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                  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, 1998

[   ] 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. $12,200,849

The aggregate  market value of Common Stock,  $.01 par value per share,  held by
non-affiliates of the registrant was $23,113,493 on March 22, 1999 (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 22, 1999, there were 4,968,546  shares of Common Stock,  $.01 par value
per share, of the registrant outstanding.

                       Documents Incorporated by Reference
   Proxy Statement for the 1999 Annual Meeting of Stockholders      Part III



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Teknowledge(R)  and  Copernicus(R)  are  registered  trademarks  of  Teknowledge
Corporation.  Sales Associate(TM) is a trademark 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 Internet  knowledge
system  business.  Almost  all  of  Teknowledge's  projects  involve  processing
application  knowledge and  distributing  it over the Internet.  Teknowledge  is
leveraging 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  ("E-Commerce")
Systems. Each program area does application assessments for customers,  utilizes
third party software components in delivering  customer solutions,  and conducts
research  and  development  ("R&D").  The  Company  is  increasing  its focus on
commercial  software  products  and  services,  particularly  in the  E-Commerce
market;  however,  this transition takes time.  Teknowledge has become a Premier
Provider  for  IBM's  Net.Commerce(TM)  product,  and  is now  also a  Microsoft
Certified  Solution Provider and a CheckPoint Value Added Reseller  ("VAR").  In
addition,  Teknowledge  sells its own Sales  Associate(TM)  software for selling
products on Internet  E-Commerce web sites.  However,  the customer base for the
Company's  products  and services  currently  consists  primarily of  government
related  projects.  For the year ended December 31, 1998,  the Company's  direct
revenue mix from continuing  operations was  approximately 99% government and 1%
commercial products and services. This ratio is expected to change as E-Commerce
related investment and customer solution  capabilities  increase over the coming
years.

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

Overview

         The   information   economy   places  a   competitive   premium  on  an
organization's  ability to process and  distribute  its  knowledge  effectively.
Knowledge has become the primary competitive weapon in the economic and military
battlespace.  However,  knowledge  acquired by people  often does not get reused
because it is 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  software   architectures  and  programs  that  integrate
conventional  software and knowledge systems in high-value Internet  application
solutions.  These solutions are developed through software products and services
which  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. This value chain will drive the growth of Teknowledge's business.

         Teknowledge  operates five business  programs within a single reporting
segment. The Distributed Systems Engineering program provides the foundation for
optimizing the quality of Internet service  delivered through the use of network
resources.  The Data Fusion and Situation  Assessment  program develops software
algorithms that refine information from multiple sources into a coherent body of
knowledge  that can be acted  upon.  The  Education  and  Training  Technologies
program  encapsulates   knowledge  into  reusable  media,  develops  intelligent
tutoring  systems to communicate  that  knowledge,  and distributes the tutoring

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systems over the World Wide Web. The Information  Assurance program develops and
installs  software to protect the  information  stored in computer  networks and
ensures that  information  is  accessible by the right people at the right time.
Finally,  Teknowledge's  E-Commerce Systems business program provides commercial
software  products and services that enable  corporations  to manage their sales
knowledge and sell products effectively over the Internet.

         Each of Teknowledge's  business programs 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 Sales Associate product is one such example. It is an Internet web
site  sales  component  that can be sold with  storefronts  and  databases  from
companies  such as IBM 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.  The customer gets a faster and more robust solution,  and Teknowledge
gets 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 beginning a transition  from a primary focus on R&D to increasing
focus on delivering application solutions to customers.

         Since the U.S. Department of Defense and many commercial businesses are
now conducting  large-scale operations over international computer networks such
as 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 associate systems software that amplifies human productivity and
the ability to apply knowledge effectively.  Teknowledge has built six prototype
associate systems and  commercialized  one. These systems include:  the Briefing
Associate,  the Parent's Associate,  the Student's Associate, the Project Center
Associate, the Desktop Associate, and the commercial Sales Associate.

Business Programs

         Teknowledge has distributed  operations,  with its headquarters located
in Palo Alto,  California  and offices in San Diego,  California;  Arlington and
Fairfax,  Virginia;  and Orlando,  Florida.  The Company  operates five business
programs  within its current  operations:  four focused  primarily on government
customers and one,  E-Commerce,  focused entirely on commercial  customers.  The
government programs currently contribute over 99% of the revenue;  therefore all
programs are reported as a single segment.

Distributed Systems Engineering.  Operations that are widely distributed require
extensive object-oriented systems infrastructure.  Currently, the World Wide Web
provides  little  of this  systems  infrastructure,  but  instead  relies on the
distribution  of linked  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,
security of operations,  maintainability, and distribution by intelligent "push"
and  "pull"  techniques.  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  Engineering
program  focuses on providing  new Internet  systems  infrastructure  to address
these needs.

Situation  Assessment and Data Fusion.  Complex  problem solving in the military
and in  corporations  requires the ability to access and synthesize data quickly
and effectively from multiple  sources in order to develop a dynamic  assessment

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of an evolving battle,  emergency, or competitive situation.  Decision-makers in
government  and industry  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  necessary.
Teknowledge's  Situation Assessment and Data Fusion program focuses on providing
knowledge-based  tools and  systems  infrastructure  to fuse data from  multiple
sources and combine  those data into a cogent and often shared  perception  of a
situation.  This program is developing a situation  server,  which combines data
from  multiple  sources,  and detects  patterns or  conditions  of interest to a
customer. These conditions may in turn trigger alerts or actions to respond to a
situation quickly and effectively.

Education  and Training  Technologies.  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 1997,  it created a
program 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  1997.  The DARPA  Computer  Assisted
Education and Training Initiative  sponsored  Teknowledge's work on the Parent's
Associate and the Center  Associate.  The Parent's  Associate enables parents to
get advice on parenting and access to Internet-based  educational resources. The
Center Associate provides a computer-based  coach to help guide users in getting
the most from education resources available to them.  Teknowledge is now leading
the Business and Marketing Group of the Government  sponsored  Advanced Distance
Learning  Initiative,  which is actively developing distance learning technology
to provide cost effective  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.

Information  Assurance.  The need for information security solutions 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 E-Commerce  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 E-Commerce  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.  Some  new  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  product,  which
provides an opportunity for product license and services sales to government and
commercial information assurance applications.

E-Commerce Systems.  Teknowledge's  E-Commerce Systems business program provides
assessments of corporate  E-Commerce  strategy and  technology,  VAR services to
deliver  and  support  leading   E-Commerce   products,   and  installations  of
Teknowledge's  own Sales  Associate  software.  Teknowledge  is  focusing on the
delivery of a total web site E-Commerce solution, which incorporates one or more
leading commercial products.  This provides VAR license fees, services revenues,
and  some  pull-through   opportunities  for  selling  Teknowledge's  own  Sales
Associate  product.  The Sales Associate is a commercial  software product which
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  specializes the sales  presentation to each prospect.  It
learns and  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's profile,  selecting among web text, audio,

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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 new product in a rapidly  growing,  but still  unformed  market.
There are  uncertainties  and risks  associated with the introduction of any new
software  product (see Part II, Item 6),  however,  the Company has continued to
evolve  Sales  Associate  capabilities  to help make the  product  a  commercial
success.

Sales and Marketing

         Teknowledge's  services  and  software  are  marketed  primarily by the
Company's employees,  including the Chief Executive Officer, the President,  and
business program managers.  Each business program offers consulting  services to
help  prospective  customers  define  their  problems and  projects.  Government
proposal work conducted in response to a Broad Area  Announcement or Request for
Proposal is typically not funded. However,  consulting assignments are funded to
evaluate  current  corporate  E-Commerce  capabilities and recommend next steps,
including application work.

         Teknowledge has increased its commercial sales and marketing efforts to
lay the foundation for increased commercial business. In 1998, the Company began
implementation  of its VAR strategy and has achieved VAR and premier status from
IBM as a member of its award-winning  BESTeam software business partner program.
It is now a Microsoft Certified Solution Provider, and a CheckPoint VAR partner.
The Company is offering  value-added  services for leading  commercial  products
with  considerable  market  demand.  This should  provide  license and  services
revenues,  and broaden market acceptance of Teknowledge's  product by increasing
our access to an expanded base of commercial customers.

Backlog

         At December 31, 1998, the expected order backlog was  approximately $15
million,  which consisted of (i) new orders for which work has not yet begun and
(ii) revenue remaining to be recognized on work in progress. One hundred percent
of the December 31, 1998 backlog is from government customers. Approximately 75%
of the backlog  consists of  government-sponsored  programs that are awarded but
not yet  authorized  for funding.  The  government  normally funds a contract in
incremental  amounts for the tasks that are currently in production.  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  reasonably  expected to be  fulfilled  in the current
fiscal year is approximately 50%.

Research and Development

         Almost all of the Company's software engineering operations, except for
the E-Commerce business program, were related to advanced government development
projects.  As  a  result,  the  Company's  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.  From time
to time the Company 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 $132,501 and $206,603 of its own
funds on R&D for the years ended  December 31, 1998 and 1997,  respectively.  In
addition,  the Company  capitalized  $267,046  and $10,712 of computer  software
development costs in the years ended December 31, 1998 and 1997, respectively.


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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 advantage is its experienced  management team,
its extraordinary  technical talent base, its extensive  intellectual  property,
and its leading-edge R&D program.  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 Trinzic Corp. Distributed systems engineering,  data fusion, 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 are mostly in the
R&D stage,  with  competitors  still  emerging  in the  commercial  marketplace.
Potential  competitors  could  also be  collaborators,  such as  Macromedia  and
Asymetrix Learning Systems, Teknowledge's technology suppliers on our Courseware
Factory project.

Proprietary Rights

         Teknowledge  maintains  an active  intellectual  property  program  and
currently holds eight U.S. software patents.  The application software developed
by Teknowledge  includes the Sales Associate for configuring  automated sales on
the Internet,  knowledge-based expert systems, pattern detection and data fusion
tools,  and systems to manage and protect webs of networked  information.  Sales
Associate  is a  trademark  of  the  Company.  The  COPERNICUS(R)  trademark  is
registered  in the U.S.  and many foreign  jurisdictions.  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.


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Government Contracts

         In  1998,  approximately  99%  of  the  Company's  revenues  were  from
cost-type  government  contracts,  and 100% of its December 31, 1998 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 is a "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
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 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.  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,  and did not have a material
effect on 1998 results due to the Company's  ability to utilize  technical staff
on alternate  projects.  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  certain
allowable costs (less than 1% of total costs in 1998), 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  some  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.


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Employees

         Including contract  engineers and temporaries,  the Company had a total
of 57 full time  employees at December 31, 1998. All the employees were employed
in the  continental  United  States.  The majority of  employees,  including top
management,  are technical.  They perform  direct  billable work on contracts or
develop and support  software  products.  A core group of  administrative  staff
performs  general  and  administrative  functions.  A  large  percentage  of the
employees 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.  The Company
has  never  had a  work  stoppage,  and  it is not a  party  to  any  collective
bargaining agreement with any of its employees.

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, 1996, with an option to extend the lease for an additional three years.
The Company is currently  finalizing the renewal of this lease.  The Company has
also  signed  renewable  leases  for  office  space in  Arlington  and  Fairfax,
Virginia; and San Diego, California.

         In January 1994, the Company  entered into a settlement  agreement with
the landlord for its former Franklin, Massachusetts location. Under the terms of
this  agreement,  the lease scheduled to expire in May 1999 was terminated for a
total consideration, including accrued interest, of $131,760 which is to be paid
in  escalating  payments over a five-year  period.  The last payment was made on
January 31, 1998 and no liability remained as of December 31, 1998.

         In September 1993, the Company entered into a settlement agreement with
the landlord at the former Bridgeville,  Pennsylvania location.  Under the terms
of the agreement,  the Company will avoid an annual settlement amount of $18,306
unless there exists a differential  in rent between what the new tenant pays and
what the Company was expected to pay during the term of the original lease.  The
settlement  agreement  provides for a maximum  payment of $18,306 by the Company
per annum until  1998.  There has been no such rent  assessment  to date and any
liability previously recorded was written off in its entirety as of December 31,
1998.

Item 3.  Legal Proceedings

         During 1998, the Company entered into a cash settlement  agreement with
Dan Robusto,  a former executive of the Company,  in the amount of $80,000.  The
settlement  resolves all severance claims made by the former executive  relating
to a 1994 lawsuit.

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 1998.




<PAGE>
                                       9


                                     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 22,
1999 the closing "bid" price of the stock was $5.75 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.

                         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


                         1997                        High                  Low

     First quarter, ended March 31, 1997           $ 2.95               $ 1.90
     Second quarter, ended June 30, 1997             3.40                 1.90
     Third quarter, ended September 30, 1997         2.55                 2.15
     Fourth quarter, ended December 31, 1997         3.25                 2.15

         As of December  31,  1998 there were 1,804  holders of record of Common
Stock of the Company.




<PAGE>
                                       10


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

Overview of Significant Matters

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

                          Year Ended December 31, 1998
                            Quarterly Results Summary
                    (In thousands, except for per share data)

                                First     Second    Third     Fourth       Total
Revenues                       $3,070     $3,081   $3,070     $2,980     $12,201
Costs and Expenses              2,867      2,931    2,816      2,901      11,515
Other and Tax Provision            17         36       19         28         100
Net Income                        220        186      273        107         786
Diluted Net Income per share      .04        .03      .05        .02         .14

         Teknowledge's  revenues for the year ended  December 31, 1998 increased
to $12,200,849,  a 10% improvement  over 1997. In both 1998 and 1997, 99% of the
revenues were from Federal  government  agencies.  Revenue  growth was fueled in
part from new contracts  awarded  primarily in 1997 and early 1998. During 1998,
approximately  $14 million of the Company's backlog of new work was reduced when
the government curtailed spending on several of their ongoing contracts.  DARPA,
the agency that funds most of our contracts,  experienced  extensive turnover in
management,  and the new DARPA  management  team  decided to review and  reshape
existing  programs until it finalizes its long-term  strategic plan. The Company
decided to reduce its backlog by the full  amount.  The Company  previously  had
never  experienced any material  contract  cancellations.  The effect on revenue
from these terminations is spread over several years and did not have a material
effect on 1998 results.  The Company  continues to submit proposals for new work
to the government and commercial organizations.

         The Company  intends to increase its  investment in the  development of
commercial  products in 1999 and to accelerate the transition from dependence on
government R&D contracts. In 1999, our focus is on the growth and scalability of
our commercial E-Commerce business. In general, our business strategy will be to
1) enhance and leverage our web-based  software such as Sales  Associate and the
NIST  Courseware  Factory,  2) deliver  commercial VAR services and licenses for
third party E-Commerce products,  3) license our software patents, and 4) pursue
a  strategy  of  growth  through  one or more  strategic  acquisitions  of small
commercial software companies.  The Company,  however, may not identify suitable
strategic  acquisitions  or may not be able to negotiate an acquisition on terms
acceptable  to  the  Company.  In  addition,  there  are  significant  risks  in
consolidating businesses.

         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, 1998, 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 will  increase  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  (see  Notes 1 and 6 of  Notes  to  Consolidated  Financial
Statements.)


<PAGE>
                                       11


         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, 1998 as a result of this evaluation.

         During  the third  quarter of 1998,  the  Company  reached an  amicable
settlement  with a former  executive of the Company which  required a payment of
$80,000  to the  former  executive.  With the  settlement  of this  action,  all
outstanding  lawsuits  involving the Company were eliminated (see Part 1 Item 3.
Legal Proceedings).

         Net income was $785,620,  or $.14 diluted earnings per share, for 1998;
and was $2,759,654,  or $.48 diluted earnings per share, for 1997.  During 1997,
the Company  reported  the  settlement  of a patent  matter for $1.1 million and
recorded  a  deferred  tax  asset  of  $900,000,   which  together   contributed
approximately  $.35 to earnings.  Operating  income was 6% of revenues,  both in
1998 and 1997.

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

         Teknowledge's  service  revenue is  currently  derived  primarily  from
government R&D contracts,  and the Company has  historically  been profitable in
that business.  However, dependence on government contracts can be risky because
the  contracts  are  subject  to  administrative,   legislative,  and  political
interruptions,  which may jeopardize the flow of funds.  Another  uncertainty 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 under government contracts is
the Company's ability to attract and retain  sufficient  technical staff to meet
the demands of new orders.  The Company also  recognizes that the loss of one or
more key management and technical  personnel could  adversely  affect aspects of
the Company's  business.  To mitigate this risk,  several senior program manager
positions were created in recent years. The Company relies on its executives and
program  managers for the  acquisition  and  negotiation  of government  awards,
preparation  of  proposals,  and the general  direction  and  management  of the
Company.  The Company believes that its future success depends on attracting and
retaining highly skilled technical personnel and other employees.

         Management  believes  that  the  market  for  Internet  software  is  a
significant  new  opportunity  for the  Company  and that it is in an  excellent
position to convert  software  developed under government R&D contracts into new
commercial products.  The market for Internet software,  however, is at an early
stage of  development,  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.  Further,  aspects of the
Internet  (including  security,  reliability,  cost,  ease of use and quality of
services) are  undergoing  rapid  evolution that may affect growth of the use of
the Internet in general and of Internet  software in particular.  The demand for
Internet  software  will require  broad  acceptance of new methods of conducting

<PAGE>
                                       12


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  in the  marketplace  be  estimated  at this time due to the  explosive
growth and competitive  nature of the  environment.  As the market  continues to
expand,  there can be no assurance  that the Company will be able to develop and
bring  to  market  products  that  will  gain  market   acceptance  or  generate
significant  revenue or profits. If the Internet E-Commerce develops more slowly
than expected, becomes saturated with competitors,  or if the Company's products
for  the  Internet  market  do not  achieve  market  acceptance,  the  Company's
business,  financial condition,  and results of operations may be materially and
adversely affected.

         The  Company's  operating  results are  affected  by a wide  variety of
factors,  including  successful  commercialization  of the  Company's  products,
competition  from  larger  companies,  ability to staff and  recruit  employees,
general economic conditions, and government intervention.

Year 2000

         The Company is aware of and is addressing  the issues  associated  with
the programming code in existing computer systems as the millennium ("year 2000"
or "Y2K")  approaches.  The key issue is whether  computer systems will properly
recognize  date-sensitive  information  when  the  year  changes  to  2000.  The
consequences  of this issue may include  systems  failures and business  process
interruption.

         Although  most of the  hardware  and  software  currently in use at the
Company  are  relatively  new and  expected to be Y2K  compliant,  the issue can
affect the Company's internal systems, including information technology (IT) and
non-IT  systems.  The Company has begun its  assessment  of the readiness of its
systems for handling Y2K, by inventorying and analyzing its centralized computer
and embedded systems to identify any potential  issues.  Although the assessment
is still underway,  management believes that no significant  remediation efforts
and compliance expenses inside the Company are necessary. The Company expects to
substantially complete the remaining validation and remediation,  if any, of its
internal systems,  as well as to develop  contingency plans for certain internal
systems,  by  mid-1999.  However,  if  implementation  of  remediation  plans is
delayed,  if  significant  new  non-compliance  issues  are  identified,  or  if
contingency  plans  fail,  the  Company's  results of  operations  or  financial
condition could be materially adversely affected.

         Almost all of the  Company's  revenues  are  currently  generated  from
government  R&D  service  contracts,  the  deliverable  of which is  sometimes a
software  prototype.  The  government  requires  from the Company a Y2K warranty
within the contracts,  which generally  guarantees all software  delivered under
government contracts to be able to accurately process date-sensitive information
beyond Y2K, to the extent other third party elements used in combination are Y2K
compliant.  In the case of  noncompliance  discovered  and  communicated  to the
Company  within a prescribed  timeframe,  usually 90 days from  acceptance of an
item, remedies in the form of repair or replacement will be made available.  The
Company is exposed  only on ongoing  government  contracts,  and  believes  that
software developed under them are Y2K compliant.

         The Company is currently addressing its exposure related to significant
third parties.  Key suppliers and vendors are being  identified and contacted to
determine if their  operations  and/or the products and services they provide to
the Company are Y2K  compliant.  The Company  believes its  financial  reporting
systems are  compliant.  The Company plans to replace its  telephone  system and
upgrade  its  internal  security  system,  if  required,  before  year-end.  The
Department of Defense  ("DoD") is confident  that  payments to its  contractors,
among others,  will  continue  uninterrupted  in January  2000.  The DoD payment
systems are Y2K compliant  and are targeted to be on Y2K compliant  platforms by
the end of May 1999.  Since the majority of DoD payments are made by  electronic
funds  transfer  (EFT),  systems will be tested with the Federal  Reserve System
(FRB) and several financial  institutions in the June-July 1999 time period. The
Company intends to continue  working  directly with other material third parties
to avoid any business interruptions in Y2K. Where practicable,  the Company will
attempt to  mitigate  its risks with  respect to the  failure of other key third
parties to be Y2K ready,  including developing  contingency plans. However, such
failures,  including failures of any contingency plans, remain a possibility and
could have a materially adverse impact on the Company's results of operations or
financial condition.


<PAGE>
                                       13


Results of Operations

         1998 compared to 1997

         Revenues  rose  $1,105,919,  or  10%,  to  $12,200,849  in  1998,  from
$11,094,930 in 1997.  Revenue from service  contracts awarded by agencies of the
Federal government  accounted for 99% of total revenues.  Revenues are generated
when direct labor or other direct costs, such as subcontractors and consultants,
are incurred in the  performance of contracts.  Between 1997 and 1998,  revenues
increased  primarily  because of anticipated  growth in the demand for technical
services on government  contracts awarded in previous  periods.  Due to changing
priorities at the government  customer agency,  a number of long-term  contracts
were  concluded  late in 1998.  The effect of this change in priorities  was not
evident in 1998, but it may adversely affect future revenue growth.  The company
often engages  subcontractors and consultants to work on larger and more complex
projects.  Teaming  arrangements  help the  Company  compete  for new  business,
because they  complement  our skill set.  For the year ended  December 31, 1998,
subcontractor  and consultant costs were  $2,760,906,  compared to $2,417,308 in
1997.  The  subcontractor  and  consultant  costs incurred by the Company in the
performance  of the contracts are  reimbursed by the  government and the results
are reflected in revenues.

         Cost of revenues  increased 9% to $8,244,290 in 1998 from $7,575,634 in
1997.  The  increase was mostly  attributable  to the  aforementioned  growth in
contract services and use of subcontractors and consultants,  the costs of which
accounted for nearly 33% of the total cost of revenues in 1998.  Since  revenues
and cost of  revenues  grew at  approximately  the same rate,  cost of  revenues
remained at 68% of revenues in 1998 and 1997.

         General and administrative costs were $2,373,789 and $2,122,499 in 1998
and 1997, respectively. The Company experienced cost increases related to office
rents, information system consultants, placement advertising, and director fees.
Overall,  general and administrative costs were relatively stable between years,
reflecting the Company's  conscientious effort to control  administrative costs.
General and  administrative  costs remained at 19% of revenues  between 1998 and
1997.

         Sales and marketing costs  increased  $229,165 to $764,911 in 1998 from
$535,746  in  1997,  as the  Company  built a team  and  dedicated  increasingly
substantial  resources  to market  and sell  commercial  Internet  products  and
services.  The  Company's  sales  and  marketing  efforts  include  applications
engineering and technical support, direct sales efforts, as well as trade shows,
demonstrations, advertising and other traditional marketing activities.

         The Company  expended  $132,501 of its internally  funded  research and
development   ("R&D")  costs  in  1998  and  $206,603  in  1997.   Most  of  the
Company-sponsored R&D was concentrated in the development of commercial products
for the Internet.  The  development of commercial  products for the Internet has
not achieved  significant  revenues to date.  The majority of the  Company's R&D
efforts were funded externally through government projects (and recorded as cost
of  revenues),  which are  expected to provide  the basis for future  commercial
development opportunities.  The Company also capitalized $267,046 and $10,712 of
computer  software  development  costs in the years ended  December 31, 1998 and
1997, respectively.

         Interest  income was  $102,945  in 1998  versus  $83,229  in 1997.  The
increase was primarily due to increased  cash  balances  during the year.  Other
income and expense decreased to $2,065 in 1998 from $1,145,108 in 1997. Included
in other income in 1997 was the  aforementioned  settlement of a patent  lawsuit
with Trilogy  Development Group that accounted for approximately $1.1 million of
other income.

         Net income in 1998 was $785,620 versus $2,759,654 in 1997.  Diluted net
income per share was $.14 for 1998 and $.48 in 1997.



<PAGE>
                                       14


Liquidity and Capital Resources

         As of December  31,  1998,  unused  sources of liquidity of the Company
were $2,378,390 in cash and cash  equivalents,  an increase of $206,155 over the
previous  year.  The  Company  generated  cash  reserves  of  $570,282  from its
operating  activities  and $102,962  from  issuance of common stock to employees
exercising their stock options. It invested $267,046 for developing  capitalized
software   and  $198,122  for   purchases  of  computer   equipment   and  other
improvements.

         The  Company   believes  that  the  present  level  of  cash  and  cash
equivalents  is adequate to service the liquidity  needs of the Company in 1999.
The Company  relies  principally  on the  collection of  receivables to generate
internal cash reserves.

         The  Company  has  an  unsecured   line  of  credit  from  a  financial
institution in the amount of $2,000,000.  The Company may borrow up to the lower
of 60% of the receivable base or $2,000,000 at a rate of one percent over Prime.
The line is subject to certain covenants and maintenance  requirements that have
been fulfilled.  The line expires in June 1999 and is renewable. The Company did
not utilize the credit line in 1998.

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>
                                       15


                                    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 and executive
officers of the Company is  incorporated  herein by  reference  to the  sections
entitled  "Election  of  Directors"  and  "Executive  Compensation  - Employment
Arrangements"  included in the definitive proxy statement for the Company's 1999
Annual Meeting of Stockholders (the "1999 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
1999 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 1999
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 1999 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

        3.2       Amended and Restated Bylaws of Teknowledge Corporation

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


<PAGE>
                                       16


Exhibit No.                Description

       10.2       Teknowledge Corporation 1998 Stock Option Plan (3)

       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.

(b)      Reports on Form 8-K

         None.

(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.


<PAGE>
                                       17


                                   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, 1999                     By:   /s/ Frederick Hayes-Roth
                                                ------------------------
                                                Frederick Hayes-Roth
                                                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/ Frederick Hayes-Roth           Chairman of the Board         March 30, 1999
------------------------------     of Directors and
Frederick Hayes-Roth               Chief Executive Officer
                                   (Principal Executive
                                   Officer)

/s/ Neil A. Jacobstein             President, Chief Operating    March 30, 1999
------------------------------     Officer and Director
Neil A. Jacobstein                 

/s/ Dennis A. Bugbee               Director of Finance,          March 30, 1999
------------------------------     Treasurer and Secretary
Dennis A. Bugbee                   (Principal Financial and
                                   Accounting Officer)
                                   
/s/ Lawrence Druffel               Director                      March 30, 1999
------------------------------
Lawrence Druffel

/s/ General Robert T. Marsh        Director                      March 30, 1999
------------------------------
General Robert T. Marsh (Ret.)

/s/ William G. Roth                Director                      March 30, 1999
------------------------------
William G. Roth

/s/ James C. Workman               Director                      March 30, 1999
------------------------------
James C. Workman










<PAGE>
                                       18


                         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, 1998 AND FOR THE TWO YEARS ENDED DECEMBER 31, 1998

                             TEKNOWLEDGE CORPORATION

                              PALO ALTO, CALIFORNIA







<PAGE>
                                       19


                             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                                      20

Consolidated Balance Sheet - December 31, 1998                                21

Consolidated Statements of Operations and Comprehensive Income
- Years ended December 31, 1998 and 1997                                      22

Consolidated  Statements of Stockholders' Equity - Years ended 
December 31, 1998 and 1997                                                    23

Consolidated Statements of Cash Flows - Years ended 
December 31, 1998 and 1997                                                    24

Notes to Consolidated Financial Statements                               25 - 35




<PAGE>
                                       20


                    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, 1998, and
the related  consolidated  statements of operations  and  comprehensive  income,
stockholders'  equity and cash flows for the years ended  December  31, 1998 and
1997.  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  generally   accepted  auditing
standards.  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,  1998,  and the results of their  operations  and
their cash flows for the years ended  December  31, 1998 and 1997 in  conformity
with generally accepted accounting principles.


/s/ Arthur Andersen LLP   
-----------------------     
Arthur Andersen LLP



San Jose, California
February 10, 1999


<PAGE>
                                       21


                 TEKNOWLEDGE CORPORATION
                CONSOLIDATED BALANCE SHEET
                 As of December 31, 1998

                          ASSETS

Current assets:

    Cash and cash equivalents                              $    2,378,390
                                                             -------------
    Receivables:
       Customer - billed, net of allowance of $10,000           2,471,242
       Customer - unbilled                                         62,541
                                                             -------------
           Total receivables                                    2,533,783
                                                             -------------

    Deferred tax asset, short-term                                400,000
    Deposits and prepaid expenses                                 116,255
                                                             -------------
       Total current assets                                     5,428,428
                                                             -------------

Capitalized software development costs, net of accumulated
    amortization of $11,562                                       267,206
                                                             -------------
Fixed assets, at cost
    Computer and other equipment                                2,939,274
    Furniture and fixtures                                        112,647
    Leasehold improvements                                        838,398
                                                             -------------
                                                                3,890,319
    Less accumulated depreciation and amortization             (3,385,942)
                                                             -------------
                                                                  504,377
                                                             -------------
Deferred tax asset, long-term                                     500,000
                                                             -------------
Total assets                                               $    6,700,011
                                                             =============


           LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable                                       $      661,321
    Payroll and related                                           678,514
    Other accrued liabilities                                     267,863
                                                             -------------
       Total current liabilities                                1,607,698
                                                             -------------
Commitments and contingencies (Note 4 and 11)

Stockholders' equity:
    Preferred stock, $.01 par value, authorized 2,500,000
       shares, Series A, Convertible, none issued                       -
    Common stock, $.01 par value, authorized 25,000,000
       shares, issued and outstanding 4,954,954 shares             49,550
    Additional paid-in capital                                  1,553,980
    Retained earnings since January 1, 1993
       (following quasi-reorganization)                         3,488,783
                                                             -------------
       Total stockholders' equity                               5,092,313
                                                             -------------
Total liabilities and stockholders' equity                 $    6,700,011
                                                             =============


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



<PAGE>
                                       22


                        TEKNOWLEDGE CORPORATION
                 CONSOLIDATED STATEMENTS OF OPERATIONS
                        AND COMPREHENSIVE INCOME


                                                 Years ended December 31,
                                                      1998         1997
                                                      ----         ----

Revenues                                        $12,200,849 $ 11,094,930
                                                 ----------  -----------

Costs and expenses:
  Cost of revenues                                8,244,290    7,575,634
  General and administrative                      2,373,789    2,122,499
  Sales and marketing                               764,911      535,746
  Research and development                          132,501      206,603
                                                 ----------  -----------
   Total costs and expenses                      11,515,491   10,440,482
                                                 ----------  -----------
   Operating income                                 685,358      654,448

Interest income                                     102,945       83,229
Other income and expense, net (Note 10)               2,065    1,145,108
                                                 ----------  -----------
Income before taxes                                 790,368    1,882,785
Provision (benefit) for income taxes                  4,748     (876,869)
                                                 ----------  -----------
Net income and comprehensive income             $   785,620 $  2,759,654
                                                 ==========  ===========

Net income per share:

                     - Basic                    $      0.16 $       0.56
                                                 ==========  ===========
                     - Diluted                  $      0.14 $       0.48
                                                 ==========  ===========

Shares used in computing net income per share:

                     - Basic                      4,887,910    4,942,900
                                                 ==========  ===========
                     - Diluted                    5,763,361    5,775,787
                                                 ==========  ===========



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


<PAGE>
                                       23


<TABLE>

                             TEKNOWLEDGE CORPORATION
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<CAPTION>

                                                                  Retained
                                 Common Stock      Additional     Earnings
                               Shares       Par      Paid-in    (Accumulated   Treasury
                               Issued      Value     Capital      Deficit)       Stock       Total
                               ------      -----     -------    ------------   --------      -----

<S>                           <C>       <C>       <C>         <C>            <C>         <C>        
Balance,  January 1, 1997     5,219,354 $  62,748 $ 2,191,013 $      (56,491)$    (3,000)$ 2,194,270

Exercise of stock options        49,783     2,490      16,078              -           -      18,568

Net income                            -         -           -      2,759,654           -   2,759,654

Reversal of portions of
   provisions made prior to
   quasi-reorganization for
   restructuring reserve              -         -     193,306              -           -     193,306

Common stock received from
   Trilogy settlement                 -         -           -              -  (1,005,757) (1,005,757)

Retirement of treasury stock   (472,594)  (23,630)   (985,127)             -   1,008,757           -
                             -----------  --------  ----------  -------------  ----------  ----------

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
                             ===========  ========  ==========  =============  ==========  ==========


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

</TABLE>



<PAGE>
                                       24


<TABLE>
                             TEKNOWLEDGE CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<CAPTION>

                                                          Years ended December 31,
                                                              1998           1997
                                                              ----           ----
Cash flows from operating activities:
<S>                                                     <C>           <C>         
  Net income                                            $   785,620   $  2,759,654
  Adjustments to reconcile net income to net cash
  provided by operating activities:
   Depreciation and amortization                            319,578        326,805
   Noncash portion of other income from Trilogy Settlement        -     (1,005,757)
   Deferred tax asset                                             -       (900,000)
   Changes in assets and liabilities:
    Receivables                                            (245,030)      (999,350)
    Deposits and prepaid expenses                           (18,350)       (36,453)
    Accounts payable                                        (41,577)       493,136
    Accrued liabilities                                    (229,959)       225,852
                                                          ----------    -----------
   Net cash provided by operating activities                570,282        863,887
                                                          ----------    -----------

Cash flows from investing activities:
  Capitalization of software development costs             (267,046)       (10,712)
  Purchase of fixed assets                                 (198,122)      (497,400)
                                                          ----------    -----------
   Net cash used for investing activities                  (465,168)      (508,112)
                                                          ----------    -----------

Cash flows from financing activities:
  Proceeds from issuance of common stock                    102,962         18,568
  Redemption of fractional shares from reverse stock split   (1,921)             -
                                                          ----------    -----------
   Net cash provided by financing activities                101,041         18,568
                                                          ----------    -----------

Net increase in cash and cash equivalents                   206,155        374,343

Cash and cash equivalents at beginning of year            2,172,235      1,797,892
                                                          ----------    -----------
Cash and cash equivalents at end of year                $ 2,378,390   $  2,172,235
                                                          ==========    ===========
</TABLE>



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


<PAGE>
                                       25


                             TEKNOWLEDGE CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

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.  As of December
         31, 1998,  there was no remaining  accrued  liability for  discontinued
         operations  or  restructuring  obligations  and no  benefits  have been
         recorded for tax loss and credit carryforwards  existing at the date of
         the quasi-reorganization (see Note 6).

                  The  Company is in the  Internet  knowledge  system  business.
         Almost all of  Teknowledge's  projects involve  processing  application
         knowledge  and  distributing  it  over  the  Internet.  Teknowledge  is
         leveraging  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
         ("E-Commerce") Systems.

                  The  Company  recognizes  that the  continued  success  of the
         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.

         Consolidated Financial Statements

                  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>
                                       26


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, 1998, 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  contracts.  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, 1993.

         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 1998 and 1997,
         software  development  costs of $267,046 and $10,712 were  capitalized,
         respectively.  Amortization  costs were  $27,238 in 1998 and $83,408 in
         1997.

                  The  Company's  policy  is to  amortize  capitalized  software
         development  costs by the greater of (a) the ratio that  current  gross
         revenues  for a product  bear 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.

         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>
                                       27


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 both  1998 and  1997,  approximately  99% of the  Company's
         revenues were recorded in connection  with U.S.  Government  contracts,
         principally  of  the  cost-plus-fixed-fee  type.  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, 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.  For the  year ended  December 31, 1997,  the DARPA
         Information Systems Office was the sponsor  for the first three largest
         government  contracts,  accounting  for  approximately  32%  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>
                                       28


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

         Net Income Per Share

                  Basic  earnings per share is calculated by dividing net income
         by the weighted average shares of common stock  outstanding  during the
         period. Diluted earnings per share 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,  1998 and 1997 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.

                                                            1998           1997
                                                            ----           ----
         Basic earnings per share:
             Net income                                 $     786       $  2,760
                                                        ---------       --------
             Weighted average common shares                 4,888          4,943
                                                        ---------       --------
         Basic earnings per share                       $    0.16       $   0.56
                                                        =========       ========

         Diluted earnings per share:
             Net income                                 $     786       $  2,760
                                                        ---------       --------
             Weighted average common shares                 4,888          4,943
             Weighted average common shares equivalent:
                  Options                                     875            833
                                                        ---------       --------
             Diluted weighted average common shares         5,763          5,776
                                                        ---------       --------
         Diluted earnings per share                     $    0.14       $   0.48
                                                        =========       ========

         Accounting for Stock-Based Compensation

                  Effective  January 1, 1997, the Company 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 APB Opinion No. 25 and
         related  interpretations  in accounting for the Company's  stock plans.
         Note 9 to the Consolidated  Financial  Statements contains a summary of
         the pro forma effects on reported net income and earnings per share for
         1998 and 1997  based on the fair  value of the  options  granted at the
         grant date as prescribed by SFAS No. 123.




<PAGE>
                                       29


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
         ("FASB") issued SFAS No. 133,  "Accounting  for Derivative  Instruments
         and Hedging  Activities" which requires  companies to record derivative
         financial  instruments  on the balance sheet as assets or  liabilities,
         measured at fair value.  Gains or losses  resulting from changes in the
         values of those derivatives would be accounted for depending on the use
         of the  derivative and whether it qualifies for hedge  accounting.  The
         key  criterion for hedge  accounting  is that the hedging  relationship
         must be highly effective in achieving  offsetting changes in fair value
         or cash flows. SFAS No. 133 is effective for all fiscal quarters of all
         fiscal years  beginning  after June 15, 1999.  This  Statement will not
         have a material  impact on the  financial  condition  or results of the
         operations of the Company.

                  In March 1998, the Accounting Standards Executive Committee of
         the American Institute of Certified Public  Accountants  (AICPA) issued
         Statement of Position (SOP) 98-4,  "Deferral of the Effective Date of a
         Provision of SOP 97-2,  `Software Revenue  Recognition,'"  which defers
         for one year the application of provisions in SOP 97-2 which limit what
         is considered  vendor-specific  objective evidence of the fair value of
         the  various  elements  in a multiple  element  arrangement.  All other
         provisions  of SOP 97-2 remain in effect.  This SOP was effective as of
         March  31,  1998.  In  October   1998,   the  AICPA  issued  SOP  98-9,
         "Modification of SOP 97-2, `Software Revenue Recognition,' With Respect
         to Certain  Transactions,"  which  amends  paragraphs  11 and 12 of SOP
         97-2, Software Revenue  Recognition,  to require recognition of revenue
         using the "residual value method" under certain  conditions.  Effective
         December 15, 1998, SOP 98-9 amends SOP 98-4, "Deferral of the Effective
         Date of a Provision of SOP 97-2,  `Software  Revenue  Recognition,'" to
         extend the deferral of the application of certain  passages of SOP 97-2
         provided by SOP 98-4 through fiscal years  beginning on or before March
         15,  1999.  All  other   provisions  of  this  SOP  are  effective  for
         transactions  entered  into in fiscal years  beginning  after March 15,
         1999. The Company does not anticipate that these statements will have a
         material adverse impact on its statement of operations.



<PAGE>
                                       30


3.       Other Accrued Liabilities

                  Other Accrued  liabilities  as of December 31, 1998 consist of
         the following:

                  Provision for contract charges        $     175,000
                  Accrual for professional services            79,280
                  Miscellaneous                                13,583
                                                        -------------
                                                        $     267,863
                                                        =============

4.       Commitments

                  Teknowledge  leases its facilities and certain equipment under
         operating  leases.  As of  December  31,  1998,  the Company had active
         leases in the following locations:

                  Location                          Date Lease Expired
                  --------                          ------------------
                  Palo Alto, California                  April 4, 1999
                  San Diego, California                   May 31, 1999
                  Arlington, Virginia                 January 31, 2002
                  Fairfax, Virginia                      June 30, 2002

                  The remaining obligations under these leases are as follows:

                                         Year Ending
                                         December 31,
                                         ------------
                  1999                   $   215,000
                  2000                       160,000
                  2001                       127,000
                  2002                        45,000
                                         ------------
                                         $   547,000
                                         ============

                  Rent  expense for the years ended  December  31, 1998 and 1997
         totaled $504,111 and $421,655, respectively.

5.       Line of Credit

                  The  Company  has  a  $2,000,000   unsecured  line  of  credit
         agreement  with a  bank.  The  line  expires  in June  1999  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. The agreement includes certain financial covenants and disclosure
         requirements  that were met during the year.  The line was not utilized
         in 1998.



<PAGE>
                                       31


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:

                                                        1998         1997
                                                        ----         ----
         Provision at U.S. statutory rate               34.0%        34.0%
         State income taxes, net of Federal benefit      6.1          6.1
         Change in valuation allowance                 (39.5)       (86.7)
                                                       ------       ------
         Provision (benefit) for income taxes            0.6%       (46.6)%
                                                       ======       ======


                  The  components  of the net  deferred  income  tax asset as of
         December 31, 1998 was as follows:

         Net operating loss carryforwards              $   24,511,845
         Cumulative temporary differences                     303,126
         Tax credit carryforwards                           1,017,339
                                                       --------------
                                                           25,832,310
         Valuation allowance                              (24,932,310)
                                                       --------------
         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,  1998,  the Company  had net  operating  loss
         carryforwards of approximately  $72 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, 1998 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>
                                       32


7.       401(k) Plan

                  Teknowledge  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  $143,333 and $115,599
         to the plan, during 1998 and 1997, respectively.

8.       Executive Compensation Plan

                  The Chief  Executive  Officer and the President of the Company
         each  have an  employment  agreement  that  provides  for  annual  base
         salaries  and an  incentive  compensation  plan with target  objectives
         established  in the five strategic  areas of cash flow,  profitability,
         bookings,  new commercial  lines, and recruiting,  that were determined
         and  assessed  by the Board of  Directors  to a maximum of 100% of base
         salary. As of December 31, 1998, $155,162 in incentive compensation was
         accrued for these  executives  and was  included  in Accrued  Payroll &
         Related Liabilities.

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 this plan 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:

                                                 1998                    1997
                                                 ----                    ----

        Net Income       As Reported         $785,620              $2,759,654
                         Pro Forma           $681,737              $2,642,156

        Diluted EPS      As Reported             $.14                    $.48
                         Pro Forma               $.12                    $.46

                  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>
                                       33


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 347,900
         shares ($2.15 - $8.60 per share) and 160,000  shares ($1.90 - $3.25 per
         share) in 1998 and 1997, respectively,  and has reserved for issuance a
         total of 1,500,219  shares  through  December  31,  1998.  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  Company  also has a stock  option  plan for  non-employee
         directors.  The aggregate  number of shares issued under the Directors'
         Plan, may not exceed 100,000 shares of Common Stock. 50,000 shares were
         available  for future grant as of December  31, 1998.  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 45,000  shares were  outstanding  as of
         December 31, 1998 at $.75 to $8.15 per share and a weighted  average of
         $4.24 per share.  Options for 33,000  shares at $.75 to $4.30 per share
         and a weighted  average of $2.82 per share were vested at December  31,
         1998. No options were exercised during the year.

                  A summary of the status of the Company's stock option plans as
         of December 31, 1998 and 1997, and changes during the years then ending
         is presented below:
<TABLE>
<CAPTION>

                                                       1998                                   1997              
                                          ----------------------------------     -------------------------------
                                                                  Wtd Avg                             Wtd Avg
                                                Shares           Ex Price              Shares        Ex Price
                                          ----------------------------------     -------------------------------
<S>                                          <C>                 <C>                <C>                <C>   
         Outstanding at beg. of year         1,268,516           $   1.75           1,209,366          $ 1.64
         Granted                               347,900               2.85             198,000            2.41
         Exercised                            (158,839)               .65             (49,783)            .37
         Forfeited                            (192,678)              6.59             (89,067)           2.60
                                          ------------                           ------------
         Outstanding at end of year          1,264,899               1.44           1,268,516            1.73
                                          ------------                           ------------

         Exercisable at end of year            890,482                .91           1,117,341            1.63
         Weighted average fair value
          of options granted                     $2.26                                  $1.35
</TABLE>




<PAGE>
                                       34


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

                  The following table summarizes information about stock options
         outstanding at December 31, 1998:
<TABLE>
<CAPTION>

                                            Options Outstanding                        Options Exercisable    
          ----------------   ------------------------------------------------     -------------------------------
                                                       Wtd Avg
                 Range of              Number        Remaining                                Number
                Ex Prices         Outstanding        Plan Life       Wtd Avg             Exercisable     Wtd Avg
                    ($'s)            12/31/98          (Years)      Ex Price                12/31/98    Ex Price   
          ----------------   ------------------------------------------------     -------------------------------
<S>          <C>      <C>                <C>           <C>            <C>                     <C>        <C>   
             .05 -    .19                700,375       5.5            $  .15                  700,375    $  .15
             .20 -   4.99                510,308       8.7              2.22                  162,891      2.12
            5.00 -  13.15                 54,216       4.8             10.73                   27,216     13.15
                             -------------------                                  -------------------
             .05 -  13.15              1,264,899       6.8              1.44                  890,482       .91
                             -------------------                                  -------------------
</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 1998 and
         1997,  respectively;  risk-free  interest rates of 5.5 and 6.3 percent;
         expected  lives of 5.5 and 5.3 years;  expected  volatility of 100% and
         50%; and expected dividend yield of 0%.

                  As of December 31,  1998,  the  following  number of shares of
         Common Stock have been reserved for future issuance under both Plans:

         Teknowledge Corporation 1998 Stock Option Plan         1,500,219
         Stock Option Plan for Non-Employee Directors              95,000
                                                                ---------
                                                                1,595,219
                                                                =========

10.      Other Income and expense

                  The composition of other income and expense is as follows:

                                                         1998               1997
                                                         ----               ----
         Settlement of patent litigation, net    $          -      $   1,145,108
         Other                                          2,065                  -
                                                 ------------      -------------
              Total                              $      2,065      $   1,145,108
                                                 ============      =============

                  On May 15, 1997,  the Company and Trilogy  Development  Group,
         Inc.  ("Trilogy")  agreed to a settlement of all  outstanding  lawsuits
         between the companies. The Settlement Agreement, License Agreement, and
         Mutual Release specifies that the Company  immediately grant to Trilogy
         a  non-exclusive,  royalty-free  license to the Company's United States
         Patent  4,591,983 in exchange for 467,794 shares of Company stock owned
         by  Trilogy,  with a fair  market  value  of  $1,006,000,  based on the
         average trading stock price over 6 months preceding the settlement, and
         $400,000 in cash.  After the provision for legal fees of $260,000,  net
         proceeds of $1,145,000 were reported as Other Income.



<PAGE>
                                       35


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 and
         the President of the Company will be entitled to severance  benefits to
         include:  (i) full  accrued  salaries 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 their most recent
         respective annual salaries.

         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 Teknowledge without paying all stockholders full and fair value.

                  Under the Plan, stockholders will receive 5 Rights to purchase
         one  one-hundredth  of a share of a new series of  Preferred  Stock for
         each  outstanding  share of Teknowledge  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.