UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
one)
|
[X] |
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the
quarterly period ended March 31, 2005.
|
[
] |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the
transition period from to
Commission
File Number 0-26392
LEVEL
8 SYSTEMS, INC.
(Exact
name of registrant as specified in its charter)
|
Delaware |
11-2920559 |
|
(State
or other jurisdiction of incorporation or organization) |
(I.R.S
Employer Identification Number) |
|
1433
State Highway 34, Building C; Farmingdale, New Jersey |
07727 |
|
(Address
of principal executive offices) |
(Zip
Code) |
(732)
919-3150
(Registrant's
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. YES X NO
_
Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). YES _ NO X
Indicate
the number of shares outstanding in each of the issuer’s classes of common
stock, as of the latest practicable date.
43,441,917
common shares, $.001 par value, were outstanding as of May 6,
2005.
Level
8 Systems, Inc.
Index
|
PART
I. Financial
Information |
Page
Number |
| |
|
|
Item
1. Financial Statements |
|
| |
|
|
Consolidated
balance sheets as of March 31, 2005 (unaudited) and December 31, 2004
|
3 |
| |
|
|
Consolidated
statements of operations for the three months ended March 31, 2005 and
2004 (unaudited) |
4 |
| |
|
|
Consolidated
statements of cash flows for the three months ended March 31, 2005 and
2004 (unaudited) |
5 |
| |
|
|
Consolidated
statements of comprehensive loss for the three months ended March 31, 2005
and 2004 (unaudited) |
6 |
| |
|
|
Notes
to consolidated financial statements (unaudited) |
7 |
| |
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations |
15 |
| |
|
|
Item
3. Quantitative and Qualitative Disclosures about Market Risk
|
21 |
| |
|
|
Item
4. Controls and Procedures |
21 |
| |
|
|
PART
II. Other
Information |
21 |
| |
|
| |
|
|
SIGNATURES |
25 |
| |
|
Part
I. Financial Information
Item
1. Financial Statements
LEVEL
8 SYSTEMS, INC.
CONSOLIDATED
BALANCE SHEETS
(in
thousands)
(unaudited)
|
|
|
March
31,
2005 |
|
December
31,
2004 |
|
|
ASSETS |
|
|
|
|
|
|
|
|
Current
assets: |
|
|
|
|
|
|
|
|
Cash
and cash equivalents |
|
$ |
62 |
|
$ |
107 |
|
|
Assets
of operations to be abandoned |
|
|
141 |
|
|
148 |
|
|
Trade
accounts receivable, net |
|
|
126 |
|
|
152 |
|
|
Prepaid
expenses and other current assets |
|
|
49 |
|
|
108 |
|
|
Total
current assets |
|
|
378 |
|
|
515 |
|
|
Property
and equipment, net |
|
|
12 |
|
|
15 |
|
|
Total
assets |
|
$ |
390 |
|
$ |
530 |
|
|
LIABILITIES
AND STOCKHOLDERS' DEFICIT |
|
|
|
|
|
|
|
|
Current
liabilities: |
|
|
|
|
|
|
|
|
Senior
reorganization debt |
|
$ |
2,405 |
|
$ |
1,548 |
|
|
Short-term
debt |
|
|
3,422 |
|
|
3,646 |
|
|
Accounts
payable |
|
|
2,437 |
|
|
2,351 |
|
|
Accrued
expenses: |
|
|
|
|
|
|
|
|
Salaries,
wages, and related items |
|
|
1,009 |
|
|
879 |
|
|
Other |
|
|
1,818 |
|
|
1,725 |
|
|
Liabilities
of operations to be abandoned |
|
|
518 |
|
|
536 |
|
|
Deferred
revenue |
|
|
76 |
|
|
85 |
|
|
Total
current liabilities |
|
|
11,685 |
|
|
10,770 |
|
|
Long-term
debt |
|
|
217 |
|
|
250 |
|
|
Senior
convertible redeemable preferred stock |
|
|
1,367 |
|
|
1,367 |
|
|
Total
liabilities |
|
|
13,269 |
|
|
12,387 |
|
|
Stockholders'
(deficit): |
|
|
|
|
|
|
|
|
Preferred
stock |
|
|
-- |
|
|
-- |
|
|
Common
stock |
|
|
43 |
|
|
43 |
|
|
Additional
paid-in-capital |
|
|
210,150 |
|
|
210,142
|
|
|
Accumulated
other comprehensive loss |
|
|
(7 |
) |
|
(8 |
) |
|
Accumulated
deficit |
|
|
(223,065 |
) |
|
(222,034 |
) |
|
Total
stockholders' (deficit) |
|
|
(12,879 |
) |
|
(11,857 |
) |
|
Total
liabilities and stockholders' (deficit) |
|
$ |
390 |
|
$ |
530 |
|
The
accompanying notes are an integral part of the consolidated financial
statements.
LEVEL
8 SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
(in
thousands, except per share amounts)
(unaudited)
|
|
|
Three
Months Ended
March
31, |
|
| |
|
2005
|
|
2004 |
|
|
Revenue: |
|
|
|
|
|
|
|
|
Software |
|
$ |
89 |
|
$ |
10 |
|
|
Maintenance |
|
|
33 |
|
|
73 |
|
|
Services |
|
|
31 |
|
|
-- |
|
|
Total
operating revenue |
|
|
153 |
|
|
83 |
|
| |
|
|
|
|
|
|
|
|
Cost
of revenue |
|
|
|
|
|
|
|
|
Software |
|
|
4 |
|
|
719 |
|
|
Maintenance |
|
|
100 |
|
|
104 |
|
|
Services |
|
|
228 |
|
|
280 |
|
|
Total
cost of revenue. |
|
|
332 |
|
|
1,103 |
|
| |
|
|
|
|
|
|
|
|
Gross
margin (loss) |
|
|
(179 |
) |
|
(1,020 |
) |
| |
|
|
|
|
|
|
|
|
Operating
expenses: |
|
|
|
|
|
|
|
|
Sales
and marketing |
|
|
224 |
|
|
335 |
|
|
Research
and product development |
|
|
264 |
|
|
312 |
|
|
General
and administrative |
|
|
248 |
|
|
471 |
|
|
Impairment
of intangible assets |
|
|
-- |
|
|
587 |
|
|
Total
operating expenses |
|
|
736 |
|
|
1,705 |
|
|
Loss
from operations |
|
|
(915 |
) |
|
(2,725 |
) |
| |
|
|
|
|
|
|
|
|
Other
income (expense): |
|
|
|
|
|
|
|
|
Interest
income |
|
|
-- |
|
|
1 |
|
|
Interest
expense |
|
|
(124 |
) |
|
(39 |
) |
|
Change
in fair value of warrant liability |
|
|
-- |
|
|
19 |
|
|
Other
income |
|
|
8 |
|
|
117 |
|
|
Loss
before provision for income taxes |
|
|
(1,031 |
) |
|
(2,627 |
) |
|
Income
tax provision |
|
|
-- |
|
|
-- |
|
| |
|
|
|
|
|
|
|
|
Loss
from continuing operations |
|
|
(1,031 |
) |
|
(2,627 |
) |
|
Loss
from discontinued operations |
|
|
-- |
|
|
(9 |
) |
|
Net
loss |
|
$ |
(1,031 |
) |
$ |
(2,636 |
) |
| |
|
|
|
|
|
|
|
|
Loss
per share from continuing operations—basic and diluted |
|
|
(0.02 |
) |
|
(0.09 |
) |
|
Loss
per share from discontinued operations-basic and diluted |
|
|
-- |
|
|
-- |
|
|
Net
loss per share applicable to common shareholders—basic and
diluted |
|
$ |
(0.02 |
) |
$ |
(0.09 |
) |
| |
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding -- basic and diluted |
|
|
43,412 |
|
|
30,727 |
|
The
accompanying notes are an integral part of the consolidated financial
statements.
LEVEL
8 SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
(unaudited)
|
|
|
Three
Months Ended
March
31, |
|
| |
|
2005 |
|
2004 |
|
|
Cash
flows from operating activities: |
|
|
|
|
|
|
|
|
Net
loss |
|
$ |
(1,031 |
) |
$ |
(2,636 |
) |
|
Adjustments
to reconcile net loss to net cash used in operating
activities: |
|
|
|
|
|
|
|
|
Depreciation
and amortization |
|
|
3 |
|
|
657 |
|
|
Change
in fair value of warrant liability |
|
|
-- |
|
|
(19 |
) |
|
Stock
compensation expense |
|
|
8 |
|
|
61 |
|
|
Impairment
of intangible assets |
|
|
-- |
|
|
587 |
|
|
Provision
for doubtful accounts |
|
|
(12 |
) |
|
(8 |
) |
|
Changes
in assets and liabilities, net of assets acquired and liabilities
assumed: |
|
|
|
|
|
|
|
|
Trade
accounts receivable and related party receivables |
|
|
38 |
|
|
7 |
|
|
Assets
& liabilities - discontinued operations |
|
|
(11 |
) |
|
3 |
|
|
Prepaid
expenses and other assets |
|
|
59 |
|
|
186 |
|
|
Accounts
payable and accrued expenses |
|
|
307 |
|
|
45 |
|
|
Deferred
revenue |
|
|
(9 |
) |
|
141 |
|
|
Net
cash used in operating activities |
|
|
(648 |
) |
|
(976 |
) |
| |
|
|
|
|
|
|
|
|
Cash
flows from financing activities: |
|
|
|
|
|
|
|
|
Proceeds
from issuance of common shares, net of issuance costs |
|
|
-- |
|
|
1,247 |
|
|
Borrowings
under credit facility, term loans, notes payable |
|
|
632 |
|
|
100 |
|
|
Repayments
of term loans, credit facility and notes payable |
|
|
(30 |
) |
|
(269 |
) |
|
Net
cash provided by financing activities |
|
|
602 |
|
|
1,078 |
|
|
Effect
of exchange rate changes on cash |
|
|
1 |
|
|
1 |
|
|
Net
increase in cash and cash equivalents |
|
|
(45 |
) |
|
103 |
|
|
Cash
and cash equivalents: |
|
|
|
|
|
|
|
|
Beginning
of period |
|
|
107 |
|
|
19 |
|
|
End
of period |
|
$ |
62 |
|
$ |
122 |
|
The
accompanying notes are an integral part of the consolidated financial
statements.
LEVEL
8 SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE LOSS
(in
thousands)
| |
|
Three
Months Ended March 31, |
|
| |
|
2005 |
|
2004 |
|
|
Net
loss |
|
$ |
(1,031 |
) |
$ |
(2,636 |
) |
|
Other
comprehensive income, net of tax: |
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment |
|
|
1 |
|
|
1 |
|
|
Comprehensive
loss |
|
$ |
(1,030 |
) |
$ |
(2,635 |
) |
The
accompanying notes are an integral part of the consolidated financial
statements.
LEVEL
8 SYSTEMS, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts
in thousands, except share and 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
of the United States of America 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, 2004. 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. Certain reclassifications have
been made to the prior year amounts to conform to the current year
presentation.
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 of the United States of
America.
The
accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. All of the Company's subsidiaries are wholly owned
for the periods presented.
Liquidity
The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. The Company has incurred a loss of $9,761 and
$10,006 in the past two years and has experienced negative cash flows from
operations for each of the past three years. For the quarter ended March 31,
2005, the Company incurred a loss of $1,031 and had a working capital deficiency
of $11,307. The Company’s future revenues are entirely dependent on acceptance
of Cicero software, which has limited success in commercial markets to date.
Accordingly, there is substantial doubt that the Company can continue as a going
concern. In order to address these issues and to obtain adequate financing for
the Company’s operations for the next twelve months, the Company is actively
promoting and expanding its product line and continues to negotiate with
significant customers that have demonstrated interest in the Cicero technology.
The Company is experiencing difficulty increasing sales revenue largely because
of the inimitable nature of the product as well as customer concerns about the
financial viability of the Company. The Company is attempting to solve the
former problem by improving the market’s knowledge and understanding of Cicero
through increased marketing and leveraging its limited number of reference
accounts. Additionally, the Company is seeking additional equity capital or
other strategic transactions in the near term to provide additional liquidity.
On December 31, 2004, Level 8 completed a Note and Warrant Offering wherein it
has raised a total of approximately $1,615. On March 31, 2005, we completed an
extension to the Note and Warrant Offering and raised an additional $965, of
which $310 related to non-cash transactions, converting $55 of accounts payable
and $255 of short-term debt to Senior Reorganization Debt. Under the terms of
the Offers, warrant holders of Level 8’s common stock were offered a one-time
conversion of their existing warrants at a conversion price of $0.10 per share
as part of a recapitalization merger plan which the Company currently intends to
propose to its shareholders at the Company’s next annual meeting. Those warrant
holders who elected to convert, tendered their conversion price in cash and
received a Note Payable in exchange. Upon approval of the recapitalization
merger by the Company’s shareholders at an annual meeting anticipated to be held
in mid 2005, these Notes would convert into common shares of Cicero, Inc., the
surviving corporation in the proposed merger. These funds were used to finance
the operations of Level 8. There can be no assurance that management will be
successful
in
continued execution of these strategies as anticipated or in a timely manner or
that increased revenues will reduce further operating losses. If the Company is
unable to significantly increase cash flow or obtain additional financing, it
will likely be unable to generate sufficient capital to fund operations for the
next twelve months and may be required to pursue other means of financing that
may not be on terms favorable to the Company or its stockholders. These factors
among others may indicate that the Company will be unable to continue as a going
concern for a reasonable period of time.
The
financial statements presented herein do not include any adjustments relating to
the recoverability of assets and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
Management expects that it will be able to raise additional capital and to
continue to fund operations and also expects that increased revenues will reduce
its operating losses in future periods, however, there can be no assurance that
management’s plan will be executed as anticipated.
Use
of Accounting Estimates
The
preparation of financial statements in conformity with accounting principals
generally accepted in the United States of America 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.
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. Had compensation cost for the
Company’s stock option plan been determined based on the fair value at the grant
dates for awards under the plan consistent with the method required by SFAS No.
123, the Company’s net loss and diluted net loss per common share would have
been the pro forma amounts indicated below.
| |
|
|
Three
Months Ended March 31, |
|
| |
|
|
2005 |
|
|
2004 |
|
|
Net
loss applicable to common stockholders |
|
$ |
(1,031 |
) |
$ |
(2,636 |
) |
|
Less:
Total stock-based employee compensation expense under
fair
value based method for all awards, net of related tax
effects |
|
|
(98 |
) |
|
(332 |
) |
|
Pro
forma loss applicable to common stockholders |
|
$ |
(1,129 |
) |
$ |
(2,968 |
) |
|
Earnings
per share: |
|
|
|
|
|
|
|
|
Basic
and diluted, as reported |
|
$ |
(0.02 |
) |
$ |
(0.09 |
) |
|
Basic
and diluted, pro forma |
|
$ |
(0.03 |
) |
$ |
(0.10 |
) |
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 for the quarter ended March 31, 2005 as
follows:
Expected
life (in years) |
|
|
7.67
years |
|
|
Expected
volatility |
|
|
152.95 |
% |
|
Risk
free interest rate |
|
|
4.75 |
% |
|
Expected
dividend yield |
|
|
0 |
% |
The
following table sets forth certain information as of March 31, 2005, about
shares of Common Stock outstanding and available for issuance under the
Company’s existing equity compensation plans: the Level 8 Systems, Inc. 1997
Stock Option Incentive Plan, the 1995 Non-Qualified Option Plan and the Outside
Director Stock Option Plan. The Company’s stockholders approved all of the
Company’s Equity Compensation Plans.
| |
|
Shares |
|
|
Outstanding
on January 1, 2005 |
|
|
7,488,639 |
|
|
Granted |
|
|
114,286 |
|
|
Exercised |
|
|
(114,286 |
) |
|
Forfeited |
|
|
(229,992 |
) |
|
Outstanding
on March 31, 2005 |
|
|
7,258,647 |
|
| |
|
|
|
|
|
Weighted
average exercise price of outstanding options |
|
$ |
1.34 |
|
|
Shares
available for future grants on March 31, 2005 |
|
|
1,844,778 |
|
NOTE
2. RECENT ACCOUNTING PRONOUNCEMENTS
In
December 2004, FASB issued SFAS No. 123R, “Share-Based Payment.” This
statement is a revision of SFAS No. 123 and supersedes APB No. 25
and its related implementation guidance. SFAS No. 123R focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. The statement requires
entities to recognize compensation expense for awards of equity instruments to
employees based on the grant-date fair value of those awards (with limited
exceptions). SFAS No. 123R is effective for the first annual
reporting period that begins after June 15, 2005, although earlier adoption
is encouraged.
The
Company expects to adopt SFAS No. 123R in the quarterly period
beginning on January 1, 2006. The Company is evaluating the two
methods of adoption allowed under SFAS 123R: the modified-prospective transition
method and the modified-retrospective transition method, and has not quantified
the effect of the adoption on the consolidated financial
statements.
NOTE
3. ACQUISITIONS
In
January 2004, the Company acquired substantially all of the assets and certain
liabilities of Critical Mass Mail, Inc., d/b/a Ensuredmail, a federally
certified encryption software company. Under the terms of the purchase
agreement, the Company issued 2,027,027 shares of common stock at a price of
$0.37. The total purchase price of the assets acquired was $750, plus certain
liabilities assumed, and has been accounted for by the purchase method of
accounting. The Company agreed to register the common stock for resale under the
Securities Act of 1933, as amended.
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
Company assessed the net realizable value of the Ensuredmail software technology
acquired and determined the purchase price exceeded the amounts allocated to the
software technology acquired by approximately $587. This excess of the purchase
price over the fair values of the assets acquired was allocated to goodwill,
and, because it was deemed impaired, charged to the Statements of Operations for
the period ended March 31, 2004. (See Note 4.)
NOTE
4. SOFTWARE PRODUCT TECHNOLOGY
In
accordance with SFAS 86, "Accounting for the Costs of Computer Software to Be
Sold, Leased, or Otherwise Marketed", the
Company completed an assessment of the recoverability of the Cicero product
technology. This assessment was performed during 2004, due to the Company’s
continued operating losses and the limited software revenue generated by the
Cicero technology over the previous twelve to eighteen months. The Company was
in negotiations with customers to purchase licenses, which would have a
significant impact on the cash flows from the Cicero technology and the Company.
Since the negotiations had been in process for several months and expected
completion of the transactions had been delayed, the Company had reduced its
cash flow projections. Historical cash flows generated by the Cicero technology
do not support the long-lived asset and accordingly the Company impaired the
unamortized book value of the technology in excess of the expected net
realizable value for the year ended December 31, 2004. This charge, in the
amount
of
$2,844, was recorded as software amortization for the year ended December 31,
2004. As of December 31, 2004, the Company has no capitalized costs for the
Cicero technology.
As noted
above, in January 2004, the Company acquired substantially all of the assets
assumed and certain liabilities of Critical Mass Mail, Inc., d/b/a Ensuredmail.
In accordance with SFAS 86, the
Company completed an assessment of the recoverability of the Ensuredmail product
technology. The purchase price of the assets was $750 plus liabilities assumed.
The Company has assessed the net realizable value of the Ensuredmail software
technology acquired. The purchase price exceeded the amounts allocated to the
software technology by approximately $587. This excess of the purchase price
over the fair values of the assets acquired was allocated to goodwill and
charged to the Statement of Operations for the period ended March 31, 2004. This
assessment was also completed during 2004, due to the Company’s revised cash
flow projections from software revenue. These revised cash flow projections do
not support the long-lived asset and accordingly the Company has impaired the
unamortized book value of the technology in excess of the expected net
realizable value. This charge, in the amount of $154, was recorded as software
amortization for the year ended December 31, 2004. As of December 31, 2004, the
Company has no capitalized costs for the Ensuredmail software technology.
NOTE
5. SENIOR REORGANIZATION DEBT
In 2004,
the Company announced a Note and Warrant Offering in which warrant holders of
Level 8’s common stock were offered a one-time conversion of their existing
warrants at a conversion price of $0.10 per share as part of a recapitalization
merger plan which the Company currently intends to propose to its shareholders
at the Company’s next annual meeting. Under the terms of the Offer, which
expired on December 31, 2004, warrant holders who elect to convert, would tender
their conversion price in cash and receive a Note Payable in exchange. Upon
approval of the recapitalization merger by the Company’s shareholders at an
annual meeting anticipated to be held in mid 2005, these Notes would convert
into common shares of Cicero, Inc., the surviving corporation in the proposed
merger. In addition, those warrant holders who elected to convert the first
$1,000 of warrants would receive additional replacement warrants at a ratio of
2:1 for each warrant converted, with a strike price of $0.10 per share. In
addition, upon approval of the recapitalization merger, each warrant holder
would be entitled to additional warrants to purchase common stock in Cicero,
Inc.
As of
December 31, 2004, the Company has raised a total of $1,548 from the Note and
Warrant Offering. An additional $67 was in transit to the Company. In March
2005, the Company extended the Note and Warrant Offering under the same terms as
the initial offering. The Company was able to secure an additional $965, of
which $310 related to non-cash transactions, in Senior Reorganization Debt under
the financing, for a total of $2,578. As of March 31, 2005 the Company had
raised $790 of the $965 and an additional $175 was committed and in transit. If
the merger proposal is not approved, the Notes will immediately become due and
payable.
NOTE
6. SHORT TERM DEBT
Notes
payable, long-term debt, and notes payable to related party consist of the
following:
| |
|
March
31, 2005 |
|
December
31, 2004 |
|
|
Term
loan (a) |
|
$ |
1,971 |
|
$ |
1,971 |
|
|
Note
payable; related party (b) |
|
|
94 |
|
|
69 |
|
|
Notes
payable (c) |
|
|
395 |
|
|
644 |
|
|
Short
term convertible note (d) |
|
|
235 |
|
|
235 |
|
|
Short
term convertible note, related party (e) |
|
|
727 |
|
|
727 |
|
| |
|
$ |
3,422 |
|
$ |
3,646 |
|
|
(a) |
The
Company has a $1,971 term loan bearing interest at LIBOR plus 1%
(approximately 3.77% at March 31, 2005). Interest is payable quarterly.
There are no financial covenants and the term loan is guaranteed by Liraz
Systems, Ltd., the Company's former principal shareholder. The loan
matures November 3, 2005. |
|
(b) |
From
time to time during the year the Company entered into promissory notes
with the Company's Chief Executive Officer. The notes bear interest at 12%
per annum. |
|
(c) |
The
Company does not have a revolving credit facility and from time to time
has issued a series of short term promissory notes with private lenders,
which provide for short term borrowings both secured and unsecured by
accounts receivable. In addition, the Company has settled certain
litigation and agreed to a series of promissory notes to support the
obligations. The notes bear interest between 10% and 12% per annum.
|
|
(d) |
The
Company entered into convertible notes with private lenders. The notes
bear interest between 12% and 24% per annum and allows for the conversion
of the principal amount due into common stock of the Company.
|
|
(e) |
The
Company entered into convertible promissory notes with Anthony Pizi, and
Mark and Carolyn Landis, who are related by marriage to Anthony Pizi, the
Company’s Chief Executive Officer. The notes bear interest at 12% per
annum and allow for the conversion of the principal amount due into common
stock of the Company. |
NOTE
7. STOCKHOLDERS’ EQUITY
As
described in Note 3, Acquisitions, in January 2004, the Company acquired
substantially all of the assets and assumed certain liabilities of Critical Mass
Mail, Inc., d/b/a Ensuredmail, a federally certified encryption software
company. Under the terms of the purchase agreement, the Company issued 2,027,027
shares of common stock at a price of $0.37 per share. The total purchase price
of the assets acquired and liabilities assumed was $750 and has been accounted
for by the purchase method of accounting.
Also in
January 2004, and simultaneously with the asset purchase of Critical Mass Mail,
Inc., the Company completed a Securities Purchase Agreement with several new
investors as well as certain investors of Critical Mass Mail, Inc., wherein the
Company raised $1,247 through the sale of 3,369,192 shares of common stock at a
price of $0.37 per share. As part of the financing, the Company has also issued
warrants to purchase 3,369,192 shares of the Company’s common stock at an
exercise price of $0.37. The warrants expire three years from the date of grant.
NOTE
8. 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 2005 or 2004. Because of the Company's recurring losses, the
deferred tax assets have been fully offset by a valuation allowance.
NOTE
9. LOSS PER SHARE
Basic
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 outstanding during the
periods presented include stock options, warrants and preferred stock.
The
following table sets forth the reconciliation of net loss to loss available to
common stockholders:
| |
|
Three
Months Ended
March
31, |
|
|
|
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
|
|
|
Net
loss applicable to common stockholders, as reported |
|
$ |
(1,031 |
) |
$ |
(2,636 |
) |
| |
|
|
|
|
|
|
|
|
Basic
and diluted loss per share: |
|
|
|
|
|
|
|
|
Loss
per share continuing operations |
|
$ |
(0.02 |
) |
$ |
(0.09 |
) |
|
Loss
per share discontinued operations |
|
|
-- |
|
|
-- |
|
|
Net
loss per share applicable to common shareholders |
|
$ |
(0.02 |
) |
$ |
(0.09 |
) |
| |
|
|
|
|
|
|
|
|
Weighted
common shares outstanding - basic and diluted |
|
|
43,412 |
|
|
30,727 |
|
The
following table sets forth the potential shares that are not included in the
diluted net loss per share calculation because to do so would be anti-dilutive
for the periods presented:
| |
|
March
31, |
|
| |
|
2005 |
|
2004 |
|
|
Stock
options, common share equivalent |
|
|
7,258,647 |
|
|
7,650,870 |
|
|
Warrants,
common share equivalent |
|
|
19,953,406 |
|
|
14,295,898 |
|
|
Preferred
stock, common share equivalent |
|
|
9,855,723 |
|
|
14,062,136 |
|
|
|
|
|
37,067,776 |
|
|
36,008,904 |
|
NOTE
10. SEGMENT INFORMATION AND GEOGRAPHIC INFORMATION
Management
makes operating decisions and assesses performance of the Company’s operations
based on the following reportable segments: Desktop Integration segment and
Messaging and Application Engineering segment.
The
principal product in the Desktop Integration segment is Cicero. Cicero is a
business integration software product that maximizes end-user productivity,
streamlines business operations and integrates disparate systems and
applications.
The
products that comprise the Messaging and Application Engineering segment are the
encryption technology products, Email Encryption Gateway, Software Development
Kit (SDK), Digital Signature Module, Business Desktop, and Personal
Desktop.
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 other income/(expense), taxes,
and in-process research and development.
While
segment profitability should not be construed as a substitute for operating
income or a better indicator of liquidity than cash flows from operating
activities, which are determined in accordance with accounting principles
generally accepted in the United States of America, it is included herein to
provide additional information with respect to our ability to meet our future
debt service, capital expenditure and working capital requirements. Segment
profitability is not necessarily a measure of our ability to fund our cash
needs. The non-GAAP measures presented may not be comparable to similarly titled
measures reported by other companies.
The table
below presents information about reported segments for the three months ended
March 31, 2005 and 2004:
| |
|
Desktop
Integration |
|
Messaging
and
Application
Engineering |
|
TOTAL |
|
|
2005: |
|
|
|
|
|
|
|
|
|
|
|
Total
revenue |
|
$ |
148 |
|
$ |
5 |
|
$ |
153 |
|
|
Total
cost of revenue |
|
|
332 |
|
|
-- |
|
|
332 |
|
|
Gross
margin (loss) |
|
|
(184 |
) |
|
5 |
|
|
(179 |
) |
|
Total
operating expenses |
|
|
706 |
|
|
30 |
|
|
736 |
|
|
Segment
profitability (loss) |
|
$ |
(890 |
) |
$ |
(25 |
) |
$ |
(915 |
) |
|
2004: |
|
|
|
|
|
|
|
|
|
|
|
Total
revenue |
|
$ |
77 |
|
$ |
6 |
|
$ |
83 |
|
|
Total
cost of revenue |
|
|
1,058 |
|
|
45 |
|
|
1,103 |
|
|
Gross
margin (loss) |
|
|
(981 |
) |
|
(39 |
) |
|
(1,020 |
) |
|
Total
operating expenses |
|
|
988 |
|
|
30 |
|
|
1,118 |
|
|
Segment
profitability (loss) |
|
$ |
(1,969 |
) |
$ |
(169 |
) |
$ |
(2,138 |
) |
A
reconciliation of total segment operating expenses to total operating expenses
for the quarters ended March 31:
| |
|
Three
Months Ended
March
31, |
|
| |
|
|
2005 |
|
|
2004 |
|
|
Total
segment operating expenses |
|
$ |
736 |
|
$ |
1,118 |
|
|
Impairment
of intangible assets |
|
|
-- |
|
|
587 |
|
|
Total
operating expenses |
|
$ |
736 |
|
$ |
1,705 |
|
A
reconciliation of total segment profitability (loss) to loss before provision
for income taxes for the quarters ended March 31:
| |
|
Three
Months Ended
March
31, |
|
| |
|
|
2005 |
|
|
2004 |
|
|
Total
segment profitability (loss) |
|
$ |
(915 |
) |
$ |
(2,138 |
) |
|
Change
in fair value of warrant liability |
|
|
-- |
|
|
19 |
|
|
Impairment
of intangible assets |
|
|
|
|
|
(587 |
) |
|
Interest
and other income/(expense), net |
|
|
(116 |
) |
|
79 |
|
|
Total
loss before income taxes |
|
$ |
(1,031 |
) |
$ |
(2,627 |
) |
The
following table presents a summary of assets by segment:
| |
|
March
31, |
|
| |
|
|
2005 |
|
|
2004 |
|
|
Desktop
Integration |
|
$ |
12 |
|
$ |
3,477 |
|
|
Messaging
and Application Engineering |
|
|
-- |
|
|
168 |
|
|
Total
assets |
|
$ |
12 |
|
$ |
3,645 |
|
NOTE
11. CONTINGENCIES
Litigation.
Various
lawsuits and claims have been brought against us in the normal course of our
business. In January 2003, an action was brought against us in the Circuit Court
of Loudon County, Virginia, for a breach of a real estate lease. The case was
settled in August 2003. Under the terms of the settlement agreement, we agreed
to assign a note receivable with recourse equal to the unpaid portion of the
note should the note obligor default on future payments. The unpaid balance of
the note was $545 and it matures in December 2007. We assessed the probability
of liability under the recourse provisions using a weighted probability cash
flow analysis and have recognized a long-term liability in the amount of $131.
In
October 2003, we were served with a summons and complaint in Superior Court of
North Carolina regarding unpaid invoices for services rendered by one of our
subcontractors. The amount in dispute was approximately $200 and is included in
accounts payable. Subsequent to March 31, 2004, we settled this litigation.
Under the terms of the settlement agreement, we agreed to pay a total of $189
plus interest over a 19-month period ending November 15, 2005.
In March
2004, we were served with a summons and complaint in Superior Court of North
Carolina regarding a security deposit for a sublease in Virginia. The amount in
dispute is approximately $247 and is included in other liabilities. In October
2004, we reached a settlement agreement wherein we agreed to pay $160 over a
24-month period ending October 2006.
In August
2004, we were notified that we were in default under an existing lease agreement
for office facilities in Princeton, New Jersey. The amount of the default is
approximately $65 and is included in accounts payable. Under the terms of the
lease agreement, we may be liable for future rents should the space remain
vacant. We have reached a settlement agreement with the landlord which calls for
a total payment of $200 over a 20-month period ending July 2006.
In March
2005, we were notified that EM Software Solutions, Inc. is seeking damages
amounting to approximately $300 resulting from alleged misrepresentations made
by us as part of the sale of the Geneva Enterprise Integrator asset sale in
December 2002. The basis of the claim involves EM Software’s inability to secure
renewals on maintenance contracts. We disagree with this allegation, will
aggressively defend our position and accordingly, have not reserved for this
contingency.
Under the
indemnification clause of the Company’s standard reseller agreements and
software license agreements, the Company agrees to defend the reseller/licensee
against third party claims asserting infringement by the Company’s products of
certain intellectual property rights, which may include patents, copyrights,
trademarks or trade secrets, and to pay any judgments entered on such claims
against the reseller/licensee.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
GENERAL
INFORMATION
Level 8
Systems, Inc. is a global provider of business integration software that enables
organizations to integrate new and existing information and processes at the
desktop with Cicero 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.
In
addition to software products, Level 8 also provides technical support, training
and consulting services as part of its commitment to providing its customers
with industry-leading integration solutions. Level 8’s 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 services around its integration software products.
This
discussion contains forward-looking statements relating to such matters as
anticipated financial performance, business prospects, technological
developments, new products, research and development activities, liquidity and
capital resources and similar matters. The Private Securities Litigation Reform
Act of 1995 provides a safe harbor for forward-looking statements. In order to
comply with the terms of the safe harbor, the Company notes that a variety of
factors could cause its actual results to differ materially from the anticipated
results or other expectations expressed in the Company's forward-looking
statements.
The
Company's results of operations include the operations of the Company and its
subsidiaries. During 2002, the Company identified the assets of the Systems
Integration segment as being held for sale and thus a discontinued operation.
Accordingly, the assets and liabilities have been reclassified to assets and
liabilities of operations to be abandoned and the results of operations of that
segment for 2004 are reclassified as gain or loss from discontinued operations.
In 2004,
the Company acquired Critical Mass Mail, Inc., d/b/a Ensuredmail, a federally
certified email encryption technology. Ensuredmail products are also available
as an integrated feature of Level 8's desktop application integration solution,
Cicero.
Unless
otherwise indicated, all information is presented in thousands
(000’s).
RESULTS
OF OPERATIONS
The table
below presents information about reported segments for the three months ended
March 31, 2005 and 2004:
| |
|
Desktop
Integration |
|
Messaging
and
Application
Engineering |
|
TOTAL |
|
|
2005: |
|
|
|
|
|
|
|
|
|
|
|
Total
revenue |
|
$ |
148 |
|
$ |
5 |
|
$ |
153 |
|
|
Total
cost of revenue |
|
|
332 |
|
|
-- |
|
|
332 |
|
|
Gross
margin (loss) |
|
|
(184 |
) |
|
5 |
|
|
(179 |
) |
|
Total
operating expenses |
|
|
706 |
|
|
30 |
|
|
736 |
|
|
Segment
profitability (loss) |
|
$ |
(890 |
) |
$ |
(25 |
) |
$ |
(915 |
) |
|
2004: |
|
|
|
|
|
|
|
|
|
|
|
Total
revenue |
|
$ |
77 |
|
$ |
6 |
|
$ |
83 |
|
|
Total
cost of revenue |
|
|
1,058 |
|
|
45 |
|
|
1,103 |
|
|
Gross
margin (loss) |
|
|
(981 |
) |
|
(39 |
) |
|
(1,020 |
) |
|
Total
operating expenses |
|
|
988 |
|
|
30 |
|
|
1,118 |
|
|
Segment
profitability (loss) |
|
$ |
(1,969 |
) |
$ |
(169 |
) |
$ |
(2,138 |
) |
Revenue
and Gross Margin. The
Company has three categories of revenue: software products, maintenance, and
services. Software products revenue is comprised primarily of fees from
licensing the Company's proprietary software products. Maintenance revenue is
comprised of fees for maintaining, supporting, and providing periodic upgrades
to the Company's software products. Services revenue is comprised of fees for
consulting and training services related to the Company's software products.
The
Company's revenues vary from quarter to quarter, due to market conditions, the
budgeting and purchasing cycles of customers and the effectiveness of the
Company’s 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 the recognition of revenue can cause
significant variations in operating results from quarter to quarter.
Fluctuations in operating results may result in volatility of the price of the
Company's common stock.
Total
revenues increased 84.3% from $83 to $153 for the quarter ended March 31, 2005
as compared with the same period of the previous year. The increase in revenues,
while insignificant in total dollars, reflects the Company’s success in securing
several smaller pilot programs from several different companies. Gross
margin/(losses) were (117)% for the quarter ended March 31, 2005 and (1,229)%
for the quarter ended March 31, 2004. The primary reason for the decline in the
gross margin loss as a percentage of revenues is the impairment of the remaining
unamortized software costs of the Cicero technology in June 2004.
Software
Products.
Software product revenue increased 790% from $10 to $89 for the quarters ended
March 31, 2004 and 2005 respectively, however, the absolute dollar change was
not significant.
The gross
margin on software products for the quarter ended March 31, 2005 was 96%. The
gross margin (loss) on software products was (7,090)% for the quarter ended
March 31, 2004 and reflects the amortization of acquired software not offset by
revenues. Cost of software is composed primarily of amortization of software
product technology, amortization of capitalized software costs for internally
developed software and royalties to third parties, and to a lesser extent,
production and distribution costs. Historical cash flows generated by the Cicero
technology do not support the long-lived asset and accordingly the Company
impaired the unamortized book value of the technology in excess of the expected
net realizable
value for
the year ended December 31, 2004. As of December 31, 2004, the Company had no
capitalized costs for the Cicero technology.
The
Company expects to see significant increases in software sales related to the
Desktop Integration segment coupled with improving margins on software products
as Cicero gains acceptance in the marketplace. The Company’s expectations are
based on its review of the sales cycle that has developed around the Cicero
product since being released by the Company, its review of the pipeline of
prospective customers and their anticipated capital expenditure commitments and
budgeting cycles, as well as the status of in-process proof of concepts or beta
sites with select corporations. The Messaging and Application Engineering
segment revenue is expected to increase marginally with on-line sales of its
products.
Maintenance.
Maintenance
revenue for the quarter ended March 31, 2005 decreased by approximately 55% or
$40 as compared to the similar quarter for 2004. The decline in overall
maintenance revenues is primarily due to the non-renewal of one maintenance
contract for the Cicero product within the Desktop Integration
segment.
The
Desktop Integration segment accounted for approximately 91% of total maintenance
revenue for the quarter. The Messaging and Application Engineering segment
accounted for approximately 9% of total maintenance revenues. The increase in
the Desktop Integration maintenance as a percentage of the total is directly
tied to the percentage composition of the revenue streams between the Desktop
segment and the Messaging segment.
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 margin (loss) on maintenance products for the quarters ended
March 31, 2005 and March 31, 2004 was (203)%, and (43)%, respectively. The
increase in gross margin (loss) is attributable to the decline in maintenance
revenues from 2004 to 2005.
Maintenance
revenues are expected to increase in the Desktop Integration segment and
increase slightly in the Messaging and Application Engineering segment. The cost
of maintenance should remain constant for the Desktop Integration segment and
the Messaging and Application Engineering segment.
Services.
The
Company recognized $31 in services revenue for the quarter ended March 31, 2005.
The increase in service revenues for the quarter ended March 31, 2005 as
compared to 2004 is attributable to the pilot engagements that were initiated
during the quarter. Services revenues are expected to increase for the Desktop
Integration segment as the Cicero product gains acceptance. The Messaging and
Application Engineering segment service revenues should be insignificant as the
majority of the relevant products are commercial off-the-shelf applications.
Cost of
services primarily includes personnel and travel costs related to the delivery
of services. Services gross margin (loss) was (635)% for the quarter ended March
31, 2005.
Sales
and Marketing. Sales and
marketing expenses primarily include personnel costs for salespeople, marketing
personnel, travel and related overhead, as well as trade show participation and
promotional expenses. Sales and marketing expenses decreased by 33% or
approximately $111 due to a reduction in the Company’s sales and marketing
workforce and sales compensation structure. Specifically, the Company changed
the compensation structure to lower fixed costs and increase variable
success-based costs.
The
Company's emphasis for the sales and marketing groups will be the Desktop
Integration segment.
Research
and Product Development. Research
and product development expenses primarily include personnel costs for product
authors, product developers and product documentation and related overhead.
Research and development expense decreased by 15% or approximately $48 in the
period ended March 31, 2005 as compared to the same period in 2004. The decrease
in costs in 2005 reflects the reduction in headcount by one employee, plus
associated overheads.
The
Company intends to continue to make a significant investment in research and
development on its Cicero product while enhancing efficiencies in this
area.
General
and Administrative. General
and administrative expenses consist of personnel costs for the legal, financial,
human resources, and administrative staff, related overhead, and all
non-allocable corporate costs of operating the Company. General and
administrative expenses for the quarter ended March 31, 2005 decreased by 47% or
$223 over the same period in the prior year. The reason for the decrease in
costs is the reduction of headcount and an overall reduction in the costs of
business fees and a dependency on third party services.
General
and administrative expenses are expected to decrease slightly going forward as
the Company continues to create certain efficiencies and
consolidations.
Change
in Fair Value of Warrant Liability. The
Company has recorded a warrant liability for derivatives in accordance with EITF
00-19 for its common stock warrants with redemption features outside the control
of the Company. As of March 31, 2005, the warrant liability had a fair value of
$0 and has been determined using valuation techniques consistent with the
valuation performed as of December 31, 2004. The fair value of the warrants as
of March 31, 2004 was $19.
Provision
for 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 first quarter of 2005 or 2004. Because of the Company’s
recurring losses, the deferred tax assets have been fully offset by a valuation
allowance.
Segment
Profitability. Segment
profitability represents loss before income taxes, interest and other income
(expense) gain (loss) on sale of assets, and impairment charges. Segment
profitability (loss) for the three months ended March 31, 2005 was approximately
($900) as compared to ($2,100) for the same period of the previous year. The
decrease in the loss before income taxes, interest and other income and expense,
gain or loss on sale of assets and impairment charges is primarily attributable
to the impairment of the Company’s software technology in 2004. As of December
31, 2004, the Company has no capitalized costs for Cicero or the Ensuredmail
software technology.
Segment
profitability is not a measure of performance under accounting principles
generally accepted in the United States of America, and should not be considered
as a substitute for net income, cash flows from operating activities and other
income or cash flow statement data prepared in accordance with accounting
principles generally accepted in the United States of America, or as a measure
of profitability or liquidity. We have included information concerning segment
profitability as one measure of our cash flow and historical ability to service
debt and because we believe investors find this information useful. Segment
profitability as defined herein may not be comparable to similarly titled
measures reported by other companies.
Impact
of Inflation. Inflation
has not had a significant effect on the Company’s operating results during the
periods presented.
LIQUIDITY
AND CAPITAL RESOURCES
Operating
and Investing Activities
The
Company utilized $45 of cash for the three months ended March 31,
2005.
Operating
activities utilized approximately $648 of cash, which is primarily comprised of
the loss from operations of approximately $1,031, offset by non-cash charges for
depreciation and amortization of approximately $3, stock compensation expense of
$8. In addition, the Company’s cash increased by approximately $38 and $59 from
the reduction in accounts receivable and prepaid expenses and other assets
respectively, and approximately $307 for the increase in accounts payable and
accrued expenses from vendors for services rendered.
The
Company generated approximately $632 in cash during the quarter ended March 31,
2005 from financing activities from the proceeds of an additional round of
investment from several new investors, offset by a net reduction in the
Company’s short-term debt in the amount of $30.
By
comparison, in 2004, the Company generated approximately $103 in cash during the
quarter ended March 31, 2004.
Operating
activities utilized approximately $976 of cash, which is primarily comprised of
the loss from operations of approximately $2,636 and a non-cash adjustment to
the fair value of a warrant liability in the amount of $19, offset by non-cash
charges for depreciation and amortization of approximately $657, and an
impairment of goodwill from the acquisition of the Ensuredmail technology in the
amount of approximately $587.. In addition, the Company’s cash increased by
approximately $186 from the reduction in prepaid expenses and other assets,
approximately $141 for an increase in deferred revenues from maintenance
contracts and approximately $45 for the increase in accounts payable and accrued
expenses from vendors for services rendered.
The
Company generated approximately $1,078 in cash during the quarter ended March
31, 2005 from financing activities from the proceeds of an additional round of
investment from several new investors totaling $1,247, net short-term borrowings
of $100, offset by a net reduction in the Company’s short-term debt in the
amount of $269.
Financing
Activities
The
Company funded its cash needs during the quarter ended March 31, 2005 with cash
on hand from December 31, 2004, with the cash realized from a Note and Warrant
Offering and Extended Note and Warrant Offering.
The
Company has a $1,971 term loan bearing interest at LIBOR plus 1% (approximately
3.77% at March 31, 2005), interest on which is payable quarterly. There are no
financial covenants. In September 2004, the Company and Liraz Systems Ltd.
agreed to extend its guaranty on the term loan and with Bank Hapoalim, and to
extend the maturity date on the loan to November 3, 2005. In consideration for
the extension of the guaranty, the Company issued 3,942,000 shares of our common
stock to Liraz at the time of the extension.
In March
2004, the Company entered into a convertible loan agreement with Mark and
Carolyn Landis, who are related by marriage to Anthony Pizi, the Company’s
Chairman and Chief Executive Officer, in the amount of $125. Under the terms of
the agreement, the loan is convertible into 446,429 shares of our common stock
and warrants to purchase 446,429 shares of our common stock exercisable at
$0.28. The warrants expire in three years. The Company also entered into
convertible loan agreements with two other individual investors, each in the
face amount of $50. Under the terms of the agreement, each loan is convertible
into 135,135 shares of common stock and warrants to purchase 135,135 shares of
common stock at $0.37 per share. The warrants expire in three years.
The
Company has incurred losses of approximately $9,800 and $10,000 in the past two
years and has experienced negative cash flows from operations for each of the
past three years. For the quarter ended March 31, 2005 the Company incurred an
additional loss of approximately $1,031 and has a working capital deficiency of
approximately $11,307. The Company’s future revenues are largely dependent on
acceptance of a newly developed and marketed product - Cicero. Accordingly,
there is substantial doubt that the Company can continue as a going concern. In
order to address these issues and to obtain adequate financing for the Company’s
operations for the next twelve months, the Company is actively promoting and
expanding its product line and continues to negotiate with significant customers
that have demonstrated interest in the Cicero technology. The Company is
experiencing difficulty increasing sales revenue largely because of the
inimitable nature of the product as well as customer concerns about the
financial viability of the Company. The Company is attempting to solve the
former problem by improving the market’s knowledge and understanding of Cicero
through increased marketing and leveraging its limited number of reference
accounts. The Company is attempting to address the financial concerns of
potential customers by pursuing strategic partnerships with companies that have
significant financial
resources
although the Company has not experienced significant success to date with this
approach. Additionally, the Company is seeking additional equity capital or
other strategic transactions in the near term to provide additional liquidity.
On December 31, 2004, Level 8 completed a Note and Warrant Offering wherein it
has raised a total of approximately $1,615. On March 31, 2005, we completed an
extension to the Note and Warrant Offering and raised $790 and an additional
$175 was committed and in transit. Under the terms of the Offers, warrant
holders of Level 8’s common stock were offered a one-time conversion of their
existing warrants at a conversion price of $0.10 per share as part of a
recapitalization merger plan which the Company currently intends to propose to
its shareholders at the Company’s next annual meeting. Those warrant holders who
elected to convert, tendered their conversion price in cash and received a Note
Payable in exchange. Upon approval of the recapitalization merger by the
Company’s shareholders at an annual meeting anticipated to be held in mid 2005,
these Notes would convert into common shares of Cicero, Inc., the surviving
corporation in the proposed merger. These funds were used to finance the
operations of Level 8. There can be no assurance that management will be
successful in continued execution of these strategies as anticipated or in a
timely manner or that increased revenues will reduce further operating losses.
If the Company is unable to significantly increase cash flow or obtain
additional financing, it will likely be unable to generate sufficient capital to
fund operations for the next twelve months and may be required to pursue other
means of financing that may not be on terms favorable to the Company or its
stockholders.
The
accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The financial statements
presented herein do not include any adjustments relating to the recoverability
of assets and classification of liabilities that might be necessary should Level
8 be unable to continue as a going concern.
OFF-BALANCE
SHEET ARRANGEMENTS
The
Company does not have any off balance sheet arrangements. We have no
unconsolidated subsidiaries or other unconsolidated limited purpose entities,
and we have not guaranteed or otherwise supported the obligations of any other
entity.
FORWARD-LOOKING
AND CAUTIONARY STATEMENTS
Certain
statements contained in this Quarterly Report may constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 ("Reform Act"). We may also make forward-looking statements in other
reports filed with the Securities and Exchange Commission, in materials
delivered to shareholders, in press releases and in other public statements.
Forward-looking statements provide current expectations of future events based
on certain assumptions and include any statement that does not directly relate
to any historical or current fact. Words such as "anticipates," "believes,"
"expects," "estimates," "intends," "plans," "projects," and similar expressions,
may identify such forward looking statements. In accordance with the Reform Act,
set forth below are cautionary statements that accompany those forward looking
statements. Readers should carefully review these cautionary statements as they
identify certain important factors that could cause actual results to differ
materially from those in the forward-looking statements and from historical
trends.
The
following cautionary statements are not exclusive and are in addition to other
factors discussed elsewhere in our filings with the Securities and Exchange
Commission and in materials incorporated therein by reference: there may be a
question as to our ability to operate as a going concern, our future success
depends on the market acceptance of the Cicero product and successful execution
of the new strategic direction; general economic or business conditions may be
less favorable than expected, resulting in, among other things, lower than
expected revenues; an unexpected revenue shortfall may adversely affect our
business because our expenses are largely fixed; our quarterly operating results
may vary significantly because we are not able to accurately predict the amount
and timing of individual sales and this may adversely impact our stock price;
trends in sales of our products and general economic conditions may affect
investors' expectations regarding our financial performance and may adversely
affect our stock price; our future results may depend upon the continued growth
and business use of the Internet; we may lose market share and be required
to reduce prices as a result
of
competition from its existing competitors, other vendors and information systems
departments of customers; we may not have the ability to recruit, train and
retain qualified personnel; rapid technological change could render the
Company's products obsolete; loss of any one of our major customers could
adversely affect our business; our products may contain undetected software
errors, which could adversely affect our business; because our technology is
complex, we may be exposed to liability claims; we may be unable to enforce or
defend its ownership and use of proprietary technology; because we are a
technology company, our common stock may be subject to erratic price
fluctuations; and we may not have sufficient liquidity and capital resources to
meet changing business conditions.
Item
3. Quantitative and Qualitative Disclosures about Market Risk
As the
Company has sold most of its European based business and has closed several
European sales offices, the majority of revenues are generated from US sources.
The Company expects that trend to continue for the next year. As such, there is
minimal foreign currency risk at present. Should the Company continue to develop
a reseller presence in Europe and Asia, that risk will be
increased.
Item
4. Controls and Procedures
Our
management, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the design and operation of the Company’s disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of the end of the
period covered by this report. Based upon that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company’s disclosure
controls and procedures were effective of the end of the period covered by this
report. There have not been any changes in the Company’s internal control over
financial reporting during the fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
Part
II. Other Information
Item
1. Legal Proceedings
Various
lawsuits and claims have been brought against the Company in the normal course
of business.
In
January 2003, an action was brought against us in the Circuit Court of Loudon
County, Virginia, for a breach of a real estate lease. The case was settled in
August 2003. Under the terms of the settlement agreement, we agreed to assign a
note receivable with recourse equal to the unpaid portion of the note should the
note obligor default on future payments. The unpaid balance of the note was $545
and it matures in December 2007. We assessed the probability of liability under
the recourse provisions using a weighted probability cash flow analysis and have
recognized a long-term liability in the amount of $131.
In
October 2003, we were served with a summons and complaint in Superior Court of
North Carolina regarding unpaid invoices for services rendered by one of our
subcontractors. The amount in dispute was approximately $200 and is included in
accounts payable. Subsequent to March 31, 2004, we settled this litigation.
Under the terms of the settlement agreement, we agreed to pay a total of $189
plus interest over a 19-month period ending November 15, 2005.
In March
2004, we were served with a summons and complaint in Superior Court of North
Carolina regarding a security deposit for a sublease in Virginia. The amount in
dispute is approximately $247. In October 2004, we reached a settlement
agreement wherein we agreed to pay $160 over a 24-month period ending October
2006.
In August
2004, we were notified that we were in default under an existing lease agreement
for office facilities in Princeton, New Jersey. The amount of the default is
approximately $65. Under the terms of the lease agreement, we may be liable for
future rents should the space remain vacant. We have reached a settlement
agreement with the landlord which calls for a total payment of $200 over a
20-month period ending July 2006.
In March
2005 we were notified that EM Software Solutions, Inc. is seeking damages
amounting to approximately $300 resulting from alleged misrepresentations made
by us as part of the sale of the Geneva Enterprise Integrator asset sale in
December 2002. The basis of the claim involves EM Software’s inability to secure
renewals on maintenance contracts. We disagree with this allegation, will
aggressively defend our position and accordingly, have not reserved for this
contingency.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
In 2004,
the Company announced a Note and Warrant Offering in which warrant holders of
Level 8’s common stock were offered a one-time conversion of their existing
warrants at a conversion price of $0.10 per share as part of a recapitalization
merger plan which the Company currently intends to propose to its shareholders
at the Company’s next annual meeting. Under the terms of the Offer, which
expired on December 31, 2004, warrant holders who elect to convert, would tender
their conversion price in cash and receive a Note Payable in exchange. Upon
approval of the recapitalization merger by the Company’s shareholders at an
annual meeting anticipated to be held in mid 2005, these Notes would convert
into common shares of Cicero, Inc., the surviving corporation in the proposed
merger. In addition, those warrant holders who elected to convert the first
$1,000 of warrants would receive additional replacement warrants at a ratio of
2:1 for each warrant converted, with a strike price of $0.10 per share. In
addition, upon approval of the recapitalization merger, each warrant holder
would be entitled to additional warrants to purchase common stock in Cicero,
Inc.
As of
December 31, 2004, the Company has raised a total of $1,548 from the Note and
Warrant Offering. An additional $67 was in transit to the Company. In March
2005, the Company extended the Note and Warrant Offering under the same terms as
the initial offering. The Company was able to secure an additional $965 in
Senior Reorganization Debt under the financing, for a total of $2,578. If the
merger proposal is not approved, the Notes will immediately become due and
payable. As of March 31, 2005 the Company had raised $790 and an additional $175
was committed and in transit. The Notes and Warrants were issued in reliance
upon the exemption from registration under Rule 506 of Regulation D and 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.
In March
2004, the Company entered into a convertible loan agreement with Mark and
Carolyn Landis, who are related by marriage to Anthony Pizi, the Company’s
Chairman and Chief Executive Officer, in the amount of $125. Under the terms of
the agreement, the loan is convertible into 446,429 shares of our common stock
and warrants to purchase 446,429 shares of our common stock exercisable at
$0.28. The warrants expire in three years. We also entered into convertible loan
agreements with two other individual investors, each in the face amount of
$50,000. Under the terms of the agreement, each loan is convertible into 135,135
shares of our common stock and warrants to purchase 135,135 shares of our common
stock at $0.37 per share. The warrants expire in three years.
In
January 2004, the Company acquired substantially all of the assets and certain
liabilities of Critical Mass Mail, Inc., d/b/a Ensuredmail, a federally
certified encryption software company. Under the terms of the purchase
agreement, the Company issued 2,027,027 shares of common stock at a price of
$0.37. The total purchase price of the assets and certain liabilities being
acquired was $750 and has been accounted for by the purchase method of
accounting. These shares were issued in reliance upon the exemption from
registration under Rule 506 of Regulation D and 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.
Also in
January 2004, and simultaneously with the asset purchase of Critical Mass Mail,
Inc., the Company completed a Securities Purchase Agreement with several new
investors as well as certain investors of Critical Mass Mail, Inc. wherein the
Company raised $1,247 through the sale of 3,369,192 shares of common stock at a
price of $0.37 per share. As part of the financing, the Company has also issued
warrants to purchase 3,369,192 shares of the Company’s common stock at an
exercise price of $0.37. The warrants expire three years from the date of grant.
These shares were issued in reliance upon the exemption from registration under
Rule 506 of Regulation D and 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.
Item
3. Defaults Upon Senior Securities
None
Item
4. Submission of Matters to a Vote of Security Holders
None
Item
5. Other Information
None
Item
6. Exhibits and Reports on Form 8-K
(a) Exhibits
|
Exhibit
No. |
Description |
|
31.1 |
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) (filed
herewith). |
|
31.2 |
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) (filed
herewith). |
|
32.1 |
Certification
of Anthony C. Pizi and John P. Broderick pursuant to 18 USC § 1350, as
adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed
herewith). |
(b) Reports
on Form 8-K
On March
10, 2005, Level 8 Systems filed a Form 8-K reporting the election of Mr. Ralph
Martino as Chairman of the Board of Directors.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
LEVEL 8
SYSTEMS, INC.
By:
/s/
Anthony C. Pizi
Anthony
C. Pizi
Chief
Executive Officer
Date: May
12, 2005