UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000.
[ ] 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.
---------------------
(Exact name of registrant as specified in its charter)
Delaware 11-292055
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(State or other jurisdiction of incorporation. (I.R.S Employer Identification
Number or organization)
8000 Regency Parkway, Cary, NC 275111
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(Address of principal executive offices (ZipCode)
(919) 380-5000
--------------
(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.
13,805,797 common shares, $.001 par value, were outstanding as of August 9,
2000.
LEVEL 8 SYSTEMS, INC. PAGE 1
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LEVEL 8 SYSTEMS, INC.
INDEX
<S> <C>
Page
PART I. Financial Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Number
------
Item 1. Financial Statements
Consolidated balance sheets as of June 30, 2000 (unaudited)
and December 31, 1999. . . . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated statements of operations (unaudited) for the three and six
months ended June 30, 2000 and 1999. . . . . . . . . . . . . . . . . . . 4
Consolidated statements of cash flows (unaudited) for six months
ended June 30, 2000 and 1999 . . . . . . . . . . . . . . . . . . . . . . 5
Consolidated statements of comprehensive income (unaudited) for
three and six months ended June 30, 2000 and 1999. . . . . . . . . . . . 6
Notes to consolidated financial statements (unaudited) . . . . . . . . . 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk. . . . . . . . . 19
PART II. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
</TABLE>
LEVEL 8 SYSTEMS, INC. PAGE 2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
June 30, December 31,
2000 1999
---------- --------------
Assets
<S> <C> <C>
Cash and cash equivalents. . . . . . . . . . . . . . . . . . $ 14,042 $ 6,509
Accounts receivable, less allowance for doubtful accounts
of $1,506 and $1,150 at June 30, 2000 and December 31,
1999, respectively . . . . . . . . . . . . . . . . . . 19,504 22,199
Notes receivable . . . . . . . . . . . . . . . . . . . . . . 2,000 2,000
Prepaid expenses and other current assets. . . . . . . . . . 4,998 5,134
---------- --------------
Total current assets. . . . . . . . . . . . . . . 40,544 35,842
Property and equipment, net. . . . . . . . . . . . . . . . . 5,485 5,845
Intangible assets, net . . . . . . . . . . . . . . . . . . . 62,110 69,948
Software product technology, net . . . . . . . . . . . . . . 18,229 20,488
Other assets . . . . . . . . . . . . . . . . . . . . . . . . 791 1,458
---------- --------------
Total assets. . . . . . . . . . . . . . . . . . . $ 127,159 $ 133,581
========== ==============
Liabilities and stockholders' equity
Notes payable, due on demand . . . . . . . . . . . . . . . . $ 10,172 $ 4,996
Current maturities of loan from related company. . . . . . . -- 519
Current maturities of long-term debt . . . . . . . . . . . . 183 395
Accounts payable . . . . . . . . . . . . . . . . . . . . . . 2,347 2,194
Accrued expenses:
Salaries, wages and related items . . . . . . . . . . . 4,873 4,172
Merger-related. . . . . . . . . . . . . . . . . . . . . 647 4,075
Restructuring . . . . . . . . . . . . . . . . . . . . . 395 630
Other . . . . . . . . . . . . . . . . . . . . . . . . . 7,949 8,336
Due to related party . . . . . . . . . . . . . . . . . . . . 102 41
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . 9,655 9,020
---------- --------------
Total current liabilities . . . . . . . . . . . . 36,323 34,378
Long-term debt, net of current maturities. . . . . . . . . . 20,349 22,202
Loan from related company, net of current maturities . . . . 3,000 4,000
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . - 780
Stockholders' equity
Preferred stock . . . . . . . . . . . . . . . . . . . . - -
Common stock. . . . . . . . . . . . . . . . . . . . . . 14 12
Additional paid-in-capital. . . . . . . . . . . . . . . 122,846 113,507
Accumulated other comprehensive income. . . . . . . . . (413) (159)
Accumulated deficit . . . . . . . . . . . . . . . . . . (54,960) (41,139)
---------- --------------
Total stockholders' equity. . . . . . . . . . . . 67,487 72,221
---------- --------------
Total liabilities and stockholders' equity. . . . $ 127,159 $ 133,581
========== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
LEVEL 8 SYSTEMS, INC. PAGE 3
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LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Revenue:
Software. . . . . . . . . . . . . . . . . . . . . . . $11,669 $ 3,190 $ 19,902 $ 5,902
Maintenance . . . . . . . . . . . . . . . . . . . . . 3,804 3,981 7,478 7,864
Services. . . . . . . . . . . . . . . . . . . . . . . 5,608 5,836 13,364 12,446
-------- -------- --------- --------
Total operating revenue . . . . . . . . . . . 21,081 13,007 40,744 26,212
Cost of revenue:
Software. . . . . . . . . . . . . . . . . . . . . . . 1,702 1,090 3,632 1,928
Maintenance . . . . . . . . . . . . . . . . . . . . . 1,545 1,450 2,929 3,050
Services. . . . . . . . . . . . . . . . . . . . . . . 4,487 5,069 11,302 11,087
-------- -------- --------- --------
Total cost of revenue . . . . . . . . . . . . 7,734 7,609 17,863 16,065
Gross profit. . . . . . . . . . . . . . . . . . . . . . 13,347 5,398 22,881 10,147
Operating expenses:
Sales and marketing . . . . . . . . . . . . . . . . . 8,602 2,754 15,721 5,374
Research and development. . . . . . . . . . . . . . . 2,549 1,555 4,761 3,234
General and administrative. . . . . . . . . . . . . . 2,652 1,707 6,201 2,873
In-process research and development . . . . . . . . . -- 744 -- 744
Amortization of intangible assets . . . . . . . . . . 3,587 1,687 7,113 3,384
Loss on disposal of assets. . . . . . . . . . . . . . 338 -- 338 --
-------- -------- --------- --------
Total operating expenses. . . . . . . . . . . 17,728 8,447 34,134 15,609
-------- -------- --------- --------
Loss from operations. . . . . . . . . . . . . (4,381) (3,049) (11,253) (5,462)
Other income (expense)
Interest income . . . . . . . . . . . . . . . . . . . 77 81 116 156
Interest expense. . . . . . . . . . . . . . . . . . . (844) (847) (1,753) (1,607)
Net foreign currency gains/(losses) . . . . . . . . . (79) (212) (116) (740)
-------- -------- --------- --------
Loss before provision for income taxes. . . . . . . . . (5,227) (4,027) (13,006) (7,653)
Income tax provision. . . . . . . . . . . . . . . . . . 300 197 550 399
-------- -------- --------- --------
Net loss. . . . . . . . . . . . . . . . . . . . . . . . $(5,527) $(4,224) $(13,556) $(8,052)
======== ======== ========= ========
Net loss per share - basic and diluted. . . . . . . . . $ (0.41) $ (0.49) $ (1.04) $ (0.93)
======== ======== ========= ========
Weighted common shares outstanding - basic and diluted. 13,706 8,697 13,317 8,704
======== ======== ========= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
LEVEL 8 SYSTEMS, INC. PAGE 4
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<CAPTION>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended
June 30,
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . $(13,556) $(8,052)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization . . . . . . . . . . . . . . 11,389 5,600
Deferred income taxes . . . . . . . . . . . . . . . . . . -- 2
Purchased research and development. . . . . . . . . . . . -- 744
Provision for doubtful accounts . . . . . . . . . . . . . 357 196
Other . . . . . . . . . . . . . . . . . . . . . . . . . . 43 172
Changes in assets and liabilities, net of assets acquired
and liabilities assumed:
Trade accounts receivable. . . . . . . . . . . . . . 2,125 1,527
Prepaid expenses and other assets. . . . . . . . . . 312 549
Accounts payable and accrued expenses - excluding
merger-related and restructuring. . . . . . . . 24 (2,248)
Merger-related and restructuring . . . . . . . . . . (2,423) (2,791)
Deferred revenue . . . . . . . . . . . . . . . . . . (145) (1,610)
--------- --------
Net cash used in operating activities . . . . . (1,916) (5,911)
Cash flows from investing activities:
Purchases of property and equipment. . . . . . . . . . . . . . (540) (102)
Payments for acquisitions. . . . . . . . . . . . . . . . . . . (515) (2,190)
Investment held for resale . . . . . . . . . . . . . . . . . . 635 --
Purchased technology . . . . . . . . . . . . . . . . . . . . . (167) --
Capitalization of software development costs . . . . . . . . . (576) (927)
--------- --------
Net cash used in investing activities . . . . . (1,163) (3,219)
Cash flows from financing activities:
Issuance of common shares. . . . . . . . . . . . . . . . . . . 7,437 157
Issuance of preferred shares, net. . . . . . . . . . . . . . . -- 20,896
Dividends on preferred shares. . . . . . . . . . . . . . . . . (320) --
Payments on borrowings from related company. . . . . . . . . . (1,519) (528)
Payments on capital leases . . . . . . . . . . . . . . . . . . (45) (20)
Net borrowings on line of credit . . . . . . . . . . . . . . . 5,060 5,796
Pay down on line of credit . . . . . . . . . . . . . . . . . . -- (4,000)
--------- --------
Net cash provided by financing activities . . . 10,611 22,301
Effect of exchange rate changes on cash . . . . . . . . . . . . . . (41) (2)
Net increase in cash and cash equivalents . . . . . . . . . . . . . 7,533 13,169
Cash and cash equivalents:
Beginning of period. . . . . . . . . . . . . . . . . . . . . . 6,509 6,078
--------- --------
End of period. . . . . . . . . . . . . . . . . . . . . . . . . $ 14,042 $19,247
========= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
LEVEL 8 SYSTEMS, INC. PAGE 5
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<TABLE>
<CAPTION>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Net loss . . . . . . . . . . . . . . . . . . $(5,527) $(4,224) $(13,556) $(8,052)
Other comprehensive income, net of tax
Foreign currency translation adjustment (180) 66 (254) (95)
-------- -------- --------- --------
Comprehensive loss . . . . . . . . . . . . . $(5,707) $(4,158) $(13,810) $(8,147)
======== ======== ========= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
LEVEL 8 SYSTEMS, INC. PAGE 6
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LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
NOTE 1. INTERIM FINANCIAL STATEMENTS
The accompanying financial statements are unaudited, and have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and note disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to those rules and
regulations. Accordingly, these interim financial statements should be read in
conjunction with the audited financial statements and notes thereto contained in
the Level 8 Systems, Inc.'s (the "Company") Annual Report on Form 10-K for the
year ended December 31, 1999. The results of operations for the interim periods
shown in this report are not necessarily indicative of results to be expected
for other interim periods or for the full fiscal year. In the opinion of
management, the information contained herein reflects all adjustments necessary
for a fair statement of the interim results of operations. All such adjustments
are of a normal, recurring nature, except for the conversion of certain notes
payable as described in Note 6.
The year-end condensed balance sheet data was derived from audited financial
statements in accordance with the rules and regulations of the SEC, but does not
include all disclosures required for financial statements prepared in accordance
with generally accepted accounting principles.
The accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. During the period ended June 30, 2000, all of the
Company's subsidiaries were wholly-owned. During the period ended June 30,
1999, all of the Company's subsidiaries are wholly-owned for the entire six
month period presented, except for Seer Technologies, Inc. ("Seer"). The
Company acquired a 69% interest in Seer on December 31, 1998 and the remaining
31% interest on April 30, 1999. Prior to the completion of the Seer
acquisition, Level 8 assumed Seer's net liabilities. The minority stockholders
were deemed to have shared in the losses of Seer only for their proportionate
share of Seer's net assets until April 30, 1999. Accordingly, there is no
minority interest in the losses of the Seer subsidiary reflected in the
consolidated financial statements as for the periods ended June 30, 1999.
Certain prior year amounts in the accompanying financial statements have been
reclassified to conform to the 2000 presentation. Such reclassifications had no
effect on previously reported net loss or stockholders' equity.
NOTE 2. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed based upon the weighted average
number of common shares outstanding. Diluted earnings (loss) per share is
computed based upon the weighted average number of common shares outstanding and
any potentially dilutive securities. Potentially dilutive securities are not
included in the diluted earnings per share calculations if their inclusion would
be anti-dilutive to the basic earnings (loss) per share calculations.
Potentially dilutive securities outstanding during the first half of fiscal year
1999 and 2000 include stock options, stock warrants and preferred stock.
Dividends of $209 and $111 were paid to the holders of Series A Preferred Stock
in the first and second quarter of 2000, respectively.
LEVEL 8 SYSTEMS, INC. PAGE 7
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The following table sets forth the reconciliation of net loss to loss available
to common stockholders:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
---------- ---------- --------- --------
<S> <C> <C> <C> <C>
Net loss . . . . . . . . . . . . . . . $ (5,527) $ (4,224) $(13,556) $(8,052)
Preferred stock dividends. . . . (117) -- (265) --
---------- ---------- --------- --------
Loss available to common stockholders. $ (5,644) $ (4,224) $(13,821) $(8,052)
========== ========== ========= ========
Loss per common share:
Net loss per share - basic and diluted $ (0.41) $ (0.49) $ (1.04) $ (0.93)
========== ========== ========= ========
Weighted common shares outstanding -
basic and diluted. . . . . . . . . . . 13,706 8,697 13,317 8,704
========== ========== ========= ========
</TABLE>
NOTE 3. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." The Company's
effective tax rate differs from the statutory rate primarily due to the fact
that no income tax benefit was recorded for the net loss in the first half of
fiscal year 2000 or 1999. Because of the Company's inconsistent earnings
history, the deferred tax assets have been fully offset by a valuation
allowance.
The income tax provision for the second quarter of fiscal year 2000 and 1999 is
primarily related to income taxes from profitable foreign operations and foreign
withholding taxes.
NOTE 4. USE OF ACCOUNTING ESTIMATES
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 amounts could differ from these estimates.
NOTE 5. SEGMENT INFORMATION
Management of the Company makes operating decisions and assesses performance of
its operations based on the following reportable segments: (1) Software, (2)
Maintenance, (3) Services, and (4) Research and Development.
The accounting policies of the segments are the same as those described in the
"Summary of Significant Accounting Policies," included in the Company's Annual
Report on Form 10-K for year ended December 31, 1999. Segment data includes a
charge allocating all general and administrative expenses to each of its
operating segments based on each segment's proportionate share of expenses.
The Company evaluates the performance of its segments and allocates resources
to them based on loss before interest, net foreign currency gains/(losses), loss
on disposal of assets, taxes and amortization of goodwill and other intangible
assets (EBITA).
LEVEL 8 SYSTEMS, INC. PAGE 8
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The table below presents information about reported segments for the quarter
ended June 30, 2000:
<TABLE>
<CAPTION>
Research
And
Software Maintenance Services Development Total
---------- ------------ --------- ------------- --------
<S> <C> <C> <C> <C> <C>
Total Revenue $ 11,669 $ 3,804 $ 5,608 $ -- $21,081
Total EBITA . $ (82) $ 2,043 $ 491 $ (2,908) $ (456)
</TABLE>
The table below presents information about reported segments for the quarter
ended June 30, 1999:
<TABLE>
<CAPTION>
Research
And
Software Maintenance Services Development Total
---------- ------------ --------- ------------- --------
<S> <C> <C> <C> <C> <C>
Total Revenue $ 3,190 $ 3,981 $ 5,836 $ -- $13,007
Total EBITA . $ (1,205) $ 2,324 $ 41 $ (1,778) $ (618)
</TABLE>
The table below presents information about reported segments for the six
months ended June 30, 2000:
<TABLE>
<CAPTION>
Research
And
Software Maintenance Services Development Total
---------- ------------ --------- ------------- --------
<S> <C> <C> <C> <C> <C>
Total Revenue $ 19,902 $ 7,478 $ 13,364 $ -- $40,744
Total EBITA . $ (2,581) $ 4,075 $ 235 $ (5,531) $(3,802)
</TABLE>
The table below presents information about reported segments for the six
months ended June 30, 1999:
<TABLE>
<CAPTION>
Research
And
Software Maintenance Services Development Total
---------- ------------ --------- ------------- --------
<S> <C> <C> <C> <C> <C>
Total Revenue $ 5,902 $ 7,864 $ 12,446 $ -- $26,212
Total EBITA . $ (2,251) $ 4,460 $ 68 $ (3,611) $(1,334)
</TABLE>
A reconciliation of total segment EBITA to total consolidated loss before taxes
for the three and six months ended June 30 is as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Total EBITA . . . . . . . . . . . . $ (456) $ (618) $ (3,802) $(1,334)
Amortization of goodwill. . . . . . (3,587) (1,687) (7,113) (3,384)
In-process research and development -- (744) -- (744)
Other expense, net. . . . . . . . . (1,184) (978) (2,091) (2,191)
-------- -------- --------- --------
Total loss before income taxes. . . $(5,227) $(4,027) $(13,006) $(7,653)
======== ======== ========= ========
</TABLE>
LEVEL 8 SYSTEMS, INC. PAGE 9
<PAGE>
The following table presents a summary of revenue by geographic region for the
three and six months period ended June 30:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
--------- --------- ------- -------
<S> <C> <C> <C> <C>
Australia. . . $ 342 $ 869 $ 695 $ 1,517
Denmark. . . . 1,561 2,628 2,519 4,036
France . . . . 306 -- 1,931 --
Germany. . . . 389 927 780 1,469
Greece . . . . 149 451 1,755 859
Italy. . . . . 355 603 741 1,881
Norway . . . . 450 541 1,085 1,149
Switzerland. . 463 680 921 1,680
United Kingdom 5,730 920 6,783 2,528
USA. . . . . . 10,159 3,507 21,384 8,018
Other. . . . . 1,177 1,881 2,150 3,075
--------- --------- ------- -------
Total revenue. $ 21,081 $ 13,007 $40,744 $26,212
========= ========= ======= =======
</TABLE>
Presentation of revenue by region is based on the country in which the customer
is domiciled.
NOTE 6. LONG-TERM DEBT
In connection with the acquisition of Momentum Software Corporation
("Momentum"), on December 1, 1998, the Company issued notes to various Momentum
shareholders totaling $3,000 payable over three years and bearing an interest
rate of 10% per annum. As of December 31, 1999, the remaining three
installments on the notes totaled $2,250, plus interest. During the first
quarter of 2000, the Company offered to exchange the notes held by former
Momentum shareholders for shares of the Company's common stock at a per share
price based on the average market price for a set period prior to the date the
noteholder accepted the offer. The Company converted $1,904 of the Momentum
notes in exchange for approximately 55,000 shares of common stock in the first
quarter of 2000 as a result of this exchange offer.
During July 2000, the Company's $10,000 term loan with a commercial bank was
amended. The amendment extended the due date from May 31, 2001 to November 30,
2001. No other terms were amended. In conjunction with the extension, Liraz
Systems, Ltd ("Liraz") extended their guarantee of the note in exchange for
additional shares of common stock.
Subsequent to June 30, 2000 the Company paid the remaining $3,000 balance of the
$12,000 loan from Liraz.
NOTE 7. PREFERRED STOCK
During the first half of 2000, 7,216 shares of the Company's Series A Preferred
Stock were converted into 721,600 shares of the Company's common stock.
Subsequent to June 30, 2000, the Company completed its agreement to sell 30,000
shares of Series B Convertible Redeemable Preferred Stock ("Series B Preferred
Stock"), for $30,000, convertible into an aggregate of approximately 1.2 million
shares of common stock of the Company. The proceeds will be used to pay down
debt and for other general corporate purposes. The sale of the Series B
Preferred Stock was made in a private transaction exempt from the registration
requirements of the federal securities laws.
Holders of the Series B Preferred Stock are entitled to receive 4% annual cash
dividends payable quarterly and will have one vote per share of Series B
Preferred Stock, voting together with the common stock and not as a separate
class except on certain matters adversely affecting the rights of holders of the
Series B Preferred Stock. The Series B Preferred Stock may be redeemed at the
option of Level 8 at a redemption price equal to the original purchase price at
any time after July 20, 2001 if the closing price of Level 8's common stock over
20 consecutive trading days is greater than $50.125 per share. The conversion
price of the Series B Preferred Stock is subject to certain anti-dilution
provisions, including adjustments in the event of certain sales of common stock
at a price of less than $25.0625 per share. In the event Level 8 breaches its
LEVEL 8 SYSTEMS, INC. PAGE 10
<PAGE>
obligations to pay dividends when due or issue common stock upon conversion, or
Level 8's common stock is delisted, the dividend rate on the Series B Preferred
Stock would increase to 18% per annum (partially payable in shares of common
stock at the option of Level 8 during the first 60 days of such increased
dividend rate). As part of the $30 million financing, Level 8 also issued the
investors warrants to purchase 1,047,382 shares of common stock at an exercise
price of $25.0625 per share. Level 8 has agreed to register the common stock
issuable upon conversion of the Series B Preferred Stock and exercise of the
warrants for resale under the Securities Act of 1933, as amended. Level 8 is
required to make certain payments in the event it is unable to meet its
obligations in connection with the Series B Preferred Stock and warrants, such
as registration under the Securities Act or issuance of shares of common stock
upon conversion or exercise. The aggregate amount of all such payments, together
with dividends on the Series B Preferred Stock, is limited to 19% of the
liquidation value of the Series B Preferred Stock.
NOTE 8. CONTINGENCIES
On April 6, 1998, the Company sold substantially all the assets and
operations of its wholly owned subsidiary ProfitKey International, Inc.
("ProfitKey"). According to the terms of the ProfitKey sale agreement, the
purchase price is subject to adjustment to reflect any variance in working
capital from a specified amount. The purchaser notified the Company that it
believes there are substantial adjustments which would require a reduction in
the purchase price. The Company and the purchaser, pursuant to the terms of
the settlement agreement, entered into arbitration proceedings to resolve this
matter and a decision from the arbitrator is expected soon. The Company has
made a provision for its estimate of the purchase price adjustment and the costs
to resolve this matter. Management believes at this time that any
additional provision required to ultimately resolve this matter will not have
a material effect on the financial position, cash flows, or results of
operations of the Company.
In December 1997, Seer filed a lawsuit against Saadi Abbas ("Abbas") and
Cambridge Business Solutions (UK) Limited ("CBS") concerning a dispute over
a license agreement between Seer, CBS, and Abbas. These entities counterclaimed
against Seer. The case has proceeded through discovery and various other
procedural events and all that remains of the litigation at this point in time
are various claims against Seer by Abbas. In July 1999, most of those claims
were struck out by the court in London, England as unarguable or otherwise time
barred. The Company intends to continue to vigorously defend against the few
remaining claims. One claim that was struck out is subject to appeal. The
Company has made provision for its estimated costs to resolve this matter.
Management does not believe at this point in the litigation that any
additional amounts required to ultimately resolve this matter will have a
material effect on the financial position, cash flows, or results of
operations of the Company.
NOTE 9. SUBSEQUENT EVENT
On July 31, 2000, the Company announced that it intends to acquire the rights to
a comprehensive integrated desktop computer environment from a global financial
management and advisory company, in exchange for 1 million shares of its common
stock. The transaction is pending final United States federal regulatory
approval and certain other conditions. The Company intends to extend the
product to a multi-platform environment that works with its existing eBusiness
integration products.
LEVEL 8 SYSTEMS, INC. PAGE 11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
--------------------------------------------------------------------------------
OF OPERATIONS.
---------------
GENERAL INFORMATION
--------------------
Level 8 specializes in delivering software solutions that help companies
integrate new and existing computer applications and extend these applications
to the Internet to support eBusiness and eCommerce. This specialization is
called enterprise application integration or ''EAI.'' Level 8's products and
services are designed to enable organizations to address business process
automation and application integration in a simple and cost effective way. Level
8 provides customers with software to link their critical business applications
internally across the enterprise and externally with strategic
business-to-business partners and business-to-business consumers via the
Internet.
Level 8 offers a suite of products for eBusiness and eCommerce under the
Geneva brand name. The Geneva Integration Suite has six core components which
the Company believes, together, provide the most complete suite of integration
software products available for eBusiness integration. These components include
Geneva Enterprise Integrator, Geneva Business Process Automator, Geneva
Integration Broker, Geneva Message Queuing, Geneva AppBuilder, and Geneva XIPC.
In addition to these products, Level 8 also provides technical support, training
and consulting services as part of its commitment to providing its customers
industry-leading enterprise application integration solutions.
RESULTS OF OPERATIONS
-----------------------
The Company's results of operations include the operations of the Company
and its subsidiaries. Operations for the subsidiaries acquired during 1999 are
included from the date of acquisition. Accordingly, the results of operations
for the first half of 1999 do not include the operations of the Company's
subsidiary, TSAC, Inc. (which acquired Template Software, Inc. ("Template"))
on December 27, 1999.
LEVEL 8 SYSTEMS, INC. PAGE 12
<PAGE>
The following table sets forth, for the periods indicated, the Company's
unaudited results of operations expressed as a percentage of revenue:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue:
Software products . . . . . . . . . . . . 55.4% 24.5% 48.8% 22.5%
Maintenance . . . . . . . . . . . . . . . 18.0% 30.6% 18.4% 30.0%
Services. . . . . . . . . . . . . . . . . 26.6% 44.9% 32.8% 47.5%
------- ------- ------- -------
Total. . . . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0% 100.0%
Cost of revenue:
Software products . . . . . . . . . . . . 8.1% 8.4% 8.9% 7.4%
Maintenance . . . . . . . . . . . . . . . 7.3% 11.1% 7.2% 11.6%
Services. . . . . . . . . . . . . . . . . 21.3% 39.0% 27.7% 42.3%
------- ------- ------- -------
Total. . . . . . . . . . . . . . . . . . . . . 36.7% 58.5% 43.8% 61.3%
Gross profit . . . . . . . . . . . . . . . . . 63.3% 41.5% 56.2% 38.7%
Operating expenses:
Sales and marketing . . . . . . . . . . . 40.8% 21.2% 38.6% 20.5%
Research and product development. . . . . 12.1% 12.0% 11.7% 12.3%
General and administrative. . . . . . . . 12.6% 13.1% 15.2% 11.0%
Amortization of goodwill and intangibles. 17.0% 13.0% 17.5% 12.9%
Purchased research and development. . . . ---- 5.7% ---- 2.8%
Loss on disposal of assets. . . . . . . . 1.6% --- 0.8% ---
------- ------- ------- -------
Total. . . . . . . . . . . . . . . . . . . . . 84.1% 65.0% 83.8% 59.5%
Loss from operations . . . . . . . . . . . . . (20.8%) (23.5%) (27.6%) (20.8%)
Other income (expense), net. . . . . . . . . . (4.0%) (7.5)% (4.3)% (8.4)%
------- ------- ------- -------
Loss before taxes. . . . . . . . . . . . . . . (24.8%) (31.0%) (31.9%) (29.2%)
Income tax provision . . . . . . . . . . . . . 1.4% 1.5% 1.3% 1.5%
------- ------- ------- -------
Net loss . . . . . . . . . . . . . . . . . . . (26.2%) (32.5%) (33.2%) (30.7%)
======= ======= ======= =======
</TABLE>
The following table sets forth unaudited data for total revenue by geographic
origin as a percentage of total revenue for the periods indicated:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
United States 48 % 27 % 52 % 31 %
Europe. . . . 49 % 63 % 45 % 60 %
Asia Pacific. 2 % 7 % 2 % 7 %
Other . . . . 1 % 3 % 1 % 2 %
----- ----- ----- -----
Total . . . . 100 % 100 % 100 % 100 %
===== ===== ===== =====
</TABLE>
LEVEL 8 SYSTEMS, INC. PAGE 13
<PAGE>
REVENUE AND GROSS MARGIN. The Company has three categories of
revenue: software products, maintenance, and services. Software products
revenue is comprised primarily of fees from licensing the Company's proprietary
software products. Maintenance revenue is comprised of fees for maintaining,
supporting, and providing periodic upgrades to the Company's software
products. Services revenue is comprised of fees for consulting and training
services related to the Company's software products.
The Company's revenues may vary from quarter to quarter due to market
conditions, the budgeting and purchasing cycles of customers, and the
effectiveness of its sales force. The Company typically does not have any
material backlog of unfilled software orders, and product revenue in any quarter
is substantially dependent upon orders received in that quarter. Because the
Company's operating expenses are based on anticipated revenue levels and are
relatively fixed over the short term, variations in the timing of recognition
revenue can cause significant variations in operating results from quarter to
quarter. Fluctuations in operating results may result in volatility in the
price of the Company's common stock.
Total revenues increased significantly for the second quarter and
year-to-date periods of 2000 as compared to the same periods of 1999 due to
growth in the sales of the Company's software products and due to the services
business acquired with Template. The Company's gross margins improved to 63%
and 56% for the second quarter and year-to-date periods ended June 30, 2000 from
42% and 39% for the comparable periods of 1999.
SOFTWARE PRODUCTS. Software products revenue increased significantly
for the second quarter and year-to-date periods of 2000 as compared to the same
periods of 1999. Software product sales increased due to the Company's focus on
sales and marketing, which resulted in increased sales of its products.
Gross margins on software products increased from a margin of 66% and 67%
for the second quarter and year-to-date periods of 1999 to 85% and 82% for the
same periods of 2000 primarily due to the increase in the Company's software
products revenue. The increase in revenue in the first six months of 2000, was
offset somewhat by a $1.7 million increase in cost of software. Cost of
software is composed primarily of amortization of purchased technology,
capitalized software costs for internally developed software, royalties to third
parties for the Company's Geneva Message Queuing product and, to a lesser
extent, production and distribution costs. The increase in cost of software was
primarily due to amortization of purchased technology from the acquisition of
Template and Seer Technology, Inc ("Seer").
MAINTENANCE. Maintenance revenue during the second quarter and
year-to-date periods of 2000 was relatively consistent with the same periods of
1999. This consistency is the result of a decline in the number of customers
not renewing the same level of maintenance for Geneva AppBuilder and Geneva
XIPC, which was partly offset by new maintenance revenue from Template's
customers and new software sales. Historically, maintenance was not a
significant part of Template's revenue. The Company plans to focus on
increasing maintenance for the historical Template products in future sales.
Cost of maintenance is comprised of personnel costs and related overhead
and the cost of third-party contracts for the maintenance and support of the
Company's software products. Gross margins on maintenance were constant at
approximately 60% in the second quarter and year-to-date periods of both 2000
and 1999. During the first quarter of 2000, the Company ended its relationship
with the third-party support contractor, and now provides these services with
its own personnel.
SERVICES. Services revenue decreased 4% from the second quarter of 1999
and increased 7% from the year-to-date period of 1999 as compared to the same
periods of 2000. The increase in the year-to-date period of 2000 is primarily
due to the acquisition of Template. Through the acquisition of Template, the
Company became party to government services contracts, which resulted in
approximately $3.5 million in revenue in the year-to-date period of 2000.
During the second quarter, the Company disposed of its classified government
contracts, which were not related to the Company's products.
Cost of services primarily includes personnel and travel costs related to
the delivery of services. Services gross margins increased from 13% in the
second quarter and 11% in the year-to-date period of 1999 to 20% and 15% in the
comparable periods of 2000 due to higher utilization of billable resources and
by providing more services for its EAI products, rather than the Company's
AppBuilder products which historically carry lower margins.
LEVEL 8 SYSTEMS, INC. PAGE 14
<PAGE>
SALES AND MARKETING. Sales and marketing expenses primarily include
personnel costs for sales and technical sales support personnel, travel, and
related overhead, as well as trade show participation and other promotional
expenses. Sales and marketing expenses increased significantly from the second
quarter and year-to-date period of 1999 to the same periods of 2000 due to an
increase in the size of the Company's sales and marketing workforce, both
through acquisition and recruiting, and through increased promotional
activities. Sales and marketing expenses have also increased as a percentage of
revenue from 21% in the year-to-date period of 1999 to 39% in the comparable
period of 2000. These changes were instituted to drive increased software
product revenue. The Company plans further increases in the marketing area to
enhance market awareness and acceptance of its products and to further establish
its indirect distribution network.
RESEARCH AND DEVELOPMENT. Research and development expenses primarily
include personnel costs for product authors, product developers and product
documentation personnel and related overhead. Research and development expense
increased 64% and 47% from the second quarter and year-to-date periods of 1999
to the comparable periods of 2000 primarily due to the addition of an average of
thirty-five developers from Template. The Company intends to continue making a
significant investment in research and development while also improving
efficiencies in this area.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
consist of personnel costs for the executive, legal, financial, human resources,
and administrative staff, related overhead, and all non-allocable corporate
costs of operating the Company. General and administrative expenses increased
significantly from the second quarter and year-to-date period of 1999 to the
same periods of 2000. The increases were primarily the result of increased
professional fees and personnel costs due to the growth in the Company's
business both internally and through its acquisition of Template.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS. Amortization
of goodwill and other intangible assets was $3.6 million in the second quarter
and $7.1 million in the year-to-date period of 2000 compared to and $1.7 million
and $3.4 million in the comparable periods of 1999. The amortization of
goodwill in the first half of 1999 was related to the purchases of Seer,
Momentum Software Corporation ("Momentum"), and Level 8 Technologies. During
the first half of 2000, amortization of goodwill and other intangibles also
included the amortization of intangible assets acquired with Template. The
Company will continue to assess the recoverability of its intangible assets on a
quarterly basis based on the net present value of the expected future cash
flows.
PROVISION FOR INCOME TAXES. The Company's effective income tax rate
for continuing operations differs from the statutory rate primarily because an
income tax benefit was not recorded for the net loss incurred in the second
quarter and year-to-date period of 2000 or 1999. Because of the Company's
inconsistent earnings history, the deferred tax assets have been fully offset by
a valuation allowance. The income tax provision for the year-to-date period of
fiscal year 2000 is primarily related to income taxes from profitable foreign
operations and foreign withholding taxes.
IMPACT OF INFLATION. Inflation has not had a significant effect on
the Company's operating results during the periods presented.
LIQUIDITY AND CAPITAL RESOURCES
----------------------------------
Net cash used in operations and investing activities during the first two
quarters of 2000 was $3.1 million. Payments of approximately $2.9 million for
merger and restructuring costs primarily related to the acquisition of Template
were the primary components of the net cash outflow in addition to the Company's
planned spending to support its sales and marketing efforts. During the
year-to-date period of 2000, the Company has paid approximately $1.5 million on
its outstanding debt obligations with its majority shareholder Liraz Systems,
Ltd. ("Liraz"). The Company funded its cash needs during the first half of 2000
with cash on hand at December 31, 1999, through operations, through $7.4 million
in proceeds from the issuance of common stock as a result of the exercise of
stock options and warrants, and through $5 million in additional borrowings
under its line of credit.
LEVEL 8 SYSTEMS, INC. PAGE 15
<PAGE>
As of June 30, 2000, the Company had outstanding borrowings of $20.2
million under a credit facility with a commercial bank shared between the
Company and its subsidiaries (the "Credit Facility") at an interest rate
of 11.5%. The Credit Facility provides for borrowings up to the lesser of $25
million or the sum of 80% of eligible receivables and a $10 million term loan
payable on December 31, 2001. The receivables-based borrowings under the Credit
Facility are due on demand. The Credit Facility bears interest at the prime rate
plus 2% per annum and has no financial covenant provisions. The receivables
based borrowing instrument terminates on December 1, 2000; however, it is
automatically renewed for successive additional terms of one year each, unless
terminated by either party. The Credit Facility is collateralized by the
Company's accounts receivable, equipment and intangibles, including intellectual
property.
In conjunction with the purchase of Template, the Company entered into a
term loan with a commercial bank for $10 million. The loan bears interest at
LIBOR plus 1% (7.75% at June 30, 2000), which is payable quarterly. This term
loan will be due November 30, 2001 and has no financial covenants. The loan is
guaranteed by Liraz.
In connection with the acquisition of Momentum Software Corporation
("Momentum"), on December 1, 1998, the Company issued notes to various Momentum
shareholders totaling $3 million payable over three years and bearing an
interest rate of 10% per annum. As of December 31, 1999, the remaining three
installments on the notes totaled $2.25 million, plus interest. During the
first quarter of 2000, the Company offered to exchange the notes held by former
Momentum shareholders for shares of the Company's common stock at a per share
price based on the average market price for a set period prior to the date the
noteholder accepted the offer. The Company converted $1.9 million of the
Momentum notes in exchange for approximately 55,000 shares of common stock in
the first quarter of 2000 as a result of this exchange offer. As of June 30,
2000 $.2 million of the notes are outstanding.
In addition to the debt described above, the Company has other outstanding
borrowings at June 30, 2000 including $3 million from Liraz which bears interest
at 12% and is payable on December 15, 2001. The borrowings from Liraz are
subordinate in right of payment to the Credit Facility. Subsequent to June 30,
2000, the Company repaid the $3 million loan from Liraz.
Future maturities on the Company's outstanding debt at June 30, 2000
include $10.4 million in 2000 and $23.3 million in 2001. Of such amounts, $3
million in 2001 is due to Liraz.
Subsequent to June 30, 2000, the Company completed its agreement to sell
30,000 shares of Series B Convertible Redeemable Preferred Stock ("Series B
Preferred Stock"), for $30 million convertible into an aggregate of
approximately 1.2 million shares of common stock of the Company. The proceeds
will be used to pay down debt and for other general corporate purposes. The
sale of the Series B Preferred Stock was made in a private transaction exempt
from the registration requirements of the federal securities laws.
Holders of the Series B Preferred Stock are entitled to receive 4% annual
cash dividends payable quarterly and will have one vote per share of Series B
Preferred Stock, voting together with the common stock and not as a separate
class except on certain matters adversely affecting the rights of holders of the
Series B Preferred Stock. The Series B Preferred Stock may be redeemed at the
option of Level 8 at a redemption price equal to the original purchase price at
any time after July 20, 2001 if the closing price of Level 8's common stock over
20 consecutive trading days is greater than $50.125 per share. The conversion
price of the Series B Preferred Stock is subject to certain anti-dilution
provisions, including adjustments in the event of certain sales of common stock
at a price of less than $25.0625 per share. In the event Level 8 breaches its
obligations to pay dividends when due or issue common stock upon conversion, or
Level 8's common stock is delisted, the dividend rate on the Series B Preferred
Stock would increase to 18% per annum (partially payable in shares of common
stock at the option of Level 8 during the first 60 days of such increased
dividend rate). As part of the $30 million financing, Level 8 also issued the
investors warrants to purchase 1,047,382 shares of common stock at an exercise
price of $25.0625 per share. Level 8 has agreed to register the common stock
issuable upon conversion of the Series B Preferred Stock and exercise of the
warrants for resale under the Securities Act of 1933, as amended. Level 8 is
required to make certain payments in the event it is unable to meet its
obligations in connection with the Series B Preferred Stock and warrants, such
as registration under the Securities Act or issuance of shares of common stock
upon conversion or exercise. The aggregate amount of all such payments, together
with dividends on the Series B Preferred Stock, is limited to 19% of the
liquidation value of the Series B Preferred Stock.
As of June 30, 2000, the Company did not have any material commitments for
capital expenditures.
During the first two quarters of 2000, the Company incurred a net loss of
$13.6 million and has working capital of $4.2 million and an accumulated deficit
of $55.0 million at June 30, 2000. The Company believes that existing cash on
hand, cash provided by future operations and additional borrowings under the
Credit Facility will be sufficient to finance its operations and expected
working capital and capital expenditure requirements for at least the next
twelve months so long as the Company continues to perform to its operating plan.
However, there can be no assurance that the Company will be able to continue to
meet its cash requirements through operations or, if needed, obtain additional
financing on acceptable terms, and the failure to do so may have an adverse
impact on the Company's business and operations. The Company may also explore
additional debt or equity financing to expand its operations and take advantage
of market opportunities.
LEVEL 8 SYSTEMS, INC. PAGE 16
<PAGE>
EURO CONVERSION
----------------
Several European countries adopted a Single European Currency (the "Euro")
as of January 1, 1999 with a transition period continuing through January 1,
2002. The Company is reviewing the anticipated impact the Euro may have on its
internal systems and on its competitive environment. The Company believes its
internal systems will be Euro capable without material modification cost.
Further, the Company does not presently expect the introduction of the Euro
currency to have an adverse material impact on the Company's financial
condition, cash flows, or results of operations.
LEVEL 8 SYSTEMS, INC. PAGE 17
<PAGE>
FORWARD LOOKING AND CAUTIONARY STATEMENTS
---------------------------------------------
Certain statements contained in this Annual Report may constitute ''forward
looking statements'' within the meaning of the Private Securities Litigation
Reform Act of 1995 (''Reform Act''). The Company may also make forward looking
statements in other reports filed with the Securities and Exchange Commission,
in materials delivered to shareholders, in press releases and in other public
statements. In addition, the Company's representatives may from time to time
make oral forward looking statements. Forward looking statements provide current
expectations of future events based on certain assumptions and include any
statement that does not directly relate to any historical or current fact. Words
such as ''anticipates,'' ''believes,'' ''expects,'' ''estimates,'' ''intends,''
''plans,'' ''projects,'' and similar expressions, may identify such forward
looking statements. In accordance with the Reform Act, set forth below are
cautionary statements that accompany those forward looking statements. Readers
should carefully review these cautionary statements as they identify certain
important factors that could cause actual results to differ materially from
those in the forward looking statements and from historical trends. The
following cautionary statements are not exclusive and are in addition to other
factors discussed elsewhere in the Company's filings with the Securities and
Exchange Commission and in materials incorporated therein by reference: the
Company's future success depends on the market acceptance of the new Geneva
Integration Suite; general economic or business conditions may be less favorable
than expected, resulting in, among other things, lower than expected revenues;
an unexpected revenue shortfall may adversely affect the Company's business
because its expenses are largely fixed; the Company's quarterly operating
results may vary significantly because the Company is not able to accurately
predict the amount and timing of individual sales and this may adversely impact
the Company's stock price; trends in sales of the Company's products and general
economic conditions may affect investors' expectations regarding the Company's
financial performance and may adversely affect the Company's stock price; the
Company's future results may depend upon the continued growth and business use
of the Internet; the Company's government contracts business is subject to a
number of risks associated with doing business with the federal government; the
Company may lose market share and be required to reduce prices as a result of
competition from its existing competitors, other vendors and information systems
departments of customers; the Company may not have the ability to recruit, train
and retain qualified personnel; the Company may not have the resources to
successfully manage the integration of Template; the Company's future results
may depend upon the successful integration of future acquisitions; the Company
may not have the resources to successfully manage additional growth; rapid
technological change could render the Company's products obsolete; if the
Company's relationship with Microsoft weakens, it could adversely affect the
Company's business; the loss of any one of the Company's major customers could
adversely affect the Company's business; the Company's business is subject to a
number of risks associated with doing business abroad including the effect of
foreign currency exchange fluctuations on the Company's results of operations;
the Company's products may contain undetected software errors, which could
adversely affect its business; because the Company's technology is complex, the
Company may be exposed to liability claims; year 2000 issues may cause problems
with the Company's systems and expose the Company to liability; the failure of
the Company to meet product delivery dates could adversely affect its business;
the Company may be unable to enforce or defend its ownership and use of
proprietary technology; because the Company is a technology company, its common
stock may be subject to erratic price fluctuations; and the Company may not have
sufficient liquidity and capital resources to meet changing business conditions.
LEVEL 8 SYSTEMS, INC. PAGE 18
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
--------------------------------------------------------------------------
Approximately 52% and 48% of the Company's revenues for three and six
months ended June 30, 2000, respectively, were generated by sales outside the
United States. The Company is exposed to significant risks of foreign currency
fluctuation primarily from receivables denominated in foreign currency and are
subject to transaction gains and losses, which are recorded as a component in
determining net income. Additionally, the assets and liabilities of the
Company's non-U.S. operations are translated into U.S. dollars at exchange rates
in effect as of the applicable balance sheet dates, and revenue and expense
accounts of these operations are translated at average exchange rates during the
month the transactions occur. Unrealized translation gains and losses will be
included as an adjustment to shareholders' equity.
The Company hedges its foreign currency receivables in an effort to reduce
its exposure to currency exchange rates. However, as a matter of procedure, the
Company will not invest in speculative financial instruments as a means of
hedging against such risk. The Company's accounting policies for these contracts
are based on the Company's designation of the contracts as hedging transactions.
The criteria the Company uses for designating a contract as a hedge include the
contract's effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. Gains and losses on forward foreign
exchange contracts are recognized in income in the same period as gains and
losses on the underlying transactions. If an underlying hedged transaction is
terminated earlier than initially anticipated, the offsetting gain or loss on
the related forward exchange contract would be recognized in income in the same
period. In addition, since the Company enters into forward contracts only as a
hedge, any change in currency rates would not result in any material net gain or
loss, as any gain or loss on the underlying foreign currency denominated balance
would be offset by the gain or loss on the forward contract.
LEVEL 8 SYSTEMS, INC. PAGE 19
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 6, 1998, the Company sold substantially all the assets and
operations of its wholly owned subsidiary ProfitKey International, Inc.
("ProfitKey"). According to the terms of the ProfitKey sale agreement, the
purchase price is subject to adjustment to reflect any variance in working
capital from a specified amount. The purchaser notified the Company that it
believes there are substantial adjustments which would require a reduction in
the purchase price. The Company and the purchaser, pursuant to the terms of
the settlement agreement, entered into arbitration proceedings to resolve this
matter and a decision from the arbitrator is expected soon. The Company has
made a provision for its estimate of the purchase price adjustment and the costs
to resolve this matter. Management believes at this time that any
additional provision required to ultimately resolve this matter will not have
a material effect on the financial position, cash flows, or results of
operations of the Company.
In December 1997, Seer filed a lawsuit against Saadi Abbas
("Abbas") and Cambridge Business Solutions (UK) Limited ("CBS") concerning a
dispute over a license agreement between Seer, CBS, and Abbas. These entities
counterclaimed against Seer. The case has proceeded through discovery and
various other procedural events and all that remains of the litigation at this
point in time are various claims against Seer by Abbas. In July 1999, most of
those claims were struck out by the court in London, England as unarguable or
otherwise time barred. The Company intends to continue to vigorously defend
against the few remaining claims. One claim that was struck out is subject to
appeal. The Company has made provision for its estimated costs to resolve this
matter. Management does not believe at this point in the litigation that
any additional amounts required to ultimately resolve this matter will have a
material effect on the financial position, cash flows, or results of
operations of the Company.
From time to time, the Company is a party to routine litigation incidental
to its business. As of the date of this Report, the Company was not engaged in
any legal proceedings that are expected, individually or in the aggregate, to
have a material adverse effect on the Company.
ITEM 2. CHANGES IN SECURITIES
On July 20, 2000, Level 8 Systems, Inc. completed a $30 million private
placement of 30,000 shares of Series B 4% Convertible Redeemable Preferred Stock
("Series B Preferred Stock"), convertible into an aggregate of 1,197,007 shares
of common stock of Level 8. Net proceeds of the private placement will be used
to acquire assets, reduce debt and for working capital. Holders of the Series B
Preferred Stock are entitled to receive 4% annual cash dividends payable
quarterly and will have one vote per share of Series B Preferred Stock, voting
together with the common stock and Series A 4% Convertible Redeemable Preferred
Stock and not as a separate class except on certain matters adversely affecting
the rights of holders of the Series B Preferred Stock. The Series B Preferred
Stock may be redeemed at the option of Level 8 at a redemption price equal to
the original purchase price at any time after July 20, 2001 if the closing price
of Level 8's common stock over 20 consecutive trading days is greater than
$50.125 per share. The conversion price of the Series B Preferred Stock is
subject to certain anti-dilution provisions, including adjustments in the event
of certain sales of common stock at a price of less than $25.0625 per share. In
the event Level 8 breaches its obligations to pay dividends when due or issue
common stock upon conversion, or Level 8's common stock is delisted, the
dividend rate on the Series B Preferred Stock would increase to 18% per annum
(partially payable in shares of common stock at the option of Level 8 during the
first 60 days of such increased dividend rate). As part of the $30 million
financing, Level 8 also issued the investors warrants to purchase 1,047,382
shares of common stock at an exercise price of $25.0625 per share. Level 8 has
agreed to register the common stock issuable upon conversion of the Series B
Preferred Stock and exercise of the warrants for resale under the Securities Act
of 1933, as amended (the "Securities Act"). Level 8 is required to make certain
payments in the event it is unable to meet its obligations in connection with
the Series B Preferred Stock and warrants, such as registration under the
Securities Act or issuance of shares of common stock upon conversion or
exercise. The aggregate amount of all such payments, together with dividends on
the Series B Preferred Stock, is limited to 19% of the liquidation value of the
Series B Preferred Stock. Investors in the Series B Preferred Stock and warrants
include investment funds affiliated with Brown Simpson Asset Management and
Seneca Capital Management. The foregoing summary description is qualified in
its entirety by reference to the definitive transaction documents, copies of
which are attached as exhibits to Level 8's Current Report on Form 8-K filed
July 31, 2000. Level 8 placed the Series B Preferred Stock and warrants in
reliance upon the exemption from the registration requirements of the Securities
Act provided in Section 4(2) for transactions not involving a public offering.
LEVEL 8 SYSTEMS, INC. PAGE 20
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ITEM 3. DEFAULTS 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
3.4 Certificate of Designation relating to Series B 4%
Convertible Redeemable Preferred Stock (incorporated by
reference to Form 8-K filed July 31, 2000, No.0-26392).
10.33 Securities Purchase Agreement dated July 20, 2000 among
Level 8 Systems, Inc. and the investors named on the
signature pages thereof (incorporated by reference to
Form 8-K filed July 31, 2000, No. 0-26392).
10.34 Warrant for 523,691 shares issued to Brown Simpson
Partners I, Ltd., July 20, 2000 in connection with the
sale of Series B 4% Convertible Redeemable Preferred
Stock (incorporated by reference to Form 8-K filed
July 31, 2000, No. 0-26392).
10.35 Warrant for 182,506 shares issued to Seneca Capital,
L.P., July 20, 2000 in connection with the sale of
Series B 4% Convertible Redeemable Preferred Stock
(incorporated by reference to Form 8-K filed July 31,
2000, No. 0-26392).
10.36 Warrant for 341,185 shares issued to Seneca Capital
International, Ltd., July 20, 2000 in connection with
the sale of Series B 4% Convertible Redeemable Preferred
Stock (incorporated by reference to Form 8-K filed
July 31, 2000, No. 0-26392).
10.37 Registration Rights Agreement dated July 20, 2000 among
Level 8 Systems, Inc. and the investors named on the
signature pages thereof (incorporated by reference to
Form 8-K filed July 31, 2000, No. 0-26392).
10.38 Amendment dated August 2, 2000, to the Promissory Note,
among the Company and Greyrock Capital, a division of
Banc of America Commercial Finance Corporation dated
March 31, 1999(filed herewith).
27.1 Financial Data Schedule for the Company(filed herewith).
LEVEL 8 SYSTEMS, INC. PAGE 21
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(b) Reports on Form 8-K
On July 17, 2000 Level 8 filed a Form 8-K reporting its July 10,
2000 dismissal of PriceWaterhouseCoopers LLP and engagement
of Deloitte & Touche LLP as its independent accountants.
This form 8-K was amended with a filing on August 2, 2000.
On July 31, 2000, the Company filed a Form 8-K reporting the July
20, 2000 issuance of 30,000 shares of its Series B 4%
Convertible Redeemable Preferred Stock warrants to purchase
1,047,382 shares of common stock at an exercise price of
$25.0625 per share.
LEVEL 8 SYSTEMS, INC. PAGE 22
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SIGNATURES
Pursuant to the requirements 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.
Level 8 Systems, Inc.
Date: August 11, 2000 /s/ Steven Dmiszewicki
------------------------
Steven Dmiszewicki
President
Date: August 11, 2000 /s/ Renee D. Fulk
------------------------
Renee D. Fulk
Chief Financial Officer
LEVEL 8 SYSTEMS, INC. PAGE 23
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