-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BQhJfH/3vI32xbb0A+IR+ibb4yxxGioY9Zk25X85Q7AUCzaA10Gt18sdbFt25wUP 1UcfKzyxMNO/N2JJnDDaJA== 0000950128-98-000803.txt : 19980518 0000950128-98-000803.hdr.sgml : 19980518 ACCESSION NUMBER: 0000950128-98-000803 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CARNEGIE GROUP INC CENTRAL INDEX KEY: 0001001188 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 251435252 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26964 FILM NUMBER: 98623825 BUSINESS ADDRESS: STREET 1: FIVE PPG PLACE CITY: PITTSBURGH STATE: PA ZIP: 15222 BUSINESS PHONE: 4126426900 MAIL ADDRESS: STREET 1: FIVE PPG PLACE CITY: PITTSBURGH STATE: PA ZIP: 15222 10-Q 1 CARNEGIE GROUP, INC. 1 FORM 10-Q 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 MARCH 31, 1998 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-26964 CARNEGIE GROUP, INC. DELAWARE 25-1435252 (State or other Jurisdiction of (I.R.S Employer Incorporation or Organization) Identification Number) FIVE PPG PLACE, PITTSBURGH, PENNSYLVANIA 15222 (Address of principal executive offices) (Zip Code) (412) 642-6900 (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 Indicate the number of shares outstanding of each of the issuer's classes of Common Stock as of the latest practicable date: CLASS OUTSTANDING AT APRIL 30, 1998 ----- ----------------------------- Common Stock, $.01 par value 6,539,866 2 FORM 10-Q CARNEGIE GROUP, INC. TABLE OF CONTENTS PAGE NUMBER ------ PART 1 FINANCIAL INFORMATION Item 1. Financial Statements Carnegie Group, Inc. and Subsidiaries 3 Consolidated Statements of Operations for the three months ended March 31, 1998 and 1997 Carnegie Group, Inc. and Subsidiaries 4 Consolidated Balance Sheets at March 31, 1998 and December 31, 1997 Carnegie Group, Inc. and Subsidiaries 5 Consolidated Statements of Cash Flows for the three months ended March 31, 1998 and 1997 Notes to Unaudited Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of 8 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures about 15 Market Risks PART 2 OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 16 Signatures 17 Exhibit Index 18 -2- 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CARNEGIE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED ------------------ MARCH MARCH 31, 31, 1998 1997 ---- ---- Revenue Software services--Unrelated parties $ 3,834,834 $ 5,499,732 Software services--Related parties 3,408,965 1,007,108 ----------- ----------- Total software services 7,243,799 6,506,840 Software licenses 359,630 625,078 ----------- ----------- Total revenue 7,603,429 7,131,918 ----------- ----------- Costs and expenses: Cost of revenue - Unrelated parties 2,901,305 3,837,500 Cost of revenue - Related parties 2,279,097 581,745 ----------- ----------- Total cost of revenue 5,180,402 4,419,245 Research and development 194,635 357,682 Selling, general and administrative 2,103,911 1,876,836 Write-off of purchased in-process research and development 2,425,000 -- ----------- ----------- Total costs and expenses 9,903,948 6,653,763 ----------- ----------- Income (loss) from operations (2,300,519) 478,155 Other income (expense): Interest income 198,363 163,898 Other income 6,099 6,199 Interest expense (12,403) (3,645) ----------- ----------- Total other income 192,059 166,452 ----------- ----------- Income (loss) before income taxes (2,108,460) 644,607 Income tax provision (123,721) (256,360) ----------- ----------- Net income (loss) $(2,232,181) $ 388,247 ----------- ----------- Basic earnings (loss) per share $ (0.34) $ 0.06 =========== =========== Diluted earnings (loss) per share $ (0.34) $ 0.06 =========== ===========
The accompanying notes are an integral part of these financial statements. -3- 4 CARNEGIE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(UNAUDITED) MARCH 31, DECEMBER 31, 1998 1997 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents $7,246,188 $13,483,284 Accounts receivable 2,454,979 2,955,241 Accounts receivable from related parties 2,112,673 3,396,859 Accounts receivable--unbilled 3,042,125 1,390,650 Accounts receivable related parties--unbilled 1,115,774 211,885 Deferred income taxes 1,961,893 2,005,855 Other current assets 844,030 871,931 ----------- ----------- Total current assets 18,777,662 24,315,705 ----------- ----------- Property and equipment, net of accumulated depreciation and amortization 2,734,548 2,568,758 Deferred income taxes 1,846,758 1,910,760 Long term notes receivable--from officers 794,170 784,984 Goodwill and other intangible assets 3,073,546 -- Other assets 8,289 10,597 ----------- ----------- Total assets $27,234,973 $29,590,804 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Trade accounts payable $ 896,907 $ 663,667 Payables to related parties 194,755 182,145 Accrued compensation 930,395 933,004 Advance billings and deferred revenue 1,866,853 2,388,660 Accrued rent 330,470 330,981 Accrued restructuring 277,324 598,723 Other accrued liabilities 666,755 423,544 Obligations under capital leases--current portion 167,927 -- ----------- ----------- Total current liabilities 5,331,386 5,520,724 ----------- ----------- Obligations under capital leases-noncurrent portion 101,872 -- ----------- ----------- Total liabilities 5,433,258 5,520,724 ----------- ----------- STOCKHOLDERS' EQUITY: Common stock, $.01 par value; 20,000,000 shares authorized, 6,772,685 and 6,707,934 shares issued at March 31, 1998 and December 31, 1997 respectively 67,726 67,079 Capital in excess of par value 31,796,596 31,704,241 Accumulated deficit (9,458,417) (7,226,240) Treasury stock, 223,000 and 190,000 shares (at cost) (604,190) (475,000) ----------- ----------- Total stockholders' equity 21,801,715 24,070,080 ----------- ----------- Total liabilities and stockholders' equity $27,234,973 $29,590,804 =========== ===========
The accompanying notes are an integral part of these financial statements. -4- 5 CARNEGIE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED ------------------ MARCH 31, MARCH 31, 1998 1997 ---- ---- Cash flows from operating activities: Net income $ (2,232,181) $ 388,247 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 362,656 283,841 Deferred income taxes 74,898 228,160 Write-off of purchased in-process research and development 2,425,000 Changes in working capital components, net of acquisition of business: Accounts receivable (815,446) (137,071) Accounts receivable - related parties 380,297 (1,953) Other assets 42,186 (74,540) Trade accounts payable (140,192) 397,988 Payables to related parties 12,610 (597,461) Accrued compensation (98,650) (106,686) Accrued rent (511) (92,517) Interest receivable (9,186) -- Accrued restructuring (321,399) -- Other accrued liabilities 284,365 40,667 Advance billings and deferred revenue (802,370) 30,768 ------------ ----------- Net cash (used in) provided by operating activities (837,923) 359,443 Cash flows from investing activities: Capital expenditures (272,643) (651,259) Acquisition of business (5,090,341) - ----------- --------- Net cash used in investing activities (5,362,984) (651,259) ----------- ---------- Cash flows from financing activities: Principal payments under capital lease obligations -- (14,615) Purchase of treasury stock (129,190) -- Proceeds from sales of common stock, net 93,001 10,697 ---------- ---------- Net cash used in financing activities (36,189) (3,918) ----------- ----------- Net change in cash and cash equivalents (6,237,096) (295,734) Cash and cash equivalents: Beginning of period 13,483,284 14,691,765 End of period $7,246,188 $14,396,031 ========== ===========
The accompanying notes are an integral part of these financial statements. -5- 6 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 period ended March 31, 1998. 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, 1997 as filed with the Securities and Exchange Commission. ACQUISITION The Company acquired the capital stock of Advantage kbs, Inc. (Advantage kbs) on March 19, 1998. The initial consideration paid was $5,000,000 in cash, with terms of the transaction providing for additional consideration of up to $2,500,000 in cash, which is dependent on revenue and earnings of Advantage kbs for the year ending December 31, 1998. Financing for the initial consideration was obtained from available cash remaining from the proceeds of a public offering by the Company in December of 1995. The additional consideration, if incurred, will also be paid from the remaining proceeds of the December 1995 public offering. Advantage kbs, based in Edison, New Jersey, provides problem resolution software and professional services for automating customer support. The acquisition was treated as a purchase for financial accounting purposes, and accordingly the Company's results of operations include the results of Advantage kbs since the acquisition date. The purchase price was allocated to the net assets acquired based upon their estimated fair market values and 2,425,000 was written off as purchased in-process research and development. The excess of the purchase price over the fair market value of net assets acquired (related to capitalized software, goodwill and other intangible assets) amounted to approximately $3.1 million and is being amortized over periods ranging from 5 to 15 years using the straight line method. This allocation was based on preliminary estimates and may be revised as the year proceeds. The following unaudited proforma summary presents the Company's results of operations as if the acquisition had occurred at the beginning of the periods presented and does not purport to be indicative of what would have occurred had the acquisition been made as of those dates or of results which may occur in the future.
March 31, December 31, 1998 1997 ---- ---- Sales $ 8,439,414 $ 32,589,000 Net loss (18,118) (381,145) Basic earnings (loss) per share $0.00 $(0.06) Diluted earnings (loss) per share $0.00 $(0.06)
EARNINGS PER COMMON SHARE The computation of basic and diluted earnings per common share for the periods ended March 31, 1998 and 1997 is performed as follows:
1998 1997 ---- ---- Net Income (loss) $(2,232,181) $388,247 ============ ======== Weighted average common shares outstanding 6,497,584 6,278,594 Effect of dilutive options 308,107 674,220 --------- --------- Dilutive shares outstanding 6,805,691 6,952,814 ========= ========= Earnings (loss) per common share Basic $(0.34) $0.06 ======= ===== Diluted $(0.34) $0.06 ======= =====
RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires certain disclosures about segment information in interim and annual -6- 7 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 adoption of SFAS No. 131 is 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. In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 establishes standards for accounting for costs incurred in developing or procuring computer software for internal use. The Company will be required to adopt this standard effective January 1, 1999. The adoption of this standard is not expected to have a material effect on the Company's financial position, results of operations or cash flows. -7- 8 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL Carnegie Group, Inc. ("Carnegie Group" or the "Company") provides business and technical consulting, client/server and Internet-based custom software development, third-party package implementation and systems integration services. The Company focuses on two business areas in the information technology professional services marketplace: customer interaction; and logistics, planning and scheduling. Within these areas, the Company helps clients in the financial services, government, manufacturing and telecommunications industries improve business processes, customer relations, productivity and market position. The Company's expertise encompasses a wide range of advanced software technologies, including knowledge management 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 its three-phased RAPID methodology to help provide speed and repeatable reliability in creating software solutions across different client engagements. RAPID begins with an Analysis phase, is followed by an Implementation phase, and ends with a Deployment phase. On March 19, 1998, the Company acquired all the outstanding stock of Advantage kbs for a purchase price of $5 million, plus an additional contingent payment of up to $2.5 million which is dependent upon revenue and earnings of Advantage kbs for the year ending December 31, 1998. Based in Edison, New Jersey, Advantage kbs provides problem resolution software and professional services for automating customer support. The Company believes that the acquisition of Advantage kbs will enhance its customer interaction and call center strategy by enabling the Company to offer Advantage's IQSupport Application Suite in the call center and help desk markets. In addition, the Company believes that the acquisition will broaden its capacity to offer business consulting services to its customers. The integration of Advantage kbs is subject to certain risks. The possible business and financial advantages of the acquisition may not be achieved unless the operations of Advantage kbs are successfully integrated with the Company in a timely manner. 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 U S WEST Communications, Inc. the United States Transportation Command, the U. S. Army, Diebold, BellSouth Telecommunications, 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 March 31, 1998 was $15.0 million, compared to $17.3 million at March 31, 1997 and $8.7 million at December 31, 1997. 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. COMPARISON OF QUARTERS ENDED MARCH 31, 1998 AND MARCH 31, 1997. Revenue. Total revenue for the quarter ended March 31, 1998 was $7.6 compared to $7.1 million in the first quarter of 1997, an increase of $.5 million or 7%. Total software services revenue was $7.2 million in the first quarter of 1998 compared to $6.5 million in the first quarter of 1997, an increase of $.7 million or 11%. Revenue from software services-unrelated parties was $3.8 million in the first quarter of 1998 compared to $5.5 million in the first quarter of 1997, a decrease of $1.7 million or 31%. This decrease was the result of the Company being engaged in a large fixed-price contract in the first quarter of 1997 that did not exist in the first quarter of 1998. Revenue from software services-related parties was $3.4 million in the first quarter of 1998 compared to $1.0 million in the first quarter of 1997, an increase of $2.4 million or 240%. This increase was the result of an increase in the number of customer contact engagements for a telecommunications industry client. -8- 9 Revenue from software licenses was $360,000 in the first quarter of 1998 compared to $625,000 in the first quarter of 1997, a decrease of $265,000 or 42%. This decrease was attributable to the decreased sales of reusable software templates. 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. Total cost of revenue was $5.2 million in the first quarter of 1998, compared to $4.4 million in the first quarter of 1997, an increase of $.8 million or 18%. Cost of revenue-unrelated parties was $2.9 million in the first quarter of 1998 compared to $3.8 million in 1997, a decrease of $.9 million or 24%. Cost of revenue-related parties was $2.3 million in the first quarter of 1998 compared to $.6 million in 1997, an increase of $1.7 million or 283%. This increase was the result of an increase in the number of customer contact engagements for a telecommunications industry client. Research and Development. Research and development expenses were $195,000 in the first quarter of 1998 compared to $358,000 in the first quarter of 1997, a decrease of $163,000 or 46%. Selling, General and Administrative. Selling, general and administrative expenses include costs of proposal development and proposal writing, marketing communications and advertising, 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 $2.1 million in the first quarter of 1998 compared to $1.9 million in the first quarter of 1997, an increase of $.2 million or 11%. This increase was due primarily to an increase in corporate services administration costs. Write-off of Purchased In Process Research and Development. During the first quarter of 1998, $2.4 million of purchased in process research and development was written off related to the acquisition of Advantage kbs. Other Income (Expense). Other income (expense) was $192,000 in the first quarter of 1998 compared to $166,000 in the first quarter of 1997, an increase of $26,000 or 16%. 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 $124,000 was recorded in the first quarter of 1998, 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 four years and future income expectations against the negative evidence of dependence upon a limited number of customers and other uncertainties and concluded that retaining a valuation allowance related to net operating losses was not necessary at December 31, 1996 and continues to be unnecessary. 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. For example, in the forth quarter of 1996 and 1995, as a result of its annual strategic business planning process, the Company reevaluated its future years' income expectations and recorded a discrete income tax benefit as an adjustment to the valuation allowance in each of those quarters. 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 quarter of 1998 the Company used $838,000 in cash for operating activities. Overall, the Company had a net use of cash amounting to $6,237,096. Approximately $5,000,000 was used in the acquisition of Advantage kbs. -9- 10 The Company's net accounts receivable increased by $435,000 in the first quarter of 1998, which reflects increases in revenue. 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-offs 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 decreased $522,000 in the first quarter of 1998. 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 March 31, 1998 and December 31, 1997. This agreement was amended on June 30, 1997 by extending the expiration date to June 29, 1998. No borrowings were outstanding against the line of credit at March 31, 1998 or December 31, 1997. 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 1998 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 financing. 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. IMPACT OF YEAR 2000 ISSUE During 1997, the Company began a strategic project to replace and enhance its existing financial systems technology. While the decision to embark on this project was solely business-related, the new software that the Company implemented is Year 2000 compliant. Therefore, the Year 2000 issue will not pose significant operational problems for the Company's computer systems. The Company has designed a systems environment that is Year 2000 compliant and all systems are verified for Year 2000 compliance prior to purchase from suppliers. However, there can be no guarantee that the systems of other companies on which the Company's system rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have material adverse effect on the Company. The Company believes that it has no material exposure to contingencies related to the year 2000 Issue for systems it has developed for its clients. The Company is and will continue to utilize both internal and external resources to implement and test the software for Year 2000 modifications. The Company plans to complete the Year 2000 project by December 31, 1998. The total cost of the Year 2000 project is estimated at $550,000 and is being funded through operating cash flows. Of the total project cost, approximately $150,000 is attributed to the purchase of new software which was purchased and capitalized in 1997. The remaining $80,000, some of which will be capitalized or expensed as incurred during 1998, is not expected to have a material effect on the results of operations. To date, the Company has capitalized or expensed approximately $540,000 related to the assessment of, and preliminary efforts in connection with, its Year 2000 project. The costs of the project and the date on which the Company plans to complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modifications and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." 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 -10- 11 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. 131 is 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. In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 establishes standards for accounting for costs incurred in developing or procuring computer software for internal use. The Company will be required to adopt this standard effective January 1, 1999. The adoption of this standard is not expected to have a material effect on the Company's financial position, results of operations or cash flows. 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 79%, 83% and 87% of total software services revenue in the years ended December 31, 1997, 1996 and 1995, respectively, was derived from the Company's five largest clients in each such period. In 1997, revenue from billings to each of the United States Transportation Command, U S WEST Communications, Inc. and BellSouth Telecommunications accounted for more than 10% of the Company's total revenue. In 1996, revenue from billings to the United States Transportation Command, the U S Army, Caterpillar, Inc. and BellSouth Telecommunications 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 68%, 76%, and 68% of total software services revenue in the years ended December 31, 1997, 1996 and 1995, 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 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. Risks Associated with the Integration of Advantage kbs. On March 19, 1998, the Company acquired all the outstanding capital stock of Advantage kbs which became a wholly owned subsidiary of the Company. The integration of companies in the information technology services industry may be more difficult to achieve than in other industries. There can be no assurance that the acquisition of Advantage kbs will result in any business and financial benefits to the Company. The realization of any such benefit requires, among other things, that the operations of Advantage kbs be successfully integrated with those of the Company in a timely manner. The successful integration of the Company and Advantage kbs will require the coordination of research and development and sales and marketing efforts. The difficulties of such integration may be increased by the need to coordinate geographically separated organizations and integrating personnel with disparate business backgrounds. In addition, the Company's senior management -11- 12 has not had previous experience in integrating acquisitions. There can be no assurance that the Company will be able successfully to manage the integration of Advantage kbs. 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 more uncertain, and management's assessments of its ability to realize its deferred tax asset through future taxable income reflects this. The Company's interim and annual financial statements included a valuation allowance that is 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 on the other hand. The Company then adjusts the valuation allowance to reflect the portion of the deferred tax asset that the Company believes it will, more likely than not, be unable to realize. The valuation allowance reflects the Company's belief that it is more likely than not to realize most but not all of its deferred tax assets. 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. 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, 1997 through -12- 13 December 31, 1997, the size of the Company's staff increased from 238 to 257 employees and independent contractors. In addition, the Company has opened offices in Atlanta, Georgia and Fairview Heights, Illinois, Oakland, California and Arlington, Virginia 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 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. In addition, business combinations among the Company's competitors may result in the creation of additional large information technology service providers with greater financial, marketing and other resources, than the Company. 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 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 -13- 14 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. -14- 15 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable -15- 16 PART II - OTHER INFORMATION ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS DESCRIPTION 11.1 Statement regarding computation of per share earnings 27. Financial Data Schedule (b) Reports on Form 8-K The registrant filed a report on Form 8-K on March 30, 1998 in connection with the acquisition of Advantage kbs. -16- 17 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: May 15, 1998 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 -17- 18 EXHIBIT INDEX SEQUENTIAL EXHIBIT NO. DESCRIPTION PAGE NUMBER - ----------- ----------- ----------- 11.1 Statement Regarding Computation of Per Share Earnings 27 Financial Data Schedule -18- EX-11.2 2 CARNEGIE GROUP, INC. 1 Exhibit 11.1 CARNEGIE GROUP, INC. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
1998 1997 ---- ---- Net income (loss) $(2,232,000) $388,000 ============ ======== Weighted average common shares outstanding 6,497,584 6,278,594 Effect of dilutive shares outstanding 308,107 674,220 --------- --------- Dilutive shares outstanding 6,805,691 6,952,814 ========= ========= Earnings (loss) per common share Basic $(0.34) $0.06 ======= ===== Diluted $(0.34) $0.06 ======= =====
EX-27 3 CARNEGIE GROUP, INC.
5 0001001188 CARNEGIE GROUP, INC. 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 7,246,188 0 8,725,551 0 0 18,777,662 2,734,548 0 27,234,973 5,331,386 0 0 0 67,726 21,733,989 27,234,973 359,630 7,603,429 4,908,110 9,903,948 0 0 12,403 (2,108,460) 123,721 (2,232,181) 0 0 0 (2,232,181) (0.34) (0.34)
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