UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-26392
LEVEL 8 SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
NEW YORK 11-2920559
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(State or other jurisdiction of incorporation (I.R.S Employer Identification
or organization) Number)
8000 Regency Parkway, Cary, NC 27511
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(Address of principal executive offices) (Zip Code)
(919) 380-5000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15d of the Securities Exchange Act of 1934 during
the preceding 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 X NO
--
Indicate the number of shares outstanding in each of the issuer's classes of
common stock, as of the latest practicable date.
7,639,822 common shares, $.01 par value, were outstanding as of October 31,
1998.
1
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LEVEL 8 SYSTEMS, INC.
INDEX
<S> <C>
Page
PART I. Financial Information Number
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Item 1. Financial Statements
Consolidated balance sheets as of September 30, 1998 (unaudited)
and December 31, 1997 3
Consolidated statements of operations (unaudited) for the three and
nine months ended September 30, 1998 and 1997 4
Consolidated statements of cash flows (unaudited) for the nine months
ended September 30, 1998 and 1997 5
Notes to consolidated financial statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
PART II. Other Information 12
SIGNATURES 13
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Introductory Note:
This Amendment on Form 10-Q/A amends the Registrant's Quarterly Report on Form
10-Q for the period ended September 30, 1998, as filed by the Registrant on
November 13, 1998, and is being filed to reflect the restatement of the
Registrant's consolidated financial statements (the "Restatement"). The
Restatement reflects the revaluation of acquired in-process research and
development from the acquisition of Momentum Software Corporation on March 26,
1998, based upon revised guidelines as set forth by the Securities and Exchange
Commission (the "SEC"); informal discussions with the SEC regarding the
accounting for renegotiations of royalty payments under a software development
agreement which the Company is now amortizing over the term of the agreement;
and other adjustments to properly reflect quarterly results. The adjustments to
the previously presented quarterly information, except for the revaluation of
acquired in-process research and development and the renegotiated royalty
payments, are between quarters within each of the years ended December 31, 1997
and 1998 and have no impact on year-end results.
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ITEM I.
PART1.
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LEVEL 8 SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
September 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $ 3,537 $ 7,062
Accounts receivable, less allowance for doubtful accounts
of $1,086 and $434 at September 30, 1998 and December
31, 1997, respectively 8,598 6,455
Income taxes receivable - 406
Inventory - 336
Prepaid expenses and other current assets 1,889 421
Net assets from discontinued operations 1,770 3,577
Deferred income taxes 1,325 -
-------- --------
Total current assets 17,119 18,257
Property and equipment, net 1,609 974
Excess of cost over net assets acquired, net 6,156 1,793
Software development costs 3,347 2,168
Deposits and deferred costs 733 -
Other assets - 290
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Total assets $28,964 $23,482
======== ========
Liabilities and stockholders' equity
Current maturities of loan and note payable from related company $ 1,048 $ 128
Current maturities of long-term debt 48 7
Accounts payable 1,425 1,936
Accrued expenses 315 224
Due to related company 197 -
Customer deposits and deferred revenue 4,853 42
Deferred taxes - 94
-------- --------
Total current liabilities 7,886 2,431
Long-term debt, net of current maturities 59 16
Loan and note payable from related company, net of current maturities 552 202
Deferred income taxes 353 462
Stockholders' equity
Preferred stock - -
Common stock 77 70
Additional paid-in-capital 27,650 20,603
Accumulated deficit (7,613) (184)
Unearned compensation - (118)
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Total stockholders' equity 20,114 20,371
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Total liabilities and stockholders' equity $28,964 $23,482
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
3
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LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating revenue:
Consulting and services $ 1,813 $2,416 $ 6,877 $6,400
Software 450 411 1,077 2,002
Other 86 110 643 155
-------- ------- -------- -------
Total operating revenue 2,349 2,937 8,597 8,557
Cost of revenue 1,741 843 5,330 3,761
-------- ------- -------- -------
Gross profit 608 2,094 3,267 4,796
Operating expenses:
Selling, general and administrative 3,563 1,685 9,227 4,052
Purchased research and development - - 1,200 -
-------- ------- -------- -------
Total operating expenses 3,563 1,685 10,427 4,052
Income (loss) from operations (2,955) 409 (7,160) 744
Other income (expense)
Interest income 71 112 225 321
Interest expense (34) (5) (73) (15)
-------- ------- -------- -------
Income (loss) before tax provision (2,918) 516 (7,008) 1,050
Income tax provision (benefit) - 202 (558) 423
-------- ------- -------- -------
Income (loss) from continuing operations (2,918) 314 (6,450) 627
Discontinued operations:
Income (loss) from discontinued operation, net
of taxes (benefit) of ($90) and $22 - 8 (135) 67
Loss on disposal, net of income tax expense of $519 - - (843) -
-------- ------- -------- -------
- 8 (978) 67
Net income (loss) $(2,918) $ 322 $(7,428) $ 694
======== ======= ======== =======
Net income (loss) per common share:
Income (loss) from continuing operations - basic $ (0.38) $ 0.05 $ (0.86) $ 0.09
Income (loss) from discontinued operations - basic $ - $ - $ (0.13) $ 0.01
-------- ------- -------- -------
Net income (loss) per share - basic $ (0.38) $ 0.05 $ (0.99) $ 0.10
======== ======= ======== =======
Net income (loss) per common share:
Income (loss) from continuing operations - diluted $ (0.38) $ 0.04 $ (0.86) $ 0.08
Income (loss) from discontinued operations - diluted $ - $ - $ (0.13) $ 0.01
-------- ------- -------- -------
Net income (loss) per share - diluted $ (0.38) $ 0.04 $ (0.99) $ 0.09
======== ======= ======== =======
Weighted shares outstanding - basic 7,690 7,007 7,498 6,978
======== ======= ======== =======
Weighted shares outstanding - diluted 7,690 7,642 7,498 7,598
======== ======= ======== =======
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
4
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LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(7,429) $ 893
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
(Income) loss from discontinued operations 135 (67)
Loss on disposal of discontinued operations 843 -
Depreciation and amortization 2,366 537
Deferred income taxes (934) 343
Purchased research and development costs 1,200 -
Write-off of capitalized software 294 -
Other 406 87
Changes in assets and liabilities, net of assets acquired
and liabilities assumed:
Trade accounts receivable (2,019) (3,024)
Prepaid expenses and other assets (580) (271)
Accounts payable and accrued expenses (594) (41)
Customer deposits and deferred revenue 4,502 35
-------- --------
Net cash used in operating activities (1,810) (1,508)
Cash flows from investing activities:
Cash received from acquisition 362 -
Purchase of marketable securities - (1,998)
Redemption of marketable securities - 6,498
Purchases of property and equipment (1,274) (212)
Capitalization of software development costs (643) (839)
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Net cash provided by (used in) investing activities (1,555) 3,449
Cash flows from financing activities:
Issuance of common shares 59 165
Costs of issuance of common shares - (137)
Proceeds on long-term debt (156) -
Payments on other long-term debt (63) (99)
-------- --------
Net cash used in financing activities (160) (71)
Net increase (decrease) in cash and cash equivalents (3,525) 1,870
Cash and cash equivalents:
Beginning of period 7,062 3,318
-------- --------
End of period $ 3,537 $ 5,188
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
5
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LEVEL 8 SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
1. Basis of Presentation -
In the opinion of the Company, these unaudited consolidated financial statements
contain all normal, recurring adjustments necessary to present fairly the
financial position of the Company as of September 30, 1998 and the results of
operations and cash flows for the three and nine months ended September 30, 1998
and 1997. The results of operations and cash flows for the three and nine
months ended September 30, 1998 are not necessarily indicative of the results to
be expected for the year ending December 31, 1998, or any other period.
This amendment on Form 10-Q/A amends the Company's Quarterly Report on Form 10-Q
originally filed on November 13, 1998 and is being filed to reflect the
restatement of the Company's consolidated financial statements. See Note 3.
The Company filed its annual report on Form 10-K for the year ended December 31,
1998 which contains subsequent information regarding certain matters disclosed
herein. For further information, refer to the 1998 consolidated financial
statements and notes included therein.
Additionally, for further information, refer to the consolidated financial
statements and notes included in the Company's annual report on Form 10-K/A for
the year ended December 31, 1997, filed September 11, 1998.
2. Principles of Consolidation -
The September 30, 1998 consolidated financial statements include the accounts of
Level 8 Systems, Inc. ("Level 8") and its wholly-owned subsidiaries, Level 8
Technologies, Inc. ("Level 8 Technologies") and ProfitKey International, Inc.
("ProfitKey") and its new wholly-owned subsidiary, Momentum Software
Corporation, from the date of acquisition of March 26, 1998. The September 30,
1997 condensed consolidated financial statements include the accounts of Level
8, Level 8 Technologies, ProfitKey, and its ASU consulting division. On April
6, 1998, the Company sold its wholly-owned subsidiary, ProfitKey. ProfitKey has
been accounted for as a discontinued operation and the results of its operations
have been excluded from continuing operations in the condensed consolidated
financial statements for all periods presented. All inter-company accounts and
transactions are eliminated in consolidation.
3. Restatement -
Purchased research and product development
Subsequent to the issuance of the Company's Quarterly Report on Form 10-Q for
quarterly period ended September 30, 1998, the Company's management revised the
amount of the purchase price which was allocated to in-process research and
development ("IPR&D") in accounting for the acquisition of Momentum Software
Corporation in March of 1998. See Note 4. The revised allocation is based upon
methods prescribed in a letter from the Securities and Exchange Commission
("SEC") sent to the American Institute of Certified Public Accountants in
September 1998. The letter sets forth the SEC's views regarding the valuation
methodology to be used in allocating a portion of the purchase price to IPR&D at
the date of the acquisition.
The Company's initial calculations to value the acquired IPR&D were based upon a
methodology that estimated the costs to develop the IPR&D into commercially
viable products, and discounted the net cash flows back to their present value.
The increase in selling, general and administrative is primarily due to an
increase in the recognition of goodwill related to the purchase of Momentum
Software Corp, approximately $420 for the quarter ended September 30, 1998.
The Company also adjusted the value and shares of stock issued for the purchase
of Momentum. This adjustment resulted in a $668 increase to goodwill
The change in weighted average shares outstanding for the three and nine month
period ending September, 1998 is due to the recomputation of shares taking into
effect the purchase of Momentum Software Corporation.
Royalty agreement
During 1995, the Company and Liraz, the Company's majority shareholder, entered
into a custom computer programming agreement for the joint development of
certain software. Liraz and the Company were each to pay 50% of the total
project development costs. In exchange for providing 50% of the project
development costs, Liraz was to receive royalties of 30% of the first $2,000 in
contract revenue from the sale of products developed under this agreement, 20%
of the next $1,000, and 8% thereafter.
6
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Due to a change in the Company's development plans for this product, during the
first quarter of 1998, the Company and Liraz orally agreed to amend the original
custom computer programming agreement. Under the new agreement signed April 1,
1998, the Company agreed to reimburse Liraz's costs of development of $1,500 and
to pay Liraz royalties of 3% of program revenues, as defined in the agreement,
generated from January 1, 1998 until December 31, 2000. The Company originally
recorded the transaction as a purchase of technology with an offsetting note to
Liraz for $1,500 during the first quarter of 1998. Additionally, the Company
recorded an impairment loss related to the capitalized cost of the joint
development agreement due to the net realizable value of the future cash flows
expected from the product. Based on informal discussions with the SEC, the
Company has restated its quarterly financial statements to amortize the cost of
reimbursement over the term of the agreement beginning on April 1, 1998 with the
signing of the agreement.
The increase in prepaid expenses and other current assets is primarily related
to recognition of current deferred royalty expenses of $500 for the quarter
ended June 30, 1998.
Other adjustments
In connection with the audit of the Company's 1998 annual consolidated financial
statements, certain adjustments were identified in order to recognize revenue in
the appropriate quarter of 1998 in accordance with Statement of Position 97-2,
"Software Revenue Recognition," issued by the American Institute of Certified
Public Accountants. For the nine months ended September 30, 1998, revenues
totaling $823 have been deferred until the fourth quarter of 1998. $234 of
expenses related to the revenues previously reported in prior quarters has been
restated to be properly accounted for in the third quarter of 1998. The nature
of this transaction also impacts accounts receivable and deferred revenues.
The decrease in cost of revenue related to software sales for the quarter ended
September 30, 1998 was due to an adjustment to the amortization of capitalized
software development costs.
The adjustments to the current maturities of loan from related company, current
maturities of long-term debt, long-term debt, net of current maturities, loan
from related company, net of current maturities, and accrued expenses was a
reclassification among those accounts and has no impact on the consolidated
balance sheet as of September 30, 1998.
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A summary of the significant effects of the restatement is as follows:
As of Sept 30, 1998
As
Previously As
Reported Restated
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<S> <C> <C>
BALANCE SHEET DATA
Accounts receivable, net $ 9,624 $ 8,598
Prepaid expenses and other current assets 1,389 1,889
Property and equipment, net 1,547 1,609
Excess of cost over net assets acquired, net 2,154 6,156
Software development costs, net 3,035 3,347
Customer deposits and deferred costs 269 733
Total assets 24,290 28,964
Current maturities of loan from related company 594 1,048
Current maturities of long-term debt 27 48
Due to related company 212 197
Accrued expenses 275 312
Deferred revenue 4,460 4,853
Long-term debt, net of current maturities 85 59
Loan from related company, net of current maturities 1,038 552
Additional paid-in-capital 28,362 27,650
Accumulated deficit (12,502) (7,613)
Unearned compensation (118) -
Total shareholders' equity (deficiency) 15,818 20,114
Total liabilities 24,290 28,964
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7
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Three Months Ended Nine Months Ended
Sept. 30,1998 Sept. 30, 1998
Previously Previously
Reported Restated Reported Restated
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<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
Consulting and services $ 1,706 $ 1,813 $ 7,503 $ 6,877
Software 485 450 1,309 1,077
Cost of consulting and services 1,151 1,385 4,125 4,125
Cost of software 551 356 1,021 1,205
Gross profit 575 608 4,309 3,267
Selling, general and administrative 3,143 3,563 8,039 9,227
Purchased research and development - - 6,510 1,200
Write-off of capitalized software - - 1,794 -
Income (loss) from operations (2,568) (2,995) (12,034) (7,160)
Other expense (net) 22 37 137 152
Income tax provision - - (762) (558)
Loss from continuing operations (2,546) (2,918) (11,135) (6,450)
Loss on disposal, net of income tax expense of $519 - - (1,047) (843)
Net Loss (2,546) (2,918) (12,317) (7,428)
Net loss per common share - basic and diluted (0.33) (0.38) (1.65) (0.99)
Weighted average shares outstanding - basic and diluted 7,640 7,690 7,448 7,498
</TABLE>
Certain adjustments made in the fourth quarter of 1997 have been reflected in
the restated third quarter 1997 financial statements presented herein.
The adjustments to the results of the third quarter ended September 30, 1997,
reflect a change in software revenue of $461 and the cost of software of $336.
This amount was previously recognized in the third quarter of 1997 and has now
been reclassified to be recognized in the fourth quarter of 1997.
Consulting and services revenue of $260 recognized in the third quarter of 1997
has now been reclassified to the fourth quarter of 1997.
Salaries expense of $19 has been reclassified to the third quarter of 1997 from
the fourth quarter of 1997.
These adjustments have no impact on the previously reported results for the year
ended December 31, 1997.
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<CAPTION>
Three Months Ended Nine Months Ended
Sept 30,1997 Sept 30, 1997
Previously Previously
Reported Restated Reported Restated
------ ----- ----- ------
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
Consulting and services $2,676 $2,416 $6,659 $6,400
Software 872 411 2,463 2,002
Cost of consulting and services 1,380 1,074 3,233 2,927
Cost of software 106 (230) 1,133 796
Gross profit 2,173 2,094 4,875 4,796
Selling, general and administrative 1,666 1,685 3,932 4,052
Income (loss) from operations 507 409 944 744
Net income (loss) 421 322 893 694
Net income per common share - basic 0.06 0.05 0.13 0.10
Net income per common share - diluted 0.05 0.04 0.12 0.09
Weighted average shares outstanding - basic 7,007 7,007 6,978 6,978
Weighted average shares outstanding - diluted 7,642 7,642 7,598 7,598
</TABLE>
4. Acquisition -
On March 26, 1998, the Company acquired Momentum Software Corporation
("Momentum"). Under the agreement, Level 8 issued 594,866 shares of common
stock and warrants to purchase 200,000 common shares at an exercise price of
$13.108 per share, subject to adjustment based on the value of the Level 8
common shares on December 1, 1998. The amount of contingent consideration, if
any, will be determined in the fourth quarter of 1998. The total cost of the
acquisition, excluding additional contingent consideration paid in the fourth
quarter, was approximately $7,717 and is treated as a purchase. As a result of
the acquisition of Momentum, the Company incurred a nonrecurring charge to
earnings of an estimate of approximately $1.2 million related to the purchase
of in-process research and development costs. The remaining amount was allocated
to goodwill and software development costs. The results of operations of
Momentum are included in the financial statements since the date of acquisition.
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The purchase price was preliminarily allocated to the assets acquired and
liabilities assumed based on the Company's estimates of fair value at the
acquisition date. The fair value assigned to intangible assets acquired was
based on a valuation prepared by an independent third-party appraisal company of
the purchased in-process research and development, developed technology, and
assembled workforce of Momentum. The purchase price exceeded the amounts
allocated to tangible and intangible assets acquired less liabilities assumed by
approximately $5,615. This excess of the purchase price over the fair values of
assets acquired less liabilities assumed was allocated to goodwill.
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<CAPTION>
The cost of the acquisition was allocated as follows:
<S> <C>
Cash $ 437
Accounts receivable 125
Prepaid expenses and other current assets 52
Property and equipment 174
In-process research and development 1,200
Developed technology 1,100
Goodwill and other intangibles 5,615
Accounts payable (507)
Deferred revenue (367)
Long-term debt (112)
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Cost of net assets acquired $7,717
=======
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Approximately $1,200 of the purchase price represents purchased in-process
research and development that had not yet reached technological feasibility and
had no alternative future use. Accordingly, this amount was immediately
expensed in the Consolidated Statement of Operations upon consummation of the
acquisition. The value assigned to in-process research and development, based
on a valuation prepared by an independent third-party appraisal company, was
determined by identifying research projects, all of which related to either
add-ons or enhancements of Momentum's existing XIPC product, in areas for which
technological feasibility had not been established. The value of in-process
projects was adjusted to reflect the relative value and contributions of the
required research and development. In doing so, consideration was given to the
stage of completion, the complexity of the work completed to date, the
difficulty of completing the remaining development costs already incurred, and
the projected cost to complete projects. The discount rate included a factor
that takes into account the uncertainty surrounding successful development of
the purchased in-process research and development.
5. Discontinued Operations -
On April 6, 1998, the Company sold its wholly owned subsidiary, ProfitKey. The
disposition of ProfitKey was accounted for as a discontinued operation as of
March 31, 1998. The Company received $464 at the closing and a $2,000 note from
the buyer. The purchase price is subject to adjustment to reflect any variance
in working capital from a specified amount. The buyer has notified the Company
that it believed there was a variance of $1,466, which would require a reduction
in the purchase price of that amount. Based on information available to the
Company at this time, management believes that an adjustment, if any, is not
determinable and should not have a material adverse effect on the Company. In
connection with the sale, the Company recorded a loss from the discontinued
operation of approximately $1,362 million including a tax expense of $519.
6. Related Party Agreement
During 1995, the Company and Liraz entered into a custom computer programming
agreement for the joint development of certain software. Liraz and the Company
were each to pay 50% of the total project development costs. In exchange for
providing 50% of the project development costs, Liraz was to receive royalties
of 30% of the first $2,000 in contract revenue from the sale of products
developed under this agreement, 20% of the next $1,000, and 8% thereafter.
On April 1, 1998, the Company and Liraz entered into an amendment to the
original custom computer programming agreement, whereby the original royalty
payment provisions were rescinded. Under the new agreement, the Company agreed
to reimburse Liraz's costs of development of $1,500 and to pay Liraz royalties
of 3% of program revenues, as defined in the agreement, generated from January
1, 1998 until December 31, 2000. The Company issued a note to Liraz for $1,500
for cost reimbursement pursuant to this agreement and is amortizing the cost of
reimbursement over the term of the agreement. The amortization of the cost
reimbursement is included as a component of cost of software in the consolidated
statement of operations.
9
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LEVEL 8 SYSTEMS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
Results of Operations
Overview
General. For the three months ended September 30, 1998, the Company's
revenue was $2,349, a decrease of 20% from $2,937 for the three months ended
September 30, 1997. The operating loss for the three months ended September 30,
1998 was $2,918, compared to a profit of $314 for the three months ended
September 30, 1997. For the three months ended September 30, 1998, the Company
had a net loss of $2,918, or $(0.38) per share, basic and diluted, compared to a
net profit of $322, or $0.05 per share basic and $0.04 per share diluted, for
the three months ended September 30, 1997.
The third quarter results do not reflect any revenue from an agreement the
Company entered into with Microsoft Corporation ("Microsoft") in August 1998.
Under the agreement, the Company granted Microsoft exclusive rights to the
English and Japanese versions of its FalconMQ bridge product. Microsoft
accepted the English version of the product in September and the Japanese
version of the product in November. The Company billed Microsoft $2.96 million
for the English version in September, and will bill Microsoft $740,000 for the
Japanese version in November. The Company expects to receive the $3.7 million
total from Microsoft by December. The Company is in the process of determining
how long generally accepted accounting principles will require the Company to
continue to defer recognizing such revenue.
The results of the third quarter reflect the Company's transition toward
developing a base of messaging and enterprise application integration products.
During the third quarter, revenue had not yet begun to reflect the continuing
investment in the development of new products and the infrastructure to support
such products. Toward the end of this quarter, however, the Company had begun
to reduce its expense structure to accommodate its planned transition. The
Company reduced its use of outside consultants, it reassigned some development
personnel to revenue-generating assignments and it reduced headcount generally.
Other Matters. On March 26, 1998, Level 8 acquired all the stock of
Momentum Software Corporation ("Momentum") for 594,866 shares of Level 8 common
stock and 200,000 warrants, subject to additional consideration based upon the
Level 8 common stock price on December 1, 1998. The results of Momentum are
included in the financial statements since the date of acquisition.
On April 6, 1998, Level 8 sold its wholly-owned subsidiary, ProfitKey
International, Inc. ("ProfitKey"). The sale resulted in a loss of approximately
$1,362. Level 8 recorded the loss in the first quarter of 1998 for the disposal
of the business and the anticipated operating losses until disposal. ProfitKey
is reported as a discontinued operation for 1998 and 1997, and, accordingly, the
loss from operations is recorded as a loss from a discontinued operation. Level
8's operating results for prior periods were restated to reflect the continuing
operations.
In connection with the sale of ProfitKey, the parties agreed to adjust the
purchase price to reflect any variance in ProfitKey's closing date working
capital from a specified amount. The buyer has notified the Company that it
believed there was a variance of $1,466, which would require a reduction in the
purchase price of that amount. Based on information available to the Company at
this time, management believes that an adjustment, if any, is not determinable
and should not have a material adverse effect on the Company.
During 1995, the Company and Liraz entered into a custom computer
Programming agreement for the joint development of certain software. Liraz and
the Company were each to pay 50% of the total project development costs. In
exchange for providing 50% of the project development costs, Liraz was to
receive royalties of 30% of the first $2,000 in contract revenue from the
sale of products developed under this agreement, 20% of the next $1,000,
and 8% thereafter.
Due to a change in the Company's development plans for this product, the
Company and Liraz entered into an amendment to the original custom computer
Programming agreement, whereby the original royalty payment provisions were
rescinded. Under the new agreement, the Company agreed to reimburse Liraz's
costs of development of $1,500 and to pay Liraz royalties of 3% of program
revenues, as defined in the agreement, generated from January 1, 1998 until
December 31, 2000. The Company issued a note to Liraz for $1,500 for cost
reimbursement pursuant to this agreement and is amortizing the cost of
reimbursement over the term of the agreement. The amortization of the cost
reimbursement is included as a component of cost of software in the
consolidated statement of operations.
See Note 3 to the Company's consolidated financial statements in Item 1 for
additional information regarding the restatement of the Company's consolidated
financial statements.
10
<PAGE>
Three Months Ended September 30, 1998 Compared With Three Months Ended September
30, 1997
Revenue for the three months ended September 30, 1998 was approximately
$2,349 as compared to $2,937, for the three months ended September 30, 1997, a
decrease of $588 or 20%. The decrease in revenue was primarily attributable to a
decrease in consulting revenue of $603 offset by a small increase in software
license sales. The decrease in consulting revenue was mainly attributable to
delays in projects by some of the Company's larger customers.
Cost of revenue for the three months ended September 30, 1998 was
Approximately $1,741 as compared to $843 for the three months ended September
30, 1997, an increase of $898 or 106%. The increase in cost of revenue was
attributable to certain consulting projects, which necessitated the use of
outside consultants carrying higher costs and a change in product mix.
The gross margin for the three months ended September 30, 1998 was
approximately 26% as compared to approximately 71% for the three months ended
September 30, 1997. The decrease was a result of the changes in revenue and
cost of revenue as mentioned above.
Selling, general, and administrative expenses for the three months ended
September 30, 1998 were approximately $3,563 as compared to approximately $1,685
for the three months ended September 30, 1997, an increase of approximately
$1,878. The increase in selling, general and administrative expenses reflects
added general expenses associated with Momentum ($525) and the investment in
infrastructure needed to support the expected growth in revenue. Additionally,
selling, general and administrative expense includes approximately $468 related
to the goodwill amortization for the Momentum acquisition in 1998.
Nine Months Ended September 30, 1998 Compared With Nine Months Ended September
30, 1997
Revenue for the nine months ended September 30, 1998 was approximately
$8,597 as compared to $8,557 for the nine months ended September 30, 1997, an
increase of $40 or 0.5%. The components of total revenue have shifted with an
approximate $965 increase in services being offset by a corresponding decrease
in license sales.
Cost of revenue for the nine months ended September 30, 1998 was
approximately $5,330 as compared to $3,761 for the nine months ended September
30, 1997, an increase of $1,569 or 42%. The increase was due to Level 8
Technologies' increase in the cost of outside consulting, services and
maintenance of approximately $1,198 coupled with an increase in software
amortization and a $294 write-off of capitalized software.
The gross margin for the nine months ended September 30, 1998 was
Approximately 38% as compared to approximately 56% for the nine months ended
September 30, 1997. The decrease was due to lower margins on consulting
and services revenue.
Selling, general, and administrative expenses for the nine months ended
September 30, 1998 were approximately $9,227 as compared to approximately $4,052
for the nine months ended September 30, 1997, an increase of approximately
$5,175. The increase is a result of additional expenses of approximately $1,045
relating to Momentum. The other increases in expenses were associated with the
investment in infrastructure needed to support the expected growth in revenue.
Other income decreased by approximately $154 for the nine months ended
September 30, 1998 and $70 for the three months ended September 30, 1998 due to
a decrease in interest income from fewer idle funds invested and an increase of
interest expense associated with long-term debt.
Income taxes represent a benefit of 8.0% of the loss from continuing
operations before income taxes. The rate is below the expected tax rate
primarily due to the non-deductibility of the purchased research and development
costs of $1,200, and a valuation allowance.
The loss on disposal from a discontinued operation of ProfitKey totaled
approximately $1,362 including a tax expense of $519.
Liquidity and Capital Resources
Continuing operating activities for the nine months ended September 30,
1998 used net cash of approximately $1,810. Level 8 used approximately $1,555
for investing activities in the nine months ended September 30, 1998 primarily
as a result of purchases of property and equipment. Continuing financing
activities for the nine months ended September 30, 1998 used net cash of
approximately $160. At September 30, 1998, Level 8 had working capital of
approximately $9,233 and a current ratio of approximately 2.2. Level 8 believes
that the existing working capital and the anticipated funds generated from
operations will be sufficient to fund its working capital, capital expenditure
and financing requirements at least through the next twelve months.
11
<PAGE>
PART II.
LEVEL 8 SYSTEMS, INC.
OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Default Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security-Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
11.0 Weighted Average and Common Share Equivalents
27.0 Financial Data Schedule
(b) Reports on Form 8-K:
On October 13, 1998, the Company filed an 8-K under Item 5 regarding the Company
entering into an exclusive licensing agreement with Microsoft Corporation.
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date April 21, 1999 LEVEL 8 SYSTEMS, INC.
------------------------------ ------------------------
(Registrant)
/s/ Arie Kilman
-----------------
Arie Kilman
Chief Executive Officer
13
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT 11.0
LEVEL 8 SYSTEMS, INC.
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENTS
Three Months Ended
September 30,
1998 1997
------ ------
BASIC
<S> <C> <C>
WEIGHTED AVERAGE COMMON SHARES 7,690 7,007
------ ------
------ ------
DILUTED
WEIGHTED AVERAGE COMMON SHARES 7,690 7,007
COMMON STOCK EQUIVALENTS (1) 635
------ ------
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES 7,690 7,642
------ ------
------ ------
Nine Months Ended
September 30,
1998 1997
------ ------
BASIC
WEIGHTED AVERAGE COMMON SHARES 7,498 6,978
------ ------
------ ------
DILUTED
WEIGHTED AVERAGE COMMON SHARES 7,498 6,978
COMMON STOCK EQUIVALENTS (1) 620
------ ------
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES 7,498 7,598
------ ------
------ ------
(1) Anti-dilutive
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME FIELD AS PART OF
THE ANNYUAL REPORT ON FORM 10-k AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,537
<SECURITIES> 0
<RECEIVABLES> 9,684
<ALLOWANCES> 1,086
<INVENTORY> 0
<CURRENT-ASSETS> 17,119
<PP&E> 2,341
<DEPRECIATION> 732
<TOTAL-ASSETS> 28,964
<CURRENT-LIABILITIES> 7,886
<BONDS> 0
0
0
<COMMON> 77
<OTHER-SE> 20,037
<TOTAL-LIABILITY-AND-EQUITY> 28,964
<SALES> 0
<TOTAL-REVENUES> 8,597
<CGS> 0
<TOTAL-COSTS> 5,330
<OTHER-EXPENSES> 10,427
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 73
<INCOME-PRETAX> (7,008)
<INCOME-TAX> (558)
<INCOME-CONTINUING> (6,450)
<DISCONTINUED> (978)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,428)
<EPS-PRIMARY> (0.99)
<EPS-DILUTED> (0.99)
</TABLE>
