SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
(AMENDMENT NO. 1)
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported) December 15, 1998
Level 8 Systems, Inc.
(Exact Name of Registrant as Specified in its Charter)
Delaware 0-26392 11-2920559
(State or Other Jurisdiction (Commission File Number) (I.R.S. Employer
of Incorporation) Identification No.)
1250 Broadway
35th Floor
New York, New York 10001
(Address of Principal Executive Offices)
Registrant's telephone number, including area code (212) 244-1234
N/A
(Former Name or Former Address, if Changed Since Last Report)
-1-
Item 4. Changes in Registrant's Certifying Accountant.
On December 15, 1998, Level 8 Systems, Inc. and its subsidiaries (the
"Company") dismissed Grant Thornton LLP ("Grant Thornton") as its independent
auditors.
The decision to change independent auditors was recommended by the Audit
Committee of the Board of Directors and approved by the Board of Directors.
The decision to dismiss Grant Thornton was made in conjunction with the
recently announced acquisition of Seer Technologies, Inc. ("Seer") by the
Company. Given the size of the Company following the acquisition of Seer,
the Company believed that it required a larger firm with greater resources.
The Company is in the process of selecting a new accounting firm.
Grant Thornton had served as independent auditors of the Company since
January 1998, succeeding Lurie, Besikof, Lapidus & Co., LLP, who served as
independent auditors to the Company (and the Company's predecessor entities)
for the ten years preceding its January 28, 1998 replacement by Grant Thornton.
During the most recent fiscal year and any subsequent interim period, none
of Grant Thornton's reports on the Company's financial statements contained an
adverse opinion or a disclaimer of opinion or was qualified or modified as to
uncertainty, audit scope or accounting principles.
In connection with the preparation of the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended September 30, 1998, the Company
discussed with Grant Thornton whether the Company should recognize as revenue
in the third quarter of 1998 $2.96 million the Company had billed Microsoft
Corporation. The Company expressed the view that all of that revenue should
be reflected in the third quarter. Grant Thornton expressed the view that
none of that revenue should be reflected in the third quarter. After
discussion, the Company deferred the recognition of all such revenue and
indicated in the Form 10-Q that it was in the process of determining how long
generally accepted accounting principles required the Company to continue to
defer recognizing such revenue. Subject to the foregoing, there have been no
disagreements with Grant Thornton regarding any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure. Letters from Grant Thornton have been filed as exhibits to this
report.
In planning and performing the audit of the financial statements of the
Company for the year ended December 31, 1997, Grant Thornton noted certain
internal control structure matters that it considered reportable conditions
under standards established by the American Institute of Certified Public
Accountants. Reportable conditions involve matters relating to significant
deficiencies in the design or operation of the internal control structure that
could adversely affect the organization's ability to record, process,
summarize, and report financial data consistent with the assertions of
management in the financial statements.
On or about May, 7, 1998, Grant Thornton provided the Company with an
audit communications letter regarding such reportable conditions. This
amendment to
-2-
the Company's Form 8-K filed with the Commission on December 22, 1998 sets
forth the reportable conditions discussed in the audit communications letter
from Grant Thornton. The Company is addressing these issues and is in the
process of engaging a major national accounting firm to perform the audit of
its 1998 financial statements, as well as assist the Company in addressing
these issues.
Software Service Transactions.
During 1997, the Company began entering into multi-year contracts that
were non-cancelable or included significant cancellation penalties. To entice
customers to sign for this extended period of time, the Company offered
substantial discounts or free service periods. Grant Thornton recommended that
the Company recognize the complexity of these arrangements and the need to
address the effects on revenue recognition. Due to the unique circumstances
surrounding these types of transactions, Grant Thornton stressed the importance
of the Company's Chief Financial Officer reviewing these contracts on a case-by-
case basis, with specific emphasis on ensuring proper revenue recognition by
reviewing cancellation provisions and allocations of revenue and discounts to
products covered by the contract. Grant Thornton identified that there were no
standard agreements - each was separately negotiated and accordingly the terms
of each agreement needed to be assessed for revenue recognition issues. Grant
Thornton suggested that this made it difficult for the Company personnel to
determine revenue recognition under SOP 91-1, and may become an even greater
issue under SOP 97-2.
Grant Thornton noted that accounting personnel of the Company appeared to
be unaware of certain key transactions, or aspects of transactions, which may
have been a result of a lack of adequate communication.
Cash Collections and Billings.
Grant Thornton noted that cash collections had been "poor" throughout 1997
and early 1998. Grant Thornton identified a number of factors:
Lack of written documentation and purchase orders from customers to support
sales, before the amount was invoiced.
Lack of communication between sales and accounting departments of delivery
and payment terms, leading to problems when collection calls were made by the
accounting staff.
Long lead times between performance of work and the sending of invoices to
customers.
Grant Thornton recommended that management of the Company develop formal
credit and collection policies providing for regular follow-up communication
with customers once accounts are 30 days past due. Grant Thornton also
recommended that management of the Company consider using sales personnel to
help with collections, in an appropriate manner. The Company paid commissions
upon recognition of a sale, and Grant Thornton recommended that the Company
-3-
consider payment only after the Company is paid. Grant Thornton also
recommended that management develop an objective formula to determine the
minimum amount of the allowance for doubtful accounts.
During its audit of the Company for fiscal 1997, Grant Thornton noted
items that gave rise to concerns encompassing the timeliness and efficiency
of the Company's billing process and the accuracy of information provided to
customers. According to Grant Thornton, lack of an efficient process had led
to relatively large amounts being recorded as "unbilled" receivables. In
addition, Grant Thornton noted that numerous problems were encountered when
collecting amounts recorded as overdue with customers stating they had
received invoices only days prior to the collection call. Grant Thornton
suggested that systems should be implemented to ensure all expense claims and
time sheets are received on a timely basis, and unbilled revenue should be
maintained at zero or an insignificant amount.
Software Development Costs.
FASB 86 requires that costs incurred internally in creating a computer
software product shall be charged to expense when incurred as research and
development until technological feasibility has been established for the
product. Technological feasibility is established upon completion of a
detailed program design or, in its absence, completion of a working model.
Thereafter, all software production costs shall be capitalized and
subsequently reports at the lower of unamortized cost or net realizable
value. Capitalized costs are amortized based on current and future revenue
for each product with an annual minimum equal to the straight line
amortization over the remaining estimated economic life of the product.
Grant Thornton suggested that sensitive decisions relating to
capitalization and amortization of software development costs should be
documented and supported. All details, such as date of and rationale behind
technological feasibility and the date of general availability for sale to the
public, should be recorded.
Insufficient Accounting Personnel.
According to Grant Thornton, staffing levels at the Company did not appear
sufficient to deal with the growth in the Company's sales. In addition, the
accounting clerk at the Company resigned effective December 31, 1997, which
Grant Thornton suggested resulted in delays in performing routine accounting
functions such as cash collections and billings as well as providing schedules
required to complete the year end audit.
The Company's Chief Financial Officer performed or assisted in practically
all of the Company's accounting functions, account reconciliations, general
ledger posting, financial reporting and various others. Grant Thornton
believed that by his involvement in such a myriad of activities, chances of
errors were increased. Grant Thornton believed that priorities should be
redirected from daily mundane bookkeeping chores to more important functions.
Grant Thornton recommended that management perform a review of staffing
levels at the Company and hire additional staff where required.
-4-
Lack of Internal Controls and Accounting Systems - General.
Grant Thornton reported that the size of the Company's accounting
department precluded strict segregation of accounting functions and a detailed
system of internal controls. Grant Thornton believed there were a number of
areas in which controls and systems could be improved.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
Exhibit
99.1 Letter from Grant Thornton LLP regarding change in certifying
accountant, dated December 22, 1998 (incorporated by reference to
Exhibit 16 to the Registrant's Form 8-K filed as of December 22,
1998).
99.2 Letter from Grant Thornton LLP dated January 11, 1999 regarding
Form 8-K/A (filed herewith).
-5-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
LEVEL 8 SYSTEMS, INC.
Date: January 11, 1999 By:/s/Steven Dmiszewicki
--------------------------
Name:Steven Dmiszewicki
Title:Chief Operating Officer
-6-
Exhibit 99.2
[LETTERHEAD OF GRANT THORNTON LLP]
January 11, 1999
Securities and Exchange Commission
Washington, D.C. 20549
Re: Level 8 Systems, Inc.
File No. 0-26392
Dear Sir or Madam:
We have read Item 4 of the Form 8-K/A of Level 8 Systems, Inc. filed January
11, 1999, and agree with the statements contained therein.
Very truly yours,
/s/Grant Thornton LLP
-7-
