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As filed with the Securities and Exchange Commission on September 22, 2000
Registration No. 333-44588
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 1
to
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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LEVEL 8 SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
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DELAWARE 11-2920559
(I.R.S. Employer
(State or other jurisdiction of Identification Number)
incorporation or organization)
8000 REGENCY PARKWAY
CARY, NORTH CAROLINA 27511
(919) 380-5000
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
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DENNIS McKINNIE, ESQ.
SENIOR VICE PRESIDENT, CHIEF LEGAL AND
ADMINISTRATIVE OFFICER, CORPORATE SECRETARY
LEVEL 8 SYSTEMS, INC.
8000 REGENCY PARKWAY
CARY, NORTH CAROLINA 27511
(919) 380-5000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
COPIES OF COMMUNICATIONS TO:
Scott D. Smith, Esq.
Eliot W. Robinson, Esq.
Powell, Goldstein, Frazer & Murphy LLP
Sixteenth Floor
191 Peachtree Street, N.E.
Atlanta, Georgia 30303
(404) 572-6600
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Approximate Date of Commencement of Proposed Sale to the Public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the Prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
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<PAGE>
5,162,169 Shares
LEVEL 8 SYSTEMS, INC.
[LOGO OF LEVEL 8 SYSTEMS]
Common Stock
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This prospectus relates to the resale of up to 5,162,169 shares of our common
stock, $.001 par value, which are being offered by the stockholders named in
the section entitled "Selling Stockholders" on page 12. The number of shares
the selling stockholders may offer and sell under this prospectus includes
common shares:
. the selling stockholders currently hold;
. issuable to them upon the conversion of outstanding convertible
preferred stock; and
. issuable to them upon the exercise of warrants previously issued by us.
The selling stockholders may also offer additional shares of common stock
acquired upon conversion of convertible preferred stock or exercise of the
warrants as a result of anti-dilution provisions, stock splits, stock dividends
or similar transactions.
We will not receive any of the proceeds from any resales by the selling
shareholders. We however, receive the proceeds from the exercise of the
warrants issued to the selling stockholders. The selling stockholders may sell
the shares of common stock from time to time in various types of transactions,
including on The Nasdaq National Market, in the over-the-counter market, and in
privately negotiated transactions. For additional information on methods of
sale, you should refer to the section entitled "Plan of Distribution" on page
14. On September 21, 2000, the last sales price of the common stock on The
Nasdaq National Market was $17.375 per share. Our company's common stock is
quoted on The Nasdaq National Market under the symbol "LVEL."
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Investing in our common stock involves a high degree of risk.
See "Risk Factors" beginning on page 3.
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Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved these securities or passed upon the adequacy or
accuracy of this prospectus. Any representation to the contrary is a criminal
offense.
The date of this prospectus is September 22, 2000.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Prospectus Summary..................................................... 1
<S> <C>
Risk Factors........................................................... 3
Forward-Looking Statements............................................. 10
Use Of Proceeds........................................................ 10
Price Range Of Our Common Stock........................................ 11
Dividend Policy........................................................ 11
Selling Stockholders................................................... 12
Plan Of Distribution................................................... 14
Selected Consolidated Financial Data................................... 16
Management's Discussion And Analysis Of Financial Condition And Results
Of Operations......................................................... 17
Business............................................................... 29
Management............................................................. 41
Principal Stockholders................................................. 47
Certain Relationships And Related Transactions......................... 49
Changes In And Disagreements With Accountants.......................... 50
Description Of Capital Stock........................................... 54
Legal Matters.......................................................... 57
Experts................................................................ 57
Available Information.................................................. 57
Index To Consolidated Financial Statements ............................ F-1
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this
prospectus. This summary does not contain all of the information you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including "Risk Factors" and the financial statements,
before making an investment decision. References to "we," "our," "Level 8" and
the "Company" generally refer to Level 8 Systems, Inc., a Delaware corporation.
Our company is a leading global provider of high performance eBusiness
integration software. Business integration software addresses the emerging need
for a company's information systems to deliver enterprise-wide views of the
company's business information processes. As new computer technologies have
proliferated in enterprise computing environments, the integration and
management of the applications which rely on them has become increasingly
complex. Our products and services are designed to enable organizations to
address information systems integration and management problems in a simple and
cost effective way. We provide customers with solutions to meet their
enterprise application integration (EAI) and development needs. Our products
allow companies to link their critical business applications internally across
the enterprise and externally with strategic business partners. Our products
and services enable organizations to engage in business-to-business and
business-to-consumer electronic commerce. Electronic commerce refers to
business conducted over the Internet. Currently, our products and services are
sold worldwide through a network of regional sales offices. To date, our
products and services have been utilized by companies in a wide variety of
industries, including banking and financial services, insurance, retail,
manufacturing, data processing, public utilities and transportation.
Specifically, our customer base includes major corporations around the world
such as Amdocs Software Systems Limited, Cirquit.com, Enron Corporation,
Spacenet Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Paine Webber
Inc., Siemens Power Transmission & Distribution, Inc., Sikorsky Aircraft
Corporation, Sunrider International, EDB 4tel AS, Wells Fargo Bank, N.A.,
WinStar Wireless, Inc. and United Healthcare Services, Inc.
In April 1999, we completed our acquisition of Seer Technologies, Inc.
("Seer"). In connection with the acquisition of Seer, we acquired significant
intellectual property assets, including Geneva AppBuilder (formerly Seer*HPS).
In December 1999, we acquired Template Software, Inc. ("Template"). Our
management team identified Template as a provider of technologies that would
enable us to be one of the first to market with a comprehensive product
portfolio representing the next generation of EAI solutions for eBusiness. In
connection with the acquisition of Template, we acquired significant
intellectual property assets, including Geneva Enterprise Integrator and Geneva
Business Process Automator. These products, together with our existing software
portfolio, provide customers a comprehensive suite of EAI solutions for
eBusiness.
Recent Developments
On July 31, 2000, we entered into a purchase agreement with Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch"). Pursuant to that
purchase agreement, on August 23, 2000, we issued to Merrill Lynch 1,000,000
shares of our common stock in exchange for a license agreement, granting us
exclusive worldwide marketing, sales and development rights to CiceroTM, a
comprehensive integrated desktop computer environment developed by Merrill
Lynch and used by more than 30,000 Merrill Lynch professionals worldwide. We
intend to market CiceroTM as part of the Geneva eBusiness integration product
line.
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On July 20, 2000, we completed a $30 million private placement of 30,000
shares of Series B 4% Convertible Redeemable Preferred Stock, convertible into
an aggregate of 1,197,007 shares of our common stock. In addition to the
preferred stock, we also issued the investors warrants to purchase 1,047,382
shares of our common stock. Investors in the Series B Preferred Stock and
warrants include investment funds affiliated with Brown Simpson Asset
Management and Seneca Capital Management.
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Our principal executive offices are located at 8000 Regency Parkway, Cary,
North Carolina 27511, our telephone number is (919) 380-5000. Our web site is
located at www.Level8.com. Information contained on our web site is not a part
of this prospectus.
Level 8, Level 8 Systems, Level 8 Technologies, Geneva, Geneva Integration
Suite, Geneva Message Queuing, Geneva XIPC, Geneva Integration Broker, Geneva
Enterprise Integrator, Geneva Business Process Automator, Geneva AppBuilder and
MonitorMQ are trademarks of Level 8 Systems, Inc. All other product and company
names are for identification purposes only and are the property of, and may be
the trademarks of, their respective owners.
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RISK FACTORS
An investment in our common stock involves a high degree of risk. You should
carefully consider the specific factors listed below together with the other
information included in this prospectus before you decide whether to purchase
shares of our common stock. Additional risks and uncertainties, including those
that are not yet identified or that we currently think are immaterial, may also
adversely affect our business, results of operations and financial condition.
The market price of our common stock could decline due to any of these risks,
and you could lose all or part of your investment.
We have a history of losses.
Although we reported operating income and net income in 1997, we experienced
operating losses and net losses in 1998 and 1999, and net losses on a pro forma
basis reflecting our acquisition of Seer Technologies, Inc. We incurred net
losses of $25.1 million for 1998 ($88.1 million on a pro forma basis reflecting
our acquisition of Seer), $15.5 million for 1999 ($38.8 million on a pro forma
basis reflecting our acquisition of Template) and $13.6 million for the six
months ended June 30, 2000. At June 30, 2000, we had working capital of $4.2
million and an accumulated deficit of $55.0 million. Although we have raised
$30 million of equity financing from the sale of our Series B Preferred Stock
and warrants, our ability to generate positive cash flow is dependent upon
achieving and sustaining certain cost reductions and generating sufficient
revenues. Part of our strategy is to grow our business rapidly through a series
of carefully selected, synergistic acquisitions. Accounting for these
acquisitions in accordance with generally accepted accounting principles and
SEC rules and regulations may require us to amortize intangible assets for
several years after an acquisition or record significant charges for in-process
research and development at the time of acquisition. These charges are
typically non-cash in nature.
Therefore, due to these and other factors, we expect that we will continue to
experience net losses at least through 2000. We cannot predict with accuracy
our future results of operations and believe that any period-to-period
comparisons of our results of operations are not meaningful. We expect to
increase our operating expenses significantly, expand our sales and marketing
operations and continue to develop and enhance our products. In the future, we
may not generate sufficient revenues to pay for all of these operating costs or
other expenses. In addition, dividends of $.1 million per quarter accrue on the
outstanding Series A Preferred Stock and $.3 million per quarter accrue on the
outstanding Series B Preferred Stock; both dividends are required to be
declared and paid in cash to the extent funds are legally available for the
payment of dividends. If we fail to generate sufficient cash to pay these
expenses and dividends, we will need to identify other sources of financing. We
may not be able to borrow money or issue more shares of common stock or other
securities to meet our cash needs, and even if we can complete such
transactions, the terms may not be favorable. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" on page 17 for a
more complete description of our historical financial condition, results of
operations and liquidity.
Because our expenses are largely fixed, an unexpected revenue shortfall may
adversely affect our business
Our expense levels are based primarily on our estimates of future revenues
and are largely fixed. A large portion of our expense relates to headcount that
cannot be easily reduced without adversely affecting our business. We also
intend to hire additional personnel to support the growth of our business. This
expansion will substantially increase our operating expenses. We may be unable
to adjust spending rapidly enough to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in revenues in relation to
our planned expenditures would reduce, and possibly eliminate, any operating
income and could materially adversely affect our business, operating results
and financial condition.
Because we cannot accurately predict the amount and timing of individual sales,
our quarterly operating results may vary significantly, which may adversely
impact our stock price.
Our quarterly operating results have varied significantly in the past, and we
expect they will continue to do so in the future. We have derived, and expect
to continue to derive in the near term, a significant portion of our revenue
from relatively large customer contracts or arrangements. The timing of revenue
recognition from those contracts and arrangements has caused and may continue
to cause fluctuations in our operating results,
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particularly on a quarterly basis. Our quarterly revenues and operating results
typically depend upon the volume and timing of customer contracts received
during a given quarter and the percentage of each contract which we are able to
recognize as revenue during the quarter. Each of these factors is difficult to
forecast. As is common in the software industry, the largest portion of
software license revenues are typically recognized in the last month of each
fiscal quarter and the third and fourth quarters of each fiscal year. We
believe these patterns are partly attributable to budgeting and purchasing
cycles of our customers and our sales commission policies, which compensate
sales personnel for meeting or exceeding periodic quotas.
Furthermore, because the size of individual sales of the Geneva AppBuilder
and the Geneva Integrator Suite products are large and such sales can account
for a large percentage of our revenue, a single sale may have a significant
impact on the results of a quarter. In addition, the substantial commitment of
executive time and financial resources that have historically been required in
connection with a customer's decision to purchase certain of our products
increases the risk of quarter-to-quarter fluctuations. Typically, the purchase
of our products involves a significant technical evaluation by the customer and
the delays frequently associated with customers' internal procedures to approve
large capital expenditures and to test, implement and accept new technologies
that affect key operations. This evaluation process frequently results in a
lengthy sales process of several months. It also subjects the sales cycle for
our products to a number of significant risks, including our customers'
budgetary constraints and internal acceptance reviews. The length of our sales
cycle may vary substantially from customer to customer. We typically do not
have any material backlog of unfilled software orders, and product revenue may
fluctuate from quarter-to-quarter due to the completion or commencement of
significant assignments, the number of working days in a quarter and the
utilization rate of services personnel. As a result of these factors, we
believe that a period-to-period comparison of our historical results of
operations is not necessarily meaningful and should not be relied upon as
indications of future performance. In particular, our revenues in the third and
fourth quarters of our fiscal years may not be indicative of the revenues for
the first and second quarters. Fluctuations in operating results may have a
material adverse effect on our business, operating results and financial
condition, and could result in volatility of the trading price of our common
stock. Moreover, if our quarterly results do not meet the expectations of our
securities analysts and investors, the trading price of our common stock would
likely decline.
General economic conditions may affect investors' expectations regarding our
financial performance and adversely affect our stock price.
Certain industries to which we sell our products, such as the financial
services industry, are highly cyclical. In addition, we market our products and
services internationally, and historically a substantial portion of our revenue
has been derived from markets outside the United States. In the future, our
results may be subject to substantial period-to-period fluctuations as a
consequence of the industry patterns of our customers, general or regional
economic conditions and other factors. These factors may also have a material
adverse effect on our business, operating results and financial condition.
Because a substantial amount of our pro forma revenues have been derived from
one product, decreased demand for this product could adversely affect our
business.
On a pro forma basis, a substantial amount of our revenue has historically
been derived from the Geneva AppBuilder (formerly known as Seer*HPS) products
and services. Sales of Geneva AppBuilder products and services represented
approximately 44% of our revenue for 1999 on a pro forma basis and over 84% of
our revenue for 1998 on a pro forma basis. Although we intend to focus much of
our future business efforts on the enterprise application integration market,
we intend to continue to support and enhance the Geneva AppBuilder product. We
anticipate that the Geneva AppBuilder product and related services over the
near term will account for a substantial portion of our revenues. If our
current or future competitors release new products that provide, or are
perceived as providing, more advanced features, greater functionality, better
performance, better compatibility with other systems or lower prices than our
product line, demand for our Geneva AppBuilder product or our other products
and related services will likely decline. A decline in demand for, or market
acceptance of, the Geneva AppBuilder product line as a result of competition,
technological change or other factors could have a material adverse effect on
our business, operating results and financial condition.
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Loss of key personnel could adversely affect our business.
Our success depends in part on our ability to attract and retain qualified
professional, technical, managerial and marketing personnel. Competition for
all types of personnel in the software industry is intense. We may not be
successful in attracting and retaining the personnel required to develop new
and technical products and to sell and market our products successfully.
We may lose market share and be required to reduce prices as a result of
competition from our existing competitors, other vendors and the information
systems departments of customers.
We compete in markets that are intensely competitive and feature rapidly
changing technology and evolving standards. To maintain or improve our position
within these markets, or to compete in new markets, we must continue to enhance
our current products and develop new products in a timely fashion. We expect to
experience increased competition from current and potential competitors, many
of which have longer operating histories, greater resources, greater name
recognition, more extensive distribution and sales networks and a larger, more
established customer base. Accordingly, we may not be able to provide products
and services that compare favorably with the products and services of our
competitors. These competitive pressures could reduce our market share or
require us to reduce the price of our products, either of which could have a
material adverse effect on our business, operating results and financial
condition.
Acquisitions may affect future results or fail to be successfully integrated.
Part of our strategy is to grow our business rapidly through acquisitions,
although there can be no guarantee that suitable companies, divisions or
products will be available for acquisition. Future acquisitions will also
entail numerous risks, including our inability to successfully assimilate
acquired operations and products, our inability to retain key employees of
acquired operations and products, the diversion of management's attention, and
the difficulties and uncertainties in transitioning to us key business
relationships from the acquired entities. In addition to paying cash for future
acquisitions, we may issue additional securities which would be dilutive to our
existing stockholders. Alternatively, we may assume or incur debt obligations
or large one-time expenses. These factors could have a material adverse effect
on our business, operating results and financial condition.
We may also evaluate, on a case-by-case basis, joint venture relationships
with complementary businesses. Any joint venture investment could involve many
of the same risks posed by an acquisition, particularly those risks associated
with the diversion of our resources, our inability to generate sufficient
revenues, the management of relationships with third parties and potential
expenses. Any of these risks could have a material adverse effect on our
business, operating results and financial condition.
We may not have the resources to successfully manage additional growth.
Our recent growth has placed, and will continue to place, significant demands
on management as well as on our administrative, operational, sales and
financial resources. Our inability to sustain or manage any additional growth
could have a material adverse effect on our business, operating results and
financial condition. To manage additional growth, we must expand our sales,
marketing and customer support organizations, further develop our technical
expertise so that we can influence and respond to emerging industry standards
and improve our operational processes and management controls.
Rapid technological change could render our products obsolete.
Our markets are characterized by rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer requirements and evolving industry standards. The introduction of
new products embodying new technologies and the emergence of shifting customer
demands or changing industry standards could render our existing products
obsolete and unmarketable which would have a material adverse effect on our
business, operating results and financial condition. Our future success will
depend upon our ability to continue to develop and introduce a variety of new
products and product enhancements to address the increasingly sophisticated
needs of our customers. This will require us to continue to make substantial
product development investments. We may experience delays in releasing new
products and product enhancements in the future. Material delays in introducing
new products or product enhancements may cause customers to forego purchases of
our products and purchase those of our competitors.
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Loss of any one of our major customers could adversely affect our business.
A significant portion of our business is attributable to a limited number of
changing customers. In 1999, our top five customers accounted for 22% of our
total revenue. There can be no assurance that these customers or other of our
current customers will continue to purchase our products in the future. The
loss of any one of our major customers and/or the failure to attract new
customers could have a material adverse effect upon our business. In addition,
as a result of our reliance on a limited number of changing customers, our
results of operations have fluctuated in the past and may continue to fluctuate
materially from period to period.
There are a number of risks associated with doing business abroad.
International sales represented approximately 66% of our 1999 revenue. We
expect that such sales will continue to generate a significant portion of our
total revenue. Our revenues from international sales could be subject to large
currency exchange fluctuations, which in some circumstances could reduce our
overall revenue. International sales also expose us to a risk of loss due to an
increase in the value of the U.S. dollar relative to foreign currencies which
would make our products more expensive to potential foreign customers.
Additional risks inherent in our international business activities include:
.unexpected changes in regulatory requirements;
.tariffs and other trade barriers;
.costs and risks of customizing products for foreign markets;
.longer accounts receivable payment cycles and greater difficulty in
accounts receivable collections;
.difficulties in staffing and managing international operations;
.potentially adverse tax consequences;
.repatriation of earnings;
.the burden of complying with a variety of foreign, legal and regulatory
restrictions;
.political instability;
.possible recessionary environments in economies outside the United States;
and
.reduced protection for intellectual property rights in some countries.
There can be no assurance that these factors, among others, will not have a
material adverse effect on our future international revenue and, consequently,
on our business, operating results and financial condition.
Our products may have unknown defects which could harm our reputation or
decrease market acceptance of our products.
Because our customers depend on our products for their critical systems and
business functions, any interruptions caused by unknown defects in our products
could damage our reputation, cause our customers to initiate product liability
suits against us, increase our product development costs, divert our product
development resources or cause us to lose revenue or delay market acceptance of
our products, any of which could cause our business to suffer. Our product
offerings consist of complex software and services, both internally developed
and licensed from third parties. Complex software may contain errors or
defects, particularly when first introduced or when new versions or
enhancements are released. Although we conduct extensive testing, we may not
discover software defects that affect our current or new products or
enhancements until after they are sold. Such defects could cause our customers
to experience severe system failures.
The complex technology of our products subjects us to liability claims.
Because our products provide critical database access, integration and
management functions, we may be subject to significant liability claims if our
customers believe that our products have failed to perform their intended
functions. Our agreements with customers typically contain provisions intended
to limit our exposure to liability claims. However, these contract provisions
may not preclude all potential claims. Liability claims could require us to
spend significant time and money in litigation or to pay significant damages.
As a result, any such claims, whether or not successful, could have a material
adverse effect on our reputation and business, operating results and financial
condition.
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Failure to meet product delivery dates could adversely affect our business.
Because of the complexity of software products and the possibility of
unforeseen technological problems arising late in the development process, it
has not been uncommon for software companies to miss announced delivery dates
for new products, upgrades and/or modifications to existing products.
Unforeseen technical problems may delay the availability of these products and
services or cause us to release such products without support for the range of
platforms currently anticipated. Any substantial delays in the availability of
these products and services could have a material adverse effect on our
business.
We may be unable to enforce or defend our ownership and use of proprietary
technology.
Our success depends to a significant degree upon our proprietary technology.
We rely on a combination of patent, trademark, trade secret and copyright law,
and contractual restrictions and passwords to protect our proprietary
technology. However, these measures provide only limited protection, and there
is no guarantee that our protection of our proprietary rights will be adequate.
Furthermore, the laws of some jurisdictions outside the United States do not
protect proprietary rights as fully as in the United States. In addition, our
competitors may independently develop similar technology, duplicate our
products or design around our patents or our other intellectual property
rights. We may not be able to detect or police the unauthorized use of our
products or technology, and litigation may be required in the future to enforce
our intellectual property rights, to protect our trade secrets or to determine
the validity and scope of our proprietary rights. Any litigation to enforce our
intellectual property rights would be expensive and time-consuming, would
divert management resources and may not be adequate to protect our business.
We do not believe that any of our products infringe the proprietary rights of
third parties. However, companies in the software industry have experienced
substantial litigation regarding intellectual property and third parties could
assert claims that we have infringed their intellectual property rights. In
addition, we may be required to indemnify our distribution partners and end-
users for similar claims made against them. Any claims against us would divert
management resources, and could require us to spend significant time and money
in litigation, pay damages, develop new intellectual property or acquire
licenses to intellectual property that is the subject of the infringement
claims. These licenses, if required, may not be available on acceptable terms.
As a result, intellectual property claims against us could have a material
adverse effect on our business, operating results and financial condition.
As a technology company, our common stock may be subject to erratic price
fluctuations.
The market price of our common stock has fluctuated in the past and may in
the future be subject to significant fluctuations in response to numerous
factors, including: variations in our annual or quarterly financial results or
those of our competitors; changes by financial research analysts in their
estimates of our earnings or our failure to meet such estimates; conditions in
the software and other technology industries; announcements of key developments
by competitors; unfavorable developments with respect to our proprietary
rights; unfavorable publicity affecting our industry or us; adverse legal
events affecting us; and sales of our common stock by existing stockholders. In
addition, from time to time, the stock market experiences significant price and
volume fluctuations, which may affect the market price of our common stock for
reasons which may or may not be related to our performance. Recently, such
volatility has particularly impacted the stock prices of publicly traded
technology companies. In the past, securities class action litigation has been
instituted against a company following periods of volatility in the market
price of a company's securities. If similar litigation were instituted against
us, it could result in substantial costs and a diversion of our management's
attention and resources, which could have an adverse effect on our business.
We have not paid any dividends on our common stock and it is likely that no
dividends will be paid in the future.
We have never declared or paid cash dividends on our common stock and we do
not anticipate paying any cash dividends on our common stock in the foreseeable
future.
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Liraz could significantly influence matters submitted to our stockholders.
Liraz Systems, Ltd. ("Liraz"), an Israeli public company, and its
subsidiaries currently hold approximately 31.9% of our outstanding voting
stock. As a result, Liraz may have significant influence over all matters
submitted to our stockholders for a vote, including the election of directors
and the approval of mergers and other business combination transactions for
which a majority vote is required, which could adversely affect the market
price of our common stock or delay or prevent a change of control. In addition,
a wholly owned subsidiary of Liraz beneficially owns an additional 1,000,000
shares of common stock issuable upon the conversion of our Series A Preferred
Stock. If Liraz's subsidiary converts all of its Level 8 preferred stock, Liraz
and its subsidiaries would then hold approximately 36.2% of our outstanding
common stock, based on the number of shares of our common stock outstanding as
of August 24, 2000. We have the right to direct the voting of another 1,000,000
Level 8 shares issued to the sellers of Seer Technologies stock to us in
December 1998, plus another 250,000 Level 8 shares issuable upon the exercise
of warrants issued to these sellers. Two of our directors have relationships
with Liraz which are described in the following paragraph.
Some of our directors have conflicts of interest involving Liraz.
Liraz, as our principal stockholder, and Messrs. Arie Kilman and Lenny
Recanati, who are directors of Level 8, are in positions involving the
possibility of conflicts of interest with respect to transactions concerning
Liraz and Level 8. Mr. Kilman, our Chairman of the Board and Chief Executive
Officer, is a significant stockholder of Liraz. Mr. Recanati is Chairman of the
Board of Liraz and an executive officer of a significant stockholder of Liraz.
As of June 30, 2000, our total indebtedness to Liraz was $3 million, which was
paid in full in July 2000. See "Certain Relationships and Related Transactions"
on page 49.
Some decisions concerning our operations or financial structure may present
conflicts of interest between us and Liraz and/or its affiliates. For example,
if we are required to raise additional capital from public or private sources
to finance our anticipated growth and contemplated capital expenditures, our
interests might conflict with those of Liraz and/or its affiliates with respect
to the particular type of financing sought. In addition, we may have an
interest in pursuing acquisitions, divestitures, financings or other
transactions that, in our judgment, could be beneficial to us, even though the
transactions might conflict with the interests of Liraz and/or its affiliates.
If these conflicts do occur, Liraz and its affiliates may exercise their
influence in their own best interests. We have in the past engaged in
transactions and joint development projects with Liraz.
Provisions of our charter and Bylaws and Delaware law could deter takeover
attempts.
Section 203 of the Delaware General Corporation Law, which prohibits certain
persons from engaging in business combinations with Level 8, may have anti-
takeover effects and may delay, defer or prevent a takeover attempt that a
stockholder may consider to be in the holder's best interests. These provisions
of Delaware law also may adversely affect the market price of our common stock.
Our certificate of incorporation authorizes the issuance, without stockholder
approval, of preferred stock, with such designations, rights and preferences as
may be determined from time to time by the board of directors. Such
designations, rights and preferences established by the board may adversely
affect our stockholders. In the event of issuance, the preferred stock could be
used, under certain circumstances, as a means of discouraging, delaying or
preventing a change of control of Level 8. Although we have no present
intention to issue any shares of preferred stock in addition to the currently
outstanding preferred stock, we may issue preferred stock in the future. See
"Certain Relationships and Related Transactions" on page 49.
Our stockholders may be diluted by the exercise of options and warrants and
conversion of preferred stock.
We have reserved 5,250,000 shares of common stock for issuance under our
employee and director incentive plans. As of June 30, 2000, options to purchase
an aggregate of 4,022,147 shares of common stock were outstanding pursuant to
our employee and director incentive plans. Warrants to purchase an additional
1,349,521 shares of common stock are outstanding. Subsequent to June 30, 2000,
an additional 1,047,382 warrants were issued and are outstanding. We have also
reserved 1,157,000 shares of common stock for issuance upon conversion of the
outstanding Series A Preferred Stock. Furthermore, we have reserved
8
<PAGE>
1,197,007 shares of common stock for issuance upon conversion of the
outstanding Series B Preferred Stock. The exercise of such options and warrants
or conversion of preferred stock, and subsequent sale of the underlying common
stock in the public market could adversely affect the market price of our
common stock. Our Series A and Series B Preferred Stock and our outstanding
warrants include anti-dilution provisions, including in some cases adjustments
to the applicable conversion price or exercise price in the event we issue
common stock at a price less than the conversion price or exercise price then
in effect. This would increase the dilutive impact of future equity offerings
at prices less than the conversion price or exercise price of the outstanding
warrants.
Future sales of common stock by existing investors could adversely affect the
market price of our common stock.
Future sales of substantial numbers of shares of common stock (including
shares issued upon the exercise of stock options or warrants or conversion of
preferred stock) by Liraz, Level 8 or our executive officers or principal
stockholders, or the perception that such sales could occur, could adversely
affect the market price of our common stock. We have granted registration
rights to Liraz and its affiliates covering up to 5,683,120 shares of common
stock, including 1,000,000 shares issuable upon conversion of preferred stock.
These registration rights enable those investors to require that we register
resales of their securities. In addition, we have granted Welsh, Carson,
Anderson & Stowe and related parties (which together own 1,000,000 shares of
common stock and warrants to purchase an additional 250,000 shares) "piggyback"
registration rights which allows them to include their shares in any
registration statement we file in connection with an underwritten public
offering before January 1, 2001. Furthermore, Merrill Lynch has been granted
"piggyback" and demand registration rights that may be exercised after November
21, 2000, with respect to 1,000,000 shares of common stock. If these investors
sell a large portion of their securities on the open market at or about the
same time, the market price of our common stock may decline.
We are required to pay additional amounts or issue more equity securities if we
do not timely fulfill our obligations to the holders of our outstanding
preferred stock and warrants.
If we fail to pay dividends on the Series A or Series B Preferred Stock when
due, or our common stock is delisted from The Nasdaq Stock Market and is not
traded on the New York Stock Exchange or American Stock Exchange, or the rights
of holders of Series A or Series B Preferred Stock are adversely affected by a
reclassification of our common stock, the dividend rate on our Series A or
Series B Preferred Stock would increase to 18% annually, with such dividend
partially payable in shares of our common stock for the first 60 days that
dividends accrue at 18% annually. In addition, we are also required to make
additional payments to holders of the Series A or Series B Preferred Stock and
warrants in the event that we do not fulfill other obligations to the holders,
including keeping the registration statement and prospectus for the underlying
common stock in effect and current and issuing common stock promptly upon
conversion of the Series A or Series B Preferred Stock or exercise of warrants.
The total amount of cash payments in respect of the Series A or Series B
Preferred Stock, including dividends and any additional amounts required to be
paid, is limited to 19% annually of the liquidation value of the Series A or
Series B Preferred Stock.
9
<PAGE>
FORWARD-LOOKING STATEMENTS
This prospectus contains certain forward-looking statements, including or
related to our future results, including certain projections and business
trends. Assumptions relating to forward-looking statements involve judgments
with respect to, among other things, future economic, competitive and market
conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond our control. When
used in this prospectus, the words "estimate," "project," "intend," "believe,"
"expect" and similar expressions are intended to identify forward-looking
statements. Although we believe that assumptions underlying the forward-looking
statements are reasonable under the circumstances, any of the assumptions could
prove inaccurate, and we may not realize the results contemplated by the
forward-looking statement. Management decisions are subjective in many respects
and susceptible to interpretations and periodic revisions based on actual
experience and business developments, the impact of which may cause us to alter
our business strategy or capital expenditure plans that may, in turn, affect
our results of operations. In light of the significant uncertainties inherent
in the forward-looking information included in this prospectus, you should not
regard the inclusion of such information as our representation that we will
achieve any strategy, objective or other plans. The forward-looking statements
contained in this prospectus speak only as of the date of this prospectus as
stated on the front cover, and we have no obligation to update publicly or
revise any of these forward-looking statements.
These and other statements, which are not historical facts are based largely
on management's current expectations and assumptions and are subject to a
number of risks and uncertainties that could cause actual results to differ
materially from those contemplate by such forward-looking statements. These
risk and uncertainties include, among others, the risks and uncertainties
described under "Risk Factors" (page 3).
USE OF PROCEEDS
We will not receive any of the proceeds from the sale of the shares of common
stock by the selling stockholders. We will, however, receive the proceeds from
the exercise of the warrants by the selling stockholders. We anticipate that
the net proceeds received by us from the exercise of the warrants will be used
for general corporate purposes.
10
<PAGE>
PRICE RANGE OF OUR COMMON STOCK
Our common stock is traded on the Nasdaq National Market under the symbol
"LVEL." The following table sets forth for the periods indicated the high and
low sales prices per share of common stock as reported on the Nasdaq National
Market.
<TABLE>
<CAPTION>
High Low
-------- --------
1998
<S> <C> <C>
First quarter............................................. $16.3125 $ 10.375
Second quarter............................................ $ 14.000 $ 8.375
Third quarter............................................. $ 11.000 $ 6.5625
Fourth quarter............................................ $ 9.875 $ 5.000
<CAPTION>
1999
<S> <C> <C>
First quarter............................................. $ 16.250 $ 7.625
Second quarter............................................ $ 13.125 $ 7.938
Third quarter............................................. $ 14.000 $ 9.375
Fourth quarter............................................ $ 46.438 $ 11.500
2000
First quarter............................................. $ 49.125 $ 29.500
Second quarter............................................ $ 47.500 $ 11.250
Third quarter, through September 21, 2000................. $ 28.500 $17.0625
</TABLE>
On August 24, 2000, there were approximately 145 holders of record of common
stock. On September 21, 2000, the closing sale price of the common stock on the
Nasdaq National Market was $17.375 per share.
DIVIDEND POLICY
We have not declared or paid any cash dividends on the common stock. For the
foreseeable future we do not intend to declare cash dividends. We intend to
retain earnings to grow our business and strengthen our capital base. In
addition, our credit agreement requires that we to obtain approval from our
lenders prior to declaration or payment of any cash dividends on our common
stock. The terms of our outstanding preferred stock also place restrictions on
the declaration or payment of any cash dividends on our common stock.
11
<PAGE>
SELLING STOCKHOLDERS
The table below sets forth information with respect to and provided by the
selling stockholders, including:
. the name of each selling stockholder;
. the number of shares of common stock owned by each selling stockholder
as of August 24, 2000;
. the number of shares which may be offered and are being offered by this
prospectus for the account of each selling stockholder; and
. the amount of the class and percentage to be owned by each selling
stockholder assuming all of the shares offered by this prospectus are
sold.
<TABLE>
<CAPTION>
Shares of
Number of Shares Common Stock To Be
Number of Shares of of Owned After Offering
Common Stock Common Stock Which -------------------------
Name and Address Owned(1) May Be Offered(1) Number Percent
---------------- ------------------- ------------------ ----------- ----------
<S> <C> <C> <C> <C>
Brown Simpson Partners
I, Ltd. ............... 2,151,995(2) 1,822,195(2) 329,800(2) 2.22%
Seneca Capital, L.P..... 601,744(3) 601,744(3) * *
Seneca Capital
International, Ltd..... 731,090(4) 731,090(4) * *
Advanced Systems Europe
B.V. (a subsidiary of
Liraz Systems, Ltd.)... 2,000,000 1,753,527 246,473 1.7%
ABS Ventures IV, L.P.... 37,829 28,158 9,671 *
ABX Fund, L.P........... 9,458 7,040 2,418 *
Brown Technology
Associates ............ 953 245 708 *
New York Life Insurance
Co..................... 92,427 92,427 * *
C. Michael Markbreiter
....................... 2,708 2,708 * *
Lawrence D. Duckworth... 1,920 1,920 * *
Leo T. Abbe............. 20,754 20,754 * *
Richard K. Abbe......... 20,754 20,754 * *
Jonathan Abbey.......... 3,000 3,000 * *
Leslie Abbey............ 3,000 3,000 * *
Mitchell Jay Bayer...... 300 300 * *
Jeffrey M. Berman....... 20,754 20,754 * *
Michael J. Chill........ 18,489 18,489 * *
Scot Cohen.............. 800 800 * *
Monroe H. Firestone..... 404 404 * *
F. Garafalo Electric,
Inc.................... 5,500 5,500 * *
Raymond H. Godfrey,
Jr..................... 500 500 * *
Morton D. Kurzok........ 1,404 404 * *
Adam Lawrence Larkey.... 800 800 * *
Enid Morris............. 1,404 1,404 * *
Richard Nager........... 206,750(5) 900(5) 205,850 1.4%
Charles K. and Liza
Osburn................. 500 500 * *
Christine K. Pollio..... 800 800 * *
Vivek N. J. Rao......... 3,500 3,500 * *
Realprop Capital Corp... 5,250 5,250 * *
Peter Rosenthal......... 300 300 * *
Andrew L. Rudolph....... 400 400 * *
Irene M. Rudolph........ 100 100 * *
John H. Starr........... 9,356 9,356 * *
David Emmett Topkins.... 400 400 * *
Tradewind Fund I, LP.... 2,750 2,750 * *
</TABLE>
--------
*Less than one percent (1%)
12
<PAGE>
(1) The number of shares of common stock owned by each selling stockholder
includes the aggregate number of shares of common stock which may be
obtained by such stockholder upon conversion of all of the shares of Series
A and Series B Preferred Stock and exercise of the warrants owned by the
stockholder. However, the selling stockholders are not currently the
beneficial owners of all of such shares of common stock.
(2) Brown Simpson Partners I, Ltd. is offering by this prospectus 598,504
shares of common stock issuable upon the conversion of Series B Preferred
Stock and 1,223,691 shares issuable upon the exercise of warrants. The
exercise price of these warrants is as follows: (i) 523,691 warrants at an
exercise price of $25.0625 per share of common stock subject to adjustment
and (ii) 700,000 warrants at an exercise price of $10.00 per share of
common stock subject to adjustment. Brown Simpson Partners I, Ltd. holds
329,800 shares of unrestricted common stock that is not being offered by
this prospectus. Brown Simpson Partners I, Ltd. is not currently the
beneficial owner of all of such shares of common stock.
(3) Seneca Capital, L.P. is offering by this prospectus 208,598 shares of
common stock issuable upon the conversion of Series B Preferred Stock and
182,506 shares issuable upon the exercise of warrants. The exercise price
of these warrants is $25.0625 per share of common stock subject to
adjustment. Seneca Capital, L.P. is also offering by this prospectus
157,000 shares of common stock issuable upon the conversion of Series A
Preferred Stock and 53,640 shares issuable upon the exercise of warrants.
The exercise price of these warrants is $10.00 per share of common stock
subject to adjustment.
(4) Seneca Capital International, Ltd. is offering by this prospectus 389,905
shares of common stock issuable upon the conversion of Series B Preferred
Stock and 341,185 shares issuable upon the exercise of warrants. The
exercise price of these warrants is $25.0625 per share of common stock
subject to adjustment.
(5) Richard Nager also holds 205,850 shares of unrestricted common stock that
is not being offered by this prospectus.
13
<PAGE>
PLAN OF DISTRIBUTION
Our company is registering the shares of common stock on behalf of the
selling stockholders. All costs, expenses and fees in connection with the
registration of the shares offered by this prospectus will be borne by us,
other than brokerage commissions and similar selling expenses, if any,
attributable to the sale of shares which will be borne by the selling
stockholders. Sales of shares may be effected by selling stockholders from time
to time in one or more types of transactions (which may include block
transactions) on The Nasdaq National Market, in the over-the-counter market, in
negotiated transactions, through put or call options transactions relating to
the shares, through short sales of shares, or a combination of such methods of
sale, at market prices prevailing at the time of sale, or at negotiated prices.
Such transactions may or may not involve brokers or dealers. The selling
stockholders have advised us that they have not entered into any agreements,
understandings or arrangements with any underwriters or broker-dealers
regarding the sale of their securities, nor is there an underwriter or
coordinated broker acting in connection with the proposed sale of shares by the
selling stockholders.
The selling stockholders may enter into hedging transactions with broker-
dealers or other financial institutions. In connection with such transactions,
broker-dealers or other financial institutions may engage in short sales of the
shares or of securities convertible into or exchangeable for the shares in the
course of hedging positions they assume with selling stockholders. The selling
stockholders may also enter into options or other transactions with broker-
dealers or other financial institutions which require the delivery to such
broker-dealers or other financial institutions of shares offered by this
prospectus, which shares such broker-dealer or other financial institution may
resell pursuant to this prospectus (as amended or supplemented to reflect such
transaction).
The selling stockholders may make these transactions by selling shares
directly to purchasers or to or through broker-dealers, which may act as agents
or principals. Such broker-dealers may receive compensation in the form of
discounts, concessions or commissions from selling stockholders and/or the
purchasers of shares for whom such broker-dealers may act as agents or to whom
they sell as principal, or both (which compensation as to a particular broker-
dealer might be in excess of customary commissions).
The selling stockholders and any broker-dealers that act in connection with
the sale of shares are "underwriters" within the meaning of Section 2(11) of
the Securities Act, and any commissions received by such broker-dealers or any
profit on the resale of the shares sold by them while acting as principals
might be deemed to be underwriting discounts or commissions under the
Securities Act. The selling stockholders may agree to indemnify any agent,
dealer or broker-dealer that participates in transactions involving sales of
the shares against certain liabilities, including liabilities arising under the
Securities Act.
Because selling stockholders are "underwriters" within the meaning of Section
2(11) of the Securities Act, the selling stockholders will be subject to the
prospectus delivery requirements of the Securities Act. We have informed the
selling stockholders that the anti-manipulative provisions of Regulation M
promulgated under the Exchange Act may apply to their sales in the market.
Selling stockholders also may resell all or a portion of the shares in open
market transactions in reliance upon Rule 144 under the Securities Act,
provided they meet the criteria and conform to the requirements of Rule 144.
Upon our being notified by a selling stockholder that any material
arrangement has been entered into with a broker-dealer for the sale of shares
through a block trade, special offering, exchange distribution or secondary
distribution or a purchase by a broker or dealer, a supplement to this
prospectus will be filed, if required, pursuant to Rule 424(b) under the
Securities Act, disclosing:
. the name of each such selling stockholder and of the participating
broker-dealer(s);
. the number of shares involved;
14
<PAGE>
. the initial price at which such shares were sold;
. the commissions paid or discounts or concessions allowed to such broker-
dealer(s), where applicable;
. that such broker-dealer(s) did not conduct any investigation to verify
the information set out or incorporated by reference in this prospectus;
and
. other facts material to the transactions.
In addition, upon our being notified by a selling stockholder that a donee or
pledgee intends to sell more than 500 shares, a supplement to this prospectus
will be filed.
15
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data is derived from the consolidated
financial statements of the Company. The data should be read in conjunction
with the consolidated financial statements, related notes, and other financial
information included herein. The statement of operations data for the six month
period ended June 30, 1999 and 2000 and the balance sheet data as of June 30,
1999 and 2000 are derived from and qualified by reference to, our unaudited
financial statements included in this prospectus. The unaudited financial
statements have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for fair presentation.
For 1999, the following data includes the Company, Level 8 Technologies, Seer
and Template since its acquisition on December 27, 1999. For 1998, the
following data includes the Company, Level 8 Technologies and Momentum since
its acquisition on March 26, 1998. For 1997, the following data includes the
Company, ASU, and Level 8 Technologies. For 1996, the following data includes
the Company, ASU, and Level 8 Technologies. For 1995, the following data
includes the Company for the full year and Level 8 Technologies since its
acquisition on April 1, 1995.
<TABLE>
<CAPTION>
Six Months Ended
Year Ended December 31, June 30,
-------------------------------------------- -----------------
1995 1996 1997 1998 1999 2000 1999
------- ------- ------- -------- -------- -------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Selected Statement of
Operations Data
Revenue................. $ 3,012 $ 7,272 $14,680 $ 10,685 $ 52,920 $ 40,744 $26,212
Net income (loss) from
continuing operations.. (429) (845) 1,036 (23,688) (15,477) (13,556) (8,052)
Net income (loss) from
continuing operations
per common and common
equivalent share--
basic.................. (.10) (.14) .16 (3.14) (1.78) (1.04) (.093)
Net income (loss) from
continuing operations
per common and common
equivalent share--
diluted................ (.10) (.14) .14 (3.14) (1.78) (1.04) (.093)
Weighted average common
and common equivalent
shares outstanding--
basic.................. 4,314 6,076 6,992 7,552 8,918 13,317 8,704
Weighted average common
and common equivalent
shares outstanding--
diluted................ 4,314 6,076 7,561 7,552 8,918 13,317 8,704
<CAPTION>
As of December 31, As of June 30,
-------------------------------------------- -----------------
1995 1996 1997 1998 1999 2000 1999
------- ------- ------- -------- -------- -------- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Selected Balance Sheet
Data
Working capital
(deficiency)........... $ 4,103 $11,007 $15,826 $(19,554) $ 1,464 $ 4,221 $ 5,245
Total assets............ 15,059 20,787 23,482 70,770 133,581 127,159 79,103
Long-term debt, net of
current maturities..... 43 23 16 1,541 22,202 20,349 11,561
Loans from related
companies, net......... 454 331 202 12,519 4,000 3,000 12,618
Shareholders' equity.... 11,499 18,300 20,371 8,892 72,221 67,487 20,123
</TABLE>
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
All statements, trend analyses and other information contained in this
Prospectus relative to markets for our products and services, and trends in
revenues and anticipated expense levels, as well as other statements including
words such as "believe," "anticipate," "expect," "estimate," "plan," "intend,"
and other similar expressions, constitute forward-looking statements. These
forward-looking statements are subject to business and economic risks, and our
actual results of operations may differ materially from those contained in the
forward-looking statements. For a more detailed discussion of these business
and economic risks, see "Risk Factors" (page 3). The following discussion of
financial condition and results of operations of Level 8 should also be read in
conjunction with the financial statements included elsewhere in this
prospectus.
Overview
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,
together, provide the most complete suite of integration software products
available for eBusiness integration. These components include Geneva Enterprise
Integrator (formerly Enterprise Integration Template), Geneva Business Process
Automator (formerly Business Process Template), Geneva Integration Broker
(formerly Geneva Integrator), Geneva Message Queuing, Geneva AppBuilder
(formerly Seer*HPS), and Geneva XIPC (formerly 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. Level
8's worldwide consulting team has in-depth experience in developing successful
enterprise-class solutions as well as valuable insight into the business
information needs of customers in the Global 5000. Level 8 offers consulting
services around its products for eBusiness and eCommerce enablement. These
services include project management, application and platform integration,
application design and development, and application renewal along with
expertise in a wide variety of development environments and programming
languages.
During April 1999, Level 8 completed its acquisition of Seer Technologies,
Inc. ("Seer"). Level 8 purchased the remaining minority interest in Seer, for
$0.35 per share of the outstanding common stock in cash. The total purchase
price for the remaining 31% of Seer was $1.7 million. As a result of the
completion of acquisition, Seer became a wholly owned subsidiary of Level 8.
In December 1999, Level 8 acquired Template for approximately $64 million in
cash and stock. Level 8's management team identified Template as a provider of
technologies that enables Level 8 to be one of the first to market with a
comprehensive product portfolio representing the next generation of EAI
solutions for eBusiness. As part of the Template transaction, Level 8 obtained
an additional $10 million in financing in the form of a 17 month term loan. The
financing was guaranteed by Liraz Systems, Ltd. ("Liraz"), our principal
stockholder, in return for 60,000 shares of the Company's common stock. The
number of shares of common stock provided in exchange for the guarantee, was
determined by the independent directors of Level 8 based on market conditions
and our anticipated financing needs at closing. The commitment provides for an
interest rate equal to the London InterBank Offered Rate plus 1% annually.
17
<PAGE>
Results of Operations
Level 8's results of operations include the operations of the Company and its
subsidiaries. Operations for the subsidiaries acquired during 1999 and 1998 are
included from the date of acquisition. Accordingly, the 1999 and 1998 results
of operations include the operations of Template, Seer, and Momentum since
December 27, 1999, December 31, 1998, and March 26, 1998, respectively.
The 1998 results of operations do not reflect any of Seer's operations since
the Company's 69% interest in Seer was not acquired until December 31, 1998.
The shareholders of the remaining 31% of the outstanding voting stock were
considered to have shared in the losses of Seer only for their proportionate
share of Seer's net assets. No minority interest for Seer is reflected in the
Company's consolidated balance sheet at December 31, 1998 because Seer had net
liabilities of $25 million at December 31, 1998. As of December 31, 1998, the
Company only recorded 69% of the value of the Company's intangible assets,
including the value of in-process technology, which has been written off. On
April 15, 1999, the Company completed a tender offer for the remaining 31% of
Seer and recorded the remainder of the intangible assets, including an
additional write-off of in-process technology. Until the completion of the
tender offer, the Company reported only 69% of any net earnings and 100% of any
net losses of Seer.
Except as otherwise indicated, the discussion below relates to the actual
results of operations without giving pro forma effect to the acquisitions and
dispositions in 1998. Pro forma combined data assumes the acquisition of
Momentum and Seer had each occurred as of January 1, 1998 and does not purport
to be indicative of the results which would have actually been obtained had the
transactions taken place as of such date or of future results of operations.
The acquisitions made in 1998 make it difficult to compare the actual results
of operations for the periods presented. A discussion of 1999 to 1998
comparative results of operations on a pro forma combined basis has been
included below where considered meaningful for an understanding of the
Company's results of operations for the 1999 periods. However, pro forma
combined results reflect the operations of Level 8, Momentum, and Seer on a
separate basis without consideration for any synergies obtained through the
integration of the companies' operations. The operations of Template did not
have a material effect on the 1999 results; therefore, Template is not included
in the pro forma comparisons.
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.
18
<PAGE>
The following table sets forth, for the years indicated, the Company's
results of continuing operations expressed as a percentage of revenue:
<TABLE>
<CAPTION>
Year Ended Six Months Ended
December 31, June 30,
---------------------- -------------------
1999 1998 1997 2000 1999
----- ------ ----- -------- --------
<S> <C> <C> <C> <C> <C>
Revenue:
Software products............. 30.3 % 14.5 % 29.7 % 48.8 % 22.5 %
Maintenance................... 28.3 % 10.2 % 0.2 % 18.4 % 30.0 %
Services...................... 41.3 % 75.3 % 70.1 % 32.8 % 47.5 %
----- ------ ----- -------- --------
Total........................ 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenue:
Software products............. 8.0 % 19.3 % 17.4 % 8.9 % 7.4 %
Maintenance................... 10.2 % 4.5 % 0.1 % 7.2 % 11.6 %
Services...................... 36.4 % 54.1 % 34.2 % 27.7 % 42.3 %
----- ------ ----- -------- --------
Total........................ 54.6 % 77.9 % 51.7 % 43.8 % 61.3 %
Gross profit.................... 45.4 % 22.1 % 48.3 % 56.2 % 38.7 %
Operating expenses:
Sales and marketing........... 22.7 % 22.3 % 10.4 % 38.6 % 20.5 %
Research and product
development.................. 12.8 % 26.0 % 7.2 % 11.7 % 12.3 %
General and administrative.... 12.9 % 60.3 % 20.0 % 15.2 % 11.0 %
Amortization of goodwill and
intangibles.................. 2.9 % 18.1 % 2.9 % 17.5 % 12.9 %
Write-off of in process
research and development..... 5.6 % 55.1 % -- -- 2.8 %
Write-off of goodwill......... -- 43.1 % -- -- --
Restructuring Charges......... 0.7 % 14.4 % -- -- --
Loss on Disposal of assets.... -- -- -- 0.8 % --
----- ------ ----- -------- --------
Total........................ 67.9 % 239.3 % 40.5 % 83.8 % 59.5 %
Income (loss) from Operations... (22.5)% (217.2)% 7.8 % (27.6)% (20.8)%
Other income (expense), net..... (5.4)% (0.8)% 3.0 % (4.3)% (8.4)%
----- ------ ----- -------- --------
Income (loss) before taxes...... (27.9)% (218.0)% 10.8 % (31.9)% (29.2)%
Income tax provision............ 1.4 % 3.8 % 3.8 % 1.3 % 1.5 %
----- ------ ----- -------- --------
Net income (loss) from
continuing operations.......... (29.3)% (221.8)% 7.0 % (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>
Six Months Ended
Year Ended December 31, June 30,
--------------------------- -------------------
1999 1998 1997 2000 1999
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
United States................... 34% 99% 99% 52% 31%
Europe.......................... 58% -- -- 45% 60%
Asia Pacific.................... 7% -- -- 2% 7%
Other........................... 1% 1% 1% 1% 2%
------- ------- ------- -------- --------
Total........................ 100% 100% 100% 100% 100%
</TABLE>
Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999
Revenue and Gross Margin
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.
19
<PAGE>
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 Technologies.
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 sold its classified government contracts, which were not
related to the Company's products. In connection with the sale, the Company
recorded an insignificant loss on the disposal of these contracts.
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.
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
20
<PAGE>
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 undiscounted future operating 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.
Years Ended December 31, 1999, 1998, and 1997
Revenue and Gross Margin
Total revenues increased 395% from 1998 to 1999 and decreased 27% from 1997
to 1998. Total revenues increased significantly from 1998 to 1999 primarily due
to the acquisitions of Momentum and Seer during 1998 and increased sales of
software products. The decrease from 1997 to 1998 was primarily attributable to
a decrease in software products revenue, along with a reduction in services
revenue. The gross margins were 45%, 22%, and 48% for 1999, 1998, and 1997,
respectively.
On a pro forma combined basis, total revenues for 1998 were $67.2 million.
The $14.3 million decline in revenue on a pro forma combined basis is primarily
due to a decline in the number of former Seer consulting
21
<PAGE>
resources employed in 1999 compared to 1998. The gross margin for 1998 on a pro
forma combined basis was approximately 23%.
Software Products
Software products revenue increased 933% in 1999 in comparison to 1998 and
decreased 64% from 1997 to 1998. The significant increase from 1998 to 1999 is
primarily due to the sales of products acquired from Seer in 1998 coupled with
sales of the Company's new Geneva Integration Broker product (formerly Geneva
Integrator).
During 1997, the Company's product sales were primarily resales of IBM's MQ
Series licenses. During 1998, the Company's software sales were primarily
resales of IBM's MQ Series licenses and sales of Geneva Message Queing
(formerly FalconMQ) and Geneva XIPC (formerly XIPC) messaging products. The
decrease in software revenue from 1997 to 1998 is the result of the Company's
shift in strategic direction primarily relating to the Company's dispositions
and acquisitions in 1998, as well as reduced emphasis on resales of IBM's MQ
Series licenses in favor of the Company's messaging products developed by the
Company.
Through its acquisitions in 1998, the Company acquired Momentum's XIPC
messaging product and Seer's HPS products, now known as Geneva AppBuilder,
which is used for application engineering. As discussed above, the Company
began selling Geneva Integration Broker, an EAI solution, during the second
quarter of 1999. Additionally, with the acquisition of Template, the Company
added their products to its offering and recorded initial sales of Template's
former Enterprise Integration Template and Business Process Template products
in the fourth quarter of 1999.
Software products revenue has continued to grow as a percentage of total
revenue, reflecting the Company's emphasis on expanding product sales.
Management believes software products revenue will continue to increase over
the next several quarters.
The gross margin on software products was 74%, (33)%, and 41% for the 1999,
1998, and 1997 fiscal periods, respectively. The improvement in gross margins
from 1998 to 1999 was due to the significant increase in software products
revenue. Cost of software is composed primarily of amortization of capitalized
software and royalties to third parties for the Company's Geneva Message
Queuing product and to a lesser extent production and distribution costs. This
increase in cost of software was primarily due to amortization of capitalized
software from Momentum's and Seer's developed technology, which was valued as
part of the purchase accounting for these business combinations, and royalties
which are principally for technology acquired in 1998 from Liraz, the Company's
principal shareholder. The decrease in gross margins between 1997 and 1998 is
the effect of increased amortization costs, lower software product revenues,
royalties to Liraz under the joint development agreement, and a write-off of
approximately $.3 million of capitalized technology costs. Software
amortization will increase in 2000 due to the $12.2 million of developed
technology acquired in the Template acquisition resulting in approximately $.5
million per quarter.
Services
Services revenue increased 172% from 1998 to 1999 and decreased by 22% from
1997 to 1998. Services gross margins were 12%, 28%, and 51% for 1999, 1998, and
1997 respectively. Cost of services primarily includes personnel and travel
costs related to the delivery of services.
The increase in services revenue from 1998 to 1999 was primarily a result of
the Seer acquisition, which resulted in adding an average of 115 consultants
during 1999. Changes in the composition of the Company's services revenue have
caused margins to decline in 1999, since the Geneva AppBuilder-related services
have
22
<PAGE>
historically generated lower margins than the Company's other service
offerings. The Company is seeking to improve its consulting margins through
improvement in the utilization of its consultants and attempting to provide
higher margin services for the Company's Geneva Integration Broker, Geneva
Message Queuing, and recently acquired Template products.
The services revenue decline from 1997 to 1998 was primarily attributable to
the decline in software products revenue and the resultant decline in
utilization of billable services. The decline in software products revenue
impacted services revenue as there were fewer new customers than in the prior
year, reducing the base of the customers utilizing the Company's consulting and
training services as part of an overall technology solution purchase. Gross
margins decreased in 1998 in relation to 1997 due to lower than normal billable
utilization of consultants caused by project delays.
On a pro forma combined basis, services revenue for 1998 was $47 million. The
decrease from 1998 to 1999 is chiefly due to a decline in the amount of Geneva
AppBuilder related services provided, due to the low level of software products
sold by Seer in the year preceding the acquisition, as well as a decline in the
number of consulting personnel on a pro forma basis.
Maintenance
Maintenance revenue increased significantly from 1998 to 1999 primarily due
to the addition of Geneva AppBuilder to the Company's products, which has
historically had a significant revenue stream from maintenance. The increase
from 1997 to 1998 is primarily due to the addition of the Geneva XIPC product
acquired from Momentum. Prior to the Momentum acquisition, the Company did not
have a significant amount of maintenance revenue as its primary source of
license revenue was from reselling IBM's MQ Series licenses. On a pro forma
combined basis, maintenance revenue for 1998 was $14.4 million, which is
relatively consistent with 1999.
Gross margins on maintenance were 64%, 56%, and 47% for 1999, 1998, and 1997,
respectively. Cost of maintenance is comprised of personnel costs and related
overhead, and beginning in 1999 includes the cost of third-party contracts for
the maintenance and support of the Company's Geneva AppBuilder products. The
increase in gross margins is primarily due to the addition of the Geneva
AppBuilder and Geneva XIPC to the Company's products from which the Company has
created additional economies of scale in 1999.
Sales and Marketing
Sales and marketing expenses primarily include personnel costs for
salespeople, travel, and related overhead, as well as analyst subscriptions,
trade show participation, and other promotional expenses. Sales and marketing
expenses increased fourfold from 1998 to 1999 and 57% from 1997 to 1998 due to
an increase in the size of the Company's sales force, both through acquisition
and recruiting. During 1999, the number of sales and marketing personnel
doubled from the beginning of the year to the end. This increase in personnel
is due to the reorganization of the Company's sales and promotional activities
to correspond with its new product strategy, as well as the Company's expansion
into the global marketplace with the acquisitions of Seer and Template. The
Company intends to continue to increase its spending in the sales and marketing
area in an effort to increase software products revenue through heightened
market awareness and improved acceptance of its products and expanding its
indirect distribution network.
Research and Development
Research and development expenses primarily include personnel costs for
product authors, product developers and product documentation personnel.
Research and development expense increased 145% from 1998 to 1999 and 163% from
1997 to 1998. The increases in 1998 and 1999 are a result of the Company's
23
<PAGE>
investment in new products, primarily Geneva Integration Broker, which was
released in the second quarter of 1999 and Version 2.0 of Geneva Message
Queuing which was released in the fourth quarter of 1999. The expense increase
in 1999 is also attributable to the acquisition of Seer and the personnel added
to this area of the Company as a result of the acquisition. Management expects
this trend to continue and has increased the number of personnel by
approximately 50% with the acquisition of Template, as the Company's continues
to more tightly integrate its products and attempts to strengthen its position
in the EAI marketplace.
General and Administrative
General and administrative expenses consist of personnel costs for the
executive, legal, financial, human resources, and administrative staff and
related overhead and non-allocable corporate costs of operating the Company.
General and administrative expenses increased 6% from 1998 to 1999 and 118%
from 1997 to 1998. These expenses decreased as a percentage of revenue for 1999
due to synergies obtained through the integration of Seer and management's
focus to bring general and administrative expenses to a more reasonable level
in relation to revenue.
Amortization of Goodwill and Other Intangible Assets
Amortization of intangible assets, primarily goodwill, was $7 million, $1.9
million, and $.4 million for 1999, 1998, and 1997, respectively. The
amortization of goodwill in 1997 was related to the purchase of Level 8
Technologies in April 1995. The amortization of goodwill in 1998 was related to
the purchase of Level 8 Technologies and beginning in the second quarter
included amortization related to the purchase of Momentum in March, 1998. In
1999, amortization of intangible assets also includes the amortization of
goodwill and other intangible assets related to the purchase of Seer. Due to
the acquisition of Template, the Company will incur approximately $1.8 million
per quarter in additional amortization expense beginning in the first quarter
of 2000.
Purchased Research and Development
Based on the results of third-party appraisals, the Company recorded charges
in 1998 of $1.2 million in the first quarter and $4.7 million in the fourth
quarter in order to expense purchased in-process research and development costs
related to the acquisition of Momentum and Seer, respectively. As a result of
completing the acquisition of the remaining 31% of Seer, the Company recorded a
charge of $.7 million for in-process research and development costs in the
second quarter of 1999. As part of the acquisition of Template, the Company
recorded a charge to expense in-process research and development costs related
to the acquisition of Template in the amount of $2.2 million.
For all in-process research and development charges recorded in 1998 and
1999, it was determined that the acquired in-process research and development
had not yet reached technological feasibility and had no alternative future
uses. The value of the in-process projects was adjusted to reflect the relative
value and contribution of the acquired research and development. In doing so,
management gave consideration to the stage of completion, the difficulty of
completing the remaining development costs already incurred, and the projected
cost to complete the projects. The value assigned to purchased in-process
technology was based on key assumptions, including revenue growth rates for
each technology considering, among other things, current and expected industry
trends, acceptance of the technologies and historical growth rates for similar
industry products.
Other Charges
As a result of the acquisitions of Template, Momentum, and Seer, the Company
recorded several charges. In 1998, as a consequence of the Company's transition
to an enterprise application integration solutions provider, the Company
abandoned certain planned development efforts for products acquired in the
Momentum transaction and reassessed the remaining undiscounted projected cash
flows related to the identifiable and unidentifiable intangible assets acquired
from Momentum. It was concluded that, with the principal exception of the
Momentum technology utilized in the Level 8's product suite and the Geneva XIPC
products, the
24
<PAGE>
goodwill and intangible acquired in the Momentum transaction should be written
off. Accordingly, during the fourth quarter of 1998, the Company adjusted the
carrying value of its identifiable and unidentifiable assets to their fair
value of $32.2 million, resulting in a non-cash impairment loss of $4.6
million.
During the fourth quarter of 1999, the Company reorganized its existing
operations due to its acquisition of Template. The Company's restructuring,
included a management change in its development and operations areas, the
abandonment of certain leased facilities, and the closure of its French
subsidiary. The Company recorded a restructuring charge of $.55 million, which
consisted of approximately $.28 million in costs associated with improving
leased space to be subleased, approximately $.23 million in personnel-related
charges, and approximately $.04 million in professional fees to close its
French subsidiary. Through December 31, 1999, the Company had not paid any cash
related to these restructuring charges.
At December 31, 1999, the Company revised its estimate of the 1998
restructuring charge by reducing it by $.16 million based on a review of the
costs paid through December 31, 1999 and the remaining estimated costs. The
change in estimate is reflected in the 1999 Consolidated Statement of
Operations as a reduction of the restructuring charge for 1999.
During the fourth quarter of 1998, the Company reorganized its existing
operations due to its acquisition of Seer. The restructuring included a staff
reduction in its development and administrative areas of 20% (15 employees),
the abandonment of certain leased facilities, and the write-down to fair value
of certain capitalized software costs for product lines which were being
discontinued. The Company recorded a restructuring charge of approximately
$1.54 million, which consisted of approximately $.71 million in personnel-
related charges, approximately $.29 million in costs associated with carrying
vacated space until the lease expiration date, approximately $.19 million of
property and equipment related charges, approximately $.24 million in write-
down of capitalized software costs, approximately $.1 million in professional
fees related to the restructuring, and approximately $.01 million for other
charges. Through December 31, 1999, the Company has paid approximately $.86
million in cash related to the restructuring.
The Company believes the accrued restructuring cost of $.63 million at
December 31, 1999 represents its remaining cash obligations for the
restructuring charges included above.
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 losses incurred during 1999 and 1998. The provision for
income taxes in 1997, was approximately 35% due to income from operations.
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
1999 is primarily related to income taxes from profitable foreign operations
and foreign withholding taxes.
Discontinued Operations
The loss on disposal of ProfitKey during 1998 was approximately $1.2 million.
The loss on discontinued operations related to ProfitKey was $.14 million for
1998.
Impact Of Inflation
Inflation has not had a significant effect on the Company's operating results
during the periods presented.
Liquidity and Capital Resources
Cash and cash equivalents increased $3.7 million during 1997 to $7.0 million
at December 31, 1997. The increase was due primarily to the Company's
redemption of investments in marketable securities offset by a $1.7 million
investment for capitalized software development costs and equipment, and a $.9
million use of cash in investing activities by the Company's discontinued
operations. The Company funded its operations in 1997 with cash remaining from
the $9.1 million in net proceeds from its 1996 offering.
25
<PAGE>
During 1998, cash and cash equivalents decreased by $1 million to $6 million
at December 31, 1998. The decrease in cash was due to the purchase of $.9
million in equipment, spending of $1.2 million for capitalized software
development costs, and debt service of $1.5 million. This decrease was offset
by $1.7 million of cash provided by operations, $.5 million from the sale of
ProfitKey, and $.4 million of net cash acquired from acquisitions.
Additionally, the Company borrowed $12 million from Liraz which was used to pay
down Seer's bank debt on December 31, 1998.
During 1999, cash and cash equivalents increased by $.4 million to $6.5
million at December 31, 1999. The increase in cash is due to cash provided by
financing activities, including $19.2 million in net proceeds from issuance of
shares of preferred stock and $17.3 million in proceeds from the issuance of
shares of common stock due to the exercise of stock options and warrants. These
financing inflows, combined with approximately $16.7 million of additional
borrowings, were used to retire $12.6 million of debt obligations, fund
additional acquisition activity, and fund the $12.9 million net cash used in
operations.
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 first six months of 2000, the Company paid approximately $1.5 million on
its outstanding debt obligations to its principal 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.
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 exchanged $1.9 million of the Momentum notes
for approximately 55,000 shares of common stock. As of June 30, 2000 $.2
million of the notes were outstanding. Subsequent to June 30, 2000, the
remaining $.2 million of the notes were paid off.
On April 15, 1999, the Company acquired the remaining 31% minority interest
in Seer, through a tender offer and merger for approximately $1.7 million in
cash.
During the second quarter of 1999, the Company used $4 million to pay down
the Credit Facility. During the third quarter of 1999, the Company paid down $8
million of the $12 million loan from Liraz.
In June 1999, the Company sold 21,000 shares of Series A 4% Convertible
Redeemable Preferred Stock, convertible into an aggregate of 2,100,000 shares
of the Company's common stock and related warrants for $21 million. Holders of
the Series A Preferred Stock are entitled to receive 4% annual cash dividends
payable quarterly. The Series A Preferred Stock may be redeemed at the option
of the Company at a redemption price equal to the original purchase price at
any time after June 29, 2000 if the closing price of the Company's common stock
over 20 consecutive trading days is greater than $20 per share. In the event
the Company breaches its obligations to pay dividends when due or issue common
stock upon conversion, or the Company's common stock is delisted, the dividend
rate on the Series A 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 $21 million financing,
the Company also issued the investors warrants to purchase 2.1 million shares
of common stock at an exercise price of $10 per share. These warrants are
callable by the Company on the same terms as the preferred stock, which is
outlined above. Advanced Systems Europe B.V. purchased $10 million of Series A
Preferred Stock and warrants in the transaction, and is a subsidiary of Liraz,
the Company's principal stockholder.
26
<PAGE>
Subsequent to the issuance of the Series A Preferred Stock, holders have
exercised Series A warrants resulting in the issuance of approximately 1.26
million shares of the Company's common stock and resulting in net proceeds of
approximately $12.6 million.
On December 27, 1999, the Company acquired all of the outstanding common
stock of Template for a combination of stock and cash. Purchase consideration
included $21.6 million in cash. The Company partially funded this acquisition
with a $10 million term loan from a commercial bank, which was guaranteed by
Liraz in exchange for 60,000 shares of common stock. The term loan has no
financial covenants and has an interest rate of LIBOR plus 1%, approximately
7.75% at June 30, 2000.
In addition to the debt obligations related to its acquisitions activity, the
Company uses an asset-based lending arrangement to finance working capital
needs from operations, if necessary. As of June 30, 2000, the Company had
outstanding borrowings of $20.2 million under a credit facility with a
commercial bank 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 1, 2000. 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.
The Company had 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, including $3 million due to
Liraz that was paid subsequent to June 30, 2000.
Subsequent to June 30, 2000, the Company sold 30,000 shares of Series B
Convertible Redeemable Preferred Stock ("Series B Preferred Stock") and related
warrants, for $30 million. The shares of Series B Preferred Stock are
convertible into an aggregate of approximately 1.2 million shares of common
stock of the Company. The net proceeds will be used to reduce debt.
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
27
<PAGE>
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 1999, the Company had EBITDA, exclusive of acquisition related
charges, of $3.1 million and incurred a net loss of $15.5 million. The Company
has working capital of $1.5 million and an accumulated deficit of $41.1 million
at December 31, 1999. 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.
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.
Quantitative and Qualitative Disclosures about Market Risk
Approximately 66% of the Company's 1999 revenues and approximately 52% and
48% of the Company's revenues for the 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.
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BUSINESS
Overview
Our software products and enabling services address three of the most
pervasive eBusiness challenges facing global 5000-sized organizations today:
. Using the Internet as the primary communications medium ("eBusiness")
. Using the Internet to enable buying and selling ("eCommerce")
. Optimizing an enterprise's value through the rapid adoption of digital
technology
These eBusiness challenges are driven by intensifying competition in the
global marketplace, which is forcing companies to make better and faster
business decisions and find new ways to attract and retain customers. To
accomplish this, a company must have access to enterprise-wide views of
business information and processes, and mechanisms for extending their business
applications to reach customers and business partners via the Internet.
Providing these capabilities requires an integration of existing computer
applications and platforms, enabling them to communicate with one another and
the Internet. However, the evolution of computing from mainframes to
client/server systems and then to the Internet and intranets has resulted in
these applications running on a diverse and typically incompatible mix of new
and legacy computing platforms.
We specialize 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." Our products and services are
designed to enable organizations to address business process automation,
application integration and application engineering in a simple and cost
effective way. We provide customers with software to link their critical
business applications internally across the enterprise and externally directly
with strategic business-to-business partners and business-to-business consumers
via the Internet.
We offer a suite of products for eBusiness and eCommerce under the Geneva
brand name. The Geneva Integration Suite has six core components which,
together, we believe provide the most complete suite of integration software
products available for eBusiness integration. These components include Geneva
Enterprise Integrator (formerly Enterprise Integration Template), Geneva
Business Process Automator (formerly Business Process Template), Geneva
Integration Broker (formerly Geneva Integrator), Geneva Message Queuing, Geneva
AppBuilder (formerly Seer*HPS) and Geneva XIPC (formerly XIPC).
In addition to these products, we also provide technical support, training
and consulting services as part of our commitment to providing our customers
with industry-leading enterprise application integration solutions. Our
worldwide consulting team has in-depth experience in developing successful
enterprise-class solutions as well as valuable insight into the business
information needs of customers in the Global 5000. We offer consulting services
around our products for eBusiness and eCommerce enablement. These services
include project management, application and platform integration, application
design and development and application renewal along with expertise in a wide
variety of development environments and programming languages.
In April 1999, we completed our acquisition of Seer Technologies, Inc.
("Seer"). In connection with the acquisition of Seer, we acquired significant
intellectual property assets, including Geneva AppBuilder (formerly Seer*HPS).
In December 1999, we acquired Template Software, Inc. ("Template"). Our
management team identified Template as a provider of technologies that would
enable us to be one of the first to market with a comprehensive product
portfolio representing the next generation of EAI solutions for eBusiness. In
connection with the acquisition of Template, we acquired significant
intellectual property assets, including Geneva Enterprise Integrator and Geneva
Business Process Automator. These products, together with our existing software
portfolio, provide customers a comprehensive suite.
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We were incorporated in New York in 1988, and re-incorporated in Delaware in
1999. Our principal executive offices are located at 8000 Regency Parkway,
Cary, North Carolina, 27511, and our telephone number is (919) 380-5000.
Industry Background
A significant challenge facing global 5000-sized organizations today is the
integration and management of critical business applications which run on
disparate or otherwise incompatible computer systems. Business and competitive
pressures are pushing companies to move towards an eBusiness model as quickly
as possible in order to remain competitive and viable in an increasingly
online, information-driven economy. eBusiness systems involve a combination of
consumer-oriented or business-to-business eCommerce, internal and external data
exchange, online customer service, customer relationship management and value
chain integration processes. Inter-operability and information exchange between
new and legacy systems within the extended enterprise are key components for a
successful eBusiness strategy, as is the ability to link those applications and
processes in extremely secure and highly reliable ways. Organizations must also
ensure that large volumes of eBusiness transactions can be processed in
Internet time and incorporate the entire extended, integrated enterprise
processing environment into a reliable, scalable, robust and manageable
infrastructure. The eBusiness model and the competitive need for rapid access
to business-critical information from across the enterprise are together
driving an increasing demand for Internet-enabled information systems that can
also offer enterprise-wide views of a company's business information. Further,
information systems departments of global 5000-sized companies are compelled by
both economic necessity and internal mandates to find ways to leverage their
existing investments in information technology.
Enterprise application integration solutions, including those developed by
Level 8, are designed to provide these capabilities through an open,
enterprise-wide infrastructure that can accomplish the complete integration of
a company's entire computing systems environment, including technologies
enabling eBusiness and eCommerce.
There is currently a movement toward "virtual enterprises" that must link
application systems from different companies in the supply chain. Additionally,
e-Commerce and customer service on the Web require communication between Web-
based, front-end systems (e.g., payment systems) and back-end systems, for
example inventory, accounts receivable and invoicing systems.
Key factors driving the current need for enterprise application integration
solutions in the eBusiness integration software market include:
. The current computer systems of most companies were developed in an era
when systems tended to be self-contained and were not developed with the
Internet in mind. The ability of the systems to communicate with other
systems was not emphasized. As a result, many current systems are not
designed to accommodate communications with different systems. The
ability to integrate the Internet and Web-based technologies with a
company's core business systems provides business value by adding new
revenue models (eCommerce) and improving customer service.
. Web-based customer self-service is becoming the standard for forging
more meaningful customer relationships.
. Integrating with company business partners and supply chain partners is
now a key differentiator for business inventory costs and increases
profitability.
. Many global 5000-sized companies have made significant investments in
ensuring that their existing computer systems will function properly in
the Year 2000 and beyond. The size of the investments made by these
companies addressing Year 2000 problems is forcing information systems
departments to find ways to leverage such investments by extending the
life of current systems. By providing Web-based access to core business
systems, companies can leverage these investments.
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. Many Global 5000-sized companies addressed computer system development
problems by adopting new technologies as they have emerged. This
approach has resulted in increasingly diverse computing environments
that mix a variety of hardware platforms, operating systems and
programming languages.
. Global 5000-sized companies have dramatically increased their use of the
Internet and intranets both to expedite internal communication and to
support business-to-business and business-to-consumer transactions. This
increased use has created strong demand for an entirely new class of
enterprise-wide computer applications. Meeting this demand in a cost
efficient manner requires modernizing existing systems to enable them to
support eBusiness and eCommerce applications, as well as developing new
applications.
. As a result of mergers and acquisitions, the computer systems of many
companies have become considerably more complex at an enterprise-wide
level. The increased complexity results from the fact that the newly-
acquired computer systems are rarely compatible with the existing
computer systems. Furthermore, there are often redundancies between the
respective systems that make integration more difficult.
Our Solution
We are a leading provider of eBusiness integration software for integrating
enterprise applications both within the enterprise and between business-to-
business partners. Different computer systems and the applications developed
for them vary widely in the ways in which they send, receive, view and process
information. As a result, diverse applications running on different systems
cannot work together because information cannot generally be exchanged between
them.
Our products are designed to enable the sharing of information between
disparate systems by automatically transforming the data from one system into
the formats and representations that can be used by other application systems.
This means organizations can link legacy systems to other legacy systems, to
new systems, and also to the Web. In this way our products can facilitate the
delivery of timely enterprise-wide views of critical business information while
substantially reducing the need for complex and costly manual programming and
ongoing software program modifications.
Our software is flexible enough to link together a wide array of applications
operating on disparate systems, and can scale to meet the challenges of growth
and technological development in even the most heterogeneous computing
environments. Most significantly, our products allow enterprises to utilize
their core system functions for new uses including Web access. This allows for
the full support of eBusiness and eCommerce and closer relationships with
business-to-business partners and suppliers.
Our solution to solving business integration challenges provides the
following key benefits:
Supports Rapid Implementation of eBusiness Solutions. Our Geneva Integration
Suite enables rapid eBusiness implementations, reducing installation and
integration costs, including the extension of ERP packages, and provides an
open platform for integrating new or acquired applications, systems and
architectures.
Links Existing Operational Systems to The Internet. The Geneva Integration
Suite can transmit communications via the Internet as well as between
applications. It can automatically collect messages or packets of information
and processing instructions, from existing legacy systems and transform them
into forms that can be exchanged via the Internet with other applications
running on diverse platforms, and vice versa. These powerful features allow
organizations to Web-enable existing application systems, expanding their
functionality and extending their life cycles by opening them up for intranet
and Internet-based eBusiness and eCommerce.
Preserves Existing Information Technology Investment. Traditionally, larger
organizations have relied on mainframe computers to run their core business
programs. To date, there has been a tremendous investment in these mainframe
legacy systems. More recently, there has been large investments made in other
computing
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platforms (e.g., midrange, client/server, LANS and Web), which are not readily
compatible with each other or with legacy mainframe systems. Linking together
newer computing platforms and applications to existing systems helps preserve
and increase the return on the investments made by organizations in their
information technology systems.
Additionally, by linking the flexibility and innovations available on newer
computing platforms and applications to the rich databases and functions that
are typically maintained on the larger mainframe computers, organizations can
utilize this information in new ways. The Geneva Integration Suite helps
organizations bridge the gap between legacy systems and newer platforms and the
result is the extension of existing capabilities to modern architectures, such
as the Web, thereby preserving the existing information technology investment.
Improves Efficiency of Existing Enterprise Infrastructure. The high
throughput capability of the Geneva Integration Suite of products enables
organizations to provide just-in-time data delivery across a wide variety of
systems and among people in a unified business process. By removing the
bottlenecks to the integration of people, process and data, our software
products support numerous business critical computing operations such as
business process automation, data replication, data warehousing and
transaction-based processing.
Supports Broad Range of Applications, Platforms and Standards. The IT
departments of larger enterprises need solutions to integrate a broad array of
applications and platforms using a wide variety of industry standards to ensure
ease of implementation and integration into existing environments. Our products
provide enterprise application integration solutions that support common
industry standards and can handle a wide array of disparate applications,
platforms and data types. The Geneva Integration Suite can be used to link
custom or packaged applications together regardless of the tools or programming
language used. The Geneva Integration Suite ties together applications running
on a variety of popular operating systems including; Windows NT, UNIX, Solaris,
MVS, VMS, OS/400 and many other operating systems that run on hardware
platforms from vendors such as Hewlett Packard, Sun, Compaq/Digital, Dell and
IBM.
Ease of Implementation and Enhanced Information Technology Productivity. The
Geneva Integration Suite allows IT departments to create comprehensive data
transformation and information exchange solutions without the need for custom
coding. Our products provide pre-built adapters for a wide variety of different
systems that are pre-programmed for transforming data into the format required
by that system and transporting it using the appropriate transport mechanism.
This greatly simplifies and speeds development of enterprise application
integration solutions. The Geneva Integration Suite allows the IT department to
instantly integrate new and existing systems with little or no customization
required.
Our Strategy
Our goal is to be a recognized global leader in the growing market for
enterprise application integration solutions for eBusiness and eCommerce. The
following are key elements of our strategy:
The Geneva Integration Suite. No single product, technology or paradigm
answers all of a large organization's integration challenges. Our eBusiness
integration software portfolio provides the most comprehensive suite of
integration software products available for eBusiness integration. We offer a
suite of integration products under the Geneva brand name. The Geneva
Integration Suite is a set of eBusiness integration software products that
supports business process automation, application integration, enterprise
messaging and application engineering. Our strategy for evolving the Geneva
Integration Suite is threefold: 1) make substantial investments in research and
development focusing enhancing/extending the products in the suite, 2) add
market-driven functionality based on customer requirements and feedback and 3)
add complementary products and technologies via strategic acquisitions.
Expand Worldwide Sales and Marketing Capability. We are making considerable
investments in worldwide sales and marketing in an attempt to acquire market
share in a high growth market. Specifically, we are increasing our sales and
marketing personnel and programs around the globe. Worldwide sales personnel
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grew approximately 105% during the first half of 2000. The sales team includes
account executives, inside sales (or telephone sales) personnel and sales
engineers. We also intend to continue to expand our global sales coverage
through additional direct sales offices and the expansion of indirect channels.
To support indirect sales we have already established joint marketing
relationships with original equipment manufacturers, independent software
vendors and value added resellers, including IBM, Microsoft, Hewlett-Packard,
Unisys, Cambridge Technology Partners, Amdocs, Tanning Technology Corporation,
Emplifi, Clarus Corporation, Catalyst and Crystal Solutions.
Maintain Global Presence. Our strategy for sales and marketing is to become
recognized among IT professionals as a global provider of eBusiness integration
software. More than 50 percent of Fortune Magazine's 1999 Global 500 were
headquartered outside of the United States. In recognition of this, we continue
to support our international sales and marketing efforts. We had a strong
international presence during 1999, accounting for 67% of revenue.
Leverage Strategic Partners. We also intend to continue expanding sales
through both direct and indirect sales channels. As part of this strategy, we
continue to work on strengthening and growing our relationships with Microsoft,
IBM, Hewlett-Packard and other strategic partners. Our strategy is to use the
market visibility of key customers to engage strategic partners to then
leverage their lead generation capacity to create new sales opportunities for
our eBusiness integration software.
We have also aggressively pursued original equipment manufacturer ("OEM")
partners who wish to embed our eBusiness integration software products into
their own products or solutions. These OEM partners include Clarus Corporation,
which embedded Geneva Integration Broker into the Company's eProcurement
application; Catalyst, which embedded Geneva Message Queuing into its warehouse
management application; and Crystal Solutions, which is using the Geneva
products in its eBusiness solutions.
Expand into New Markets. In the past, we have served many customers in the
highly demanding financial services, insurance and telecommunications markets.
Our strategy is to apply our experience with these customers to other vertical
markets. Specifically, we intend to further penetrate the retail and
transportation sectors as well as providing Internet integration solutions for
any company trying to establish a presence in the emerging eCommerce sector. We
plan to accomplish this objective by redirecting our sales and marketing
efforts worldwide.
Products
Geneva Integration Suite
We offer a suite of products under the Geneva brand name. These products,
ranging from business process automation, application integration, enterprise
messaging and application engineering, are all components of the Geneva
Integration Suite. The Geneva Integration Suite makes information systems work
together seamlessly for a totally connected, eBusiness-enabled extended
enterprise.
The primary use of Geneva technology is to provide an end-to-end
infrastructure for eBusiness, including:
. Integrating Web and legacy applications
. Real-time access to enterprise information over the Internet
. Linking business partners in an integrated supply chain across the
Internet
The primary benefits of the Geneva technology are:
. Acceleration of the creation and deployment of new eBusiness systems
. The leveraging of existing information systems when building new
eBusiness systems
. Robust, transactional infrastructures for eBusiness
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Geneva Products
The Geneva Integration Suite has six core components which provide the most
complete suite of integration software products available for eBusiness
integration. These components include Geneva Enterprise Integrator (formerly
Enterprise Integration Template), Geneva Business Process Automator (formerly
Business Process Template), Geneva Integration Broker (formerly Geneva
Integrator), Geneva Message Queuing, Geneva AppBuilder (formerly Seer*HPS) and
Geneva XIPC (formerly XIPC).
Geneva Enterprise Integrator. Geneva Enterprise Integrator is an integration
tool that provides unified, real-time views of enterprise business information
for eBusiness applications. Real-time integration of back-end enterprise
business systems with Web-based applications is an essential component in
meeting rising customer expectations of eCommerce, Web-based customer service
and enterprise portal applications. Geneva Enterprise Integrator also leverages
a high performance, memory-based information cache to provide an infrastructure
that will support the performance demands of Internet-style computing.
Geneva Business Process Automator. Geneva Business Process Automator is a
product designed to work with Geneva Enterprise Integrator for automating the
many business processes that an organization uses to run its operations.
Business process automation enables the automation of information workflows,
designed by business experts, and spanning front and back office systems.
Business process automation provides business analysts with a set of easy-to-
use tools for defining, changing and refining the exchange of information and
the workflow for a domain-specific business process.
Geneva Integration Broker. Geneva Integration Broker is a transport
independent message broker that enables an organization to rapidly integrate
diverse business systems regardless of platform, transport, format or protocol.
The key feature of Geneva Integration Broker is its support for XML and other
standards for open data exchange on the Internet. The product provides a robust
platform for building eBusiness applications that integrate with existing back-
office systems. Geneva Integration Broker's support for open data exchange and
secure Internet transports make it an excellent platform for building Internet-
based business-to-business solutions.
Geneva Message Queuing. Geneva Message Queuing is a reliable enterprise
connectivity product for Microsoft and non-Microsoft applications. The primary
use is for guaranteed, transactional, once and only once connectivity of
Windows-based Web applications to back-office information resources like
mainframes and other legacy systems. Microsoft's Web application platform,
called Windows DNA, is one of the dominant architectural models for building
eBusiness applications. Geneva Message Queuing provides native interoperability
essential for deploying Windows DNA applications in a heterogeneous
environment.
Geneva XIPC. Geneva XIPC (formerly XIPC) provides similar, guaranteed
delivery of information between applications. The difference being that where
Geneva Message Queuing is based around a Microsoft standard, Geneva XIPC is for
use with Linux and other brands of UNIX servers. The Linux platform was the
largest growing server platform during 1999. The UNIX/Linux family of servers,
from companies like Sun Microsystems, IBM and Hewlett Packard, are the dominant
Web Server and Web Application Server platforms. Geneva XIPC enables Linux and
UNIX Web and Applications Servers to communicate reliably.
Geneva AppBuilder. Geneva AppBuilder is a set of application engineering
tools that assists customers in developing, adapting and managing enterprise-
wide computer applications for the Internet/intranets and client/server
networks. The product is designed to enable users to define in a high level,
simplified language tasks and operations the users would like an application to
perform. Users can then simply "push a button" and Geneva AppBuilder
automatically generates the necessary software programming to perform the tasks
and operations defined. This significantly accelerates the development and
deployment of highly complex, large-scale, custom enterprise applications and
greatly enhances the productivity of programming resources.
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Future Integration and Product Development
We intend to enhance the Geneva suite of products to meet marketplace needs
as they evolve. We are making substantial investments into all areas of
research and development to meet the demands of current and future markets.
We feel that the strength of our product line is its diversity. We believe
that by creating native integration between the different components of the
Geneva Integration Suite, we will be able to provide more comprehensive
solutions for our customers, such as the use of Geneva XIPC to enhance the
functionality of Geneva Message Queuing Version 2.0.
Similarly, our two primary application integration technologies, Geneva
Integration Broker and Geneva Enterprise Integrator, include a base level of
integration. Native robust integration between the two products will provide
the ability for customers to leverage the best attributes of both products.
Other areas of product enhancement include monitoring the emerging Internet
standards such as XML and Java to provide the proper level of support and
integration for all our products.
We also intend to extend the Cicero technology, acquired from Merrill Lynch
in August 2000, to provide enterprise-wide business process automation. We will
also plan to collaborate with Merrill Lynch and develop a universal integration
bus for the enterprise.
Services
We provide a full spectrum of technical support, training and consulting
services as part of our commitment to providing our customers industry-leading
enterprise application integration solutions. We believe our worldwide
consulting team has in-depth experience in developing successful enterprise-
class solutions as well as valuable insight into the business information needs
of Global 5000 companies.
Maintenance and Support
We offer customers varying levels of technical support tailored to their
needs, including periodic software upgrades, telephone support and twenty-four
hour, seven days a week access to support-related information via the Internet.
Training Services
Our training organization offers a full curriculum of courses and labs
designed to help customers become proficient in the use of our products and
related technology as well as enabling customers to take full advantage of our
field-tested best practices and methodologies.
Consulting Services
We offer consulting services around our product offerings in project
management, applications and platform integration, application design and
development, application renewal and eBusiness and eCommerce enablement, along
with expertise in a wide variety of development environments and programming
languages. We also have a very active partner program for recruiting leading IT
consulting and system integration firms to provide services for the design,
implementation and deployment of our eBusiness solutions. Our consulting
organization supports third party consultants by providing architectural and
enabling services.
Customers
Our products and services are currently used by thousands of software
developers. In addition, hundreds of enterprise-wide applications built and
integrated through our products are used daily by over a million end users
worldwide. Our customer base includes major corporations around the world such
as Amdocs Software Systems Limited, Cirquit.com, Enron Corporation, Spacenet
Inc., Merrill Lynch, Pierce, Fenner &
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Smith Incorporated, Paine Webber Inc., Siemens Power Transmission &
Distribution, Inc., Sikorsky Aircraft Corporation, Sunrider International, EDB
4tel AS, Wells Fargo Bank, N.A., WinStar Wireless, Inc. and United Healthcare
Services, Inc. Industries that are significantly represented in our customer
base include: financial services, insurance, retail, manufacturing,
telecommunications, transportation, and government. ABN AMRO was our only
customer accounting for more than 10% of 1997 and 1998 historical operating
revenue. No one customer accounted for more than 10% of operating revenues in
1999.
We seek strong relationships with our customers in order to gain an in-depth
understanding of the business and technology challenges they face. We have
established an international customer advisory board that will follow the
Geneva Integration Suite. It will be used to present new information, address
customer requirements and concerns, and provide a constructive and open forum
for interaction. The volunteer members of the customer advisory board will
represent our global customer base and act as a sounding board for new ideas
and initiatives, as well as provide a means for information flow and feedback
regarding our products and services.
In many areas around the world, local customers also hold periodic regional
user group meetings that we support and encourage. Additionally, we receive a
great deal of feedback through our consulting services and technical support
organization regarding the effectiveness of our products in meeting customer
needs.
Sales and Marketing
Sales
To reach a broad potential customer base, we have pursued multiple
distribution channels, including a direct sales force, as well as third party
relationships with distributors, value-added resellers, systems integrators and
IT consulting firms.
Our direct sales force focuses on large customers and leverages our industry
experience to access target organizations within particular vertical markets.
These markets are characterized by business areas to which our products are
particularly well suited, and businesses that possess the financial resources
and scale of operations necessary to support the engagement.
We identify leading organizations in each focus industry and seek to provide
an initial solution that builds on one of our eBusiness integration software
products. After initial success, we will attempt to sell a broader set of
software solutions to the customer. We intend to target additional industries
in which our business area expertise and advanced software technology can be
applied.
An important element of our sales strategy is to expand our relationships
with third parties to increase market awareness and acceptance of our
integration software solutions. As part of these relationships, we generally
provides training and other support necessary to promote the market acceptance
of our products.
Our current direct sales staff has substantial knowledge of our products and
service offerings as well as general experience in the software industry. As we
expand out direct sales force, we are recruiting sales people with equivalent
general experience in the software industry and successful track records in
selling enterprise-class software products.
We are organized worldwide into two major geographic divisions for sales of
our software products: the Americas and Europe. One general manager heads each
of these sales divisions. We have 15 sales offices in the United States. The
international territories currently include the United Kingdom, Germany,
Denmark, Sweden, Italy and France. The General Managers' respective operations
include sales and consulting services for new and existing customers.
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Approximately $18 million or 34% of our 1999 revenues were generated from the
United States and approximately $35 million or 66% was generated outside the
United States. The geographic distribution of our revenues may change in the
future.
Marketing
The target market for our products and services are Global 5000 companies.
The rapid deployment of the Internet and intranet technology is driving
companies to find ways to take advantage of these new technologies out of
competitive necessity. As a result, information systems departments are
compelled by both economic necessity and internal mandates to find ways to
leverage their investment in current information technology.
In addition, the lines between "new" development and what has in the past
been considered "maintenance" are blurring. We believe more and more of the
"new" development going forward will be in the area of enhancing the
functionality of existing operational systems in an enterprise's current
computing infrastructure. This will result in the identification of new and
emerging opportunities for enterprise application integration solutions.
Our marketing staff has an in-depth understanding of the global software
marketplace and the needs of customers in that marketplace, as well as
experience in all of the key marketing disciplines. The staff also has broad
knowledge of our products and services and how they can meet customer needs.
Marketing is headed by a senior vice president of worldwide marketing who
manages an international staff. Core marketing functions including product
management, product marketing, marketing communications, strategic alliances
and public relations, which include investor and industry analysts, are handled
by the corporate marketing staff. Regional marketing programs are supported by
corporate staff as well as by marketing staff based in the Company's European
headquarters in the UK, with support from local marketing resources in the
regional offices.
We utilize a wide variety of marketing programs that are intended to attract
potential customers and to promote Level 8 and our brands. We use a mix of
market research, analyst updates, seminars, advertising, telemarketing, direct
mail, tradeshows, webcasts, speaking engagements, public relations, and web
site marketing in order to achieve these goals.
The marketing department also produces collateral material for distribution
to prospects including demonstrations, presentation materials, white papers,
case studies, articles, brochures and data sheets. We also intend to implement
an alliance cooperative marketing program to support its channel partners with
a variety of programs, incentives and support plans.
We have increased our investment in marketing significantly. Management
intends to continue to increase our sales and marketing staff worldwide and
significantly increase the marketing budget.
We have a key strategic relationship with Microsoft. Microsoft has licensed
from us software originally developed by us that enables its Windows NT server
platforms to integrate with IBM's MQ Series message- oriented middleware, which
currently represents a significant share of the worldwide message-oriented
middleware market. Microsoft has shipped this software as part of its Windows
2000 operating system and will make it available to its Windows NT server
platform customers through its website. Microsoft also currently recommends
Geneva Message Queuing as its preferred implementation of the MSMQ
functionality on operating systems other than Microsoft Windows.
Research and Product Development
We have made substantial investments in research and development. We conduct
research and development to enhance our existing products and to develop new
products. We intend to focus our research and development efforts on
integrating and evolving our Geneva product line in such a manner that all
products can interact with each other to provide customers a comprehensive
enterprise application integration solution.
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We had research and development expense of $4.8 million during the first six
months of 2000. The increase of 47% in the first six months of 2000 compared to
the same period of 1999 is primarily attributable to the acquisition of
Template. We had research and development expense of $6.8 million, $2.8 million
and $1.1 million in 1999, 1998 and 1997, respectively. This resulted in
increases in research and development expenses of 145% from 1998 to 1999, and
163% from 1997 to 1998. The increase in 1999 is primarily attributable to the
acquisitions of Seer and and our investments in new products, primarily version
2.0 of Geneva Integration Broker, which was released in the second quarter of
1999 and version 2.0 of Geneva Message Queuing, which was released in the
fourth quarter of 1999. This trend is expected to continue along with our
ongoing efforts to strengthen and evolve our messaging, enterprise application
integration and application engineering products.
The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. Our future success will depend to a substantial
degree upon our ability to enhance our existing products and to develop and
introduce, on a timely and cost-effective basis, new products and features that
meet changing customer requirements and emerging and evolving industry
standards.
Our budgets for research and development are based on planned product
introductions and enhancements. Actual expenditures, however, may significantly
differ from budgeted expenditures. Inherent in the product development process
are a number of risks. The development of new, technologically advanced
software products is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends.
The introduction of new or enhanced products also requires us to manage the
transition from older products in order to minimize disruption in customer
ordering patterns, as well as ensure that adequate supplies of new products can
be delivered to meet customer demand. There can be no assurance that we will
successfully develop, introduce or manage the transition to new products.
We have in the past, and may in the future, experience delays in the
introduction of its products, due to factors internal and external to our
business. Any future delays in the introduction or shipment of new or enhanced
products, the inability of such products to gain market acceptance or problems
associated with new product transitions could adversely affect our results of
operations, particularly on a quarterly basis. For additional information, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Years Ended December 31, 1997, 1998, and 1999--Research and
Development."
Competition
The eBusiness integration software market includes a large number of
participants, is subject to rapid changes, and is highly competitive. These
markets are highly fragmented and served by numerous firms, many of which
address only their respective local markets. Clients may elect to use their
internal information systems resources to satisfy their needs, rather than
using those offered by Level 8.
The rapid growth and long-term potential of the market for enterprise
application integration solutions make it attractive to new competition. Many
of our competitors have greater name recognition, a larger installed customer
base and greater financial, technical, marketing and other resources than us.
We believe that we offer a broader range of enterprise application integration
solutions than our competitors, and therefore generally compete on a product-
by-product basis.
Representative Competitors
. In the Message Queuing market, primary competition comes from IBM with
its MQSeries product
. In the Enterprise Application Integration market, primary competition
comes from NEON, Active Software, Tibco, Mercator, IBM and Candle
38
<PAGE>
. In the Business Process Automation market, primary competition comes
from Vitria and IBM
. In the Application Engineering market, primary competition comes from
Sterling Software and Platinum Technology
We believe that our ability to compete depends in part on a number of
competitive factors outside our control, including the ability of our
competitors to hire, retain and motivate senior project managers, the ownership
by competitors of software used by potential clients, the development by others
of software that is competitive with our products and services, the price at
which others offer comparable services and the extent of our competitors'
responsiveness to customer needs.
Intellectual Property
Our success is dependent upon developing, protecting and maintaining our
intellectual property assets. We rely upon combinations of copyright, trademark
and trade secrecy protections, along with contractual provisions, to protect
our intellectual property rights in software, documentation, data models,
methodologies, data processing systems and related written materials in the
international marketplace. In addition, we have patents with respect to certain
of our products. Copyright protection is generally available under United
States laws and international treaties for our software and printed materials.
The effectiveness of these various types of protection can be limited, however,
by variations in laws and enforcement procedures from country to country.
We use the trademarks "Level 8", "Level 8 Systems", "Level 8 Technologies",
"Geneva", "Geneva Integration Suite", "Geneva Message Queuing", "Geneva XIPC",
"Geneva Integration Broker", "Geneva Enterprise Integrator", "Geneva Business
Process Automator", "Geneva AppBuilder" and "MonitorMQ."
There can be no assurance that the steps we have taken will prevent
misappropriation of our technology, and such protections do not preclude
competitors from developing products with functionality or features similar to
our products. Furthermore, there can be no assurance that third parties will
not independently develop competing technologies that are substantially
equivalent or superior to our technologies. If we fail to or are unable to
protect our proprietary technology, it could have a material adverse effect on
our business, operating results and financial condition.
Although we do not believe that our products infringe the proprietary rights
of any third parties, there can be no assurance that infringement claims will
not be asserted against us or our customers in the future. In addition, we may
be required to indemnify our distribution partners and end users for similar
claims made against them. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights or to
establish the validity of our proprietary rights. Litigation, either as a
plaintiff or defendant, would cause us to incur substantial costs and divert
management resources from productive tasks whether or not said litigation is
resolved in our favor, which could have a material adverse effect on our
business operating results and financial condition.
As the number of software products in the industry increases and the
functionality of these products further overlaps, we believe that software
developers may become increasingly subject to infringement claims. Any such
claims, with or without merit, could be time consuming and expensive to defend
and could adversely affect our business, operating results and financial
condition.
Employees
As of July 31, 2000, we had a total of 450 employees. Our continued success
is dependent on our ability to attract and retain qualified employees. During
the second half of 1999, we significantly increased our number of employees
through the Template acquisition and through internal hiring. Due to the
competitiveness in the market for employees, we may experience future
difficulty in recruiting and retaining staff.
39
<PAGE>
We believe that to fully implement our business plan we will be required to
enhance our marketing functions by adding additional marketing personnel. In
addition, we believe that additional sales executives will be required to
support our sales operations. Although we believe that we will be successful in
attracting and retaining qualified employees to fill these positions, no
assurance can be given that we will be successful in attracting and retaining
these employees now or in the future.
Our employees are not represented by a union or a collective bargaining
agreement.
Properties
Our worldwide corporate headquarters is located in approximately 54,000
square feet in Cary, North Carolina pursuant to a lease expiring in 2004. The
United States operations groups are based in the Cary office, with field
offices in the following locations: Scottsdale, Arizona; San Francisco and Los
Angeles, California; Denver, Colorado; Orlando, Florida; Atlanta, Georgia;
Chicago, Illinois; Overland Park, Kansas; East Lansing, Michigan; Plymouth,
Minnesota; New York, New York; Norristown, Pennsylvania; Warwick, Rhode Island;
Plano and Austin, Texas; Dulles, Virginia; and Bellevue, Washington. The
foreign operations groups are based in London, England with field offices in
the following locations: Sydney, Australia; Copenhagen, Denmark; Manchester,
England; Paris, France; Frankfurt, Germany; Milan, Italy; Stockholm, Sweden;
and Nieuwegein, The Netherlands. We also maintain an office in Limerick,
Ireland on a set fee arrangement. The research and development and customer
support groups are located in New York, New York; Dulles, Virginia; Cary, and
London.
As of December 27, 1999, we own a building in Windsor, England due to the
acquisition of Template. We are in the process of selling this building.
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. Subsequent to June 30, 2000 this matter was resolved for an immaterial
amount.
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.
40
<PAGE>
MANAGEMENT
Executive Officers and Directors
The following table sets forth certain information regarding our executive
officers and directors.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
Arie Kilman................. 47 Chairman of the Board, Chief Executive
Officer and Director
Steven Dmiszewicki.......... 37 President, Chief Operating Officer and
Director
Samuel Somech............... 48 Chairman Emeritus, Chief Technology Officer
and Director
Dennis McKinnie............. 43 Vice President, Chief Legal and
Administrative Officer and Corporate
Secretary
Renee Fulk.................. 31 Chief Financial Officer, Treasurer and
Assistant Secretary
Michel Berty, Ph.D.......... 61 Director
Robert M. Brill, Ph.D....... 53 Director
Anthony C. Pizi............. 41 Director
Theodore Fine............... 63 Director
Lenny Recanati.............. 46 Director
</TABLE>
Arie Kilman has served as Chairman of the Board of Directors since July 1997.
Mr. Kilman has also been Chief Executive Officer since July 1996. He was
President of the Company from July 1996 to October 1996. He previously served
as Chairman of the Board of Directors of the Company from December 1994 to July
1996. He is a citizen of Israel.
Steven Dmiszewicki has served as Chief Operating Officer since January 1999,
as President since June 1999 and as Director since June 2000. Mr. Dmiszewicki
served as Co-President and Chief Financial Officer of Seer Technologies, Inc.
("Seer") from May 1998 to January 1999. From October 1996 to May 1998, he
served as Senior Vice President and Chief Financial Officer of Seer. From July
1996 to October 1996, he was employed by Healthpoint G.P. as Vice President,
Chief Financial and Administrative Officer. From February 1996 to July 1996,
Mr. Dmiszewicki served Seer as Vice President and Chief Financial Officer. From
February 1993 until February 1996, Mr. Dmiszewicki served as Seer's Vice
President--Finance. Mr. Dmiszewicki, a Certified Public Accountant, obtained
his B.S. in Business Administration from Bucknell University.
Samuel Somech served as President of the Company through June 1999, as
Chairman Emeritus since July 1999, as Chief Technology Officer of the Company
since October 1996, and as a Director of the Company since April 1995. Mr.
Somech served as Vice President of the Company from April 1995 to October 1996.
He also served as the Technical Director, Messaging Group, of Apertus
Technologies, Inc. from January 1994 to March 1994 and Technical Director,
Messaging Group, of NYNEX from September 1990 to December 1993. Mr. Somech co-
founded Level 8 Technologies, Inc. with Theodore Fine in February 1994. We
acquired Level 8 Technologies, Inc. in 1995 and it remains a wholly-owned
subsidiary. Mr. Somech is a citizen of Israel.
Dennis McKinnie has served as Senior Vice President, Chief Legal and
Administrative Officer and Corporate Secretary of the Company since January
1999. Previously, Mr. McKinnie served as Vice President, Chief Legal and
Administrative Officer and Corporate Secretary of Seer since April, 1998. Prior
to that, Mr. McKinnie was Vice President and General Counsel of Seer. He has
also served as Corporate Secretary of Seer since February 1996 and as Assistant
Secretary prior thereto. From September 1989 to October 1994, he was associated
with the Atlanta, Georgia law firm of Powell, Goldstein, Frazer & Murphy LLP,
where he was a member of that firm's Technology Litigation Group. Prior to
becoming associated with Powell Goldstein, he was Staff Counsel to the Supreme
Court of the United States. During his 16 years of law practice, he also
clerked for the Alabama Supreme Court and the United States Court of Appeals
for the Eleventh Circuit. Mr. McKinnie holds a B.A. from Union University and a
J.D. from the Cumberland School of Law of Samford University.
41
<PAGE>
Renee Fulk currently serves as the Chief Financial Officer of the Company.
Ms. Fulk served as Vice President, Finance for the Company from January 1999 to
December 1999. Prior to this position, she served as Seer's Director of
Corporate Finance and Director of Finance for the Americas Operating Division.
From March 1996 to November 1996, she was employed as Seer's Manager of
Financial Reporting. Prior to joining Seer, Ms. Fulk was with Deloitte &
Touche, LLP from August 1990 to March 1996. Ms. Fulk, a Certified Public
Accountant, obtained her B.S. in Accounting from East Carolina University.
Michel Berty, Ph.D. has served as a director of the Company since July 1997.
Since April 1997, Dr. Berty has been the owner of MBY Consultant, Inc. Dr.
Berty currently serves as a director of Sapiens International Corporation,
N.V., I Gate Capital, Merant, Elligent Consulting Group, Inc. and NetGain, Inc.
Dr. Berty served as the Chairman of the Board and Chief Executive Officer of
Cap Gemini America (an international information technology consulting firm)
from 1993 to April 1997. From 1986 to 1992, he served as the General Secretary
of the Gemini Sogeti Group (the parent corporation of Cap Gemini America).
Robert M. Brill, Ph.D. has served as a director of the Company since March
1998. Dr. Brill also serves on the Audit Committee of the Board of Directors.
Dr. Brill is a General Partner of New Light Management, L.P., Newlight
Associates (BVI), L.P., and Poly Ventures II, L.P., venture capital funds
specializing in investments in high technology companies. He is also a director
of Standard MicroSystems Corporation. Prior to 1989, Dr. Brill had been the
Chief Executive Officer of several high technology companies and has held
executive and technical positions with Harris Corporation and IBM. Dr. Brill
received degrees in engineering physics and physics from Lehigh University and
a Ph.D. in physics from Brown University.
Theodore Fine has served as a director of the Company since April 1995. He
currently serves on the Audit and Compensation Committees of the Board of
Directors. Mr. Fine co-founded Level 8 Technologies, a subsidiary of the
Company, with Mr. Somech in February 1994. Mr. Fine is also a director and the
Chief Executive Officer of Buysmart Enterprises, Inc. Since January 1993, Mr.
Fine has been a management information systems consultant to the financial
community and, from April 1995 to July 1996, served as a marketing and sales
consultant to the Company. From March 1974 to December 1992, Mr. Fine was Vice
President of Technology for Retail International Operations of CitiBank, N.A.
Anthony C. Pizi has served as a director of the Company since August 2000. He
is First Vice President and Chief Technology Officer of Merrill Lynch's Private
Client Technology's Architecture and Service Quality Group. Mr. Pizi's 16 years
with Merrill Lynch includes assignments in Corporate MIS, Investment Banking
and Private Client. Mr. Pizi earned his BS in Engineering from West Virginia
University. Mr. Pizi sits on the Board of Directors for StarQuest Software,
Inc. and is on the Technical Board of Crossgain Corporation.
Lenny Recanati has served as a director of the Company since December 1994.
He currently serves on the Audit and Compensation Committees of the Board of
Directors. Mr. Recanati has been an executive with Discount Investment
Corporation Ltd. since 1983 and is currently an Executive Vice President and
Director. He serves on the Board of Directors of IDB Holdings Ltd. and of a
number of Israeli industrial and other enterprises connected with DIC and PEC,
including Chairman of Ilanot-Betucha Investment House Ltd. and Liraz Systems
Ltd. Level 8 Systems Inc., Klil Industries Ltd., Bayside Land Corporation Ltd.,
Tefron Ltd., Tambour Ltd., Elron Electronic Industries Ltd., Elbit Systems
Ltd., SuperSol Ltd. He received his bachelors degree in economics from the
Hebrew University of Jerusalem and he holds a masters degree in business
administration from Columbia University.
Committees of the Board of Directors
Messrs. Fine, Kilman and Recanati presently serve on the Compensation
Committee of the Board of Directors. The Compensation Committee has (i) full
power and authority to interpret the provisions of and supervise the
administration of the Company's 1995 Stock Incentive Plan, the 1997 Stock
Option Plan, the Company's Employee Stock Purchase Plan (U.S.), the Company's
International Stock Purchase Plan and the Company's Outside Directors Stock
Incentive Plan, and (ii) the authority to review all compensation matters
relating to the Company. The Compensation Committee met ten times during fiscal
1999.
During 1999, Mr. Frank J. Klein served as a member of the Company's Board of
Directors. He tendered his resignation effective December 31, 1999. During
1999, he served on the Compensation and Audit Committees.
42
<PAGE>
Messrs. Brill, Fine and Recanati presently serve on the Audit Committee of
the Board of Directors. The Audit Committee recommends to the Board of
Directors the independent public accountants to be selected to audit the
Company's annual financial statements and approves any special assignments
given to such accountants. The Audit Committee also reviews the planned scope
of the annual audit, any changes in accounting principles and the effectiveness
and efficiency of the Company's internal accounting staff. The Audit Committee
met six times during fiscal 1999.
The Board of Directors does not have a nominating committee.
The Board of Directors may from time to time establish certain other
committees to facilitate the management of the Company.
Director Compensation
In May 1999, stockholders of the Company approved the Outside Director Stock
Incentive Plan of the Company. Under this plan, the outside directors may be
granted an option to purchase 12,000 shares of common stock at a price equal to
the fair market value of the common stock as of the grant date. These options
vest over a three year period in equal investments upon the eligible Director's
election to the Board. Newly elected eligible directors are also eligible to
receive an option to purchase 12,000 shares upon initial election or
appointment. The Outside Director Stock Incentive Plan also permits eligible
directors to receive partial payment of director fees in common shares in lieu
of cash, subject to approval by the Board of Directors. In addition, the plan
permits the Board of Directors to grant discretionary awards to eligible
directors under the plan. Pursuant to the Outside Director Stock Incentive
Plan, Messrs. Berty, Brill and Fine received options to purchase 12,000 shares
of common stock at an exercise price of $9.00 per share. Dr. Brill received
options to purchase an additional 6,000 shares of common stock pursuant to the
1997 Stock Option Plan at an exercise price of $12.5781 for his service on the
Audit Committee. Mr. Fine received options to purchase an additional 16,000
shares of common stock at an exercise price of $9.00 per share for his previous
uncompensated service on the Board. Those options also vest over a three-year
period in equal installments upon their re-election to the Board.
Michel Berty is entitled to receive $12,000 each year for serving as a
Director, and, in addition to the above detailed options, he previously
received options to purchase 12,000 shares of common stock at an exercise price
of $12.75 per share. None of the Company's other Directors received additional
monetary compensation for serving on the Board of Directors of the Company in
1999, other than reimbursement of reasonable expenses incurred in attending
meetings.
Dr. Brill was previously granted options to purchase 12,000 shares of common
stock of the Company at an exercise price of $8.50. Those options vest in equal
installments over a four year period beginning in 1998.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee is comprised of Messrs. Fine, Kilman and Recanati.
Mr. Kilman is the Chairman of the Board of Directors and Chief Executive
Officer of the Company. Except for Mr. Kilman, none of the other members of the
Compensation Committee has served as an executive officer of the Company and no
executive officer of the Company has served as a member of the Compensation
Committee of any other entity of which Messrs. Fine, Kilman or Recanati have
served as executive officers. There were no interlocking relationships between
the Company and other entities that might affect the determination of the
compensation of the directors and executive officers of the Company.
Executive Compensation
The following summary compensation table sets forth the compensation earned
by the Company's current Chief Executive Officer and the four other executive
officers serving or having served at the end of fiscal 1999 whose salary and
bonus exceeded $100,000 for services rendered to the Company during fiscal
1999. The table reflects compensation earned for each of the last three years
or for such shorter period of service as an executive officer as is reflected
below. For the principal terms of the options granted during fiscal 1999, see
"Option Grants in Fiscal 1999."
43
<PAGE>
Summary Compensation Table
Annual Compensation
<TABLE>
<CAPTION>
Securities
Name and Principal Fiscal Other Annual Underlying All Other
Position Year Salary Compensation(1) Options Compensation
------------------ ------ -------- --------------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Arie Kilman............. 1999 $120,000(1) $ 90,000(2) 200,000(3) $ 0
Chief Executive
Officer, 1998 $115,000(4) $ 96,350(5) 0 $ 0
Chairman of the Board
and Director 1997 $112,500 $ 0 0 $ 0
Steven Dmiszewicki...... 1999 $200,000 $200,000(6) 35,000(7)
President 1998 $ 0 $ 0 200,000(8)
Samuel Somech........... 1999 $150,000 $ 6,954(9) 0 $ 0
Chairman Emeritus 1998 $150,000 $ 7,200(9) 0 $ 0
Chief Technology
Officer and Director 1997 $150,000 $ 0 50,000 $ 0
Dennis McKinnie......... 1999 $172,917 $ 50,000(10) 95,000(11) $ 0
Senior Vice President,
Chief Legal and
Administrative
Officer, and Secretary
Renee Fulk.............. 1999 $110,583 $ 65,000(12) 40,000(13) $ 0
Chief Financial
Officer,
Treasurer and Assistant
Secretary
</TABLE>
--------
(1) The indicated amounts do not reflect non-cash compensation in the form of
personal benefits provided by the Company that may have value to the
recipient. Although such compensation cannot be determined precisely, the
Company has concluded that the aggregate value of such benefits awarded to
any named executive officer did not exceed the lesser of $50,000 or 10% of
his or her salary and bonus for any fiscal year to which such benefits
pertain.
(2) Consists of a $90,000 bonus for the successful completion of the
acquisition of Template Software, Inc.
(3) Mr. Kilman previously held 200,000 options to purchase common stock of the
Company at exercise prices ranging from $9.50 to $14.73. On March 30,
1999, he forfeited all of those options, and in December 1999, he was
issued options to purchase 200,000 shares of common stock at an exercise
price of $30.25. In the first quarter of 2000, Mr. Kilman was also granted
options to purchase an additional 50,000 shares of common stock
(4) Mr. Kilman's salary for 1998 includes an aggregate of $60,000 paid by the
Company and $55,000 paid by Liraz.
(5) The indicated amounts reflect compensation for 1998 paid to Mr. Kilman to
pay for travel expenses to and from New York and living expenses in New
York, including rent for an apartment, an automobile lease and
miscellaneous expenditures related thereto. Liraz has agreed to reimburse
the Company at a rate of $3,000 per month for Mr. Kilman's travel
expenses.
(6) Includes a $100,000 performance based bonus and a bonus of $100,000 for
the successful completion of the acquisition of Template Software, Inc.
(7) Mr. Dmiszewicki received options to purchase 35,000 shares of common stock
at an exercise price of $11.9375.
(8) In December 1998, Mr. Dmiszewicki received options to purchase 200,000
shares of common stock at an exercise price of $7.25.
(9) Includes compensation paid to Mr. Somech for an automobile lease and
mobile telephone lease.
(10) Includes a $50,000 performance based bonus.
(11) Mr. McKinnie received options to purchase 95,000 shares of common stock at
exercise prices ranging from $9.50 to $11.9375.
(12) Consists of performance based bonuses totaling $65,000.
(13) Ms. Fulk received options to purchase 40,000 shares of common stock at
exercise prices ranging from $9.50 to $11.9375.
44
<PAGE>
The following table sets forth information regarding each grant of stock
options to each of the named executives during fiscal 1999. The Company is
required to withhold from the shares issued upon exercise a number of shares
sufficient to satisfy applicable withholding tax obligations. The Company did
not award any stock appreciation rights ("SARs") during fiscal 1999.
Option Grants in Fiscal 1999
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------
Potential Realizable
Value at Assumed
Number of Percent of Annual Rates of
Securities Total Options Appreciation for
Underlying Granted to Exercise Option Term
Options Employees in Price Expiration ----------------------
Name Granted Fiscal Year ($/share) Date 5%($) 10%($)
---- ---------- ------------- -------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Arie Kilman............. 200,000 10.94% $ 30.25 12/15/09 $4,756,015 $12,052,677
Steven Dmiszewicki...... 35,000 1.91% $11.9375 11/04/09 $ 262,760 $ 665,886
Samuel Somech........... 0 0 $ 0 -- $ 0 $ 0
Dennis McKinnie......... 80,000 5.2% $ 9.50 02/26/09 $ 477,960 $ 1,211,244
15,000 $11.9375 11/04/09 $ 112,611 $ 285,379
Renee Fulk.............. 25,000 2.19% $ 9.50 02/26/09 $ 149,362 $ 378,514
5,000 $ 9.875 06/10/09 $ 31,052 $ 78,691
10,000 $11.9375 11/04/09 $ 75,074 $ 190,253
</TABLE>
The following table sets forth information concerning the options exercised
during fiscal 1999 and held at December 31, 1999 by the named executives.
Fiscal 1999 Year-End Option Holdings and Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Shares Options at Options at
Acquired December 31, 1999 December 31, 1999(1)
on Value ------------------------- -------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- -------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Arie Kilman(2).......... 0 $ 0 0 200,000 0 0
Steven Dmiszewicki...... 0 $ 0 135,000 100,000 3,522,788 2,731,000
Samuel Somech........... 0 $ 0 477,805 0 12,695,279 0
Dennis McKinnie......... 0 $ 0 35,000 60,000 840,538 1,503,600
Renee Fulk.............. 0 $ 0 21,250 18,750 506,275 496,875
</TABLE>
--------
(1) Calculated by subtracting the exercise price from $34.56 per share, the
closing price of the Company's common stock as reported by the Nasdaq Stock
Market on December 31, 1999, and multiplying the difference by the number
of shares underlying each option.
(2) On March 30, 1999, Mr. Kilman voluntarily terminated all of his outstanding
options to purchase 200,000 shares of common stock with exercise prices of
$10.45 to $14.73. In December 1999, Mr. Kilman was issued 200,000 options
at an exercise price of $30.25. In the first quarter of 2000, Mr. Kilman
was also granted options to purchase an additional 50,000 shares of common
stock.
Employment Agreements, Termination of Employment and Change-In-Control
Arrangements
Under the employment agreement between the Company and Mr. Kilman, Mr. Kilman
will serve as Chief Executive Officer of the Company. In February 1999, Mr.
Kilman's annual base salary was set at $120,000 and he was eligible for an
incentive bonus based upon the Company achieving certain performance goals. In
February 2000, Mr. Kilman's base salary was increased to $225,000. In February
1999, Mr. Kilman was granted an option to purchase 150,000 shares of common
stock. Twenty-five (25%) of these stock options
45
<PAGE>
vested on February 26, 1999, and the remainder would have vested in three
increments of twenty-five (25%) percent each over the next three years. On
March 30, 1999, Mr. Kilman voluntarily terminated all of his outstanding
options to purchase 200,000 shares of common stock at exercise prices ranging
from $10.45 to $14.73. In December 1999, Mr. Kilman was issued 200,000 options
at an exercise price of $30.25. During the first quarter of 2000, Mr. Kilman
was issued options to purchase an additional 50,000 shares of common stock. If
Mr. Kilman's employment by the Company is terminated for any reason, Mr. Kilman
has agreed that, for one year after such termination and except for his
services for Liraz, he will not engage in any business that competes with the
Company's business at the time of the termination.
Under the employment agreement between the Company and Mr. Somech, the
Company pays Mr. Somech (a) an annual base salary of $150,000, (b) an annual
increase in base salary as determined by the Board of Directors of the Company,
in its discretion, (c) a performance bonus determined by the Board of Directors
of the Company and (d) a car and telephone allowance of $2,000 a month. If Mr.
Somech's employment is terminated for any reason (other than by the Company
without cause), Mr. Somech has agreed that, for one year after such
termination, he will not directly or indirectly (i) compete with Level 8
Technologies' consulting services in the United States regarding middleware,
messaging or fault-tolerant transaction processing, (ii) engage or participate
in any business that provides consulting services within the United States with
respect to middleware, messaging or fault-tolerant transaction processing,
(iii) solicit or divert business from Level 8 Technologies or assist any
business in attempting to do so, (iv) cause any business to refrain from doing
business with Level 8 Technologies or (v) solicit or hire any person who was an
employee of Level 8 Technologies during the term of his employment agreement or
assist any business in attempting to do so. On February 26, 1999, Mr. Somech
and the Company entered into an amendment to his employment agreement that
permits Mr. Somech to retire from the Company at any time during his employment
upon three months notice to the Company. Upon his retirement, Mr. Somech will
receive retirement benefits of $20,000 per month for a period of two years and
his health care benefits will continue during this time or until he obtains
alternative health care coverage, whichever is sooner. During his first year of
retirement, Mr. Somech has agreed to make himself available to assist the
Company and its employees on transition matters.
Mr. Dmiszewicki was elected to serve as the Chief Operating Officer of the
Company on January 27, 1999 and as President in June 1999. Under the employment
arrangement between the Company and Steven Dmiszewicki effective December 4,
1998, the Company will pay to Mr. Dmiszewicki an annual base salary of
$200,000. His base salary was increased to $225,000 in February 2000. In
addition, he is eligible to participate in an incentive bonus program based
upon the Company's attainment of certain performance goals. During the first
year of his employment, Mr. Dmiszewicki had a bonus potential of up to
$200,000. In the event of termination of Mr. Dmiszewicki's employment, other
than voluntarily or for cause, his base salary will be continued for twelve
(12) months. In December of 1998, Mr. Dmiszewicki was granted options to
purchase 200,000 shares of common stock, twenty-five percent (25%) of this
stock option vested on December 4, 1998, twenty-five percent (25%) of this
stock option vested on December 4, 1999 and the remainder vests in increments
of twenty-five percent (25%) over the next two years. In November 1999, he was
granted an option to purchase 35,000 shares of common stock all of which vested
immediately. He is eligible, at the discretion of the Compensation Committee of
the Board of Directors, to receive additional options from time to time.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information as of August 24, 2000 with respect
to beneficial ownership of shares by (i) each person known to the Company to be
the beneficial owner of more than 5% of the outstanding common stock, (ii) each
of the Company's directors, (iii) the executive officers of the Company named
in the Summary Compensation Table (the "named executives") and (iv) all
directors and executive officers of the Company as a group. Unless otherwise
indicated, the address for each person listed is c/o Level 8, Inc., 8000
Regency Parkway, Cary, North Carolina 27511.
Stock ownership information has been furnished to the Company by the named
person. Beneficial ownership as reported in this section was determined in
accordance with Securities and Exchange Commission regulations and includes
shares as to which a person possesses sole or shared voting and/or investment
power and shares that may be acquired on or before October 23, 2000 upon the
exercise of stock options. Except as otherwise stated in the footnotes below,
the named persons have sole voting and investment power with regard to the
shares shown as beneficially owned by such persons.
<TABLE>
<CAPTION>
Common Stock
------------------------------
No. of
Name of Beneficial Owner Shares Percent of Class
------------------------ --------- ----------------
<S> <C> <C>
Liraz Systems Ltd. ("Liraz")(1)................ 5,743,120(2) 36.2%
Welsh, Carson, Anderson & Stowe ("WCAS")(3).... 1,250,000(4) 8.3%
Brown Simpson Partners I, Ltd.(5).............. 1,029,800(6) 6.6%
Seneca Capital, L.P.(7)........................ 601,744(8) 3.9%
Seneca Capital International, Ltd.(9).......... 731,090(10) 4.8%
Merrill Lynch, Pierce, Fenner & Smith
Incorporated(11).............................. 1,000,000 6.7%
Arie Kilman.................................... 10,000(12) *
Samuel Somech.................................. 485,607(13) 3.2%
Theodore Fine.................................. 123,887(14) *
Lenny Recanati................................. 0(15) *
Anthony C. Pizi................................ 0 *
Michel Berty................................... 8,000(16) *
Robert M. Brill................................ 32,307(17) *
Steven Dmiszewicki............................. 135,000(18) *
Dennis McKinnie................................ 55,000(19) *
Renee Fulk..................................... 27,500(20) *
All current directors and executive officers as
a group (10 persons)(21)...................... 877,301 5.6%
</TABLE>
--------
* Represents less than one percent of the outstanding shares.
(1) The address of Liraz is 5 Hatzoref Street, Holon 58856 Israel.
(2) Includes 821,257 shares that Liraz may be deemed to share voting power and
dispositive power of common stock with Liraz Export (1990) Ltd., an Israeli
corporation and a wholly-owned subsidiary of Liraz and 1,000,000 shares of
common stock issuable upon the conversion of Series A 4% Convertible
Redeemable Preferred Stock that Liraz may be deemed to share voting and
dispositive power with Advanced Systems Europe B.V., a Dutch corporation
and a wholly-owned subsidiary of Liraz. Mr. Arie Kilman is a shareholder of
Liraz. We have been advised that, as of May 11, 2000, Mr. Kilman owned
1,183,170 ordinary shares of Liraz, which was approximately 19.4% of the
ordinary shares of Liraz. Mr. Kilman may, by reason of his ownership in and
relationship with Liraz, be deemed to share voting power and dispositive
power with respect to the shares beneficially owned by Liraz and therefore
may be deemed to be the beneficial owner of such shares. IDB Holding
Corporation Ltd. ("IDB Holding") owns approximately 71% of the outstanding
shares of IDB Development Corporation Ltd. ("IDB Development"). IDB
Development, in turn, owns approximately 71.7% of the outstanding Discount
Investment Corporation Ltd. ("DIC") common stock which owns all of the
outstanding capital stock of PEC Israel Electric Corporation ("EOC"). By
reason of the IDB Holdings ownership of IDB
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Development voting securities, IDB Holding may be deemed to be the
beneficial owner of PEC common stock and DIC common stock held by IDB
Development. By reason of their positions with, and control of voting
securities of, IDB Holding, Mr. Oudi Recanati of Tel Aviv, Israel, Mr.
Leon Recanati of Tel Aviv, Israel, Judith Yovel Recanati of Herzlya,
Israel and Mrs. Elaine Recanati, may be each deemed to share the power to
direct the voting and disposition of the outstanding shares of PEC common
stock and DIC common stock owned by IDB Development and may each, under
existing regulations of the Securities and Exchange Commission therefore
be deemed a beneficial owner of the shares. Mrs. Elaine Recanati is the
aunt of Mr. Leon Recanati and Mrs. Judith Yovel Recanati, who are brother
and sister, and of Mr. Oudi Recanati, who is the cousin of Mr. Leon
Recanati and Judith Yovel Recanati. Companies that the Recanati family
control hold approximately 51.6% of the outstanding shares of IDB Holding.
Excludes 1,250,000 shares of common stock held by Welsh, Carson, Anderson
and Stowe VI, L.P. ("WCAS VI") and certain parties affiliated or
associated with WCAS VI (collectively, the "WCAS Parties"), which Liraz
and the Company may be deemed to share voting power and/or investment
power pursuant to an agreement between the Company and the WCAS Parties
dated November 23, 1998.
(3) The address of WCAS is 320 Park Avenue, Suite 2500, New York, New York
10022.
(4) Includes 944,844 shares of common stock, and 236,209 additional shares of
common stock issuable upon the exercise of warrants held by WCAS VI;
11,290 shares of common stock, and 2,823 additional shares of common stock
issuable upon the exercise of warrants held by WCAS Information Partners
II, L.P.; 806 shares of common stock, and 202 additional shares of common
stock issuable upon the exercise of warrants held by Trust U/A dated
November 26, 1984 for the Benefit of Eric Welsh; 806 shares of common
stock, and 202 additional shares of common stock issuable upon the
exercise of warrants held by Trust U/A dated November 26, 1984 for the
benefit of Randall Welsh; 806 shares of common stock, and 202 additional
shares of common stock issuable upon the exercise of warrants held by
Trust U/A dated November 26, 1984 for the benefit of Jennifer Welsh; 1,613
shares of common stock, and 403 additional shares of common stock issuable
upon the exercise of warrants held by Reboul, MacMurray, Hewitt, Maynard
and Kristol; and 39,835 shares of common stock, and 9,959 additional
shares of common stock issuable upon the exercise of warrants held by
general partners of WCAS. WCAS is general partner of each of the foregoing
limited partnerships. The principals of WCAS are Bruce K. Anderson,
Russell L. Carson, Anthony J. de Nicola, James B. Hoover, Thomas E.
McInerney, Robert A. Minicucci, Andrew M. Paul, Richard A. Stowe, Laura
Van Buren and Patrick J. Welsh.
(5) The address of Brown Simpson Partners I, Ltd. is Walkers P.O. Box 265GT,
Walkers' House, Grand Cayman, Cayman Islands.
(6) Represents 329,800 shares of common stock and 700,000 shares of common
stock issuable upon the exercise of warrants at an exercise price of
$10.00 per share. Brown Simpson Asset Management, LLC is the investment
manager of Brown Simpson Partners I, Ltd. Excludes certain securities of
which Brown Simpson Partners I, Ltd. is not currently the beneficial
owner.
(7) The address of Seneca Capital, L.P. is 527 Madison Avenue, 11th Floor, New
York, New York 10022.
(8) Includes 208,598 shares of common stock issuable upon conversion of Series
B Preferred Stock and 182,506 shares issuable upon exercise of warrants at
an exercise price of $25.0625 per share. Seneca Capital, L.P. also owns
157,000 shares of common stock issuable upon conversion of Series A
Preferred Stock and 53,640 shares issuable upon exercise of warrants at an
exercise price of $10.00 per share.
(9) The address of Seneca Capital International, Ltd. is 527 Madison Avenue,
11th Floor, New York, New York 10022.
(10) Includes 389,905 shares of common stock issuable upon conversion of Series
B Preferred Stock and 341,185 shares issuable upon conversion of warrants
at an exercise price of $25.0625.
(11) The address if Merrill Lynch, Pierce, Fenner & Smith Incorporated is 4
World Financial Center, New York, New York 10080.
(12) Excludes shares owned by Liraz, which may be deemed beneficially owned by
Mr. Kilman as a result of his position as a shareholder of Liraz and owner
of approximately 19.4% of Liraz. On March 30, 1999, Mr. Kilman voluntarily
terminated all of his outstanding options exercisable for 200,000 shares
of
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<PAGE>
common stock at exercise prices ranging from $10.45 to $14.73. In December
1999, he was granted options to purchase 200,000 shares at an option price
of $30.25 per share, which are not exercisable within sixty (60) days. In
the first quarter of 2000, Mr. Kilman was also granted options to purchase
an additional 50,000 shares of common stock, which are not exercisable
within sixty (60) days.
(13) Includes 477,805 shares subject to stock options exercisable within sixty
(60) days; excludes 50,000 shares subject to stock options not exercisable
within sixty (60) days.
(14) Includes 97,402 shares subject to stock options exercisable within sixty
(60) days; excludes 14,500 shares subject to stock options not exercisable
within sixty (60) days.
(15) Excludes shares owned by Liraz, see Note 2, which may be deemed
beneficially owned by Mr. Recanati as a result of his position as an
executive officer of Discount Investment Corporation Ltd. ("DIC"), which
owns approximately 20.75% of Liraz.
(16) Includes 8,000 shares subject to stock options exercisable within sixty
(60) days; excludes 8,000 shares subject to stock options not exercisable
within sixty (60) days.
(17) Includes 15,511 shares of common stock held by Poly Ventures II, L.P.,
which may be deemed beneficially owned by Dr. Brill as a result of his
position as a General Partner of Poly Ventures II, L.P.; includes 15,000
shares subject to stock options exercisable within sixty (60) days;
excludes 15,000 shares subject to stock options not exercisable within
sixty (60) days.
(18) Includes 135,000 shares subject to stock options exercisable within sixty
(60) days; excludes 200,000 shares subject to stock options not
exercisable within sixty (60) days.
(19) Includes 55,000 shares subject to stock options exercisable within sixty
(60) days; excludes 55,000 shares subject to stock options not exercisable
within sixty (60) days.
(20) Includes 27,500 shares subject to stock options exercisable within sixty
(60) days; excludes 27,500 shares subject to stock options not exercisable
within sixty (60) days.
(21) Excludes shares owned by Liraz as described in Note 2 and includes 815,707
shares issuable upon exercise of options and warrants exercisable within
sixty (60) days as described in Notes 13 through 20.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Borrowings and Commitments from Liraz
Under an agreement between Liraz and the Company dated December 31, 1998 (the
"Liraz Agreement"), Liraz made a $12 million loan to the Company, which bears
simple interest at a rate of 12% a year and matures on June 30, 2000. On May
31, 1999, the Liraz Agreement was amended to change the maturity date from
June 30, 2000 to December 15, 2000, and to provide for semiannual interest
payments rather than payment of interest at maturity. No other terms of the
loan were amended. The Company used part of the proceeds from the issuance of
the Series A 4% Convertible Redeemable Preferred Stock to make an $8 million
payment to Liraz to pay down the balance of the loan. Liraz had previously
committed to provide the Company with up to $7.5 million of working capital
payable upon the earlier of March 31, 2001 or the successful completion of an
earlier financing providing more than $7.5 million in proceeds to the Company.
As a result of raising more than $7.5 million from the issuance of preferred
stock and warrants in June 1999, the Liraz commitment terminated. At June 30,
2000 the Company's total indebtedness to Liraz was $3 million. Subsequent to
June 30, 2000 the Company paid off the remaining $3 million due to Liraz.
Template Software, Inc. Acquisition
In December 1999, the Company acquired Template Software, Inc. ("Template")
for approximately $64 million in cash and stock. The Company's management team
identified Template as a provider of
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<PAGE>
technologies that enables the Company to be one of the first to market with a
comprehensive product portfolio representing the next generation of EAI
solutions for eBusiness. As part of the Template transaction, the Company
obtained an additional $10 million in financing in the form of a 17 month term
loan. The financing was guaranteed by Liraz, the Company's principal
stockholder, in return for 60,000 shares of the Company's common stock. The
number of shares of common stock provided in exchange for the guarantee, was
determined by the independent directors of the Company in consultation with an
outside appraisal firm and based upon market conditions and the Company's
anticipated financing needs at closing. The commitment provides for an interest
rate equal to the London Interbank Offered Rate plus 1% annually.
Joint Development Arrangement with Liraz
The Company and Liraz previously had an agreement for the joint development
of certain software for a Microsoft contract. Under the agreement, Liraz and
the Company were each to pay 50% of the total project development costs. In
exchange for providing 50% of such costs, Liraz was previously entitled to
receive royalties of 30% of the first $2 million in contract revenue, 20% of
the next $1 million, and 8% thereafter. On April 1, 1998, the agreement was
amended to provide that the Company would reimburse Liraz's costs of
development of $1.5 million and would pay Liraz royalties of 3% of program
revenues generated from January 1, 1998 until December 31, 2000. The $1.5
million reimbursement is being amortized over the term of the revised royalty
agreement and was paid to Liraz by the delivery of an 8% note payable in three
installments in 1998, 1999 and 2000. Additional royalties of $.13 million were
paid to Liraz in 1999 for 1998 sales.
See "Principal Stockholders" for a description of the relationships among
Liraz and Messrs. Kilman and Recanati, directors of the Company.
Merrill Lynch Licensing Agreement
On July 31, 2000, Level 8 Systems, Inc. entered into a Purchase Agreement
with Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch").
Pursuant to the Purchase Agreement, on August 23, 2000, Level 8 issued to
Merrill Lynch 1,000,000 shares of Level 8 common stock. As consideration for
the issuance of the shares, Merrill Lynch granted Level 8 exclusive worldwide
marketing, sales and development rights to CiceroTM, a comprehensive integrated
desktop computer environment developed by Merrill Lynch and used by more than
30,000 Merrill Lynch professionals worldwide. Level 8 intends to market
CiceroTM as part of the Geneva eBusiness integration product line.
Pursuant to the Purchase Agreement, Level 8 and Merrill Lynch entered into a
Registration Rights Agreement granting Merrill Lynch certain rights to have
resales of the shares of Level 8 common stock issued under the Purchase
Agreement registered under the Securities Act. Level 8, Merrill Lynch and
certain Level 8 shareholders, including Liraz Systems Ltd. and certain of its
affiliates, and Welsh, Carson, Anderson & Stowe VI, L.P. and certain of its
affiliates, entered into a Stockholders Agreement agreeing to vote their shares
in favor of the designee of Merrill Lynch to the Level 8 Board of Directors.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Deloitte & Touche LLP was appointed as Level 8's independent accountants for
fiscal 2000 on July 11, 2000. From January 21, 1999 until July 10, 2000
PricewaterhouseCoopers LLP had been designated as Level 8's independent
accountants and had audited Level 8's Consolidated Financial Statements for
fiscal 1998 and 1999. From January 28, 1998 until December 15, 1998, Grant
Thornton LLP had been designated as Level 8's independent accountants and had
audited Level 8's Consolidated Financial Statements for fiscal 1997. Prior
thereto, Lurie, Besikof, Lapidus & Co., LLP had been Level 8's auditors.
Appointment of Deloitte & Touche LLP to Replace PricewaterhouseCoopers LLP
On July 11, 2000, Level 8 appointed Deloitte & Touche LLP as its independent
auditors. On July 10, 2000, Level 8 dismissed PricewaterhouseCoopers LLP as its
independent auditors. The decision to change
50
<PAGE>
independent auditors was recommended by the Audit Committee of the Board of
Directors and approved by the Board of Directors. During the most recent fiscal
year and any subsequent interim period, none of PricewaterhouseCoopers LLP's
reports on the Company's financial statements contained an adverse opinion or a
disclaimer of opinion or was qualified or modified as to uncertainty, audit
scope or accounting principles.
In connection with their audit of the financial statements of Level 8
Systems, Inc. as of December 31, 1998 and for the year then ended,
PricewaterhouseCoopers LLP communicated the following reportable conditions to
the Company:
Adequate Accounting Personnel. The Company lacked sufficient personnel in
1998 to maintain accurate books and records. In addition, it appeared that
accounting supervisors lacked adequate knowledge of specific industry
accounting or did not conduct sufficient reviews to ensure entries were booked
properly.
Documentation. During 1998, the Company failed to maintain adequate
documentation to support revenue and other transactions. In addition, certain
documentation, while available, was not stored in a manner to facilitate
access. In some circumstances, key accounting documentation had to be obtained
from employees outside of the accounting and finance organization or from other
alternative sources.
Billing and Collections. During 1998, the Company was forced to write off or
reserve significant amounts of receivables due to inadequate documentation or
timely follow-up.
Revenue Recognition and Cutoff. During 1998, the Company recognized the
revenue from several contracts prior to the point in time when the applicable
requirements of Statement of Position 97-2 "Software Revenue Recognition" ("SOP
97-2") had been met. This resulted in several adjustments at year end.
Software Development Costs. During 1998, the Company's accounting department
failed to collect and maintain adequate documentation for the composition of
development costs capitalized under Statement of Financial Accounting Standards
No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed" ("SFAS 86") or for adjustments made to the carrying value
of this software due to declines in the related product net realizable value.
While adequate documentation for these decisions was eventually obtained from
alternative sources, the Company's accounting department had to make
considerable efforts to locate such documentation.
Related Party Transactions. During 1998, the Company failed to maintain
adequate documentation for certain transactions with Liraz Systems Ltd., a
significant shareholder of the Company. While adequate documentation was
eventually located, due to the subjective nature of related party transactions,
PricewaterhouseCoopers LLP recommended that the Company should ensure that all
transactions with related parties are documented thoroughly and that the
Company can support the valuation of any transactions.
All of the reportable conditions identified above related to the Company's
accounting operations as they existed at its New York/New Jersey facilities
during 1998. In early 1999, the Company itself conducted an extensive internal
review of the Company's 1998 accounting and made numerous adjustments in
conjunction with the finalization of the Company's 1998 annual report.
Additionally, on January 1, 1999, the Company ceased all accounting functions
at its New York/New Jersey facilities and relocated all accounting, financial
reporting and internal control responsibility to the Company's Cary, North
Carolina operations.
Appointment of PricewaterhouseCoopers LLP to Replace Grant Thornton
On December 15, 1998, Level 8 dismissed Grant Thornton as its independent
auditors. The decision to change independent auditors was recommended by the
Audit Committee of the Board of Directors and approved by the Board of
Directors. The decision to dismiss Grant Thornton was made in conjunction with
the recently announced acquisition of Seer by the Company. Given the size of
Level 8 following the acquisition of Seer Technologies, Level 8 believed that
it required a larger firm with greater resources. Grant Thornton served
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<PAGE>
as independent auditors of Level 8 since January 1998, succeeding Lurie Besikof
who served as independent auditors to Level 8 (and Level 8's predecessor
entities) for the ten years preceding its January 28, 1998 replacement by Grant
Thornton. During the most recent fiscal year and any subsequent interim period,
none of Grant Thornton's reports on the Company's financial statements
contained an adverse opinion or a disclaimer of opinion or was qualified or
modified as to uncertainty, audit scope or accounting principles.
In connection with the preparation of the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 1998, the Company discussed
with Grant Thornton whether the Company should recognize as revenue in the
third quarter of 1998 $2.96 million the Company had billed Microsoft. The
Company expressed the view that all of that revenue should be reflected in the
third quarter. Grant Thornton expressed the view that none of that revenue
should be reflected in the third quarter. After discussion, the Company
deferred the recognition of all such revenue and indicated in the Form 10-Q
that it was in the process of determining how long generally accepted
accounting principles required the Company to continue to defer recognizing
such revenue. Subject to the foregoing, there have been no disagreements with
Grant Thornton regarding any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure.
In planning and performing the audit of the financial statements of the
Company for the year ended December 31, 1997, Grant Thornton noted certain
internal control structure matters that it considered reportable conditions
under standards established by the American Institute of Certified Public
Accountants. Reportable conditions involve matters relating to significant
deficiencies in the design or operation of the internal control structure that
could adversely affect the organization's ability to record, process,
summarize, and report financial data consistent with the assertions of
management in the financial statements.
On or about May 7, 1998, Grant Thornton provided the Company with an audit
communications letter regarding such reportable conditions. These reportable
conditions are discussed below.
Software Service Transactions. During 1997, the Company began entering into
multi-year contracts that were non-cancelable or included significant
cancellation penalties. To entice customers to sign for this extended period of
time, the Company offered substantial discounts or free service periods. Grant
Thornton recommended that the Company recognize the complexity of these
arrangements and the need to address the effects on revenue recognition. Due to
the unique circumstances surrounding these types of transactions, Grant
Thornton stressed the importance of the Company's Chief Financial Officer
reviewing these contracts on a case-by-case basis, with specific emphasis on
ensuring proper revenue recognition by reviewing cancellation provisions and
allocations of revenue and discounts to products covered by the contract. Grant
Thornton identified that there were no standard agreements, each was separately
negotiated and accordingly the terms of each agreement needed to be assessed
for revenue recognition issues. Grant Thornton suggested that this made it
difficult for the Company personnel to determine revenue recognition under SOP
91-1, and may become an even greater issue under SOP 97-2. Grant Thornton noted
that accounting personnel of the Company appeared to be unaware of certain key
transactions, or aspects of transactions, which may have been a result of a
lack of adequate communication.
Cash Collections and Billings. Grant Thornton noted that cash collections had
been "poor" throughout 1997 and early 1998. Grant Thornton identified a number
of factors:
. Lack of written documentation and purchase orders from customers to
support sales, before the amount was invoiced.
. Lack of communication between sales and accounting departments of
delivery and payment terms, leading to problems when collection calls
were made by the accounting staff.
. Long lead times between performance of work and the sending of invoices
to customers.
Grant Thornton recommended that management of the Company develop formal
credit and collection policies providing for regular follow-up communication
with customers once accounts are 30 days past due. Grant Thornton also
recommended that management of the Company consider using sales personnel to
help with collections, in an appropriate manner. The Company paid commissions
upon recognition of a sale, and
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Grant Thornton recommended that the Company consider payment only after the
Company is paid. Grant Thornton also recommended that management develop an
objective formula to determine the minimum amount of the allowance for doubtful
accounts.
During its audit of the Company for fiscal 1997, Grant Thornton noted items
that gave rise to concerns encompassing the timeliness and efficiency of the
Company's billing process and the accuracy of information provided to
customers. According to Grant Thornton, lack of an efficient process had led to
relatively large amounts being recorded as "unbilled" receivables. In addition,
Grant Thornton noted that numerous problems were encountered when collecting
amounts recorded as overdue with customers stating they had received invoices
only days prior to the collection call. Grant Thornton suggested that systems
should be implemented to ensure all expense claims and time sheets are received
on a timely basis, and unbilled revenue should be maintained at zero or an
insignificant amount.
Software Development Costs. FASB 86 requires that costs incurred internally
in creating a computer software product shall be charged to expense when
incurred as research and development until technological feasibility has been
established for the product. Technological feasibility is established upon
completion of a detailed program design or, in its absence, completion of a
working model. Thereafter, all software production costs shall be capitalized
and subsequently reports at the lower of unamortized cost or net realizable
value. Capitalized costs are amortized based on current and future revenue for
each product with an annual minimum equal to the straight-line amortization
over the remaining estimated economic life of the product.
Grant Thornton suggested that sensitive decisions relating to capitalization
and amortization of software development costs should be documented and
supported. All details, such as date of and rationale behind technological
feasibility and the date of general availability for sale to the public, should
be recorded.
Insufficient Accounting Personnel. According to Grant Thornton, staffing
levels at the Company did not appear sufficient to deal with the growth in the
Company's sales. In addition, the accounting clerk at the Company resigned
effective December 31, 1997, which Grant Thornton suggested resulted in delays
in performing routine accounting functions such as cash collections and
billings as well as providing schedules required to complete the year-end
audit.
The Company's Chief Financial Officer performed or assisted in practically
all of the Company's accounting functions, account reconciliations, general
ledger posting, financial reporting and various others. Grant Thornton believed
that by its involvement in such a myriad of activities, chances of errors were
increased. Grant Thornton believed that priorities should be redirected from
daily mundane bookkeeping chores to more important functions. Grant Thornton
recommended that management perform a review of staffing levels at the Company
and hire additional staff where required.
Lack of Internal Controls and Accounting Systems General. Grant Thornton
reported that the size of the Company's accounting department precluded strict
segregation of accounting functions and a detailed system of internal controls.
Grant Thornton believed there were a number of areas in which controls and
systems could be improved.
Appointment of Grant Thornton to Replace Lurie Besikof
On January 28, 1998, Level 8 replaced Lurie Besikof as its independent
auditors with Grant Thornton. The decision to change independent auditors was
recommended by the Audit Committee of the Board of Directors and approved by
the Board of Directors. The decision was based on advice Level 8 received from
the investment banking firm that was providing financial guidance to Level 8 at
the time.
Lurie Besikof served as independent auditors to Level 8 (and Level 8's
predecessor entities) for the ten years preceding its January 28, 1998
replacement. During these ten years, there have been no disagreements with
Lurie Besikof regarding any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure.
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DESCRIPTION OF CAPITAL STOCK
The following descriptions of certain provisions of the certificate of
incorporation and bylaws of Level 8 are necessarily general and do not purport
to be complete and are qualified in their entirety by reference to the
certificate of incorporation and bylaws of Level 8 which have been incorporated
by reference herein.
Common Stock
The authorized capital stock of our company consists of 50 million shares, of
which 40 million shares have been designated common stock, par value $.001 per
share. As of August 24, 2000, there were 14,849,995 shares of common stock
issued and outstanding, held by approximately 145 holders of record. The
holders of common stock are entitled to one vote for each share on all matters
submitted to a vote of stockholders. Holders of common stock are entitled to
such dividends as may be declared from time to time by the board of directors
out of funds legally available therefore, subject to the dividend and
liquidation rights of any preferred stock (as described below) that may be
issued, and subject to the dividend restrictions in certain credit facilities
and various other agreements. In the event of the liquidation, dissolution or
winding-up of our company, the holders of common stock are entitled to share
equally and ratably in our assets, if any, remaining after provision for
payment of all debts and liabilities of the company and satisfaction of the
liquidation preference of any shares of preferred stock that may be
outstanding. The holders of common stock have no preemptive, subscription,
redemptive or conversion rights. The outstanding shares of common stock are
fully paid and nonassessable.
Preferred Stock
Our company is authorized to issue 10 million shares of preferred stock, par
value $.001 per share. The board of directors of our company has authority,
without stockholder approval, to issue shares of preferred stock in one or more
series and to determine the number of shares, designations, dividend rights,
conversion rights, voting power, redemption rights, liquidation preferences and
other terms of any such series. The issuance of preferred stock, while
providing desired flexibility in connection with possible acquisitions and
other corporate purposes, could adversely affect the voting power of the
holders of common stock and the likelihood that such holders will receive
dividend payments and payments upon liquidation and could have the effect of
delaying, deferring, or preventing a change in control of our company. As of
the date of this prospectus, 21,000 shares have been designated as Series A 4%
Convertible Redeemable Preferred Stock and 11,570 are outstanding. Also as of
the date of this prospectus, 30,000 shares have been designated as Series B 4%
Convertible Redeemable Preferred Stock and are entirely issued and outstanding.
There are no present plans for any further issuances of preferred stock.
Holders of the Series A Preferred Stock are entitled to receive 4% annual
cash dividends payable quarterly and will have one vote per share of Series A
Preferred Stock, respectively, 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 A Preferred Stock. The Series A Preferred Stock may be
redeemed at our option at a redemption price equal to the original purchase
price at any time after June 29, 2000 if the closing price of our common stock
over 20 consecutive trading days is greater than $20 per share. The conversion
price of the Series A 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 $10 per share. In the event we breach our obligations
to pay dividends when due or issue common stock upon conversion, or our common
stock is delisted, the dividend rate on the Series A Preferred Stock would
increase to 18% per annum (partially payable in shares of common stock at our
option during the first 60 days of such increased dividend rate). As part of
the $21 million financing, we also issued the investors warrants to purchase
2.1 million shares of common stock at an exercise price of $10 per share. We
have registered the common stock issuable upon conversion of the Series A
Preferred Stock and exercise of the warrants for resale under the Securities
Act of 1933. We are required to make certain payments in the event we are
unable to meet our obligations in connection with the Series A Preferred Stock
and warrants, such as registration under the Securities Act or issuance of
shares of common stock upon conversion
<PAGE>
or exercise. The aggregate amount of all such payments, together with dividends
on the Series A Preferred Stock, is limited to 19% of the liquidation value of
the Series A Preferred Stock. Investors in the Series A Preferred Stock and
warrants include Advanced Systems Europe B.V., which purchased $10 million of
Series A Preferred Stock and warrants in the transaction, and is a subsidiary
of Liraz, our principal stockholder. Due to limitations on convertibility and
exercisability, as set forth more fully in the Certificate of Designation of
Rights, Preferences and Limitations of Preferred Stock and the warrants, shares
of Series A Preferred Stock and warrants that have been issued to certain
holders may not be convertible/exercisable at the present time.
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, respectively, 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 our option at a redemption price equal to the original purchase
price at any time after July 20, 2001 if the closing price of our 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 we breach
our obligations to pay dividends when due or issue common stock upon
conversion, or our 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 our option during the first 60 days of such increased dividend
rate). As part of the $30 million financing, we also issued the investors
warrants to purchase 1,047,382 million shares of common stock at an exercise
price of $25.0625 per share. We have 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. We are required to make
certain payments in the event we are unable to meet our 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. Due to limitations on convertibility
and exercisability, as set forth more fully in the Certificate of Designation
of Rights, Preferences and Limitations of Preferred Stock and the warrants,
shares of Series B Preferred Stock and warrants that have been issued to
certain holders may not be convertible/exercisable at the present time.
Delaware Law and Anti-Takeover Provisions
Section 203 of the Delaware General Corporation Law generally prohibits an
interested stockholder from entering into certain types of business
combinations with a Delaware corporation for three years after becoming an
interested stockholder. An "interested stockholder" under the Delaware General
Corporation Law is any person other than the corporation and its majority-owned
subsidiaries who own at least 15% of the outstanding voting stock, or who owned
at least 15% within the preceding three years, and this definition includes
affiliates of the corporation. Briefly described, the prohibited combinations
include:
. mergers or consolidations;
. sales, leases, exchanges or other dispositions of 10% or more of (1) the
aggregate market value of all assets of the corporation, or (2) the
aggregate market value of all the outstanding stock of the corporation;
. issuances or transfers by the corporation of its stock that would
increase the proportionate share of stock owned by the interested
stockholder;
. receipt by the interested stockholder of the benefit of loans, advances,
guarantees, pledges or other financial benefits provided by the
corporation; and
. any other transaction, with certain exceptions, that increases the
proportionate share of the stock owned by the interested stockholder.
55
<PAGE>
A Delaware corporation may choose not to have Section 203 of the Delaware
General Corporation Law apply. Our company has chosen in our certificate of
incorporation, however, to accept the protections of Section 203. Nevertheless,
Section 203 will not apply in the following cases:
. if, before the stockholder became an interested stockholder, the board
of directors approved the business combination or the transaction that
resulted in the stockholder becoming an interested stockholder;
. if, after the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of
the voting stock of the corporation outstanding at the time the
transaction commenced, subject to technical calculation rules; or
. if, on or after the time the interested stockholder became an interested
stockholder, the board of directors approved the business combination,
and at least two-thirds of the outstanding voting stock which is not
owned by the interested stockholder also ratified the business
combination at a stockholders' meeting.
Because Liraz and certain of its affiliates have beneficially owned more than
15% of the outstanding voting stock of Level 8 for longer than the three-year
restricted period, the restrictions under the Delaware General Corporation Law
on business combinations generally do not apply to Liraz and its affiliates.
Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law permits indemnification
of directors, officers, employees and agents of corporations for liabilities
arising under the Securities Act of 1933, as amended.
The registrant's certificate of incorporation and bylaws provide for
indemnification of the registrant's directors and officers to the fullest
extent permitted by Section 145 of the Delaware General Corporation Law.
Statutory Provisions Section 102(b)(7) of the Delaware General Corporation Law
enables a corporation in its certificate of incorporation to eliminate or limit
the personal liability of members of its board of directors to the corporation
or its stockholders for monetary damages for violations of a director's
fiduciary duty of care. The provision would have no effect on the availability
of equitable remedies, such as an injunction or rescission, for breach of
fiduciary duty. In addition, no provision may eliminate or limit the liability
of a director for breaching his duty of loyalty, failing to act in good faith,
engaging in intentional misconduct or knowingly violating a law, paying an
unlawful dividend or approving an illegal stock repurchase, or obtaining an
improper personal benefit.
Section 145 of the Delaware General Corporation Law empowers a corporation to
indemnify any person who was or is a party to or is threatened to be made a
party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative, by reason of the fact
that he is or was a director, officer, employee or agent of the corporation,
against expenses (including attorney's fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by him in connection with the
action, suit or proceeding if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. No indemnification shall
be made in respect of any claim, issue or matter as to which such person shall
have been adjudged to be liable to the corporation unless and only to the
extent that the court in which such action or suit was brought shall determine
upon application that, despite the adjudication of liability but in view of all
the circumstances of the case, such person is fairly and reasonably entitled to
indemnity for expenses which the court shall deem proper. Additionally, a
corporation is required to indemnify its directors and officers against
expenses to the extent that the directors or officers have been successful on
the merits or otherwise in any action, suit or proceeding or in defense of any
claim, issue or matter.
An indemnification can be made by the corporation only upon a determination
that indemnification is proper in the circumstances because the party seeking
indemnification has met the applicable standard of conduct as set forth in the
Delaware General Corporation Law. The indemnification provided by the Delaware
56
<PAGE>
General Corporation Law shall not be deemed exclusive of any other rights to
which those seeking indemnification may be entitled under any bylaw, agreement,
vote of stockholders or disinterested directors, or otherwise. A corporation
also has the power to purchase and maintain insurance on behalf of any person,
whether or not the corporation would have the power to indemnify him against
such liability. The indemnification provided by the Delaware General
Corporation Law shall, unless otherwise provided when authorized or ratified,
continue as to a person who has ceased to be a director, officer, employee or
agent and shall inure to the benefit of the heirs, executors and administrators
of the person. The Company's Charter Provisions Our company's certificate of
incorporation limits a director's liability for monetary damages to our company
and our stockholders for breaches of fiduciary duty except under the
circumstances outlined in the Delaware General Corporation Law as described
above under "Statutory Provisions."
Our company's certificate of incorporation extends indemnification rights to
the fullest extent authorized by the Delaware General Corporation Law to
directors and officers involved in any action, suit or proceeding where the
basis of the involvement is the person's alleged action in an official capacity
or in any other capacity while serving as a director or officer of our company.
LEGAL MATTERS
Certain legal matters in connection with the shares of common stock offered
by this prospectus will be passed upon for Level 8 Systems, Inc. by Powell,
Goldstein, Frazer & Murphy LLP, Atlanta, Georgia.
EXPERTS
Our financial statements for the years ended December 31, 1998 and 1999, as
included in this prospectus, have been audited by PricewaterhouseCoopers LLP,
independent accountants, as stated in their report with respect thereto. The
financial statements have been included in this prospectus in reliance upon
their report given on their authority as experts in auditing and accounting.
Our financial statements for the year ended December 31, 1997, as included in
this prospectus, for the year ended December 31, 1999 have been audited by
Grant Thornton LLP, independent auditors, as stated in their report with
respect thereto. The financial statements have been included in this prospectus
in reliance upon their report given on their authority as experts in auditing
and accounting.
The financial statements for Seer Technologies included in this prospectus
for the fiscal years ended September 30, 1998, 1997 and 1996 have been audited
by PricewaterhouseCoopers LLP, independent accountants, as stated in their
report with respect thereto. The financial statements have been included in
this prospectus in reliance upon their report given on their authority as
experts in auditing and accounting.
Template's financial statements for the years ended December 31, 1998, 1997
and 1996, as included in this prospectus, have been audited by
PricewaterhouseCoopers LLP, independent accountants, as stated in their report
with respect thereto. The financial statements have been included in this
prospectus in reliance upon their report given on their authority as experts in
auditing and accounting.
AVAILABLE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You can receive copies
of such reports, proxy and information statements, and other information, at
prescribed rates, from the Securities and Exchange Commission by addressing
written requests to the Public Reference Section of the Securities and Exchange
Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549.
In addition, you can read such reports, proxy and information statements, and
other information at the public reference facilities and at the regional
offices of the Securities
57
<PAGE>
and Exchange Commission, Washington, D.C., New York, New York and Chicago,
Illinois. Please call the Securities and Exchange Commission at 1-800-SEC-0330
for further information on the public reference rooms. The Securities and
Exchange Commission also maintains a Web site that contains reports, proxy and
information statements and other information regarding registrants such as
Level 8 Systems, Inc. that file electronically with the Securities and Exchange
Commission. The address of the Securities and Exchange Commission Web site is
http://www.sec.gov.
We have filed with the Securities and Exchange Commission a Registration
Statement on Form S-1 to register the shares that we will issue in this
offering. This Prospectus is a part of the Registration Statement. This
Prospectus does not include all of the information contained in the
Registration Statement. For further information about us and the securities
offered in this Prospectus, you should review the Registration Statement. You
can inspect or copy the Registration Statement, at prescribed rates, at the
Securities and Exchange Commission 's public reference facilities at the
addresses listed above.
58
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
----------------
<TABLE>
<CAPTION>
Page
-----
<S> <C>
LEVEL 8 SYSTEMS, INC.
Report of Independent Accountants....................................... F-2
Report of Independent Certified Public Accountants...................... F-3
Audited Consolidated Financial Statements as of December 31, 1999 and
1998 and for the years ended December 31, 1999, 1998 and 1997.......... F-4
Unaudited Consolidated Financial Statements as of June 30, 2000 and June
30, 1999 and for the three and six months ended June 30, 2000 and
1999................................................................... F-35
SEER TECHNOLOGIES, INC.
Report of Independent Accountants....................................... F-44
Audited Consolidated Financial Statements as of September 30, 1998 and
1997 and for the years ended September 30, 1998, 1997 and 1996......... F-45
Unaudited Consolidated Financial Statements as of December 31, 1998 and
September 30, 1997 and for the three months ended December 31, 1998 and
1997................................................................... F-65
TEMPLATE SOFTWARE
Report of Independent Accountants....................................... F-73
Audited Consolidated Financial Statements as of November 30, 1997 and
December 31, 1998 and for the years ended November 30, 1996 and 1997,
the one month ended December 31, 1997 and for year ended December 31,
1998................................................................... F-74
Unaudited Consolidated Financial Statements as of September 30, 1999 and
December 31, 1998 and for the three and nine months ended September 30,
1999 and 1998.......................................................... F-95
PRO FORMA FINANCIAL INFORMATION......................................... F-101
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
----------------
To the Stockholders of Level 8 Systems, Inc.
In our opinion, the accompanying consolidated balance sheets as of December 31,
1999 and 1998 and the related consolidated statements of operations, changes in
stockholders' equity and cash flows present fairly, in all material respects,
the financial position of Level 8 Systems, Inc. (the "Company") and its
subsidiaries at December 31, 1999 and 1998 and the results of their operations
and their cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
February 18, 2000
F-2
<PAGE>
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
Board of Directors
Level 8 Systems, Inc. and Subsidiaries
We have audited the consolidated statements of operations, stockholders'
equity, comprehensive income and cash flows of Level 8 Systems, Inc. and
Subsidiaries for the year ended December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated statements
of operations, stockholders' equity, comprehensive income and cash flows are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated statements
of operations, stockholders' equity, comprehensive income and cash flows. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of
the results of operations. We believe that our audit of the consolidated
statements of operations, stockholders' equity, comprehensive income and cash
flows provides a reasonable basis for our opinion.
In our opinion, the consolidated statements of operations, stockholders'
equity, comprehensive income and cash flows referred to above present fairly,
in all material respects, the consolidated results of operations of Level 8
Systems, Inc. and Subsidiaries for the year ended December 31, 1997, in
conformity with accounting principles generally accepted in the United States.
/s/ GRANT THORNTON LLP
New York, New York
February 23, 1998 (except for Note 2, as to which the date is February 27, 1998
and Note 3, as to which the date is April 6, 1998)
F-3
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
December 31, December 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 6,509 $ 6,078
Accounts receivable, less allowance for doubtful
accounts............................................ 22,199 16,992
Due from related company............................. -- 271
Notes receivable..................................... 2,000 --
Prepaid expenses and other current assets............ 5,134 2,606
-------- --------
Total current assets............................. 35,842 25,947
Property and equipment, net.......................... 5,845 2,682
Intangible assets, net............................... 69,948 32,217
Software development costs, net...................... 20,488 6,753
Notes receivable..................................... -- 2,000
Other assets......................................... 1,458 1,171
-------- --------
Total assets..................................... $133,581 $ 70,770
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable, due on demand......................... $ 4,996 $ 12,275
Current maturities of loan from related company...... 519 628
Current maturities of long-term debt................. 395 799
Accounts payable..................................... 2,194 3,691
Accrued expenses:
Salaries, wages, and related items................. 4,172 1,339
Restructuring...................................... 630 973
Merger-related..................................... 4,075 4,803
Other.............................................. 8,336 10,056
Due to related party................................. 41 82
Deferred revenue..................................... 9,020 10,855
-------- --------
Total current liabilities........................ 34,378 45,501
Long-term debt, net of current maturities............ 22,202 1,541
Loan from related company, net of current
maturities.......................................... 4,000 12,519
Deferred revenue..................................... 780 2,317
Commitments and contingencies (Note 18)
Stockholders' equity
Preferred stock, $0.001 par value, 1,000,000
authorized; 18,945 and 0 issued and outstanding at
December 31, 1999 and 1998, respectively; $1,000
per share liquidation preference (aggregate
liquidation value of $18,945)..................... -- --
Common stock, $0.001 par value, 21,000,000
authorized; 12,328,610 and 8,708,231 issued and
outstanding at December 31, 1999 and 1998,
respectively...................................... 12 87
Additional paid-in-capital......................... 113,507 34,045
Accumulated other comprehensive income............. (159) --
Accumulated deficit................................ (41,139) (25,240)
-------- --------
Total stockholders' equity....................... 72,221 8,892
-------- --------
Total liabilities and stockholders' equity....... $133,581 $ 70,770
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
Revenue:
Software......................................... $ 16,030 $ 1,552 $ 4,354
Maintenance...................................... 14,981 1,091 30
Services......................................... 21,909 8,042 10,296
-------- -------- -------
Total operating revenue........................ 52,920 10,685 14,680
Cost of revenue:
Software......................................... 4,245 2,060 2,554
Maintenance...................................... 5,391 481 16
Services......................................... 19,270 5,776 5,019
-------- -------- -------
Total cost of revenue.......................... 28,906 8,317 7,589
Gross profit...................................... 24,014 2,368 7,091
Operating expenses:
Sales and marketing.............................. 12,009 2,384 1,521
Research and development......................... 6,796 2,777 1,057
General and administrative....................... 6,822 6,443 2,952
In-process research and development.............. 2,944 5,892 --
Amortization of intangible assets................ 6,959 1,933 422
Write-off of intangible assets................... -- 4,601 --
Restructuring, net............................... 383 1,540 --
-------- -------- -------
Total operating expenses....................... 35,913 25,570 5,952
-------- -------- -------
Income (loss) from operations.................. (11,899) (23,202) 1,139
Other income (expense)
Interest income.................................. 579 283 410
Gain on sale of ASU.............................. -- -- 60
Interest expense................................. (2,742) (364) (20)
Net foreign currency loss........................ (695) -- --
-------- -------- -------
Income (loss) before provision for income taxes... (14,757) (23,283) 1,589
Income tax provision.............................. 720 405 553
-------- -------- -------
Income (loss) from continuing operations.......... (15,477) (23,688) 1,036
Discontinued operations:
Income (loss) from discontinued operation, net of
tax............................................. -- (135) 53
Income (loss) on disposal, net of tax............ -- (1,233) --
-------- -------- -------
Income (loss) from discontinued operations..... -- (1,368) 53
Net income (loss)................................. $(15,477) $(25,056) $ 1,089
======== ======== =======
Income (loss) per common share:
Income (loss) from continuing operations--basic.. $ (1.78) $ (3.14) $ 0.15
Income (loss) from discontinued operations--
basic........................................... -- (0.18) 0.01
-------- -------- -------
Net income (loss) per share--basic................ $ (1.78) $ (3.32) $ 0.16
======== ======== =======
Income (loss) per common share:
Income (loss) from continuing operations--
diluted......................................... $ (1.78) $ (3.14) $ 0.13
Income (loss) from discontinued operations--
diluted......................................... -- (0.18) 0.01
-------- -------- -------
Net income/(loss) per share--diluted.............. $ (1.78) $ (3.32) $ 0.14
======== ======== =======
Weighted average common shares outstanding--
basic............................................ 8,918 7,552 6,992
======== ======== =======
Weighted average common shares outstanding--
diluted.......................................... 8,918 7,552 7,561
======== ======== =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Accumulated
Preferred Additional Retained Other
Common Stock Stock Paid-in Unearned Earnings Comprehensive
Shares Amount Shares Amount Capital Compensation (Deficit) Income Total
------ ------ ------ ------ ---------- ------------ --------- ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at 12/31/96..... 6,955 $ 69 -- -- $ 19,506 $ (3) $ (1,273) $ -- $ 18,299
Exercises of stock
options and warrants... 90 1 507 508
Additional public
offering costs......... (137) (137)
Unearned compensation
related to issuance of
non-employee stock
options................ 263 (263) --
Tax benefit from stock
plans.................. 464 464
Adjustment of unearned
compensation........... 148 148
Net income.............. 1,089 1,089
------ ---- --- ---- -------- ---- -------- ------ --------
Balance at 12/31/97..... 7,045 70 -- -- 20,603 (118) (184) -- 20,371
Shares issued for
Momentum............... 595 6 6,480 6,486
Shares Issued for Seer.. 1,000 10 6,088 6,098
Warrants issued for
Momentum 654 654
Warrants issued for
Seer................... 280 280
Exercises of stock
options................ 68 1 58 59
Adjustment of unearned
compensation........... (118) 118 --
Net income (loss)....... (25,056) (25,056)
------ ---- --- ---- -------- ---- -------- ------ --------
Balance at 12/31/98..... 8,708 87 -- -- 34,045 -- (25,240) -- 8,892
Reclass par value to
$0.001................. (79) (79)
Shares issued for
Template acquisition... 1,531 2 41,586 41,588
Shares issued for
Private Placement...... 21 -- 19,149 19,149
Shares issued for loan
guarantee.............. 60 -- 1,207 1,207
Conversion of preferred
shares................. 206 -- (2) -- -- --
Warrants issued for
Private Placement...... -- --
Conversion of warrants.. 1,263 1 12,637 12,638
Exercises of stock
options................ 561 1 4,883 4,884
Preferred stock
dividend............... (422) (422)
Cumulative translation
adjustment............. (159) (159)
Net income (loss)....... (15,477) (15,477)
------ ---- --- ---- -------- ---- -------- ------ --------
Balance at 12/31/99..... 12,329 $ 12 19 $-- $113,507 $-- $(41,139) $ (159) $ 72,221
====== ==== === ==== ======== ==== ======== ====== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-6
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- ------
<S> <C> <C> <C>
Net income (loss).................................... $(15,477) $(25,056) $1,089
Other comprehensive income, net of tax............... -- -- --
Foreign currency translation adjustment............. (159) -- --
-------- -------- ------
Comprehensive income (loss).......................... $(15,636) $(25,056) $1,089
======== ======== ======
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-7
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)
<TABLE>
<CAPTION>
For the Years Ended December 31,
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income/(loss)......................... $ (15,477) $ (25,056) $ 1,089
Adjustments to reconcile net income/(loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization............. 11,633 3,175 788
Deferred income taxes..................... 2 (129) 281
Income (loss) from discontinued
operations............................... -- 135 (53)
(Gain) loss on sale of business........... -- 1,233 (60)
Loss on disposal of property.............. -- 407 --
Purchased in-process research and
development.............................. 2,944 5,892 --
Write-down of goodwill and other
intangible assets........................ -- 4,601 --
Write-down of capitalized software
costs.................................... -- 723 --
Provision for doubtful accounts........... 757 838 332
Other..................................... 170 -- 120
Changes in assets and liabilities, net of
assets acquired and liabilities assumed:
Trade accounts receivable................ 1 3,255 (4,376)
Due from Liraz........................... 271 -- --
Net assets of discontinued operations.... -- -- 507
Prepaid expenses and other assets........ (557) (755) (156)
Accounts payable and accrued expenses.... (4,275) (3,326) 969
Merger-related and restructuring......... (4,545) 5,776 --
Deferred revenue......................... (3,811) 4,888 42
----------- ----------- ---------
Net cash provided by (used in) operating
activities............................. (12,887) 1,657 (517)
Cash flows from investing activities:
Purchases of property and equipment....... (353) (941) (516)
Proceeds from sale of subsidiaries........ -- 464 65
Change in net assets of discontinued
operations............................... -- -- (888)
Purchase of marketable securities......... -- -- (1,998)
Redemption of marketable securities....... -- -- 8,523
Payment for acquisitions.................. (25,340) (484) --
Cash received from acquisitions........... 160 916 --
Capitalization of software development
costs.................................... (1,427) (1,177) (1,156)
----------- ----------- ---------
Net cash provided by (used in) investing
activities............................. (26,960) (1,222) 4,030
Cash flows from financing activities:
Issuance of common shares................. 17,272 59 507
Issuance of preferred shares, net of
issuance costs........................... 19,215 -- --
Dividends on preferred shares............. (250) -- --
Cost of issuance of common shares......... -- -- (137)
Change in net assets of discontinued
operations............................... -- -- (7)
Borrowings from related party............. -- 12,000 --
Payments on loans to related company...... (8,628) (683) (123)
Payments under capital lease obligations.. (47) (45) --
Net borrowings on line of credit.......... 6,717 -- --
Borrowing on term loan.................... 10,000
Payments on line of credit................ (4,000) (12,000) --
Payments on other long-term debt.......... -- (750) (9)
----------- ----------- ---------
Net cash provided by (used in) financing
activities............................. 40,279 (1,419) 231
Effect of exchange rate changes on cash.... (1) -- --
Net increase (decrease) in cash and cash
equivalents............................... 431 (984) 3,744
Cash and cash equivalents:
Beginning of period....................... 6,078 7,062 3,318
----------- ----------- ---------
End of period............................. $ 6,509 $ 6,078 $ 7,062
=========== =========== =========
Supplemental disclosures of cash flow
information:
Cash paid during the period for:
Income taxes.............................. $ 949 $ -- $ 11
Interest.................................. $ 1,604 $ 293 $ 20
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(in thousands, except share data)
Noncash Investing and Financing Activities
During 1999, the Company acquired all of the common stock of Template Software,
Inc. ("Template") for approximately $63,972. In connection with the
acquisition, the Company purchased 5,394,959 shares of Template common stock
for $21,579 in cash and 1,531,089 shares of Level 8 common stock. Additionally,
Level 8 also issued stock options exercisable for 1,124,023 shares of the
Company's common stock in exchange for all of the outstanding Template stock
options. See Note 2.
A reconciliation of the cost of the acquisition to the net cash paid for the
acquisition is as follows:
<TABLE>
<S> <C>
Fair value of:
Assets received............................................... $ 73,160
Liabilities assumed........................................... (7,712)
Additional direct costs....................................... (1,129)
Stock and stock options issued................................ (41,526)
---------
Cash paid..................................................... (22,793)
Cash acquired................................................. 160
---------
Net cash paid for acquisition................................. $ (22,633)
=========
</TABLE>
During 1999, the Company obtained a guarantee from a related party in order to
secure a $10 million term loan to partially finance the Template acquisition.
The guarantee was received in exchange for 60,000 shares of the Company's
common stock and was valued at $1,208. See Note 8.
During 1998, the Company acquired all of the common stock of Momentum Software
Corporation ("Momentum") for approximately $10,717. In connection with the
acquisition, the Company issued 594,866 shares of common stock, warrants to
purchase an additional 200,000 shares of common stock, and a $3,000 note. See
Note 2.
A reconciliation of the cost of the acquisition to the net cash received from
the acquisition is as follows:
<TABLE>
<S> <C>
Fair value of:
Assets received................................................. $ 11,703
Liabilities assumed............................................. (986)
Additional direct costs......................................... (503)
Stock issued.................................................... (6,485)
Warrants issued................................................. (654)
Note payable issued............................................. (3,000)
--------
Cash paid....................................................... 75
Cash acquired................................................... 437
--------
Net cash received from acquisition.............................. $ 362
========
</TABLE>
During 1998, the Company acquired 69% of the voting stock of Seer for
approximately $7,754. In connection with the acquisition, the Company issued
1,000,000 shares of common stock and warrants to purchase an additional 250,000
shares of common stock. See Note 2.
The accompanying notes are an integral part of the consolidated financial
statements.
F-9
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(in thousands, except share data)
A reconciliation of the cost of the acquisition to the net cash received from
the acquisition is as follows:
<TABLE>
<S> <C>
Fair value of:
Assets received................................................. $ 55,081
Liabilities assumed............................................. (47,327)
Additional direct costs......................................... (966)
Stock issued.................................................... (6,099)
Warrants issued................................................. (280)
--------
Cash paid....................................................... 409
Cash acquired................................................... 479
--------
Net cash received from acquisition.............................. $ 70
========
</TABLE>
On April 15, 1999, the Company acquired the remaining minority interest in
Seer, for $0.35 in cash per share of the outstanding common stock of Seer. The
total cost of completing the Seer acquisition was $1,697, which was equal to
the cash paid. During 1999, the Company paid $850 in direct acquisition costs
related to the acquisition of the initial 69% of Seer.
During 1998, the Company renegotiated a royalty arrangement with its majority
stockholder. The arrangement was financed through a $1,500 note. See Note 15.
During 1998, the Company sold its subsidiary ProfitKey International, Inc. in
exchange for $464 in cash at closing and a $2,000 note receivable. See Note 3.
During 1997, the Company acquired certain computer equipment through the
issuance of capital leases totaling $60.
During 1997, the Company recognized deferred unearned compensation expense
related to the issuance of nonemployee stock options totaling $25.
During 1997, the Company sold its ASU consulting division for $65, resulting in
a gain of $60. See Note 3.
The accompanying notes are an integral part of the consolidated financial
statements.
F-10
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share data)
NOTE 1. SUMMARY OF OPERATIONS, SIGNIFICANT ACCOUNTING POLICIES, AND RECENT
ACCOUNTING PRONOUNCEMENTS
Level 8 Systems, Inc. ("Level 8" or the "Company") is a global provider of
rapid business integration solutions for eBusiness and eCommerce. Business
integration solutions address the emerging need for a company's information
systems to deliver enterprise-wide views of the company's business information
processes.
Liraz Systems, Ltd. ("Liraz") and its wholly-owned subsidiaries own
approximately 38% of Level 8's outstanding common stock at December 31, 1999
and hold preferred stock convertible into an additional one million shares of
common stock.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. See Notes 2 and 3 regarding the acquisitions and
sales of subsidiaries. All of the Company's subsidiaries are wholly-owned for
the periods 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,
the Company assumed Seer's net liabilities. The stockholders of the remaining
31% of the outstanding voting stock 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 for the Seer subsidiary
reflected in the consolidated balance sheet at December 31, 1998.
All significant intercompany accounts and transactions are eliminated in
consolidation.
Use of 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.
Foreign Currency Translation
The assets and liabilities of foreign subsidiaries are translated to U.S.
dollars at the current exchange rate as of the balance sheet date. The
resulting translation adjustment is recorded in other comprehensive income as a
component of stockholders' equity. Statements of operations items are
translated at average rates of exchange during each reporting period.
Transaction gains and losses that arise from exchange rate fluctuations on
transactions denominated in a currency other than the functional currency, are
included in the results of operations as incurred.
Revenue Recognition
Statement of Position 98-9, "Modification of SOP 97-2, "Software Revenue
Recognition,' with Respect to Certain Transactions" ("SOP 98-9") was effective
for the Company's fiscal year beginning January 1, 1999. SOP 98-9 amends SOP
97-2 to require that an entity recognize revenue for multiple element
arrangements by means of the "residual method" when (1) there is vendor-
specific objective evidence ("VSOE") of the fair values of all of the
undelivered elements that are not accounted for by means of long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements, and (3) all revenue recognition criteria of SOP 97-2 (other
than the requirement for VSOE of the fair value of each delivered element) are
satisfied. Prior to January 1, 1998, the Company recognized revenue in
accordance with SOP 91-1 "Software Revenue Recognition."
F-11
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue from recurring maintenance contracts is recognized ratably over the
maintenance contract period, which is typically twelve months. Maintenance
revenue that is not yet earned is included in deferred revenue.
Revenue from consulting and training services is recognized as services are
performed. Any unearned receipts from service contracts result in deferred
revenue.
Cost of Revenue
The primary components of the Company's cost of revenue for its software
products are software amortization on internally developed and acquired
technology, royalties on certain products, and packaging and distribution
costs. The primary component of the Company's cost of revenue for maintenance
and services is compensation expense.
Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and highly liquid
investments with a maturity of three months or less from the date of purchase.
For these instruments, the carrying amount is considered to be a reasonable
estimate of fair value. The Company places substantially all cash and cash
equivalents with various financial institutions in both the United States and
several foreign countries. At times, such cash and cash equivalents may be in
excess of FDIC insurance limits.
Property and Equipment
Property and equipment is stated at cost and depreciated using the straight-
line method over the estimated useful lives of the related assets as follows:
<TABLE>
<S> <C>
Leasehold improvements........................ The lesser of the lease term
or estimated useful life
Furniture and fixtures........................ 3 to 5 years
Office equipment.............................. 3 to 5 years
Computer equipment............................ 3 to 5 years
</TABLE>
Expenditures for repairs and maintenance are charged to expense as incurred.
The cost and related accumulated depreciation of property and equipment are
removed from the accounts upon retirement or other disposition and any
resulting gain or loss is reflected in operations.
Software Development Costs
The Company capitalizes certain software costs after technological feasibility
of the product has been established. Additionally, the Company has recorded
software development costs for its purchases of developed technology through
its acquisitions of Momentum, Seer, and Template. The establishment of
technological feasibility and the ongoing assessment of recoverability of
capitalized software development costs requires considerable judgment by
management with respect to certain external factors, including, but not limited
to, technological feasibility, anticipated future gross revenue, estimated
economic life and changes in software and hardware technologies.
Capitalized software costs are amortized over related sales on a product-by-
product basis at the greater of the amount computed using (a) the ratio of
current gross revenues for a product to the total of current and anticipated
future gross revenues or (b) the straight-line method over the remaining
estimated economic life of the product. Generally, an original estimated
economic life of three years is assigned to capitalized software costs, once
the product is available for general release to customers. Costs incurred prior
to the establishment of technological feasibility are charged to research and
development expense. Each quarter, the Company evaluates the value of its
capitalized software costs based on the estimated discounted future cash flows.
See Note 6.
F-12
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Excess of Cost Over Net Assets of Business Acquired
Excess of Cost over Net Assets of Business Acquired consists of both
identifiable and unidentifiable assets (goodwill) and is amortized on a
straight-line basis over periods from three to seven years. The Company
periodically assesses the recoverability of intangible assets by determining
whether the amortization of the balance over its remaining life can be
recovered through undiscounted future operating cash flows of the related
operations. See Note 7.
Comprehensive Loss
Components of comprehensive loss are included in the consolidated statement of
stockholders' equity and consist of foreign currency translation adjustments.
Advertising Expenses
The Company expenses advertising costs as incurred. Sales brochures and
materials are carried as prepaid expenses until they are consumed or determined
to be obsolete. Advertising expenses were approximately $108, $770, and $358,
for the years ended December 31, 1999, 1998 and 1997, respectively.
Research and Product Development
Research and product development costs are expensed as incurred.
Acquired In-process Research and Development
The fair value of acquired in-process research and development ("IPR&D")
projects acquired in business combinations is expensed immediately. The amount
of purchase price allocated to IPR&D is determined based on appraisals, using
appropriate valuation techniques, including percentage-of-completion which
utilizes the key milestones to estimate the stage of development of each
project at the date of acquisition, estimating cash flows resulting from the
expected revenue generated from such projects, and discounting the net cash
flows back to their present value. The discount rate includes a factor that
takes into account the uncertainty surrounding the successful development of
the purchased in-process technology. At the respective dates of acquisition,
the IPR&D projects had not yet reached technological feasibility and did not
have alternative future uses. As discussed in Note 2, material risks existed
with each IPR&D project, however, management expects that such projects will be
completed.
Income Taxes
The Company uses Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes" to account for income taxes. This statement
requires an asset and liability approach that recognizes deferred tax assets
and liabilities for the expected future tax consequences of events that have
been recognized in the Company's financial statements or tax returns. In
estimating future tax consequences, all expected future events other than
enactments of changes in the tax law or rates are generally considered. A
valuation allowance is recorded when it is "more probable than not" that
recorded deferred tax assets will not be realized.
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. During 1999 potentially dilutive
securities included stock options, warrants to purchase common stock, and
preferred stock. Potentially dilutive securities outstanding during 1998 and
1997 include stock options and warrants to purchase common stock of the
Company.
F-13
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock-Based Compensation
The Company has adopted the disclosure provisions of SFAS 123 and has applied
Accounting Principles Board Opinion No. 25 and related Interpretations in
accounting for its stock-based compensation plans. Accordingly, no compensation
cost has been recognized in the Consolidated Statement of Operations for its
stock option plans. See Note 10.
Derivative Financial Instruments
During 1999, the Company began using foreign currency forward exchange
contracts ("forward contracts") to manage exposure related to accounts
receivable denominated in foreign currencies. The Company does not enter into
derivative financial instruments for trading purposes. All outstanding forward
contracts at the end of the period are marked-to-market, with unrealized gains
and losses included in net income as a component of other income (expense),
net. The costs of the forward contracts are recorded as expense over the lives
of the contracts. Cash flows related to forward exchange contracts are
classified in the Consolidated Statement of Cash Flows in the same categories
as the hedged assets or liabilities.
Government Contracts
As a result of the acquisition of Template Software, Inc. ("Template"), the
company provides certain technical services to federal government agencies
under certain contracts, some of which are classified. The nature of this work
is technical design and software development, which was historically performed
by Template since 1977.
Government contracts, by their terms, generally can be terminated at any time
by the government, without cause, for the convenience of the government. If a
government contract is so terminated, the Company would be entitled to receive
compensation for the services provided or costs incurred at the time of
termination and a negotiated amount of the profit on the contract to the date
of termination. In addition, all government contracts require compliance with
various contract provisions and procurement regulations. The adoption of new or
modified procurement regulations could adversely affect the Company or increase
its costs of competing for or performing government contracts. Any violation
(intentional or otherwise) of these regulations could result in the termination
of such government contracts, imposition of fines, and or debarment from award
of additional government contracts.
Reclassifications
Certain prior year amounts in the accompanying financial statements have been
reclassified to conform to the 1999 presentation. Such reclassifications had no
effect on previously reported net income or stockholders' equity.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133 "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities on the balance sheet and measure those instruments
at fair value. The Company, to date, has engaged in limited derivative and
hedging activities, and accordingly, does not believe that the adoption of SFAS
No. 133 will have a material impact on the financial reporting and related
disclosures of the Company. The Company will adopt SFAS No. 133 as required by
SFAS 137, "Deferral of the Effective Date of the FASB Statement No. 133," on
January 1, 2001.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements." SAB 101 provides specific
guidance, among other things, as to the recognition of revenue related to up-
front non-refundable fees and services charges received in connection with a
contractual arrangement. The Company has applied the provisions of SAB 101 for
the year ended December 31, 1999. The adoption of SAB 101 did not have a
material impact on the Company's financial condition or results of operations.
F-14
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2. ACQUISITIONS AND PRO FORMA FINANCIAL STATEMENTS
Acquisition of Template
On December 27, 1999, the Company acquired Template Software, Inc.
("Template"). Under the terms of the agreement, Level 8 purchased 5,394,959
shares of Template common stock for $21,579 in cash and 1,531,089 shares of
Level 8 common stock. Additionally, Level 8 also issued stock options
exercisable for 1,124,023 shares of the Company's common stock to assume all of
the outstanding Template stock options. The total purchase price of the
acquisition was $63,972 and has been accounted for by the purchase method of
accounting. The operations of Template are included in the Company's
consolidated results of operations from the date of acquisition.
The purchase price was 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 Template. The purchase price exceeded the amounts allocated to tangible and
intangible assets acquired less liabilities assumed by approximately $44,371.
This excess of the purchase price over the fair values of assets acquired less
liabilities assumed was allocated to goodwill.
Prior to completing the acquisition, the Company had determined not to continue
with certain non-strategic operations of Template in Germany and Austria. These
operations were primarily reselling third party software and providing related
consulting services. At the time of merger, the Company had entered into an
agreement in principle to sell the assets of these operations, which consist
principally of its consulting workforce and certain lease agreements.
Accordingly, the Company has recorded the estimated fair value of these
operations at the acquisition date based on its estimate of the net future cash
flows from the transactions and associated operations through the wind up
period. The fair value of the German and Austrian operating liability was
estimated at $25.
The purchase price of the acquisition was allocated as follows:
<TABLE>
<S> <C>
Cash................................................................ $ 160
Accounts receivable................................................. 6,123
Prepaid expenses and other current assets........................... 597
Property and equipment.............................................. 4,183
Capitalized software and developed technology....................... 12,200
In-process research and development................................. 2,200
Goodwill and other intangibles...................................... 47,291
Other assets........................................................ 431
Assets held for resale.............................................. (25)
Accounts payable.................................................... (668)
Accrued expenses and other liabilities.............................. (6,445)
Deferred revenue.................................................... (439)
Deferred tax liability.............................................. (1,476)
Long-term debt...................................................... (160)
-------
Cost of net assets acquired......................................... $63,972
=======
</TABLE>
Approximately $2,200 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 in areas for which technological
F-15
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
feasibility had not been established. The efforts considered included projects
related to Template's Enterprise Integration Template ("EIT") product ($1,298),
and projects related to new versions of Template's Business Process Template
("BPT") product ($902). The value of the 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 difficulty of completing the remaining development costs already incurred,
and the projected cost to complete the projects. The discount rate included a
factor that takes into account the uncertainty surrounding successful
development of the purchased in-process research and development.
Acquisition of Seer Technologies, Inc.
On December 31, 1998, the Company, as the first step in its acquisition of the
entire equity interest in Seer, acquired beneficial ownership of approximately
69% of the outstanding voting stock of Seer, which was held by Welsh, Carson,
Anderson and Stowe VI L.P. ("WCAS") and certain other parties affiliated or
associated with WCAS ("WCAS Parties") in exchange for 1,000,000 shares of the
Company common stock and warrants to purchase an additional 250,000 shares of
the Company common stock at an exercise price of $12.00 per share ("Step 1").
On April 15, 1999, the Company acquired the remaining minority interest in
Seer, for $0.35 in cash per share of the outstanding common stock of Seer
("Step 2"). As a result of Step 2 of the acquisition, Seer became a wholly-
owned subsidiary of the Company. The total cost of the acquisition was $7,754
for Step 1 and $1,697 for Step 2 and has been accounted for by the purchase
method of accounting. The net book value of Seer's liabilities exceeded its
assets on the acquisition dates, no minority interest in Seer was recorded.
Step 1 of the acquisition occurred on December 31, 1998, there are no
operations of Seer included in the Company's consolidated results of operations
for 1998.
The purchase price was 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 valuations
prepared by an independent third-party appraisal company of the purchased in-
process research and development, developed technology, installed customer
base, assembled workforce, and trademarks of Seer at the completion of Step 1.
The purchase price exceeded the amounts allocated to tangible and intangible
assets acquired less liabilities assumed by approximately $18,684 in Step 1.
For Step 2, the fair value assigned to intangible assets acquired was based on
a valuation of the purchased in-process research and development, developed
technology, installed customer base, and assembled workforce of Seer. The Step
2 purchase price was less than the amounts allocated to the tangible and
intangible assets acquired by approximately $1,307. This difference between the
purchase price and the fair values of assets acquired less liabilities assumed
was allocated to goodwill.
The cost of the acquisition was allocated as follows:
<TABLE>
<CAPTION>
Step 1 Step 2 Total
-------- ------- --------
<S> <C> <C> <C>
Cash.................... $ 479 $ -- $ 479
Accounts receivable..... 14,505 -- 14,505
Prepaid expenses and
other current assets... 1,418 -- 1,418
Property and equipment.. 1,614 -- 1,614
Capitalized software and
developed technology... 3,659 3,410 7,069
In-process research and
development............ 4,692 744 5,436
Goodwill and other
intangibles............ 28,344 (1,307) 27,037
Other assets............ 370 -- 370
Accounts payable........ (1,949) -- (1,949)
Accrued expenses and
other liabilities...... (13,228) (1,150) (14,378)
Deferred revenue........ (7,875) -- (7,875)
Notes payable, due on
demand................. (12,275) -- (12,275)
Long-term debt.......... (12,000) -- (12,000)
-------- ------- --------
Cost of net assets
acquired............... $ 7,754 $ 1,697 $ 9,451
======== ======= ========
</TABLE>
F-16
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Approximately $4,692 for Step 1 and $744 for Step 2, 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 in areas for which technological feasibility had not been
established. For Step 1, this included Java based projects ($3,105) and
application warehousing projects ($1,587). For Step 2, the amount was related
to Java based projects only, as there was no change in the status of the
application warehouse projects. The value of the 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 the projects. The discount rate included a factor that takes
into account the uncertainty surrounding successful development of the
purchased in-process research and development.
In connection with the Company's purchase of Seer's capital stock from the WCAS
Parties, WCAS contributed approximately $17 million to Seer and the Company
provided a $12 million subordinated loan to Seer to pay down Seer's bank debt.
The funds used by the Company to make the subordinated loan to Seer were
obtained from Liraz Systems Ltd. ("Liraz"), a principal stockholder of the
Company. See Note 8.
Under the agreement between Company and the WCAS Parties, the WCAS Parties
agreed that, prior to January 1, 2001, at any meeting of stockholders of the
Company, WCAS Parties shall grant a proxy to one or more individuals named by
the Company to vote all of the WCAS Parties' shares of common stock acquired by
the WCAS Parties in connection with the transaction. Also, subject to limited
exceptions, prior to January 1, 2001, the WCAS Parties may not sell, exchange
or otherwise assign any of its shares of the Company without the prior written
consent of the Company.
Acquisition of Momentum
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. During the fourth quarter of 1998, the Company issued a
$3,000 note as additional consideration as provided in the purchase agreement.
The total cost of the acquisition was approximately $10,717. The acquisition
was recorded utilizing purchase accounting. As a result of the acquisition of
Momentum, the Company incurred a one-time charge to earnings of approximately
$1,200 related to the estimated value of the purchase of in-process research
and development costs. The remaining amount was allocated to other intangibles,
goodwill and software development costs. The results of operations of Momentum
are included in the financial statements since the date of acquisition.
The purchase price was 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 $8,615.
This excess of the purchase price over the fair values of assets acquired less
liabilities assumed was allocated to goodwill.
F-17
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The cost of the acquisition was allocated as follows:
<TABLE>
<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............................................................ 8,615
Accounts payable.................................................... (507)
Deferred revenue.................................................... (367)
Long-term debt...................................................... (112)
-------
Cost of net assets acquired......................................... $10,717
=======
</TABLE>
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 the 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 the projects. The discount rate included a
factor that takes into account the uncertainty surrounding successful
development of the purchased in-process research and development.
The following unaudited pro forma results of continuing operations assume the
acquisitions of Template, Seer, and Momentum, as described above, occurred as
of January 1, 1998 after giving effect to certain adjustments, including
amortization of the excess of cost over underlying net assets.
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Net sales.............................................. $ 74,977 $ 96,115
Net loss from continuing operations before income taxes
and extraordinary items............................... (36,458) (64,826)
Net loss............................................... (35,831) (87,367)
Loss per share--basic and diluted...................... $ (3.45) $ (8.61)
Weighted average shares outstanding--basic and
diluted............................................... 10,509 10,143
</TABLE>
The pro forma financial information does not purport to be indicative of the
results of operations which would have actually resulted had the transactions
taken place at the beginning of the periods presented or of future results of
operations.
NOTE 3. DISCONTINUED OPERATIONS AND OTHER DISPOSITIONS
Sale of ProfitKey
From October 3, 1994 through the first quarter of 1998, the Company's
operations included the operations of ProfitKey International, Inc.
("ProfitKey"). ProfitKey offered turnkey manufacturing resource planning and
scheduling software packages, and related installation, training and support
services for use by manufacturing businesses.
F-18
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On April 6, 1998, the Company sold substantially all assets and operations of
ProfitKey for $464 at closing and a note receivable from the purchaser of
$2,000. The note is due on April 6, 2000 and bears interest at 9%. 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 has notified the Company that it believes there are adjustments
totaling $1,466, which would require a reduction in the purchase price. The
Company has attempted to negotiate a settlement with the purchaser and has,
pursuant to the terms of the settlement agreement, entered into arbitration
proceedings to resolve this matter and is currently awaiting the report of the
arbitrator. The Company has made provision for its estimate of the purchase
price adjustment and the costs to resolve this matter as part of discontinued
operations. Management believes at this time that any additional provisions
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.
The Company recorded a net loss from the sale of ProfitKey of $1,233.
The disposition of ProfitKey was accounted for as a discontinued operation and,
accordingly, prior periods have been restated. Results of the discontinued
operations of ProfitKey consisted of the following for the years ended December
31:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Net sales.................................................... $1,156 $5,545
Income (loss) from operations before tax..................... (225) 191
Income tax expense (benefit)................................. (90) 138
Income (loss) from discontinued operations................... $ (135) $ 53
</TABLE>
For 1998, discontinued operations of ProfitKey includes ProfitKey's results of
operations through the date of sale.
Sale of ASU
Effective December 31, 1997, the Company sold the business and related assets
of the ASU Consulting division for $65, resulting in a gain of $60 for the year
ended December 31, 1997. The sale of the ASU Consulting division was not
accounted for as a discontinued operation.
NOTE 4. ACCOUNTS RECEIVABLE
Trade accounts receivable consists of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Current trade accounts receivable.......................... $23,349 $20,244
Less: Allowance for doubtful accounts...................... (1,150) (3,252)
------- -------
$22,199 $16,992
======= =======
</TABLE>
Approximately $4,230 and $4,165 of current trade receivables were unbilled at
December 31, 1999 and 1998, respectively. There were no receivables with
payment terms in excess of one year recorded during the fiscal year ended
December 31, 1999.
During 1998 and 1999, the Company acquired certain trade receivables, net of
allowances for doubtful accounts, in conjunction with its acquisition of
Momentum, Seer, and Template. See Note 2.
The provision for uncollectible amounts was $757, $838 and $332 for the years
ended December 31, 1999, 1998, and 1997, respectively. Write-offs of accounts
receivable were $3,044, $736, and $95 for the years ended December 31, 1999,
1998, and 1997, respectively.
F-19
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
------- ------
<S> <C> <C>
Computer equipment.......................................... $ 4,038 $1,922
Furniture and fixtures...................................... 1,369 286
Office equipment............................................ 1,221 312
Leasehold improvements...................................... 1,808 544
Land and buildings.......................................... 1,979 --
------- ------
Subtotal................................................ 10,415 3,064
Less accumulated depreciation and amortization.............. (4,570) (382)
------- ------
Total................................................... $ 5,845 $2,682
======= ======
</TABLE>
Depreciation and amortization expense was $1,373, $426, and $228 for the fiscal
years ended December 31, 1999, 1998, and 1997, respectively.
During the fourth quarter of fiscal year 1998, property and equipment was
written down for obsolescence and retirement of assets based in part on the
Company's restructured operations. The write-down totaled $595, of which $188
is included in the restructuring charges in the Consolidated Statement of
Operations, see Note 16.
The Company now owns a building in Windsor, England from the acquisition of
Template Software, Inc.
NOTE 6. CAPITALIZED SOFTWARE COSTS
For the fiscal years ended December 31, 1999, 1998 and 1997, the Company
capitalized $1,427, $1,177, and $1,156, respectively, of internal costs related
to developing software for sale. During fiscal year 1999, the Company acquired
$3,410 and $12,200 in capitalized software costs through its acquisitions of
Seer and Template, respectively. During fiscal year 1998, the Company acquired
$1,100 and $3,659 in capitalized software costs through its acquisitions of
Momentum and Seer, respectively.
During the fiscal years ended December 31, 1999, 1998 and 1997, the Company
recognized $3,301, $816, and $137, respectively, of expense related to the
amortization of these costs, which is recorded as cost of software in the
Consolidated Statements of Operations. During the first and fourth quarters of
fiscal year 1998, capitalized software cost was written down to its fair value
based upon an evaluation of its net realizable value. The write downs totaled
$535, of which $241 is included in the restructuring charges in the
Consolidated Statement of Operations. Accumulated amortization of capitalized
software costs is $3,907 and $606 at December 31, 1999 and 1998, respectively.
NOTE 7. IDENTIFIABLE AND UNIDENTIFIABLE INTANGIBLE ASSETS
Identifiable and unidentifiable intangible assets primarily include goodwill,
existing customer base, assembled workforce and trademarks recorded in
connection with the acquisitions of Template Software on December 27, 1999 and
Seer Technologies on December 31, 1998 and April 30, 1999. Goodwill and
intangible assets from these acquisitions are being amortized using the
straight-line method over periods ranging from three to seven years. Also
included are goodwill amounts acquired in the purchase of Momentum Software on
March 26, 1998 and Level 8 Technologies on April 1, 1995. These assets are
being amortized over three years and seven
F-20
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
years, respectively. At December 31, 1999 and 1998, identifiable and
unidentifiable intangible assets consist of the following:
<TABLE>
<CAPTION>
1999 1998
-------- -------
<S> <C> <C>
Goodwill, Level 8 Technologies............................ $ 2,954 $ 2,954
Goodwill, Momentum........................................ 4,014 4,014
Goodwill, Seer Technologies............................... 12,545 18,684
Goodwill, Template Software............................... 44,371 --
Assembled workforce, Seer Technologies.................... 5,673 4,278
Assembled workforce, Template Software.................... 2,920 --
Customer base, Seer Technologies.......................... 6,900 4,761
Trademark, Seer Technologies.............................. 623 623
-------- -------
Subtotal.............................................. 80,000 35,314
Less accumulated amortization............................. (10,052) (3,097)
-------- -------
Total..................................................... $ 69,948 $32,217
======== =======
</TABLE>
Amortization expense was $6,959, $1,933, and $422 for the fiscal years ended
December 31, 1999, 1998, and 1997, respectively.
In the fourth quarter of 1999, the Company revised its estimates of certain
Seer merger costs and assumed liabilities, which resulted in an approximately
$1,300 reduction in goodwill.
The Company assesses whether its identifiable and unidentifiable intangible
assets are impaired as required by SFAS No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, based on an
evaluation of undiscounted projected cash flows through the remaining
amortization period. If impairment exists, the amount of such impairment is
calculated based on the estimated fair value of the asset determined based upon
anticipated cash flows discounted at a rate commensurate with the risk
involved. As a consequence of the Company's transition to an enterprise
application integration solutions provider during 1998, the Company abandoned
certain planned development efforts for products acquired in the Momentum
transaction and reassessed the remaining undiscounted projected cash flows
related to the identifiable and unidentifiable intangible assets acquired from
Momentum. It was concluded that, with the principal exception of the Momentum
technology utilized in the Level 8's Geneva Message Queuing product set and the
Geneva XIPC products, the goodwill and intangible assets acquired in the
Momentum transaction should be written off. Accordingly, during the fourth
quarter of 1998, the Company adjusted the carrying value of its identifiable
and unidentifiable assets to their fair value of $32,217, resulting in a non-
cash impairment loss of $4,601.
NOTE 8. LONG-TERM DEBT AND CREDIT FACILITIES
Notes payable, long-term debt, and notes payable to a related party consist of
the following at December 31:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Credit facility............................................ $ 4,996 $ 2,775
Notes payable--Momentum.................................... 2,250 2,250
Term loans................................................. 20,242 9,500
Capital leases............................................. 105 90
------- -------
27,593 14,615
Less current maturities.................................... (5,391) (13,074)
------- -------
$22,202 $ 1,541
======= =======
Related party:
Notes payable to a related party........................... 4,519 13,147
Less current maturities.................................... (519) (628)
------- -------
$ 4,000 $12,519
======= =======
</TABLE>
F-21
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has a credit facility with a commercial bank to provide for
borrowings up to the lesser of $25,000 or the sum of 80% of eligible
receivables and a $10,000 term loan. The receivables-based borrowings under
this credit facility are due on demand. This credit facility bears interest at
prime rate plus 2%, which was 10.5% at December 31, 1999, and has no financial
covenant provisions. The balance was $4,996 and $2,775 at December 31, 1999
and 1998, respectively. The credit facility terminates on December 31, 2001 at
which time the term loan is also due; however, it is automatically renewed for
successive terms of one year each, unless terminated by either party. This
credit facility is collateralized by the Company's accounts receivable,
equipment and intangibles including intellectual property. The credit facility
requires the Company to obtain approval from its lender prior to declaration
or payment of any cash dividends on its common stock.
On December 20, 1999, the Company entered into a term loan with a commercial
bank for $10,000. The loan bears interest at LIBOR plus 1% (7.2% at December
31, 1999), which is payable quarterly. This term loan will be due May 31, 2001
and has no financial covenants. The proceeds from this loan were used to
partially fund the purchase of Template, see Note 2. This note is guaranteed
by a related party. This guarantee was provided in exchange for 60,000 shares
of the Company's common stock and a deferred loan origination costs of $1,208
were recorded as assets to reflect the fair market value of the stock issued.
On December 1, 1998, in connection with the acquisition of Momentum Software
Corporation as described in Note 2, the Company issued notes totaling $3,000
payable over three years and bearing an interest of 10% per annum. The
remaining three installments total $2,250, plus interest. One installment was
due on November 26, 1999 with the remaining two payments due on November 20,
2000, and November 15, 2001. There are no financial covenants in this note.
Subsequent to December 31, 1999, 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 accepts the offer. The Company converted $1,904 of
the Momentum notes to common stock in the first quarter of 2000 as a result of
this exchange offer.
The Company is obligated under various capital leases for certain computer and
office equipment providing for aggregate payment, excluding interest, of $60
during 2000 and $45 during 2001.
On December 31, 1998 in connection with the acquisition of Seer Technologies,
Inc. as described in Note 2, the Company issued a note payable to Liraz, the
Company's principal shareholder in the amount of $12,000. The note bears
interest at 12% per year, payable at maturity, and is due on December 15,
2001. The Company used $8,000 of proceeds from the issuance of preferred stock
and warrants in June 1999 to reduce the outstanding balance under this note to
$4,000.
On April 1, 1998 in connection with an amendment to a custom computer
programming agreement, the Company issued a note payable to Liraz in the
amount of $1,500. The note bears interest at 8% per year and is payable in
three annual installments. The first two installments, including accrued
interest, were paid during 1998 and 1999, respectively. The third installment
of $450 plus interest is due on April 1, 2000.
On September 1, 1995, the Company issued a note payable to Liraz in the amount
of $628. The note bears interest at 4% per year and is payable in equal
quarterly installments of $35, including interest. As of December 31, 1999,
the principal amount outstanding on the note payable is $110.
Principal amounts of notes payable and long-term debt and notes payable to
Liraz maturing in each of the next five years ending December 31 are as
follows:
<TABLE>
<CAPTION>
Notes Payable Notes Payable
And to
Long-term Debt Liraz
-------------- -------------
<S> <C> <C>
2000............................................ $ 5,391 $ 519
2001............................................ 22,202 4,000
------- ------
Total......................................... $27,593 $4,519
======= ======
</TABLE>
F-22
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 9. INCOME TAXES
Income tax expense consists of the following as of December 31:
<TABLE>
<CAPTION>
1999 1998 1997
----- ----- ----
<S> <C> <C> <C>
Federal--current............................................ $ -- $ -- $239
State and local--current.................................... -- -- 42
----- ----- ----
-- -- 281
Foreign taxes and withholdings.............................. 720 -- --
----- ----- ----
Current taxes............................................... 720 -- --
Federal--deferred........................................... -- 344 231
State and local--deferred................................... -- 61 41
----- ----- ----
Deferred taxes.............................................. -- 405 272
Total income tax expense.................................... $ 720 $ 405 $553
===== ===== ====
</TABLE>
A reconciliation of expected income tax at the statutory Federal rate with the
actual income tax expense (benefit) is as follows for the fiscal years ended
December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -----
<S> <C> <C> <C>
Expected income tax benefit at statutory rate
(34%)............................................ $(5,017) $(7,916) $ 540
Loss on sale of discontinued operations........... -- (331) --
Discontinued operations........................... -- (77) 65
State taxes, net of federal tax benefit........... (335) (1,082) 97
Effect of foreign operations including withholding
taxes............................................ 503 -- --
Effect of change in valuation allowance........... 4,497 6,246 (304)
Amortization and write-off of non-deductible good-
will............................................. 521 2,787 197
In-process research and development--Momentum..... -- 408 --
In-process research and development--Template..... 748 -- --
Write-off of income tax receivable................ -- 406 --
Non-deductible expenses........................... 17 12 34
Other............................................. (214) 121 61
------- ------- -----
Total......................................... $ 720 $ 574 $ 690
======= ======= =====
The total income tax expense is allocated as follows:
Continuing operations......................... 720 405 553
Sale of discontinued operations............... -- 259 --
Discontinued operations....................... -- (90) 137
</TABLE>
F-23
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of the net deferred tax asset (liability) are as
follows:
<TABLE>
<CAPTION>
1999 1998
-------- -------
<S> <C> <C>
Current assets:
Allowance for uncollectible accounts receivable......... $ 720 $ 240
Accrued expenses non-tax deductible..................... 371 660
Deferred revenue........................................ 2,192 1,621
Noncurrent assets:
Loss carryforwards...................................... 11,751 5,539
Depreciation and amortization........................... -- 577
-------- -------
15,034 8,637
-------- -------
Noncurrent liabilities:
Depreciation and amortization........................... (3,230) --
-------- -------
(3,230) --
-------- -------
Valuation allowance....................................... (11,804) (8,637)
-------- -------
$ -- $ --
======== =======
</TABLE>
At December 31, 1999, the Company has net operating loss carryforwards of
approximately $29,300, which may be applied against future taxable income.
These carryforwards will expire at various times between 2005 and 2020. A
substantial portion of these carryforwards is restricted to future taxable
income of certain of the Company's subsidiaries or limited by Internal Revenue
Code Section 382. Thus, the utilization of these carryforwards cannot be
assured. Approximately $2,200 of the valuation allowance relates to deferred
tax assets for which any subsequently recognized tax benefits will be allocated
directly to reduce goodwill or other noncurrent intangible assets of Momentum.
Additionally, Template's net operating loss carryforwards include tax
deductions for the disqualifying dispositions of incentive stock options. When
the Company utilizes the net operating loss related to these deductions, the
tax benefit will be reflected in additional paid in capital and not as a
reduction of tax expense. The total amount of these deductions included in the
net operating loss carryforwards is $5,300.
During 1999, the Company acquired the stock of Template Software. This
acquisition was accounted for using the purchased method of accounting. The
purchase price of the acquired company was in excess of the carryover tax basis
of the assets acquired, resulting in the recognition of a deferred tax
liability of $1,476. Since the acquired company and the Company may elect to
file a consolidated return on an ongoing basis, the future taxable difference
may be offset by the Company's future deductible differences, primarily its net
operating loss carryforwards. Therefore, the Company's valuation allowance
against its deferred tax asset and its investment in the acquired subsidiary
was reduced by $1,476.
The Company provided a full valuation allowance on the total amount of its
deferred tax assets at December 31, 1999 since management does not believe that
it is more likely than not that these assets will be realized.
NOTE 10. STOCKHOLDERS' EQUITY
Stock Options
The Company has 1995 and 1997 Stock Incentive Plans, which permit the issuance
of incentive and nonstatutory stock options, stock appreciation rights,
performance shares, and restricted and unrestricted stock to employees,
officers, directors, consultants, and advisors. The Plans reserve a combined
total of 4,000,000
F-24
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
shares of common stock for issuance upon the exercise of awards and provide
that the term of each award be determined by the Board of Directors. The
Company also has a stock incentive plan for outside directors and the Company
has set aside 120,000 shares of common stock for issuance under this plan.
Under the terms of the Plans, the exercise price of the incentive stock options
may not be less than the fair market value of the stock on the date of the
award and the options are exercisable for a period not to exceed ten years from
date of grant. Stock appreciation rights entitle the recipients to receive the
excess of the fair market value of the Company's stock on the exercise date, as
determined by the Board of Directors, over the fair market value on the date of
grant. Performance shares entitle recipients to acquire Company stock upon the
attainment of specific performance goals set by the Board of Directors.
Restricted stock entitles recipients to acquire Company stock subject to the
right of the Company to repurchase the shares in the event conditions specified
by the Board are not satisfied prior to the end of the restriction period. The
Board may also grant unrestricted stock to participants at a cost not less than
85% of fair market value on the date of sale. Options granted vest at varying
periods up to five years and expire in ten years.
In December 1999, as part of its acquisition of Template Software, Inc. the
Company has assumed the three Stock Option Plans of Template; the 1992
Incentive Stock Option Plan, the 1992 Non-Statutory Stock Option Plan and the
1996 Equity Incentive Plan. No further grants may be made under these plans.
The options granted under these plans were converted to options for the
Company's common stock upon the assumption of these plans by the Company at the
acquisition date. There are 1,124,023 options outstanding under these plans.
Activity for stock options issued under these plans for the fiscal years ending
December 31, 1999, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
Weighted Average
Plan Activity Option Price per Share Exercise Price
------------- ---------------------- ----------------
<S> <C> <C> <C>
Balance at December 31,
1996................... 783,155 0.69-11.00 7.31
Granted................ 444,500 10.69-16.62 8.14
Exercised.............. (91,646) 0.69-16.62 7.01
Forfeited.............. (45,705) 0.69-16.62 11.38
--------- -----
Balance at December 31,
1997................... 1,090,304 0.69-16.62 7.51
Granted................ 1,293,000 7.25-12.75 8.14
Exercised.............. (38,175) 0.69-11.76 9.13
Forfeited.............. (433,035) 0.69-16.62 10.88
--------- -----
Balance at December 31,
1998................... 1,912,094 0.69-16.62 8.85
Granted................ 1,797,210 8.38-30.25 14.15
Assumed Template
options............... 1,124,023 3.39-39.29 17.22
Exercised.............. (386,440) 0.69-16.62 9.26
Forfeited.............. (646,995) 7.88-11.76 9.0
--------- -----
Balance at December 31,
1999................... 3,799,892 1.37-39.29 13.65
========= =====
</TABLE>
The weighted average grant date fair value of options issued during the years
ended December 31, 1999, 1998, and 1997 was equal to $9.77, $4.37, and $9.35
per share, respectively. The fair value of options granted during the fiscal
years ended December 31, 1999, 1998 and 1997 was equal to $17,550, $5,652 and
$4,156, respectively. There were no option grants issued below fair market
value during 1999, 1998 or 1997.
F-25
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of the Company's stock-based awards to employees was estimated
as of the date of the grant using the Black-Scholes option-pricing model, using
the following weighted-average assumptions:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Expected life (in years).......................... 5 years 5 years 5 years
Expected volatility............................... 82% 52% 77%
Risk free interest rate........................... 5.44% 5.00% 6.05%
Expected dividend yield........................... 0% 0% 0%
</TABLE>
For disclosure purposes, the adjusted estimated fair value of the Company's
stock-based awards to employees is amortized over the vesting period. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates as calculated in
accordance with SFAS 123, the Company's net loss and loss per share for the
fiscal years December 31, 1999, 1998, and 1997 would have been increased to the
pro forma amounts indicated below. The Company's adjusted information follows
(in thousands, except for per share information):
<TABLE>
<CAPTION>
1999 1998 1997
-------- --------- -------
<S> <C> <C> <C>
Net income (loss), as reported............... $(15,477) $ (25,056) $ 1,089
Net income (loss), as adjusted............... (22,538) (27,697) (821)
Net income (loss) per share, as reported--
basic....................................... (1.80) (3.32) 0.16
Pro forma net income (loss) per share, as
adjusted--basic............................. (2.57) (3.67) (0.12)
Net income (loss) per share, as reported--
diluted..................................... (1.80) (3.32) 0.14
Pro forma net income (loss) per share, as
adjusted--diluted........................... (2.57) (3.67) (0.11)
</TABLE>
At December 31, 1999, 1998 and 1997, options to purchase approximately
1,850,087, 908,638, and 539,980 shares of common stock were exercisable,
respectively, pursuant to the plans at prices ranging from $1.37 to $39.29. The
following table summarizes information about stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
Remaining Contractual
Number Life for Options Number
Exercise Price Outstanding Outstanding Exercisable
-------------- ----------- --------------------- -----------
<S> <C> <C> <C>
1.37-- 2.00 5,134 4.4 5,134
3.39-- 4.87 207,516 4.4 195,302
5.00-- 7.25 480,782 7.0 377,657
7.88--11.76 1,845,313 8.5 736,714
11.94--16.62 445,569 8.1 303,477
18.88--18.88 186,924 8.2 89,789
30.25--39.29 628,654 9.0 142,014
--------- ---------
3,799,892 1,850,087
========= =========
</TABLE>
Preferred Stock
On June 29, 1999, Level 8 Systems, Inc. completed its agreement to sell 21,000
shares of Series A 4% Convertible Redeemable Preferred Stock ("Series A
Preferred Stock"), for $21,000, convertible into an aggregate of 2.1 million
shares of common stock of Level 8. The proceeds, net of accrued issuance costs,
of $19,150, will be used to pay down debt and for other general corporate
purposes. The sale of the Series A Preferred Stock was made in a private
transaction exempt from the registration requirements of the federal securities
laws.
F-26
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Holders of the Series A Preferred Stock are entitled to receive 4% annual cash
dividends payable quarterly and will have one vote per share of Series A
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 A Preferred Stock. The Series A 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 June 29, 2000 if the closing price of Level 8's common
stock over 20 consecutive trading days is greater than $20 per share. The
conversion price of the Series A 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 $10 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 A 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 $21 million financing, Level 8
also issued the investors warrants to purchase 2.1 million shares of common
stock at an exercise price of $10 per share. Level 8 has agreed to register the
common stock issuable upon conversion of the Series A Preferred Stock and
exercise of the warrants for resale under the Securities Act of 1933. Level 8
is required to make certain payments in the event it is unable to meet its
obligations in connection with the Series A 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 A Preferred Stock, is limited to 19% of
the liquidation value of the Series A Preferred Stock. One of the investors in
the Series A Preferred Stock included Advanced Systems Europe B.V., which
purchased $10 million of Series A Preferred Stock and warrants in the
transaction, and is a subsidiary of Liraz, Level 8's principal stockholder.
During 1999, 2,005 shares of preferred stock were converted into 200,500 shares
of the Company's common stock. Subsequent to December 31, 1999, 7,000 shares of
preferred stock were converted into 700,000 shares of the Company's common
stock.
Stock Warrants
In connection with the issuance of preferred stock in June 1999, the Company
issued warrants to purchase 2,100,00 shares of the Company's common stock,
including warrants to purchase 1,000,000 shares of common stock that were
issued to a related party. The warrants have an exercise price of $10.00 per
share and expire on June 29, 2004. The Company may cause the redemption of
these warrants at any time after June 29, 2000 if the closing price of the
Company's common stock over 20 consecutive trading days is greater than $20 per
share.
Warrants totaling 1,260,460 were exercised at an exercise price of $10.00
during the year ended December 31, 1999. A related party exercised warrants to
purchase 1,000,000 shares of common stock.
In connection with the acquisition of Momentum during 1998, the Company issued
warrants to purchase 200,000 shares of the Company's common stock. The warrants
have an exercise price of $13.108 per share and expire on March 26, 2003. The
warrants were valued at $654 or $3.27 per share. See Note 2.
In connection with the acquisition of Seer during 1998, the Company issued
warrants to purchase 250,000 shares of the Company's common stock. The warrants
have an exercise price of $12 per share and expire on December 31, 2002. The
warrants were valued at $280 or $1.12 per share. See Note 2.
In connection with the initial and secondary public offerings, the Company
issued 140,000 and 110,000 warrants, respectively, to the underwriter. The
warrants are exercisable for four years, commencing one year from the effective
dates of the public offerings at exercise prices of $7.43 and $14.85 per share,
respectively, and have grant date fair values of $3.82 and $6.85 per share,
respectively. Warrants totaling 3,000, 1,200 and 18,168 were exercised at an
exercise price of $7.43 during the years ended December 31, 1999, 1998 and
1997, respectively.
F-27
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Reincorporation and Common Stock
Effective June 23, 1999, the Company completed its re-incorporation under
Delaware law. As a result of the re-incorporation of the Company under Delaware
law, the rights of stockholders of the Company are now governed by the
Certificate of Incorporation and Bylaws of Level 8 Systems, Inc., a Delaware
corporation, and the General Corporation Law of the State of Delaware. In
conjunction with the re-incorporation, the Company changed the par value of its
common stock from $.01 to $.001.
NOTE 11. EMPLOYEE BENEFIT PLANS
As of January 1, 1999 the Company had separate 401(k) plans for employees of
Momentum, Seer, and Level 8. Effective January 27, 1999, the Company merged the
Momentum 401(k) Plan and the Level 8 401(k) Plan into the Seer 401(k) Plan and
changed the name of the Seer 401(k) Plan to the Level 8 Systems 401(k) and
Profit Sharing Plan (the "Plan"). Participants in the former Momentum 401(k)
Plan and the Level 8 401(k) Plan are allowed to roll over the balance of their
accounts into the Plan, with recognition of certain protected benefits. Also
effective January 27, 1999, the Company amended the Plan to provide a 50%
matching contribution for an employee's contribution, up to 2% of an employee's
salary, and a discretionary match of up to $0.50 on the dollar up to 2% of the
employees salary based on the Company's performance and board of directors
discretion. Participants must be eligible Plan participants and employed at
December 31 of each calendar year to be eligible for employer matching
contributions. Matching contributions made by the Company totaled $156 were
accrued during 1999 and were paid out in January of 2000.
The Company also has employee benefit plans for each of its foreign
subsidiaries, as mandated by each country's laws and regulations. For fiscal
year ended December 31, 1999 there was $408 in expense recognized under this
plan. There was no expense recognized under these plans for the years ended
December 31, 1998, and 1997 as these subsidiaries were acquired with the
acquisition of Seer.
Effective January 27, 1999, the Company adopted an Employee Stock Purchase Plan
(U.S.) for its U.S. employees and the International Stock Purchase Plan,
currently available to its UK employees, (collectively, the "Stock Purchase
Plans"). The Stock Purchase Plans allow employees to purchase shares of the
Company's common stock for 85% of fair market value. The Stock Purchase Plans
are authorized to grant rights to purchase an aggregate maximum of 250,000
shares of common stock. The Company is responsible for the administrative costs
of the plans.
NOTE 12. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
No customers accounted for more than 10% of operating revenue in fiscal year
1999. For the fiscal years ended December 31, 1998 and 1997, one customer
accounted for more than 10% of operating revenue.
As a result of its acquisition of Seer, the Company has entered into several
marketing and distribution agreements with IBM, primarily in the European
market. The percentage of outstanding receivables from IBM and its
subsidiaries, transactions as of December 31, 1999 and 1998, is approximately
23% and 25%, respectively.
As of December 31, 1999, the Company had significant balances outstanding from
individual customers due to the nature of its operations. It is the policy of
the Company to closely monitor all accounts receivable and to record a
provision for uncollectible accounts as they become estimable. Generally, no
collateral is required.
NOTE 13. FOREIGN CURRENCIES AND FORWARD EXCHANGE CONTRACTS
At December 31, 1999, the Company had approximately $526 and $8,190 U.S. dollar
equivalent cash and trade receivable balances, respectively, denominated in
foreign currencies. As of December 31, 1998, the amount of US dollar equivalent
cash and trade receivable balances were $219 and $8,527, respectively.
F-28
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The more significant trade accounts receivable denominated in foreign
currencies as a percentage of total trade accounts receivable were as follows:
<TABLE>
<CAPTION>
1999 1998
----- -----
<S> <C> <C>
Pound Sterling................................................... 8.68% 8.53%
Deutsche Mark.................................................... 5.62% 2.43%
Italian Lira..................................................... 5.33% 8.33%
Danish Krona..................................................... 4.64% 8.73%
</TABLE>
In 1999, the Company began entering into forward exchange contracts to hedge
the exposures that arise from foreign exchange movements between dates that
foreign currency denominated receivables are recorded and the dates they are
paid. The Company does not engage in foreign currency speculation. The forward
contracts are generally 90 to 120 day forward window contracts having
maturities of less than one year and relate to specific transactions or
balances. The table below summarizes, by currency, the contractual amounts of
the Company's forward contracts for the year ended December 31, 1999.
<TABLE>
<CAPTION>
As of December 31, 1999
---------------------------
Original Contract Contract Fair Unrealized
Currency Contracts Drawdowns Balance Value Gain/(Loss)
-------- --------- --------- -------- ------ -----------
<S> <C> <C> <C> <C> <C>
Pound Sterling.................. 1,556 (1,181) 375 379 (4)
Danish Krona.................... 2,704 (1,730) 974 969 5
Euro............................ 5,043 (3,173) 1,870 1,827 43
Norwegian Krone................. 1,053 (791) 262 265 (3)
Swedish Krone................... 461 (328) 133 135 (2)
------- ------- ------ ------ ---
Total......................... $10,817 $(7,203) $3,614 $3,575 $39
======= ======= ====== ====== ===
</TABLE>
Unrealized gains and losses on forward contracts reflect changes in exchange
rates and are recorded directly in income, as they offset corresponding
unrealized gains and losses on the foreign currency denominated assets being
hedged (see Note 1). Forward contract liabilities related to unrealized losses
are recorded as other accrued expenses in the Consolidated Balance Sheet.
The Company is exposed to exchange related losses on forward contracts should a
transaction with a related forward exchange contract not be consummated by the
forward contract expiration date. In such instances, the Company extends or
repurchases the contact at the then prevailing market rates. Net realized
losses on the extension or repurchase of contracts totaled $3 for the fiscal
year ended December 31, 1999.
NOTE 14. SEGMENT INFORMATION AND GEOGRAPHIC 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.
Segment data includes a charge allocating all corporate-headquarters costs 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 earnings (loss) before interest, taxes,
restructuring and amortization of goodwill (EBITA).
Comparative information is not available for the same period of 1998 and 1997
because the Company previously reviewed its operations as one reportable
segment and did not have international operations.
F-29
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below presents information about reported segments for the fiscal
year ending December 31, 1999:
<TABLE>
<CAPTION>
Research
And
Software Maintenance Services Development Total
-------- ----------- -------- ----------- -------
<S> <C> <C> <C> <C> <C>
Total Revenue................ $16,030 $14,981 $21,909 $ -- $52,920
Total EBITA.................. $(2,549) $ 8,819 $ (116) $(7,767) $(1,613)
</TABLE>
A reconciliation of total segment EBITA to loss before provision for income
taxes for the fiscal year ended December 31, 1999 is as follows:
<TABLE>
<S> <C>
EBITA............................................................. $ (1,613)
Amortization of goodwill.......................................... (6,959)
In-process research and development............................... (2,944)
Restructuring..................................................... (383)
Other income/(expense), net....................................... (2,858)
--------
Loss before provision for income taxes............................ $(14,757)
========
</TABLE>
The following table presents a summary of revenue by geographic region for the
fiscal year ended December 31, 1999:
<TABLE>
<CAPTION>
Year ended
December 31, 1999
-----------------
<S> <C>
Australia.................................................. $ 2,429
Denmark.................................................... 4,861
Germany.................................................... 3,553
Italy...................................................... 3,370
Norway..................................................... 2,128
Switzerland................................................ 2,782
United Kingdom............................................. 5,055
USA........................................................ 18,134
Other...................................................... 10,608
-------
Total revenue............................................ $52,920
=======
</TABLE>
Presentation of revenue by region is based on the country in which the customer
is domiciled. Only countries with greater than 4% of total revenue are
disclosed individually.
The following table represents a summary of long-lived assets by geographic
region as of December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- ------
<S> <C> <C> <C>
United States......................................... $93,946 $41,136 $4,935
United Kingdom........................................ 2,168 416 --
France................................................ 119 -- --
Other................................................. 48 100 --
------- ------- ------
Total assets........................................ $96,281 $41,652 $4,935
======= ======= ======
</TABLE>
The Company's foreign operations are reimbursed by the Company for their costs
plus an appropriate mark-up for profit. Intercompany profits and losses are
eliminated in consolidation.
F-30
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 15. RELATED PARTY INFORMATION
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, during the
first quarter of 1998, the Company and Liraz entered into an amendment to the
original custom computer programming agreement, whereby the original royalty
payment provisions were repealed. 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. See Note 8. The amortization of
the cost reimbursement is included as a component of cost of software in the
Consolidated Statement of Operations. Total royalties paid to Liraz were $15
and $130 for the years ended December 31, 1999 and 1998, respectively.
In addition, the Company and Liraz were awarded an Israel--U.S. Binational
Industrial Research and Development Foundation ("BIRD") grant totaling $432.
The BIRD grant provided for reimbursement of up to 50% of the development costs
of the above project. At the point at which the products developed under this
grant are available for sale, BIRD will be paid a royalty of 2.5% of related
sales in the first year and 5% in subsequent years until BIRD recovers 110% to
150% (depending on the elapsed time) of its reimbursement of development costs.
The Company capitalized the software development costs associated with Level
8's project development costs and reduced the capitalized costs by any grant
funds received from BIRD. At December 31, 1999, the Company had capitalized
approximately $1,249, after reimbursement of BIRD funds totaling approximately
$400. This product was completed during fiscal year 1998.
The Company sold software licenses to Liraz for $15 and $160 in 1998 and 1997,
respectively, for resale to unrelated third parties.
Liraz also pays the salaries and expenses of certain company employees and is
reimbursed by the Company. Salaries and expenses paid by Liraz amounted to
$372, $568, and $14 during 1999, 1998, and 1997 respectively.
At December 31, 1999 and 1998, the Company had accounts receivable of $- and
$271 and accounts payable of $41 and $82 from and to Liraz, respectively.
In June 1999, a subsidiary of Liraz purchased convertible preferred stock and
warrants from the Company for $10,000 on the same terms as the other investors
in the $21,000 offering. In December, 1999, Liraz exercised its warrants for
one million shares of common stock for an aggregate exercise price of $10,000.
The Company issued Liraz 60,000 shares of common stock in exchange for Liraz's
guaranty of a $10,000 term loan to the Company used to finance the Template
acquisition.
See Note 8 regarding notes payable to Liraz.
NOTE 16. RESTRUCTURING CHARGES
During the fourth quarter of 1999, the Company reorganized its existing
operations due to its acquisition of Template. The Company's restructuring
included a management change in its development and operations areas, the
abandonment of certain leased facilities, and the closure of its French
subsidiary. The Company recorded a restructuring charge of $545, which
consisted of approximately $275 in costs associated with subleasing excess
F-31
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
space, approximately $235 in personnel-related charges, and approximately $35
in professional fees to close its French subsidiary. Through December 31, 1999,
the Company had not paid any cash related to these restructuring charges.
During the fourth quarter of 1998, the Company reorganized its existing
operations due to its acquisition of Seer. The restructuring included a staff
reduction in its development and administrative areas of 20% (15 employees),
the abandonment of certain leased facilities, and the write-down to fair value
of certain capitalized software costs for product lines which were being
discontinued. The Company recorded a restructuring charge of approximately
$1,540, which consisted of approximately $706 in personnel-related charges,
approximately $292 in costs associated with carrying vacated space until the
lease expiration date, approximately $188 of property and equipment related
charges, approximately $241 in write-down of capitalized software costs,
approximately $100 in professional fees related to the restructuring, and
approximately $13 for other charges. Through December 31, 1999, the Company has
paid approximately $864 in cash related to the restructuring.
At December 31, 1999 the Company revised its estimate of the 1998 restructuring
charge by reducing it by $162 based on a review of the costs paid through
December 31, 1999 and the remaining estimated costs. The change in estimate is
reflected in the 1999 Consolidated Statement of Operations as a reduction of
the restructuring charge for 1999.
The Company believes the accrued restructuring cost of $630 at December 31,
1999 represents its remaining cash obligations for the restructuring charges
included above.
NOTE 17. LEASE COMMITMENTS
The Company leases certain facilities and equipment under various operating
leases. Future minimum lease commitments on operating leases that have initial
or remaining non-cancelable lease terms in excess of one year as of December
31, 1999 are as follows:
<TABLE>
<S> <C>
2000............................................................... $ 3,816
2001............................................................... 3,400
2002............................................................... 2,964
2003............................................................... 2,574
2004............................................................... 1,671
Thereafter......................................................... 4,040
-------
$18,465
=======
</TABLE>
Rent expense for the fiscal years ended December 31, 1999, 1998 and 1997 was
$2,940, $790, and $378, respectively.
NOTE 18. CONTINGENCIES
Litigation. Various lawsuits and claims have been brought against the Company
in the normal course of business. Management is of the opinion that the
liability, if any, resulting from these claims would not have a material effect
on the financial position or results of operations of the Company.
In December 1997, Seer Technologies, Inc. ("Seer"), a wholly-owned subsidiary
of the Company, instituted litigation in London, England against Saadi Abbas
("Abbas") and Cambridge Business Solutions (UK) Ltd. ("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 and CBS. In July, most
of those claims were struck out by the court in London as unarguable or
otherwise time barred. The
F-32
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company intends to continue to vigorously defend against the few remaining
claims. 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.
On April 6, 1998, the Company sold substantially all 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 has 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 arbitration proceedings to resolve this matter and a
discussion 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.
On June 30, 1999, Template Software, Inc., filed a claim with the National
Association of Securities Dealers for arbitration against Merrill Lynch Pierce
Fenner & Smith ("Merrill Lynch") seeking compensatory damages of $950,000 plus
attorney's fees and lost income resulting from advice rendered by Merrill Lynch
to purchase, and the failure of Merrill Lynch to divest at Template's
instruction, a portfolio of zero coupon long-term bonds held by Template. On
December 27, 1999, Template Software, Inc. was merged into TSAC, Inc., a wholly
owned subsidiary of the Company. Discovery has commenced in the arbitration.
The Company expects that the arbitration will be completed by the end of summer
2000. The Company cannot at this time predict the outcome of these proceedings.
Management does not believe that the results of this arbitration will have a
material effect on the financial position, cash flows, or results of operations
of the Company.
On July 15, 1999, Template filed an action against Manugistics, Inc.
("Manugistics") in the United States District Court for the Eastern District of
Virginia, seeking compensatory damages of approximately $1.25 million resulting
from breach of certain representations contained in a license agreement for
Manugistics-developed software. Manugistics filed a counterclaim against the
Company, asserting breach of contract, breach of alleged settlement, and
wrongful hiring. On October 19, 1999, the Company filed an amended complaint to
include two additional claims, fraud in the inducement and constructive fraud,
seeking additional damages of $2 million. Subsequent to December 31, 1999, the
Company settled this litigation matter at no loss to the Company. The terms of
this settlement are confidential.
NOTE 19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ----------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
1999:
Net revenues.................... $ 13,205 $ 13,007 $ 12,803 $ 13,905
Gross profit.................... 4,749 5,398 6,178 7,689
Net loss........................ (3,828) (4,224) (2,544) (4,881)
Net loss per share -- basic and
diluted........................ ($0.44) ($0.49) ($0.31) ($0.54)
1998:
Net revenues.................... $ 3,093 $ 3,155 $ 2,349 $ 2,088
Gross profit.................... 901 1,308 358 (199)
Net loss........................ (2,484) (2,026) (2,918) (17,628)
Net loss per share -- basic and
diluted........................ ($0.35) ($0.26) ($0.38) ($2.29)
</TABLE>
F-33
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During the fourth quarter of 1999, the Company recorded significant
nonrecurring adjustments totaling $2,583. The fourth quarter adjustments
related primarily to the acquisition of Template and restructuring charges. See
Notes 2 and 16.
During the fourth quarter of 1998, the Company recorded significant
nonrecurring adjustments totaling $14,025. These adjustments related primarily
to the acquisition of Seer, the impairment of the note receivable from the sale
of a subsidiary, the impairment of goodwill recorded in connection with the
acquisition of Momentum, and the restructuring charges. See Notes 2, 3, 7, and
16.
F-34
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------- ------------
<S> <C> <C>
ASSETS
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.
F-35
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
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.
F-36
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
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.
F-37
<PAGE>
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
<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)
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.
F-38
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO 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.
F-39
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(unaudited)
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).
F-40
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(unaudited)
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 Six months ended
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>
F-41
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(unaudited)
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 Six months
ended June 30, ended 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
F-42
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(unaudited)
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.
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.
F-43
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
----------------
To the Stockholders of Seer Technologies, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and retained earnings and of cash flows
present fairly, in all material respects, the financial position of Seer
Technologies, Inc. and its subsidiaries at September 30, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
As discussed in Note 18, Level 8 Systems, Inc. has acquired a controlling
interest in the Company.
/s/ PricewaterhouseCoopers LLP
Washington, D.C.
December 31, 1998
F-44
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
September 30, September 30,
1998 1999
------------- -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents.............................. $ 1,040 $ 4,268
Trade accounts receivable, less allowance for doubtful
accounts.............................................. 17,285 31,383
Prepaid expenses and other current assets.............. 1,476 1,947
Deferred income taxes.................................. -- 1,152
Total current assets............................... 19,801 38,750
Trade accounts receivable, net......................... -- 2,041
Property and equipment, net............................ 1,867 4,528
Capitalized software costs, net........................ 1,140 3,206
Deferred income taxes, net of valuation allowance...... -- 17,599
Other assets........................................... 387 411
--------- --------
Total assets....................................... $ 23,195 $ 66,535
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable, due on demand........................... $ 38,148 $ 22,052
Accounts payable....................................... 2,897 4,279
Accrued expenses:
Compensation......................................... 744 1,964
Commissions.......................................... 1,156 1,536
Restructuring........................................ 4,064 --
Other................................................ 3,459 5,241
Deferred revenue....................................... 7,355 7,813
Income taxes payable................................... 1,644 1,826
--------- --------
59,467 44,711
Deferred revenue....................................... 253 981
Commitments and contingencies (Notes 15 and 16)
Stockholders' equity (deficiency):
Convertible preferred stock, $0.01 par value,
10,000,000 shares authorized in 1998 and 1997,
respectively:
Series A--2,094,143 shares issued and outstanding at
September 30, 1998 and 1997, respectively; $5.969
per share liquidation preference (aggregate
liquidation value of $12,500,000).................. 21 21
Series B--1,732,115 shares issued and outstanding at
September 30, 1998; $2.874 per share liquidation
preference (aggregate liquidation value of
$5,000,000)........................................ 18 --
Common stock $0.01 par value, 30,000,000 shares
authorized in 1998 and 1997, respectively;
11,980,216 and 11,865,167 shares issued and
outstanding at September 30, 1998 and 1997,
respectively........................................ 120 119
Additional paid-in-capital--preferred................ 17,232 12,281
Additional paid-in-capital--common................... 58,791 58,486
Cumulative translation adjustments................... (847) (644)
Accumulated deficit.................................. (111,860) (49,420)
--------- --------
Total stockholder's equity (deficiency)............ (36,525) 20,843
--------- --------
Total liabilities and stockholders' equity......... $ 23,195 $ 66,535
========= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-45
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Years Ended
September 30,
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Operating Revenue:
Software products............................. $ 6,986 $ 34,244 $ 28,795
Maintenance................................... 13,557 14,598 13,182
Services...................................... 43,421 54,311 49,680
--------- -------- --------
Total operating revenue.................... 63,964 103,153 91,657
Cost of Revenue:
Software products............................. 1,786 1,545 1,562
Maintenance................................... 6,480 8,436 9,157
Services...................................... 39,512 41,860 42,401
--------- -------- --------
Total cost of revenue...................... 47,778 51,841 53,120
Gross profit................................... 16,186 51,312 38,537
Operating Expenses:
Sales and marketing........................... 19,312 30,693 43,982
Research and product development.............. 12,894 12,485 16,789
General and administrative.................... 9,999 14,705 19,878
Restructuring charges......................... 13,200 500 3,000
--------- -------- --------
Total operating expenses................... 55,405 58,383 83,649
--------- -------- --------
Loss from operations....................... (39,219) (7,071) (45,112)
Other Income (expense):
Interest income............................... 477 514 648
Interest expense.............................. (3,488) (2,181) (802)
--------- -------- --------
Other income (expense), net................ (3,011) (1,667) (154)
--------- -------- --------
Loss before provision for income taxes......... (42,230) (8,738) (45,266)
Income tax provision (benefit)................. 20,210 1,228 (13,684)
--------- -------- --------
Net loss....................................... $(62,440) $ (9,966) $(31,582)
========= ======== ========
Loss per share--basic and diluted.............. $ (5.23) $ (0.85) $ (2.76)
========= ======== ========
Weighted average common shares outstanding--
basic and diluted............................. 11,941 11,707 11,445
========= ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-46
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(CAPITAL DEFICIENCY)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Series A Series B
Preferred Stock Preferred Stock Common Stock Additional
---------------- ---------------- ----------------- Paid-In Capital
Shares Amount Shares Amount Shares Amount Preferred
--------- ------ --------- ------ ---------- ------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1995.. -- $-- $-- 11,351,948 $114 $ --
Issuance of convertible
preferred shares............. 2,094,143 21 12,281
Issuance of common shares..... 260,159 2
Cumulative translation
adjustment...................
Net loss.......................
--------- ---- --------- ---- ---------- ---- -------
Balance at September 30, 1996.. 2,094,143 21 -- -- 11,612,107 116 12,281
Issuance of stock............. 263,060 3
Repurchase of common shares... (10,000)
Cumulative translation
adjustment...................
Net loss.......................
--------- ---- --------- ---- ---------- ---- -------
Balance at September 30, 1997.. 2,094,143 21 -- -- 11,865,167 119 12,281
Issuance of convertible
preferred shares............. 1,762,115 18 115,049 4,951
Issuance of common shares..... 1
Cumulative translation
adjustment...................
Net loss.......................
--------- ---- --------- ---- ---------- ---- -------
Balance at September 30, 1998.. 2,094,143 $ 21 1,762,115 $ 18 11,980,216 $120 $17,232
========= ==== ========= ==== ========== ==== =======
</TABLE>
<TABLE>
<CAPTION>
Total
Additional Cumulative Stockholders'
Paid-In Capital Translation Accumulated Equity/(Capital
Common Adjustment Deficit Deficiency)
--------------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
Balance at September 30,
1995................... $56,541 $(395) $ (7,822) $ 48,438
Issuance of convertible
preferred shares...... 12,302
Issuance of common
shares................ 1,003 1,005
Cumulative translation
adjustment............ (110) (110)
Net loss............... (31,582) (31,582)
------- ----- --------- --------
Balance at September 30,
1996................... 57,544 (505) (39,404) 30,053
Issuance of stock...... 992 995
Repurchase of common
shares................ (50) (50) (100)
Cumulative translation
adjustment............ (139) (139)
Net loss............... (9,966) (9,966)
------- ----- --------- --------
Balance at September 30,
1997................... 58,486 (644) (49,420) 20,843
Issuance of convertible
preferred shares...... 4,969
Issuance of common
shares................ 305 306
Cumulative translation
adjustment............ (203) (203)
Net loss............... (62,440) (62,440)
------- ----- --------- --------
Balance at September 30,
1998................... $58,791 $(847) $(111,860) $(36,525)
======= ===== ========= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-47
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For The Years Ended
September 30,
----------------------------
1998 1997 1996
--------- ------- --------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net loss........................................ $(62,440) $(9,966) $(31,582)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.................. 3,716 4,328 4,408
Deferred income taxes.......................... 18,751 (1,159) (16,577)
Provision for uncollectible accounts........... 1,027 4,338 10,158
Write-down of assets........................... 4,792 -- --
Non-cash cost of credit guaranty............... 98 336 67
Non-cash compensation cost..................... -- 86 --
Changes in assets and liabilities:
Trade accounts receivable..................... 11,929 8,863 (9,043)
Prepaid expenses and other assets............. 340 1,882 28
Accounts payable, accrued expenses, and income
taxes payable................................ (882) (7,899) 2,444
Deferred revenue.............................. (1,186) (2,721) 3,922
--------- ------- --------
Net cash used in operating activities........ (23,855) (1,912) (36,175)
Cash Flows From Investing Activities:
Purchases of property and equipment............. (358) (1,031) (2,768)
Capitalization of software development costs.... (128) (1,373) (1,600)
--------- ------- --------
Net cash used in investing activities........ (486) (2,404) (4,368)
Cash Flows From Financing Activities:
Issuance of common shares....................... 208 797 602
Repurchase of common shares..................... -- (100) --
Issuance of preferred shares.................... 5,000 -- 12,500
Preferred stock issuance costs.................. (31) -- (198)
Debt issuance costs............................. -- (280) --
Net borrowings under lines of credit............ 15,956 7,813 14,379
--------- ------- --------
Net cash provided by financing activities.... 21,133 8,230 27,283
Effect of exchange rate changes on cash.......... (20) (23) (13)
--------- ------- --------
Net increase (decrease) in cash and cash
equivalents..................................... (3,228) 3,891 (13,273)
Cash And Cash Equivalents:
Beginning of period............................. 4,268 377 13,650
--------- ------- --------
End of period................................... $ 1,040 $ 4,268 $ 377
========= ======= ========
Supplemental disclosures of cash flow
information:
CASH PAID DURING THE PERIOD FOR:
Income Taxes.................................... $ 1,326 $ 2,400 $ 1,596
========= ======= ========
Interest........................................ $ 3,006 $ 2,040 $ 846
========= ======= ========
</TABLE>
During fiscal years 1998 and 1996, the Company issued 30,000 and 75,000 shares
of its common stock, respectively, to Welsh, Carson, Anderson, & Stowe VI
("WCAS") in exchange for WCAS's guaranty of one of the Company's lines of
credit. See Note 5. The Company recorded expense of $98 and $403 related to
these transactions based on the fair market value of the stock on the date of
issuance.
The accompanying notes are an integral part of the consolidated financial
statements.
F-48
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share data)
NOTE 1. SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Operations
Seer Technologies, Inc. ("Seer" or the "Company") is one of the software
industry's earliest pioneers and a long-time leader in component-based software
application development. Seer helps Global 5000 companies leverage information
technology as a competitive weapon by enabling the deployment and on going
renewal of large-scale, business-critical systems. Seer provides solutions for
the business problems of delivering application functionality, extending the
return on information technology investment and managing enterprise application
life cycles in complex development environments through a combination of
consulting services, best practices methodologies, application assets and
enabling technologies.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries, all of which are wholly owned. All significant
intercompany accounts and transactions are eliminated in consolidation.
Foreign Currency Translation
The assets and liabilities of foreign subsidiaries are translated to U.S.
dollars at the current exchange rate as of the balance sheet date. The
resulting translation adjustment is recorded as a separate component of
stockholders' equity. Statements of operations items are translated at average
rates of exchange during each reporting period. Transaction gains and losses
are included in current operations. Realized and unrealized net losses (gains)
for transactions denominated in foreign currencies were $10, $136, and $556,
respectively, for the fiscal years ended September 30, 1998, 1997, and 1996.
Revenue Recognition
Revenue from the non-exclusive licensing of existing software products is
recognized when the software is accepted and delivered or installed by the
customer in accordance with the terms of the contract and only if no
significant vendor obligations remain and collection of the resulting
receivables is deemed probable. For license agreements where maintenance is
bundled with the software license for a time period greater than three months,
an appropriate portion of the license fees is deferred and amortized over the
initial maintenance period.
Revenue from recurring maintenance contracts is recognized ratably over the
maintenance contract period, which is typically twelve months. Maintenance
revenue that is not yet earned is included in deferred revenue.
Revenue from consulting and training services is recognized as services are
performed.
Proceeds from product development contracts are recorded as deferred revenue
when collected and the revenue is recognized as the development work is
performed.
The Company typically does not grant to its customers a contractual right to
return software products. Accordingly, no provision for estimated returns is
recorded at the time of sale. When approved by management, however, the Company
will accept returns of certain software products and will provide an allowance
for those specific transactions.
The Company typically does not grant to its customers a contractual right to
return software products. Accordingly, no provision for estimated returns is
recorded at the time of sale. When approved by management, however, the Company
will accept returns of certain software products and will provide an allowance
for those specific transactions.
F-49
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cost of Revenue
The primary components of the Company's cost of revenue for its software
products are packaging and distribution costs, software amortization and
royalties. The primary components of the Company's cost of revenue for
maintenance are payments under various distribution and marketing agreements
with IBM and customer support. A portion of the costs related to customer
support are deferred and recognized as the service is provided. The primary
component of the Company's cost of revenue for services is compensation
expense.
Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and highly liquid
investments with a maturity of three months or less from the date of purchase.
For these instruments, the carrying amount is a reasonable estimate of fair
value. The Company places substantially all cash and cash equivalents with
various financial institutions in both the United States and several foreign
countries. At times, such cash and cash equivalents may be in excess of FDIC
insurance limits.
Property and Equipment
Property and equipment is stated at cost and depreciated using the straight-
line method over the estimated useful lives of the related assets as follows:
<TABLE>
<S> <C>
Leasehold improvements........................ The lesser of the lease term
or estimated useful life
Furniture and fixtures........................ 3 to 5 years
Office equipment.............................. 3 years
Computer equipment............................ 4 years
</TABLE>
Expenditures for repairs and maintenance are charged to expense as incurred.
The cost and related accumulated depreciation of property and equipment are
removed from the accounts upon retirement or other disposition and any
resulting gain or loss is reflected in operations.
Software Costs
The Company capitalizes certain software costs after technological management
with respect to certain external factors, including, feasibility of the product
has been established. The establishment of technological feasibility and the
ongoing assessment of recoverability of capitalized software development costs
requires considerable judgment by management with respect to certain external
factors, including, but not limited to, technological feasibility, anticipated
future gross revenue, estimated economic life and changes in software and
hardware technologies.
All capitalized software costs are amortized over related sales on a product-
by-product basis at the greater of the amount computed using (a) the ratio of
current gross revenues for a product to the total of current and anticipated
future gross revenues or (b) the straight-line method over the remaining
estimated economic life of the product. Generally, an original estimated
economic life of three years is assigned to capitalized software costs, once
the product is available for general release to customers. Costs incurred prior
to the establishment of technological feasibility are charged to research and
development expense. Each quarter, the Company evaluates the value of its
capitalized software costs based on the estimated discounted future cash flows.
Research and Product Development
Research and product development costs are expensed as incurred.
F-50
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Forward Exchange Contracts
The Company conducts its business in various foreign currencies. As a result,
it is subject to the transaction exposures that arise from foreign exchange
rate movements between the dates that foreign currency transactions are
recorded and the date they are consummated. The Company enters into foreign
exchange forward contracts to hedge the effect of fluctuating foreign
currencies on its results of operations (see Note 11). Gains and losses
associated with exchange rate fluctuations on forward contracts are recorded
currently as income or loss as they offset corresponding gains and losses on
the foreign currency denominated assets or liabilities being hedged. The gains
and losses are computed by multiplying the foreign currency amounts of the
forward contracts by the difference between the quoted market spot rate at the
balance sheet date and the spot rate at the date of inception of the forward
contracts. The costs of the forward contracts are recorded as expense over the
lives of the contracts. Cash flows related to forward exchange contracts are
classified in the Consolidated Statement of Cash Flows in the same categories
as the hedged assets or liabilities.
Income Taxes
The Company has adopted Statement of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes" to account for income taxes. This
statement requires an asset and liability approach that recognizes deferred tax
assets and liabilities for the expected future tax consequences of events that
have been recognized in the Company's financial statements or tax returns. In
estimating future tax consequences, all expected future events other than
enactments of changes in the tax law or rates are generally considered.
Earnings/(Loss) Per Share
During fiscal year 1998, the Company adopted the provisions of SFAS No. 128,
"Earnings per Share", which specifies the computation, presentation, and
disclosure requirements for earnings per share. All prior period earnings per
share data has been restated, as applicable, to conform with the provisions of
the statement.
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. Basic earnings (loss) per share equals
diluted earnings (loss) per share for all periods presented since the inclusion
of potentially dilutive securities would be anti-dilutive to the diluted
earnings (loss) per share calculations. Potentially dilutive securities
outstanding during fiscal years 1996, 1997 and 1998 include stock options,
nonvested stock, and Series A convertible preferred stock. Series B convertible
preferred stock were also potentially dilutive securities outstanding since the
third quarter of fiscal year 1998.
Stock-Based Compensation
The Company has adopted the disclosure provisions of SFAS 123 and has applied
Accounting Principles Board Opinion No. 25 and related Interpretations in
accounting for its stock-based compensation plans. Accordingly, no compensation
cost has been recognized in the Consolidated Statement of Operations for its
stock option plans. See Note 7.
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.
Reclassifications
Certain prior year amounts in the accompanying financial statements have been
reclassified to conform to the 1998 presentation. Such reclassifications had no
effect on previously reported net income or stockholders' equity.
F-51
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at September 30:
<TABLE>
<CAPTION>
1998 1997
------- --------
<S> <C> <C>
Computer equipment........................................... $ 3,532 $ 12,961
Leasehold improvements....................................... 1,675 2,122
Office equipment............................................. 1,194 1,286
Furniture and fixtures....................................... 1,884 2,354
------- --------
8,285 18,723
Less accumulated depreciation and amortization............... (6,418) (14,195)
------- --------
$ 1,867 $ 4,528
======= ========
</TABLE>
Depreciation and amortization expense was $2,027, $2,962, and $3,137 for the
fiscal years ended September 30, 1998, 1997, and 1996, respectively.
During the second quarter of fiscal year 1998, property and equipment was
written down for obsolescence and retirement of assets based on the Company's
revised business plan. The write down totaled $901 and is included in
restructuring charges in the Consolidated Statement of Operations. See Note 12.
NOTE 3. CAPITALIZED SOFTWARE COSTS
For the fiscal years ended September 30, 1998, 1997 and 1996, the Company
capitalized $128, $1,372, and $1,600, respectively, of internal costs related
to developing software for sale. During the fiscal years ended September 30,
1998, 1997 and 1996, the Company recognized $1,544, $1,223, and $968,
respectively, of expense related to the amortization of these costs, which is
recorded in cost of revenue, software products, in the Consolidated Statements
of Operations.
During the second quarter of fiscal year 1998, capitalized software cost was
written down to its fair value based on the Company's revised business plan.
The write down totaled $650 and is included in the restructuring charges in the
Consolidated Statement of Operations. Accumulated amortization of capitalized
software costs is $4,096 and $2,814 at September 30, 1998 and 1997,
respectively.
NOTE 4. ACCOUNTS RECEIVABLE
Trade accounts receivable consists of the following at September 30:
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Current trade accounts receivable............................ $19,585 $33,355
Less: Allowance for doubtful accounts........................ (2,124) (1,360)
Unamortized discount....................................... (176) (612)
------- -------
$17,285 $31,383
======= =======
Noncurrent trade accounts receivable......................... $ -- $ 2,414
Less: Unamortized discount................................... -- (373)
------- -------
$ -- $ 2,041
======= =======
</TABLE>
F-52
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Approximately $4,118 and $8,942 of current trade receivables were unbilled at
September 30, 1998 and 1997, respectively. All noncurrent receivables were
unbilled at September 30, 1997. Discounts on receivables with payment terms in
excess of one year were calculated based on an imputed interest rate of 12% for
the fiscal year ended September 30, 1997. There were no receivables with
payment terms in excess of one year recorded during the fiscal year ended
September 30, 1998.
The provision for uncollectible amounts was $1,027, $4,338 and $10,158 for the
years ended September 30, 1998, 1997, and 1996, respectively. During the second
and third quarters of fiscal year 1998, accounts receivable was written down
due to a deterioration in specific client relationships as a result of the
Company's revised business plan. The write down totaled $3,000 and is included
in restructuring charges in the Consolidated Statement of Operations. Write-
offs of accounts receivable were $3,263, $12,329, and $1,457 for the years
ended September 30, 1998, 1997, and 1996, respectively.
NOTE 5. CREDIT FACILITIES
At September 30, 1998, the Company maintained two credit facilities (the
"Revolving Facility" and the "Guaranteed Facility") which provided for combined
borrowings of up to $42 million for working capital purposes based on the
Company's eligible accounts receivable, as defined in the loan agreements. The
Revolving Facility allows for borrowings of up to $25 million, bears interest
at the London Interbank Offered Rate ("LIBOR") plus 5.0% and is collateralized
by the Company's accounts receivable, equipment and intangibles. The Guaranteed
Facility allows for borrowings of up to $17 million and bears interest at the
higher of LIBOR plus 1.25% or .5% plus the prime rate quoted by the Federal
Reserve. Until December 31, 1998, the Guaranteed Facility was guaranteed by the
Company's principal stockholder, Welsh, Carson, Anderson, & Stowe VI, L.P.
("WCAS"), pursuant to an agreement with the Company. Borrowings under the
Revolving Facility must always exceed borrowings under the Guaranteed Facility.
There are no other financial covenants for either credit facility. As of
September 30, 1998, the Company had outstanding borrowings of $21,223 under the
Revolving Facility and $16,925 under the Guaranteed Facility. The interest
rates for the Revolving Facility and the Guaranteed Facility were 10.6% and
8.5%, respectively, at September 30, 1998.
During fiscal year 1997, the Company incurred approximately $280 in connection
with the renegotiation of its revolving credit facility. The loan costs were
amortized over the initial term of the facility and were fully amortized at
September 30, 1998. The unamortized loan costs of $140 at September 30, 1997
are included in the Consolidated Balance Sheet as a deduction from notes
payable.
In exchange for WCAS' guarantee of its credit facility, the Company issued
30,000 and 75,000 shares of its common stock to WCAS in fiscal years 1998 and
1996, respectively. The Company recorded expense of $98 and $403 related to
these transactions based on the fair market value of the stock on the date of
issuance.
Additionally, at September 30, 1998, the Company had a line of credit of $500
available to enter foreign exchange forward contracts which was also guaranteed
by WCAS. At September 30, 1998 the aggregate notional amount of foreign
exchange forward contracts outstanding was $6,308.
Subsequent to September 30, 1998, the Company and its lender completed several
amendments to the Revolving Facility and the Guaranteed Facility and the
foreign exchange line of credit were terminated. See Note 18.
NOTE 6. CONVERTIBLE PREFERRED STOCK
During April, 1998, the Company completed its agreement to sell 1,762,115
shares of its Series B Convertible Preferred Stock (the "Preferred Stock") to
WCAS and certain WCAS affiliates, resulting in gross proceeds to the Company of
$5 million.
F-53
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During August 1996, the Company sold 2,094,143 shares of its newly authorized
Series A Convertible Preferred Stock (the "Preferred Stock") to WCAS and
certain WCAS affiliates, resulting in gross proceeds to the Company of $12,500.
Approximately $198 of expenses was incurred in connection with the stock
issuance and has been recorded in the Consolidated Statement of Stockholders'
Equity (Capital Deficiency) as an offset to the Preferred Stock proceeds.
Each share of Preferred Stock may be converted at any time at the option of the
holder into shares of Common Stock at a conversion rate of one common share for
each share of Preferred Stock, subject to adjustment upon the occurrence of
certain events. The Preferred Stock is not entitled to receive dividends in any
fixed amount but will receive dividends on an as converted basis in the event
that a dividend is paid on the Common Stock. The Preferred Stock will rank
senior in right of payment to the Common Stock. In the event of any
liquidation, dissolution or winding up of the Company, holders of Series A and
Series B Preferred Stock will be entitled to receive a liquidation preference
of $5.969 and $2.8375 per share, respectively, before payment is made or assets
are distributed to holders of the Common Stock. In addition, the holders of
Preferred Stock are entitled to vote together with the holders of Common Stock
on all matters to be voted on by the stockholders of the Company.
The Company is subject to certain restrictions while shares of Preferred Stock
remain outstanding, including restrictions on the Company's ability to declare
dividends, purchase or redeem any outstanding shares of its Common Stock,
create or authorize the creation of additional classes of capital stock of the
Company, increase the authorized amount of Preferred Stock, create or authorize
the creation of any securities convertible into shares of Preferred Stock or
any other class of capital stock of the Company.
NOTE 7. STOCK-BASED COMPENSATION PLANS
The Company has a Stock Option and Restricted Stock Purchase Plan pursuant to
which certain employees and officers of the Company have been or will be
granted nonvested stock or stock options to acquire up to a maximum of
2,900,000 shares of the Company's common stock. Option exercise prices are no
less than 100% of the fair market value at the date of grant, and vested
options may be exercised for a period of up to ten years from the date of
grant. During the fiscal year ended September 30, 1996, the Company exchanged
all options with exercise prices of $7.50 or more per share for options with an
exercise price of $6.38 per share, which was the fair market value of the
Company's common stock on the date of exchange. During the fiscal year ended
September 30, 1998, the Company exchanged all options held by employees with
exercise prices of $4.75 or more per share for options with an exercise price
of $4.59. Effective October 1, 1996, the vesting provisions of the plan were
amended so that the nonvested stock and stock options issued after that date
vest over a specified period of time as determined by the Company's
compensation committee when the options are granted. Vesting provisions for
options issued prior to October 1, 1996 were amended so that any options
existing at October 1, 1996 vested over a four year period.
The Company also has a Stock Option Plan for Non-Employee Directors, pursuant
to which non-employee directors can be granted options to acquire up to 200,000
shares of the Company's common stock, with a maximum of 10,000 options
available per non-employee director. The options vest in one-third increments
on each of the first through third anniversaries of the grant date.
F-54
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Activity for stock options issued under these plans for the fiscal years ending
September 30, 1998, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
Weighted Average
Plan Activity Option Price per Share Exercise Price
------------- ---------------------- ----------------
<S> <C> <C> <C>
Balance at September 30,
1995................... $ 2,147,650 $3.25-$18.00 $3.38
Granted................ 735,450 5.50- 18.00 9.91
Exercised.............. (185,159) 3.25- 10.00 3.26
Forfeited.............. (581,696) 3.25- 14.50 3.64
----------- -----
Balance at September 30,
1996................... 2,116,245 3.25- 18.00 4.74
Granted................ 808,625 3.25- 6.50 4.37
Exercised.............. (243,696) 3.25- 6.38 3.26
Forfeited.............. (907,805) 3.25- 6.38 3.64
----------- -----
Balance at September 30,
1997................... 1,773,369 3.25- 18.00 5.31
Granted................ 2,240,600 2.84- 7.88 3.64
Exercised.............. (63,716) 3.25- 6.38 3.36
Forfeited.............. (1,550,827) 2.84- 8.25 4.76
----------- -----
Balance at September 30,
1998................... $ 2,399,426 $3.25-$14.50 $3.32
=========== =====
</TABLE>
The weighted average grant date fair value of options issued during the years
ended September 30, 1998, 1997 and 1996 was equal to $1.82, $2.72 and $3.87 per
share, respectively. The fair value of options granted during the fiscal years
ended September 30, 1998, 1997 and 1996 was equal to $4,413, $2,159 and $2,813,
respectively. There were no option grants issued below fair market value during
fiscal years 1998, 1997 or 1996.
The fair value of the Company's stock-based awards to employees was estimated
as of the date of the grant using the Black-Scholes option-pricing model, using
the following weighted-average assumptions:
<TABLE>
<CAPTION>
<S> <C>
Expected life (in years)............................................... 3
Expected volatility.................................................... 77%
Risk free interest rate................................................ 5.53%
Expected dividend yield................................................ 0%
</TABLE>
For disclosure purposes, the adjusted estimated fair value of the Company's
stock-based awards to employees is amortized over the vesting period. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates as calculated in
accordance with SFAS 123, the Company's net loss and loss per share for the
fiscal years September 30, 1998, 1997, and 1996 would have been increased to
the pro forma amounts indicated below. The Company's adjusted information
follows (in thousands, except for per share information):
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- --------
<S> <C> <C> <C>
Net loss, as reported.......................... $(62,440) $(9,966) $(31,582)
Net loss, as adjusted.......................... (63,348) (10,591) (31,703)
Pro forma net loss per share, as reported...... $ (5.23) $ (0.85) $ (2.76)
Pro forma net loss per share, as adjusted...... $ (5.31) $ (0.90) $ (2.77)
</TABLE>
F-55
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At September 30, 1998, 1997 and 1996 options to purchase approximately 382,067,
284,015 and 184,348 shares of common stock were exercisable, respectively,
pursuant to the plans at prices ranging from $3.25 to $18.00. The following
table summarizes information about stock options outstanding at September 30,
1998:
<TABLE>
<CAPTION>
Remaining Contractual
Number Life for Options Number
Exercise Price Outstanding Outstanding Exercisable
-------------- ----------- --------------------- -----------
<S> <C> <C> <C>
$ 2.50 50,000 9.50 50,000
$ 2.84 1,528,150 9.61 --
$ 3.25 234,086 6.12 202,622
$ 3.75 89,375 8.14 23,750
$ 4.59 397,582 9.61 72,130
$ 4.75 20,002 8.33 13,334
$ 5.00 40,000 7.91 10,000
$ 6.38 233 8.79 233
$ 7.00 30,000 8.95 --
$10.00 3,333 6.42 3,333
$14.50 6,665 7.00 6,665
--------- -------
2,399,426 382,067
========= =======
</TABLE>
During the fiscal year ended September 30, 1997, the Company issued 38,500
shares of nonvested stock to employees. The Company recognized compensation
expense with respect to nonvested stock awards equal to the difference between
the market price and the par value of the stock on the grant date. Compensation
expense recognized during fiscal year 1997 for nonvested stock was $172. Of the
total shares issued, 21,750 shares vested during fiscal year 1998, and the
remaining shares were forfeited.
NOTE 8. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan for all U.S. employees. Effective January 1,
1997, the Company amended the plan to provide a 25% matching contribution for
an employee's contribution up to 4% of an employee's salary. Participants must
be employed at December 31 of each calendar year to be eligible for employer
matching contributions. During fiscal year 1998, the Company recorded expense
of $257 related to the matching contribution. Prior to this amendment, matching
contributions were made at the discretion of the Board of Directors. For the
year ended September 30, 1996, the Board of Directors did not authorize any
contributions to the 401(k) plan.
The Company also has employee benefit plans for each of its foreign
subsidiaries, as mandated by each country's laws and regulations. Expense
recognized under these plans for the years-ended September 30, 1998, 1997, and
1996 was $669, $684, and $629, respectively.
The Company has an Employee Stock Purchase Plan for its employees. The plan
allows employees to purchase shares of the Company's common stock for 85% of
fair market value. The Company is responsible for the differential in market
value, as well as, all administrative costs of the plan. For fiscal years 1998,
1997, 1996, the Company incurred expenses of $26, $48, and $31, respectively,
for the plan.
NOTE 9. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
No one customer accounted for more than 10% of operating revenue for the fiscal
years ended September 30, 1998, 1997, and 1996.
F-56
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has entered into several marketing and distribution agreements with
IBM throughout the world. Transactions resulting from these agreements are as
follows for the fiscal years ended September 30:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Expenses incurred................................. $ 2,128 $ 1,720 $ 4,907
Revenues generated................................ $24,456 $55,029 $59,493
Percentage of revenues............................ 38% 53% 65%
Percentage of outstanding receivables............. 37% 46% 70%
</TABLE>
As of September 30, 1998 and 1997, the Company had outstanding trade accounts
receivable primarily from 86 and 97 customers, respectively. It is the policy
of the Company to closely monitor all accounts receivable and to record a
provision for uncollectible accounts when the uncollectible amounts are
estimable. Generally, no collateral is required.
NOTE 10. SEGMENT INFORMATION
In 1998, the Company adopted SFAS 131, "Enterprise and Related Information."
SFAS 131 supercedes SFAS 14, "Financial Reporting for Segments of a Business
Enterprise," replacing the "industry segment" approach with the "management"
approach. The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of the Company's relating segment information. The prior year's
segment information has been restated to present the Company's four 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." Segment data
includes a charge allocating all corporate-headquarters costs 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 earnings (loss) before interest, taxes, and restructuring charges
(EBITR).
The table below presents information about reported segments for the years
ending September 30:
<TABLE>
<CAPTION>
Research and
Software Maintenance Services Development Total
-------- ----------- -------- ------------ --------
(in thousands)
<S> <C> <C> <C> <C> <C>
FY 1998
Total Revenue.......... $ 6,986 $13,557 $43,421 $ -- $ 63,964
Total EBITR............ $(16,962) $ 6,267 $(1,031) $(14,293) $(26,019)
-------- ------- ------- -------- --------
FY 1997
Total Revenue.......... $ 34,244 $14,598 $54,311 $ -- $103,153
Total EBITR............ $ (3,203) $ 4,860 $ 5,971 $(14,199) $ (6,571)
-------- ------- ------- -------- --------
FY 1996
Total Revenue.......... $ 28,795 $13,182 $49,680 $ -- $ 91,657
Total EBITR............ $(24,698) $ 2,426 $ (122) $(19,719) $(42,113)
-------- ------- ------- -------- --------
</TABLE>
A reconciliation of total segment revenue to total consolidated revenues and of
total segment EBITR to total consolidated income before taxes, for the years
ended September 30, 1998, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- --------
<S> <C> <C> <C>
Total EBITR.................................... $(26,019) $(6,571) $(42,113)
Restructuring charges.......................... (13,200) (500) (3,000)
Interest expense............................... (3,011) (1,667) (154)
-------- ------- --------
Total loss before income taxes............... $(42,230) $(8,738) $(45,267)
======== ======= ========
</TABLE>
F-57
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents a summary of revenue by geographic region for the
fiscal years ended September 30:
<TABLE>
<CAPTION>
1998 1997 1996
------- -------- -------
<S> <C> <C> <C>
United States....................................... $17,544 $ 32,864 $28,974
United Kingdom...................................... 8,935 15,899 3,951
Denmark............................................. 6,226 4,420 5,157
Italy............................................... 5,395 12,738 14,770
Switzerland......................................... 3,687 2,965 1,850
Norway.............................................. 3,130 3,561 2,120
Australia........................................... 2,858 4,726 3,167
Germany............................................. 2,780 6,233 9,588
Other............................................... 13,140 19,747 22,080
------- -------- -------
Total revenue..................................... $63,965 $103,153 $91,657
======= ======== =======
</TABLE>
Foreign revenue is based on the country in which the customer is domiciled.
The following table represents a summary of long-lived assets by geographic
region as of September 30:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
United States........................................... $2,383 $6,208 $7,431
United Kingdom.......................................... 487 979 1,438
Other................................................... 137 547 647
------ ------ ------
Total assets.......................................... $3,007 $7,734 $9,516
====== ====== ======
</TABLE>
The Company's foreign operations are reimbursed by the Company for their costs
plus an appropriate mark-up for profit. Intercompany profits and losses are
eliminated in consolidation.
NOTE 11. FOREIGN CURRENCIES AND FORWARD EXCHANGE CONTRACTS
At September 30, 1998, the Company had approximately $628 and $8,754 U.S.
dollar equivalent cash and trade receivable balances, respectively, denominated
in foreign currencies. At September 30, 1997, the Company had approximately
$1,378 and $15,618 U.S. dollar equivalent cash and trade receivable balances,
respectively, denominated in foreign currencies.
The more significant trade accounts receivable denominated in foreign
currencies as a percentage of total trade accounts receivable were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Pound Sterling................................................... 10.9% 9.2%
Australian Dollar................................................ 1.2 7.2
Deutsche Mark.................................................... 3.5 2.0
Brazilian Real................................................... 3.1 4.2
Italian Lira..................................................... 8.1 12.4
Danish Krona..................................................... 4.9 3.1
</TABLE>
The Company enters into forward exchange contracts to hedge the exposures that
arise from foreign exchange movements between dates that foreign currency
denominated receivables and payables are recorded and the date they are paid.
The Company does not engage in foreign currency speculation. The forward
contracts are
F-58
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
generally 60 to 90 day forward window contracts having maturities of less than
one year. The table below summarizes, by currency, the contractual amounts of
the Company's forward contracts for the years ended September 30:
<TABLE>
<CAPTION>
As of September 30, 1998
--------------------------
Original Contract Contract Fair Unrealized
1998 Currency Contracts Drawdowns Balance Value Gain/(loss)
------------- --------- --------- -------- ------ ----------
<S> <C> <C> <C> <C> <C>
Outbound Transactions
Australian Dollars.............. $ 140 $ (140) $ -- $ -- $ --
Pound Sterling.................. 16,030 (16,030) -- -- --
Deutsche Mark................... 1,322 (1,322) -- -- --
Irish Punt...................... 1,760 (640) 1,120 1,196 76
------- -------- ------ ------ -----
Total......................... $19,252 $(18,132) $1,120 $1,196 $ 76
======= ======== ====== ====== =====
Inbound Transactions
Australian Dollars.............. $ 1,427 $ (1,427) $ -- $ -- $ --
Pound Sterling.................. 10,590 (8,742) 1,848 1,887 (39)
Canadian Dollars................ 520 (520) -- -- --
Danish Krona.................... 6,230 (5,870) 360 380 (20)
Deutsche Mark................... 2,723 (2,177) 546 563 (17)
Dutch Guilder................... 1,976 (1,739) 237 241 (4)
French Franc.................... 567 (479) 88 93 (5)
Italian Lira.................... 9,860 (8,948) 912 943 (31)
Norwegian Krone................. 4,450 (4,128) 322 335 (13)
South African Rand.............. 1,760 (1,430) 330 348 (18)
Spanish Peseta.................. 899 (602) 297 299 (2)
Swedish Krone................... 2,139 (1,891) 248 257 (9)
------- -------- ------ ------ -----
Total......................... $43,141 $(37,953) $5,188 $5,346 $(158)
======= ======== ====== ====== =====
<CAPTION>
As of September 30, 1997
--------------------------
Original Contract Contract Fair Unrealized
1997 Currency Contracts Drawdowns Balance Value Gain/(Loss)
------------- --------- --------- -------- ------ ----------
<S> <C> <C> <C> <C> <C>
Outbound Transactions
Australian Dollars.............. $ 389 $ (389) $ -- $ -- $ --
Pound Sterling.................. 13,264 (7,865) 5,399 5,496 97
Deutsche Mark................... 3,405 (3,405) -- -- --
------- -------- ------ ------ -----
Total......................... $17,058 $(11,659) $5,399 $5,496 $ 97
======= ======== ====== ====== =====
Inbound Transactions
Australian Dollars.............. $ 2,629 $ (2,629) $ -- $ -- $ --
Pound Sterling.................. 24,430 (22,882) 1,548 1,570 (22)
Canadian Dollars................ 926 (628) 298 299 (1)
Danish Krona.................... 4,371 (3,880) 491 494 (3)
Deutsche Mark................... 9,156 (8,719) 437 458 (21)
Dutch Guilder................... 865 (865) -- -- --
Italian Lira.................... 21,058 (19,526) 1,532 1,589 (57)
Norwegian Krone................. 4,456 (4,182) 274 291 (17)
Spanish Peseta.................. 1,303 (1,156) 147 154 (7)
Swedish Krone................... 5,826 (5,645) 181 185 (4)
Other........................... 1,005 (989) 16 17 (1)
------- -------- ------ ------ -----
Total......................... $76,025 $(71,101) $4,924 $5,057 $(133)
======= ======== ====== ====== =====
</TABLE>
F-59
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Unrealized gains and losses on forward contracts reflect changes in exchange
rates and are recorded directly in income, as they offset corresponding
unrealized gains and losses on the foreign currency denominated assets being
hedged (see Note 1). Forward contract liabilities related to unrealized losses
are recorded as other accrued expenses in the Consolidated Balance Sheet.
The Company is exposed to exchange related losses on forward contracts should a
transaction with a related forward exchange contract not be consummated by the
forward contract expiration date. In such instances, the Company extends or
repurchases the contract at the then prevailing market rates. Net realized
(gains) losses on the extension or repurchase of contracts totaled ($15), $156,
and $88 for the fiscal years ended September 30, 1998 and 1997, and 1996,
respectively.
NOTE 12. RESTRUCTURING CHARGES
During the second quarter of fiscal year 1998, the Company began work on a
revised business plan, necessitated by a decline in demand for the Company's
software products. As a result of this effort, at the end of the second quarter
of fiscal year 1998, the Company announced its plans to streamline its sales
and marketing organizations, as well as reorganize its technical operations
into one cohesive unit, providing improved product support and more focused
development of new products. The general and administrative organization within
the Company was also streamlined to support the newly-restructured operating
divisions. The restructuring included a staff reduction of approximately 5% (31
employees), the abandonment of leased facilities in the US, Brazil, and
Singapore, and the write-down to fair value of certain assets or accrual of
costs related to products, distribution channels, and vendor-provided product
support contracts which were being discontinued. The Company recorded a
restructuring charge of $9,000 during the second quarter of fiscal year 1998,
which consisted of approximately $1,400 in personnel-related charges,
approximately $1,100 of costs associated with carrying vacated space until the
lease expiration date, approximately $2,700 in write-down of assets,
approximately $3,000 for contractually obligated product support services, and
approximately $700 in professional fees related to the restructuring.
The Company completed its restructuring in the third quarter of fiscal year
1998 and recorded an additional charge of $4,200. An additional staff reduction
of approximately 8% (37 employees) was made. This restructuring charge
consisted of approximately $1,100 in personnel related-charges, approximately
$2,000 in the write-down of assets for discontinued distribution channels, and
approximately $1,100 in professional fees related to the restructuring.
The Company's efforts to settle these restructuring liabilities resulted in a
change in the Company's estimates in regard to the specific categories of
expense, however, the amount of the overall charge has not changed. The revised
estimate reflects a total restructuring charge of $2,500 for personnel related
charges, approximately $500 of premises related costs, approximately $4,700 in
write-down of assets, and approximately $1,100 for contractually obligated
product support services, and approximately $4,400 in professional fees and
legal settlement. See Note 16. To date, the Company has paid approximately
$4,400 in cash related to the restructuring. The Company believes the accrued
restructuring cost of $4,100 at September 30, 1998 represents its remaining
cash obligations.
During the third quarter of the fiscal year ended September 30, 1996, the
Company developed and implemented a reorganizational plan which included, among
other things, a 9% staff reduction (75 employees) and the abandonment of
certain leased facilities. The Company recorded a restructuring charge of
$3,000, which consisted of approximately $1,400 in personnel-related charges
and approximately $1,600 of costs associated with carrying vacated space until
the lease expiration date. In the first quarter of 1997, the Company recorded
an additional restructuring charge of $500 for severance and lease costs
related to its reorganizational plan. To date, the Company has paid
approximately $3,500 in cash related to the restructuring. The Company believes
there are no remaining obligations related to this restructuring at September
30, 1998.
F-60
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 13. INCOME TAXES
The provision for income taxes consists of the following for the years ended
September 30:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ --------
<S> <C> <C> <C>
Federal--current.................................. $ -- $ -- $ --
State and local--current.......................... -- -- --
------- ------ --------
Foreign taxes and withholdings.................... 1,459 2,176 2,501
------- ------ --------
Current taxes..................................... 1,459 2,176 2,501
------- ------ --------
Federal--deferred................................. -- (757) (12,832)
State and local--deferred......................... -- (191) (3,353)
------- ------ --------
Deferred taxes.................................... -- (948) (16,185)
------- ------ --------
Change in beginning of year valuation allowance... 18,751 -- --
------- ------ --------
Total income tax expense (benefit)................ $20,210 $1,228 $(13,684)
======= ====== ========
</TABLE>
Seer Technologies, Inc. and its U.S. subsidiary file a consolidated Federal
income tax return. Foreign subsidiaries file income tax returns in their
respective countries. Foreign tax credit carryforwards of approximately $2,268
exist at September 30, 1998. These carryforwards expire from 1999 to 2001 if
not utilized. Federal alternative minimum tax credit carryforwards of $184,
which have no expiration period, also exist at September 30, 1998. The
Company's federal net operating loss carryovers of approximately $89,471 expire
in 2011, 2012 and 2018 if not utilized.
Income before provision for income taxes as shown in the Consolidated
Statements of Operations consists of the following for the years ended
September 30:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Domestic....................................... $(43,747) $(11,214) $(47,868)
Foreign........................................ 1,517 2,476 2,602
-------- -------- --------
$(42,230) $ (8,738) $(45,266)
======== ======== ========
</TABLE>
A reconciliation of expected income tax at the statutory Federal rate with the
actual income tax expense (benefit) is as follows for the fiscal years ended
September 30:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- --------
<S> <C> <C> <C>
Expected income tax benefit at statutory rate
(34%)........................................ $(14,351) $(2,971) $(15,391)
Increase (decrease) in income tax expense
resulting from:
Non deductible expenses..................... 87 213 197
State income taxes.......................... (2,957) (1,693) (2,915)
Effect of foreign operations including
withholding taxes.......................... 1,236 2,177 2,505
Other....................................... -- 92 (92)
Effect of change in valuation allowance..... 36,195 3,410 2,012
-------- ------- --------
$ 20,210 $ 1,228 $(13,684)
======== ======= ========
</TABLE>
F-61
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The components of net deferred tax assets are as follows for the years ended
September 30:
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Current Assets:
Deferred revenue $ 122 $ 303
Accrued liabilities..................................... 1,307 504
Bad debt expense........................................ 786 503
Other................................................... (36) (158)
-------- -------
Net current deferred tax asset........................ 2,179 1,152
Noncurrent Assets:
Depreciation............................................ 536 465
Deferred revenue........................................ -- 49
Foreign tax credits..................................... 2,268 3,212
Minimum tax credits..................................... 184 184
Research and development tax credit..................... 3,000 2,282
Net operating loss carryforward......................... 33,104 21,446
-------- -------
Net noncurrent deferred tax asset..................... 39,092 27,638
Valuation allowance....................................... (40,850) (8,853)
Noncurrent Liabilities:
Capitalized software costs.............................. (421) (1,186)
-------- -------
Net deferred tax asset................................ $ -- $18,751
======== =======
</TABLE>
Due to a decline in the Company's software revenues, the Company determined
during the fourth quarter of fiscal year 1998 that certain previously available
tax planning strategies were no longer deemed to be prudent or feasible. This
caused the Company to record a full valuation allowance equaling the entire
deferred tax asset balances at September 30, 1998 and accordingly, resulted in
an increase in income tax expense for the fiscal year ended September 30, 1998.
NOTE 14. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair market
value. The statement also requires that changes in the derivative's fair market
value be recognized currently in earnings unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for fiscal years beginning June 15,
1999, with earlier adoption permitted. The Company is currently assessing the
impact of this new statement on its consolidated financial position, liquidity,
and results of operations.
In June, 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 is required to be adopted for fiscal years beginning after
December 15, 1997. Upon the effective date of the new statement, the Company
will make the necessary changes to comply with the provisions of the statement
and restate all prior periods presented. The Company does not expect the
adoption of the statement to have a material impact on the Company's financial
condition or results of operations.
The American Institute of Certified Public Accountants has issued Statement of
Position 97-2, "Software Revenue Recognition". SOP 97-2 is effective for
transactions entered into in fiscal years beginning after December 15, 1997 and
provides guidance on applying generally accepted accounting principles in
recognizing revenue on software transactions. The Company does not expect the
application of the SOP to have a material impact on the Company's financial
condition or results of operations.
F-62
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 15. LEASE COMMITMENTS
The Company leases certain facilities and equipment under various operating
leases. Future minimum lease commitments on operating leases that have initial
or remaining non-cancelable lease terms in excess of one year as of
September 30, 1998 are as follows:
<TABLE>
<S> <C>
1999.............................................................. $ 2,870
2000.............................................................. 2,092
2001.............................................................. 1,392
2002.............................................................. 1,242
2003.............................................................. 1,242
Thereafter........................................................ 1,541
-------
$10,379
=======
</TABLE>
Rent expense for the fiscal years ended September 30, 1998, 1997 and 1996 was
$3,894, $3,655, and $3,370, respectively.
NOTE 16. CONTINGENCIES
Various lawsuits and claims have been brought against the Company in the normal
course of business. Management is of the opinion that the liability, if any,
resulting from these claims would not have a material effect on the financial
position or results of operations of the Company.
In December 1997, the Company filed a lawsuit against Saadi Abbas and Cambridge
Business Solutions (UK) Limited ("CBS") alleging that Mr. Abbas and CBS had
injured the Company by interfering with the Company's ability to market and
sublicense the LightSpeed Financial Model. The Company obtained a preliminary
injunction against Mr. Abbas and CBS halting their actions. Mr. Abbas and CBS
filed counterclaims against the Company claiming wrongful dismissal of Abbas
and breach of the license agreement. Due to the erosion of the market for the
LightSpeed Financial Model, the Company voluntarily dismissed its claims
against Mr. Abbas and CBS in the summer of 1998. Mr. Abbas and CBS are
continuing to pursue their claims against the Company. At the present point in
the litigation, it is impossible to calculate the chances of success in this
litigation. However, the Company intends to continue to vigorously defend
against the counterclaim. 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 17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- -------- -------- --------
(Unaudited)
(In thousands, except per share
data)
<S> <C> <C> <C> <C>
1998:
Net revenues.......................... $18,356 $ 15,960 $ 15,631 $ 14,017
Gross profit.......................... 4,715 2,426 4,286 4,760
Net loss.............................. (9,906) (21,275) (10,646) (20,612)
Net loss per share.................... $ (0.83) $ (1.78) $ (0.89) $ (1.72)
1997:
Net revenues.......................... $23,125 $ 24,112 $ 26,929 $ 28,987
Gross profit.......................... 9,930 11,882 14,417 15,083
Net income (loss)..................... (8,270) (2,436) 89 651
Net income (loss) per share........... $ (0.71) $ (0.21) $ 0.01 $ 0.05
</TABLE>
F-63
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Due to a decline in the Company's software revenues, the Company determined
during the fourth quarter of fiscal year 1998 that certain previously available
tax planning strategies were no longer deemed to be prudent or feasible. This
caused the Company to record a full valuation allowance equaling the entire
deferred tax asset balances at September 30, 1998 and accordingly, resulted in
an increase in income tax expense for the fiscal year ended September 30, 1998.
NOTE 18. SUBSEQUENT EVENTS
On October 13, 1998, the Company was delisted from the Nasdaq Stock Market. The
Common Stock of the Company is currently quoted on the Over-the-Counter
Bulletin Board.
On November 24, 1998, the Company and Level 8 Systems, Inc. ("Level 8")
announced the pending strategic merger of the Company with Level 8. Level 8 is
a leading provider of message queuing and enterprise application integration
technologies that allow end-to-end connectivity between heterogeneous platforms
across the enterprise. As the first step in this transaction, on December 31,
1998, Level 8 acquired approximately 69% of the outstanding voting stock of the
Company from WCAS and its affiliates in exchange for 1,000,000 shares of
Level 8 common stock and warrants to purchase an additional 250,000 shares of
Level 8 at an exercise price of $12 per Level 8 share. On December 31, 1998,
Level 8 acquired 7,130,894 shares of the Company's Common Stock, 2,094,143
shares of the Company's Series A Convertible Preferred Stock, and 1,762,115
shares of the Company's Series B Convertible Preferred Stock (representing
approximately 69% of the outstanding voting stock of the Company) and therefore
may be deemed to control the Company. In connection with Level 8's purchase of
the Company's voting stock from WCAS, WCAS contributed $17 million to the
Company and Level 8 provided the Company a $12 million subordinated loan to
help pay down the Company's bank debt. Level 8 has also agreed to acquire all
of remaining shares of the Company's Common Stock for $0.35 per share in cash
as soon as practicable upon completion of required filings and approvals. In
addition, Level 8 has agreed to fund the Company's operations, as necessary,
through January 15, 2000.
On December 22, 1998, the Company's Revolving Facility was amended. The
Revolving Facility now bears interest at the prime rate and terminates on
December 31, 2001. The Revolving Facility is automatically renewed for
successive additional terms of one year each, unless terminated by either
party.
F-64
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1998
------------ -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents........................... $ 479 $ 1,040
Trade accounts receivable, less allowance for doubt
accounts of $2,153 and $2,124 at December 31, 1998
and September 30, 1998, respectively............... 15,005 17,285
Prepaid expenses and other current assets........... 1,418 1,476
--------- ---------
Total current assets............................ 16,902 19,801
Property and equipment, net......................... 1,614 1,867
Capitalized software costs, net..................... 451 1,140
Other assets........................................ 370 387
--------- ---------
Total assets.................................... $ 19,337 $ 23,195
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable, due on demand........................ $ 12,275 $ 38,148
Accounts payable.................................... 1,949 2,897
Accrued expenses:
Compensation...................................... 318 744
Commissions....................................... 1,021 1,156
Restructuring..................................... 3,335 4,064
Other............................................. 3,318 3,459
Deferred revenue.................................... 7,778 7,355
Income taxes payable................................ 1,781 1,644
--------- ---------
Total current liabilities....................... 31,775 59,467
Note payable to majority shareholder................ 12,000 --
Deferred revenue.................................... 97 253
Stockholders' equity (deficiency):
Series A convertible preferred stock, $.01 par
value............................................ 21 21
Series B convertible preferred stock, $.01 par
value............................................ 18 18
Common stock, $.01 par value...................... 120 120
Additional paid-in capital........................ 92,948 76,023
Accumulated other comprehensive income............ (880) (847)
Accumulated deficit............................... (116,762) (111,860)
--------- ---------
Total stockholders' equity (deficiency)......... (24,535) (36,525)
--------- ---------
Total liabilities and stockholders' equity...... $ 19,337 $ 23,195
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-65
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months
Ended
December 31,
1998 1997
-------- -------
<S> <C> <C>
Revenue:
Software products......................................... $ 69 $ 2,698
Maintenance............................................... 3,056 3,449
Services.................................................. 7,778 12,209
-------- -------
Total operating revenue................................ 10,903 18,356
Cost of Revenue:
Software products......................................... 765 507
Maintenance............................................... 1,227 2,183
Services.................................................. 7,301 10,951
-------- -------
Total cost of revenue.................................. 9,293 13,641
Gross profit............................................... 1,610 4,715
Operating Expenses:
Sales and marketing....................................... 1,887 6,893
Research and product development.......................... 1,541 3,826
General and administrative................................ 2,068 3,093
-------- -------
Total operating expenses............................... 5,496 13,812
-------- -------
Loss from operations................................... (3,886) (9,097)
Other income (expense):
Interest income........................................... 68 135
Interest expense.......................................... (938) (785)
-------- -------
Other expense, net..................................... (870) (650)
-------- -------
Loss before provision for income taxes..................... (4,756) (9,747)
Income tax provision....................................... 146 159
-------- -------
Net loss................................................... $(4,902) $(9,906)
======== =======
Basic and diluted loss per share........................... $ (0.41) $ (0.83)
======== =======
Weighted average common shares outstanding--basic and
diluted................................................... 11,981 11,888
======== =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-66
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
December 31,
1998 1997
--------- ---------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Loss................................................. $ (4,902) $ (9,906)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 467 1,198
Deferred income taxes................................... -- (3)
Provision for uncollectible accounts.................... 123 226
Write-down of assets.................................... 476 --
Changes in assets and liabilities:
Trade accounts receivable.............................. 2,120 7,027
Prepaid expenses and other assets...................... 74 208
Accounts payable, accrued expenses, and income taxes
payable............................................... (2,242) (2,548)
Deferred revenue....................................... 267 (586)
--------- --------
Net cash used in operating activities................. (3,617) (4,384)
Cash Flows from Investing Activities:
Purchases of property and equipment...................... -- (126)
Capitalization of software development costs............. -- (128)
--------- --------
Net cash used in investing activities................. -- (245)
Cash Flows from Financing Activities:
Note payable to majority shareholder..................... 12,000 --
Capital contribution..................................... 16,925 --
Paydown of lines of credit............................... (28,925) --
Net borrowings under lines of credit..................... 3,052 7,101
Issuance of common shares................................ -- 165
--------- --------
Net cash provided by financing activities............. 3,052 7,266
Effect of exchange rate changes on cash................... 4 (3)
--------- --------
Net increase (decrease) in cash and cash equivalents.. (561) 2,625
Cash and cash equivalents:
Beginning of period...................................... 1,040 4,268
--------- --------
End of period............................................ $ 479 $ 6,893
========= ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-67
<PAGE>
SEER TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months
Ended December
31,
1998 1997
-------- -------
<S> <C> <C>
Net loss..................................................... $ (4,902) $(9,906)
Other comprehensive income, net of tax
Foreign currency translation adjustment..................... (33) 247
-------- -------
Comprehensive loss........................................... $ (4,935) $(9,659)
======== =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-68
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(dollars in thousands, except share and per share data)
NOTE 1. INTERIM FINANCIAL STATEMENTS
The accompanying unaudited financial statements should be read in conjunction
with the audited financial statements and notes thereto contained in the
Company's Annual Report on Form 10-K for fiscal year 1998. The Company's fiscal
year ends September 30. 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 transaction discussed in Note
7 and the write-down of $476 of capitalized software costs based on
management's evaluation of the asset's net realizable value.
During the first quarter of fiscal year 1999, the Company has adopted Statement
of Financial Accounting ("SFAS") No. 130, "Reporting Comprehensive Income."
SFAS No. 130 requires additional disclosures with respect to certain changes in
assets and liabilities that previously were not required to be reported as
results of operations for the period.
The American Institute of Certified Public Accountants has issued Statement of
Position 97-2 ("SOP 97-2"), "Software Revenue Recognition." SOP 97-2 is
effective for transactions entered into in fiscal years beginning after
December 15, 1997, and provides guidance on applying generally accepted
accounting principles in recognizing revenue on software transactions. The
Company adopted SOP 97-2 at the beginning October 1, 1998, and the Company does
not expect the adoption of this standard to have a material impact on the
Company's financial position or results of operations.
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 quarter of fiscal
year 1999 include stock options and convertible preferred stock.
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 for the first quarter
of fiscal year 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 first quarter of fiscal year 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.
F-69
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair market value. The statement also requires that changes in
the derivative's fair market value be recognized currently in earnings unless
specific hedge accounting criteria are met. SFAS No. 133 is effective for
fiscal years beginning June 15, 1999, with earlier adoption permitted. The
Company is currently assessing the impact of this new statement on its
consolidated financial position, liquidity, and results of operations.
NOTE 6. 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 fiscal year 1998. Segment data includes a charge
allocating all corporate-headquarters costs 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
earnings (loss) before interest and taxes (EBIT).
The table below presents information about reported segments for the quarters
ending December 31:
<TABLE>
<CAPTION>
Research
And
Software Maintenance Services Development Total
-------- ----------- -------- ----------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
Q1 1999
Total revenue.............. $ 69 $3,056 $ 7,778 $ -- $10,903
Total EBIT................. (3,014) 1,630 (710) (1,792) (3,886)
Q1 1998
Total revenue.............. 2,698 3,449 12,209 -- 18,356
Total EBIT................. (5,642) 989 (132) (4,312) (9,097)
</TABLE>
A reconciliation of total segment revenue to total consolidated revenues and of
total segment EBIT to total consolidated income before taxes, for the quarters
ended December 31, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
Q1 1999 Q1 1998
------- -------
<S> <C> <C>
Total EBIT................................................ $(3,886) $(9,097)
Interest expense.......................................... (870) (650)
------- -------
Total loss before income taxes.......................... $(4,756) $(9,747)
======= =======
</TABLE>
F-70
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents a summary of revenue by geographic region for the
quarters ended December 31:
<TABLE>
<CAPTION>
Q1 1999 Q1 1998
------- -------
<S> <C> <C>
Australia.................................................... $ 678 $ 538
Denmark...................................................... 1,249 1,112
Germany...................................................... 541 624
Greece....................................................... 327 168
Italy........................................................ 854 2,026
Norway....................................................... 508 876
South Africa................................................. 409 684
Sweden....................................................... 464 350
Switzerland.................................................. 792 892
United Kingdom............................................... 1,898 3,495
USA.......................................................... 2,182 5,478
Other........................................................ 1,001 2,113
------- -------
Total revenue.............................................. $10,903 $18,356
======= =======
</TABLE>
Foreign revenue is based on the country in which the customer is domiciled.
NOTE 7. ACQUISITION BY LEVEL 8
On December 31, 1998, Level 8 Systems, Inc. ("Level 8"), as the first step in
its pending acquisition of the entire equity interest in the Company, acquired
approximately 69% of the outstanding common stock of the Company held by Welsh,
Carson, Anderson and Stowe VI L.P. and certain other parties affiliated or
associated with WCAS ("WCAS") in exchange for 1,000,000 shares of Level 8
common stock and warrants to purchase an additional 250,000 shares of Level 8
common stock at an exercise price of $12.00 per share. Level 8 acquired
7,130,894 shares of the Company's common stock, 2,094,143 shares of the
Company's Series A Convertible Preferred Stock, and 1,762,115 shares of the
Company's Series B Convertible Preferred Stock from WCAS representing
approximately 69% of the outstanding common stock of the Company and, as a
consequence, may be deemed to control the Company. As part of the agreement,
Level 8 agreed to commence a tender offer for the remaining outstanding common
stock of the Company as soon as reasonably practicable. See Note 9.
In connection with Level 8's purchase of Seer's capital stock from the WCAS
Parties, WCAS contributed approximately $17 million to Seer and Level 8
provided a $12 million subordinated loan to enable Seer to reduce Seer's bank
debt. The funds used by Level 8 to make the subordinated loan to Seer were
obtained from Liraz Systems Ltd., a principal stockholder of Level 8. In
addition, Level 8 has agreed to fund the Company's operations through January
15, 2000.
NOTE 8. DEBT AGREEMENTS
During the first quarter of 1999, the Company maintained two credit
facilities--the Revolving Facility and the Guaranteed Facility.
On December 22, 1998, the Company's Revolving Facility was amended. The
Revolving Facility now bears interest at the prime rate and terminates on
December 31, 2001. The Revolving Facility is automatically renewed for
successive additional terms of one year each, unless terminated by either
party. Level 8 has agreed to guarantee any borrowings under the Revolving
Facility exceeding $20 million through December 31, 1999, exceeding $10 million
from January 1, 2000 through December 31, 2000, and without limit thereafter.
F-71
<PAGE>
SEER TECHNOLOGIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of December 31, 1998, Level 8 made the Company a $12 million subordinated
loan to help pay down the Company's outstanding bank debt and WCAS contributed
approximately $17 million to the Company, which was also used to reduce
outstanding borrowings under the Guaranteed Facility to $0. Additionally, the
Guaranteed Facility and the line of credit available for foreign exchange
contracts were terminated on December 31, 1998. The principal amount of the
note payable to Level 8 shall bear interest, compounded quarterly, at a rate
per annum equal to the weighted average interest rate from time to time on the
Company's other indebtedness for borrowed money. Interest shall be payable upon
maturity in June, 2002.
NOTE 9. SUBSEQUENT EVENTS
On February 1, 1999, Level 8 commenced a tender offer for all the remaining
outstanding shares of the common stock of the Company at $0.35 per share, net
to the seller in cash, upon the terms and conditions set forth in the offer to
purchase and the letter of transmittal. The tender offer is scheduled to expire
on March 2, 1999.
F-72
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Template Software, Inc.
In our opinion the accompanying consolidated balance sheets and the related
consolidated statements of operations and comprehensive income (loss), changes
in shareholders' equity and cash flows, present fairly, in all material
respects, the financial position of Template Software, Inc. and its
subsidiaries (the "Company") at November 30, 1997 and December 31, 1998, and
the results of their operations and their cash flows for the years ended
November 30, 1996 and 1997, for the one month ended December 31, 1997, and for
the year ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
McLean, VA
March 17, 1999
F-73
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
November 30, December
1997 31, 1998
------------ -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............................ $ 2,739,075 $ 1,830,806
Marketable securities................................ 13,317,901 8,221,300
Accounts receivable, net............................. 10,474,254 15,751,823
Income tax receivable 235,848 19,780
Deferred income taxes................................ 406,172 1,872,580
Prepaid expenses and other current assets............ 688,577 1,698,639
----------- -----------
Total current assets............................... 27,861,827 29,394,928
----------- -----------
Property, plant and equipment, net................... 2,193,932 5,422,931
Software development costs, net...................... 1,490,776 2,601,474
Goodwill, net........................................ 10,710,555 10,298,088
Deferred income taxes................................ 408,328 --
Note receivable...................................... -- 1,040,667
Other assets......................................... 306,075 326,018
----------- -----------
Total assets....................................... $42,971,493 $49,084,106
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable..................................... $ 1,431,162 $ 2,642,350
Accrued expenses..................................... 2,717,618 4,101,615
Revolving credit agreement........................... 33,553 166,797
Current portion of long-term debt.................... 91,667 229,373
Capital lease obligations............................ 54,023 55,209
Income taxes payable................................. 34,639 46,465
Deferred income...................................... 794,832 1,437,014
----------- -----------
Total current liabilities.......................... 5,157,494 8,678,823
----------- -----------
Long-term Liabilities:
Long-term debt, net of current portion............... 84,028 --
Capital lease obligations, noncurrent................ 127,226 76,602
Deferred income taxes................................ -- 827,030
Other liabilities.................................... 309,450 421,083
----------- -----------
Total liabilities.................................. 5,678,198 10,003,538
----------- -----------
Commitments and Contingencies (see Note 10)
Shareholders' equity:
Preferred Stock, $0.01 par value per share; 3,000,000
shares authorized; no shares issued and outstanding
as of November 30, 1997 and December 31, 1998,
respectively........................................ -- --
Common Stock, $0.01 par value per share; 17,000,000
shares authorized; 4,675,433 shares issued and
outstanding as of November 30, 1997 and 5,153,755
shares issued and 4,969,755 shares outstanding, as
of December 31, 1998................................ 46,755 51,538
Additional paid-in capital........................... 35,088,542 36,619,503
Deferred compensation................................ (1,177,920) (727,243)
Accumulated other comprehensive income............... 49,752 154,156
Retained earnings.................................... 3,286,166 3,793,839
Common stock in treasury, at cost no shares and
184,000 shares as of November 30, 1997 and December
31, 1998............................................ -- (811,225)
----------- -----------
Total shareholders' equity......................... 37,293,295 39,080,568
----------- -----------
Total liabilities and shareholders' equity......... $42,971,493 $49,084,106
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-74
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>
Year Ended November 30, Month Ended Year Ended
------------------------ December 31, December 31,
1996 1997 1997 1998
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Products.................. $ 1,918,568 $ 8,539,387 $ 95,292 $ 8,014,139
Services.................. 11,611,543 18,371,005 2,050,140 34,625,087
----------- ----------- ---------- -----------
Total revenues.......... 13,530,111 26,910,392 2,145,432 42,639,226
----------- ----------- ---------- -----------
Cost of Revenues:
Products.................. 782,804 2,145,552 162,509 1,685,913
Services.................. 6,245,888 10,639,845 1,646,626 22,491,322
----------- ----------- ---------- -----------
Total cost of revenues.. 7,028,692 12,785,397 1,809,135 24,177,235
----------- ----------- ---------- -----------
Gross profit.............. 6,501,419 14,124,995 336,297 18,461,991
----------- ----------- ---------- -----------
Operating Expenses:
Selling and marketing..... 2,362,648 6,270,769 706,861 9,758,355
Product development....... 966,088 1,314,770 127,694 1,444,474
General and
administrative........... 1,473,062 3,163,587 403,096 6,139,040
----------- ----------- ---------- -----------
Total operating
expenses............... 4,801,798 10,749,126 1,237,651 17,341,869
----------- ----------- ---------- -----------
Income (loss) from
operations............... 1,699,621 3,375,869 (901,354) 1,120,122
Interest income (expense),
net...................... (22,130) 872,613 45,477 615,300
Other income (expense),
net...................... 12,079 (100,673) (38,515) 142,905
----------- ----------- ---------- -----------
Net income (loss) before
income taxes............. 1,689,570 4,147,809 (894,392) 1,878,327
Income tax benefit
(provision).............. (644,502) (1,768,016) 271,855 (748,117)
----------- ----------- ---------- -----------
Net income (loss)......... $ 1,045,068 $ 2,379,793 $ (622,537) $ 1,130,210
=========== =========== ========== ===========
Other Comprehensive Income
(loss):
Foreign currency
translation adjustment... -- 49,752 (46,029) 272,846
Unrealized loss on
marketable securities,
net of taxes............. -- -- -- (122,413)
=========== =========== ========== ===========
Comprehensive income
(loss)................... $ 1,045,068 $ 2,429,545 $ (668,566) $ 1,280,643
=========== =========== ========== ===========
Earnings (loss) per share
basic.................... $ 0.48 $ 0.58 $ (0.13) $ 0.23
=========== =========== ========== ===========
Shares used in computing
basic earnings (loss) per
share.................... 2,182,260 4,091,566 4,676,304 5,013,528
=========== =========== ========== ===========
Earnings (loss) per share
diluted.................. $ 0.23 $ 0.44 $ (0.13) $ 0.20
=========== =========== ========== ===========
Shares used in computing
diluted earnings (loss)
per share................ 4,643,919 5,419,150 4,676,304 5,708,932
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-75
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A
Convertible Convertible Class A Class B
Preferred Stock Preferred Stock Common Stock Common Stock
------------------- ----------------- -------------------- -----------------
Shares Amount Shares Amount Shares Amount Shares Amount
-------- --------- -------- ------- ---------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, November 30,
1995................... 195,847 $ 385,701 $ 1,808,924 $ 18,089 423,006 $ 4,230
Retirement of stock
held in treasury...... (195,847) (385,701) (48,936) (489) -- --
Issuance of Class B
Common Stock.......... -- -- -- -- -- -- 64,014 640
Issuance of Convertible
Preferred Stock Series
A..................... -- -- 500,000 5,000 -- -- -- --
Exchange of Class A and
Class B Common Stock.. -- -- -- -- (1,759,988) (17,600) (487,020) (4,870)
Net income............. -- -- -- -- -- -- -- --
-------- --------- -------- ------- ---------- -------- -------- -------
Balance, November 30,
1996................... -- -- 500,000 5,000 -- -- -- --
Conversion of Series A
Convertible Preferred
Stock................. -- -- (500,000) (5,000) -- -- -- --
Initial public offering
of common stock,
$16.00 per share, net
of expenses........... -- -- -- -- -- -- -- --
Exercise of stock
options............... -- -- -- -- -- -- -- --
Common Stock issued in
connection with
business acquisitions,
$12.18--$14.90 per
share................. -- -- -- -- -- -- -- --
Translation
Adjustment............ -- -- -- -- -- -- -- --
Deferred compensation
related to stock
options granted below
fair market value..... -- -- -- -- -- -- -- --
Amortization of
Deferred
Compensation.......... -- -- -- -- -- -- -- --
Expenses related to
issuance of Series A
Convertible Preferred
Stock in 1996......... -- -- -- -- -- -- -- --
Tax benefit associated
with exercise of stock
options............... -- -- -- -- -- -- -- --
Net Income............. -- -- -- -- -- -- -- --
-------- --------- -------- ------- ---------- -------- -------- -------
Balance, November 30,
1997................... -- -- -- -- -- -- -- --
Exercise of stock
options............... -- -- -- -- -- -- -- --
Translation
Adjustment............ -- -- -- -- -- -- -- --
Forfeitures of stock
options............... -- -- -- -- -- -- -- --
Amortization of
Deferred
Compensation.......... -- -- -- -- -- -- -- --
Tax benefit associated
with exercise of stock
options............... -- -- -- -- -- -- -- --
Net Loss............... -- -- -- -- -- -- -- --
-------- --------- -------- ------- ---------- -------- -------- -------
Balance, December 31,
1997................... -- -- -- -- -- -- -- --
Exercise of stock
options............... -- -- -- -- -- -- -- --
Issue Stock related to
FY97 contingent
consideration......... -- -- -- -- -- -- -- --
Translation
Adjustment............ -- -- -- -- -- -- -- --
Gain on investment..... -- -- -- -- -- -- -- --
Forfeitures of stock
options............... -- -- -- -- -- -- -- --
Amortization of
Deferred
Compensation.......... -- -- -- -- -- -- -- --
Purchase of Treasury
Shares................ -- -- -- -- -- -- -- --
Tax benefit associated
with exercise of stock
options............... -- -- -- -- -- -- -- --
Net Income............. -- -- -- -- -- -- -- --
-------- --------- -------- ------- ---------- -------- -------- -------
Balance, December 31,
1998................... -- $ -- -- $ -- -- $ -- -- $ --
======== ========= ======== ======= ========== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-76
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Retained
Common Stock Additional Accumulated Earnings Treasury
------------------ Paid-in Deferred Comprehensive (Accum. Stock At
Shares Amount Capital Compensation Income Deficit) Cost Total
--------- ------- ----------- ------------ ------------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, November 30,
1995................... -- $ -- $ 969,491 $ -- $ -- $ (138,695) $(337,801) $ 901,015
Retirement of stock
held in treasury...... -- -- 48,389 -- -- -- 337,801 --
Issuance of Class B
Common Stock.......... -- -- 96,108 -- -- -- -- 96,748
Issuance of Convertible
Preferred Stock Series
A..................... -- -- 7,995,000 -- -- -- -- 8,000,000
Exchange of Class A and
Class B Common Stock.. 2,247,008 22,470 -- -- -- -- -- --
Net income............. -- -- -- -- -- 1,045,068 -- 1,045,068
--------- ------- ----------- ----------- -------- ---------- --------- -----------
Balance, November 30,
1996................... 2,247,008 22,470 9,108,988 -- -- 906,373 -- 10,042,831
Conversion of Series A
Convertible Preferred
Stock................. 500,000 5,000 -- -- -- -- -- --
Initial public offering
of common stock,
$16.00 per share, net
of expenses........... 1,400,000 14,000 19,749,359 -- -- -- -- 19,763,359
Exercise of stock
options............... 344,675 3,447 684,035 -- -- -- -- 687,482
Common Stock issued in
connection with
business acquisitions,
$12.18--$14.90 per
share................. 183,750 1,838 2,998,114 -- -- -- -- 2,999,982
Translation
Adjustment............ -- -- -- -- 49,752 -- -- 49,752
Deferred compensation
related to stock
options granted below
fair market value...... -- -- 1,584,905 (1,584,905) -- -- -- --
Amortization of
Deferred
Compensation.......... -- -- -- 406,985 -- -- -- 406,985
Expenses related to
issuance of Series A
Convertible Preferred
Stock in 1996......... -- -- (75,096) -- -- -- -- (75,096)
Tax benefit associated
with exercise of stock
options............... -- -- 1,038,207 -- -- -- -- 1,038,207
Net Income............. -- -- -- -- -- 2,379,793 -- 2,379,793
--------- ------- ----------- ----------- -------- ---------- --------- -----------
Balance, November 30,
1997................... 4,675,433 46,755 35,088,542 (1,177,920) 49,752 3,286,166 -- 37,293,295
Exercise of stock
options............... 2,250 23 898,181 -- -- -- -- 4,455
Translation
Adjustment............ -- -- -- -- (46,029) -- -- (46,029)
Forfeitures of stock
options............... -- -- (14,400) 14,400 -- -- -- --
Amortization of
Deferred
Compensation.......... -- -- -- 32,483 -- -- -- 32,483
Tax benefit associated
with exercise of stock
options............... -- -- 2,500 -- -- -- -- 2,500
Net Loss............... -- -- -- -- -- (622,537) -- (622,537)
--------- ------- ----------- ----------- -------- ---------- --------- -----------
Balance, December 31,
1997................... 4,677,683 46,778 35,081,074 (1,131,037) 3,723 2,663,629 -- 36,664,167
Exercise of stock
options............... 424,730 4,247 898,181 -- -- -- -- 902,428
Common stock issued in
connection with 1997
business
acquisitions.......... 51,342 513 (513) -- -- -- -- --
Translation
Adjustment............ -- -- -- -- 272,846 -- -- 272,846
Gain on investment..... -- -- -- -- (122,413) -- -- (122,413)
Forfeitures of stock
options............... -- -- (14,651) 14,651 -- -- -- --
Amortization of
Deferred
Compensation.......... -- -- -- 389,143 -- -- -- 389,143
Purchase of treasury
shares................ (184,000) -- -- -- -- -- (811,225) (811,225)
Tax benefit associated
with exercise of stock
options............... -- -- 655,412 -- -- -- -- 655,412
Net Income............. -- -- -- -- -- 1,130,210 -- 1,130,210
--------- ------- ----------- ----------- -------- ---------- --------- -----------
Balance, December 31,
1998................... 4,969,755 $51,538 $36,619,503 $ (727,243) $154,156 $3,793,839 $(811,225) $39,080,568
========= ======= =========== =========== ======== ========== ========= ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-77
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended November 30, Month Ended Year Ended
------------------------- December 31, December 31,
1996 1997 1997 1998
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss)....... $ 1,045,068 $ 2,379,793 $ (622,537) $ 1,130,210
Adjustments to reconcile
net income (loss) to
net cash provided by
(used in) operating
activities:
Amortization of
discounts on marketable
securities............. -- (76,608) (18,463) (112,664)
Depreciation and
amortization of
property, plant and
equipment.............. 117,121 354,569 59,137 559,048
Provision for losses on
accounts receivable.... -- 98,026 (3,831) 114,910
Deferred rent
amortization........... 2,272 89,569 4,947 96,519
Deferred compensation
amortization........... -- 406,985 32,483 389,143
Amortization of
capitalized software
development costs...... 252,260 394,770 37,874 584,738
Goodwill amortization... -- 374,237 46,579 803,701
Deferred tax provision.. 61,410 632,240 (294,603) 169,261
Changes in assets and
liabilities, net of
effect of acquisitions:
Accounts receivable..... (708,163) (6,156,891) 1,077,883 (6,056,081)
Current year income tax
receivable............. -- (235,848) -- 216,092
Prepaid expenses and
other assets........... (521,911) (195,754) 108,426 (462,611)
Accounts payable and
accrued liabilities.... 920,907 (1,449,207) 311,579 1,402,352
Income taxes payable.... 492,498 (532,097) 16,520 (6,557)
Deferred income......... (104,870) (276,327) (140,323) 758,179
----------- ------------ ---------- -----------
Net cash provided by
(used in) operating
activities............ 1,556,592 (4,192,543) 615,671 (413,760)
----------- ------------ ---------- -----------
Cash Flows From Investing
Activities:
Purchases of marketable
securities............. -- (43,169,673) -- (5,201,293)
Proceeds from sales and
maturities of
marketable securities.. -- 29,928,380 -- 10,231,580
Capital expenditures and
leasehold
improvements........... (652,359) (933,403) (166,063) (3,566,909)
Capitalization of
software development
costs.................. (395,303) (1,167,452) (84,194) (1,649,114)
Issuance of note
receivable............. -- -- -- (1,540,667)
Acquisitions of
businesses, net of cash
acquired............... -- (7,356,848) -- (57,539)
----------- ------------ ---------- -----------
Net cash used in
investing activities.. (1,047,662) (22,698,996) (250,257) (1,783,942)
----------- ------------ ---------- -----------
Cash Flows From Financing
Activities:
Proceeds from notes
payable................ 275,000 -- -- 269,123
Payments on notes
payable................ (363,632) (91,667) (7,639) (214,515)
Revolving credit
facility, net.......... (161,330) (47,839) 310,282 (233,592)
Income tax benefit
related to stock
options................ -- 1,038,207 2,500 655,413
Payments on capital
lease obligations...... (21,340) (49,759) (4,334) (62,176)
Proceeds from issuance
of capital stock, net
of expenses............ 8,000,000 19,688,264 -- --
Proceeds from sale of
common stock under
stock programs......... 96,748 687,482 4,455 902,428
Purchase of treasury
shares................. -- -- -- (811,225)
----------- ------------ ---------- -----------
Net cash provided by
financing activities.. 7,825,446 21,224,688 305,264 505,456
----------- ------------ ---------- -----------
Effect of exchange rate
changes on cash......... -- 8,766 15,543 97,756
----------- ------------ ---------- -----------
Net increase (decrease)
in cash and cash
equivalents........... 8,334,376 (5,658,085) 686,221 (1,594,490)
Cash and cash equivalents
at beginning of period.. 62,784 8,397,160 2,739,075 3,425,296
----------- ------------ ---------- -----------
Cash and cash equivalents
at end of period........ $ 8,397,160 $ 2,739,075 $3,425,296 $ 1,830,806
----------- ------------ ---------- -----------
Supplemental cash flow
disclosures:
Cash paid for interest.. $ 46,668 $ 91,367 $ 5,944 $ 123,404
Cash paid for income
taxes.................. $ 90,594 $ 810,140 $ 2,099 $ 91,598
Non cash investing and
financing activities:
Property and equipment
acquired through
capital leases......... $ 247,086 $ -- $ -- $ 17,073
Retirement of treasury
stock:
Class A Common Stock.... $ 67,560 $ -- $ -- $ --
Preferred Stock......... $ 270,241 $ -- $ -- $ --
Conversion of series a
convertible preferred
stock:
Series A Convertible
Preferred Stock........ $ -- $ (5,000) $ -- $ --
Common Stock............ $ -- $ 5,000 $ -- $ --
Business acquisitions,
net of cash acquired:
Working capital, other
than cash acquired..... $ -- $ 2,714,547 $ -- $ 374,129
Property and equipment.. $ -- $ (699,939) $ -- $ (43,985)
Cost in excess of net
assets of companies
acquired, net.......... $ -- $(11,084,792) $ -- $ (383,774)
Other non-current
assets................. $ -- $ (1,356,073) $ -- $ (3,909)
Non-current
liabilities............ $ -- $ 69,428 $ -- $ --
Fair market value of
common stock issued.... $ -- $ 2,999,981 $ -- $ --
Non cash investing
activities:
Fair value adjustment to
deferred tax asset
acquired............... $ -- $ -- $ -- $ (54,039)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-78
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Business
Template Software, Inc. (the "Company") provides enterprise-wide software
solutions to organizations that require the integration of their operations and
systems in an effort to better automate their critical business processes. The
Company's solutions are targeted at large-scale, mission-critical applications,
such as order handling and fulfillment, human resource management, and network
monitoring systems primarily in the telecommunications, finance/insurance and
government industries.
Recapitalization of Common Stock
The Company, formerly a Maryland corporation, elected to change its capital
structure in October 1996, and reincorporated into Template Software, Inc., a
Virginia corporation (the "Recapitalization"). Pursuant to the
Recapitalization, the Company (i) exchanged its Class A and Class B Common
Stock for an equal amount of shares of a single class of $0.01 par value,
common stock ("Common Stock") and (ii) increased the Company's authorized
capital stock to 20,000,000 shares, which consisted of 17,000,000 shares of
Common Stock and 3,000,000 shares of a new class of preferred stock ("Preferred
Stock"). The preferences, limitations and relative rights of the Preferred
Stock, which is issuable in series, are determined by the Board of Directors
upon designation.
Registration Statement
In January 1997, the Company completed an underwritten public offering of
2,100,000 shares of its common stock; 1,400,000 shares of Common Stock for the
account of the Company and 700,000 shares of Common Stock for the accounts of
selling security holders, with an aggregate offering price of $16.00 per share
registered. The expenses incurred for the Company's account in connection with
the issuance and distribution of the securities were $1,568,000 of underwriting
discounts and commissions and $1,068,641 of other expenses for a total expense
of $2,636,641. The net offering proceeds to the Company were $19,763,359. From
the effective date of the Registration Statement, through the end date of the
period covered by this report, the Company used $7,414,387 to acquire other
businesses, $8,211,006 to purchase temporary investments in marketable
securities, $1,500,000 to invest in convertible promissory notes of other
businesses, and the remaining $2,637,966 in property, plant and equipment.
There has not been a material change in the use of proceeds described in the
Company's prospectus.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of Template
Software, Inc. and its wholly-owned subsidiaries. All material intercompany
accounts and transactions have been eliminated in consolidation.
Revenue Recognition
Prior to December 15, 1997, the Company recognized revenue in accordance with
the American Institute of Certified Public Accountants' (AICPA) Statement of
Position (SOP) 91-1, "Software Revenue Recognition." Subsequent to December 15,
1997, the Company began recognizing revenue in accordance with SOP 97-2,
"Software Revenue Recognition." SOP 97-2 was amended on March 31, 1998 by SOP
98-4 "Deferral of the effective date of a provision of SOP 97-2." In December
1998, the AICPA issued SOP 98-9 "Modification of SOP 97-2, Software Revenue
Recognition," which amends SOP 98-4, and is effective after December 31, 1998.
F-79
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Management has assessed these new statements and believes that their adoption
will not have a material effect on the timing of the Company's revenue
recognition or cause changes to its revenue recognition policies. The Company
licenses the rights to use its software products to customers under perpetual
license agreements, and provides product support and enhancements under annual
maintenance agreements. Revenue from product licensing arrangements is
generally recognized after execution of a licensing agreement and shipment of
the product, provided that no significant Company obligations remain and the
resulting receivable is deemed collectible by management. Services revenue
includes consulting, product support and maintenance and training. The Company
defers and recognizes product support and maintenance revenue ratably over the
terms of the contract period, which is generally one year. The Company
recognizes training and consulting revenue as the services are provided.
Customization is sometimes involved in the development of a software solution
by the Company. Under these circumstances, the Company's revenues are derived
from contracts of various types. Revenue from federal government agency cost-
plus-award-fee contracts is recognized to the extent of costs incurred plus a
proportionate amount of the fee. Revenues from fixed-price contracts is
recognized using the percentage-of-completion method based on the relationship
of actual costs incurred to total costs estimated to be incurred over the
duration of the contract. Fees under federal government agency contracts may be
increased or decreased in accordance with certain provisions which measure
actual performance against established targets or other criteria. Such fee
adjustments are included in revenues at the time the amounts can be reasonably
determined. Provisions for anticipated contract losses are recognized at the
time they become evident.
Cash and Cash Equivalents
Cash and cash equivalents consist of demand deposits and short-term repurchase
agreements which have original maturities of three months or less. As of
December 31, 1998 the Company has not experienced any losses on these
investments.
Marketable Securities
Marketable securities at November 30, 1997 and December 31, 1998 consisted of
direct obligations of the United States Government, municipalities and
commercial paper with strong credit ratings. These investments are considered
available-for-sale as defined by Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
The Company's investments are held for an unspecified period of time and are
sold to meet its liquidity needs. Accordingly, the Company has classified these
investments as current assets. Available-for-sale securities are reported at
fair value based generally on quoted market prices with unrealized gains and
losses, net of taxes, recorded in shareholders equity until realized. At
November 30, 1997, amortized cost of marketable securities approximated market;
therefore, no adjustment was made to shareholders equity as a result of changes
in market value to these securities. At December 31, 1998, unrealized loss from
marketable securities was $197,441, net of taxes of $75,028. Interest income is
accrued as earned.
<TABLE>
<CAPTION>
Fair Value Year Ended
-------------------------
November 30, December 31,
1997 1998
------------ ------------
<S> <C> <C>
U.S. government securities (maturity of less than
1 year)......................................... $ 4,986,146 $ --
U.S. government securities (maturity of 29
years).......................................... -- 4,056,300
U.S. corporate debt securities (maturities of
less than 1 year)............................... 3,366,755 --
Municipal obligations (maturities of 23-27 years
with 7 day call feature)........................ 4,965,000 4,165,000
----------- ----------
Total............................................ $13,317,901 $8,221,300
=========== ==========
</TABLE>
F-80
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Inventory
The Company's European subsidiaries maintain an inventory of various third
party software licenses for resale. The inventory is recorded at cost and is
accounted for using the FIFO method. The inventory balance, which is included
in prepaid expenses and other current assets in the consolidated balance sheet,
was $57,711 and $358,253 as of November 30, 1997 and December 31, 1998,
respectively.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentration of credit risk consist primarily of cash, cash equivalents,
marketable securities and accounts receivable. The Company limits the amount of
investment exposure in any one financial instrument and minimizes the amount of
cash it maintains in foreign currencies by maintaining sufficient cash in U.S.
dollars. To date, the impact of exchange rates on foreign cash balances has
been immaterial. The Company sells products and services to customers without
requiring collateral, however, the Company routinely assesses the financial
strength of its customers and maintains allowances for anticipated losses.
For the years ended November 30, 1996 and 1997, for the one month period ended
December 31, 1997 and for the year ended December 31, 1998, revenues from
federal government agencies represent 20%, 23%, 20% and 29%, respectively, of
total consolidated revenues. With the exception of federal government agencies,
there were two customers (28% from Customer A and 20% from Customer B) for the
year ended November 30, 1996, one customer (13% from Customer C) for the year
ended November 30, 1997, one customer for the one month ended December 31, 1997
(13% from Customer D) and one customer (11% from Customer E) for the year ended
December 31, 1998, that accounted for more than 10% of total consolidated
revenues.
With the exception of federal government agencies, there was one customer at
November 30, 1997 that accounted for 11% of total consolidated accounts
receivable and no customers at December 31, 1998 that accounted for greater
than 10% of total consolidated accounts receivable.
Fair Value of Financial Instruments
The Company believes that the carrying amount of certain of its financial
instruments, which include cash, cash equivalents, accounts receivable, notes
receivable, accounts payable and accrued expenses, and obligations under
capital leases approximate fair value due to the relatively short maturity of
these instruments. Marketable securities held as available-for-sale have been
adjusted to fair market value with any unrealized gain or loss included as a
component of shareholders equity until realized. The carrying amounts of the
revolving credit agreement and notes payable approximate fair value because
these financial instruments contain variable interest rates which reprice
frequently.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences of temporary differences and income tax credits. Temporary
differences are primarily the result of the differences between the tax bases
of assets and liabilities and their financial reporting amounts. Deferred tax
assets and liabilities are measured by applying enacted statutory tax rates
applicable to the future years in which deferred tax assets or liabilities are
expected to be settled or realized. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense consists of the taxes payable for the current period and the
change during the period in deferred tax assets and liabilities.
Foreign Currency Translation
Financial statements of international subsidiaries are translated into U.S.
dollars using the exchange rate at each balance sheet date for assets and
liabilities and an average exchange rate for each period for revenues,
F-81
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
expenses, gains and losses. Where the local currency is the functional
currency, translation adjustments are recorded as a separate component of
shareholders' equity. Transaction gains and losses, which are included in the
statement of operations, are immaterial for all periods presented.
Earnings Per Share
Basic earnings (loss) per share is computed by dividing net income (loss)
available to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted earnings (loss) per share is
computed by dividing net income (loss) available to common shareholders by the
weighted average of common shares outstanding assuming conversion of dilutive
common stock equivalent shares from common stock options.
The following table reconciles the weighted average number of common shares
outstanding during each period for basic and diluted earnings (loss) per share.
<TABLE>
<CAPTION>
One Month
Year Ended Year Ended Ended Year Ended
November 30, November 30, December 31, December 31,
1996 1997 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average shares
outstanding basic........ 2,182,260 4,091,566 4,676,304 5,013,528
Diluted impact of common
shares issuable on
exercise of stock
options.................. 2,461,659 1,327,584 -- 695,404
Weighted average shares
outstanding diluted...... 4,643,919 5,419,150 4,676,304 5,708,932
</TABLE>
Common stock equivalents are included in the computation of diluted net income
(loss) per share using the treasury stock method. For the one month ended
December 31, 1997, stock options granted by the Company to purchase 1,089,091
common shares, were not included in the computation because the effect was
anti-dilutive.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets,
five years for office furniture and equipment, three years for computer
equipment and software and forty years for office buildings. Amortization of
leasehold improvements is computed using the straight line method over the
shorter of the assets useful life or the lease term. When assets are retired or
sold, the cost and related accumulated depreciation and amortization are
removed from the accounts, and any gain or loss is reflected in operations.
Maintenance and repairs are charged to expense when incurred, and the cost of
significant additions and improvements is capitalized.
Software Development Costs
The Company capitalizes the direct costs associated with the development of
software products in accordance with Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed." Research costs are charged to product
development expense prior to the development of a detailed program design or a
working model. Costs incurred subsequent to the product release, and research
and development performed under contract are charged to operations.
Capitalized costs are amortized over the estimated product life using the
greater of the straight-line method or the ratio of current product revenues to
total projected future revenues. Software development costs at November 30,
1997 and December 31, 1998 are presented net of accumulated amortization of
$3,401,811 and
F-82
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$4,024,423, respectively. Amortization expense related to software development
costs was $252,260, $394,770, $37,874 and $584,738, respectively, for the years
ended November 30, 1996 and 1997, for the one month ended December 31, 1997 and
for the year ended December 31, 1998, respectively.
Goodwill
The Company has classified as goodwill the cost in excess of fair value of the
net assets of companies acquired in purchase business combinations. Goodwill is
being amortized on a straight-line basis over periods ranging from 10 to 15
years. Goodwill at November 30, 1997 and December 31, 1998 is presented net of
accumulated amortization of $374,237 and $1,224,517, respectively.
Long-Lived Assets
The Company evaluates the recoverability of the carrying value of property and
equipment and intangible assets in accordance with the provisions of Statement
of Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets to be Disposed Of". The Company considers historical performance and
anticipated future results in its evaluation of potential impairment.
Accordingly, when indicators of impairment are present, the Company evaluates
the carrying value of these assets in relation to the operating performance of
the business and future and undiscounted cash flows expected to result from the
use of these assets. Impairment losses are recognized when the sum of expected
future cash flows are less than the assets' carrying value. No such impairment
losses have been recognized to date.
Use of 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 results could differ from those estimates.
Recent Accounting Standards
As of December 31, 1998, the Company has adopted SFAS No. 130, "Reporting
Comprehensive Income," which requires additional disclosures with respect to
certain changes in assets and liabilities that previously were not required to
be reported as results of operations for the period. In addition, the Company
adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which establishes standards for the manner in which public
companies report information about operating segments, products and services,
geographic areas and major customers in annual and interim financial
statements. The Company accounts for all operations under one segment.
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133). SFAS 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. The Company has not
determined the effort of adopting this standard.
3. CHANGE IN FISCAL YEAR
In the fourth quarter of 1998, the Company changed its fiscal year end from
November 30 to December 31 effective with the fiscal year ending December 31,
1998. The accompanying financial statements include audited statements of
operations and comprehensive income (loss), shareholders' equity and cash flows
for the one month transition period ended December 31, 1997.
F-83
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. ACQUISITIONS OF BUSINESSES AND STRATEGIC VENTURES
Krystal Ingenierie S.A.
On March 4, 1997, the Company consummated its acquisition of all of the issued
and outstanding capital stock of Krystal Ingenierie S.A. ("Krystal"), a
corporation organized under the laws of the Republic of France in a transaction
accounted for as a purchase business combination. The total consideration of
$1,460,005 consisted of: (1) the exchange of an aggregate of 48,064 shares of
the Company's common stock (the "Common Stock") for 2,500 shares of Krystal
held by Kuhner, representing all of the issued and outstanding capital stock of
Krystal; (2) the exchange an aggregate of 45,686 additional shares of the
Company's Common Stock for certain indebtedness of Krystal owed to Kuhner in
the aggregate amount of FF 3,914,331 ($677,179 at March 4, 1997); and (3)
acquisition costs of $63,224. The shares of common stock issued were valued at
the approximate weighted average price per share of $14.90 (based on volume of
shares traded during the period from February 24, 1997 to February 28, 1997).
Concurrently with the closing of the Krystal acquisition, Krystal's name was
formally changed to Template Software S.A. The excess of the purchase price
over the fair value of the net tangible liabilities acquired of $1,306,511 was
allocated to goodwill and will be amortized over its estimated useful life of
10 years.
Milestone Software GMBH and Milestone Software Ges. mbH
On June 27, 1997, the Company acquired all of the issued and outstanding equity
interests of milestone software GmbH, a German limited liability company
("Milestone"), which included 34% of the issued and outstanding equity
interests of milestone software, Ges. mbH, an Austrian corporation ("Milestone-
Austria"), from Milestone's three owners, Klaus Dieter Jansen ("Jansen"),
Heinz-Dieter Dietrich ("Dietrich") and NeSBIC III, C.V., for an aggregate cash
purchase price of DM 12,000,000 ($6,970,800 at June 27, 1997) plus acquisition
costs of $480,567. This transaction was accounted for as a purchase business
combination. An additional 10% interest of Milestone-Austria was acquired from
Dietrich and Jansen in exchange for 90,000 shares of the Company's Common
Stock. The shares of common stock issued were valued at the approximate
weighted price per share of $12.18 (based on the volume of shares traded during
the period June 10, 1997 to June 16, 1997. The excess of the purchase price
over the fair value of the net tangible liabilities acquired of $9,271,281 was
allocated to goodwill at the acquisition date and will to be amortized over its
estimated useful life of 15 years.
The acquisition agreement also provides for the Company to issue $507,000 of
equivalent shares of common stock to Dietrich and Jansen on both November 30,
1997 and 1998 if certain profit objectives are met over the five month and
twelve month periods ended November 30, 1997 and 1998, respectively. The profit
objective for the five month period ended November 30, 1997 was met.
Consequently, the company issued an additional 51,342 shares of common stock to
Dietrich and Jansen in February 1998.
The fair value of these shares of $507,000 has been allocated to goodwill as of
November 30, 1997. The profit objective for the twelve month period ended
November 30, 1998 was not met; therefore, no contingent consideration was
provided.
Milestone Software Ges. mbH
On March 30, 1998, the Company acquired the remaining 56% of the issued and
outstanding equity interests of milestone software Ges. mbH, an Austrian
corporation, for an aggregate cash purchase price of $100,000 plus acquisition
expenses of $34,837. The Company assumed liabilities of $248,937. The excess of
the purchase price over the fair value of the net liabilities acquired of
$383,774 was allocated to goodwill and is being amortized over its estimated
useful life of 14.2 years. The final allocation of the purchase price is
subject to the completion of management's due diligence, however, that
allocation is not expected to differ materially from the initial allocation. As
a result of this transaction, the Company owns 100% of Milestone Austria.
F-84
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The acquisition agreement also provides for additional contingent consideration
not to exceed $250,000 of equivalent shares of common stock to all of the
selling shareholders if certain revenue and profit objectives are met by the
Company's fiscal year end. The profit objectives were not met; therefore, no
contingent consideration was provided.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company and Milestone-Austria as if
the acquisition had occurred December 1, 1996:
<TABLE>
<CAPTION>
Year Ended
--------------------------
November 30, December 31,
1997 1998
------------ ------------
(In thousands except
per share amounts)
<S> <C> <C>
Net sales....................................... $28,091,901 $42,954,754
Net income (loss)............................... 2,385,353 1,058,069
Earnings per common share--diluted.............. $ 0.44 $ 0.19
</TABLE>
These unaudited pro forma results have been prepared for comparative purposes
only. They do not purport to be indicative of the results of operations which
actually would have resulted had the combinations been in effect on December 1,
1996. In addition, they do not purport to be indicative of future results of
operations on the consolidated entities.
Precise Connectivity Solutions Ltd.
On March 30, 1998, the Company entered into a Convertible Note Purchase
Agreement ("Note Agreement") with Precise Connectivity Solutions Ltd.
("Precise"), an Israeli limited corporation, pursuant to which the Company
purchased a Note from Precise for an aggregate purchase price of $500,000 due
on March 30, 1999 with a 9% percent interest rate per annum. The Note is
convertible at the option of the Company or Precise into that number of fully-
paid, non-assessable shares of Preferred Stock of Precise equal to eight
percent (8%) of the issued and outstanding capital stock of Precise, on a
fully-diluted basis, including such shares of Preferred Stock. The note
receivable is included in prepaid expenses and other current assets in the
consolidated balance sheet as of December 31, 1998.
Eagle Eye Technologies Strategic Relationship
On September 1, 1998, the Company entered into a strategic relationship with
Eagle Eye Technologies, Inc. ("Eagle Eye") to sell software and related
services to Eagle Eye with respect to the creation by Eagle Eye of its Service
Operations Center (the "SOC"). The SOC supports the operations of the Global
Locating System, a satellite-based location and messaging system.
In connection therewith, the Company invested $1,000,000 in Eagle Eye in return
for (i) a promissory note (the "Convertible Promissory Note") that is
convertible, at the Company's option, into 66,695 shares of common stock of
Eagle Eye ("Eagle Eye Common Stock") and (ii) a warrant (the "Warrant") that
gives the Company the right to purchase an additional 66,695 shares of Eagle
Eye Common Stock for an additional $1,000,000. Interest on the Convertible
Promissory Note accrues at the rate of 12% per annum, payable together with
principal in a single lump sum on September 1, 2000, unless converted into
Eagle Eye Common Stock prior to that date. The Convertible Promissory Note is
prepayable by Eagle Eye in whole, but not in part, at any time prior to
maturity. The Convertible Promissory Note may be converted at any time prior to
the date that is 30 days after the date on which Eagle Eye notifies the Company
that the aggregate amount of payments made by Eagle Eye to the Company exceeds
$1,000,000 (the "Notification Date"). The Warrant is exercisable by the
Company, in whole or in part, at any time beginning on the Notification Date
and ending on the date that is 12 months after the Notification Date.
F-85
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Furthermore, under the Financing Agreement, the Company also agreed to make
available to Eagle Eye an additional $500,000, which may be loaned to Eagle Eye
at Eagle Eye's request, on substantially the same terms as set forth in the
Convertible Promissory Note, except that such additional indebtedness would be
convertible, at the Company's option, into 33,348 shares of Eagle Eye Common
Stock. As of December 31, 1998, no amounts were loaned to Eagle Eye under this
provision.
5. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
Year Ended
------------------------
November December
30, 1997 31, 1998
----------- -----------
<S> <C> <C>
Government:
Billed............................................. $ 3,109,725 $ 4,864,392
Unbilled........................................... 65,798 2,244,649
Retainage.......................................... 87,652 97,013
----------- -----------
3,263,175 7,206,054
----------- -----------
Domestic:
Billed............................................. 1,690,101 2,494,031
Unbilled........................................... 4,971 --
----------- -----------
1,695,072 2,494,031
----------- -----------
Foreign:
Billed............................................. 5,534,199 5,255,038
Unbilled........................................... 530,525 1,474,056
----------- -----------
6,064,724 6,729,094
----------- -----------
Total............................................. 11,022,971 16,429,179
Less: allowance for doubtful accounts.............. (548,717) (677,356)
----------- -----------
$10,474,254 $15,751,823
=========== ===========
</TABLE>
6. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
Year Ended
--------------------------
November 30, December 31,
1997 1998
------------ ------------
<S> <C> <C>
Data processing equipment........................ $ 1,526,474 $ 2,205,576
Office furniture and equipment................... 1,240,335 2,231,512
Leasehold improvements........................... 453,533 645,934
Building......................................... -- 2,050,808
----------- -----------
3,220,342 7,133,830
Less: accumulated depreciation................... (1,026,410) (1,710,899)
----------- -----------
$ 2,193,932 $ 5,422,931
=========== ===========
</TABLE>
F-86
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. REVOLVING CREDIT FACILITY AND LONG-TERM DEBT
<TABLE>
<CAPTION>
Year Ended
-------------------------
November 30, December 31,
1997 1998
------------ ------------
<S> <C> <C>
Revolving credit facility.......................... $ 33,553 $ 166,797
======== =========
Long-term debt consists of the following:
Term Loan.......................................... $175,695 $ 229,373
Less current portion............................... (91,667) (229,373)
-------- ---------
Long-term portion.................................. $ 84,028 $ --
======== =========
</TABLE>
Revolving Credit Facilities
The Company has a revolving credit facility (the "Facility") under a Loan
Agreement (the "Loan Agreement") with First Union National Bank, successor by
merger to Signet Bank, (the "Bank") in the aggregate principal amount of $3.0
million with an expiration date of June 30, 1999. As of December 31, 1998,
there were no amounts outstanding under this Facility. Availability of the
funds under the Loan Agreement is also subject to the Company's compliance with
certain covenants customary with commercial loans, including covenants related
to maintenance of certain levels of tangible net worth and a certain ratio of
current assets to current liabilities. The Loan Agreement further imposes
restrictions on creation of debt, merger, sale of assets, loans or advances,
guarantees, payment of dividends or repurchase of capital stock without the
Bank's consent. As of November 30, 1997 and for certain compliance periods
during the two years ended November 30, 1997, the Company was not in compliance
with the foregoing financial covenants for which waivers were obtained. During
the year ended December 31, 1998, the Company was in compliance with all
financial and non-financial covenants. The Company obtained the Bank's consent
in connection with the Board of Directors approved stock repurchase program.
The Facility bears interest at the LIBOR Market Index Rate (for the United
States Dollar quoted by the British Bankers Association) plus 1.85%. On August
3, 1998, the Bank issued a letter of credit on the Company's behalf as a
performance guarantee for a German customer in the amount of DEM 1,700,000
(approximately $1.0 million).
The Company's French subsidiary maintains with Banque Hervet an unsecured line
of credit for 500,000FF plus an additional 500,000FF of credit collateralized
by 70% of accounts receivable (approximately $180,000 in aggregate) at an
interest rate of 8.3%. The Company's Austrian subsidiary maintains a line of
credit with Raiffeisen Bank for 1,000,000ATS (approximately $85,000),
collateralized by 100% of accounts receivable at an interest rate of 5%. As of
December 31, 1998, 568,845FF (approximately $101,596) and 765,005ATS
(approximately $65,201), was outstanding under the French and Austrian lines of
credit, respectively.
Subordinated Note Payable
In December 1991, the Company repurchased 101,554 shares of Class A Common
Stock and 406,316 shares of Convertible Preferred Stock from a minority
shareholder for $300,000 in cash and a subordinated note in the amount of
$400,860 (the "Subordinated Note"). The Subordinated Note, as amended, requires
annual interest payments through March 1995 and quarterly principal and
interest payments of $31,000, beginning in April 1995. The Subordinated Note
bears interest at 2% above the prime rate. Any remaining balance is due
January 1, 1999. Stock representing the unpaid portion of the note is held in
treasury, and is being retired as the principal is repaid.
In October 1996, the balance of the Subordinated Note was paid in full and all
of the remaining, underlying shares of Preferred Stock and Class A Common Stock
held in treasury were retired. The repayment of the Subordinated Note was
financed with a $275,000, three year term loan pursuant to the Loan Agreement
from the Company's
F-87
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
commercial bank (the "Term Loan"). The Term Loan bears interest at the prime
rate plus 1/4% (8.75% at November 30, 1997 and 8.00% at December 31, 1998) and
requires monthly principal payments of $7,639, beginning in November 1996. The
balance of the Subordinated Note was $76,389 as of December 31, 1998.
In January 1998, the Company financed its Directors and Officers insurance
premiums with AI Credit Corporation in the amount of $269,123 at an annual
percentage rate of 9.16%. The Company makes monthly payments of $12,803 with
the note maturing in December 1999. The balance of this note was $152,984 as of
December 31, 1998.
8. CAPITAL STOCK
Stock Option Plans
The Company has three Stock Option Plans, the 1992 Incentive Stock Option Plan,
the 1992 Non-Statutory Stock Option Plan and the 1996 Equity Incentive Plan.
The 1992 Plans replace the Company's former 1986 Incentive Stock Option Plan
and the 1984 Incentive Stock Option Plan. No further grants may be made under
the 1992 plans.
In October 1996, the Company established the 1996 Equity Incentive Plan (1996
Equity Plan). Under the 1996 Equity Plan, which is administered by the
Compensation Committee of the Board of Directors, a variety of awards,
including stock options, stock appreciation rights, stock awards and incentive
awards may be made to the Company's employees and directors. Initially,
1,000,000 shares of Common Stock were reserved for issuance under the 1996
Equity plan. On April 28, 1998, the shareholders voted to increase the number
of authorized shares under such plan from 1,000,000 to 2,500,000.
Options granted under the Company's stock option plans generally vest over a
four year period and expire either three months after termination of
employment, or seven to ten years after date of grant. Options to purchase
1,309,313 shares were vested and exercisable at December 31, 1998.
Stock option activity for the years ended November 30, 1996 and 1997, for the
one month ended December 31, 1997, and for the year ended December 31, 1998 is
summarized as follows:
<TABLE>
<CAPTION>
1984 1986 1992 1996 Weighted
Incentive Incentive Incentive Incentive Average
Stock Plan Stock Plan Stock Plan Stock Plan Total Exercise Price
---------- ---------- ---------- ---------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, November
30, 1995............... 120,120 156,749 1,386,366 -- 1,663,235 $ 1.84
Granted................ -- -- 618,300 -- 618,300 4.58
Exercised.............. (14,014) -- (50,000) -- (64,014) 1.51
Forfeited.............. (13,106) -- (23,500) -- (36,606) 1.98
------- ------- --------- --------- --------- ------
Outstanding, November
30, 1996............... 93,000 156,749 1,931,166 -- 2,180,915 $ 2.63
Granted................ -- -- -- 1,190,712 1,190,712 12.38
Exercised.............. (81,000) (70,249) (193,426) -- (344,675) 1.99
Forfeited.............. -- -- (32,750) (14,000) (46,750) 5.03
------- ------- --------- --------- --------- ------
Outstanding, November
30, 1997............... 12,000 86,500 1,704,990 1,176,712 2,980,202 $ 6.56
Granted................ -- -- -- -- -- --
Exercised.............. -- (1,500) (750) -- (2,250) 1.98
Forfeited.............. -- -- (4,500) (48,000) (52,500) 1.96
------- ------- --------- --------- --------- ------
Outstanding, December
31, 1997............... 12,000 85,000 1,699,740 1,128,712 2,925,452 $ 6.47
Granted................ -- -- -- 583,000 583,000 9.80
Exercised.............. (12,000) (55,500) (350,980) (6,250) (424,730) 2.12
Forfeited.............. -- -- (13,000) (274,875) (287,875) 11.38
------- ------- --------- --------- --------- ------
Outstanding, December
31, 1998............... -- 29,500 1,335,760 1,430,587 2,795,847 $ 7.31
======= ======= ========= ========= ========= ======
</TABLE>
F-88
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The range of exercise prices for options outstanding at December 31, 1998 was
$1.38 to $16.00. The following table summarizes additional information about
stock options outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Weighted Weighted
Average Weighted Average
Remaining Average Exercise
Number Contractual Exercise Number Price of
Range of Exercise Prices Outstanding Life Price Exercisable Exercisable
------------------------ ----------- ----------- -------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$1.3800-$1.980.......... 970,885 5 years $1.779 820,260 $1.743
$4.0625-$6.000.......... 587,875 8 years 5.362 194,375 6.000
$9.0000-$12.875......... 534,712 9 years 9.837 123,219 9.696
$14.0000-$16.000........ 702,375 9 years 14.680 171,459 15.134
--------- ---------
2,795,847 1,309,313
========= =========
</TABLE>
The Company has adopted SFAS No. 123, "Accounting for Stock-Based forma amounts
shown below (in thousands, except per-share amounts): Compensation". In
accordance with SFAS No. 123, the Company applies APB Opinion 25 and related
Interpretations in accounting for its stock option plans. If the Company had
elected to recognize compensation cost based on the fair value of the options
granted at grant date as prescribed by SFAS No. 123, net income (loss) and net
income (loss) per common share would have been reduced to the pro forma amounts
shown below (in thousands, except per-share amounts):
<TABLE>
<CAPTION>
Year Ended One Month
November 30, Ended Year Ended
--------------------- December 31, December 31,
1996 1997 1997 1998
---------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss)--as
reported..................... $1,045,068 $2,379,793 $(622,537) $1,130,210
Net income (loss)--pro forma.. 988,901 1,956,444 (657,816) (876,785)
Earnings (loss) per common
share--as reported........... 0.23 0.44 (0.13) 0.20
Earnings (loss) per common
share--pro forma............. 0.21 0.34 (0.14) (0.17)
</TABLE>
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
Year
Ended
November One Month
30, Ended Year Ended
---------- December 31, December 31,
1996 1997 1997 1998
---- ---- ------------ ------------
<S> <C> <C> <C> <C>
Expected dividend yield................... 0.0% 0.0% -- 0.0%
Risk-free interest rate................... 6.4 6.5 -- 5.1
Expected volatility....................... 70.0 70.0 -- 70.0
Expected life (in years).................. 5 5 -- 5
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion the existing models do not necessarily provide a reliable
single measure of the fair value of the Company's options. The weighted average
estimated fair values of employee stock options granted during the years ended
November 30, 1996 and 1997, for the one month period ended December 31, 1997
and for the year ended December 31, 1998 were $2.90, $7.83, $0 and $6.09 per
share, respectively.
F-89
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Prior to the initial public offering of the Company's Common Stock, the fair
value of the Company's Common Stock was determined through an independent
valuation. The Company calculated deferred compensation expense of $1,634,527
related to certain options granted during the years ended November 30, 1995 and
1996 and will recognize compensation expense over the vesting period of those
stock options. The Company did not record any adjustments for deferred
compensation expense as of November 30, 1995 and 1996 since it did not have a
material effect on total shareholders' equity. During the year ended November
30, 1997, for the one month ended December 31, 1997 and for the year ended
December 31, 1998, the company recorded $406,985, $32,483 and $389,143 of
deferred compensation expense, respectively.
9. INCOME TAXES
Foreign (loss) income before income taxes was ($13,819), $1,017,199, ($390,203)
and $173,926 for the years ended November 30, 1996 and 1997, for the one month
ended December 31, 1997 and for the year ended December 31, 1998, respectively.
The benefit (provision) for income taxes for the years ended November 30, 1996
and 1997, for the one month ended December 31, 1997 and for the year ended
December 31, 1998 is summarized as follows:
<TABLE>
<CAPTION>
Year Ended One Month Year
November 30, Ended Ended
---------------------- December 31, December 31,
1996 1997 1997 1998
--------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Current:
Federal....................... $(485,853) $ (981,736) $ -- $ (83,150)
State......................... (97,239) (118,808) -- (58,688)
Foreign....................... -- (35,232) (20,249) (62,543)
--------- ----------- -------- ---------
(583,092) (1,135,776) (20,249) (204,381)
--------- ----------- -------- ---------
Deferred:
Federal....................... (54,670) (91,042) 169,781 (319,370)
State......................... (2,179) (3,473) 18,864 (29,663)
Foreign....................... (4,561) (537,725) 103,459 (194,703)
--------- ----------- -------- ---------
(61,410) (632,240) 292,104 (543,736)
--------- ----------- -------- ---------
Total benefit (provision)... $(644,502) $(1,768,016) $271,855 $(748,117)
========= =========== ======== =========
</TABLE>
F-90
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The source and tax effects of the temporary differences giving rise to the
Company's net deferred tax assets (liabilities) at November 30, 1997 and
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Year Ended
-------------------------
November 30, December 31,
1997 1998
------------ ------------
<S> <C> <C>
Capitalized software................................. $(563,439) $ (988,560)
Deferred revenue..................................... 165,153 297,459
Allowance for doubtful accounts...................... 99,800 79,354
Accrued liabilities.................................. 141,219 336,375
Deferred compensation................................ 154,663 --
Net operating loss carryforward...................... 733,859 1,120,750
Goodwill............................................. 47,844 196,598
Research and development credits..................... -- 100,000
Other................................................ 35,401 (56,426)
--------- ----------
$ 814,500 $1,085,550
Valuation allowance.................................. -- (40,000)
--------- ----------
Total.............................................. $ 814,500 $1,045,550
========= ==========
</TABLE>
During 1998, the Company recorded a valuation allowance of $40,000. The
valuation allowance at December 31, 1998 relates to the future utilization of
foreign net operating loss carryforwards that the Company has determined are
not realizable at this time.
As of December 31, 1998, the Company has research and development tax credits
of $100,000 which will be utilized to offset future taxes payable. In addition,
as of November 30, 1997 and December 31, 1998, the Company had net operating
loss carryforwards of approximately $1.9 million and $1.7 million,
respectively, related to its foreign operations. The research and development
tax credits and the net operating loss carryforwards begin to expire in 1999.
The Company's tax provision for the years ended November 30, 1996 and 1997, the
one month ended December 31, 1997 and the year ended December 31, 1998 differs
from the statutory rate for Federal income taxes as a result of the tax effect
of the following factors:
<TABLE>
<CAPTION>
Year Ended Year
------------------------- Month Ended Ended
November 30, November 30, December 31, December 31,
1996 1997 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Statutory rate............. (34)% (34)% 34% (34)%
State income taxes, net
of federal benefit...... (4)% (4) 2 (5)
Permanent differences.... (1)% (2) (1) 4
Foreign rate
differential............ -- (3) (5) (10)
Research and development
credits................. -- -- -- 5
Other...................... 1% -- -- --
--- --- --- ---
Effective tax rate....... (38)% (43)% 30% (40)%
=== === === ===
</TABLE>
F-91
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. COMMITMENTS AND CONTINGENCIES
Pending Litigation
On December 23, 1998, the Company filed an action against Automated Financial
System, Inc, ("AFS") in the United States District Court for the Eastern
District of Virginia seeking compensatory damages of approximately $950,000
resulting from AFS's failure to pay fees to the Company pursuant to a February,
1998 consulting agreement. AFS has filed a counterclaim against the Company,
asserting breach of contract, deceit and fraud, seeking an unspecified amount
of money damages for lost profits, loss of business and other economic damages.
The Company has filed a motion to dismiss the counterclaim, which is pending.
Discovery has commenced in the action. The Company cannot currently predict the
outcome of this litigation. If the Company is not successful in pursuing these
claims, there could be a material adverse effect on the Company's business,
results of operations and financial condition.
In addition, the Company is and may from time to time be involved in ordinary
routine litigation incidental to its business. Other than is described above,
the Company is not aware of any pending or threatened litigation that could
have a material adverse effect on the Company's business, results of operation
or financial condition.
Operating Leases
During September 1996, the Company entered into a noncancelable operating lease
for the corporate headquarters that expires in December 2006. As an incentive
to lease this space, the landlord provided a rent abatement through December
1996. Additionally, the lease contains an escalation clause that provides for
an increase in base rent beginning in December 1997 and a renewal clause
whereby the Company has the option to renew the lease for a period of five
additional years.
During 1997, the Company entered into a sublease agreement for a portion of its
leased office space that continued through December 31, 1998. Rent expense was
reduced by approximately $56,000, $8,000 and $206,000 for the year ended
November 30, 1997, for the one month ended December 31, 1997 and for the year
ended December 31, 1998, respectively, due to this rental income.
The Company also leases certain office equipment and other office space under
noncancelable operating leases which expire at various dates through 2008.
Certain operating leases provide for adjustments relating to changes in real
estate taxes and other operating expenses. Rent expense under all leases is
recognized ratably over the lease terms. Rent expense under all operating
leases was approximately $706,902, $1,508,707, $188,500 and $2,123,435,
respectively, for the years ended November 30, 1996 and 1997, for the one month
ended December 31, 1997 and for the year ended December 31, 1998.
Capital Leases
The company leases certain office equipment under arrangements that meet the
criteria requiring capitalization as prescribed by Statement of Financial
Accounting Standards No. 13, "Accounting for Leases" ("SFAS No. 13"). Included
in the balance sheets are the following amounts at November 30, 1997 and
December 31, 1998:
<TABLE>
<CAPTION>
Year Ended
-------------------------
November 30, December 31,
1997 1998
------------ ------------
<S> <C> <C>
Office furniture and equipment..................... $210,042 $210,042
Data processing equipment.......................... 37,044 54,117
Less: accumulated amortization..................... (69,372) (131,052)
-------- --------
$177,714 $133,107
======== ========
</TABLE>
F-92
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Future minimum lease payments, under all leases, at December 31, are as
follows:
<TABLE>
<CAPTION>
Operating Capital
---------- --------
<S> <C> <C>
1999....................................................... $1,329,295 $ 63,884
2000....................................................... 1,135,430 49,333
2001....................................................... 1,149,910 32,916
2002....................................................... 1,180,751 --
2003....................................................... 1,216,176 --
Thereafter................................................. 3,773,210 --
---------- --------
Total minimum payments................................. $9,784,772 146,134
==========
Less: portion representing interest........................ 14,322
--------
Present value of capital lease obligations................. $131,811
========
</TABLE>
11. ACCRUED EXPENSES
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
Year Ended
-------------------------
November 30, December 31,
1997 1998
------------ ------------
<S> <C> <C>
Accrued payroll, bonus and vacation................... $1,871,569 $2,314,890
Accrued commissions................................... 106,553 92,713
Accrued subcontractor's fees.......................... 22,857 461,309
Accrued value added tax............................... 371,339 624,107
Accrued acquisition costs............................. 160,872 --
Other accrued expenses................................ 184,428 608,596
---------- ----------
$2,717,618 $4,101,615
========== ==========
</TABLE>
12. RELATED PARTY TRANSACTIONS
In November 1996, Alcatel Alsthom Compagnie Generale d'Electricite S.A.
("Alcatel") invested $8.0 million in the Company in the form of Preferred Stock
at the equivalent of $16.00 per share of Common Stock. The costs related with
the issuance of the Preferred Stock was $75,096. Coincident with the Company's
initial public offering of stock, the Preferred Stock converted to Common Stock
at a one to one conversion rate. During 1997, Alcatel and the Company entered
into agreements whereby the Company provides products and services to Alcatel
for their internal use and for resale to their customers. For the year ended
November 30, 1997, for the one month ended December 31, 1997 and for the year
ended December 31, 1998, the Company earned $1,712,683, $145,802 and $556,081
of revenue from Alcatel, respectively. Accounts receivable from Alcatel as of
November 30, 1997 and December 31, 1998 were $785,314 and $31,177,
respectively.
13. EMPLOYEE BENEFIT PLANS
Deferred Compensation Plan
The Company maintains a deferred compensation profit-sharing plan under section
401(k) of the Internal Revenue Code. Under the plan, domestic employees may
elect to defer up to 12% of their salary, subject to Internal Revenue Service
limits. The Company contributes a matching 50% of the first 4% of employee
contributions. In addition, the plan allows for the Company to make
discretionary contributions based on the
F-93
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
participants salary. Total Company contributions to the plan were $100,003,
$129,917, $16,815 and $196,972 for the years ended November 30, 1996 and 1997,
for the one month ended December 31, 1997 and for the year ended December 31,
1998, respectively.
Incentive Bonus Plan
The Company has an incentive bonus plan whereby the Board of Directors
authorized the officers to grant awards to nominated employees in recognition
of exceptional contributions. Awards totaling $50,850, $101,375, $0 and
$27,833, were given to employees (excluding executives) for the years ended
November 30, 1996 and 1997, for the one month ended December 31, 1997 and for
the year ended December 31, 1998, respectively.
14. Segment Information
The Company provides software products and services worldwide. Revenue from
foreign operations and identifiable assets of foreign operations were less than
10% of consolidated revenue and assets in 1996. Summarized financial
information by geographic region for 1997 and 1998 is as follows (in
thousands):
<TABLE>
<CAPTION>
Sales
Sales to Between Income Identifiable
Unaffiliated Geographic from Assets at Capital Depreciation/
Customers Areas Operations Year End Expenditures Amortization
------------ ---------- ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Year ended November 30,
1997:
United States.......... $14,630 $ 2,745 $2,266 $ 39,790 $ 461 $204
Europe................. 12,188 606 1,103 18,733 432 145
Americas/Pacific....... 92 60 7 133 40 6
Eliminations........... -- (3,411) -- (15,685) -- --
Consolidated........... $26,910 $ -- $3,376 $ 42,971 $ 933 $355
Month ended December 31,
1997:
United States.......... $ 937 $ 121 $ (549) $ 40,679 $ 119 $ 29
Europe................. 1,231 193 (293) 18,333 47 29
Americas/Pacific....... (23) 11 (59) 134 0 1
Eliminations........... -- (325) -- (15,827) -- --
Consolidated........... $42,639 $ -- $ (901) $ 43,319 $ 166 $ 59
Year ended December 31,
1998:
United States.......... $21,345 $ 1,519 $1,103 $ 45,649 $ 516 $280
Europe................. 21,235 1,045 (15) 24,467 3,041 267
Americas/Pacific....... 59 95 32 52 10 12
Eliminations........... -- 2,659 -- (20,792) -- --
Consolidated........... $42,639 $ -- $1,120 $ 49,376 $3,567 $559
</TABLE>
Intercompany revenues between geographic areas are accounted for as transfer
fees which are intended to cover primarily software development and cost of
goods sold. The Company did not derive more than 10% of its total consolidated
revenue from export sales for the years 1996, 1997 and 1998.
15. Liquidation of Mexican Subsidiary
On December 1, 1998, the Company commenced liquidation of its Mexican
subsidiary formed in 1997. The Company pursued this course of action as the
result of the losses incurred since the inception of that operation coupled
with the instability of Mexico's economic environment. The total cost related
to the liquidation of this subsidiary was approximately $175,000 as of December
31, 1998. The Company has accrued the remaining costs associated with this
liquidation in the amount of $83,127 as of December 31, 1998. Management
believes these accrued costs represent all remaining obligations of the Company
with regard to the liquidation of this subsidiary.
F-94
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(Unaudited) (Audited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents........................... $ 2,527 $ 1,831
Marketable securities............................... 4,346 8,221
Accounts receivable, net............................ 9,415 15,752
Deferred income taxes............................... 4,511 1,873
Note receivable..................................... -- 500
Prepaid expenses.................................... 1,173 732
Other current assets................................ 239 486
------- -------
Total current assets.............................. 22,211 29,395
Property and equipment, net......................... 5,135 5,423
Software development costs, net..................... 3,164 2,601
Goodwill, net....................................... 8,667 10,298
Other assets........................................ 1,427 1,367
------- -------
Total assets...................................... $40,604 $49,084
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses............... $ 6,262 $ 6,791
Current portion of long-term debt................... 282 451
Deferred income..................................... 352 1,437
------- -------
Total current liabilities......................... 6,896 8,679
------- -------
Long-term Liabilities:
Long-term debt, net of current portion.............. 68 76
Deferred income taxes............................... 1,119 827
Other long-term liabilities......................... 474 421
------- -------
Total liabilities................................. 8,557 10,003
------- -------
Shareholders' Equity:
Common stock........................................ 52 52
Additional paid-in capital.......................... 36,598 36,619
Deferred compensation............................... (321) (727)
Accumulated other comprehensive income (loss)....... (867) 154
Retained earnings................................... (2,117) 3,794
Treasury stock...................................... (1,298) (811)
------- -------
Total shareholders' equity........................ 32,047 39,081
------- -------
Total liabilities and shareholders' equity........ $40,064 $49,084
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-95
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Thousands, except Per Share and Share Data)
(Unaudited)
<TABLE>
<CAPTION>
For the Three
Months Ended For the Nine Months
September 30, Ended September 30,
-------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Products............................ $ 490 $ 1,214 $ 3,887 $ 5,106
Services............................ 8,598 8,646 27,482 23,559
--------- --------- --------- ---------
Total Revenues.................... 9,088 9,860 31,369 28,665
--------- --------- --------- ---------
Cost of Revenues:
Products............................ 500 349 1,583 1,102
Services............................ 6,422 5,447 21,057 14,727
--------- --------- --------- ---------
Total cost of revenues............ 6,922 5,796 22,640 15,829
--------- --------- --------- ---------
Gross profit........................ 2,166 4,064 8,729 12,836
--------- --------- --------- ---------
Operating Expenses:
Selling and marketing............... 2,950 2,348 8,029 7,157
Product development................. 586 354 1,497 1,021
General and administrative.......... 1,690 1,289 7,337 4,098
--------- --------- --------- ---------
Total operating expenses.......... 5,226 3,991 16,863 12,276
--------- --------- --------- ---------
Income (loss) from operations....... (3,060) 73 (8,134) 560
Interest expense................... 58 128 231 437
Other income....................... (7) 36 (8) 210
--------- --------- --------- ---------
Net income (loss) before income
taxes.............................. (3,009) 237 (7,911) 1,207
Income tax provision (benefit)...... (762) 207 (2,000) 557
--------- --------- --------- ---------
Net income (loss)................... $ (2,247) $ 30 $ (5,911) $ 650
========= ========= ========= =========
Earnings (loss) per share--basic.... $ (0.46) $ 0.01 $ (1.19) $ 0.13
========= ========= ========= =========
Shares used in computing basic
earnings (loss) per share.......... 4,901,909 5,120,860 4,951,050 5,021,608
========= ========= ========= =========
Earnings (loss) per share--diluted.. $ (0.46) $ 0.01 $ (1.19) $ 0.11
========= ========= ========= =========
Shares used in computing diluted
earnings (loss) per share.......... 4,901,909 5,669,497 4,951,050 5,803,578
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-96
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the
Three Months For the Nine
Ended Months Ended
September September
30, 30,
------------- -------------
1999 1998 1999 1998
------- ---- ------- ----
<S> <C> <C> <C> <C>
Net income (loss)................................. $(2,247) $ 30 $(5,911) $650
Foreign currency translation adjustment........... 283 338 (474) 280
Unrealized loss on marketable securities, net of
taxes............................................ (48) -- (547) --
------- ---- ------- ----
Comprehensive income (loss)....................... $(2,012) $368 $(6,932) $930
======= ==== ======= ====
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-97
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the Nine
Months Ended
September 30,
----------------
1999 1998
------- -------
<S> <C> <C>
Cash flows used in operating activities...................... $ (264) $ (11)
------- -------
Cash flows from investing activities:
Proceeds from sales and maturities of marketable securities.. 5,165 8,400
Purchase of marketable securities............................ (2,000) (5,201)
Purchase of convertible note................................. -- (1,500)
Proceeds from note receivable................................ 500 --
Capital expenditures and leasehold improvements.............. (670) (3,390)
Capitalization of software development costs................. (1,348) (1,220)
Acquisition costs, net of cash acquired...................... -- (58)
------- -------
Net cash provided (used in) by investing activities......... 1,647 (2,969)
------- -------
Cash flows from financing activities:
Revolving credit facility, net............................... (69) 487
Increase in notes payable.................................... 102 269
Payments on notes payable.................................... (158) (157)
Capital lease obligations.................................... (41) (29)
Income tax benefit related to stock options.................. 9 634
Proceeds from sale of common stock under stock programs...... 122 861
Purchase of common stock..................................... (487) (501)
------- -------
Net cash provided by (used in) financing activities......... 522 1,564
------- -------
Effect of exchange rate changes on cash and cash
equivalents................................................. (165) (77)
------- -------
Net increase (decrease) in cash and cash equivalents......... 696 (1,493)
Cash and cash equivalents, beginning of period............... $ 1,831 $ 3,425
======= =======
Cash and cash equivalents, end of period..................... $ 2,527 $ 1,932
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-98
<PAGE>
TEMPLATE SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS
NOTE A--BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited consolidated financial
statements of Template Software, Inc. and subsidiaries ("Template") contain all
adjustments (consisting only of normal recurring accruals) necessary to present
fairly Template's consolidated financial position as of September 30, 1999 and
the results of operations and cash flows for the periods indicated. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. It is suggested that these condensed consolidated
financial statements be read in conjunction with the financial statements and
notes thereto included in Template's 1998 Annual Report on Form 10-K. The
results of operations for the nine months ended September 30, 1999 are not
necessarily indicative of the operating results to be expected for the full
year.
NOTE B--MERGER WITH LEVEL 8 SYSTEMS, INC.
On October 20, 1999, Template announced that it had entered into an Agreement
and Plan of Merger dated as of October 19, 1999 (the "Merger Agreement") with
Level 8 Systems, Inc., a Delaware corporation ("Level 8") and Level 8's wholly-
owned subsidiary, TSAC, Inc., a Delaware corporation (the "Subsidiary"). The
Merger Agreement provides for Level 8's acquisition of Template by Template's
merger with and into the Subsidiary (the "Merger").
Under the Merger Agreement, each share of Template's common stock will be
exchanged for $4.00 in cash plus $3.90 worth of Level 8 common stock, subject
to adjustment. The actual number of shares of Level 8 common stock to be
exchanged for each Template share will be based on the average trading price of
Level 8 stock for the 10 trading days prior to the third trading day before
Level 8's shareholder approval, but will not be less than 0.2838 Level 8 shares
per Template share (if Level 8's average trading price exceeds $13.74) or more
than 0.3672 Level 8 shares per Template share (if Level 8's average trading
price is less than $10.62). The Merger is intended to qualify as a tax-free
reorganization, which means that Template shareholders would generally be
permitted to defer taxes on the Level 8 stock portion of the merger
consideration.
In connection with the Merger, on October 17, 1999 Template's Board of
Directors approved an amendment to the Rights Agreement by and between Template
and First Union National Bank dated as of July 3, 1998 (the "Rights
Agreement"). The amendment provides that neither Level 8 nor the Subsidiary
will be considered an "Acquiring Person" (as that term is defined in the Rights
Agreement), and that the execution, delivery and consummation of the Merger
Agreement will not cause the occurrence of a "Distribution Date" or a "Stock
Acquisition Date" (as these terms are defined in the Rights Agreement). The
amendment thus ensures that the Merger will not trigger the distribution of
rights to Template's shareholders under the Rights Agreement. In addition, in
connection with the Merger Agreement, Template has agreed not to further amend
the Rights Agreement without the consent of Level 8.
The Merger is subject to certain conditions to closing, including shareholder
approval, regulatory approval, and necessary consents and filings.
NOTE C--RECENT ACCOUNTING PRONOUNCEMENTS
In December 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-9 (SOP 98-9), "Modification of SOP 97-2, Software
Revenue Recognition with Respect to Certain Transactions." The provisions of
this SOP that extend the deferral of the application of certain passages of SOP
97-2 are effective December 15, 1998. All other provisions of this SOP are
effective for transactions entered into in fiscal years beginning after March
15, 1999. Earlier adoption is permitted as of the beginning of fiscal years or
interim periods for which financial statements or information have not been
issued. Retroactive application of the provisions of this SOP are prohibited.
The adoption of SOP 98-9 is not expected to have a material impact on
Template's operating results, financial position or cash flows.
F-99
<PAGE>
TEMPLATE SOFTWARE INC. AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
NOTE D--INCOME TAXES
The Income Tax Benefit was $0.8 million for the quarter ended September 30,
1999 compared to an Income Tax Provision of $0.2 million for the quarter ended
September 30, 1998. The Income Tax Benefit for the nine months ended September
30, 1999 was $2.0 million compared to an Income Tax Provision of $0.6 million
for the nine month period ended September 30, 1998. Template's effective tax
rate was 25% for the quarter ended September 30, 1999 compared to 87% for the
quarter ended September 30, 1998. Template's effective tax rate was 25% for the
nine month period ended September 30, 1999 compared to 46% for the nine month
period ended September 30, 1998. These tax rates reflect the differences in
effective tax rates relative to Template having pre-tax losses in 1999 and pre-
tax profits in 1998 along with lower tax rates applicable to losses in foreign
jurisdictions, the effect of the permanent differences relative to Template's
profit/loss and the establishment in 1999 of valuation allowances for deferred
tax assets attributable to net operating losses in France in the amount of
approximately $482,000.
NOTE E--EARNINGS PER SHARE
Earnings per share is presented in accordance with SFAS No. 128, Earnings per
Share. Basic earnings per share is computed by dividing net income available to
common shareholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is computed by dividing net
income available to common shareholders by the weighted average of common
shares outstanding after giving effect to all dilutive potential common shares
that were outstanding during the period.
The following table reconciles the weighted average number of common shares
outstanding during each period for basic earnings per share with the comparable
amount for diluted earnings per share.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average shares outstanding--
basic................................ 4,901,909 5,120,860 4,951,050 5,021,608
Potential common shares related to
stock options........................ -- 548,637 -- 781,970
--------- --------- --------- ---------
Weighted average shares outstanding--
diluted.............................. 4,901,909 5,669,497 4,951,050 5,803,578
========= ========= ========= =========
</TABLE>
Template did not have any dilutive common shares during the three and nine
month periods ended September 30, 1999. Net income (loss) reported was not
adjusted for the computation of basic or diluted earnings per share. In 1999,
443,857 and 395,815 shares primarily related to the inclusion of the effect of
potential stock options exercises were not included in the computation of
diluted earnings per share for the three and nine month periods ended September
30, 1999, respectively, because to do so would have been antidilutive for those
periods.
F-100
<PAGE>
LEVEL 8 SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
For the Year Ended December 31, 1999
(in thousands)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
Adjustments Level 8 Adjustments
Level 8 (Note 3) Adjusted Template (Note 3) Combined
-------- ----------- -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Revenue
Products............... $ 16,030 $ -- $ 16,030 $ 3,050 $ -- $ 19,080
Services............... 36,890 -- 36,890 19,007 -- 55,897
-------- ----- -------- -------- ------- --------
Total revenue......... 52,920 -- 52,920 22,057 -- 74,977
Cost of revenue
Products............... 4,245 426 (d) 4,671 1,052 2,033 (a) 7,756
Services............... 24,661 -- 24,661 15,148 -- 39,809
-------- ----- -------- -------- ------- --------
Total cost of
revenue.............. 28,906 426 29,332 16,200 2,033 47,565
Gross profit............ 24,014 (426) 23,588 5,857 (2,033) 27,412
Operating expenses
Research and product
development........... 6,796 -- 6,796 2,157 -- 8,953
Purchased research and
development........... 2,944 -- 2,944 -- (2,200) (f) 744
Selling, general and
administrative........ 18,831 -- 18,831 17,876 -- 36,707
Amortization of
goodwill.............. 6,959 (17) (d) 6,942 -- 7,312 (a) 14,254
Restructuring charges.. 383 -- 383 -- (383) (f) --
-------- ----- -------- -------- ------- --------
Total operating
expenses............. 35,913 (17) 35,896 20,033 4,729 60,658
Loss from operations.... (11,899) (409) (12,308) (14,176) (6,762) (33,246)
Interest income......... 579 -- 579 1 -- 580
Interest and other
expense................ (2,742) -- (2,742) (1,068) (1,572) (b),(c) (5,382)
Net foreign currency
gains/(losses)......... (695) -- (695) -- -- (695)
-------- ----- -------- -------- ------- --------
(2,858) -- (2,858) (1,572) (5,497)
Net loss before taxes... (14,757) (409) (15,166) (15,243) (8,334) (39,276)
Income tax
provision/(benefit).... 720 -- 720 (1,347) 1,347 (e) 720
-------- ----- -------- -------- ------- --------
Pro forma net loss from
continuing Operations.. $(15,477) $(409) $(15,886) $(13,896) $(9,681) $(38,743)
======== ===== ======== ======== ======= ========
Pro forma loss per
share, Basic and
diluted................ -- -- -- -- -- $ (3.78)
========
Pro forma weighted
average shares
Outstanding, basic and
diluted................ -- -- -- -- -- 10,553
========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-101
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS
(in thousands, except per share amounts)
NOTE 1. BASIS OF PRESENTATION
The pro forma combined statement of operations assumes the business combination
took place as of the beginning of the period presented. The statement of
operations for the year ended December 31, 1999 combines Template's
consolidated statement of operations for the period ended December 26, 1999 and
Level 8's consolidated statement of operations for the year ended December 31,
1999. Template's results of operations are included in the unaudited historical
Level 8 consolidated statement of operations for the year ended December 31,
1999 from the date of acquisition.
Level 8 pro forma adjustments in 1999 are to record the increase in
amortization of goodwill and purchased software based on the assumption that
the purchase of the remaining 31% of Seer's outstanding voting stock occurred
before January 1, 1999.
On a combined basis there were no material transactions between Template and
Level 8 during the periods presented.
There are no material differences between the accounting policies of Template
and Level 8.
NOTE 2. GENERAL
On December 27, 1999, the Company acquired Template Software, Inc.
("Template"). Under the terms of the agreement, Level 8 purchased 5,394,959
shares of Template common stock for $21,579 in cash and 1,531,089 shares of
Level 8 common stock. Additionally, Level 8 also issued stock options
exercisable for 1,124,023 shares of the Company's common stock to assume all of
the outstanding Template stock options. The total cost of the acquisition was
$63,972 and has been accounted for by the purchase method of accounting. The
operations of Template are included in the Company's consolidated results of
operations from the date of acquisition.
The purchase price was 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 Template. The purchase price exceeded the amounts allocated to tangible and
intangible assets acquired less liabilities assumed by approximately $44,371.
This excess of the purchase price over the fair values of assets acquired less
liabilities assumed was allocated to goodwill.
Prior to completing the acquisition, the Company had determined not to continue
with certain non-strategic operations of Template in Germany and Austria. At
the time of merger, the Company had entered into an agreement in principle to
sell the assets of these operations, principally its consulting workforce and
certain lease agreements. Accordingly, the Company has recorded the estimated
fair value of these operations at the acquisition date based on its estimate of
the net future cash flows from the transactions and associated operations
through the wind up period. The fair value of the German and Austrian operating
liability was estimated at $25 and will be adjusted prospectively as this
estimate changes.
F-102
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS--(Continued)
The cost of the acquisition was allocated as follows:
<TABLE>
<S> <C>
Cash................................................................ $ 160
Accounts receivable................................................. 6,123
Prepaid expenses and other current assets........................... 597
Property and equipment.............................................. 4,183
Capitalized software and developed technology....................... 12,200
In-process research and development................................. 2,200
Goodwill and other intangibles...................................... 47,291
Other assets........................................................ 431
Assets held for resale.............................................. (25)
Accounts payable.................................................... (668)
Accrued expenses and other liabilities.............................. (6,445)
Deferred revenue.................................................... (439)
Deferred tax liability.............................................. (1,476)
Long-term debt...................................................... (160)
-------
Cost of net assets acquired......................................... $63,972
=======
</TABLE>
Approximately $2,200 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 in areas for which technological
feasibility had not been established. The efforts considered included projects
related to Template's Enterprise Integration Template ("EIT") product ($1,298),
and projects related to new versions of Template's Business Process Template
("BPT") product ($902). The value of the 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 difficulty of completing the remaining development costs already incurred,
and the projected cost to complete the projects. The discount rate included a
factor that takes into account the uncertainty surrounding successful
development of the purchased in-process research and development.
NOTE 3. PRO FORMA ADJUSTMENTS
(a) Adjustments are to record annual amortization of intangible assets
resulting from the allocation of purchase price, as discussed in Note 2.
The estimated useful life of the intangible assets is considered to range
from three to seven years. The estimated annual amortization charge to
income related to developed technology resulting from the purchase
described above approximates $2,033. The estimated annual amortization
charge to income related to goodwill and other intangible assets resulting
from the purchase described above approximates $7,312. These charges are
reflected in the pro forma combined statements of income.
(b) Adjustments are to record interest expense incurred by Level 8 on the 10
million loan obtained in connection with the acquisition. The amount of
interest expense incurred by Level 8 is computed assuming the funds were
received on January 1, 1999 and utilizing the current LIBOR rate plus one
percent.
(c) Adjustments are to record the amortization of the loan guaranty cost for
the 60,000 shares issued to Liraz Systems, Ltd. in exchange for their
guarantee of the loan to finance the acquisition. The cost of the guarantee
is being amortized over the term of the loan, which matures on May 31,
2001.
(d) Adjustments are to record the increase in amortization of goodwill and
purchased software based on the assumption that the purchase of the
remaining 31% of Seer's outstanding voting stock occurred before January 1,
1999.
F-103
<PAGE>
LEVEL 8 SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS--(Continued)
(e) Adjustments are to eliminate the income tax benefit previously recorded by
Template during 1999.
(f) Adjustments are to remove non-recurring items that are directly
attributable to the transaction as per SEC guidelines.
NOTE 4. PRO FORMA EARNINGS PER COMMON SHARE
The unaudited pro forma combined basic earnings per share data is computed by
providing pro forma combined income per share by the weighted average number of
common shares outstanding and the issuance of 1,531,089 shares of common stock
to Template stockholders and 60,000 shares of common stock to Liraz in exchange
for guarantee on the financing. Diluted earnings (loss) per share is not
presented as the inclusion of options and other common stock equivalents
outstanding would be anti-dilutive. Potentially dilutive securities outstanding
during the period presented for 1999 include preferred stock, stock options,
and stock warrants.
F-104
<PAGE>
PART II.
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, to be paid in connection with the sale
of the common stock being registered, all of which will be paid by Level 8
Systems, Inc. All amounts are estimates except the registration fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee........ $ 11,493
--------
Accounting fees and expenses............................... 40,000
--------
Legal fees and expenses.................................... 35,000
--------
Miscellaneous.............................................. 20,000
--------
Total................................................... $106,493
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the Delaware General Corporation Law permits indemnification
of directors, officers, employees and agents of corporations for liabilities
arising under the Securities Act of 1933, as amended.
The registrant's certificate of incorporation and bylaws provide for
indemnification of the registrant's directors and officers to the fullest
extent permitted by Section 145 of the Delaware General Corporation Law.
Statutory Provisions Section 102(b)(7) of the Delaware General Corporation Law
enables a corporation in its certificate of incorporation to eliminate or limit
the personal liability of members of its board of directors to the corporation
or its stockholders for monetary damages for violations of a director's
fiduciary duty of care. The provision would have no effect on the availability
of equitable remedies, such as an injunction or rescission, for breach of
fiduciary duty. In addition, no provision may eliminate or limit the liability
of a director for breaching his duty of loyalty, failing to act in good faith,
engaging in intentional misconduct or knowingly violating a law, paying an
unlawful dividend or approving an illegal stock repurchase, or obtaining an
improper personal benefit.
Section 145 of the Delaware General Corporation Law empowers a corporation to
indemnify any person who was or is a party to or is threatened to be made a
party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative, by reason of the fact
that he is or was a director, officer, employee or agent of the corporation,
against expenses (including attorney's fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by him in connection with the
action, suit or proceeding if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. No indemnification shall
be made in respect of any claim, issue or matter as to which such person shall
have been adjudged to be liable to the corporation unless and only to the
extent that the court in which such action or suit was brought shall determine
upon application that, despite the adjudication of liability but in view of all
the circumstances of the case, such person is fairly and reasonably entitled to
indemnity for expenses which the court shall deem proper. Additionally, a
corporation is required to indemnify its directors and officers against
expenses to the extent that the directors or officers have been successful on
the merits or otherwise in any action, suit or proceeding or in defense of any
claim, issue or matter.
II-1
<PAGE>
An indemnification can be made by the corporation only upon a determination
that indemnification is proper in the circumstances because the party seeking
indemnification has met the applicable standard of conduct as set forth in the
Delaware General Corporation Law. The indemnification provided by the Delaware
General Corporation Law shall not be deemed exclusive of any other rights to
which those seeking indemnification may be entitled under any bylaw, agreement,
vote of stockholders or disinterested directors, or otherwise. A corporation
also has the power to purchase and maintain insurance on behalf of any person,
whether or not the corporation would have the power to indemnify him against
such liability. The indemnification provided by the Delaware General
Corporation Law shall, unless otherwise provided when authorized or ratified,
continue as to a person who has ceased to be a director, officer, employee or
agent and shall inure to the benefit of the heirs, executors and administrators
of the person. The Company's Charter Provisions Our company's certificate of
incorporation limits a director's liability for monetary damages to our company
and our stockholders for breaches of fiduciary duty except under the
circumstances outlined in the Delaware General Corporation Law as described
above under "Statutory Provisions."
Our company's certificate of incorporation extends indemnification rights to
the fullest extent authorized by the Delaware General Corporation Law to
directors and officers involved in any action, suit or proceeding where the
basis of the involvement is the person's alleged action in an official capacity
or in any other capacity while serving as a director or officer of our company.
Item 15. Recent Sales of Unregistered Securities
On August 23, 2000, the Company acquired exclusive worldwide marketing, sales
and development rights to CiceroTM, a comprehensive integrated desktop computer
environment, from Merrill Lynch, Pierce, Fenner & Smith, Incorporated in
consideration of 1,000,000 shares of common stock.
On July 20, 2000, the Company issued 30,000 shares of Series B 4% Convertible
Redeemable Preferred Stock convertible into an aggregate of 1,197,007 shares of
common stock and warrants to purchase additional 1,047,0382 shares of common
stock at an exercise price of $25.0625 per share, subject to adjustment, for an
aggregate consideration of $30 million.
In December, 1999, the Company issued 60,000 shares of common stock to Liraz
Systems, Ltd. in consideration of Liraz's guarantee of a $10 million bank loan
to Level 8.
On June 29, 1999, the Company issued 21,000 shares of Series A 4% Convertible
Redeemable Preferred Stock convertible into an aggregate of 2,100,000 shares of
common stock and warrants to purchase additional 2,100,000 shares of common
stock at an exercise price of $10.00 per share, subject to adjustment, for an
aggregate consideration of $21 million.
On December 31, 1998, the Company acquired an approximately 69% interest in
Seer Technologies, Inc. in consideration of 1,000,000 shares of common stock
and warrants to purchase an additional 250,000 shares of common stock at an
exercise price of $12.00 per share.
In March 1998, the Company acquired Momentum Software Corporation in
consideration of 594,866 shares of common stock and warrants to purchase an
additional 200,000 shares of common stock for $13.108 per share.
During the first quarter of 2000, the Company retired $1.9 million in debt
owed to the Momentum note holders in consideration of approximately 55,000
shares of common stock. During 1999, 2,005 shares of preferred stock were
converted into 200,500 shares of the Company's common stock. Subsequent to
December 31, 1999, 7,000 shares of preferred stock were converted into 700,000
shares of the Company's common stock. Warrants totalling 146,719 were exercised
in the first six months of 2000. Warrants totaling 1,260,460 were exercised at
an exercise price of $10.00 during the year ended December 31, 1999. Additional
warrants totaling 3,000, 1,200 and 18,168 were exercised at an exercise price
of $7.43 during the years ended December 31, 1999, 1998 and 1997, respectively.
II-2
<PAGE>
All issuances of securities described above were made either in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933 for transactions by an issuer not involving a public offering
promulgated under the Securities Act of 1933, or, in the case of the conversion
of preferred stock, the Momentum note exchange and the cashless exercise of
warrants, the exemption from registration provided by Section 3(a)(9) of the
Securities Act of 1933 for transactions involving an exchange between the
Company and its existing security holders.
Item 16. Exhibits
A list of exhibits included as part of this registration statement is set
forth in the Exhibit Index which immediately precedes the exhibits and is
incorporated by reference here.
Item 17. Undertakings
(a)(1) The undersigned registrant hereby undertakes to file, during any
period in which offers or sales are being made, a post-effective amendment to
this registration statement:
(i) To include any Prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the Prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-
effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in this
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high and of the estimated maximum offering price
may be reflected in the form of Prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in this registration statement or any
material change to such information in this registration statement.
(2) That for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered herein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any of
the securities being registered which remain unsold at the termination of the
offering.
(b) The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the such Act and will be governed by the
final adjudication of such issue.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-1 and has duly caused this Amendment No. 1 to
this registration statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Cary, State of North Carolina, on
September 22, 2000.
LEVEL 8 SYSTEMS, INC.
/s/ Steven Dmiszewicki
By: _________________________________
Steven Dmiszewicki
President and Chief Operating
Officer
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
Arie Kilman* Chairman of the Board and September 22, 2000
______________________________________ Chief Executive Officer
Arie Kilman (Principal Executive
Officer)
/s/ Steven Dmiszewicki President, Chief Operating September 22, 2000
______________________________________ Officer and Director
Steven Dmiszewicki
Samuel Somech* Chairman Emeritus, Chief September 22, 2000
______________________________________ Technology Officer and
Samuel Somech Director
Renee Fulk* Chief Financial Officer, September 22, 2000
______________________________________ Treasurer and Assistant
Renee Fulk Secretary
Michel Berty* Director September 22, 2000
______________________________________
Michel Berty
Director
______________________________________
Robert M. Brill
Theodore Fine* Director September 22, 2000
______________________________________
Theodore Fine
Director
______________________________________
Lenny Recanati
Director
______________________________________
</TABLE> Anthony Pizi
<TABLE>
<S> <C>
/s/ Steven Dmiszewicki
*By: ____________________________
Steven Dmiszewicki
Attorney-in-Fact
</TABLE>
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
2.1 Agreement and Plan of Reorganization by and among Level 8, Middleware
Acquisition Corporation, Momentum Software Corporation, and Robert
Brill, Bruns Grayson and Hubertus Vandervoort, as Trustees of the
Momentum Liquidating Trust, on Behalf of the Securityholders of
Momentum Software Corporation dated February 27, 1998 (incorporated by
reference to exhibit 10.42 to Level 8's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997).
2.2 Agreement dated November 23, 1998 among Level 8 and Welsh, Carson,
Anderson & Stowe VI L.P. ("WCAS") and related parties (the "WCAS
Parties") named therein relating to the acquisition of capital stock
of Seer Technologies, Inc. by the Company (incorporated by reference
to exhibit 2.1 to the Seer Technologies, Inc. Annual Report on Form
10-K for the fiscal year ended September 30, 1998, File No. 000-
26194).
2.2A Amendment No. 1 to the Agreement dated November 23, 1998 among the
Level 8 and WCAS and the WCAS Parties relating to the acquisition of
capital stock of Seer (incorporated by reference to exhibit (c)(2) to
Seer Technologies, Inc.'s Schedule 13e-3, File No. 005-54373).
2.3 Agreement and Plan of Merger providing for the reincorporation of
Level 8 Systems under Delaware Law (incorporated by reference to
Appendix A (page 48) to Level 8's definitive proxy statement for its
1999 annual meeting filed on Schedule 14A).
2.4 Agreement and Plan of Merger, dated as of October 19, 1999, by and
among Level 8 Systems, Inc., TSAC, Inc., and Template Software, Inc.
(incorporated by reference to exhibit 2.1 to Level 8's Report on Form
8-K, filed November 5, 1999 (exhibits and schedules omitted but will
be furnished supplementally to the Securities and Exchange Commission
upon request)).
3.1 Certificate of Incorporation of Level 8 Systems, Inc., a Delaware
corporation (filed herewith).
3.2 Bylaws of Level 8 Systems, Inc., a Delaware corporation (filed
herewith).
3.3 Certificate of Designation relating to Series A 4% Convertible
Redeemable Preferred Stock (incorporated by reference to exhibit 3.3
to Level 8's Report on Form 8-K, filed July 23, 1999).
3.4 Certificate of Designation relating to Series B 4% Convertible
Redeemable Preferred Stock (incorporated by reference to exhibit 3.3
to Level 8's Report on Form 8-K, filed July 31, 2000).
4.1 Warrant to Purchase Common Stock, dated September 1, 1998, between
Template Software, Inc. and Eagle Eye Technologies, Inc. (incorporated
by reference to Exhibit 10.26 to Template Software, Inc.'s Quarterly
Report on Form 10-Q for the period ended August 31, 1998, File No.
000-21921).
4.2 Form of Warrant Agreement, between the Company and Hampshire
Securities Corporation for 135,000 shares of common stock
(incorporated by reference to exhibit 10.27 to Across Data Systems,
Inc.'s (Level 8's predecessor) Registration Statement on Form S-1,
filed May 12, 1995, File No.
33-92230).
4.3 Form of Warrants issued June 29, 1999 in connection with the sale of
Series A 4% Convertible Redeemable Preferred Stock (incorporated by
reference to exhibit 10.2 to Level 8's Form 8-K filed July 23, 1999).
</TABLE>
EX-1
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
4.4 Form of Warrant(s) representing the 250,000 Level 8 warrants issued to
the WCAS Parties (incorporated by reference to exhibit 8.2(A) to the
Seer Technologies, Inc. Annual Report on Form 10-K for the year ended
September 30, 1998, File No. 000-26194).
4.5 Registration Rights Agreement dated June 29, 1999 among Level 8
Systems, Inc. and the investors named on the signature pages thereof
(incorporated by reference to exhibit 10.3 to Level 8's Report on Form
8-K filed July 23, 1999, File No. 000-26392).
4.6 Registration Rights Agreement, dated June 13, 1995, between the
Company and Liraz (incorporated by reference to exhibit 10.24 to
Across Data Systems, Inc.'s (Level 8's predecessor) Registration
Statement on Form S-1, filed May 12, 1995, File No. 33-92230).
4.7 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 exhibit 10.2
to Level 8's Report on Form 8-K filed July 31, 2000).
4.8 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 exhibit 10.3 to Level
8's Report on Form 8-K filed July 31, 2000).
4.9 Warrant for 341,185 shares issued to Seneca International, Ltd., July
20, 2000 in connection with the sale of Series B 4% Convertible
Redeemable Preferred Stock (incorporated by reference to exhibit 10.4
to Level 8's Report on Form 8-K filed July 31, 2000).
4.10 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 exhibit 10.5 to Level 8's Report on Form
8-K filed July 31, 2000).
5.1 Opinion of Powell, Goldstein, Frazer & Murphy LLP (filed herewith).
10.1 Stockholders Agreement by and among Level 8 Systems, Inc., Template
Software, Inc., and various stockholders of Level 8 and Template
(incorporated by reference to exhibit 10.1 to Level 8's Report on Form
8-K filed November 5, 1999).
10.2 Level 8's 1997 Stock Option Plan, as Amended and Restated (filed
herewith).
10.3 Level 8's February 2, 1995 Non-Qualified Option Plan (incorporated by
reference to exhibit 10.1 to Across Data Systems, Inc.'s (Level 8's
predecessor) Registration Statement on Form S-1, filed May 12, 1995,
File No. 33-92230).*
10.4 Template Software, Inc. 1992 Non-Statutory Stock Option Plan
(incorporated by reference to an exhibit to Template Software, Inc.'s
Registration Statement on Form S-1, filed on November 27, 1996, File
No. 333-17063).
10.5 Template Software, Inc. 1992 Incentive Stock Option Plan (incorporated
by reference to an exhibit to Template Software, Inc.'s Registration
Statement on Form S- 1, filed on November 27, 1996, File No. 333-
17063).
10.6 Form of Consultant's Non Competition, Confidentiality and Invention
Assignment (incorporated by reference to exhibit 10-7 to Seer's
Registration Statement No. 33-92050 on Form S-1).
10.7 Employment Agreement between Steven Dmiszewicki and the Company dated
December 4, 1998 (incorporated by reference to exhibit 10.19 to Level
8's Annual Report on Form 10-K for the fiscal year ended December 31,
1998, File No. 000-26392).*
10.8 Amended and Restated Employment Agreement, effective November 8, 1996,
between Level 8 Technologies, Inc. ("Level 8 Technologies") and Samuel
Somech (incorporated by reference to exhibit 10.12 to Registration
Statement No. 33-92230 on Form S-1/A).*
10.8A Amendment dated February 26, 1999 to the Employment Agreement between
the Company and Samuel Somech dated November 8, 1996 (incorporated by
reference to exhibit 10.2A to Level 8's Annual Report on Form 10-K for
the fiscal year ended December 31, 1998).*
</TABLE>
EX-2
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.9 Employment Agreement, dated as of April 30, 1999, between Template
Software, Inc. and E. Linwood Pearce (incorporated by reference to
exhibit 10.2 to Template Software, Inc.'s Form 10-Q for the period
ending March 31, 1999).
10.10 License Agreement, dated as of December 17, 1998, between BULL and
Template Software, Inc. (incorporated by reference to exhibit 10.31 to
Template Software, Inc.'s Report on Form 10-K for the fiscal year
ended December 31, 1998).
10.11 Development Agreement dated July 17, 1995 between Microsoft
Corporation and the Company (incorporated by reference to exhibit
10.38 to Across Data Systems, Inc.'s (Level 8's predecessor)
Registration Statement on Form S-1, filed May 12, 1995, File No. 33-
92230).
10.12 Development Agreement dated December 19, 1995 between Liraz and the
Company (incorporated by reference to exhibit 10.38 to Across Data
Systems, Inc.'s (Level 8's predecessor) Registration Statement on Form
S-1, filed May 12, 1995, File No. 33-92230).
10.12A Amendment No. 1 to the Development Agreement dated December 15, 1995
between Liraz and the Company (incorporated by reference to exhibit
10.14A to Level 8's Annual Report on Form 10-K for the fiscal year
ended December 31, 1998).
10.13 Agreement, dated June 13, 1995, between the Company and Liraz
(incorporated by reference to exhibit 10.23 to Across Data Systems,
Inc.'s (Level 8's predecessor) Registration Statement on Form S-1,
filed May 12, 1995, File No. 33- 92230).
10.14 Sales and Purchase Agreement, dated April, 1997, between Template
Software (UK) Limited and British American Financial Services IT &
Group Services Limited (incorporated by reference to an exhibit to
Template Software, Inc.'s Quarterly Report on Form 10-Q for the period
ended May 31, 1997, File No. 0-21921).
10.15 Agreement, dated March 30, 1999, by and between Template Software,
Inc. and PCS Precise Connectivity Solutions Ltd. (incorporated by
reference to exhibit 10.2 to Template Software, Inc.'s Form 10-Q for
the period ending March 31, 1999).
10.16 Agreement NMA201-98-C-0089, dated September 30, 1998, Modification
PZ0001, dated November 30, 1998 and Modification PZ0002 dated December
31, 1998, by and between Template Software, Inc. and National Imagery
and Mapping Agency (incorporated by reference to exhibit 10.1 to
Template Software, Inc.'s Form 10-Q for the period ending June 30,
1999).
10.17 Lease Agreement for Cary, N.C. offices, dated March 31, 1997, between
Seer Technologies, Inc. and Regency Park Corporation (incorporated by
reference to exhibit 10.47 to Seer Technologies, Inc.'s Quarterly
Report on Form 10-Q for the period ended March 31, 1997, File No. 000-
26194).
10.17A Addendum #1 to the Lease Agreement for Cary, N.C. offices, dated July
6, 1998 (incorporated by reference to exhibit 10.58 to Seer Technology
Inc.'s Quarterly Report on Form 10-Q for the period ended June 30,
1998, File No. 000-26194).
10.17B Amendment to Lease Agreement for Cary, N.C. offices, dated January 21,
1999 (incorporated by reference to exhibit 10.21A to Level 8's Annual
Report on Form 10-K for the fiscal year ended December 31, 1998).
10.18 Office Lease Agreement, dated April 25, 1996, between Template
Software, Inc. and Vintage Park Two Limited Partnership (incorporated
by reference to an exhibit to Template Software, Inc.'s Registration
Statement on Form S-1, File No. 333-17063).
10.18A Amendment to Office Lease Agreement, dated August 18, 1997, between
Template Software, Inc. and Vintage Park Two Limited Partnership
(incorporated by reference to an exhibit to Template Software, Inc.'s
Annual Report on Form 10-K for the fiscal year ended December 31,
1997, File No. 000-21921).
</TABLE>
EX-3
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.19 Lease Agreement, dated December 25, 1992, between Seer Technologies,
Inc. and Capital & Counties (London, England) (incorporated by
reference to exhibit 10.22 to Seer Technologies, Inc.'s Registration
Statement on Form S-1, file No. 33-92050).
10.20 Credit Agreement between Seer and Greyrock Business Credit, dated
March 26, 1997 (incorporated by reference to exhibit 10.46 to Seer
Technologies, Inc.'s Quarterly Report on Form 10-Q for the period
ended March 31, 1997, No. 000-26194).
10.20A Amendment to Credit Agreement between Seer and Greyrock Business
Credit, dated May 5, 1998 (incorporated by reference to exhibit 10.53
to Seer Technologies, Inc.'s Quarterly Report on Form
10-Q for the period ended March 31, 1998, File No. 000-26194).
10.20B Amendment dated December 31, 1998 between Greyrock Capital, a division
of NationsCredit Corporation (formerly Greyrock Business Credit) and
Seer to the Loan and Security Agreement between Greyrock Business
Credit and Seer dated March 26, 1997, as amended (incorporated by
reference to exhibit 10.60 to Seer's Annual Report on Form 10-K for
the year ended September 30, 1998, File No. 000-26194).
10.20C Amendment dated March 31, 1999, to the Loan and Security Agreement
among Seer, the Company and Greyrock Capital, a division of
NationsCredit Commercial Corporation (incorporated by reference to
exhibit 10.30 to Level 8's Form 10-Q for the period ending March 31,
1999).
10.20D Amendment dated August 2, 2000, to the Promissory Note, among the
Company and Greyrock Capital, a division Bank of America Commercial
Finance Corporation dated March 31, 1999 (incorporated by reference to
exhibit 10.38 to Level 8's Quarterly Report on Form 10-Q for the
period ending June 30, 2000).
10.21 Level 8 Guaranty Agreement dated December 31, 1998 (incorporated by
reference to exhibit 10.1 to Level 8's Report on Form 8-K, filed
January 15, 1999).
10.22 Level 8 Promissory Note dated December 31, 1998, in favor of Liraz
Systems Ltd. in the principal amount of $12,000,000 (incorporated by
reference to exhibit 10.2 to Level 8's Report on Form 8-K, filed
January 15, 1999).
10.22A Amendment dated May 31, 1999 to amend the Loan document between the
Company and Liraz Systems, Ltd. (incorporated by reference to exhibit
10.4 to Level 8's Quarterly Report on Form 10-Q for the period ending
June 30, 1999).
10.22B Amendment dated March 27, 2000, to the Promissory Note, among the
Company and Liraz Systems LTD December 31, 1999 (incorporated by
reference to exhibit 10.31 to Level 8's Quarterly Report on Form 10-Q
for the period ending March 31, 2000).
10.23 Seer Promissory Note dated December 31, 1998, in favor of Level 8 in
the principal amount of $12,000,000 (incorporated by reference to
exhibit 10.3 to the Level 8's Report on Form 8-K, filed January 15,
1999).
10.24 Liraz Agreement dated December 31, 1998 (incorporated by reference to
exhibit 10.4 to Level 8's Report on Form 8-K, filed January 15, 1999).
10.25 Amended and Restated Loan and Security Agreement among Seer, the
Company and Greyrock Capital, a division of NationsCredit Commercial
Corporation, dated March 30, 1999 (incorporated by reference to
exhibit 10.29 to Level 8's Annual Report on Form 10-K for the fiscal
year ended December 31, 1998, filed April 1, 1999, File No. 000-
26392).
10.25A Amendment dated September 24, 1999, to the Loan and Security Agreement
among Seer, the Company and Greyrock Capital, a division of Banc of
America Commercial Finance Corporation, dated March 31, 1999
(incorporated by reference to exhibit 10.34 to the Level 8 10-Q for
the period ending September 30, 1999, No. 000-26392).
</TABLE>
EX-4
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.25B Amendment dated March 9, 2000, to the Loan and Security Agreement
among Seer, the Company and Greyrock Capital, a Bank of America
Company, dated March 31, 1999 (incorporated by reference to exhibit
10.4 to the Level 8 Annual Report on Form 10-K for the period ending
December 31, 1999, File No. 000-26392).
10.26 Financing Agreement, dated September 1, 1998, between Template
Software, Inc. and Eagle Eye Technologies, Inc. (incorporated by
reference to exhibit Incorporated by reference to Template Software,
Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended
August 31, 1998, File No. 0-21921).
10.27 Convertible Promissory Note, dated September 1, 1998, of Eagle Eye
Technologies, Inc. (incorporated by reference to Exhibit 10.25 to
Template Software, Inc.'s Quarterly Report on Form 10-Q for the period
ended August 31, 1998, File No. 0-21921).
10.28 Assignment of Indebtedness, dated as of February 19, 1997, between
Template Software, Inc. and Alain Kuhner (incorporated by reference to
an exhibit to Template Software, Inc.'s Report on
Form 8-K, dated March 4, 1997, File No. 000-21921).
10.29 Securities Purchase Agreement dated June 29, 1999 among Level 8
Systems, Inc. and the investors named on the signature pages thereof
(incorporated by reference to exhibit 10.1 to Level 8's
Form 8-K filed July 23, 1999, File No. 000- 26392).
10.30 Share Purchase Agreement, dated June 27, 1997, between Template
Holding and Jansen relating to the purchase of Milestone (incorporated
by reference to an exhibit to Template Software, Inc.'s Report on Form
8-K, dated June 27, 1997 and filed July 14, 1997, File No. 000-21921).
10.31 Share Purchase Agreement, dated June 27, 1997, between Template
Holding and NeSBIC III, C.V. relating to the purchase of Milestone
(incorporated by reference to an exhibit to Template Software, Inc.'s
Report on Form 8-K, dated June 27, 1997 and filed July 14, 1997, File
No. 000-21921).
10.32 Purchase Agreement dated July 31, 2000 between Level 8 Systems, Inc.
and Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated
by reference to Exhibit 10.1 to Level 8's Report on Form 8-K filed
August 11, 2000, File No. 000-26392).
10.33 Promissory Note of Level 8 Systems, Inc., dated December 20, 1999.
(incorporated by reference to exhibit 10.1 to Level 8's Report on Form
8-K filed January 11, 2000).
10.33A Amendment dated March 16, 2000, to the Promissory Note, among the
Company and Bank Hapolim dated December 20, 1999 (incorporated by
reference to exhibit 10.32 to Level 8's Quarterly Report on Form 10-Q
for the period ending March 31, 2000).
10.34 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 Exhibit 10.1 to Level 8's Report on Form
8-K filed July 31, 2000, No. 000-26392).
11.1 Statement Regarding Computation of Per Share Earnings (incorporated by
reference to exhibit 11.1 to Level 8's Quarterly Report on Form 10-Q
for the period ending June 30, 2000 File No. 000-26392).
16.1 Letter from PricewaterhouseCoopers LLP regarding change in certifying
accountant, dated August 2, 2000 (incorporated by reference to Exhibit
16 to Level 8's Report on Form 8-K/A filed August 2, 2000, File No.
000-26392).
16.2 Letter from Grant Thornton LLP regarding change in certifying
accountant, dated December 22, 1998 (incorporated by reference to
exhibit 16 to Level 8's Form 8-K filed December 22, 1998, File No.
000-26392).
</TABLE>
EX-5
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
16.3 Letter from Grant Thornton LLP regarding change in certifying
accountant, dated January 11, 1999 (incorporated by reference to
exhibit 99.2 to the Company's Form 8-K/A incorporated by reference to
of January 11, 1999, No. 000-26392, and incorporated herein by
reference).
21.1 List of subsidiaries of the Company (incorporated by reference to
exhibit 21.1 to the Level 8 Annual Report on Form 10-K for the period
ending December 31, 1999, File No. 000-26392).
23.1 Consent of PricewaterhouseCoopers LLP to the inclusion of their report
on Level 8's audited financial statements into Level 8's registration
statements (filed herewith).
23.2 Consent of PricewaterhouseCoopers LLP to the inclusion of their report
on Template's audited financial statements into Level 8's registration
statements (filed herewith).
23.3 Consent of PricewaterhouseCoopers LLP to the inclusion of their report
on Seer's audited financial statements into Level 8's registration
statements (filed herewith).
23.4 Consent of Grant Thornton LLP to the inclusion of their report on
Level 8's audited financial statements into Level 8's registration
statements (filed herewith).
23.5 Consent of Powell, Goldstein, Frazer & Murphy LLP (included in exhibit
5 filed herewith).
24.1 Power of Attorney (included on signature page hereto).
</TABLE>
--------
* Management contract or compensatory agreement.
EX-6
