UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002.
[ ] 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 (I.R.S Employer
or organization) Identification Number)
8000 Regency Parkway, Cary, NC 27511
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(919) 380-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15d of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO _
Indicate the number of shares outstanding in each of the issuer's classes of
common stock, as of the latest practicable date.
19,022,142 common shares, $.001 par value, were outstanding as of August 6, 2002
1
Level 8 Systems, Inc.
Index
PART I. Financial Information Page
----
Number
Item 1. Financial Statements
Consolidated balance sheets as of June 30, 2002 (unaudited)
and December 31, 2001 3
Consolidated statements of operations for the three and six
months ended June 30, 2002 and 2001 (unaudited) 4
Consolidated statements of cash flows for the six
months ended June 30, 2002 and 2001 (unaudited) 5
Consolidated statements of comprehensive loss for the three and six
months ended June 30, 2002 and 2001 (unaudited) 6
Notes to consolidated financial statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
PART II. Other Information 21
SIGNATURES 23
2
Part I. Financial Information
Item 1. Financial Statements
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
June 30, December 31,
2002 2001
----------------- ----------------
ASSETS
Cash and cash equivalents...................................................... $ 339 $ 698
Available-for-sale securities.................................................. -- 155
Trade accounts receivable, net................................................. 546 2,297
Receivable from related party.................................................. 147 1,045
Notes receivable............................................................... 511 1,977
Note receivable from related party............................................. 16 1,082
Prepaid expenses and other current assets...................................... 1,666 2,044
----------------- ----------------
Total current assets................................................. 3,225 9,298
Property and equipment, net.................................................... 695 1,249
Software product technology, net............................................... 10,899 24,406
Note receivable................................................................ -- 500
Other assets................................................................... . 290 291
----------------- ----------------
Total assets......................................................... $ 15,109 $ 35,744
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Short term debt................................................................ $ 145 $ 245
Accounts payable............................................................... 2,871 2,768
Accrued expenses:
Salaries, wages, and related items........................................... 614 1,070
Restructuring................................................................ 1,268 853
Other ..................................................................... 4,376 5,864
Due to related party........................................................... -- 56
Deferred revenue............................................................... 1,328 3,410
----------------- ----------------
Total current liabilities............................................ 10,602 14,266
Long-term debt, net of current maturities...................................... 2,600 4,600
Warrant liability.............................................................. 296 2,985
Commitments and contingencies..................................................
Stockholders' equity:
Preferred Stock..............................................................
Common Stock................................................................. 19 16
Additional paid-in-capital................................................... 200,577
196,043
Accumulated other comprehensive loss......................................... (970) (778)
Accumulated deficit.......................................................... (198,015) (181,388)
----------------- ----------------
Total stockholders' equity........................................... 1,611 13,893
----------------- ----------------
Total liabilities and stockholders' equity........................... $ 15,109 $ 35,744
================= ================
The accompanying notes are an integral part of the consolidated financial statements.
3
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
-------------------------- ---------------------------
Revenue:
Software $ 1,303 $ 381 $ 1,353 $ 1,464
Maintenance............................................ 373 4,003 882 7,758
Services............................................... 1,045 2,944 1,634 6,251
-------------------------- ---------------------------
Total operating revenue.......................... 2,721 7,328 3,869 15,473
Cost of revenue:
Software . 9,051 3,545 13,345 7,295
Maintenance............................................ 61 1,123 184 2,444
Services............................................... 563 1,938 1,077 5,049
-------------------------- ---------------------------
Total cost of revenue............................ 9,675 6,606 14,606 14,788
Gross margin............................................. (6,954) 722 (10,737) 685
Operating expenses:
Sales and marketing.................................... 899 3,471 1,862 9,781
Research and product development....................... 791 1,638 1,796 4,611
General and administrative............................. 1,173 2,319 3,042 8,783
Amortization of intangible assets...................... 0 2,662 -- 6,727
Impairment of intangible assets........................ 0 - -- 21,824
Loss (Gain)/Loss on disposal of assets................. 112 - 277 (160)
Restructuring, net..................................... 1,300 2,000 1,300 8,650
-------------------------- ---------------------------
Total operating expenses......................... 4,275 12,090 8,277 60,216
-------------------------- ---------------------------
Loss from operations..................................... (11,229) (11,368) (19,014) (59,531)
Other income (expense):
Interest income........................................ 16 217 50 561
Interest expense....................................... (197) (1,389) (301) (2,885)
Change in fair value of warrant liability.............. 971 - 2,689 -
Other expense.......................................... (104) 164 (175) 712
-------------------------- ---------------------------
Loss before provision for income taxes................... (10,543) (12,376) (16,751) (61,143)
Income tax provision................................... 0 132 (123) 275
-------------------------- ---------------------------
Net loss... $ (10,543) $ (12,508) $ (16,628) $ (61,418)
========================== ===========================
Net loss per share--basic and diluted.....................$ (0.55) $ (0.81) $(0.88) $ (3.93)
========================== ===========================
Weighted average common shares outstanding............... $ 18,969 15,904 $ 18,792 15,845
========================== ===========================
The accompanying notes are an integral part of the consolidated financial statements.
4
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)
(unaudited)
Six Months Ended
June 30,
2002 2001
--------------- --------------
Cash flows from operating activities:
Net loss ........................................................................... $ (16,628) $ (61,418)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization....................................................... 5,648 16,559
Change in fair value of warrant liability........................................... (2,689) --
Stock compensation expense.......................................................... 92 --
Impairment of intangible assets and software product technology..................... 8,064 21,824
Provision for doubtful accounts..................................................... (77) 3,745
Loss on disposal of assets.......................................................... 277 --
Other ........................................................................... 62 --
Changes in assets and liabilities, net of assets acquired and liabilities assumed:
Trade accounts receivable and related party receivables........................... 2,581 8,414
Due from Liraz.................................................................... (56) --
Prepaid expenses and other assets................................................. 175 810
Accounts payable and accrued expenses............................................. (1,408) (3,718)
Merger-related and restructuring.................................................. 415 3,783
Deferred revenue.................................................................. (975) (980)
--------------- --------------
Net cash used in operating activities........................................... (4,519) (10,981)
Cash flows from investing activities:
Proceeds from sale of assets 500 --
Purchases of property and equipment................................................... -- (151)
Cash payments secured through notes receivable........................................ -- 64
Repayment of note receivable.......................................................... 2,013 --
Investment held for resale............................................................ 145 2,205
Cash received from sale of line of business assets.................................... 1,000 --
Cash received from acquisitions, net.................................................. -- (56)
Notes Receivable -- 500
Additions to software product technology.............................................. (780) (996)
--------------- --------------
Net cash provided by investing activities....................................... 2,878 1,566
Cash flows from financing activities:
Proceeds from issuance of common shares, net of issuance costs........................ 1,974 --
Dividends paid for preferred shares................................................... -- (731)
Payments under capital lease obligations and other liabilities........................ -- (124)
Repayments of term loans, credit facility and notes payable........................... (500) (2,000)
--------------- --------------
Net cash provided by (used in) financing activities............................. 1,474 (2,855)
Effect of exchange rate changes on cash................................................. (192) (141)
Net decrease in cash and cash equivalents............................................... (359) (12,411)
Cash and cash equivalents:
Beginning of period................................................................... 698 23,856
--------------- --------------
End of period......................................................................... $ 339 $ 11,445
=============== ==============
The accompanying notes are an integral part of the consolidated financial statements.
5
LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
-------------- -------------- -------------- --------------
Net loss............................................... $ (10,543) $ (12,508) $ (16,628) $ (61,418)
Other comprehensive income, net of tax:
Foreign currency translation adjustment............. (135) (75) (192) (286)
Unrealized loss on available-for-sale securities.... -- (291) -- (354)
-------------- -------------- -------------- --------------
Comprehensive loss $ (10,678) $ (12,874) $ (16,820) $ (62,058)
============== ============== ============== ==============
The accompanying notes are an integral part of the consolidated financial statements.
6
LEVEL 8 SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
(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/A (Amendment No. 1) for the year ended December 31,
2001. 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 impairment charges as discussed in Note 7 and the
restructuring charge as discussed in Note 8.
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.
NOTE 2. 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
$105 million and has experienced negative cash flows from operations for the
year ended December 31, 2001. For the six months ended June 30, 2002, the
Company continued to incur losses of approximately $16.6 million and had a
working capital deficiency of approximately $7.4 million. The Company's future
revenues are largely dependent on acceptance of a newly developed and marketed
product - Cicero. These factors among others may indicate the Company will be
unable to continue as a going concern for a reasonable period of time.
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 has entered into preliminary sales
negotiations with significant customers that have begun the "proof of concept"
stage. Additionally, the Company successfully completed a private financing
round wherein it raised approximately $3.5 million, of which $1.6 million of new
funds was received prior to December 31, 2001. Subsequent to June 30, 2002, the
Company has completed a Series C Convertible Redeemable Preferred Stock offering
that raised approximately $1.5 million of new funds (see note 15). Furthermore,
management has and is continuing to review the Company's strategic options, such
as non-strategic asset sales with third parties. The Company has completed the
sale of the Star/SQL and CTRC components of the Messaging and Application
Engineering segment and is further evaluating the assets in the Systems
Integration segment. The Company does not intend to sell Cicero. There can be no
assurance that management will be successful in executing these strategies as
anticipated or in a timely manner or that increased revenues will reduce further
operating losses. If the Company is unable to increase cash flow, obtain
financing or close a sale of non-strategic assets, it may not be able to
generate enough 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.
NOTE 3. 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.
7
NOTE 4. RECENT ACCOUNTING PRONOUNCEMENTS
In June of 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 applies to
the accounting and reporting obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
Statement applies to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, and
development and (or) the normal operation of a long-lived asset, except for
certain obligations of lessees. Adoption of this Statement is required for
fiscal years beginning after June 15, 2002. The Company does not believe that
adoption of this standard will have an impact on its results of operations and
financial position.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets," which supercedes Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" and certain provisions of APB Opinion No.
30, "Reporting Results of Operations - Reporting the Effects of Disposal of a
Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS 144 requires that long-lived assets to be
disposed of by sale, including discontinued operations, be measured at the lower
of carrying amount or fair value less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS 144 also broadens the
reporting requirements of discontinued operations to include all components of
an entity that have operations and cash flows that can be clearly distinguished,
operationally and for financial reporting purposes, from the rest of the entity.
The Company has adopted the provisions of SFAS 144 as of January 1, 2002 and the
adoption of the statement had no impact on the Company's results of operations
and financial position.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities ("SFAS No. 146"). This statement requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We do not anticipate that the adoption of
SFAS No. 146 will have a material impact on our results of operations and
financial conditions.
In January 2002, Emerging Issues Task Force 01-14, Income Statement
Characterization of Reimbursements Received for "Out-of-Pocket" Expenses
Incurred, was issued, and considered whether reimbursements received for
"out-of-pocket" expenses incurred would be characterized in the income statement
as revenue or as a reduction of expenses incurred. The FASB staff believes that
the reimbursements received should be characterized as revenue. The Company has
adopted this policy effective January 1, 2002. Reimbursements for
"out-of-pocket" expenses of $84 and $97 for the three and six months ended June
30, 2002, and $156 and $363 for the three and six months ended June 30, 2001,
respectively, have been included in service revenues and service cost of
revenues.
NOTE 5. ACCOUNTING FOR GOODWILL AND INTANGIBLE ASSETS
In June 2001, the FASB also issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Intangible Assets" ("SFAS 142") which supersedes APB
Opinion No. 17, Intangible Assets. SFAS 142 eliminates the current requirement
to amortize goodwill and indefinite-lived intangible assets, addresses the
amortization of intangible assets with a defined life and addresses the
impairment testing for goodwill and intangible assets and the identification of
reporting units for purposes of assessing potential future impairment of
goodwill. SFAS 142 also requires the Company to complete a transitional goodwill
impairment test six months from the date of adoption. SFAS 142 will apply to
goodwill and intangible assets arising from transactions completed before and
after the statement's effective date. As of January 1, 2002, the Company adopted
SFAS 142. However, during 2001 the Company recorded an impairment of all of its
goodwill and intangible balances totaling $43.9 million and had no remaining
goodwill or intangible balances as of January 1, 2002. Goodwill amortization for
the three and six months ended June 30, 2001 was $2,662 and $6,727. Pro-forma
consolidated net loss and net loss per share, as if the provisions of SFAS 142
had been adopted for the three and six months ended June 30, 2001, would have
been $(9,846) and $(0.64), and $(54,691) and $(3.50), respectively.
NOTE 6. DISPOSITIONS
In June 2002, the Company entered into an Asset Purchase Agreement with
StarQuest Ventures, Inc., a California company and an affiliate of Paul Rampel,
a member of the Board of Directors of Level 8 Systems and a former executive
officer. Under the terms of the Asset Purchase Agreement, Level 8 has sold its
Star SQL and CTRC products and certain fixed assets to StarQuest Ventures for
$365 and the assumption of certain maintenance liabilities. The Company received
$300 in cash, and a note receivable of $65. The loss on sale of the assets was
$74. The company used $150 from the proceeds to repay borrowings from Mr.
Rampel.
8
In May 2002, the Company had received unsolicited offers from several parties
including StarQuest Ventures for the Star SQL and CTRC products which the
Company had identified to be non-strategic to its future operations. As a result
of those offers, the Company reviewed and assessed the net realizable value of
the software product technology assets associated with Star/SQL and CTRC and
based upon this assessment, the Company determined that an additional impairment
had occurred in the amount of $1,564 which was recorded as software amortization
NOTE 7. SOFTWARE PRODUCT TECHNOLOGY
In 2001, the Company and Amdocs Ltd. ("Amdocs") entered into a multi-year
agreement to fund the development of the next generation of Level 8's Geneva
Enterprise Integrator ("GEI") and Geneva Business Process Automator ("GBPA")
software. The terms of the agreement provide $6.5 million in funding for
research and development over the next 18 months in exchange for future fully
paid and discounted licensing arrangement.
In May 2002, the Company entered into a non-exclusive perpetual license to
develop and sell its GEI and GBPA and Geneva J2EE technology with Amdocs. Under
the agreement, Amdocs paid to the Company a license fee of $1,000 for the source
and object code for Geneva J2EE, a license of the GEI and GBPA embedded into
other Amdocs products and relieved the Company of its obligation to perform
under the funded research and development agreement.
The Company was able to reduce its operating costs and retain its intellectual
property rights to Geneva J2EE in its current state of development, as well as
Geneva Enterprise Integrator and Geneva Business Process Automator. In
connection with this transaction, the Company reassessed the recoverability of
the software product technology associated with the Geneva Enterprise Integrator
and Geneva Business Process Automator products based on its net realizable value
and determined that no impairment had occurred.
Subsequent to its license agreement with Amdocs, the Company has been approached
by several investment groups to explore the potential sale of the intellectual
property rights to Geneva J2EE, Geneva Enterprise Integrator and Geneva Business
Process Automator. At this time, the Company is evaluating the long-term
strategy for these assets. As a result of these unsolicited offers, and the
Company's continuing focus on the Desktop Integration segment, the Company
reviewed and assessed the net realizable value of the software product
technology assets associated with Geneva J2EE, Geneva Enterprise Integrator and
Geneva Business Process Automator. Based upon this assessment, the Company
determined that an additional impairment of had occurred in the amount of $6.4
million, which was recorded as software amortization.
NOTE 8. RESTRUCTURING
During the second quarter of 2002, the Company began another round of
operational restructurings to further reduce its operating costs and streamline
its operations. The restructuring plan includes the closure of the development
facility in Berkeley, California and the significant reduction of its employees
in EMEA and terminated approximately 12 people. The Company recorded a
restructuring charge in the amount of $1.3 million during the second quarter of
2002. The Company anticipates that all remaining obligations as of the balance
sheet date will be expended by November 2006.
In 2001, the Company began an initial operational restructuring to reduce its
operating costs and streamline its organizational structure. This operational
restructuring involves the reduction of employee staff throughout the Company in
all geographical regions in sales, marketing, services and development and
administrative functions. The Company recorded restructuring charges of $6,650
during the quarter ended March 31, 2001 and an additional $2 million during the
quarter ending June 30, 2001.
The following table sets forth a summary by category of accrued expenses and
cash paid for the six months ended June 30, 2002:
Accrued at Accrued at
December 31, Additional Cash June 30,
2001 Accrual Paid 2002
------------ ------------ ------------ ------------
Employee termination.......................... $ 43 $ 396 $ (184) $ 255
Excess office facilities...................... 647 880 (536) 991
Marketing obligations......... 53 0 (53) 0
Other miscellaneous restructuring costs....... 110 24 (112) 22
------------ ------------ ------------ ------------
Total......................................... $ 853 $ 1,300 $ (885) $ 1,268
============ ============ ============ ============
9
NOTE 9. STOCKHOLDER'S EQUITY
In January 2002, the Company amended its August 2000 license agreement with
Merrill Lynch. Under the terms of the previous agreement, the Company had a
perpetual license to commercialize and sell the Cicero technology, however, the
Company's exclusivity under that contract expired in August 2002. The amendment
provides for an exclusive, perpetual license to develop and sell the Cicero
application integration software and to obtain ownership of the Cicero
registered trademark. In exchange, a Merrill Lynch affiliate, MLBC, Inc.,
received 250,000 shares of the Company's common stock with a fair market value
of $623. Merrill Lynch now beneficially owns approximately 1.2 million shares of
the Company's common stock. In addition, Merrill Lynch and the Company entered
into a revenue sharing agreement that provides for royalties on future Cicero
software sales. Under the agreement, royalties are capped at $20 million.
In January 2002, the Company entered into a Securities Purchase Agreement with
several investors wherein the Company agreed to sell up to three million shares
of its common stock and warrants. The common stock was valued at $1.50 per share
and warrants to purchase additional shares at $2.75 per share were offered. At
December 31, 2001, the Company had received bridge financing of $1.6 million
which was convertible to common stock subject to closing conditions. The
offering closed on January 16, 2002. The Company sold 2,381,952 shares of common
stock for a total of approximately $3,573 and granted 476,396 warrants to
purchase the Company's common stock at a price of $2.75 per share. The warrants
expire in three years from the date of grant and have a call feature that forces
exercise if the Company's common stock exceeds $5.50 per share. As part of an
agreement with Liraz Systems Ltd., the guarantor of the Company's term loan, the
Company agreed to use 10% of the proceeds of any financing to reduce the
principal on the term loan. Accordingly, the Company utilized $350,000 from its
private placement and reduced the principal on the term loan to $2,650,000.
NOTE 10. 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 three and six
months. Because of the Company's recurring losses, the deferred tax assets have
been fully offset by a valuation allowance.
The income tax provision for the fiscal years 2000 and 2001 is primarily related
to income taxes and tax benefit from foreign operations and foreign withholding
taxes.
NOTE 11. 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. Dividends of $312 and $731 were paid to the holders of the Company's
preferred stock the three and six months ended June 30, 2001.
The following table sets forth the reconciliation of net loss to loss available
to common stockholders:
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
------------------------------ ---------------------------
Net loss........................................ $ (10,543) $ (12,508) $ (16,628) $ (61,418)
Preferred stock dividends....................... 0 (415) 0 (825)
------------------------------ ---------------------------
Loss available to common stockholders........... $ (10,543) $ (12,923) $ (16,628) $ (62,243)
============================== ===========================
Net loss per share - basic and diluted.......... $ (0.55) $ (0.81) $ (0.88) $ (3.93)
============================== ===========================
Weighted common shares outstanding - basic and diluted.... $ 18,969 $ 15,904 $ 18,792 $ 15,845
============================== ===========================
10
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:
June 30
2002 2001
----------- -----------
Stock options, common share equivalent 2,750 3,883
Warrants, common share equivalent 3,045 2,662
Preferred stock, common share equivalent 3,782 2,354
----------- -----------
9,577 8,899
=========== ===========
NOTE 12. SEGMENT INFORMATION AND GEOGRAPHIC INFORMATION
Management makes operating decisions and assesses performance of the Company's
operations based on the following reportable segments: (1) Desktop Integration
Products, (2) System Integration Products, and (3) Messaging and Application
Engineering Products.
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 make up the Systems Integration segment are as follows: Geneva
Enterprise Integrator and Geneva Business Process Automator. Geneva Enterprise
Integrator is an integration tool that provides unified, real-time views of
enterprise business information for eBusiness applications. 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 and enabling the automation of information workflows
spanning front and back office systems.
The products that comprise the Messaging and Application Engineering segment are
Geneva Integration Broker, Geneva Message Queuing, Geneva XIPC, Geneva
AppBuilder, CTRC and Star/SQL. During 2001, the Company sold three of its
messaging products, Geneva Message Queuing, Geneva XIPC and AppBuilder. During
2002, the Company sold its CTRC and Star/SQL products.
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, in-process research and development, restructuring and
amortization of goodwill (EBITA).
While EBITA 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. EBITA 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 and
six months ended June 30, 2002:
Desktop Integration Systems Integration Messaging/Application Total
Engineering
------------------------ ------------------------- ---------------------------- ---------------------------
June 30, 2002 June 30, 2002 June 30, 2002 June 30, 2002
Three Six Three Six Three Six Three Six
months months months months months months months months
ended ended ended ended ended ended ended ended
---------- ---------- ---------- ----------- ------------- ----------- ----------- -----------
Total Revenue $ 301 $ 376 $ 2,091 $ 2,793 $ 329 $ 700 $ 2,721 $ 3,869
Total cost of
revenue 2,302 4,493 7,296 8,232 77 1,881 9,675 14,606
---------- ---------- ---------- ----------- ------------- ----------- ----------- -----------
Gross
profit/(loss) (2,001) (4,117) (5,205) (5,439) 252 (1,181) (6,954) (10,737)
---------- ---------- ---------- ----------- ------------- ----------- ----------- -----------
Total operating
Expenses (A) 1,971 4,436 793 2,090 99 174 2,863 6,700
EBITA (A) $ (3,972) $(8,553) $ (5,998) $ (7,529) $ 153 $ (1,355) $(9,817) $ (17,437)
========== ========== ========== =========== ============= =========== =========== ===========
(A) See reconciliation below
11
The table below presents information about reported segments for the three and
six months ended June 30, 2001:
Desktop Integration Systems Integration Messaging/Application Total
Engineering
------------------------ -------------------------- --------------------------- -------------------------
June 30, 2001 June 30, 2001 June 30, 2001 June 30, 2001
Three Six Three Six Three Six Three Six
months months months months months months months months
ended ended ended ended ended ended ended ended
---------- ---------- ---------- ----------- ------------- ----------- ---------- ------------
Total Revenue $ 0 $ 79 $ 1,662 $ 3,842 $ 5,666 $ 11,552 $ 7,328 $ 15,473
Total cost of
revenue 2,203 5,001 1,011 3,239 3,392 6,548 6,606 14,788
---------- ---------- ---------- ----------- ------------- ----------- ---------- ------------
Gross
profit/(loss) (2,203) (4,922) 651 603 2,274 5,004 722 685
---------- ---------- ---------- ----------- ------------- ----------- ---------- ------------
Total operating
Expenses (A) 3,571 13,835 1,546 4,733 2,311 4,607 7,428 23,175
---------- ---------- ---------- ----------- ------------- ----------- ---------- ------------
EBITA (A) $ (5,774) $(18,757) $ (895) $ (4,130) $ (36) $ 397 $ (6,705) $ (22,490)
========== ========== ========== =========== ============= =========== ========== ============
(A) See reconciliation below
A reconciliation of total segment operating expenses to total operating expenses
for the quarters ended June 30:
Three Months Ended Six Months Ended
June 30 June 30
-------------------------------- ---------------------------------
2002 2001 2002 2001
-------------- ------------- ------------- ---------------
Total segment operating expenses $ 2,863 $ 7,428 $ 6,700 $ 23,175
Amortization of intangible assets 0 2,662 0 6,727
Restructuring 1,300 2,000 1,300 8,650
Impairment of intangible assets 0 0 0 21,824
(Gain)/loss on disposal of assets 112 0 277 (160)
-------------- ------------- ------------- ---------------
Total operating expenses $ 4,275 $ 12,090 $ 8,277 $ 60,216
============== ============= ============= ===============
A reconciliation of total segment EBITA to loss before provision for income
taxes for the quarters ended June 30:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- ---------------------------------
2002 2001 2002 2001
-------------- ------------- ------------- ---------------
Total EBITA $ (9,817) $ (6,705) $(17,437) $ (22,490)
Amortization of intangible assets 0 (2,662) 0 (6,727)
Restructuring and Impairment of
Intangible assets (1,300) (2,000) (1,300) (30,474)
Change in fair value of derivative 971 0 2,689 0
Gain/(loss) on disposal of assets (112) 0 (277) 160
Interest and other income/(expense), net (285) (1,009) (426) (1,612)
-------------- ------------- ------------- ---------------
Total loss before income taxes $ (10,543) $ (12,376) $ (16,751) $ (61,143)
============== ============= ============= ===============
12
The following table presents a summary of assets by segment:
--------------- -----------------
June 30, December 31,
2002 2001
--------------- -----------------
Desktop Integration $ 9,965 $ 13,323
Systems Integration 1,506 9,963
Messaging/Application Engineering 123 2,369
--------------- -----------------
Total assets $ 11,594 $ 25,655
=============== =================
The following table presents a summary of revenue by geographic region for the
three and six months period ended June 30:
Three months ended Six Months Ended
June 30, June 30,
-------------------------------- ---------------------------------
2002 2001 2002 2001
-------------- ------------- -------------- ---------------
Denmark................ $ 11 $ 969 $ 21 $ 1,651
France 212 86 293 331
Germany................ 18 198 24 497
Greece 0 360 0 473
Israel................. 1,010 131 1,172 620
Italy.................. 21 270 89 867
Switzerland............ 0 394 0 777
Norway 0 178 0 502
United Kingdom......... 55 1,858 293 3,335
USA.................... 1,393 1,962 1,976 4,798
Other.................. 1 922 1 1,522
-------------- ------------- -------------- ---------------
Total revenue.......... $ 2,721 $ 7,328 $ 3,869 $ 15,473
============== ============= ============== ===============
Presentation of revenue by region is based on the country in which the customer
is domiciled. Only countries with greater than 3% of total revenue are disclosed
individually.
NOTE 13. 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.
NOTE 14. SUBSEQUENT EVENTS
In August 2002, the Company entered into a Securities Purchase Agreement with
several new investors wherein the Company issued approximately $1.5 million of
Series C Convertible Redeemable Preferred Stock and approximately 1,000,000
warrants to purchase the common stock of the Company at an exercise price of
$0.38. The preferred offering is convertible into approximately 4,050,000 shares
of the Company's common stock. The offering closed on August 12, 2002.
In connection with the sale of Series C Convertible Redeemable Preferred Stock,
the Company agreed with the existing holders of its Series A1 Convertible
Redeemable Preferred Stock (the "Series A1 Preferred Stock") and the Series B1
Convertible Redeemable Preferred Stock (the "Series B1 Preferred Stock"), in
exchange for their waiver of certain anti-dilution provisions, to reprice an
aggregate of 1,801,022 warrants to purchase common stock from an exercise price
of $1.77 to $0.38. Furthermore, the Company will promptly enter into an Exchange
Agreement with such holders providing for the issuance of 11,570 shares of
Series A2 Convertible Preferred Stock ("Series A2 Preferred Stock") and 30,000
Series B2 Convertible Preferred Stock ("Series B2 Preferred Stock"),
respectively. Series A2 Preferred Stock and Series B2 Preferred Stock are
convertible into an aggregate of 1,388,456 and 2,394,063 shares of the Company's
common stock at $8.33 and $12.531 per share, respectively. The exchange is being
undertaken in consideration of the temporary release of the anti-dilution
provisions of the Series A1 Preferred Stockholders and Series B1 Preferred
Stockholders
13
Following the consummation of the transactions contemplated by the Exchange
Agreement, holders of the Series A2 Preferred Stock and Series B2 Preferred
Stock will have one vote per share of Series A2 Preferred Stock and Series B2
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 A2 Preferred Stock and Series B2 Preferred Stock, respectively. The
Series A2 Preferred Stock and B2 Preferred Stock may be redeemed at the option
of Level 8 at a redemption price equal to the original purchase price at any
time if the closing price of Level 8's common stock over 20 consecutive trading
days is greater than $16.00 and $25.0625 per share, respectively. The conversion
prices of the Series A2 Preferred Stock and Series B2 Preferred Stock are
subject to certain anti-dilution provisions, including adjustments in the event
of certain sales of common stock at a price of less than $8.33 and $12.531 per
share, respectively; provided, that the Company may issue equity securities
representing $5,000,000 in aggregate gross proceeds to the Company without
triggering the price protection anti-dilution provisions. As part of the
Exchange Agreement and of the waiver of the anti-dilution provisions, the Series
A2 holders will be entitled to a maximum of 1,000,000 warrants to purchase
common stock. The warrants to be issued shall be the product of 1,000,000,
multiplied by the quotient where (x) the numerator is the amount of gross
proceeds received by the Company in connection with a financing and (y) the
denominator is 5,000,000. Such warrants described above shall be exercisable at
the lowest effective per share of common stock price at which the financing was
consummated. Moreover, the holders of Series A2 and B2 Preferred Stock shall
receive one warrant, on substantially the same terms as the issued warrants, for
every warrant issued to a lender in connection with the Company's borrowings. In
the event the Company breaches its obligations to issue common stock upon
conversion, or the Company's common stock is delisted, dividends will be payable
on the Series A2 Preferred Stock and Series B2 Preferred Stock at a rate of 14%
per annum.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General Information
Level 8 Systems is a global provider of business integration software that
enables organizations to integrate new and existing information and processes at
the desktop with Cicero and at the server level with the Geneva Integration
products. 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 industry-leading 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 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. See "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Forward Looking and Cautionary Statements."
The Company's results of operations include the operations of the Company and
its subsidiaries. Unless otherwise indicated, all information is presented in
thousands (`000s).
As a result of the Company's acquisition activity, the nature of its operations
has changed significantly from 1998 to 2002. Due to the Company's acquisition
and divestiture activities, year-to-year comparisons of results of operations
are not necessarily meaningful. Additionally, as a result of the Company's
pursuit of a growth strategy focusing on its software product sales and
synergies gained as a result of eliminating duplicative functions, the results
of operations are significantly different than the result of combining the
previous operations of each acquired company into Level 8. Pro forma comparisons
are therefore not necessarily meaningful either. In 2001, the Company shifted
its primary focus from selling multiple Enterprise Application Integration
("EAI") products to selling Cicero, a desktop integration package, to the
financial services industry with a decreased focus on services. Further, during
the last two fiscal quarters of 2001, the Company sold most of the products that
comprised its Messaging and Application Engineering segment and thus will have
significantly reduced revenue streams within that segment.
14
Business Strategy
Management makes operating decisions and assesses performance of the Company's
operations based on the following reportable segments: (1) Desktop Integration
Products, (2) System Integration Products and (3) Messaging and Application
Engineering Products.
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 make up the Systems Integration segment are Geneva Enterprise
Integrator and Geneva Business Process Automator. Geneva Enterprise Integrator
is an integration tool that provides unified, real-time views of enterprise
business information for eBusiness applications. 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 and enables the automation of information workflows spanning front
and back office systems.
The products that comprise the Messaging and Application Engineering segment are
Geneva Integration Broker, Geneva Message Queuing, Geneva XIPC, Geneva
AppBuilder, CTRC and Star/SQL. 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.
Geneva Message Queuing is an enterprise connectivity product for Microsoft and
non-Microsoft applications. The primary use is for transactional, once and only
once connectivity of Window-based Web applications to back-office information
resources like mainframes and other legacy systems. Geneva XIPC provides similar
delivery of information between applications. While Geneva Message Queuing is
based around a Microsoft standard, Geneva XIPC is for use with Linux and other
brands of UNIX operating systems. 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. During 2001, the Company sold the Geneva AppBuilder
product along with all receivables, unbilled and deferred revenues as well as
all maintenance contracts. The Geneva AppBuilder product accounted for
approximately 79% of total year 2001 revenue within the Messaging and
Application Engineering segment and approximately 59% of total year 2001 revenue
for all segments. While future revenues will be negatively impacted by the sale
of Geneva AppBuilder, the associated costs of doing business will be positively
impacted by the overall reduction in operating costs.
In early 2001, the Company entered into an exclusive distribution agreement with
a certain software distributor for the Star/SQL products. During the third
quarter of 2001, the distributor returned the Star/SQL products back to Level 8
under the assumption that their legal obligation was satisfied. The Company
provided an allowance for the receivable, pursued collection for the reseller's
outstanding obligations and eventually settled the dispute. At the same time,
the Company had begun to re-enlist Star/SQL customers under maintenance
contracts directly with the Company. Also during 2001, the Company was notified
by one of its resellers that it would no longer engage in resales of the
Company's CTRC products acquired from StarQuest. This reseller accounted for
substantially all of the product sales. The Company has been assessing its
assets to determine which assets, if any, are to be considered non-strategic and
in May 2002, the Company received an unsolicited offer to purchase the Star/SQL
and CTRC products. As a result, the Company reviewed and assessed the net
realizable value of the software product technology assets associated with
Star/SQL and CTRC based on the potential sale to a third party. Based upon this
review and assessment, the Company determined that an additional impairment had
occurred in the amount of $1,564, which was recorded as software amortization.
In June 2002, the Company completed the sale of the Star SQL and CTRC products
to StarQuest Ventures, Inc., a California company and an affiliate of Paul
Rampel, a member of the Level 8 Board of Directors and a former executive
officer of Level 8. See Note 6 for further discussion.
In May 2002, the Company entered into a non-exclusive perpetual license to
develop and sell its Geneva J2EE technology with Amdocs Ltd. Under the
agreement, Amdocs will pay to the Company a license fee for the source and
object code for Geneva J2EE and relieve the Company of its obligation to perform
under the funded research and development agreement. Additionally, Amdocs
assumed full responsibility for the development team of professionals located in
the Company's Dulles facility and subleased a portion of that facility for a
limited period. The Company was able to reduce its operating costs and retain
its intellectual property rights to Geneva J2EE in its current state of
development, as well as Geneva Enterprise Integrator and Geneva Business Process
Automator. In connection with this transaction, the Company reassessed the
recoverability of the software product technology associated with the Geneva
Enterprise Integrator and Geneva Business Process Automator products based on
its net realizable value and determined that no impairment had occurred.
15
Subsequent to its license agreement with Amdocs, the Company was approached by
several prospective buyers to explore the potential sale of the intellectual
property rights to Geneva J2EE, Geneva Enterprise Integrator and Geneva Business
Process Automator. As a result of these unsolicited offers, and the Company's
continuing focus on the Desktop Integration segment, the Company reviewed and
assessed the net realizeable value of the software product technology assets
associated with Geneva J2EE, Geneva Enterprise Integrator and Geneva Business
Process Automator. Based upon this assessment, the Company determined that an
additional impairment had occurred in the amount of $6,500, which was recorded
as software amortization.
Results of Operations
The table below presents information about reported segments for the three and
six months ended June 30, 2002:
Desktop Integration Systems Integration Messaging/Application Total
Engineering
------------------------ -------------------------- ---------------------------- ---------------------------
June 30, 2002 June 30, 2002 June 30, 2002 June 30, 2002
Three Six Three Six Three Six Three Six
months months months months months months months months
ended ended ended ended ended ended ended ended
---------- ---------- ---------- ----------- ------------- ----------- ----------- -----------
Total Revenue $ 301 $ 376 $ 2,091 $ 2,793 $ 329 $ 700 $ 2,721 $ 3,869
Total cost of
revenue 2,302 4,493 7,296 8,232 77 1,881 9,675 14,606
---------- ---------- ---------- ----------- ------------- ----------- ----------- -----------
Gross
profit/(loss) (2,001) (4,117) (5,205) (5,439) 252 (1,181) (6,954) (10,737)
---------- ---------- ---------- ----------- ------------- ----------- ----------- -----------
Total operating
Expenses 1,971 4,436 793 2,090 99 174 2,863 6,700
EBITA $ (3,972) $ (8,553) $ (5,998) $ (7,529) $ 153 $ (1,355) $(9,817) $ (17,436)
========== ========== ========== =========== ============= =========== =========== ===========
The table below presents information about reported segments for the three and
six months ended June 30, 2001:
Desktop Integration Systems Integration Messaging/Application Total
Engineering
------------------------ ------------------------ --------------------------- -----------------------
June 30, 2001 June 30, 2001 June 30, 2001 June 30, 2001
Three Six Three Six Three Six Three Six
months months months months months months months months
ended ended ended ended ended ended ended ended
---------- ---------- ---------- ----------- ------------- ----------- --------- ------------
Total Revenue $ 0 $ 79 $ 1,662 $ 3,842 $ 5,666 $ 11,552 $ 7,328 $ 15,473
Total cost of
revenue 2,203 5,001 1,011 3,239 3,392 6,548 6,606 14,788
---------- ---------- ---------- ----------- ------------- ----------- --------- ------------
Gross
profit/(loss) (2,203) (4,922) 651 603 2,274 5,004 722 685
---------- ---------- ---------- ----------- ------------- ----------- --------- ------------
Total operating
Expenses 3,571 13,835 1,546 4,733 2,311 4,607 7,428 23,175
---------- ---------- ---------- ----------- ------------- ----------- --------- ------------
EBITA $ (5,774) $(18,757) $ (895) $ (4,130) $ (36) $ 397 $ (6,705) $ (22,490)
========== ========== ========== =========== ============= =========== ========= ============
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.
16
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 decreased 62.9% for the quarter ended June 30, 2002 from the same
period in 2001 and 75.0% for the six months ended June 30, 2002 as compared to
the same period of the previous year. The significant decrease in revenues is
primarily the result of the sale of substantially all of the Messaging and
Application Development products at the start of the fourth quarter in 2001.
Revenues in the Messaging and Application Engineering segment in the second
quarter of 2002 were approximately $329 as compared to $5,666 of revenues in the
same period of 2001. For the six months ended June 30, 2002, revenues for the
Messaging and Application Engineering segment amounted to $700 as compared to
$11,552 for the same period in 2001. Revenues from the Systems Integration
segment amounted to approximately $2,091 for the three months ended June 30,
2002 as compared with approximately $1,662 in the same period of the previous
year. For the six months ended June 30, 2002, revenues in the Systems
Integration segment amounted to $2,793 as compared to $3,842 in the same period
of the previous year. The overall decline in revenues in the System Integration
segment is primarily attributed to the development of the Geneva Enterprise
Integrator and Business Process Automator under the J2EE platform, which has
delayed sales of such products. As Level 8 has deferred any further development
of the J2EE platform, further diminishment in sales is anticipated. Revenues in
the Desktop Integration segment amounted to approximately $301, for the three
months ended June 30, 2002 as compared to no revenues in the same period of the
previous year. Sales for the six months ended June 30, 2002 amounted to $376 as
compared to $79 for the same period in 2001. The Company anticipates that this
segment will continue to grow exponentially. Gross profit margins were (255.6)%
for the quarter ended June 30, 2002 and 9.9% for the quarter ended June 30,
2001. For the six months ended June 30, 2002, gross profit margins were (277.5)%
as compared to 4.4% in the same period in 2001. The negative gross profit
margins reflect the additional software amortization charges for the Star SQL,
CTRC and Geneva Enterprise Integrator and Business Process Automator products.
See Notes 6 and 7 for further discussion.
Software Products. Software product revenue increased approximately 242% in the
quarter ended June 30, 2002 from the same period in 2001 and reflects the
results of the license transaction with Amdocs for the Geneva J, Geneva
Enterprise Integrator and Business Process Automator products, as well as
additional acceptance of the Cicero product. For the six months ended June 30,
2002, software product revenues decreased approximately 7.6%.
The gross margin on software products was (594.6)% and (830.4)% for the quarter
ended June 30, 2002 and 2001, respectively. Gross margin for the Quarter ended
June 30, 2002 reflects the amortization of acquired software not offset by
revenues along with an additional charge in the amount of $6,500 for impairment
to the net realizable value of the Geneva J, Geneva Enterprise Integrator and
Geneva Business Process Automator products. 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 less extent, production and distribution costs.
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 System Integration segment
revenue is anticipated to remain stable with fiscal 2001 levels with gross
margin remaining relatively consistent. The Messaging and Application
Engineering segment revenue is expected to decrease significantly along with
related expenses as the majority of the products comprising this segment have
been sold.
Maintenance. Maintenance revenue for the quarter ended June 30, 2002 decreased
by approximately 90.7% or $3,630 as compared to the similar quarter for 2001.
For the six months ended June 30, 2002, maintenance revenue decreased by
approximately 88.6% or $6,876 as compared to the same period of 2001. The
decline in overall maintenance revenues is primarily due to the sale of the
majority of the Messaging and Application Engineering products at the beginning
of the fourth quarter of 2001 and in the second quarter of 2002.
The Desktop Integration segment accounted for approximately 1.4% of total
maintenance revenue for the quarter. The Systems Integration segment accounted
for 47.7% of total maintenance revenues and the Messaging and Application
Engineering segment accounted for approximately 50.9% of total maintenance
revenues. The Messaging and Application Engineering maintenance as a percentage
of the total is primarily due to Star/SQL as this product returned to the
Company's control after being managed by a third-party for substantially all of
2001. The Company sold this product to StarQuest Ventures in June 2002. See Note
6 for further comment.
17
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 products increased slightly for
the quarter ended June 30, 2002 from 71.9% to 83.6%. For the six months ended
June 30, 2002, maintenance gross margins were 79.1% as compared to 68.5% in the
same period of the previous year.
The Desktop Integration segment had a negative gross margin for the quarter and
for the six months ended June 30, 2002 as future sales of the Cicero product are
subject to favorable proofs-of-concepts at several large installations. The
Systems Integration segment had a gross margin of 88.8% for the quarter and the
six months ended June 30, 2002 while the Messaging and Application Engineering
segment had a gross margin of approximately 98% for the quarter and the year to
date period.
Maintenance revenues are expected to increase, primarily in the Desktop
Integration segment and remain flat to slightly down in the System Integration
segment. The majority of the products comprising the Messaging and Application
Engineering segment have been sold and thus future revenues will be
significantly lower as will the cost of maintenance associated with this
segment. The cost of maintenance should increase slightly for the Desktop
Integration segment while remaining constant for the System Integration segment.
Services. Services revenue for the quarter ended and six months ended June 30,
2002 decreased approximately 64.5% and 73.9%, respectively, from comparable
periods in 2001. The overall decline in service revenues reflects the reduced
headcounts resulting from the Company's restructuring plan that occurred in the
early part of 2001 as well as the impact of the sale of the Geneva AppBuilder
product to BluePhoenix Solutions in October 2001. In that transaction,
approximately 20 consultants were transferred as part of the overall
transaction.
The Desktop Integration segment accounted for approximately 28.3% of the service
revenues for the quarter ended June 30, 2002, which reflects the deployment of
the Cicero application at several customers. The Systems Integration segment
accounted for approximately 68.9% of the total services revenue while the
Messaging and Application Engineering segment accounted for approximately 2.8%
of service revenue. For the six months ended June 30, 2002, the Desktop
Integration segment accounted for 19.3% of service revenues while the Systems
Integration segment accounted for 70.7% and the Messaging and Application
Engineering segment accounted for 10% of service revenues.
Cost of services primarily includes personnel and travel costs related to the
delivery of services. Services gross margins were (46.1%) for the quarter ended
June 30, 2002 as compared to 34.2% for the same period in 2001.
Services revenues are expected to increase for the Desktop Integration segment
as the Cicero product gains acceptance. The service revenues in the System
Integration segment are expected to remain fairly constant with improved margins
from a more efficient utilization of personnel. The Messaging and Application
Engineering segment service revenues will decrease dramatically as the majority
of the relevant products have been sold.
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 for the quarter ended June 30, 2002 decreased by 74.1% or approximately
$2,572 from a comparable period in 2001 due to a reduction in the Company's
sales and marketing workforce, as well as decreased promotional activities. For
the six months ended June 30, 2002, sales and marketing expenses decreased by
81% or $7,919.
Sales and marketing expenses are expected to remain fairly constant now that the
Company's 2001 restructuring efforts are complete. The Company's emphasis for
the sales and marketing groups will be the Desktop Integration segment.
Research and Development. Research and development expenses primarily include
personnel costs for product authors, product developers and product
documentation and related overhead. Research and development expense decreased
by 51.7% or approximately $847 in the period ending June 30, 2002 as compared to
the same period in 2001. For the six months ended June 30, 2002 research and
development expenses decreased by approximately 61% or $2,815 over the same
period of the previous year. The decrease in costs in 2002 reflects the
restructuring efforts completed during the first two quarters of 2001.
The Company anticipates that research and development expenses will decrease
slightly over the next few quarters as the Company has further reduced its
research and development headcount. Level 8 intends to continue to invest in
research and development on its Cicero product while enhancing efficiencies in
this area.
18
General and Administrative. General and administrative expenses consist of
personnel costs for the executive, legal, financial, human resources, IT and
administrative staff, related overhead, and all non-allocable corporate costs of
operating the Company. General and administrative expenses for the quarter ended
June 30, 2002 decreased by 49.4% or $1,146 over the same period in the prior
year. For the six months ended June 30, 2002, general and administrative
expenses decreased by 65.4% or $5,742 over the same period in the previous year.
The decrease is primarily attributable to the Company's provision for doubtful
accounts (approximately $3.8 million) relating to a bankruptcy filing from one
customer and the overall restructuring plan that was affected on the Company's
operations in 2001.
General and administrative expenses are expected to decrease slightly going
forward as the Company continues to create certain efficiencies and
consolidations.
Restructuring. During the second quarter of 2002, the Company began another
round of operational restructurings to further reduce its operating costs and
streamline its operations. The decision was made to close its development
facility in Berkeley, California and centralize the future development of Cicero
within its Princeton, New Jersey facility. Additionally, the company decided to
significantly reduce its employees in EMEA and terminated approximately 12
people. The Company recorded a restructuring charge in the amount of $1,300
during the second quarter of 2002. The Company anticipates that all remaining
obligations as of the balance sheet date will be expended by November 2006.
In 2001, the Company began an initial operational restructuring to reduce its
operating costs and streamline its organizational structure. This operational
restructuring involves the reduction of employee staff throughout the Company in
all geographical regions in sales, marketing, services and development and
administrative functions. The Company recorded restructuring charges of $6,650
during the quarter ended March 31, 2001 and an additional $2,000 during the
quarter ending June 30, 2001.
The following table sets forth a summary by category of accrued expenses and
cash paid for the six months ended June 30, 2002:
Accrued at Accrued at
December 31, Additional Cash June 30, 2002
2001 Accrual Paid
------------ ------------ ------------ ------------
Employee termination $ 43 $ 396 $ (184) $ 255
Excess office facilities................... 647 880 (536) 991
Marketing obligations ............. 53 0 (53) 0
Other miscellaneous restructuring costs.... 110 24 (112) 22
------------ ------------ ------------ ------------
Total...................................... $ 853 $ 1,300 $ (885) $ 1,268
============ ============ ============ ============
The Company believes the accrued restructuring cost of $1,292 at June 30, 2002
represents its remaining cash obligations for the restructuring charges included
above.
Impairment of Intangible Assets. In May 2001, management re-evaluated and
modified its approach to managing the business and opted to conduct business and
assess the efficiency of operations under a line-of-business approach. As such,
the Company performed an assessment of the recoverability of its long-lived
assets under a line-of-business approach. The results of an analysis of
undiscounted cash flows for each reporting segment indicated that an impairment
had occurred in the Systems Integration segment (i.e. intangible assets acquired
in the Template acquisition). The Company then estimated the fair market value
of the related assets through a discounted future cash flow valuation technique.
The results of this analysis indicated that the carrying values of these assets
exceeded their fair market values. The Company reduced the carrying value of
these intangible assets by approximately $21,824 as of March 31, 2001.
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. The fair
value of the warrants as of June 30, 2002 has been determined using valuation
techniques consistent with the valuation performed as of December 31, 2001 and
recorded as a warrant liability. As a result of the valuation, the Company has
recorded a change in the fair value of the warrant liability of $971 and $2,689
for the quarter ended and six months ended June 30, 2002.
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 2002
or 2001. Because of the Company's recurring losses, the deferred tax assets have
been fully offset by a valuation allowance. The income tax provision for the
first quarter of 2002 is primarily related to income taxes and benefit from
foreign operations and foreign withholding taxes.
19
EBITA. EBITA represents loss before income taxes, interest and other income
(expense), amortization of goodwill, restructuring charges, gain (loss) on sale
of assets, and impairment charges. EBITA for the three months and six months
ended June 30, 2002 was ($9.8) million and ($17.4) million as compared to ($6.7)
million and ($22.5) for the same periods of the previous year. The decrease in
the loss before income taxes, interest and other income and expense,
amortization of goodwill, restructuring charges, gain or loss on sale of assets
and impairment charges is primarily attributable to the reduced operations of
the Company as a result of the significant restructuring of operations conducted
in the first half of 2001.
EBITA 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 EBITA one
measure of our cash flow and historical ability to service debt and because we
believe investors find this information useful. EBITA 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 used $359 of cash for the six months ended June 30, 2002.
Operating activities utilized approximately $4.5 million of cash, which is
primarily comprised of the loss from operations of $16.6 million, offset by
non-cash charges for depreciation and amortization and intangible asset
impairments of approximately $13.6 million and a non-cash adjustment to the fair
value of a warrant liability in the amount of $2.7 million. In addition, the
Company had a reduction in accounts receivable of $2.6 million and used
approximately $1.6 million in fulfillment of its obligations to its creditors
through its accounts payable and other accrued liabilities and a reduction in
its deferred liabilities of $.3 million. The reduction in accounts receivable is
the result of the reduction in overall revenues resulting from the sale of
substantially all of the Messaging and Application Engineering products.
The Company generated approximately $2.9 million in cash from investing
activities, which is comprised of approximately $1.0 million in final proceeds
from the sale of the Geneva AppBuilder assets, approximately $2.0 million from
the collection of Notes Receivable, approximately $500 from the sale of assets,
offset by capitalization of product software technology of $780.
The Company generated approximately $1.5 million of cash during the first six
months for financing activities from the proceeds of an additional round of
investment from several new investors (approximately $3.5 million) offset by
approximately $1.6 million that was received prior to the end of the year from
the same investor group. As part of its agreement with Liraz as the guarantor on
the outstanding bank loan, the Company used approximately 10% of the proceeds
($400) from its financing and asset sales to pay down the principal on the loan.
By comparison, in 2001, the Company used approximately $12.4 million in cash
during the first six months.
Net cash used in operations during the first six months of 2001 was
approximately $11.0 million, which is primarily comprised of the net loss for
the period of $61.4 million and approximately $3.7 million for fulfillment of
vendor obligations, offset by non-cash charges for depreciation and amortization
of approximately $16.6 million, an impairment of assets of approximately $21.8
million, a provision for doubtful accounts of approximately $3.7 million and a
$8.4 million reduction in accounts receivable.
Net cash generated from investing activities during 2001 was $1.6 million, which
consisted of approximately $2.2 million which represented the proceeds from the
sale of Company's building located in Windsor, England offset by capitalization
of product software in the amount of $1.0 million
Net cash used in financing activities for the first six months of 2001 amounted
to $2.8 million which includes a reduction of the Company's outstanding bank
indebtedness as well as dividends paid to preferred shareholders during the
period.
20
Financing Activities
The Company funded its cash needs during the six months ended June 30, 2002 with
cash on hand from December 31, 2001, with cash from operations and with the cash
realized from the private placement, which closed in January 2002.
The Company has a $2,600 term loan bearing interest at LIBOR plus 1%
(approximately 3.03% at June 30, 2002), interest on which is payable quarterly.
There are no financial covenants and the term loan is guaranteed by Liraz, the
Company's principal shareholder. The loan matures on November 15, 2003.
The Company is attempting to secure a revolving credit facility and on an
interim basis has entered into an agreement with an executive officer of the
Company, which provides for borrowings up to $145 and is secured by accounts and
notes receivable. The Company is in negotiations with several external lenders
to replace the interim revolving credit facility.
In January 2002, the Company entered into a Securities Purchase Agreement with
several investors wherein the Company agreed to sell up to three million shares
of its common stock and warrants. The common stock was sold at $1.50 per share
and warrants to purchase additional shares were issued at an exercise price of
$2.75 per share. This offering closed on January 16, 2002 and $1.6 million in
proceeds were received prior to December 31, 2001. The Company sold 2,381,952
shares of common stock for a total of $3.5 million and granted 476,396 warrants
to purchase the Company's common stock at an exercise price of $2.75 per share.
The warrants expire in three years from the date of grant and have a call
feature that forces exercise if the Company's common stock exceeds $5.50 per
share.
The Company has incurred a loss of $105 million and has experienced negative
cash flows from operations for the year ended December 31, 2001. For the six
months ended June 30, 2002, the Company incurred an additional loss of $16.4 and
has a working capital deficiency of approximately $7.4 million. 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 has
entered into preliminary sales negotiations with significant customers that have
begun the "proof of concept" stage. Additionally, the Company successfully
completed a private financing round wherein it raised approximately $3.5
million, of which $1.6 million of the funds were received prior to December 31,
2001. Subsequent to June 30, 2002, the Company has completed a Series C
Convertible Redeemable Preferred Stock offering that raised approximately $1.5
million of new funds. Furthermore, management has and is continuing to review
the Company's strategic options, such as non-strategic asset sales with third
parties. The Company has completed the sale of the Star/SQL and CTRC components
of the Messaging and Application Engineering segment and is further evaluating
the assets in the Systems Integration segment. The Company does not intend to
sell Cicero. There can be no assurance that management will be successful in
executing these strategies as anticipated or in a timely manner or that
increased revenues will reduce further operating losses. If the Company is
unable to increase cash flow, obtain financing or close a sale of non-strategic
assets, it may not be able to generate enough 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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Approximately 49% of the Company's 2002 revenues were generated by sales outside
the United States. The Company is exposed to risks of foreign currency
fluctuation primarily from receivables denominated in foreign currency and is
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 are
included as a component of accumulated other comprehensive income or loss in
shareholders' equity. The Company no longer hedges foreign currency transactions
and balances.
21
Part II. Other Information
Item 1. Legal Proceedings
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 impact on
the Company.
Item 2. Changes in Securities
On June 27, 2002, the Company issued 60,901 shares of common stock to a
former executive officer of the company as part of a separation
agreement. These shares were issued 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.
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
10.1 Separation Agreement and Mutual Limited Release between
Paul Rampel and Level 8 Systems, Inc. (incorporated
by reference to exhibit 10.1 to Level 8's Form 8-K
filed June 25, 2002.)
10.2 Asset Purchase Agreement by and among Level 8 Systems,
Inc., Level 8 Technologies, Inc. and Starquest
Ventures, Inc. (incorporated by reference to exhibit
10.2 to Level 8's Form 8-K filed June 25, 2002.)
99.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
99.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
(b) Reports on Form 8-K
On June 25, 2002, Level 8 Systems filed a Form 8-K reporting the
separation of Paul Rampel, a former executive and current member of the
Board, and the sale of certain assets to an affiliate of Mr. Rampel.
On July 29, 2002, Level 8 Systems filed a Form 8-K reporting
notification of failure to maintain the minimum bid requirements of the
Nasdaq National Market.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Level 8 Systems, Inc.
.....................
Date: August 14, 2002 /s/ Anthony Pizi
...................................
Anthony Pizi
President & Chief Executive Officer
Date: August 14, 2002 /s/ John Broderick
...................................
John Broderick
Chief Financial Officer/Chief Operating Officer
23
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Level 8 Systems, Inc. (the
"Company") on Form 10-Q for the period ending June 30, 2002 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Anthony
C. Pizi, Chief Executive Officer, certify pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section
13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in
all material respects, the financial condition and results of operation of the
Company.
/s/ Anthony C. Pizi
- ----------------------------
Anthony C. Pizi
Chief Executive Officer
August 14, 2002
24
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Level 8 Systems, Inc. (the
"Company") on Form 10-Q for the period ending June 30, 2002 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, John P.
Broderick, Chief Operating and Financial Officer, certify pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operation of the
Company.
/s/ John P. Broderick
- -----------------------------
John P. Broderick
Chief Operating and Financial Officer
August 14, 2002
25