1
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FORM 10-Q/A
AMENDMENT NO. 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Transition Period From to
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Commission File Number 0-26964
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Carnegie Group, Inc.
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Delaware 25-1435252
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(State or other Jurisdiction of (I.R.S Employer Identification Number)
Incorporation or Organization)
Five PPG Place, Pittsburgh, Pennsylvania 15222
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(Address of principal executive offices) (Zip Code)
(412) 642-6900
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to files such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No_______
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Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock
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as of the latest practicable date:
Class Outstanding at July 31, 1997
Common Stock, $.01 par value 6,338,145
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FORM 10-Q/A
CARNEGIE GROUP, INC.
TABLE OF CONTENTS
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Carnegie Group, Inc. and Subsidiaries 3
Consolidated Statements of Operations for
the three months and six months
ended June 30, 1997 and 1996
Carnegie Group, Inc. and Subsidiaries 4
Consolidated Balance Sheets
Carnegie Group, Inc. and Subsidiaries 5
Consolidated Statements of Cash Flows
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 7
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about 16
Market Risks
PART II. OTHER INFORMATION 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES
EXHIBIT INDEX
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CARNEGIE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months ended Six months ended
------------------ -----------------
June 30, June 30, June 30, June
1997 1996 1997 1996
---- ---- ---- ----
Revenue
Software services--Unrelated parties $ 6,078,572 $ 5,636,264 $ 11,578,304 $13,079,014
Software services--Related parties 1,681,074 494,277 2,688,182 1,244,926
------------ ------------ ------------ -----------
Total software services 7,759,646 6,130,541 14,266,486 14,323,940
Software licenses 98,361 532,820 723,439 662,761
------------ ------------ ------------ -----------
Total revenue 7,858,007 6,663,361 14,989,925 14,986,701
------------ ------------ ------------ -----------
Costs and expenses:
Cost of revenue - Unrelated parties 3,785,525 3,907,883 7,623,025 8,609,565
Cost of revenue - Related parties 924,949 412,765 1,506,694 775,276
------------ ------------ ------------ -----------
Total cost of revenue 4,710,474 4,320,648 9,129,719 9,384,841
Research and development 392,864 288,276 750,546 467,290
Selling, general and administrative 2,061,187 2,014,917 3,938,023 4,150,886
------------ ------------ ------------ ----------
Total costs and expenses 7,164,525 6,623,841 13,818,288 14,003,017
------------ ------------ ------------ ----------
Income from operations 693,482 39,520 1,171,637 983,684
Other income (expense):
Interest income 168,978 151,524 332,876 298,690
Other income 6,399 6,699 12,598 12,798
Interest expense (3,408) (4,564) (7,053) (9,421)
------------ ------------ ------------ ----------
Total other income (expense) 171,969 153,659 338,421 302,067
------------ ------------ ------------ ----------
Income before income taxes 865,451 193,179 1,510,058 1,285,751
Income tax provision (343,942) (72,356) (600,302) (481,743)
------------ ------------ ------------ ----------
Net income $ 521,509 $ 120,823 $ 909,756 $ 804,008
------------ ------------ ------------ ----------
Earnings per share of common stock $ 0.08 $ 0.02 $ 0 .13 $ 0.11
============ ============ ============ ==========
Weighted average number of common shares 6,905,348 7,182,428 6,930,042 7,205,668
outstanding ============ ============ ============ ==========
The accompanying notes are an integral part of these financial statements.
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CARNEGIE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
1997 1996
--------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 14,819,458 $ 14,691,765
Accounts receivable 3,993,957 2,751,316
Accounts receivable from related parties 1,422,954 769,223
Accounts receivable--unbilled 2,801,797 3,660,765
Accounts receivable related parties--unbilled 717,824 188,302
Deferred income taxes 2,032,767 2,179,426
Other current assets 634,262 403,508
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Total current assets 26,423,019 24,644,305
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Property and equipment, net of accumulated depreciation
and amortization 2,603,708 2,046,415
Deferred income taxes 1,393,617 1,775,480
Other assets 18,441 23,055
------------ ------------
Total assets $ 30,438,785 $ 28,489,255
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 1,291,460 $ 614,458
Payables to related parties 292,877 1,034,608
Accrued compensation 798,543 706,965
Advance billings and deferred revenue 2,185,289 1,101,221
Accrued rent 402,915 538,641
Other accrued liabilities 755,708 821,752
Obligations under capital leases--current portion 5,343 33,242
------------ ------------
Total liabilities 5,732,135 4,850,887
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STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 20,000,000 shares authorized,
6,563,845 and 6,512,038 shares issued at June 30, 1997
and December 31, 1996 respectively 65,638 65,120
Capital in excess of par value 31,542,088 31,384,080
Accumulated deficit (6,426,076) (7,335,832)
Treasury stock, 190,000 shares at June 30, 1997 and
December 31, 1996 (at cost) (475,000) (475,000)
------------ ------------
Total stockholders' equity 24,706,650 23,638,368
------------ ------------
Total liabilities and stockholders' equity $ 30,438,785 $ 28,489,255
============ ============
The accompanying notes are an integral part of these financial statements.
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CARNEGIE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
--------------------------------------
June 30, June 30,
1997 1996
---- ----
Cash flows from operating activities:
Net income $ 909,756 $ 804,008
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 602,433 469,124
Deferred income taxes 528,522 420,744
Changes in working capital component:
Accounts receivable (383,673) (27,754)
Accounts receivable - Related parties (1,183,253) (987,431)
Other assets (226,140) 80,995
Trade accounts payable 677,002 (302,915)
Payables to related parties (741,731) (90,561)
Accrued compensation 91,578 (84,444)
Accrued rent (135,726) (29,365)
Other accrued liabilities 720 791,437
Advance billings and deferred revenue 1,084,068 (12,208)
------------- ------------
Net cash (used in) provided by operating
activities 1,223,556 1,031,630
Cash flows from investing activities:
Proceeds from the sale of fixed assets, net -- --
Capital expenditures (1,159,726) (722,192)
-------------- -------------
Net cash used in investing activities (1,159,726) (722,192)
Cash flows from financing activities:
Borrowings on line of credit -- --
Repayments on line of credit -- --
Principal payments under capital lease obligations (27,899) (26,982)
Proceeds from sales of common stock, net 91,762 105,804
------------- ------------
Net cash (used in) provided by financing
activities 63,863 78,822
------------- ------------
Net change in cash and cash equivalents 127,693 388,260
Cash and cash equivalents:
Beginning of period 14,691,765 12,394,588
End of period $ 14,819,458 $ 12,782,848
============= ============
The accompanying notes are an integral part of these financial statements.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
In the opinion of the management of Carnegie Group, Inc. (the
"Company"), these unaudited interim consolidated financial statements include
all adjustments, consisting only of normal recurring adjustments, considered
necessary for a fair presentation of operating results for the three month and
six month periods ended June 30, 1997. Results for the interim periods are not
necessarily indicative of results for the full year. The accompanying
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission and therefore do not
include all information and footnotes required by generally accepted accounting
principles for complete financial statements. Accordingly, the information
contained in this Form 10-Q should be read in conjunction with the financial
statements and notes thereto contained in the Company's Form 10-K for the year
ended December 31, 1996 as filed with the Securities and Exchange Commission.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings per
Share." SFAS No. 128 establishes new standards for computing and presenting
earnings per share. The Company is required to adopt the provisions of SFAS No.
128 for its consolidated financial statements for the year ended December 31,
1997 and subsequent interim periods. Upon adoption, the standard also requires
the restatement of all prior period earnings per share information presented.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components. The Company is required to
adopt the provisions of SFAS No. 130 beginning with its consolidated financial
statements for the three months ending March 31, 1998. SFAS No. 131 requires
certain disclosures about segment information in interim and annual financial
statements and related information about products and services, geographic
areas and major customers. The Company must adopt the provisions of SFAS No.
131 for its consolidated financial statements for the year ending December 31,
1998.
The adoptions of SFAS No. 128, SFAS No. 130 and SFAS No. 131 are not
expected to have a material effect on the measurement of the Company's
financial position, results of operations or cash flows; the Company is
reviewing possible changes in disclosures that may be called for.
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ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
General
Carnegie Group, Inc. ("Carnegie Group" or the "Company") provides
client/server software development services that integrate advanced
user-centered, intelligent software technologies with clients' existing
computing infrastructures to automate and enhance complex business processes.
The Company performs business and technical consulting, custom software
development, and systems integration services to improve clients' productivity
and market position in two business areas: customer interaction; and logistics,
planning and scheduling. Within these areas, the Company targets its services
to clients in the financial services, government, manufacturing and
telecommunications industries.
The Company's expertise encompasses a wide range of advanced software
technologies, including knowledge-based systems, object-oriented technology,
advanced graphical user interfaces, constraint-directed search and distributed
computing. The Company captures certain aspects of its business area experience
and advanced technology expertise in a portfolio of reusable software templates
that can be used as building blocks to create software solutions quickly and
effectively. In addition, Carnegie Group employs an iterative or "spiral"
approach to software design that begins with the construction of a prototype
and continues through testing of successive versions of the software against
project requirements. This iterative design facilitates rapid software
development, encourages client feedback and leads to greater congruence with
client needs and expectations.
Since inception, Carnegie Group has emphasized relationships with leading
corporations in its targeted industries. These relationships have provided the
Company with opportunities for growth through the provision of additional
services to existing clients and through references to other companies within
the Company's targeted industries. Carnegie Group's clients include the United
States Transportation Command, U S WEST Communications, Inc., BellSouth
Telecommunications, Inc., U.S. Army, Caterpillar, Inc., First USA Bank,
Highmark Blue Cross Blue Shield and Philips Medical Systems.
The Company only includes in backlog signed contracts that either have
milestones yet to be attained or for which the Company can make a reasonable
estimate of work yet to be performed. The Company's backlog at June 30, 1997
was $12.4 million, compared to $15.1 million at June 30, 1996 and $9.6 million
at December 31, 1996. The increase compared to the prior year end reflects
contract closures resulting from business development capabilities. As most of
the contracts in backlog are terminable by the Company or the client upon short
notice, there can be no assurance that contracts reflected in backlog are a
reliable measure of future revenue.
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Comparison of Quarter and Six Months Ended June 30, 1997 and June 30, 1996.
Revenue. Total revenue for the quarter ended June 30, 1997 was $7.9
million compared to $6.7 million for the quarter ended June 30, 1996, an
increase of $1.2 million or 18%. For the six months ended June 30, 1997 revenue
was unchanged at $15.0 million compared to $15.0 million for the six months
ended June 30, 1996.
Total software services revenue for the quarter ended June 30, 1997 was
$7.8 million compared to $6.1 million for the quarter ended June 30, 1996, an
increase of $1.7 million or 27%. The renegotiation of a significant fixed-price
contract in the second quarter of 1996 adversely affected revenue and earnings
for that period. Software services revenue was unchanged at $14.3 million for
the six months ended June 30, 1997 compared to $14.3 million for the six months
ended June 30, 1996. Revenue from software services-related parties was $2.7
million for the six months ended June 30, 1997 compared to $1.2 million for the
six months ended June 30, 1996, an increase of $1.5 million or 116%. This
increase was primarily due to an increase in customer contact engagements for a
telecommunications industry client.
Revenue from software licenses was $98,000 for the three month period
ended June 30, 1997, compared to $533,000 for the same three month period in
1996, a decrease of $435,000 or 82%. The decrease in software licenses in the
second quarter of 1997 when compared to 1996 was attributable to the timing of
closing sales of software templates. Revenue from software licenses was
$723,000 for the six months ended June 30, 1997 compared to $663,000 for the
six months ended June 30, 1996, an increase of $60,000 or 9%.
Cost of Revenue. Cost of revenue consists primarily of salaries and
related benefits for personnel, and also includes an allocated portion of rent,
building services and expenses. For the second quarter of 1997, total cost of
revenue was $4.7 million compared to $4.3 million for the second quarter of
1996, an increase of $.4 million or 9%. For the six months ended June 30, 1997,
total cost of revenue was $9.1 million compared to $9.4 million for the six
months ended June 30, 1996, a decrease of $.3 million or 3%. The six month
decrease was primarily attributable to a decrease in the cost of consultant
labor. Cost of revenue-related parties was $1.5 million for the six months
ended June 30, 1997 compared to $.8 million for the six months ended June 30,
1996, an increase of $.7 million or 94%. This increase was primarily
attributable to an increase in customer contact engagements for a
telecommunications industry client.
Research and Development. Research and development expenses for the
quarter ended June 30, 1997 were $393,000 compared to $288,000 for the second
quarter of 1996, an increase of $105,000 or 36%. For the six months ended June
30, 1997 research and development expenses were $751,000 compared to $467,000
for the six months ended June 30, 1996, an increase of $284,000 or 61%. These
increases were primarily attributable to continued investment in template and
methodology development.
Selling, General and Administrative. Selling, general and administrative
expenses include costs of proposal development and proposal writing, marketing
communications and advertising,
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sales and management staff, and corporate services functions including
accounting, human resources and legal services, along with corporate executive
staff. Selling, general and administrative expenses were $3.9 million for the
six months ended June 30, 1997 compared to $4.1 million for the six months
ended June 30, 1996, a decrease of $.2 million or 5%.
Other Income (Expense). Total other income for the second quarter of
1997 was $172,000 compared to total other income of $154,000 in 1996, an
increase of $18,000 or 12%. For the six months ended June 30, 1997, total other
income was $339,000 compared to total other income of $302,000 in 1996 an
increase of $37,000 or 12%. This income is primarily interest income earned on
the net proceeds received in December 1995 from the Company's initial public
offering, which were invested in an interest-bearing account.
Income Tax Provision. An income tax provision of $344,000 was recorded
for the second quarter of 1997 and $600,000 for the six months ended June 30,
1997 based on the Company's estimate of the effective tax rate for the year.
SFAS No. 109, "Accounting for Income Taxes," requires a valuation
allowance when it is "more likely than not that some portion or all of the
deferred tax assets will not be realized." It further states that "forming a
conclusion that a valuation allowance is not needed is difficult when there is
negative evidence such as cumulative losses in recent years." The ultimate
realization of its deferred income tax asset depends on the Company's ability
to generate sufficient taxable income in the future. The Company has weighed
the positive evidence of sustained profitability over the last three years and
future income expectations within the Company's three year strategic planning
horizon against the negative evidence of dependence upon a limited number of
customers and other uncertainties and has concluded that retaining a valuation
allowance related to net operating losses is no longer necessary.
In estimating the amount of its realizable deferred tax asset, the
Company gives substantial weight to recent historical results. Significant
changes in circumstances or in enacted tax laws which affect the valuation
allowance are recorded when they occur. The Company's annual strategic business
planning process takes place in the fourth quarter of the year, and the
valuation allowance is adjusted for future years' income expectations resulting
from that process. When preparing subsequent interim and annual financial
statements, the Company reevaluates whether there has been any significant
change in the assumptions underlying its plan and adjusts the valuation
allowance as necessary.
Liquidity and Capital Resources
The Company has funded its operations in recent years primarily through
cash generated from operations and the use of cash reserves, and in part by
borrowing under available lines of credit. The Company has also funded its
operations through the net proceeds of the initial public offering of its
Common Stock consummated in December 1995.
During the first six months of 1997 the Company generated $1.2 million
in positive cash flow from operating activities and overall net cash provided
of $128,000. This positive cash
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flow was generated even with a substantial six month investment of $1.2 million
in capital equipment. In comparison, capital equipment spending for the six
months ended June 30, 1996 was $722,000.
The Company's net accounts receivable increased by $1.6 million for
the six months ended June 30, 1997. Invoicing of amounts to clients generally
occurs within 45 days of time and materials cost incurrence, unless a specific
schedule is agreed upon, and payment follows invoicing in accordance with
customary terms. The Company has not experienced any significant write-downs of
receivables, nor does the Company expect that payments are doubtful;
accordingly, the Company has not made any allowance for doubtful accounts.
Advance billings and deferred revenue increased $1.1 million for the six
months ended June 30, 1997. Advanced billings and deferred revenue balances
will normally change from period to period. Any increase reflects billings in
advance of revenue earned, but which were billed in accordance with established
or agreed billings schedules. These amounts are recorded as deferred revenue
until earned. The timing and magnitude of such advance billings vary from
contract to contract and from client to client.
The Company currently has a committed line of credit agreement in the
amount of $3.5 million in place with PNC Bank, N.A. (the "Bank"). Borrowings
under this agreement are collateralized by accounts receivable. The line of
credit bears interest at the Bank's prime interest rate and the Bank charges a
0.15% fee per annum on the unused portion of that line of credit. The Bank's
prime interest rate was 8.50% at June 30, 1997 compared to 8.25% at December
31, 1996. This agreement was amended on July 1, 1997 by extending the
expiration date to June 30, 1998. No borrowings were outstanding against the
line of credit at June 30, 1997 or December 31, 1996.
The Company believes that the current cash balances, together with cash
generated from operations and borrowing available under its line of credit,
will satisfy the Company's working capital and capital expenditure requirements
during fiscal year 1997 and the foreseeable period thereafter. In the longer
term, the Company may require additional sources of liquidity to fund future
growth. Such sources of liquidity may include additional equity offerings or
debt financings. Capital expenditures are typically made for computing
equipment, software, physical plant, and furniture and fixtures in order to
seek enhancements in the productivity of the Company's employees and to support
growth.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings per
Share." SFAS No. 128 establishes new standards for computing and presenting
earnings per share. The Company is required to adopt the provisions of SFAS No.
128 for its consolidated financial statements for the year ended December 31,
1997 and subsequent interim periods. Upon adoption, the standard also requires
the restatement of all prior period earnings per share information presented.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components. The Company is required to
adopt the provisions of SFAS No. 130 beginning with its consolidated financial
statements for the three months ending March 31, 1998. SFAS No. 131 requires
certain disclosures about segment information in interim and annual financial
statements and related information about products and services, geographic
areas and major customers. The Company must adopt the provisions of SFAS No.
131 for its consolidated financial statements for the year ending December 31,
1998.
The adoptions of SFAS No. 128, SFAS No. 130 and SFAS No. 131 are not
expected to have a material effect on the measurement of the Company's
financial position, results of operations or cash flows; the Company is
reviewing possible changes in disclosures that may be called for.
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Material Factors Affecting the Company's Business
The Company's business is subject to a number of risks and
uncertainties that could materially affect future results. To the extent that
any of the statements made in this report on Form 10-Q (including, without
limitation, statements with respect to growth in the Company's business and
client engagements) may be deemed to be forward-looking statements, or to the
extent that the Company or its representatives may in the future be deemed to
make oral forward-looking statements, the following is a list of important
factors, among others, that could cause actual results to differ materially
from those expressed in any such forward-looking statements:
Dependence Upon Limited Number of Clients. The Company has derived in
the past, and expects to derive in the future, a significant portion of its
revenue from a relatively limited number of major clients. For example,
approximately 83%, 87% and 80% of total software services revenue in the years
ended December 31, 1996, 1995 and 1994, respectively, was derived from the
Company's five largest clients in each such period. In 1996, revenue from
billings to each of the United States Transportation Command, BellSouth
Telecommunications, Inc. and Caterpillar Inc. accounted for more than 10% of
the Company's total revenue. In 1995, revenue from billings to each of such
customers and U S WEST Communications, Inc. accounted for more than 10% of the
Company's total revenue. The Company's business depends in large part upon its
ability to establish and maintain relationships with a limited number of large
clients. The loss of, or any significant reduction in the services provided to,
any existing major clients, or the failure of the Company to establish and
maintain relationships with new major clients, would have a material adverse
effect on the Company's business, financial position and results of operations.
Project Risks. Many of the Company's engagements involve projects
which are critical to the operations of its clients' businesses and which
provide benefits that may be difficult to quantify. Moreover, many of these
engagements are significant to the Company, in that each may represent a
significant portion of the Company's total revenue. For example, the Company's
ten largest engagements accounted for approximately 76%, 68%, and 56% of total
software services revenue in the years ended December 31, 1996, 1995 and 1994,
respectively. The Company's failure or inability to meet a client's
expectations in the performance of an engagement could have a material adverse
effect on the Company's business, financial position and results of operations,
including damage to the Company's reputation that could adversely affect its
ability to attract new business. In addition, the Company's engagements
generally are terminable by clients on short or no notice. An unanticipated
termination of a major engagement could require the Company either to maintain
under-utilized employees, resulting in a higher than expected number of
unassigned persons and concomitant lower utilization rate, or to terminate such
employees, resulting in higher severance expenses. The Company must maintain a
sufficient number of senior professionals to oversee existing client
engagements and to participate with the Company's sales force in securing new
client engagements; thus, professional staff expenses are relatively fixed.
Although the majority of the Company's contracts are
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performed on a time-and-materials basis, some contracts are performed on a
fixed-price basis, exposing the Company to the risks of cost overruns and
inflation.
Variability of Quarterly Operating Results; Future Operating Results
Uncertain. The Company has experienced significant quarterly and other
variations in revenue and operating results. Because the Company's business is
characterized by significant client concentration and relatively large
projects, the timing of performance for each client engagement can result in
significant variability in the Company's revenue and cost of revenue from
quarter to quarter. In addition, variations in the Company's revenue and
operating results occur as a result of a number of other factors, such as
employee hiring and utilization rates and the number of working days in a
quarter. The timing of revenue is difficult to forecast because the Company's
sales cycle is relatively long and may depend on factors such as the size and
scope of assignments and general economic conditions. Because a high percentage
of the Company's expenses, particularly employee compensation, are relatively
fixed, a variation in the timing of the initiation or completion of client
engagements, especially at or near the end of any quarter, can cause
significant variations in operating results from quarter to quarter and could
result in quarterly losses. Future revenue and operating results may vary as a
result of these and other factors, including the demand for the Company's
services and solutions and the competitive conditions in the industry.
Moreover, much of the Company's revenue from software licenses is realized upon
the licensing of individual copies of software, rather than in the course of a
specific services engagement. Accordingly, the timing of software license
revenue can be difficult to predict and may vary significantly from quarter to
quarter. Many of the factors that could result in quarterly variations are not
within the Company's control. The Company believes that quarter-to-quarter
comparisons of its financial results are not necessarily meaningful and should
not be relied upon as an indication of future performance.
In addition, quarterly variations, together with the Company's
dependence upon a limited number of clients and the Company's experience of
adverse operating results in years prior to 1994, make it difficult for
management to engage in strategic planning that contemplates a horizon of more
than three years. Thus, income expectations beyond three years are viewed by
management as very uncertain, and management's past assessments of its ability
to realize its deferred tax asset through future taxable income have reflected
this. Prior to December 31, 1996, the Company's interim and annual financial
statements included a valuation allowance that was intended to reflect
management's estimation, in light of these and other risk factors, of the
realizability of its deferred tax asset. In determining the amount of any
valuation allowance and the possible need to adjust that amount, the Company
weighs the negative evidence of its dependence upon a limited number of clients
and the other risks described herein, on the one hand, against the positive
evidence of recent results and future expectations over its three-year planning
horizon, on the other hand. The Company then adjusts the valuation allowance,
if any, to reflect the portion of the deferred tax asset that the Company
believes it will, more likely than not, be unable to realize. Any valuation
allowance that may be shown on the Company's financial statements would reflect
that the Company does not believe that it is more likely than not to realize
certain deferred tax assets.
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Dependence on Key Management Personnel. The Company's success depends
in significant part upon the retention of key senior management and technical
personnel. The Company does not have employment agreements with any of its
personnel other than Dennis Yablonsky, its President and Chief Executive
Officer, nor does it maintain key man life insurance on any of its personnel.
The loss of one or more of its key management employees or the inability to
attract and retain other qualified management employees could have a material
adverse effect on the Company's business, financial position and results of
operations.
Attraction and Retention of Employees. Carnegie Group's business
involves the delivery of software development services and is labor-intensive.
The Company's success depends in large part upon its ability to attract, retain
and motivate highly skilled employees, particularly project managers, sales and
marketing personnel, engineers and other senior personnel. Qualified project
managers and engineers are in particularly great demand and are likely to
remain a limited resource in the foreseeable future. Although the Company
expects to continue to attract sufficient numbers of highly skilled employees
and to retain existing project managers, sales and marketing personnel,
engineers and other senior personnel for the foreseeable future, there can be
no assurance that the Company will be able to do so. The Company, like others
in the information technology services industry, is subject to a relatively
high annual rate of turnover in personnel. The loss of project managers, sales
and marketing personnel, engineers and other senior personnel could have a
material adverse effect on the Company's business, financial position and
results of operations, including its ability to secure and complete
engagements. No project managers, sales and marketing personnel, engineers or
other senior personnel have entered into employment agreements, other than
Dennis Yablonsky, the Company's President and Chief Executive Officer.
Management of Growth. Carnegie Group is currently experiencing a
period of growth which has placed, and could continue to place, a strain on the
Company's financial and other resources. The Company was founded in 1983 by
computer scientists at Carnegie Mellon University in Pittsburgh, Pennsylvania.
The Company was initially funded through equity investments and technology
alliances with Digital Equipment Corporation, Generale de Service Informatique,
The Boeing Company, Texas Instruments Incorporated, Ford Motor Company and U S
WEST, Inc. From January 1, 1994 through December 31, 1996, the size of the
Company's staff increased from 124 to 238 employees and independent
contractors. In addition, the Company has opened offices in Atlanta, Georgia
and Fairview Heights, Illinois since January 1, 1995. In order to manage any
further growth in its staff and facilities, the Company must continue to
improve its operational, financial and other internal systems, and to attract,
train, motivate and manage its personnel. If the Company is unable to manage
growth effectively and new personnel are unable to achieve anticipated
performance levels, the Company's business, financial position and results of
operations would be adversely affected.
Competition. The information technology services market includes a
large number of participants, is subject to rapid change and is highly
competitive. The Company competes with
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and faces potential competition for client assignments and experienced
personnel from a number of companies that have significantly greater financial,
technical and marketing resources and greater name recognition. Primary
competitors include: the consulting practices of the "Big Six" accounting
firms; systems consulting and integration firms such as American Management
Systems, Inc. and Cambridge Technology Partners, Inc.; and the professional
services groups of large companies, such as International Business Machines
Corporation, Digital Equipment Corporation and AT&T Corporation. In addition,
clients may elect to use their internal information systems resources to
satisfy their needs for software development, systems integration and technical
consulting services, rather than using those services offered by the Company.
The Company also faces competition from organizations providing outsourcing
services to the information systems departments of existing and potential
clients. In addition, the information technology services market is highly
fragmented and is served by numerous firms; some of these firms compete
nationally and internationally, while others serve only their respective local
markets. While the Company has not experienced competition from foreign
providers of information technology services, there can be no assurance that
the Company will not experience such competition in the future. Carnegie Group
has targeted, and expects to continue to target, industries that are
characterized by business areas (such as customer interaction, and logistics,
planning and scheduling) to which the Company's services and technology are
particularly well-suited, and by participants who possess the financial
resources and scale of operations necessary to support the engagement of
service providers such as the Company. A growing number of professional
services firms are seeking engagements from that same client group. The
Company believes that the principal competitive factors in the information
technology services industry include the nature of the service offering,
quality of service, timeliness, responsiveness to client needs, experience with
the client's industry and competitive environment, technical expertise, access
to replicable technology, such as software templates, and price. The Company
believes that its ability to compete also depends in part upon a number of
competitive factors outside its control, including: the ability of its
competitors to hire, retain and motivate project managers, sales and marketing
personnel and engineers; competitors' ownership of or access to software and
technology used by potential clients; the development by others of software
that is competitive with the Company's solutions and services; the price at
which others offer comparable services; and the extent of competitors'
responsiveness to customer needs.
While the information technology services market remains highly
fragmented and continues to be served by numerous firms, the Company notes that
this market has been subject to recent consolidation. Accordingly, the Company
from time to time considers possible acquisitions, consolidations and other
strategic alternatives.
Developing Market; Technological Advances. The market for
client/server software development services is continuing to develop. The
Company's success is dependent in part upon the acceptance of information
processing systems utilizing client/server architectures. While the Company
believes that corporations and government agencies will continue to accept the
use of client/server architectures, a decline in this trend could have a
material adverse effect
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on the Company's business, financial position and results of operations. The
Company's success will also depend in part on its ability to develop software
solutions that incorporate and keep pace with continuing changes in advanced
software technologies, evolving industry standards and changing client
preferences. There can be no assurance that the Company will be successful in
adequately addressing these developments on a timely basis or that, if these
developments are addressed, the Company will be successful in the marketplace.
The Company's failure to address these developments could have a material
adverse effect on the Company's business, financial position and results of
operations. In addition, there can be no assurance that products or
technologies developed by others will not render the Company's services
uncompetitive or obsolete.
Intellectual Property Rights. The Company's success is dependent in
part upon reusable software templates and other intellectual property. The
Company's business includes the development of custom software solutions in
connection with specific client engagements. Ownership of certain custom
components of such software is generally assigned to the client. The Company
has licensed through December 1997 certain custom software components developed
in the course of an engagement for a client. In addition, the Company also
develops core software technology and reusable software templates, often in the
course of engagements for clients, as well as object-oriented software
components and certain software "tools," which can be reused in software
application development and which generally remain the property of the Company.
The Company relies upon a combination of patent, trade secret,
non-disclosure and other contractual arrangements, and patent, copyright and
trademark laws, to protect its proprietary rights and the proprietary rights of
third parties from whom the Company licenses intellectual property. The Company
enters into confidentiality agreements with its employees, consultants, clients
and potential clients and limits access to and distribution of proprietary
information. There can be no assurance that the steps taken by the Company in
this regard will be adequate to deter misappropriation of proprietary
information or that the Company will be able to detect unauthorized use and
take appropriate steps to enforce its intellectual property rights.
Although the Company believes that its services and solutions
(including its reusable software templates) do not infringe on the intellectual
property rights of others and that it has all rights necessary to utilize the
intellectual property employed in its business, the Company is subject to the
risk of litigation alleging infringement of third party intellectual property
rights. There can be no assurance that third parties (including the parties for
whom the Company has been engaged to develop solutions, from which its reusable
software templates have been derived) will not assert infringement claims
against the Company in the future with respect to intellectual property
utilized by the Company now or in the future. Any such claims could require the
Company to expend significant sums in litigation, pay damages, develop
non-infringing intellectual property or acquire licenses to the intellectual
property which is the subject of asserted infringement.
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ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
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PART II - OTHER INFORMATION
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On May 13, 1997, the Company held its 1997 Annual Meeting of Stockholders.
(b) Mark S. Fox and John W. Manzetti were elected directors at the Annual
Meeting; Dennis Yablonsky, Raj Reddy, Glen F. Chatfield, Bruce D.
Russell, Tracie A. Muesing and Jaime G. Carbonell continued as directors
after the Annual Meeting.
(c) The following matters were voted upon at the Annual Meeting, with the
results indicated:
1. Election of Directors
Authority Broker
Votes For Withheld Non-Votes
--------- --------- ---------
Mark S. Fox 5,090,187 38,935 0
John W. Manzetti 5,093,087 36,035 0
2. Proposal to ratify the selection of Price Waterhouse LLP,
independent accountants, to audit the books and accounts of
the Company for the year ending December 31, 1997.
Votes for: 5,111,512 Votes against: 9,860
Abstentions: Broker Non-Votes 0
(d) Not applicable
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits listed below are filed or incorporated by reference as part of
this quarterly report on Form 10-Q:
10.01 Development Agreement, dated April 28, 1997, by and between an
affiliate of U S WEST Communications Group, Inc., and Carnegie Group,
Inc. (confidential treatment with respect to certain information
in this exhibit has been requested of the Commission pursuant to
Rule 24b-2 under the Securities Exchange Act of 1934, as amended).
10.02 Letter Agreement, dated May 20, 1997, to amend Development Agreement,
dated January 24, 1997, as previously amended by Letter Agreement,
dated March 6, 1997, by and between U S WEST Business Resources, Inc.,
as agent for U S WEST Advanced Technologies, Inc. and U S WEST
Communications, Inc., and Carnegie Group, Inc. (confidential
treatment with respect to certain information in this exhibit has
been requested of the Commission pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934, as amended).
11.1 Statement regarding computation of per share earnings
27. Financial Data Schedule
(b) Reports on Form 8-K
The registrant did not file any reports on Form 8-K during
the quarter ended June 30, 1997.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Date: September 23, 1997 CARNEGIE GROUP, INC.
/s/ DENNIS YABLONSKY
----------------------
Dennis Yablonsky
President, and
Chief Executive Officer
/s/ JOHN W. MANZETTI
------------------------
John W. Manzetti
Executive Vice President,
Chief Financial Officer
and Treasurer
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EXHIBIT INDEX
Exhibit No. Description
10.01 Development Agreement, dated April 28, 1997, by and between an
affiliate of U S WEST Communications Group, Inc., and Carnegie Group,
Inc. (confidential treatment with respect to certain information
in this exhibit has been requested of the Commission pursuant to
Rule 24b-2 under the Securities Exchange Act of 1934, as amended).
10.02 Letter Agreement, dated May 20, 1997, to amend Development Agreement,
dated January 24, 1997, as previously amended by Letter Agreement,
dated March 6, 1997, by and between U S WEST Business Resources,
Inc., as agent for U S WEST Advanced Technologies, Inc. and U S WEST
Communications, Inc., and Carnegie Group, Inc. (confidential
treatment with respect to certain information in this exhibit has
been requested of the Commission pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934, as amended).
11.1 Statement Regarding Computation of Per Share Earnings
27 Financial Data Schedule
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