<PAGE>
                                       1


                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   Form 10-KSB

[ X ]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
       ACT OF 1934 [Fee Required]

                   For the fiscal year ended December 31, 1999

[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 [No Fee Required]

                        For the transition period from to

                         Commission File Number: 0-14793

                             TEKNOWLEDGE CORPORATION
           (Name of small business issuer as specified in its charter)

                    Delaware                                    94-2760916
        (State or other jurisdiction of                      (I.R.S. Employer
        incorporation or organization)                       Identification No.)

               1810 Embarcadero Road, Palo Alto, California 94303
               (Address of principal executive offices) (Zip Code)

                    Issuer's telephone number: (650)424-0500

        Securities registered pursuant to Section 12 (b) of the Act: None

          Securities registered pursuant to Section 12 (g) of the Act:

                     Common Stock, $.01 par value per share
                    Series A Preferred Stock Purchase Rights

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes [ ] No [X]

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure  will be contained,  to
the  best  of  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB. [ ]

State issuer's revenues for its most recent fiscal year. $11,094,672

The aggregate  market value of Common Stock,  $.01 par value per share,  held by
non-affiliates of the registrant was $44,986,828 on March 21, 2000 (based on the
average bid and ask price per share of Common  Stock on that date as reported by
the Nasdaq  SmallCap  Market).  Shares of Common  Stock held by each officer and
director and by each person who owns 5% or more of the outstanding  Common Stock
have been  excluded in that such  persons may be deemed to be  affiliates.  This
determination of affiliate status is not necessarily a conclusive  determination
for other purposes.

On March 24, 2000, there were 5,315,239 shares of Common  Stock, $.01 par  value
per  share,  of the  registrant outstanding.

                       Documents Incorporated by Reference
    Proxy Statement for the 2000 Annual Meeting of Stockholders    Part III



<PAGE>
                                       2



Teknowledge(R),   TekPortal(TM), and  Sales   Associate(TM)  are  trademarks  of
Teknowledge  Corporation.  All other brand names, product names,  trademarks and
registered trademarks are the property of their respective holders.

                                     PART I

--------------------------------------------------------------------------------

Item 1.  Description of Business

         Teknowledge  Corporation (the "Company") is in the intelligent Internet
transactions  business.  Teknowledge's  services and product  solutions  involve
processing   application   knowledge,   and   conducting   flexible  and  secure
transactions over the Internet.  Knowledge  processing enables  organizations to
codify their knowledge,  represent it in machine readable forms, serve it to end
users on the Internet via agents and forms, and provide value-added  application
services to businesses and end-users.  Teknowledge's  projects utilize knowledge
processing to provide  customers with state-of the-art  software  solutions that
put knowledge to work.

         The fastest growing part of Teknowledge is the eCommerce business unit.
This division is increasingly  focused on Teknowledge's  TekPortal(TM)  solution
that  provides  customer  information  aggregation  for the  financial  services
industry.  This focus is  strengthened  by  Teknowledge's  knowledge  processing
capabilities,  and software solutions such as Teknowledge's Sales Associate(TM),
and  3rd  party  Value  Added   Reseller   components   such  as  Check  Point's
Firewall-1(TM) security product. In addition, Teknowledge is an IBM Premier Team
Provider for  Net.Commerce(TM)  and a Microsoft  Certified Solution Provider for
the Site Server(TM) product.

         Teknowledge  has  four  business  units  in   complementary   technical
application  areas.  Information  Assurance  provides network security solutions
that  protect  the  information  stored in  computer  networks  and ensure  that
information  is  accessible  by the right  people at the right  time.  Web-based
Training  encapsulates  traditional  courseware into reusable  electronic media,
develops  intelligent tutoring systems, and distributes the resulting courseware
solutions  on the  Internet.  Distributed  Systems is focused on  improving  the
quality  and  timeliness  of  services  on the  Internet.  Knowledge  Systems is
developing  solutions  for  processing  knowledge  and making  inferences  about
customer-supplied   data.  Many  of  Teknowledge's  customers  need  to  provide
knowledge-based   Internet  transactions,   supported  by  security,   web-based
training,  and  reliable  network  application  performance.   Winning  national
competitions   sponsored  by  the  Defense  Advanced  Research  Projects  Agency
("DARPA"),  the National  Institute of Standards and  Technology  ("NIST"),  and
other agencies, supports much of Teknowledge's cutting-edge R&D capability. This
provides  Teknowledge with a rich source of technology for product  development,
advanced services solutions,  patents, and licensing.  Teknowledge has an active
intellectual property-licensing program, with nine U.S. software patents.

         Teknowledge's  direct  revenue mix from  continuing  operations for the
year ending  December 31, 1999, was  approximately  15% commercial  products and
services  and 85%  government-sponsored  R&D. In 1998,  the ratio was 1% to 99%.
This ratio is expected to continue to change as eCommerce related investment and
customer solution  capabilities  increase over the coming years. In fact, during
the fourth  quarter of 1999,  this ratio was 29%  commercial  to 71%  government
business.  The eCommerce  financial  services  solutions part of the business is
growing  rapidly.  Teknowledge is increasing its investments and attention focus
on  commercial  software  products and services,  particularly  in the eCommerce
financial services market.

         Teknowledge  was  incorporated  on July 8,  1981  under the laws of the
State of Delaware.  The Company's principal  executive and technical  operations
offices are located at 1810 Embarcadero  Road, Palo Alto,  California  94303. In
addition,  Teknowledge  has technical  operations  offices located in San Diego,
California;  Fairfax, Virginia; and Orlando, Florida.  Teknowledge's business is
currently concentrated in the United States.

Overview

         The Internet economy places a competitive  premium on an organization's
ability to process and distribute its customer knowledge effectively.  Knowledge
has become the primary  competitive  weapon in the economic and military arenas.
However,  knowledge  acquired by people often does not get reused  because it is

<PAGE>
                                       3


not  organized  or  distributed  effectively.  Knowledge  systems  are  software
programs that enable  combinations  of people and computers to capture,  refine,
distribute,   and  apply  knowledge  to  solve  business  application  problems.
Teknowledge develops systems that integrate  conventional software and knowledge
processing in high-value  Internet  application  solutions.  These solutions are
developed  with  software  products  and  services  that  support   integration,
processing,  and  systematic  utilization  of an  organization's  key  knowledge
assets.  Increasingly,   an  organization's  knowledge  assets  are  encoded  in
knowledge  processing  applications  and  distributed  via the  Internet to make
solutions  available  globally,  seven  days a week,  24  hours a day.  When the
knowledge  in this value chain is  specialized  for  specific  applications  and
combined with customer  information,  it will drive the growth of  Teknowledge's
business in financial services, network security,  web-based training, and other
application areas.

         Teknowledge  operates  five  business  units within a single  reporting
segment.  Each of these business units utilizes  internally  developed and third
party software  components in its application  solutions.  Utilizing third party
components  in an  application  solution  allows  for  faster  and  more  robust
solutions.   It  also  allows  Teknowledge  to  focus  on  developing  knowledge
processing   components  in  the  context  of  a  robust  application  solution.
Teknowledge's  TekPortal(TM) and Sales Associate(TM) products are examples. They
can be sold with  interfaces  and  databases  from  companies  such as Oracle or
Microsoft,  and a  security  firewall  from  CheckPoint.  This  strategy  allows
Teknowledge  to provide its  innovative  components in the context of delivering
basic  value to the  customer  with  leading  commercial  products.  Teknowledge
delivers to the  customer a faster and more  robust  solution,  and  Teknowledge
receives a VAR license fee on each third party commercial product delivered.

         Computer  software  applications  provide maximum value when integrated
into networked operations,  both within and between enterprises.  Integration of
these various functions is facilitated if  object-oriented  software is designed
with an "open architecture." This allows the same applications software and user
interfaces to be distributed via network  protocols  across many different types
of computers.  The Company's  products and services are designed to maximize the
value  of  integrating,   distributing  and  activating  application  knowledge.
Teknowledge is executing a transition  from a primary focus on R&D to increasing
focus on delivering application solutions to commercial customers.

         Since  the  pace  of  commerce  worldwide  is  accelerating,  and  many
businesses are conducting large-scale operations over the Internet,  much of the
Company's current and future business focus is on providing  software to make it
possible  to  delegate  knowledge-intensive  tasks to  network-enabled  computer
software  "associate  systems."  These associate  systems may integrate  several
special-purpose   software  agents  to  accomplish  routine  tasks  as  well  as
accelerate knowledge gathering, refinement,  dissemination, and utilization over
computer networks.  Teknowledge's  strategic plans include  commercializing  and
embedding  associate  systems  software that amplify human  productivity and the
ability to apply  knowledge  effectively.  Teknowledge  has built six  prototype
associate  systems and one of these  prototypes has been  commercialized.  These
systems include: the Briefing Associate,  the Parent's Associate,  the Student's
Associate,  the Project Center Associate,  the Desktop Associate,  and the Sales
Associate.  Some of these  capabilities may now be incorporated into large-scale
TekPortal(TM) solutions for the financial industry.

Business Units

         Teknowledge has distributed  operations,  with its headquarters located
in  Palo  Alto,  California  and  offices  in San  Diego,  California;  Fairfax,
Virginia; and Orlando,  Florida. The Company operates five business units within
its current  operations:  four are  currently  focused  primarily on  government
customers and one, eCommerce,  is focused entirely on commercial customers.  The
four largely  government  sponsored units  contributed  over 85% of the revenue;
therefore all units are reported as a single segment.

eCommerce.  The  eCommerce  business  unit has  recently  announced  several new
contracts  with  Internet   Banks  to  provide  both   financial   services  and
Teknowledge's  new   multi-institution   account  aggregation   solution  called
TekPortal. The TekPortal solution enables institutions to provide a consolidated
view of their customers'  financial portfolio  seamlessly  integrated into their
own web site.  TekPortal  will act as an  authorized  agent of the  customer  to
access and consolidate account balance and transaction  information from various

<PAGE>
                                       4


institutions including banks, credit unions, brokerages,  credit card companies,
billing companies, and frequent travel reward sites. TekPortal also offers funds
transfers  services  between  multiple  institutions,   sweeps  capabilities  to
automatically move funds, and proactive notification services to alert customers
when  specific  events  occur on an account in their  portfolio.  The  TekPortal
solution has not gone  unnoticed by the financial  industry,  which is currently
undergoing a transformation under the  Gramm-Leach-Bliley  Act. This legislation
permits banks to offer a more complete set of banking,  brokerage, and insurance
services.  Teknowledge  believes that  financial  institution  customers will be
attracted by the  convenience of one-stop  shopping for managing their financial
portfolio,  and acquiring new products and services.  The TekPortal  solution is
uniquely  positioned to provide  financial  institutions  with the capability to
retain  customers  at their web site and then use that  opportunity  to sell new
products and services effectively.

         Teknowledge's   eCommerce   business  unit  provides   assessments  and
installations of Teknowledge's own Sales Associate  software,  along with one or
more leading commercial products. This provides license fees, services revenues,
and some pull-through  opportunities for selling Teknowledge's Internet security
and web-based training solutions. The Sales Associate is a software product that
provides  unassisted sales over the Internet.  It incorporates  rules of selling
and utilizes  specific  product  knowledge to emulate the best  practices of the
most  productive  sales  person in a firm.  The product  goes beyond the typical
browsing  interaction  on the World  Wide Web by  engaging  the  customer  in an
interactive dialog about products.  The Sales Associate creates a unique profile
of every  customer  and  tailors the sales  presentation  to each  prospect.  It
remembers a  customer's  profile  and  preferences,  and  applies all  available
information towards the next sale. The system can cater its presentation form to
match the user profile,  selecting among web text,  audio,  or 3D graphics.  The
Sales Associate incorporates both generic and domain-specific "rules of selling"
to guide the sales process. It matches a customer profile with the products in a
product   knowledge   base.  The  Sales  Associate   delivers   up-to-the-minute
information  on product  features and  availability,  as well as news of special
discounts and other promotions.  The product is designed for delivery with other
commercial components such as web servers,  databases,  firewalls, and other web
site component software. The Sales Associate is a technology-based  product in a
rapidly  growing,  but competitive  market.  There are  uncertainties  and risks
associated with the  introduction of any software product (see Part II, Item 6).
The  Company has  continued  to evolve  Sales  Associate  capabilities,  and may
specialize its knowledge base for financial services or other key markets.

Information  Assurance.  The need for information  security on computer networks
has created tremendous demand in both government and industry.  Keeping Internet
sites and transactions  secure from hackers and thieves is critical to effective
military and  eCommerce  operations.  Information  assurance  goes beyond simply
protecting information.  It is relatively easy to protect information if it does
not need to be  accessible.  However,  both military and  eCommerce  information
needs to be  accessible by people  globally,  seven days a week, 24 hours a day.
This  requirement  shifts  the focus  from  information  protection  to  assured
information  access to the appropriate  customers.  Techniques for accomplishing
information assurance,  such as authentication,  encryption,  and firewalls, are
constantly  evolving.  Teknowledge is the prime  contractor on a number of DARPA
sponsored projects focused on advanced techniques of Internet or cyber security,
including an associate  system for web site  intrusion  detection  and response.
There  are many 3rd  party  commercial  opportunities  in this  arena.  Some new
commercial products,  such as CheckPoint's firewall for web site security,  have
emerged as commercial market leaders.  Teknowledge has recently become certified
as a VAR to deliver  CheckPoint's  Firewall-1(TM)  product,  which  provides  an
opportunity  for product  license and services  sales to commercial  information
assurance applications.

Web-based  Training.  The  Internet  and the World  Wide Web have  created a new
opportunity for formerly  isolated desktop systems that provided  computer-aided
instruction. Not only have the techniques of computer-aided instruction improved
dramatically  in  recent  years,  but also the  means to  distribute  them  have
undergone  a  veritable  revolution.  Now it is  possible  to  provide  distance
learning via an interactive  course delivered  through a standard World Wide Web
browser.  There are major  opportunities to deliver in-house  corporate training
over  intranets,  K-12  education  over the  Internet,  and  just-in-time  adult
training on the job or in the home.  Teknowledge  has been involved in education
and  training  since 1981;  and,  in 1998,  it created a business  unit  devoted
entirely to this growing  opportunity.  Teknowledge served as the Cluster Leader
for the  U.S.'s  largest  multi-institution  project on  Intelligent  Tutors and
Associates  between 1995 and 1998.  The DARPA  Computer  Assisted  Education and
Training  Initiative  sponsored  Teknowledge's  prototype  work on the  Parent's
Associate and the Center  Associate.  The Parent's  Associate enabled parents to

<PAGE>
                                       5


get advice on parenting and access to Internet-based  educational resources. The
Center Associate provided a computer-based  coach to help guide users in getting
the most from education  resources  available to them.  Teknowledge is playing a
leading role in the Government  sponsored Advanced Distance Learning Initiative,
which is advancing  distance  learning  technology to provide cost effective and
industrial strength courseware over the Internet.  In 1998,  Teknowledge was one
of three prime contractors selected out of 51 teams in the National Institute of
Standards  and  Technology   (NIST)  Adaptive   Learning  Systems   competition.
Teknowledge was awarded a $2 million cost-sharing  contract for development of a
Courseware  Factory(TM)  for  converting  podium-based  traditional  courses for
delivery  over the World Wide Web.  This work has already  provided  several key
technology  results.  Teknowledge is also working on a Small Business Innovation
Research grant to provide advanced computer-based tutoring systems over the web.

Distributed  Systems.  Operations that are widely distributed  require extensive
object-oriented  systems  infrastructure  and the  ability to  extract  reliable
performance from distributed resources.  Currently,  the World Wide Web provides
little of this systems infrastructure, but instead relies on the distribution of
linked web pages or multimedia documents. In the future, complex webs of objects
and  knowledge   will  have  to  be  distributed   systematically   and  updated
dynamically.  This requires the ability to provide  reliable  quality of service
performance,  security  of  operations,  and  maintainability.  Distribution  of
knowledge  by  intelligent  "push" and "pull"  techniques  has already  become a
critical  technology.   In  addition,   the  types  and  quantity  of  knowledge
distributed  will require new designs and new software  specialized for specific
knowledge  processing  tasks.  Teknowledge's  Distributed  Systems business unit
focuses on providing new Internet systems infrastructure to address these needs.
It is a prime  contractor  on the  DARPA  sponsored  QUITE  project,  where  the
objective is to provide  innovative  solutions to the problem of optimizing  the
quality of service of distributed resources on a network.

Knowledge Systems.  Computer knowledge bases are much larger and more useful now
than they have been before.  A threshold has been reached where the power gained
from  applying  knowledge-based  technology  is much  greater  than in the past.
Techniques for creating large knowledge bases have advanced significantly.  Many
fundamental  problems of how to perform  efficient  inference on large knowledge
bases have been solved (although others remain). Many specialized techniques for
creating  and  applying  knowledge  have  matured.  The  potential  payoff  from
combining   elements  from  this  research   progress  into  useful  systems  is
considerable.  For  example,  complex  problem  solving  requires the ability to
access and  synthesize  data quickly and  effectively  from multiple  sources in
order to develop a dynamic assessment of an evolving  opportunity,  problem,  or
competitive  situation.  Decision-makers  have noticed that using  satellite and
World Wide Web information  systems is like "standing in front of an information
fire hose." It is hard to take a sip without  getting more  information  than is
useful or necessary.  Teknowledge's  Knowledge  Systems business unit focuses on
providing  knowledge-based  tools,  applications,   and  ontology  or  knowledge
structures.  It  is a  prime  contractor  on a  number  of  government-sponsored
programs,  and is participating in several  commercial  developments,  including
TekPortal, an embeddable version of Sales Associate,  and GlobalStake.com.  This
infrastructure may be used to address some situation  assessment and data fusion
problems effectively.  In addition, it can provide pragmatic problem solving and
web interface capabilities for financial services or other applications.

Sales and Marketing

         Teknowledge's   employees,   including  the  business  unit   managers,
dedicated sales staff, and the CEO, market and sell  Teknowledge's  services and
software.  Each business  unit offers  consulting  services to help  prospective
customers  define  their  problems  and  projects.   Consulting  assignments  in
eCommerce financial  services,  Internet security,  or web-based  training,  are
funded to evaluate  current  corporate  capabilities  and recommend  next steps,
including  application  work.  However,  Government  proposal work  conducted in
response to a Broad Area  Announcement  or Request for Proposal is typically not
funded.

         Teknowledge has increased its commercial sales and marketing efforts to
lay the  foundation  for increased  commercial  business.  In 1999,  the Company
continued  implementation of its VAR strategy.  It is now a Microsoft  Certified
Solution  Provider,  and a  CheckPoint  VAR  partner.  The  Company is  offering
value-added  services  for  leading  commercial  products  that  work  with  the
TekPortal  solution.  This should  provide  license and services  revenues,  and

<PAGE>
                                       6


broaden market  acceptance of Teknowledge's  products by increasing access to an
expanded  base of commercial  customers.  In addition,  Teknowledge  is actively
seeking  other VAR companies to sell  TekPortal,  and pull through the Company's
eCommerce, security, and training application solutions.

Backlog

         At December 31,  1999,  the expected  order  backlog was  approximately
$18.6  million,  which  consisted  of (i) new  orders for which work has not yet
begun and (ii) revenue  remaining to be recognized  on work in progress.  96% of
the December 31, 1999 backlog is from government customers. Approximately 90% of
the backlog consist of  government-sponsored  programs that are awarded, but not
yet  authorized  for  funding.  The  government  normally  funds a  contract  in
incremental amounts for the tasks that are currently in production.  The Company
recently  won a contract  with the  government  to  provided  Cyber  Command and
Control for mission  critical  systems that is scheduled to start in Q2 of 2000.
Backlog is an estimate  and is subject to a number of risks (see Part II Item 6.
Management's  Discussion & Analysis or Plan of Operation - Certain  Factors That
May Affect Future Results of Operations and/or Stock Price).  The portion of the
overall  backlog that is expected to be fulfilled in the current  fiscal year is
approximately 35%.

Research and Development

         Most of the Company's software engineering  operations,  except for the
eCommerce  business  unit,  and specific  Information  Assurance  and  Knowledge
Systems contracts were related to advanced government development projects. As a
result,  Teknowledge's considerable R&D activities were mostly funded externally
by the Federal Government. Generally, the Company retains the exclusive right to
market the government sponsored R&D commercially.  Teknowledge also sponsors its
own R&D, mostly in the form of  commercializing  the technology  developed under
its  government  contracts.  As the  Company  continues  to grow its  commercial
products and services business,  more internally  directed R&D is expected.  The
Company  expensed  $599,231  and  $132,501 of its own funds on R&D for the years
ended  December  31,  1999 and 1998,  respectively.  In  addition,  the  Company
capitalized  $131,517 and $267,046 of computer software development costs in the
years ended December 31, 1999 and 1998, respectively.

Competition

          A number of companies  provide  consulting  services and software that
compete with aspects of  Teknowledge's  business.  Many of these  companies  are
substantially  larger and have greater  financial  resources  than  Teknowledge.
Teknowledge's  primary  competitive  advantages are its  experienced  management
team, its technical talent base, its expertise in key application  areas such as
financial services,  its patent portfolio and other intellectual  property,  and
its unusually strong R&D program in several key Internet relevant areas.

         TekPortal is uniquely  positioned with respect to its main  competition
from  Yodlee,  VerticalOne,  and  OnMoney  that  have  historically  focused  on
providing off-premise,  centralized data center solutions. TekPortal provides an
on-premise  solution  that  allows the  financial  institution,  as the  trusted
provider,  to warehouse and manage access to the customer's  financial portfolio
information.  The  financial  institution  is  uniquely  positioned  to use  the
aggregated balance and transaction information,  with the customer's permission,
to  more  effectively  sell  relevant  products  and  services  directly  to its
customers.  In addition,  the TekPortal on-premise solution allows the financial
institution  to set  and  enforce  procedures  to  protect  the  privacy  of the
customer's financial information.

         Sales and  configuration  systems are  provided by Trilogy  Development
Group, Calico, Concentra, Selectica, Brightware, Baan, SAP, Oracle, PCorder.com,
and others.  Knowledge processing systems are provided by Logica Carnegie Group,
Inference Corp., Neuron Data Corp., Intellicorp,  Inc., and others.  Distributed
systems  and  information  assurance  services  are  provided  by  GTE,  Trusted
Information Systems, Secure Computing  Lockheed-Martin,  Boeing,  Perceptronics,
ISX, and SAIC,  among  others.  Internet-based  distance  education and training
technologies  include Click2Learn,  IBM, and KnowledgeNet,  with new competitors
still emerging in the commercial  marketplace.  Potential competitors could also
be  collaborators,  such as  Macromedia  (learning  components  sold to IBM) and

<PAGE>
                                       7


Click2Learn  (formerly  Asymetrix  Learning Systems),  Teknowledge's  technology
suppliers on the Courseware Factory project.

Proprietary Rights

         Teknowledge  maintains  an active  intellectual  property  program  and
currently holds nine U.S. software patents.  The application  software developed
by Teknowledge includes  TekPortal(TM) for financial information  consolidation,
Sales   Associate(TM)   for   configuring   automated  sales  on  the  Internet,
knowledge-based expert systems, pattern detection and data fusion tools, systems
to manage and protect webs of networked information,  and Automatic Retrieval of
Changed Files by a Network  Software  Agent.  As use of any product name becomes
consistent and established, the Company intends to apply for formal registration
of the product  name as a trademark in the United  States and  relevant  foreign
jurisdictions.

         Teknowledge  has relied on a combination  of patent,  copyright,  trade
secret and trademark  laws, as well as  contractual  provisions,  to protect its
proprietary technology. The Company has required employees,  customers, vendors,
and others  who have  access to  proprietary  technology  to sign  nondisclosure
agreements.  The Company retains a proprietary right to market commercially most
of the development that was sponsored by government agencies. The government may
not distribute proprietary  information that was developed by the Company to any
third party for commercial purposes without first receiving  permission from the
Company.

         Teknowledge   provides  its  software   products  to  end  users  under
non-exclusive,  non-transferable  licenses that  typically have a perpetual term
unless  terminated  for  breach.  The  Company  protects  the source code of its
software   products  as  trade  secrets  and  unpublished   copyrighted   works.
Additionally, Teknowledge holds patents for the knowledge processing and systems
engineering  technologies  that  form the  basis  for many of the  products  and
configuration services that the Company markets.

         There can be no assurance that Teknowledge's  protective  measures will
be adequate to protect its proprietary  rights, that others have not or will not
independently develop or acquire equivalent or superior technology,  or that the
Company  will not be  required to obtain  royalty-bearing  licenses to use other
intellectual  property  in order  to  utilize  the  inventions  embodied  in its
patents. There also can be no assurance that any patents will be issued pursuant
to the Company's  current or future patent  applications  or that patents issued
pursuant to such applications or any patents the Company currently owns will not
be invalidated,  circumvented or challenged.  Thus far, Teknowledge has not been
notified that it may be infringing  any patents or  proprietary  rights owned by
third parties. There can be no assurance that the Company would be able to enter
into an  acceptable  license  under such third  party  patent,  or that it could
redesign or modify its products  and  processes  to avoid  infringement  of such
patent  or  proprietary  rights,  or that  the  Company  could  otherwise  avoid
infringement of such patent or proprietary  rights.  In the event the Company is
unable to take such action,  its  business,  financial  condition and results of
operations could be materially and adversely affected. In some cases, litigation
may be necessary to protect the Company's proprietary rights (see Part 1 Item 3.
Legal Proceedings).

Government Contracts

         In  1999,  approximately  85%  of  the  Company's  revenues  were  from
cost-type  government  contracts,  and 96% of its  December 31, 1999 backlog was
from  government  contracts.  The  Company's  business has been  dependent  upon
successful bidding for government  contracts.  The Company applies for contracts
in the form of a proposal by  responding  to Requests  for  Proposals  and Broad
Agency  Announcements issued by the United States Federal Government or by prime
contractors  under  contract  to  the  Federal  Government.   Proposals  include
discussion of the technical  approach to be taken to satisfy the government's or
the  prime  contractor's  requirements  and a  detailed  presentation  of  costs
expected to be incurred. The proposal is reviewed and evaluated by technical and
administrative personnel employed by the government or the prime contractor.  If
the  procurement  method is  "competitive  bid",  the contract is awarded to the
company  which would best  satisfy the  government's  or the prime  contractor's
requirements.  If the procurement method was "negotiated  award," the government
or the prime contractor  would enter into  negotiations to determine a price for
the contract; upon successful conclusion of negotiations, a contract is awarded.
Government  contracts  contain  termination   clauses,   which  permit  contract

<PAGE>
                                       8


termination  upon  the  Company's  default  or at the  government's  discretion.
Government  contracts are subject to agency funding  limitations,  congressional
appropriation, and the agenda of the current administration in Washington, D.C.

         The typical cost-type  government contract performed by the Company has
a regulated  fixed fee limit,  which inhibits the Company from improving  profit
margins on  government  contracts  beyond what is  permitted  in the  government
regulations.   In  addition,   Federal  Acquisition   Regulations  exclude  from
reimbursement some  "unallowable"  expenses that the Company considers a regular
part of the business.  Furthermore,  almost all the Company's  contracts contain
termination clauses that permit contract  termination upon the Company's default
or at the contracting party's discretion.  During 1998, DARPA terminated several
of its own  projects  due to a  change  in its  program  priorities.  Since  the
terminations involve some of Teknowledge's  multi-year  projects,  the effect on
revenue is spread over approximately  three years. This resulted in a decline in
revenues  on some  government  contracts,  which  was only  partially  offset by
increases in commercial revenues later in the year. Such cancellations may occur
again in the future.  The Company  intends to build its  substantial  multi-year
backlog  further with  additional  proposals for new  government  and commercial
projects.

         The  indirect  costs and expenses  accumulated  in the  performance  of
government  contracts  are  allocated  to the  customer  in the form of overhead
(indirect)  rates.  These rates,  which are periodically  reviewed by government
auditors,  fluctuate  based on the  relationship  between the overhead costs and
direct  costs  incurred in the  performance  of the  contracts  during the year.
Excluded from these rates, and not subject to reimbursement,  are a small amount
of unallowable  costs, such as entertainment and advertising.  In addition,  the
government has  established  compensation  limits for employees  which expressly
reduces the amount of  compensation  and related  expenses,  such as bonuses and
stock  options,  that can be passed on to the  government  through the  overhead
rates.  In recent years,  the Company has  experienced a gradual  decline in the
fees on new  government  contracts due to government  cost saving  efforts.  New
contracts may not suffer this fee erosion;  however,  the overall  limitation on
potential  government  contract  fees coupled  with a potential  increase in the
expenses  not  eligible for  reimbursement,  combine to restrict  the  Company's
ability to improve  profit  margins on government  contracts in the future.  The
Company's  government-sponsored  R&D is most valuable as a technology incubator,
development laboratory,  and testbed. The best software from this work becomes a
candidate  for software  product  commercialization.  This helps the  government
amortize the considerable cost of maintenance,  and it provides Teknowledge with
the opportunity to compete in a growing commercial marketplace.

Employees

         Teknowledge had a total of 51 full time employees at December 31, 1999.
All the employees were employed in the continental  United States.  The majority
of employees are technical.  They perform  direct  billable work on contracts or
develop  and support  software  products.  In  addition to full time  employees,
Teknowledge revenues reflect several  subcontractor  companies,  and independent
contractors  working on specific  projects.  A large  percentage of  Teknowledge
employees, including management, hold advanced degrees in technical disciplines.
The future success of the Company will depend, in part, on the Company's ability
to  continue  to retain,  attract,  and  motivate  highly  qualified  technical,
marketing,  and management personnel.  This has become a particular challenge as
increasing  demand for top quality software  professionals  has exceeded supply.
Teknowledge provides competitive salaries and bonuses, an active Incentive Stock
Option program, a superior benefits program, and a stimulating work environment.
The  Company  has  never  had a work  stoppage,  and it is  not a  party  to any
collective bargaining agreement with any of its employees.

Executive Officers

         Neil A.  Jacobstein,  45, is  Chairman  of the Board,  Chief  Executive
Officer,  and  President  of  Teknowledge.  He  served  as  President  and Chief
Operating  Officer and a director  of the Company  since  January  1993.  He was
elected to the position of Chairman and CEO on November 22, 1999.  After joining
Teknowledge  in 1984,  Mr.  Jacobstein  was promoted over a nine year period to:
Senior  Knowledge  Engineer,  Manager of the Research  and Advanced  Development
Group,  Vice  President  and General  Manager of Research and  Advanced  Systems
Development,  and Vice  President and General  Manager of the Knowledge  Systems

<PAGE>
                                       9


Division.  Mr. Jacobstein  initiated  Teknowledge's  eCommerce  business unit in
1996.  In 1998, he was appointed to the  Technology  Advisory  Board of the U.S.
Army's Simulation,  Training,  and Instrumentation  Command (STRICOM).  Prior to
joining  Teknowledge,   Mr.  Jacobstein  was  a  Graduate  Research  Intern  and
consultant at Xerox PARC, and a Research  Associate at CBNS.  Since 1992; he has
served as the Chairman of the Board of Directors of the  Institute for Molecular
Manufacturing,  a nonprofit organization. He co-founded and serves as a Director
of GlobalStake.com.  In 1999, Mr. Jacobstein was elected a Henry Crown Fellow in
the Aspen Institute's executive leadership program.

         Dennis A. Bugbee, 53, is Director of Finance,  Treasurer, and Secretary
of the Company. Mr. Bugbee joined the Company in 1990 as the Division Controller
for the Knowledge Systems Division in Palo Alto, California.  He was promoted to
Director of Finance  March 1, 1993 and shortly  thereafter  to the  positions of
Treasurer and Corporate Secretary. Prior to joining the Company, Mr. Bugbee held
the position of Accounting  Manager with TRW's Space and Defense Sector.  He has
over 25 years experience in finance and accounting.

         Benedict  O'Mahoney,  40, is Vice President,  Administration  and Legal
Affairs of the Company.  Mr.  O'Mahoney was elected a Director of Teknowledge in
December 1999. Mr.  O'Mahoney  joined the Company in 1996 as Corporate  Counsel.
Prior to joining Teknowledge,  Mr. O'Mahoney practiced intellectual property law
from 1991, and served as General  Counsel for Slatt Mortgage  Company from 1988.
He served with the Federal  Reserve Bank of San Francisco from 1985 to 1988. Mr.
O'Mahoney also serves on the Board of Directors of the Virtual Reality Education
Foundation, a nonprofit organization.

Item 2.  Description of Property

         The Company's  executive  offices are located at 1810 Embarcadero Road,
Palo  Alto,  California,  under a lease for a period of three  years  commencing
April 5, 1999, with an option to extend the lease for an additional three years.
The Company has also signed  renewable  leases for office space in Arlington and
Fairfax, Virginia; and San Diego, California.

Item 3.  Legal Proceedings

         In 1999 Teknowledge offered to sell SAP a license to use the technology
related  to  Teknowledge's   Intelligent   Configuration  Patent  Portfolio,   a
collection of five patents  relating to  configuration  technologies,  including
Teknowledge's configuration systems patent, Bennett et al. U.S. Patent 4,591,983
(the "'983 patent"). In response to this offer, on October 8, 1999, SAP America,
Inc. and SAP  Aktiengesellschaft  (collectively,  "SAP") filed a lawsuit against
the Company in the United  States  District  Court for the District of Delaware.
The subject  matter of the case  involves the '983 patent and the  configuration
technology  associated with the SAP R/3 System ("R/3 System").  SAP is seeking a
judgment  against  Teknowledge  that  the  `983  patent  is  invalid  and is not
infringed by the R/3 System; an award of attorney fees, costs of suit, and other
relief the court may deem just and proper.

         On October 21, 1999  Teknowledge  filed a counterclaim  against SAP for
patent  infringement  of two of its patents.  The subject of the counter suit is
the `983  patent  entitled  "Hierarchical  Knowledge  System"  and  U.S.  Patent
4,783,752  entitled  "Knowledge Based Processing for Application  Programs Using
Conventional  Data  Processing  Capabilities."  The  management  of the  Company
considers  the suit brought by SAP to be without merit and intends to defend its
patents  vigorously.  Management  believes the ultimate  resolution of the above
matters may have a positive impact, and will not have an adverse material impact
on the Company's financial position and results of operations.

Item 4.  Submission of Matters to a Vote of Security Holders

         No matters  were  submitted  to a vote of security  holders  during the
fourth quarter of 1999.







<PAGE>
                                       10





                                     PART II

--------------------------------------------------------------------------------

Item 5.  Market for Common Equity and Related Stockholder Matters

         The Common Stock of Teknowledge  has been trading under the symbol TEKC
on the Nasdaq  SmallCap  Market  since  March 5, 1999.  Before  this date it was
traded  under  the same  symbol on the  "Bulletin  Board",  an  over-the-counter
("OTC") listing service provided by the National  Quotation Bureau. On March 28,
2000 the closing "bid" price of the stock was $11.88 a share.

          The  Company  has  effected  a  one-for-five  reverse  stock  split on
December 22, 1998. The following  table sets forth the range of high and low bid
information  for the Common  Stock on the OTC Bulletin  Board for the  quarterly
periods indicated, adjusted for the effect of the reverse stock split. All share
and per share data has been retroactively  restated to reflect the effect of the
reverse stock split. The bid information reflects  inter-dealer prices,  without
retail   mark-up,   markdown  or  commission   and  may  not  represent   actual
transactions. The Company has never paid dividends on its capital stock.

                    1999                            High               Low

    First quarter, ended March 31, 1999           $ 6.88            $ 4.50
    Second quarter, ended June 30, 1999             5.94              3.88
    Third quarter, ended September 30, 1999         5.66              4.00
    Fourth quarter, ended December 31, 1999         5.13              3.47


                    1998                            High               Low

    First quarter, ended March 31, 1998           $ 4.70            $ 2.30
    Second quarter, ended June 30, 1998            11.00              4.40
    Third quarter, ended September 30, 1998         8.45              2.50
    Fourth quarter, ended December 31, 1998         6.75              2.15

         As of December  31,  1999 there were 1,666  holders of record of Common
Stock of the Company.




<PAGE>
                                       11





Item 6.  Management's Discussion and Analysis or Plan of Operation

Overview of Significant Matters

         Forward looking statements made in this report relate to the demand for
technical  employees,   expected  revenue  growth,   realizability  of  backlog,
competition for new government contracts, development of commercial products and
services, deferred tax assets, receivables and collections, and the viability of
a  strategic  start  up.  All  forward  looking  statements  involve  risks  and
uncertainties,  and actual results could differ  materially from those set forth
in the forward looking  statements  contained herein as a result of competition,
agency funding  limitations,  other factors relating to government  contracting,
ability to attract and retain  technical and  management  personnel,  commercial
opportunities,  financing,  and other factors described in "Certain Factors That
May Affect Future Results of Operations and/or Stock Price."

                          Year Ended December 31, 1999
                            Quarterly Results Summary
                    (In thousands, except for per share data)

                               First    Second    Third    Fourth     Total
Revenues                      $2,790    $2,777   $2,901    $2,627   $11,095
Costs and Expenses             2,563     2,573    2,820     2,615    10,571
Other and Tax Provision           75        65       29       (29)      140
Net Income                       152       139       52        41       384
Diluted Net Income per share     .03       .02      .01       .01       .07

         Teknowledge   revenue  for  the  year  ended   December  31,  1999  was
$11,094,672 and net income was $383,539, or 3.5% of revenues.  Approximately 85%
of the revenues were from agencies of the Federal  Government and the balance of
15% was from  eCommerce  services and products.  While  government  revenues are
still a substantial  part of the revenue base, they declined  overall about $2.6
million from 1998's level.  Late in 1998, the government  initiated a cutback on
some DARPA  programs that started to have an effect on  Teknowledge  revenues in
early  1999.  In  response  to these  cutbacks,  the  Company  allowed  employee
headcount to decline by attrition until new contracts were awarded. In the third
quarter of 1999,  the Company  recruited  Rodney  Robinson to head the eCommerce
business  unit.  The  eCommerce  unit was  successful  in  securing  several new
contracts in Q3 and eCommerce  revenues  have  improved in successive  quarters,
accounting  for over 29% of the  revenues in fourth  quarter 1999 and 15% of the
total revenues in 1999.  This is in sharp  contrast to the eCommerce  revenue in
1998,  which totaled less than 1% of revenues for the entire year. If this trend
continues,  the  contribution  of eCommerce  products and services could surpass
government revenues in 2000.

         Teknowledge  expects  to  continue  to  be  an  active  competitor  for
government  sponsored  R&D  projects  in the  future.  Almost 96% of the current
backlog of over $18,000,000 is for government  sponsored R&D contracts.  Some of
the government  contract  related backlog is associated  with services  provided
over several years. As long as the government continues to solicit R&D contracts
in areas that favor Teknowledge's  expertise and strategic technical  directions
in areas such as Internet security,  distributed systems, web-based training, or
knowledge systems,  the Company will actively pursue these  opportunities.  This
R&D work may lead to new patents,  software solutions,  services expertise, or a
foundation for innovative commercial Internet products.

         Teknowledge's commercial business is growing faster than the government
business,  and it is likely that  commercial  revenues  will  exceed  government
revenues in coming years.  Commercial  revenues were approximately 29% of fourth
quarter  1999  revenues  compared to less than 1% in the  comparable  quarter of
1998.  Generally,  the net  margin on the  government  business  is  limited  by
government negotiated and regulated fee arrangements.  Fees rarely exceed 8% and
are  often  much  less  because  of  predetermined  limits  and cost  exclusions
contained in the government regulations.  Commercial margins, on the other hand,
are not constrained by government regulations and are potentially more lucrative
in the long run.  Because the eCommerce  unit is  relatively  new, it has yet to
achieve its potential margins.  The Company  experienced slow payments from some
commercial vendors in 1999 and elected not to record  approximately  $275,000 of
potential net revenues  pending the final outcome of the collection  matter.  If

<PAGE>
                                       12


the  arbitration is successful,  the Company will report  additional  revenue in
2000.  The Company  believes the risk of default is greater with new  commercial
businesses;   therefore,   Teknowledge  plans  to  substantially   increase  its
anticipated bad debt reserves in 2000.

         In November  1999,  Teknowledge  agreed to provide seed money for a new
web-based  real  estate  Company,  GlobalStake.com,  which  was  spun  off  from
Teknowledge Corporation.  GlobalStake.com will provide full service,  discounted
real estate  transactions under the  ExploreRealty.com  trade name.  Teknowledge
retained  19.9% of  GlobalStake.com  consisting  of Series A  Preferred  shares.
Teknowledge  currently  maintains  this  percentage  interest  against  dilution
through a warrant to acquire Common Stock until an IPO or acquisition,  and also
has  an  aggregate  liquidation  preference  over  common  shares.  As  long  as
Teknowledge owns less than 20% of GlobalStake.com,  the Company will account for
the investment in GlobalStake.com using the cost method.  Teknowledge expects to
provide: (1) approximately $1,200,000 in cumulative seed cash and services; (2)
the  proprietary   information  and  technology  developed  in  support  of  the
GlobalStake.com business plan; and (3) licenses to practice Teknowledge's patent
portfolio.  Former Chairman and CEO of Teknowledge,  Rick  Hayes-Roth,  resigned
from his  position of CEO and  Director of the Company and was elected  Chairman
and  CEO of  GlobalStake.com.  Neil  Jacobstein  was  elected  to  serve  on the
GlobalStake.com Board of Directors.

         In 1997 the  Company  recorded a deferred  tax asset of  $900,000  that
represented  the more likely than not expected tax savings which may be realized
from  its  net  operating  loss  carryforwards   generated   subsequent  to  the
quasi-reorganization.  The Company evaluates its earnings prospects in revolving
two-year cycles  annually,  to determine if adjustment to the deferred tax asset
balance is  necessary.  No  adjustment  was deemed  necessary for the year ended
December 31, 1999 as a result of this evaluation.

Certain Factors That May Affect Future Results of Operations and/or Stock Price

         Management  believes  that  the  market  for  TekPortal  software  is a
significant  new  opportunity  for the Company and that its  eCommerce  services
business will expand  rapidly.  The market for Internet  software,  however,  is
rapidly  evolving,  and characterized by an increasing number of market entrants
who have introduced or are developing  competing software products and services.
As is  typical  for a new and  rapidly  evolving  industry,  demand  and  market
acceptance for recently  introduced  products and services are subject to a high
level of  uncertainty.  In spite of this,  the stock  market for  eCommerce  and
Internet  companies  has  experienced  a large wave of  speculative  investment.
Further,  aspects of the Internet  (including  security,  privacy,  reliability,
cost, ease of use, and quality of services) are undergoing  rapid evolution that
may  affect  the  use of the  Internet  in  general,  and  Internet  information
aggregation software in particular.  In addition, for new dot.com customers, the
Company is exposed to a higher risk of bad debt and slower collections, compared
to reliable government customers. The demand for some new Internet software will
depend  upon  broad  acceptance  of  new  methods  of  conducting  business  and
exchanging  information over the Internet.  The demand for products developed by
the Company  cannot be  determined,  nor can the viability of these  products be
determined at this time due to the explosive  growth and  competitive  nature of
the market.  As the market  continues to change,  there can be no assurance that
the Company will be able to recruit or retain the technical staff to develop and
bring  to  market  products  that  will  gain  market   acceptance  or  generate
significant  revenue or profits.  If the  TekPortal(TM) or other product markets
develops more slowly than expected,  becomes saturated with  competitors,  or if
the Company's products do not achieve market acceptance, the Company's business,
financial  condition,  and results of operations may be materially and adversely
affected.

         Teknowledge  plans to grow its business by investing in  TekPortal(TM),
and by expanding into additional product or service offerings.  This may require
significant   additional   expense  and  could  strain  technical,   management,
financial,  and operational resources.  New competitors can enter the market for
TekPortal(TM) and other Internet solutions business. The Company's gross margins
in new business areas may be lower than in existing business activities,  and it
may not be able to expand or maintain  operations in a cost-effective  or timely
manner.  If a number of  customers  do not  receive  new  products  or  services
favorably, it could hurt the Company's reputation and delay future expansion.


<PAGE>
                                       13


        The  majority  of   Teknowledge's   service  revenue  is  derived  from
government R&D contracts,  and the Company has  historically  been profitable in
that business.  However, dependence on government contracts can be risky because
the  contracts  are  subject  to  administrative,   legislative,  and  political
interruptions, which may jeopardize the flow of funds. There can be no assurance
that the  government  will continue to seek services at the current level in the
future.  Another uncertainty is that the Company's revenues,  costs and earnings
on government contracts are determined based on estimated overhead rates derived
from  forecasted  annual  costs.  The Company's  actual  experience in headcount
growth,  billable  efficiency,  and costs may vary from  original  estimates and
necessitate   periodic   adjustments  to  overhead  rates  and  revenues.   Such
adjustments  are made on a cumulative  basis whereby the  resulting  revenue and
income effects are recognized in the period of the adjustments.

         The typical cost-type  government contract performed by the Company has
a regulated  fixed fee limit,  which inhibits the Company from improving  profit
margins  beyond what is permitted in the  government  regulations.  In addition,
Federal  Acquisition  Regulations  exclude from reimbursement some "unallowable"
expenses,   which  the  Company  considers  a  regular  part  of  the  business.
Furthermore,  almost all the Company's  contracts contain  termination  clauses,
which  permit  contract  termination  upon  the  Company's  default  or  at  the
contracting party's discretion.

         Another  uncertainty in providing  services is the Company's ability to
attract and retain sufficient technical staff to meet the demands of new orders.
The Company recognizes that the loss of one or more key management and technical
personnel could adversely affect aspects of the Company's business.  The Company
relies on its  executives  and business  unit managers for the  acquisition  and
negotiation of new business,  the  management of services  contracts and product
development,  and the management of on-going  operations.  The Company  believes
that its future  success  depends on  attracting  and retaining  highly  skilled
technical personnel and other employees.

         In  summary,  the  Company's  operating  results  and  stock  price are
affected by a wide variety of factors, including successful commercialization of
the Company's products, government intervention,  competition, ability to staff,
retain,  and recruit  key  employees,  financing  and  collections,  and general
economic and market conditions.


Results of Operations

         1999 compared to 1998

         Revenues  in 1999 were  $11,094,672  compared to  $12,200,849  in 1998.
Government revenues were $9,471,449, or 85% of total revenue, compared to 99% of
revenue in 1998.  Government revenues fell in 1999 by approximately $2.6 million
over the previous year because of  government  initiated  funding  reductions in
certain  DARPA  programs  that began in late  1998.  As a  consequence  of these
reductions  and the  scheduled  completion  of some task orders,  not all of the
project  overhead  costs  were  absorbed  into  revenue in 1999.  Revenues  from
commercial  enterprises  rose  to  $1,623,223,  or  approximately  15% of  total
revenues,  in 1999.  Commercial  revenue  improved  to 29% of revenues in fourth
quarter  1999.  The Company  experienced  some slow  payments  from  vendors and
elected not to record about $275,000 of net revenues at year-end,  pending final
resolution of the collection  matter.  A favorable  outcome from the arbitration
will have a positive impact on 2000's results.  The Company  believes the demand
for  government  services  may grow  slowly in 2000;  however,  the  demand  for
eCommerce related services is expected to grow rapidly. The Company is currently
seeking  new  employees  to  fill  technical  openings  in both  areas.  A large
proportion of the technical support base for eCommerce operations is provided by
outside  consultants and it is anticipated  that this trend will continue in the
future. The use of outside consultants allows the company to expand or constrict
its operations quickly both inside and outside the U.S.

         The Company typically recognizes revenue from commercial contracts on a
percentage of completion basis. This may result in timing difference between the
amount of revenue  recognized  on an accrual  basis vs. the amount billed in the
customer  invoice,  which  is  subject  to  separate  determination  based on an
analysis of certain  deliverables  and  milestones.  The difference  between the
revenue recognized on a percentage of completion basis and the amount billed the

<PAGE>
                                       14


customer is recorded in account receivable as unbilled receivables.  At December
31,  1999,  approximately  60%  of  unbilled  receivables  were  for  commercial
contracts and 40% for government  contracts.  Subsequent to year-end close, most
of the government  unbilled  receivables and a substantial  amount of commercial
receivables were billed to customers.

         Cost of revenues decreased 14% to $7,049,550 in 1999 from $8,244,290 in
1998.  The decrease was mostly  attributable  to the  aforementioned  decline in
government contracting and an increase in company-sponsored R&D investment. Cost
of revenues in 1999 was 64% of revenues as compared to 68% in 1998.  The Company
has decided to increase its bad debt reserves for eCommerce contracts in 2000 to
approximately 5% of estimated sales as a consequence of its experience with some
customers in 1999.

         General and administrative costs were $2,410,001 and $2,373,789 in 1999
and 1998, respectively. The Company experienced cost increases related to office
rents,  salary and fringe  expenses,  legal and accounting  costs, and insurance
fees. Overall,  general and administrative  costs were relatively stable between
years.  General  and  administrative  costs rose to 22% of  revenue in 1999,  as
compared to 19% of revenues in 1998.

         Sales and marketing  costs fell $258,871 to $512,040 in 1999,  compared
to $764,911  in 1998.  During the first half of 1999,  the Company was  actively
recruiting for an eCommerce manager.  The new manager was hired in third quarter
1999,  new  commercial  customers  were  developed,  and a  technical  team  was
assembled to do the work.  Most of the costs  incurred  for sales and  marketing
were incurred in the last half of 1999,  accounting for the drop in expenditures
between  comparable  periods.  The Company's sales and marketing efforts include
applications engineering and technical support, direct sales efforts, as well as
trade shows, demonstrations, and other traditional marketing activities.

         The  Company  expended  $599,231  on  internally  funded  research  and
development  ("R&D") in 1999 and $132,501 in 1998. The Company  concentrates  in
the  development  of  commercial  products for the  Internet,  which it hopes to
introduce as new products in the future. In special circumstances with strategic
value,  the  Company  may  accept  partial  funding  of R&D  efforts  from other
government  agencies,  e.g., NIST, to fund some of its R&D efforts.  The Company
has a two-year commitment to provide cost sharing on the NIST Courseware Factory
project at  approximately  the same level as 1999. The NIST contract  started in
late 1998.  The Company  expects to maintain or expand R&D  expenditures  for at
least the next two years.  The majority of the  Company's R&D  expenditures  are
funded  externally  through  government   projects  (and  recorded  as  cost  of
revenues),  which are  expected  to  provide  new  technology  and  intellectual
property.  The  Company  also  capitalized  $185,460  and  $267,046  of computer
software  development  costs in the  years  ended  December  31,  1999 and 1998,
respectively.

         Interest  income was  $112,637  in 1999 versus  $102,945  in 1998.  The
increase was primarily due to increased  cash  balances  during the year.  Other
income and expense increased to $2,744 in 1999 from $2,065 in 1998.

         The Company has  reflected,  as a reduction to the provision for income
taxes,  the  benefit  from tax losses  generated  subsequent  to the date of the
quasi-reorganization  in 1992. As of December 31, 1999, the Company has utilized
essentially   all  tax  losses   generated   subsequent   to  the  date  of  the
quasi-reorganization. Any subsequent realization of tax benefits existing at the
date  of  the  quasi-reorganization,  will  be  recorded  as  an  adjustment  to
additional paid-in-capital.  Accordingly, the Company expects that its provision
for income taxes and its  effective  income tax rate for book  purposes  will be
approximately 40% in 1999;  however,  the cash liability for income taxes is not
expected to change as a result of the  utilization of tax losses existing at the
date of the  quasi-reorganization  nor is there expected to be any material cash
outlays from the current tax period (see Notes 1 and 6 of Notes to  Consolidated
Financial Statements).

         In 1999,  Teknowledge's  net  income  was  $383,539,  or $0.07  diluted
earnings per share;  and was $785,620,  or $0.14 diluted  earnings per share for
1998. The 1998 net income reflected a much lower tax rate.  Although the Company
still has large tax loss carryforward  credit,  it has utilized  essentially all
tax losses  generated  subsequent to the 1992  quasi-reorganization.  Commencing
1999, the company has increased its effective tax rate for reporting purposes to
40% of taxable  income.  This change is  reflected  as a  reduction  in the 1999
financial results.  As a result of the change in tax reporting  treatment,  1999
net income was reduced by  approximately  $250,000 over the  comparable  period.

<PAGE>
                                       15


However,  because  of the  large  tax loss  credits  remaining,  this was only a
reporting change, and there was no cash impact to the Company.

Liquidity and Capital Resources

         As of December  31,  1999,  unused  sources of liquidity of the Company
were  $1,951,393 in cash and cash  equivalents,  a decrease of $426,997 over the
previous  year.  The  Company  generated  cash of  $226,770  from its  operating
activities  and $174,326 from  issuance of common stock to employees  exercising
their stock options.  It invested $185,460 for developing  capitalized  software
and $139,373 for  purchases of computer  equipment and other  improvements.  The
Company  expended  $291,494 to  repurchase  company stock in the open market and
invested $211,766 in GlobalStake.com as of the end of 1999.

         The  Company   believes  that  the  present  level  of  cash  and  cash
equivalents  and  borrowing  capacity  is  adequate  to  service  the  Company's
short-term  liquidity needs in 2000. The Company is  contractually  committed to
provide approximately $1,000,000 of seed money to GlobalStake.com in 2000. It is
anticipated  that this  requirement will be spread over a period of at least six
months in approximately  equal  increments;  however,  there can be no assurance
that the cash  requirements of  GlobalStake.com  will be incurred in the planned
increments. Given this uncertainty,  coupled with expanding cash requirements of
the eCommerce business unit, it is possible that the Company will have to borrow
on its line of credit to provide a  supplemental  level of cash  reserves in the
first half of 2000.

         The  Company  has  an  unsecured   line  of  credit  from  a  financial
institution in the amount of $2,000,000.  The Company may borrow up to the lower
of 60% of the receivable base or $2,000,000 at a rate of one percent over Prime.
The line is subject to certain covenants and maintenance  requirements that have
been fulfilled.  The line expires in December 2000 and is renewable. The Company
did not utilize the credit line in 1999.

Recent Accounting Pronouncements

         In June 1998, the Financial  Accounting Standards Board issued SFAS No.
133,  "Accounting  for Derivative  Instruments  and Hedging  Activities",  which
requires companies to value derivative  financial  instruments,  including those
used for hedging foreign  currency  exposures,  at current market value with the
impact of any change in market  value  being  charged  against  earnings in each
period. In June 1999, the Financial  Accounting  Standards Board issued SFAS No.
137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective  Date of SFAS No. 133" to defer the effective date of SFAS No. 133
until fiscal years  beginning  after June 15, 2000. To date, the Company has not
entered into any derivative  financial  instrument  contracts.  Thus the Company
anticipates  that  SFAS  No.  133  will  not  have  a  material  impact  on  its
consolidated financial statements.

         In December 1999, the Securities and Exchange  Commission  issued Staff
Accounting Bulletin (SAB) No. 101 "Revenue Recognition in Financial Statements".
SAB 101 provides guidance on applying generally accepted  accounting  principles
to revenue recognition issues in financial statements.  We will adopt SAB 101 as
required in the second quarter of 2000. We do not expect the adoption of SAB 101
to  have a  material  impact  on our  consolidated  results  of  operations  and
financial position.

Item 7.  Financial Statements

         The  response to this item is  incorporated  by reference in a separate
section of this report. See Exhibits,  Financial Statement Schedules and Reports
on Form 8-K, Item 13(a)(1) and (2).

Item 8.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure

         Not applicable.




<PAGE>
                                       16





                                    PART III
--------------------------------------------------------------------------------

Item 9.  Directors, Executive Officers, Promoters and Control Persons;
         Compliance with Section 15(a) of the Exchange Act

           The information required by Item 9 regarding directors of the Company
is  incorporated  herein by  reference  to the  sections  entitled  "Election of
Directors"  included in the  definitive  proxy  statement for the Company's 2000
Annual  Meeting of  Stockholders  (the "2000 Annual  Meeting Proxy  Statement").
Information regarding executive officers is included in Part I under the heading
"Executive  Officers".  Information  required  by Rule  405 is  incorporated  by
reference  to  Section   entitled   "Compliance  with  Section  16(b)  reporting
requirements" in the 2000 Annual Meeting Proxy Statement.

Item 10.   Executive Compensation

           The  information  required  by  Item  10 is  incorporated  herein  by
reference to the section entitled "Executive Compensation and Other Matters" and
"Proposal  1:  Election of Directors - Directors  Compensation"  included in the
2000 Annual Meeting Proxy Statement.

Item 11.   Security Ownership of Certain Beneficial Owners and Management

           The  information  required  by  Item  11 is  incorporated  herein  by
reference  to the section  entitled  "Security  Ownership"  included in the 2000
Annual Meeting Proxy Statement.

Item 12.   Certain Relationships and Related Transactions

           The  information  required  by  Item  12 is  incorporated  herein  by
reference to the section entitled "Certain Relationships and Other Transactions"
included in the 2000 Annual Meeting Proxy Statement.

Item 13.   Exhibits and Reports on Form 8-K

(a)(1) and (2): Financial Statements and Financial Statement Schedules

           Reference is made to the Index to Financial  Statements preceding the
consolidated  financial  statements  included  in response to Part II, Item 7 of
this annual report for a list of all financial statements filed.

(a)(3):  Exhibits

           Set  forth  below  is a  list  of  all  exhibits  filed  herewith  or
incorporated by reference as part of this Annual Report on Form 10-KSB.

Exhibit No.                  Description

        3.1        Amended and Restated Certificate of Incorporation of
                   Teknowledge Corporation (4)

        3.2        Amended and Restated Bylaws of Teknowledge Corporation (4)

        3.3        Certificate of Designation, Preferences and Rights of the
                   Terms of the Series A Preferred Stock (2)

        4.1        Rights Agreement dated January 29, 1996 between the Company
                   and Registrar and Transfer  Company as Rights Agent (2)

       10.1        Stock  Option  Agreement  between the  Company and  Frederick
                   Hayes-Roth, dated November 29, 1993 (5)


<PAGE>
                                       17


Exhibit No.                Description

       10.2        Stock   Option   Agreement   between  the  Company  and  Neil
                   Jacobstein, dated November 29, 1993 (5)

       10.3        Stock  Option  Agreement  between the  Company and  Frederick
                   Hayes-Roth, dated April 1, 1994 (5)

       10.4        Stock   Option   Agreement   between  the  Company  and  Neil
                   Jacobstein, dated April 1, 1994 (5)

       10.5        Change of Control Agreement, dated November 21, 1994, between
                   the Company and Frederick Hayes-Roth and Neil Jacobstein (1)

       10.6        Stock  Option  Agreement  between the  Company and  Frederick
                   Hayes-Roth, dated March 30, 1995 (5)

       10.7        Stock Option Agreement between the Company and Neil
                   Jacobstein, dated March 30, 1995 (5)

       10.8        Teknowledge Corporation 1998 Stock Option Plan (3)

       10.9        Executive Compensation Plan, adopted by resolution of the
                   Company's Compensation Committee, dated November 22, 1999

       10.10       Contract Agreement with GlobalStake.com, dated
                   November 22, 199

       23.1        Consent of Arthur Andersen LLP, independent public
                   accountants

       27          Financial Data Schedule

References

     (1)      Filed as an Exhibit to the Company's Annual Report on Form 10-KSB,
              for the fiscal year ended December 31, 1994.

     (2)      Filed as an Exhibit to the  Company's  Current  Report on Form 8-K
              dated  February  12,  1996,  related  to the  adoption  of a 12(g)
              Shareholder Rights Agreement dated January 29, 1996.

     (3)      Filed as an  Exhibit  to the  Company's  Quarterly  Report on Form
              10-QSB, for the quarter ended June 30, 1998.

     (4)      Filed as an Exhibit to the Company's Annual Report on Form 10-KSB,
              for the fiscal year ended December 31, 1998.

     (5)      Filed as an  Exhibit  to the  Company's  Quarterly  Report on Form
              10-QSB, for the quarter ended June 30, 1999.

(b)      Reports on Form 8-K

         None.


<PAGE>
                                       18


(c)      Exhibits

         Reference is made to the response to Item 13(a)(3)  above for a list of
all exhibits filed herewith or  incorporated by reference as part of this Annual
Report on Form 10-KSB.  Reference is also made to the Exhibit Index forming part
of this Annual Report on Form 10-KSB.

(d)      Financial Statement Schedules

         Reference is made to the  response to Item  13(a)(1) and (2) above with
regard to the financial  statement schedules filed as part of this Annual Report
on Form 10-KSB.

         For  the  purposes  of  complying  with  the  amendments  to the  rules
governing Form S-8  (effective  July 13, 1990) under the Securities Act of 1933,
the undersigned registrant hereby undertakes as follows, which undertaking shall
be incorporated by reference into registrant's  Registration  Statements on Form
S-8 Nos. 33-27291, 33-77874, 33-78984, 33-82720, 333-00261, and 333-67623.

         Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors,  officers and controlling  persons of
the  registrant  pursuant  to  the  foregoing  provisions,   or  otherwise,  the
registrant  has been advised that in the opinion of the  Securities and Exchange
Commission  such  indemnification  is against  public policy as expressed in the
Securities  Act of 1933 and is,  therefore,  unenforceable.  In the event that a
claim for  indemnification  against such liabilities  (other than the payment by
the  registrant  of  expenses  incurred  or  paid  by  a  director,  officer  or
controlling  person of the registrant in the  successful  defense of any action,
suit or proceeding) is asserted by such director,  officer or controlling person
in connection with the securities being registered,  the registrant will, unless
in the  opinion  of its  counsel  the matter  has been  settled  by  controlling
precedent,  submit to a court of appropriate  jurisdiction  the question whether
such  indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.



<PAGE>
                                       19




                                   SIGNATURES

        In  accordance  with  the  requirements  of  Section  13 or 15(d) of the
Securities  Exchange Act of 1934,  the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

                                        Teknowledge Corporation


Date:  March 30, 2000                    By: /s/ Neil A. Jacobstein
                                             ------------------------
                                             Neil A. Jacobstein
                                             Chairman of the Board of Directors

        Pursuant to the  requirements  of the  Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities and on the dates indicated.

           Name                        Capacity                     Date
           ----                        --------                     ----

/s/ Neil A. Jacobstein             Chairman of the Board         March 30, 2000
------------------------------     of Directors, President &
Neil A. Jacobstein                 Chief Executive Officer
                                   (Principal Executive
                                   Officer)

/s/ Dennis A. Bugbee               Director of Finance,          March 30, 2000
------------------------------     Treasurer and Secretary
Dennis A. Bugbee                   (Principal Financial and
                                   Accounting Officer)

/s/ Lawrence Druffel               Director                      March 30, 2000
------------------------------
Lawrence Druffel

/s/ Benedict O'Mahoney             Director, Vice President,     March 30, 2000
------------------------------     Administration and
Benedict O'Mahoney                 Legal Affairs

/s/ General Robert T. Marsh        Director                      March 30, 2000
------------------------------
General Robert T. Marsh (Ret.)

/s/ James C. Workman               Director                      March 30, 2000
------------------------------
James C. Workman






<PAGE>
                                       20





                          ANNUAL REPORT ON FORM 10-KSB

                   ITEM 7, ITEM 13(a)(1) and (2), (c) and (d)

                          LIST OF FINANCIAL STATEMENTS

                                CERTAIN EXHIBITS

                              FINANCIAL STATEMENTS

      AS OF DECEMBER 31, 1999 AND FOR THE TWO YEARS ENDED DECEMBER 31, 1999

                             TEKNOWLEDGE CORPORATION

                              PALO ALTO, CALIFORNIA




<PAGE>
                                       21





                             TEKNOWLEDGE CORPORATION

                       FORM 10-KSB - ITEM 13(a)(1) and (2)

                    LIST OF CONSOLIDATED FINANCIAL STATEMENTS



The following consolidated  financial statements of Teknowledge  Corporation are
included in Item 7:

                                                                            Page

Report of Independent Public Accountants                                      22

Consolidated Balance Sheet - December 31, 1999                                23

Consolidated Statements of Operations and Comprehensive Income
- Years ended December 31, 1999 and 1998                                      24

Consolidated  Statements of Stockholders' Equity - Years ended
December 31, 1999 and 1998                                                    25

Consolidated Statements of Cash Flows - Years ended
December 31, 1999 and 1998                                                    26

Notes to Consolidated Financial Statements                               27 - 38






<PAGE>
                                       22






                    Report Of Independent Public Accountants



To Teknowledge Corporation:


We have  audited the  accompanying  consolidated  balance  sheet of  Teknowledge
Corporation (a Delaware Corporation) and subsidiary as of December 31, 1999, and
the related  consolidated  statements of operations  and  comprehensive  income,
stockholders'  equity and cash flows for the years ended  December  31, 1999 and
1998.  These  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial  position of Teknowledge  Corporation and
subsidiary  as of December 31,  1999,  and the results of their  operations  and
their cash flows for the years ended  December  31, 1999 and 1998 in  conformity
with accounting principles generally accepted in the United States.


/s/ Arthur Andersen LLP
Arthur Andersen LLP



San Jose, California
March 17, 2000

<PAGE>
                                       23


<TABLE>
<CAPTION>
                             TEKNOWLEDGE CORPORATION
                           CONSOLIDATED BALANCE SHEET
                             AS OF DECEMBER 31, 1999


                              ASSETS

                                                                     December 31,
                                                                         1999
                                                                     --------------
<S>                                                                <C>
Current assets:

    Cash and cash equivalents                                      $     1,951,393
                                                                     --------------
    Receivables:
       Customer - billed, net of allowance of $10,000                    2,028,953
       Customer - unbilled                                               1,234,189
                                                                     --------------
           Total receivables                                             3,263,142

    Deferred tax asset, short-term                                         400,000
    Deposits and prepaid expenses                                           75,692
                                                                     --------------
       Total current assets                                              5,690,227
                                                                     --------------

Capitalized software development costs, net of accumulated
    amortization of $104,485                                               359,743
                                                                     --------------

Fixed assets, at cost
    Computer and other equipment                                         3,078,647
    Furniture and fixtures                                                 112,647
    Leasehold improvements                                                 838,398
                                                                     --------------
                                                                         4,029,692
    Less:  Accumulated depreciation and amortization                    (3,652,857)
                                                                     --------------
                                                                           376,835
Deferred tax asset, long-term                                              500,000
Other assets, long-term (note 12)                                          241,162
                                                                     --------------

Total assets                                                       $     7,167,967
                                                                     ==============

               LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                               $       747,404
    Payroll and related liabilities                                        659,752
    Other accrued liabilities (Note 3)                                     221,159
                                                                     --------------
       Total current liabilities                                         1,628,315

Commitments and contingencies (Notes 4 and 11)

Stockholders' equity:
    Preferred  stock,  $.01 par value,
       authorized 2,500,000  shares,  Series A
       Convertible Preferred Stock, none issued                                  -
    Common stock, $.01 par value, authorized
       25,000,000 shares, 5,302,540 shares issued and
       5,257,470 shares outstanding at December 31, 1999                    53,025
    Additional paid-in capital                                           1,795,402
    Retained earnings since January 1, 1993
       (following quasi-reorganization)                                  3,872,322
    Less: Treasury stock, at cost                                         (181,097)
                                                                     --------------
       Total stockholders' equity                                        5,539,652
                                                                     --------------

Total liabilities and stockholders' equity                         $     7,167,967
                                                                     ==============

The accompanying notes are an integral part of this consolidated financial statement.
</TABLE>


<PAGE>
                                       24


                                TEKNOWLEDGE CORPORATION
                         CONSOLIDATED STATEMENTS OF OPERATIONS
                                AND COMPREHENSIVE INCOME


                                                        Years Ended December 31,
                                                        ------------------------
                                                        1999           1998
                                                        ----           ----

            Revenues                           $   11,094,672 $   12,200,849
                                                 -------------  -------------
            Costs and expenses:
             Cost of revenues                       7,049,550      8,244,290
             General and administrative             2,410,001      2,373,789
             Sales and marketing                      512,040        764,911
             Research and development                 599,231        132,501
                                                 -------------  -------------
              Total costs and expenses             10,570,822     11,515,491
                                                 -------------  -------------
              Operating income                        523,850        685,358
            Interest and other income, net            115,381        105,010
                                                 -------------  -------------
            Income before tax                         639,231        790,368
            Provision for income tax                  255,692          4,748
                                                 =============  =============
            Net income                         $      383,539 $      785,620
                                                 =============  =============

            Net income per share:
                                - Basic        $         0.08 $         0.16
                                                 =============  =============
                                - Diluted      $         0.07 $         0.14
                                                 =============  =============

            Shares used in computing net income per share:
                                - Basic             5,050,386      4,887,910
                                                 =============  =============
                                - Diluted           5,795,717      5,763,361
                                                 =============  =============




The  accompanying  notes are an integral  part of these  consolidated  financial
statements.


<PAGE>
                                       25


<TABLE>
<CAPTION>

                             TEKNOWLEDGE CORPORATION
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY



                                     Common Stock       Additional
                                  Shares       Par       Paid-in      Retained     Treasury
                                  Issued      Value      Capital      Earnings       Stock      Total
                                  ------      -----      -------      --------       -----      -----
<S>                              <C>       <C>        <C>         <C>            <C>         <C>
Balance, December 31, 1997       4,796,543 $   41,608 $ 1,415,270 $    2,703,163 $         - $4,160,041

Exercise of stock options          158,839      7,942      95,020              -           -    102,962

Net income                               -          -           -        785,620           -    785,620

Distribution of cash for
   fractional shares due to
   reverse stock split                (428)         -      (1,921)             -           -     (1,921)

Reversal of portions of
   provisions made prior to
   quasi-reorganization for
   restructuring reserve                 -          -      45,611              -           -     45,611
                                 ----------  ---------  ----------  -------------  ----------  ---------

Balance, December 31, 1998       4,954,954     49,550   1,553,980      3,488,783           -  5,092,313

Repurchase of common stock               -          -           -              -    (291,494)  (291,494)

Exercise of stock options          347,586      3,475      60,454              -     110,397    174,326

Net income                               -          -           -        383,539           -    383,539

Realization of net operating
   loss carryforwards established
   prior to quasi-reorganization         -          -     180,968              -           -    180,968

                                 ----------  ---------  ----------  -------------  ----------  ---------

Balance, December 31, 1999       5,302,540 $   53,025 $ 1,795,402 $    3,872,322 $  (181,097) $5,539,652
                                 ==========  =========  ==========  =============  ==========  =========

      The  accompanying  notes  are  an  integral  part  of  these  consolidated
financial statements.

</TABLE>



<PAGE>
                                       26


<TABLE>
<CAPTION>
                                  TEKNOWLEDGE CORPORATION
                           CONSOLIDATED STATEMENTS OF CASH FLOWS




                                                                       Years Ended December 31,
                                                                       ------------------------
                                                                       1999             1998
                                                                       ----             ----
<S>                                                          <C>              <C>
Cash flows from operating activities:
  Net income                                                 $      383,539   $      785,620
  Adjustments to reconcile net income to net cash
  provided by operating activities:
   Depreciation and amortization                                    359,839          319,578
   Deferred income taxes                                            180,968                -
   Changes in assets and liabilities:
    Receivables                                                    (729,359)        (245,030)
    Deposits and prepaid expenses                                    11,167          (18,350)
    Accounts payable                                                 86,083          (41,577)
    Accrued liabilities                                             (65,467)        (229,959)
                                                               -------------    -------------
   Net cash provided by operating activities                        226,770          570,282
                                                               -------------    -------------

Cash flows from investing activities:
  Investment in GlobalStake                                        (211,766)               -
  Capitalization of software development costs                     (185,460)        (267,046)
  Purchase of fixed assets                                         (139,373)        (198,122)
                                                               -------------    -------------
   Net cash used for investing activities                          (536,599)        (465,168)
                                                               -------------    -------------

Cash flows from financing activities:
  Proceeds from issuance of common stock                            174,326          102,962
  Redemption of fractional shares from reverse stock split                -           (1,921)
  Repurchase of common stock                                       (291,494)               -
                                                               -------------    -------------
   Net cash provided by (used for) financing activities            (117,168)         101,041
                                                               -------------    -------------
Net increase (decrease) in cash and cash equivalents               (426,997)         206,155
Cash and cash equivalents at beginning of period                  2,378,390        2,172,235
                                                               -------------    -------------
Cash and cash equivalents at end of period                   $    1,951,393   $    2,378,390
                                                               =============    =============
Supplemental disclosure of cash flow information:
Cash paid for income taxes                                   $       18,200   $        8,644


  The accompanying  notes are an integral part of these  consolidated  financial
statements.

</TABLE>



<PAGE>
                                       27


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


1.       History and Business

                  Teknowledge  Corporation  (the "Company") was  incorporated on
         July 8,  1981  under  the  laws of the  State  of  Delaware  and is the
         surviving  corporation  of the merger of American  Cimflex  Corporation
         ("Cimflex") and Teknowledge  Inc., which was consummated in 1989. Prior
         to 1993,  Cimflex  restructured  and divested a significant part of its
         operations.  Reserves for  discontinued  operations  and  restructuring
         obligations  were  established for those events.  In December 1992, the
         Board of  Directors  approved  a  quasi-reorganization,  which  had the
         effect of eliminating the  accumulated  deficit at December 31, 1992 of
         approximately $58 million by reducing  paid-in-capital.  Adjustments to
         previously  established reserves and any subsequent  realization of tax
         benefits  existing  at the  date  of the  quasi-reorganization  will be
         recorded as adjustments to additional paid-in-capital.

                  The  Company is in the  Internet  knowledge  system  business.
         Almost all of the Company's  projects  involve  processing  application
         knowledge and distributing it over the Internet.  The Company leverages
         its  core  competencies  in  knowledge-based  systems  and  large-scale
         distributed  object-oriented  software with the expanding opportunities
         presented by the Internet and the World Wide Web. The Company  provides
         software products and consulting services for government and commercial
         applications.  The  application  areas are  addressed  by five  program
         areas:  Distributed Systems Engineering,  Situation Assessment and Data
         Fusion,  Education & Training Technologies,  Information Assurance, and
         Electronic Commerce ("eCommerce") Systems.

                  The  Company  recognizes  that the  continued  success  of its
         business is dependent on key  management and technical  personnel,  the
         loss of one or  more  of whom  could  adversely  affect  the  Company's
         business. The Company is also subject to risks inherent to companies at
         a   similar   stage   of   development,    including   the   successful
         commercialization  of the Company's  products,  competition from larger
         companies  with  financial  resources  greater  than the  Company,  the
         ability to retain and attract  employees,  and  capital  and  financing
         needs.

2.       Summary of Significant Accounting Policies

         Use of Estimates in the Preparation of Financial Statements

                  The  preparation  of financial  statements in conformity  with
         generally accepted  accounting  principles  requires management to make
         estimates and  assumptions  that affect the reported  amounts of assets
         and liabilities and disclosure of contingent  assets and liabilities at
         the  date of the  financial  statements  and the  reported  amounts  of
         revenues and expenses during the reporting period. Actual results could
         differ from these estimates.

         Principle of Consolidation

                  The consolidated  financial statements include the accounts of
         Teknowledge  Corporation and its wholly owned  subsidiary,  Teknowledge
         Federal  Systems,  Inc. All significant  intercompany  transactions and
         balances have been eliminated.
<PAGE>
                                       28


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


2.       Summary of Significant Accounting Policies (cont'd)

         Cash and Cash Equivalents

                  The Company  considers  all highly  liquid  investments,  with
         original maturity dates of less than 90 days, as cash  equivalents.  As
         of December 31, 1999, the Company's funds were invested almost entirely
         in money market instruments at various institutions.

         Unbilled Receivables

                  Unbilled  receivables  represent  differences between billings
         and revenues recognized on cost-type  government  contracts and certain
         eCommerce services. The unbilled amounts primarily represent (i) timing
         differences  between incurred costs and billed costs, or (ii) a portion
         of the  earned  fee  held  back as  retention  until  the  contract  is
         completed and the final indirect overhead rates have been determined. A
         substantial portion of the retained fee may be billed to the government
         after  the  final  indirect  rates  are  submitted  to the  government;
         however,  they are subject to future review and approval by the Defense
         Contract  Audit Agency.  The Company has received  final  overhead rate
         approval for costs incurred through December 31, 1997.

         Concentration of Credit Risk

                  The  Company  performs  periodic  credit  evaluations  of  the
         financial  condition of commercial  customers  and  generally  does not
         require collateral.  Historically,  the Company has experienced minimal
         write-offs from commercial receivables. The Company has not experienced
         a credit loss from a government  customer nor does it  anticipate  such
         losses.

         Capitalized Software Development Costs

                  Teknowledge  capitalizes  software  development costs starting
         from the point  technological  feasibility is determined and continuing
         until the general  availability  of the product.  During 1999 and 1998,
         software  development  costs of $185,460 and $267,046 were capitalized,
         respectively.  Amortization  costs were  $92,923 in 1999 and $27,238 in
         1998.

                  The  Company's  policy  is to  amortize  capitalized  software
         development  costs by the  greater  of (a) the ratio of  current  gross
         revenues for a product to the total of current and  anticipated  future
         gross revenues for that product,  or (b) the straight-line  method over
         the  remaining  estimated  economic  life of the product which is three
         years.

         Fixed Assets

                  Equipment and improvements, which include assets under capital
         leases,  are  depreciated  using the  straight-line  method  over their
         estimated  useful lives  ranging from three to five years.  Maintenance
         and repairs are charged to expense as incurred.  Leasehold improvements
         are  amortized  over the  shorter of the useful  life or the  remaining
         lease term.

<PAGE>
                                       29



                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


2.       Summary of Significant Accounting Policies (cont'd)

         Revenue Recognition

         (a)      Government Contracts

                  The  Company's  revenues  are  primarily  generated  from U.S.
         Government  contracts  under  which the Company may be either the prime
         contractor  or  a  subcontractor.  The  Company  principally  uses  the
         percentage-of-completion  method of accounting  for contract  revenues.
         The percentage-of-completion method is based on total costs incurred to
         date compared with estimated  total costs upon completion of contracts.
         The Company charges all losses on contracts to operations in the period
         when the loss is known.

                  In 1999,  approximately  85% of the  Company's  revenues  were
         recorded in connection with U.S. Government  contracts,  principally of
         the  cost-plus-fixed-fee  type,  compared to approximately 99% in 1998.
         These  contracts  are  predominantly  funded  by the  Defense  Advanced
         Research Projects Agency (DARPA) and administered by various government
         agencies.

                  For the year ended  December 31, 1999,  the DARPA  Information
         Technology  Office and Information  Systems Office were the sponsors of
         the Company's three largest government  contracts accounting for 58% of
         government revenue.  For the year ended December 31, 1998, a classified
         customer was the sponsor of the Company's largest government  contract,
         accounting  for  approximately   17%  of  total  revenues.   The  DARPA
         Information  Technology Office and Information  Systems Office were the
         sponsors for the second and third largest  government  contracts;  each
         contributed 14% of total revenues.

         (b)      Commercial Contracts

                  Revenue  earned under  software  license  agreements  with end
         users are  generally  recognized  as revenue upon  contract  execution,
         provided  all  shipment  obligations  have been met,  fees are fixed or
         determinable,  and collection is probable.  Revenue from  post-contract
         customer  support is  recognized  ratably  over the period the customer
         support  services  are  provided,  and  software  services  revenue  is
         recognized as services are performed.

                  Revenues from professional services provided principally under
         technology  contracts are recognized  when costs for time and materials
         are incurred.

         Reverse Stock Split

                  The Company has effected a one-for-five reverse stock split on
         December 22, 1998. All share and per share data has been  retroactively
         restated to reflect the effect of the reverse stock split.  Since there
         was no change in per share par value, aggregate par value has also been
         retroactively adjusted to reflect the reduction in the number of common
         stock.

<PAGE>
                                       30


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


2.       Summary of Significant Accounting Policies (cont'd)

         Treasury Stock

                  On  December  16,  1998,  the  Company  adopted a  program  to
         repurchase up to 300,000  shares of the  Company's  common stock in the
         open  market  or in  private  during  the  twelve-month  period  ending
         December  15,  1999  at  prevailing  prices.  Repurchases  will be made
         periodically  at  management  discretion  using the  Company's own cash
         reserves.  Shares  repurchased may be reissued to employees pursuant to
         the Company's stock option plans, or for other corporate purposes.

         Earnings Per Share

                  Basic  earnings per share is calculated by dividing net income
         by the weighted average shares of common stock  outstanding  during the
         period. Diluted earnings per share is calculated by dividing net income
         by the weighted  average shares of outstanding  common stock and common
         stock equivalents during the period.  Common stock equivalents included
         in the diluted calculation consist of dilutive shares issuable upon the
         exercise of outstanding common stock options.

                  A summary of the  earnings per share  calculation  for each of
         the two  years  ended  December  31,  1999 and 1998 is as  follows  (in
         thousands,  except  per share  amounts).  All share  amounts  have been
         adjusted  for  the  effect  of the  one-for-five  reverse  stock  split
         effective December 22, 1998.
<TABLE>
<CAPTION>
                                                                                  1999           1998
                                                                                  ----           ----
                  <S>                                                        <C>             <C>
                  Basic earnings per share:
                      Net income                                             $     384       $    786
                                                                             ---------       --------
                      Weighted average common shares                             5,050          4,888
                                                                             ---------       --------
                  Basic earnings per share                                   $    0.08       $   0.16
                                                                             =========       ========

                  Diluted earnings per share:
                      Net income                                             $     384       $    786
                                                                             ---------       --------
                      Weighted average common shares                             5,050          4,888
                      Weighted average common shares equivalent:
                           Options                                                 746            875
                                                                             ---------       --------
                      Diluted weighted average common shares                     5,796          5,763
                                                                             ---------       --------
                  Diluted earnings per share                                 $    0.07       $   0.14
                                                                             =========       ========
</TABLE>

         Accounting for Stock-Based Compensation

                  The Company has adopted the disclosure provisions of Statement
         of  Financial  Accounting  Standards  (SFAS) No. 123,  "Accounting  for
         Stock-Based  Compensation."  The  adoption  did not have a  significant
         effect on the Company's  results of operations as the Company continues
         to apply the  principles of Accounting  Principles  Board (APB) Opinion
         No. 25 and related  interpretations  in  accounting  for the  Company's
         stock plans.


<PAGE>
                                       31


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


2.       Summary of Significant Accounting Policies (cont'd)

         Segment Reporting

                  During 1998,  the Company  adopted SFAS No. 131,  "Disclosures
         About Segments of an Enterprise and Related  Information." SFAS No. 131
         requires a new basis of determining reportable business segments, i.e.,
         the management  approach.  This approach requires that business segment
         information used by management to assess performance and manage Company
         resources be the source for information disclosure.  On this basis, the
         Company is organized  and operates as one business  segment,  providing
         software products and consulting services for government and commercial
         applications.  As a result,  the adoption of SFAS No. 131 had no impact
         on the Company's disclosures or financial statements.

         Recent Accounting Pronouncements

                  In June 1998, the Financial  Accounting Standards Board issued
         SFAS No.  133,  "Accounting  for  Derivative  Instruments  and  Hedging
         Activities",  which requires  companies to value  derivative  financial
         instruments,   including  those  used  for  hedging  foreign   currency
         exposures,  at  current  market  value with the impact of any change in
         market value being  charged  against  earnings in each period.  In June
         1999,  the Financial  Accounting  Standards  Board issued SFAS No. 137,
         "Accounting  for  Derivative   Instruments  and  Hedging  Activities  -
         Deferral of the Effective  Date of SFAS No. 133" to defer the effective
         date of SFAS No. 133 until fiscal years  beginning after June 15, 2000.
         To date,  the  Company has not entered  into any  derivative  financial
         instrument  contracts.  Thus the Company  anticipates that SFAS No. 133
         will  not  have  a  material  impact  on  its  consolidated   financial
         statements.

                  In December  1999,  the  Securities  and  Exchange  Commission
         issued Staff Accounting Bulletin (SAB) No. 101 "Revenue  Recognition in
         Financial Statements".  SAB 101 provides guidance on applying generally
         accepted  accounting   principles  to  revenue  recognition  issues  in
         financial  statements.  We will adopt SAB 101 as required in the second
         quarter of 2000.  We do not expect  the  adoption  of SAB 101 to have a
         material impact on our consolidated results of operations and financial
         position.



<PAGE>
                                       32



                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


3.       Other Accrued Liabilities

                  Other Accrued  liabilities  as of December 31, 1999 consist of
         the following:

         Provision for contract charges                            $     100,000
         Accrual for professional services                                64,552
         Accrual for income taxes                                         55,315
         Miscellaneous                                                     1,292
                                                                   -------------
                                                                   $     221,159
                                                                   =============

4.       Commitments

                  The Company leases its facilities and certain  equipment under
         operating  leases.  As of  December  31,  1999,  the Company had active
         leases in the following locations:

                            Location                          Date Lease Expires
                            --------                          ------------------
                            Palo Alto, California                  April 4, 2002
                            San Diego, California                   May 31, 2000
                            Arlington, Virginia                    June 30, 2001
                            Fairfax, Virginia                      June 30, 2002

         The remaining obligations under these leases are as follows:

                                                   Year Ending
                                                  December 31,
                                                  ------------
                            2000                   $   611,453
                            2001                       591,424
                            2002                       162,604
                                                   -----------
                                                   $ 1,365,481
                                                   ===========

                  Rent  expense for the years ended  December  31, 1999 and 1998
         totaled $645,870 and $504,111, respectively.

5.       Line of Credit

                  The  Company  has  a  $2,000,000   unsecured  line  of  credit
         agreement  with a bank.  The line  expires in December  2000 and can be
         extended  from year to year.  The  Company  can borrow up to 60% of the
         eligible  receivables  base or  $2,000,000,  whichever  is  lower.  The
         maximum  rate that may be charged is one percent  over the bank's prime
         rate (8.25% at December  31,  1999).  The  agreement  includes  certain
         financial  covenants and disclosure  requirements  that were met during
         the year. The line was not utilized in 1999.


<PAGE>
                                       33


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


6.       Income Taxes

                  The Company  accounts for income taxes in accordance with SFAS
         No. 109,  "Accounting  for Income  Taxes." SFAS No. 109 is an asset and
         liability approach for computing deferred income taxes based on enacted
         tax laws and rates  applicable  to the period in which the taxes become
         payable.

                  The Company has  reflected as a reduction to the provision for
         income taxes the benefit from tax losses  generated  subsequent  to the
         date of the quasi-reorganization (see Note 1). The provision for income
         taxes differs from the statutory  U.S.  Federal  income tax rate due to
         the following:

                                                            1999          1998
                                                            ----          ----
         Provision at U.S. statutory rate                   35.0%        34.0%
         State income taxes, net of other Federal benefit    5.8          6.1
         Other                                              (0.8)           -
         Change in valuation allowance                         -        (39.5)
                                                            -----        -----
         Provision for income taxes                         40.0%         0.6%
                                                            =====        =====


                  The  components  of the net  deferred  income  tax asset as of
         December 31, 1999 are as follows:

         Net operating loss carryforwards                  $   23,487,194
         Cumulative temporary differences                         256,429
         Tax credit carryforwards                                 783,894
                                                           --------------
                                                               24,527,517
         Valuation allowance                                  (23,627,517)
                                                           --------------
         Net deferred income tax asset                     $      900,000
                                                           ==============

                  The  valuation  allowance  consists of net  operating  losses,
         cumulative temporary  differences and tax credit  carryforwards,  which
         may expire  before they can be used.  The Company  believes  sufficient
         uncertainty  exists  regarding the  realizability  of these items,  and
         accordingly, a valuation allowance has been established.

                  At December  31,  1999,  the Company  had net  operating  loss
         carryforwards of approximately  $67 million  available to offset future
         Federal  taxable  income.  Any  subsequent   realization  of  tax  loss
         carryforwards that existed at the date of the quasi-reorganization will
         be recorded as an adjustment to additional paid-in-capital.  These loss
         carryforwards expire through the year 2009. The availability and timing
         of the amount of prior  losses to be used to offset  taxable  income in
         future years may be limited due to various  provisions,  including  any
         change in ownership  interest of the Company resulting from significant
         stock transactions.

                  Realization  of the net  deferred  tax asset of $900,000 as of
         December 31, 1999 is dependent on generating  sufficient taxable income
         to offset future deduction of the related items.  Although  realization
         is not assured, management believes it is more likely than not that the
         net deferred tax asset will be realized. The amount of the deferred tax
         asset considered realizable, however, could be reduced in the near term
         if estimates of future taxable income are reduced.




<PAGE>
                                       34



                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


7.       401(k) Plan

                  The Company has a 401(k) plan  covering  all of the  Company's
         regular employees.  Participants in the plan may make a contribution as
         a percentage of their gross wages subject to the applicable  government
         limits.  Effective  January 1, 1999, the Board of Directors amended the
         Plan,  and increased the Company  matching  provision of eligible wages
         from 4% to 5%. The Company  matching  contribution  vests at 20% a year
         over a five-year period. The Company contributed  $200,201 and $143,333
         to the plan during 1999 and 1998, respectively.

8.       Executive Compensation Plan

                  The Chief  Executive  Officer of the Company has an employment
         agreement  with the Company dated  November 22, 1999 for the year 2000.
         Besides  base  compensation,   this  agreement  includes  an  incentive
         compensation  plan  with  target  objectives  established  in  the  six
         strategic categories of cash flow, profitability,  bookings, eCommerce,
         licensing  fees,  and  GlobalStake.com   performance,   which  will  be
         determined  and assessed by the Board of Directors to a maximum of 120%
         of base salary.

9.       Stock-Based Compensation Plans

                  The Company has two stock option plans.  The stock option plan
         for employees is called the Teknowledge  Corporation  1998 Stock Option
         Plan (the  "1998  Plan") and the stock  option  plan for  Directors  is
         called the Teknowledge Plan for Non-Employee Directors (the "Directors'
         Plan"). The Company accounts for these plans under APB Opinion No. 25.

                  Had   compensation   cost  for  these  plans  been  determined
         consistent with SFAS No. 123, the Company's net income and earnings per
         share would have been reduced to the following pro forma amounts:

                                                         1999          1998

         Net Income      As Reported                  $383,539      $785,620
                         Pro Forma                    $135,799      $681,737

         Diluted EPS     As Reported                     $0.07         $0.14
                         Pro Forma                       $0.02         $0.12

                  Because  the SFAS No.  123 method of  accounting  has not been
         applied to options  granted prior to January 1, 1995, the resulting pro
         forma  compensation  cost  may  not be  representative  of  that  to be
         expected in future years.
<PAGE>
                                       35


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


9.       Stock-Based Compensation Plans (cont'd)

                  The Company may grant options for up to 1,546,636 shares under
         the 1998 Plan to employees. The Company has granted options for 337,600
         shares ($3.50 - $5.38 per share) and 347,900  shares ($2.15 - $8.60 per
         share) in 1999 and 1998, respectively,  and has reserved for issuance a
         total of 1,127,426  shares  through  December  31,  1999.  The Board of
         Directors has granted  options to employees  that are either  incentive
         stock options ("ISO") or non-statutory stock options ("NSO").  For ISO,
         the exercise  price of the common stock options  granted under the 1998
         Plan may not be less than the fair  market  price on the date of grant.
         For NSO,  the  exercise  price of the common stock may not be less than
         85% of the fair market  price of the common stock on the date of grant.
         Options that have been granted  normally  vest in quarterly  increments
         starting the second year of a four-year term and expire ten years after
         the grant date.  The 1998 Stock  Option Plan is  scheduled to expire in
         April 2008.

                  The  aggregate  number of shares  issued under the  Directors'
         Plan may not exceed 100,000 shares of Common Stock.  38,000 shares were
         available  for future grant as of December  31, 1999.  Under this plan,
         non-employee  directors are entitled to receive annual option grants to
         purchase 3,000 shares of Common Stock on their initial  election to the
         Board and thereafter on the  anniversary  date of their election to the
         Board. Options, which are granted at fair market value, are exercisable
         one year after the grant date and expire ten years from the grant date.
         Options to  purchase a total of 57,000  shares were  outstanding  as of
         December 31, 1999 at $.75 to $8.15 per share and a weighted  average of
         $4.30 per share.  Options for 45,000  shares at $.75 to $8.15 per share
         and a weighted  average of $4.24 per share were vested at December  31,
         1999. No options were exercised during 1999.

                  A summary of the status of the Company's stock option plans as
         of December 31, 1999 and 1998 is presented below:

<TABLE>
<CAPTION>
                                                       1999                                   1998
                                          ----------------------------------     -------------------------------
                                                                  Wtd Avg                             Wtd Avg
                                                Shares           Ex Price           Shares           Ex Price
                                          ----------------------------------     -------------------------------
         <S>                                 <C>                 <C>                <C>                <C>
         Outstanding at beg. of year         1,264,899           $   1.44           1,268,516          $ 1.75
         Granted                               349,600               3.98             347,900            2.85
         Exercised                            (372,786)               .47            (158,839)            .65
         Forfeited                            (137,701)              4.32            (192,678)           6.59
                                          ------------                              ---------
         Outstanding at end of year          1,104,012               2.10           1,264,899            1.44

         Exercisable at end of year            591,749                .98             890,482             .91
         Weighted average fair value
          of options granted                     $3.98                                  $2.26

</TABLE>


<PAGE>
                                       36


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999


9.       Stock-Based Compensation Plans (cont'd)

                  The following table summarizes information about stock options
         outstanding at December 31, 1999:

<TABLE>
<CAPTION>
                                          Options Outstanding                           Options Exercisable
         ------------------  -------------------------------------------------    ---------------------------------
                                                       Wtd Avg
                 Range of              Shares      Contractual                                Shares
                Ex Prices         Outstanding             Life       Wtd Avg             Exercisable     Wtd Avg
                    ($'s)            12/31/99          (Years)      Ex Price                12/31/99    Ex Price
         ------------------  -------------------------------------------------    ---------------------------------
             <S>                       <C>             <C>            <C>                     <C>          <C>
             .05  -    1.76              437,957       4.6             .28                    437,957       .28
             1.77 -    3.53              311,955       8.3            2.34                    133,792      2.42
             3.54 -    5.29              342,100       9.7            4.00                      8,000      4.38
             5.30 -    8.82               12,000       8.5            8.15                     12,000      8.15
                             -------------------                                  -------------------
              .05 -    8.82            1,104,012       7.3            2.10                    591,749       .98
                             -------------------                                  -------------------
</TABLE>

                  The fair value of each option  grant is  estimated on the date
         of  grant  using  the  Black-Scholes  option  pricing  model  with  the
         following  weighted-average  assumptions  used for  grants  in 1999 and
         1998, respectively; risk-free interest rates of 5.6% and 5.5%; expected
         lives of 5.5 and 5.5 years;  expected  volatility of 68% and 100%;  and
         expected dividend yield of 0%.

                  As of December 31,  1999,  the  following  number of shares of
         Common Stock have been reserved for future issuance under both Plans:

         Teknowledge Corporation 1998 Stock Option Plan            1,127,426
         Stock Option Plan for Non-Employee Directors                 95,000
                                                                  ----------
                                                                   1,222,426
                                                                  ==========

10.      Other Income and Expense

                  The composition of other income and expense is as follows:


                                                         1999          1998
                                                         ----          ----
         Other Income and Expense                $      2,744      $  2,065



<PAGE>
                                       37


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1999



11.      Contingencies

         Change of Control - Severance Benefits

                  In  the  event  of  a  change  of  control,   defined  as  any
         consolidation  or merger of the Company in which the Company is not the
         continuing   or   surviving    corporation,    the   Chief    Executive
         Officer/President of the Company will be entitled to severance benefits
         to include:  (i) full  accrued  salary and vacation  pay,  (ii) accrued
         incentive compensation awarded or determined to be awarded by the Board
         of Directors,  (iii) insurance  coverage,  (iv) retirement benefits and
         (v) a lump sum  severance  payment  equal to two times the most  recent
         annual salary.

         Rights Agreement

                  On January 29, 1996, the Company's Board of Directors approved
         a Rights  Agreement (the "Plan").  The adoption of the Plan is intended
         as a means to guard against  takeover  tactics designed to gain control
         of the Company without paying all stockholders full and fair value.

                  Under the  Plan,  stockholders  will  receive  five  Rights to
         purchase  one  one-hundredth  of a share of a new  series of  Preferred
         Stock  for each  outstanding  share of the  Company's  Common  Stock of
         record held at the close of business on February 12, 1996.  The Company
         has effected a  one-for-five  reverse stock split on December 22, 1998.
         Pursuant to the Plan, the number of Rights received per share of Common
         Stock held has been  proportionately  adjusted to reflect the effect of
         the reverse stock split.

                  The Rights,  which will initially trade with the Common Stock,
         become  exercisable to purchase one one-hundredth of a share of the new
         Preferred  Stock,  at $2.00 per Right,  when a third party  acquires 15
         percent or more of Common Stock or announces a tender offer which could
         result in such person owning 15 percent or more of Common  Stock.  Each
         one  one-hundredth  of a share of the new  Preferred  Stock  has  terms
         designed to make it substantially the economic  equivalent of one share
         of Common  Stock.  Prior to a third party  acquiring  15  percent,  the
         Rights can be  redeemed  for $.001  each by action of the Board.  Under
         certain circumstances,  if a third party acquires 15 percent or more of
         Common  Stock,  the Rights  permit the holders to purchase  Teknowledge
         Common Stock  having a market value of twice the exercise  price of the
         Rights,  in lieu of the Preferred  Stock. In addition,  in the event of
         certain business combinations, the Rights permit purchase of the Common
         Stock of an acquirer at a 50 percent  discount.  In either case, Rights
         held by the acquirer will become null and void.

         Legal Proceedings

                  In 1999 the  Company  offered to sell SAP a license to use the
         technology related to the Company's  Intelligent  Configuration  Patent
         Portfolio,  a  collection  of five  patents  relating to  configuration
         technologies,  including the Company's  configuration  systems  patent,
         Bennett et al. U.S. Patent  4,591,983 (the "'983 patent").  In response
         to  this  offer,  on  October  8,  1999,  SAP  America,  Inc.  and  SAP
         Aktiengesellschaft  (collectively,  "SAP") filed a lawsuit  against the
         Company  in the  United  States  District  Court  for the  District  of
         Delaware.  The subject  matter of the case involves the Company's  '983
         patent and the  configuration  technology  associated  with the SAP R/3
         System ("R/3  System").  SAP is seeking a judgment  against the Company
         that the `983 patent is invalid and is not infringed by the R/3 System;
         an award of attorney  fees,  costs of suit,  and other relief the court
         may deem just and proper.

<PAGE>
                                       38


11.      Contingencies (cont'd)

                 On October 21, 1999 the Company  filed a counterclaim  against
         SAP for patent  infringement of two of its patents.  The subject of the
         counter  suit  is the  `983  patent  entitled  "Hierarchical  Knowledge
         System" and U.S. Patent 4,783,752 entitled  "Knowledge Based Processing
         for   Application   Programs   Using   Conventional   Data   Processing
         Capabilities." The management of the Company considers the suit brought
         by  SAP  to  be  without  merit  and  intends  to  defend  its  patents
         vigorously.  Management  believes the ultimate  resolution of the above
         matters  may have a  positive  impact,  and  will  not have an  adverse
         material  impact on the  Company's  financial  position  and results of
         operations.

12.      Investments in GlobalStake.com

                  In November 1999, Teknowledge agreed to provide seed money for
         a new web-based real estate  company,  GlobalStake.com,  which was spun
         off from  Teknowledge  Corporation.  GlobalStake.com  will provide full
         service,    discounted    real    estate    transactions    under   the
         ExploreRealty.com   trade   name.   Teknowledge   retained   19.9%   of
         GlobalStake.com  consisting of Series A Preferred  shares.  Teknowledge
         currently maintains this percentage interest against dilution through a
         warrant to acquire Common Stock until an IPO or  acquisition,  and also
         has an aggregate liquidation  preference over common shares. As long as
         Teknowledge  owns less than 20% of  GlobalStake.com,  the Company  will
         account for the  investment in  GlobalStake.com  using the cost method.
         Teknowledge  expects  to  provide:  (1)  approximately   $1,200,000  in
         cumulative seed cash and services; (2) the proprietary  information and
         technology  developed in support of the GlobalStake.com  business plan;
         and (3) licenses to practice  Teknowledge's  patent  portfolio.  Former
         Chairman and CEO of  Teknowledge,  Rick  Hayes-Roth,  resigned from his
         position of CEO and  Director  of the Company and was elected  Chairman
         and CEO of GlobalStake.com. Neil Jacobstein was elected to serve on the
         GlobalStake.com Board of Directors.