ 128 $ 63 $ 486 $ 108
-------- ------ ------ ------
Weighted average common shares 5,691 5,444 5,691 5,376
Weighted average shares equivalent: Options 215 536 144 644
-------- ------ ------ ------
Dilutive weighted average common shares 5,906 5,980 5,835 6,020
-------- ------ ------ ------
Dilutive earnings per share $ 0.02 $ 0.01 $ 0.08 $ 0.02
======== ====== ====== ======
6
3. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which requires companies to
value derivative financial instruments, including those used for hedging
foreign currency exposures, at current market value with the impact of any
change in market value being charged against earnings in each period. In June
1999, the Financial Accounting Standards Board issued SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS No. 133" to defer the effective date of SFAS No.
133 until fiscal years beginning after June 15, 2000. To date, the Company
has not entered into any derivative financial instrument contracts. Thus the
Company anticipates that SFAS No. 133 will not have a material impact on its
consolidated financial statements.
In July 2001, the FASB issued SFAS 141, "Business Combinations," and
SFAS 142, "Goodwill and Intangible Assets." SFAS 141 is effective for all
business combinations completed after June 30, 2001. SFAS 142 is effective
for fiscal years beginning after December 15, 2001; however, certain
provisions of this Statement apply to goodwill and other intangible assets
acquired between July 1, 2001 and the effective date of SFAS 142. Major
provisions of these Statements and their effective dates for the Company are
as follows:
o All business combinations initiated after June 30, 2001 must use the
purchase method of accounting. The pooling of interest method of
accounting is prohibited except for transactions initiated before July 1,
2001.
o Intangible assets acquired in a business combination must be recorded
separately from goodwill if they arise from contractual or other legal
rights or are separable from the acquired entity and can be sold,
transferred, licensed, rented or exchanged, either individually or as
part of a related contract, asset or liability
o Goodwill, as well as intangible assets with indefinite lives, acquired
after June 30, 2001, will not be amortized. Effective January 1, 2002,
all previously recognized goodwill and intangible assets with indefinite
lives will no longer be subject to amortization.
o Effective January 1, 2002, goodwill and intangible assets with indefinite
lives will be tested for impairment annually and whenever there is an
impairment indicator
o all acquired goodwill must be assigned to reporting units for purposes of
impairment testing and segment reporting.
Management has reviewed the provisions of these Statements and has assessed
that these Statements will not have a material impact on the Company's
financial position or results of operations, as there are no such items on
the consolidated balance sheet at June 30, 2001 and no pending acquisitions.
4. Revenue Recognition
The Company derives revenue from research and development contracts
("contract R&D") with the U.S. Government and from sales of software
products and services for financial systems solutions to commercial
customers.
(a) Contract Revenue
The Company principally uses the percentage-of-completion method of
accounting for contract revenues for both government and commercial
projects. The percentage-of-completion method is based on total costs
incurred to date compared with estimated total costs upon completion of
contracts. The Company charges all losses on contracts to operations in the
period when the loss is known. A certain portion of the fee charged to the
government is retained and may be billed after the final indirect rates are
approved by the government; however, they are subject to future review and
approval by the Defense Contract Audit Agency. Revenue on the
7
retained fee, therefore, is not recognized until billed to the government.
The Company last received final overhead rate approval for costs incurred
through December 31, 1997.
(b) Software license and services
Revenue is recognized in accordance with SOP 97-2 "Software Revenue
Recognition" using the residual method. Revenue earned under software
license agreements is generally recognized as revenue upon contract
execution, provided all shipment obligations have been met, fees are fixed
or determinable, and collection is probable. Revenue earned under software
license agreements for the quarter ended June 30, 2001 and 2000 was $8,900
and $295,000, respectively. Revenue from post-contract customer support is
recognized ratably over the period the customer support services are
provided, and software consulting services revenue is recognized as
services are performed.
(c) Patent Licensing Revenue
Patent revenue is recognized when there is a signed agreement and
evidence that the license has been earned. In the first quarter of 2001,
the Company recognized $750,000 from licensing of certain of its technology
to SAP (see note 5). Teknowledge has made patents and technology licensing
an on-going part of its business activities. The Company expects to
generate recurring revenue from this activity; however, there can be no
assurance that revenue from patents or intellectual property will be
generated on a quarter-to-quarter basis.
5. Legal
On March 30, 2001, Teknowledge Corporation, SAP America, Inc., and SAP
Aktiengesellschaft agreed to a full settlement of all outstanding lawsuits.
The subjects of the lawsuit were Teknowledge's U.S. Patent 4,591,983,
entitled "Hierarchical Knowledge System" issued May 27, 1986, and U.S.
Patent 4,783,752, entitled "Knowledge Based Processor for Application
Programs Using Conventional Data Processing Capabilities" issued November
8, 1988.
As part of the settlement agreement, SAP transferred to Teknowledge
$750,000 in cash. Teknowledge agreed not to commence any patent
infringement suits against SAP relating to any of Teknowledge's patents,
and both parties agreed to dismiss their current claims against each other.
8
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
unaudited consolidated financial statements and notes thereto.
Teknowledge Corporation sells software product and service solutions, and
is increasingly focused on the financial services industry. It also provides
contract research and development services, primarily to the Defense Advanced
Research Projects Agency. Teknowledge designs intelligent transactions that
deliver flexible, secure, and knowledge-based interactions with customers. These
transactions enable organizations to codify their knowledge, use it to interpret
data, and provide value-added services to end-users.
Teknowledge continues to execute its strategy to grow the financial
software and services business. The Company continues to invest in TekPortal(TM)
software product development, testing, and sales. For the three months ended
June 30, 2001, Teknowledge's revenues derived from the sale of financial
products and services has increased approximately 4% from the comparable quarter
to $1,711,403. As a result of commitments and anticipated growth in
Internet-based Financial Systems, the Company expects improved commercial
revenues, particularly from TekPortal licenses, in 2001.
The Company has five business operating units within one reporting segment.
The operating units are interdependent in terms of infrastructure, talent,
technology, and management incentives, and therefore are treated as a single
reporting segment. The fastest growing part of Teknowledge is the Financial
Systems operating unit. This unit is focused on Teknowledge's TekPortal
solution, which provides customer information aggregation for the financial
services industry. This focus is strengthened by Teknowledge's knowledge
processing capabilities, network security, web-based training, and distributed
systems solutions. Teknowledge is a Value Added Reseller for components such as
CheckPoint's Firewall-1(TM) security product and Financial Fusion solutions. In
addition, Teknowledge is qualified as a Microsoft Certified Partner.
Teknowledge has four other operating units in complementary technical
application areas. Security Systems (Information Assurance) provides network
security solutions that protect the information stored in computer networks and
ensure that information is accessible by the right people at the right time.
Training Systems encapsulates traditional courseware into reusable electronic
media, develops intelligent tutoring systems, and develops software to
distribute the resulting courseware solutions on the Internet. Distributed
Systems is focused on improving the quality, control, and timeliness of services
on the Internet. Knowledge Systems is developing solutions for processing
knowledge and making inferences about customer-supplied data. Virtually all of
Teknowledge's government and commercial projects involve processing application
knowledge and distributing customer solutions over the Internet.
Many of Teknowledge's customers need to provide knowledge-based
transactions, supported by security, training, and distributed application
performance solutions. Teknowledge supports its cutting-edge research and
development capabilities by winning national competitions sponsored by the
Defense Advanced Research Projects Agency, the National Institute of Standards
and Technology (NIST), and Small Business Innovation Research (SBIR) Programs
sponsored by other agencies. This provides Teknowledge with a very rich source
of technology for its own focused product development, patents, and licensing.
Teknowledge's Financial Systems operating unit delivers TekPortal product
and service solutions. TekPortal software gives financial services companies,
such as Internet banks, the ability to provide customers with a single web site
to manage their financial portfolio of bank, brokerage, credit card, and other
accounts. TekPortal permits both information aggregation and transactions
between accounts. The customer provides all of the account and transaction
permissions. TekPortal is typically installed at the financial institution, and
the financial institution provides its security and privacy policies.
Teknowledge
9
has several new Internet bank customers, and several value-added resellers for
TekPortal, including NCR, Vexis, and Financial Fusion Inc.
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 and artificial intelligence. Knowledge has become the key enabler to
providing informed advice on web sites as well as providing individualized
training. Teknowledge's Training Systems and Knowledge Systems units are
collaborating on building a new knowledge-processing component that can be used
by web servers and sales advice software such as Sales Associate(TM). This new
component is being developed for speed and flexibility. Unlike stand-alone
expert systems, Internet-based knowledge systems enable collaborative
relationships between people and computers in capturing, refining, distributing,
and applying knowledge to solve business application problems. Knowledge that
was once held only by people can now be processed consistently by a computer and
distributed via a web server to millions of customers 7 days a week, 24 hours a
day. This type of "activated" knowledge can also be used by Teknowledge's
customers to serve advice, assess situations rapidly in a crisis, defend web
sites from attack, or ensure the distribution of messages to the right people at
the right time.
Teknowledge creates and intends to license its substantial intellectual
property. The Company envisioned this possibility as far back as 1984, and
obtained its first software patent in 1986. In 2000, Teknowledge decided to make
technology and patent licensing an on-going business activity, with the
objective of bringing in multiple revenue streams. Teknowledge anticipates
continuous licensing activity in this area, and has embarked on a program of
contacting other companies for licenses. Teknowledge currently has nine U.S.
software patents. Teknowledge has an unusually large and active patents and
technology licensing program for a small company. It expects to generate
on-going revenue from this activity. However there can be no assurance that
revenue from patent or technology licensing will be generated on a
quarter-to-quarter basis.
Teknowledge has been in business for over twenty years. It has reported
twenty-eight consecutive profitable quarters. Teknowledge provides a challenging
and collaborative technical environment with many employee rewards. These
rewards include advanced education and training, incentive stock options,
performance bonuses, competitive salary, and an attractive benefits program.
Teknowledge is headquartered in Palo Alto, California with offices in Fairfax,
Orlando, Cleveland, Los Angeles and San Diego. The Company's stock is traded on
the NASDAQ SmallCap Market under the symbol TEKC. Teknowledge was incorporated
on July 8, 1981 under the laws of the State of Delaware.
Results of Operations
Revenues
Revenue for the second quarter of 2001 was $4,634,414, a 15% increase over
the comparable quarter in 2000 of $4,019,593. Revenues from contract R&D
accounted for 63% of total revenues as compared to 59% in the comparable quarter
of 2000. Revenues from the sale of Financial Systems products and services grew
to $1,711,403 in 2001 or 37% of total revenues. Financial Systems revenues were
4% higher than the first quarter of 2001 and 3% higher than the comparable
quarter in 2000. Revenue from contract R&D rose 23% over the comparable quarter
in 2000 to $2,923,012. Generally, service revenues improved in all operational
areas. Revenues from the sale of TekPortal licenses were below expectations
because the expected new contracts were not authorized to begin work until the
third quarter. As a consequence, license revenue in the third quarter of 2001
should be appreciably higher.
Financial Systems revenues include license sales for the TekPortal
software, consulting services, and post contract customer support services. The
increase in revenue between comparable periods is due to increased market
acceptance of the TekPortal software and other Financial Systems services.
Revenues from resellers accounted for 47% of Financial Systems revenues for the
three months ended June 30, 2001. The Company believes that the demand for
account aggregation technology will grow in 2001. The
10
demand for its contract R&D services will depend on competitive contract awards
and sponsor priorities. Of total revenue, 19% was from a single contract R&D
customer.
Costs and Expenses
Cost of revenues was $3,453,734 for the three months ended June 30, 2001
compared to $2,975,224 in the comparable period in 2000. The bulk of the
increase between the periods was attributed to the growth in the demand for
commercial products and services and the corresponding increase in the workforce
to meet this demand. In addition, while Financial Systems is in its infancy, the
Company incurred additional costs to fulfill project requirements. The Company
uses billable consultants and contractors to supplement its full-time employee
workforce. During the second quarter of 2001, the Company spent $1,433,188 on
these services compared to $1,475,248 in the comparable quarter of 2000.
Subcontractor growth rates are dependent on future contracts and may not grow at
the same rate in future periods. Cost of revenues as a percentage of total
revenues for the three months ended June 30, 2001 was 75%, compared to 74% for
the comparable period in 2000.
General and administrative costs for the three months ended June 30, 2001
were $865,140, compared to $651,122 in the second quarter in 2000. The Company
increased its reserve for bad debts by $145,000 over the comparable quarter in
2000. Administrative costs for the three months ended June 30, 2001 were 19% of
total revenues, versus 16% for the second quarter of last year.
Sales and marketing costs were $99,667 in 2001 as compared to $167,647 in
2000. The Company's sales and marketing efforts include applications engineering
and technical support, direct sales efforts, as well as trade shows,
demonstrations, and other traditional marketing activities. The decrease in
overall costs is attributed to an increase in the availability of billable work
assignments for senior personnel normally assigned to sales and marketing
activities. The Company also decreased its bonus reserves during the quarter by
$41,000. In 2000, the Company relied primarily on direct sales and Value Added
Resellers to lay the foundation for expanding the Financial Systems business. In
2001, Teknowledge plans to increase its sales and marketing efforts
substantially in both the domestic market and international community.
Company sponsored research and development ("R&D") costs for the three
months ended June 30, 2001 decreased to $11,888 from $130,162 in the comparable
period in 2000. Some employees who normally work on in-house R&D were diverted
to other billable projects. These figures do not include the majority of the R&D
conducted by Teknowledge under contract to government customers, nor do they
include software development costs that were capitalized during the period. The
Company expended $648,193 in the second quarter in the development of software
for its TekPortal product (version 2.0) that was capitalized. The Company
expects to capitalize additional costs in the development of the TekPortal
product consistent with the second quarter of 2001. Internal R&D costs,
excluding TekPortal development, were less than 1% of revenues for the three
months ended June 30, 2001 and 3% of revenues in the comparable quarter in 2000.
The majority of the Company's R&D expenditures are funded externally through
government projects (and recorded as cost of revenues), which are expected to
provide new technology and intellectual property. Teknowledge retains
intellectual property rights on its contract R&D work.
Interest income was $11,339 and $20,093 for the three months ended June 30,
2001 and 2000, respectively. Interest income for 2001 reflects lower average
cash balances during the period. The Company accumulated $26,893 of interest
expense related to a bank loan during the quarter. Interest expenses declined by
$22,659 as compared to the first quarter of 2001. Interest expense increased
$16,004 over the comparable quarter in 2000.
Income before taxes for the three months ended June 30, 2001 and 2000 was
$188,557 and $104,642, respectively, which represented an $83,915 increase over
the comparable period in 2000. Income before tax improved largely as a result of
improved service margins. Income before taxes represented 4% and 3% of revenues,
for the three months ended June 30, 2001 and 2000, respectively.
11
The Company utilized essentially all tax losses generated subsequent to the
date of the quasi-reorganization, which were reflected as a reduction to the
effective tax rate and provision for income taxes, up to December 31, 1998.
Commencing in 1999, realization of tax benefits existing at the date of the
quasi-reorganization is recorded as an adjustment to additional paid-in-capital.
Accordingly, the Company increased its effective tax rate and provision for
income taxes for the first quarter of 1999 and thereafter. However, even with
the increase in its effective tax rate for book purposes, the Company will
continue to realize full cash savings from its extensive tax loss benefits
existing at the date of the quasi-reorganization. In short, the Company has been
reporting increased tax expenses, but will not actually be required to pay the
full amount of such taxes, and there will be only a minimal effect on the
Company's cash reserves resulting from the reported increase in the effective
tax rate. After adjusting for tax credits associated with the capitalization of
its product development costs, the Company anticipates an effective tax rate of
27% for 2001.
Net income for the three months ended June 30, 2001 and 2000 was $128,092,
or $.02 per diluted share, versus $62,785, or $.01 per diluted share, for the
same period in 2000. Net income represented 3% of revenues, for the three months
ended June 30, 2001 and 2% for the comparable period in 2000. The Company
experienced improvement in the returns on commercial projects in the most recent
quarter. Government contracts continue to produce steady income, but at a rate
that is typically well below what one would expect from a successful commercial
enterprise. This is because contracts negotiated with the government are
restricted from exceeding the fee limits established in the Federal Acquisition
Regulations. The Company expects to achieve higher net margins on its commercial
contracts as volume increases and operating efficiencies improve.
Bookings and Backlog
At June 30, 2001, the expected order backlog was approximately $14.9
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. 0f the June 30,
2001 backlog, 96% is from government customers. Approximately 33% 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 portion of the
overall backlog expected to be fulfilled for the remainder of the current fiscal
year is approximately 30%.
Liquidity and Capital Resources
As of June 30, 2001, the Company had $2,233,886 in cash and cash
equivalents, an increase of $951,932 over the previous year. The Company
generated net cash of $2,216,875 from its operating activities and invested
$1,197,193 in the development of TekPortal software. $46,013 was spent to
purchase computer equipment and other improvements. The Company invested $71,763
in GlobalStake.com during the year and has fulfilled its $1.2M investment
obligation since GlobalStake.com was spun out in November of 1999.
To support the anticipated future growth, the Company may seek additional
equity and debt financing. However, management believes that it has sufficient
funds to support operations at least through the end of the year based on its
current cash position, available credit and equity sources, and cash flow from
operations. In June 2001, the Company refinanced its debt and moved its credit
line to a new financial institution. The assets of the Company collateralize
borrowings under the arrangement. The outstanding balance bears a variable per
annum rate of interest equal to the sum of 2.4% and the One-Month LIBOR rate.
Under the terms of the arrangement, the Company may borrow up to 80% of the
eligible receivable base, to a maximum of $3,000,000. For government
receivables, the Company may borrow 50% of eligible receivables or $750,000,
whichever is lower. At June 30, 2001 under these provisions, the Company's
borrowing base was approximately $2,200,000. As of June 30, 2001, the Company
had borrowed $1,630,328 against the calculated borrowing base. The Company
typically uses the money to supplement its existing reserves and to fund the
growth of its commercial operations.
12
Risks and Uncertainties
Management believes that the market for TekPortal software is a significant
new opportunity for Teknowledge and that its Financial Systems business will
expand over time. The market for account aggregation software, however, is
rapidly evolving, and populated by competitors who are continuously developing
competing software products and services. As is typical for a new and rapidly
evolving industry, demand and market acceptance for account aggregation products
and services are subject to a high level of uncertainty. In spite of forecasted
robust growth, many companies have merged or dropped out of the race. Further,
aspects of the business (including security, privacy, reliability, cost, ease of
use, and quality of services) are undergoing rapid evolution and review that may
affect the use of information aggregation software in particular. In general,
the Company is exposed to a higher risk of default and slower collections from
new Financial Systems clients, compared to relatively reliable government
customers. Teknowledge is addressing this difference by broadening its
aggregation customer base and targeting larger financial institutions.
The demand for account aggregation software will depend upon broad
acceptance of new methods of conducting business and exchanging information over
the Internet. It appears that banks in particular are moving quickly to install
account aggregation software. TekPortal is already in use at a number of bank
sites. However, the continuing demand for specific products developed by the
Company cannot be determined, nor can the viability of these products be
determined at this time. As the market continues to change, there can be no
assurance that the Company will be able to recruit or retain the technical staff
to develop and bring to market products that will gain market acceptance or
generate significant revenue or profits. If TekPortal or Teknowledge's other
products and services markets actually develop more slowly than expected, become
saturated with competitors, or if the Company's products do not achieve market
acceptance, the Company's business, financial condition, and results of
operations may be materially and adversely affected.
Teknowledge plans to grow its business by investing in TekPortal and by
expanding into additional products, services, and technology licensing. This may
require significant additional investment and could strain technical, financial,
and operational resources. New competitors can enter the market for TekPortal
and other financial solutions. The Company's gross margins in new business areas
may be lower than in existing business activities, and it may not be able to
expand or maintain operations in a cost-effective or timely manner. If a number
of customers do not receive new products or services favorably, it could hurt
the Company's reputation and delay future expansion.
During 2000, GlobalStake.com modified its strategy to focus on a
business-to-business model for conducting commercial real estate mortgages. The
Company has reviewed the revised business plan and cash flow projections of
GlobalStake.com, and has determined that its investment has not been impaired.
However, as GlobalStake.com is a business with limited cash and all the
associated risks of a start-up business, its success is dependent on market
demand for mortgage loans, fluctuations in interest rates, the ability to hire
qualified brokers, the ability to secure mortgage-financing sources and to
negotiate a competitive arrangement. The Company periodically reviews its
investment in GlobalStake.com for impairment.
The majority of Teknowledge's service revenue is derived from
government-sponsored contract research and development projects, and the Company
has historically been profitable in that business. However, dependence on R&D
contracts can be risky because the contracts are subject to administrative,
legislative, and political interruptions, which may jeopardize the flow of
funds. There can be no assurance that the government will continue to seek
services at the current level in the future. Another uncertainty is that 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 Company is also subject to periodic reviews of prior year
costs and expenses by audit agencies of the Federal
13
government. As a result of these audits, the Company may be exposed to cost
adjustments, which are applied on a retroactive basis to the government
contracts completed in those years. These adjustments can have a negative or
positive effect on the business. In order to diminish the possible exposure in
prior years, the Company has established a $100,000 reserve for such
contingencies.
The typical cost-type government contract performed by the Company has a
regulated fixed-fee, which limits the Company from improving profit margins on
these contracts. In addition, Federal Acquisition Regulations exclude from
reimbursement some "unallowable" expenses, which the Company considers a regular
part of the business. In addition, almost all the Company's contracts contain
termination clauses, which permit contract termination if the Company defaults
or at the contracting party's discretion.
Another uncertainty in providing services is the Company's ability to
attract and retain sufficient technical staff to meet the demands of new orders.
The Company recognizes that the loss of one or more key management and technical
personnel could adversely affect aspects of the Company's business. The Company
relies on its executives and business unit managers for the acquisition and
negotiation of new business, the management of services contracts and product
development, and the management of on-going operations. A large proportion of
the technical support base for operations is provided by outside consultants,
and it is anticipated that this trend will continue in the future. The Company
spent nearly $5,000,000 on mostly billable subcontractors in 2000. The use of
outside consultants allows the Company to expand or constrict its operations
quickly both inside and outside the United States. The Company believes that its
future success depends on attracting and retaining highly skilled technical
personnel and other employees.
In summary, the Company's operating results and stock price are affected by
a wide variety of factors, including successful commercialization of the
Company's products and services, intellectual property licenses, government
intervention, competition, ability to staff, retain, and recruit key employees,
financing and collections, and general economic and market conditions.
Forward-Looking Statements
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. All statements, other than statements of historical facts,
included in this MD&A regarding the Company's financial position, business
strategy and plans and objectives of management of the Company for future
operations are forward-looking statements. These forward-looking statements rely
on a number of assumptions concerning future events and are subject to a number
of uncertainties and other factors, many of which are outside of the Company's
control, that could cause actual results to materially differ from such
statements. While the Company believes that the assumptions concerning future
events are reasonable, it cautions that there are inherent difficulties in
predicting important factors, especially the timing and magnitude of
technological advances; the prospects for future acquisitions; the possibility
that a current customer could be acquired or otherwise be affected by a future
event that would diminish their information technology requirements; the
competition in the information technology industry and the impact of such
competition on pricing, revenues and margins; the degree to which business
entities continue to outsource information technology and business processes;
uncertainties surrounding budget reductions or changes in funding priorities of
existing government programs and the cost of attracting and retaining highly
skilled personnel.
14
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. LEGAL PROCEEDINGS
On March 30, 2001, Teknowledge Corporation, SAP America, Inc., and SAP
Aktiengesellschaft agreed to a full settlement of all outstanding lawsuits. The
subjects of the lawsuit were Teknowledge's U.S. Patent 4,591,983, entitled
"Hierarchical Knowledge System" issued May 27, 1986, and U.S. Patent 4,783,752,
entitled "Knowledge Based Processor for Application Programs Using Conventional
Data Processing Capabilities" issued November 8, 1988.
As part of the settlement agreement, SAP transferred to Teknowledge
$750,000 in cash. Teknowledge agreed not to commence any patent infringement
suits against SAP relating to any of Teknowledge's patents, and both parties
agreed to dismiss their current claims against each other.
It is Teknowledge's intention to increase its technology and intellectual
property licensing investments and operations, although winning legal
settlements is only one scenario for making this business activity pay off. It
is the Company's hope that it can convince other companies to pay a reasonable
patent or technology license fee, and avoid the expenses and distraction of
going to court.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K
(1) Current Report on Form 8-K, dated July 26, 2001, related to the change
in the Company's independent public accountants.
(2) Current Report on Form 8-K, dated August 6, 2001, Exhibit 16, letter
from Registrant's prior independent accountants
For the purposes of complying with the amendments to the rules governing
Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the
undersigned registrant hereby undertakes as follows, which undertaking shall be
incorporated by reference into registrant's Registration Statements on Form S-8
Nos. 33-27291, 33-77874, 33-78984, 33-82720, 333-00261, and 333-67623.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
15
SIGNATURES
Pursuant to the requirements of the Exchange Act, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TEKNOWLEDGE CORPORATION
-----------------------
(Registrant)
/s/ Neil A. Jacobstein Chairman and Chief August 14, 2001
- ---------------------- Executive Officer
Neil A. Jacobstein
/s/ Dennis A. Bugbee Chief Financial Officer, August 14, 2001
- ---------------------- Vice President of Finance
Dennis A. Bugbee (Principal Financial and
Accounting Officer)
16