Item 1. Business
General
Level 8 Systems, Inc. (the "Company" or "Level 8") believes that it has established itself as a technology leader in the rapidly growing middleware marketplace. The Company's middleware products and services, some of which have been developed pursuant to contracts with International Business Machines Corporation ("IBM") and Microsoft Corporation ("Microsoft"), utilize messaging and object technology to solve enterprise-wide integration problems associated with linking legacy environments, the desktop and the internet. During 1996, the Company entered into agreements with Candle Corporation ("Candle"), pursuant to which Candle purchased 246,800 shares of Common Stock for $11.00 per share and acquired certain rights to technology developed by the Company and will acquire certain non-exclusive rights to the Company's products, including Falcon External Gateways (as described below). In addition, the Company, through its wholly-owned subsidiary, ProfitKey International, Inc. ("ProfitKey"), offers MRP II and shop-floor scheduling packages and related services.
The Company has experienced steady growth on a quarter-to-quarter basis in its middleware products and services operations since 1195, as the Company's focus and operating strategy have evolved from that of an industry specific ("vertical") software developer to a provider of middleware products and services. Industry sources have estimated that the messaging middleware market exceeded $100 million in 1995 and that such market is expected to grow to approximately $1.7 billion by the year 2000.
The Company, through its wholly-owned subsidiary, Level 8 Technologies, Inc. ("Level 8 Technologies"), has been designated an IBM Premier Partner for IBM MQSeries. Pursuant to contracts with IBM, Level 8 Technologies has ported version 2 of MQSeries to the DEC VMS platform and will be entitled to royalties, if any, from sales of the ported products, and has ported IBM's distributed object product, DSOM. In addition, the Company provides installation, education, integration and help-desk services in support of IBM and Level 8 Technologies sales of MQSeries licenses. Samuel Somech, co-founder of Level 8 Technologies, was the original designer of the transactional messaging product that became version 1 of MQSeries.
Microsoft has selected the Company to develop messaging gateways (called "Falcon External Gateways") to facilitate communications between computers running Microsoft's messaging product (called "Falcon") and various non-Microsoft environments. Microsoft developed Falcon as a transactional messaging system for use within Microsoft Window NT and Windows 95. Level 8 Technologies' Falcon External Gateways are being developed and are owned by Level 8 Technologies and facilitate communications of Falcon with IBM MQSeries, mainframes and UNIX-based Systems. Microsoft's Falcon and Level 8 Technologies' Falcon External Gateways are currently being Beta tested and are expected to be available for shipment in mid-1997. Microsoft has indicated an intent to promote Level 8 Technologies' Falcon External Gateways.
The Company is developing DOT/XM, a product that uses third-party transactional messaging and distributed object products in a Level 8 Technologies designed tool that facilitates integration of legacy systems into modern, open system architectures, by representing the legacy system as a collection of objects. The first large commercial installation of DOT/XM is currently taking place at ABN/AMRO bank.
The Company's expansion plan is to grow primarily on the basis of Level 8 Technologies middleware products, such as messaging gateways, DOT/XM and other software tools that permit access to legacy information from any computing environment. Other products under development by the Company, and with respect to which the Company currently is offering consulting services, are (a) a publish/subscribe product, which sends designated data ("publish") to interested users ("subscribers") using transactional messaging as the delivery mechanism and (b) an internet-application integration product, which uses portions of the DOT/XM framework to integrate commercial transactions on the internet with legacy systems of the selling corporation.
Through ProfitKey, the Company offers MRP II and shop-floor scheduling software packages, as well as related installation, training and support services. Historically, ProfitKey has directed its software packages to job shops and custom manufacturers, which use ProfitKey's software package to facilitate "just-in-time" deliveries and efficient scheduling of expensive shop-floor equipment.
The Company began operations in 1988 as a wholly-owned subsidiary of Liraz Systems Ltd. (together with its wholly-owned subsidiaries, "Liraz"), an Israeli public company that is a systems integrator. Since 1988, the Company, through its ASU consulting division ("ASU"), has provided systems integration consulting services primarily to manufacturing businesses in the State of California. In October 1994, the Company acquired ProfitKey and Bizware Computer Systems (Canada) Inc. ("Bizware"), and, in April 1995, the Company acquired Level 8 Technologies. In July 1996, the Company decided to focus on the middleware activities of Level 8 Technologies, and, in that connection, in September 1996, sold substantially all the assets of Bizware for $230,000 and subsequently changed the Company's name from Across Data Systems, Inc. to Level 8 Systems, Inc. The Company completed a public offering in December 1996, selling 705,000 shares of Common Stock at an offering price of $11.00 per share.
Level 8 Technologies Products and Services
Level 8 Technologies' Products. The Company's expansion plan is to grow primarily on the basis of middleware products developed by Level 8 Technologies, such as messaging gateways and software tools that permit access to legacy information from any computing environment. Each of the products offers the opportunity to deliver services with the products and, to the extent that the sale is made directly by the Company, Level 8 Technologies plans to offer the services. The products also will be sold through other distribution channels, such as Candle, IBM or Microsoft Business Partners, and those third-party sellers will be encouraged and trained to provide services. The products are at various stages of development, as described below. There can be no assurance the development process will not encounter delays and unforeseen problems, which could materially delay the commercial introduction of a particular product or jeopardize that entire product.
Falcon External Gateways. Microsoft has developed a transactional messaging product, Microsoft Falcon, for use with the Microsoft Windows NT and Windows 95 operating systems. Level 8 Technologies was selected by Microsoft to develop components of software that allow messages to be passed from Falcon to IBM MQSeries and directly to other systems, such as mainframes and those running the UNIX operating system (collectively, the "Falcon External Gateways"). Microsoft has agreed to recommend exclusively Level 8 Technologies' Falcon External Gateways for the first year after commercial release of the gateways. IBM has licensed to Level 8 Technologies portions of its API from IBM MQSeries for use with the Falcon External Gateways to facilitate connections between Microsoft's Falcon and IBM MQSeries. Microsoft's Falcon and Level 8 Technologies' Falcon External Gateways are in Beta site testing, and Microsoft's Falcon and Level 8 Technologies' Falcon External Gateways are expected to be available for sale in mid-1997. Level 8 Technologies' Falcon External Gateways are expected to sell for $500 to $10,000, depending on the platform. A gateway will be purchased for each of the two systems being connected.
Level 8 Technologies' Falcon External Gateway family of products is designed primarily for customers using Windows NT LANs co-existing with other hardware platforms. By the year 2000, the installed base for Windows NT has been projected by industry sources to grow to 7 to 10 million servers. The Company estimates that each of 35,000 IBM mainframes and 1.2 million UNIX systems will be connected via messaging to multiple Windows NT servers. The Company believes that Falcon Gateways will permit interfaces between such systems.
The Falcon Gateways family of products is designed to provide efficient and reliable access to IBM mainframes, numerous UNIX platforms, such as Sun Solaris, AIX, HP-UX and AT&T GIS, as well as AS/400, OS/2, Sun OS and VMS. Communication is accomplished through a reliable message queuing technology offering assured message delivery, time independent messaging and a consistent API across all platforms.
Distributed Object Transactions. DOT/XM is a Level 8 Technologies developed tool that facilitates the integration of legacy systems into modem open systems architectures by representing legacy systems as a collection of objects. It includes a software framework for the server that is a middle-tier in a three-tier computing architecture. The server responds to requests for information from a front-end client by reformatting the request for communication directly to legacy machines in their standard communication format or via a transactional messaging product, such as IBM MQSeries. This "wrapping" of the legacy machine is accomplished on the server, so that few, if any, changes to code are necessary on the legacy machine. The server utilizes IBM MQSeries as the transactional messaging vehicle within the server framework and optionally to the legacy machine. The server framework also utilizes a distributed ORB that complies with the CORBA standard, such as DSOM or ORBIX. The server has a core framework of objects that perform the same functions for all installations of the server. The framework includes functions such as systems management, communications and security. The server also has a class library of business objects from which objects will be selected to perform similar functions for different operating environments, and it will have custom business objects designed for the particular customer. DOT/XM is priced at approximately $150,000 for a single service application, with site licenses expected to be priced in the $500,000 to $1,000,000 range. Installations include extensive use of services to customize DOT/XM business objects to particular applications.
Publish/Subscribe. The publish/subscribe product uses transactional messaging products, such as MQSeries or Microsoft Falcon, as the delivery mechanism to send designated data ("publish") to interested users ("subscribers"). The alternate technique is for interested users to query the database on a regular basis to determine if information of interest has been added to the database.
Internet-Application Integration. Level 8 Technologies is developing an internet-application integration product that uses portions of the DOT/XM framework to integrate commercial transactions on the internet with applications running on the legacy systems of the selling corporation. A prototype was demonstrated at the Object Expo/Java Expo show in New York City during August 1996. The prototype was a home banking application that used JAVA apples to provide the GUI screen for a client that could be located in the home and used the internet as the communications link to a server at the bank. The server accessed information on the customer from an MVS mainframe using IBM MQSeries and portions of the DOT/XM distributed object framework. Level 8 Technologies believes its technology will be important for companies that wish to conduct commerce on the internet and need to integrate that commerce with the legacy computers that are being used in their existing businesses.
Level 8 Technologies Services. Level 8 Technologies provides systems integration services drawing on its expertise in transactional messaging and distributed objects and offers a family of services designed to meet the needs of companies installing third-party transactional messaging products. These services have been provided to over 40 major companies, including: financial institutions, such as ABN/AMRO Bank N.A., American Express, Chase Manhattan Bank, Franklin Templeton Group, John Hancock Mutual Life Insurance Company, NationsBank Corp., New York Mercantile Exchange, Trigon Blue Cross/Blue Shield and Travelers Life Insurance; transportation companies, such as CSX Technology and Transquest (Delta Airlines); manufacturing companies, such as Motorola Inc., NSK Corp. and Stanley Tool; retailers, such as K-Mart Corp., The Dillon Company, Inc. and The May Company; and government agencies, such as Fannie Mae. The following packaged transactional messaging services are being offered for IBM MQSeries and are expected to be offered for Microsoft's Falcon:
MQ/Quick Start. A fixed price service designed to get the customer started using transactional messaging. Software is installed, configured and tested for a particular application. Hands-on training is provided to customer personnel.
MQ/Educational Services. Classroom training in messaging is provided at the customer's site or at Level 8 Technologies' Boca Raton, Florida training facility. Theory is taught in addition to practical applications, including an actual application workshop.
MQ/Fast Track Functional Slice. Level 8 Technologies demonstrates the value of messaging and its business advantage by automating a chosen application based on an on-site requirements analysis. If appropriate, Level 8 Technologies will design graphical user interface screens created for the application and integrate messaging and an application into the client-server architecture.
MQ/Enterprise Rollout. Level 8 Technologies staff assist customers with application of transactional messaging for multiple applications and provides skills transfer required to deliver production strength systems.
MQ/Help Center. Level 8 Technologies offers continuous help desk support, which can be accessed by telephone or facsimile or through the internet.
ProfitKey Products and Services
ProfitKey offers manufacturing resource planning ("MRP II") and shop-floor scheduling software packages, and related installation, training and support services for use by manufacturing businesses. ProfitKey is a value added reseller of various computers, barcode equipment and several related software packages.
ProfitKey's principal product, the Rapid Response Manufacturing software package, addresses the needs of make-to-order job shop and custom manufacturers. The customers of these make-to-order manufacturers, such as large automobile companies, frequently impose on their make-to-order suppliers especially stringent delivery deadlines, which, in turn, result in unusually complex equipment scheduling and other scheduling requirements for the make-to-order manufacturer. User preferences will allow users to customize table displays according to their own needs. Liraz and ASU have provided contract development services for this project. The GUI version of RRM is scheduled for release in mid 1996. Rapid Response Manufacturing's particular strength is its shop-floor scheduler, which is especially useful for manufacturers attempting to meet the "just-in-time" delivery requirements of their customers. ProfitKey also offers a fully integr ated MRP II software package for the make-to- stock manufacturer.
The Rapid Response Manufacturing software package is comprised of a core module, plus 20 optional modules to fit the needs of the particular manufacturer. The software offers a wide range of easy-to-use tools, including: a workbench-style framework with extensive on-screen inquiry displays, flexible browse features, pop-up windows and graphs; a variety of loading and scheduling options; management query tools for custom reports and Windows-based export of data; bar code entry of labor and job tracking data; and numerous on-screen and printed reports. The package allows manufacturers to prepare estimates, enter orders, manage capacity (labor, materials, machines and work centers), schedule and track jobs, manage inventory, prepare shipping documents and prepare financial statements.
The software package is priced based on the number and types of modules ordered, the hardware platform employed and the number of users. Typical configurations on UNIX and Novell platforms sell for approximately $35,000 to $40,000; on an AS/400 platform, the package sells for approximately $70,000 to $80,000.
The purchase price of ProfitKey software includes a professional services audit, which recommends an implementation plan supported by ProfitKey consultants. A minimum 10-day implementation plan is required, but the typical audit recommends a plan of 30 to 50 days of support services. The daily rate charged is between $800 and $ 1,100, depending upon the length of the contract and the skills required.
ProfitKey is currently rewriting its software in a fourth generation language with graphical user interface. The existing version is written in RM/COBOL and runs on UNIX, AS/400 and DOS platforms and Novell networks and with ProfitKey's proprietary database or native AS/400 or oracle databases. The new product will use an object- oriented programming approach, employing GUPTA's SQL Windows, and is being designed to run on multiple hardware platforms and commercial databases. The Company believes the new software will be available in mid- 1997. However, there can be no assurance the development process will not encounter delays and unforeseen problems, which could materially delay the commercial introduction of the product or jeopardize the entire product.
ProfitKey offers an 11-hour hotline to its service department for troubleshooting at an hourly charge or as part of an annual maintenance contract. ProfitKey's average response time is two hours. ProfitKey offers its customers annual maintenance contracts at a cost ranging between 12% and 15% of the base software license fee, which entitles the customer to telephone support and new releases of the software.
ASU Consulting Services
The ASU Consulting group provides consulting services to high technology manufacturers in the San Francisco Bay area. The group also provides contract development services to ProfitKey and consulting services for Level 8.
The table below shows the Company's percentage of net revenues by category for the years indicated. The revenues for 1995 include the results of ASU, ProfitKey and Bizware for the full year, and Level 8 from its acquisition on April 1, 1995. The revenues for 1994 include ASU for the full year, ProfitKey from its acquisition on October 3, 1994 and Bizware from its acquisition on October 28, 1994. The revenues for 1993 include only the results of the Company's ASU consulting division.
Percentage of Level 8 Net Sales By Revenue Category
Consulting and Services Software Other Total 1993............... 100% 0% 0% 100% 1994............... 72 25 3 1995............... 70 22 8 1996............... 72 22 6
Markets and Marketing
The Company sells its products and services primarily in the United States, with additional sales in Canada and the United Kingdom.
The middleware marketplace is in the early stages of development. Industry sources have estimated that the messaging middleware market exceeded $100 million in 1995 and that such market is expected to grow to exceed $1.7 billion by the year 2000. The need for middleware products and services results from the move to distributed processing and from the proliferation of computer platforms. Businesses that have these disparate systems need a cost effective and reliable method to enable the disparate systems to communicate with each other. This need has grown as companies have spread geographically, have acquired new operations and have offered new services, such as electronic commerce on the internet, that require access to information located throughout the enterprise. Companies such as IBM, Digital Equipment Corporation, SUN Microsystems and Microsoft have introduced middleware products that work across multiple platforms and that provide opportunities for add-on products and services, such as those provided by Level 8 Technologies.
Level 8 Technologies markets and sells its products and services by calling directly on large financial services companies and through referrals to other companies from its association with hardware and software providers. In July 1996, the Company entered into an agreement with Candle, pursuant to which, among other things, the Company agreed to grant Candle certain distribution rights and technology licenses for Falcon External Gateways and a technology license agreement for DOT/XM. In August 1996, the Company sold Candle all the Company's rights to MQ Secure, a security product the Company developed for IBM MQSeries. In February 1996, Level 8 Technologies entered into a licensing agreement with IBM for portions of IBM MQSeries technology, which gives IBM certain rights to distribute Level 8 Technologies' Falcon External Gateways.
ProfitKey sells into a mature market that has developed specialty products for particular manufacturing segments. ProfitKey's expertise is in shop floor scheduling systems, which are most important to make-to-order manufacturers (i.e., are manufacturers who generally start to manufacture a product only after an order is received). These manufacturers tend to be small to medium in size. ProfitKey has targeted facilities with 50 to 200 employees and sells to them with a direct sales force augmented in some territories by regional agents.
Customers
In 1996, one customer accounted for approximately $1.3 million of the Company's revenue, which represented approximately 10% of the Company's revenue for the year. No customer accounted for more than 10% of the Company's revenue in 1995.
Competition
The Company competes in the application software and systems integration services markets, as well as in the developing market for transactional messaging and distributed object middleware. Such markets are highly competitive, and the Company believes competition will intensify in such markets in the future. The Company competes with developers of middleware, such as Digital Equipment Corporation, IBM, Candle and Microsoft; with providers of systems integration services, such as Andersen Consulting and Logica PLC and numerous local and regional providers of consulting and integration services; and with providers of software packages for particular markets, such as Fourth Shift Corporation and Symix Systems, Inc. The Company's competitors generally have substantially larger operations, have broader product lines with greater name recognition and market acceptance and have significantly greater financial, marketing, personnel and operating resources than the Company.
Intellectual Property
The Company does not have any patents and has not filed any patent applications. The Company relies on a combination of trade secret laws, nondisclosure and other contractual agreements and technical measures to protect its rights in its know-how and its proprietary products. The foregoing may not afford the Company sufficient protection for its know-how and products, and other parties may develop similar know-how and products, duplicate the Company's know-how and products or be granted patents that would materially and adversely affect the Company's business.
The Company believes its products and services do not infringe the rights of third parties; however, while the Company has not received notice of any infringement claims, third parties may assert such claims against the Company, and such claims could require the Company to enter into license agreements with respect to the technology in question or enter into royalty arrangements or could result in litigation, which could materially and adversely affect the Company's business. There can be no assurance the Company would acquire such licenses on terms acceptable to the Company or at all. Any failure of the Company to acquire such licenses could materially and adversely affect the Company's business and prospects.
Employees
The Company believes its employee relations are satisfactory. The employees are not represented by a labor union, and the Company has never experienced any labor problems resulting in a work stoppage. As of December 31, 1996, the Company had 118 employees.
Executive Officers of the Registrant
The names, ages and positions of the executive officers of the Company are listed below, along with their business experience during the past five years. The officers are elected annually and serve at the discretion of the Board of Directors:
Name Age Office Business Experience During The Past Five Years Arie Kilman 43 Chief Executive Officer Chief Executive Officer and Director of the Company since July 1996, President of the Company from July 1996 to October 1996, Chairman of the Board of Directors of the Company from December 1994 to July 1996. Chairman and Chief Executive Officer of Level Technologies from July 1996. Chairman of the Board and President of Liraz Systems, Ltd. since 1983.
Robert R. McDonald 52 Chairman of the Board of Chairman of the Board of Directors Directors from July 1996, President and Chief Executive Officer of the Company from October 1994 to July 1996, Director since December 1994, Treasurer of the Company from December 1994 to April 1995, Chairman of the Board and Chief Executive Officer of Bizware from October 1994 to September 1996, President and Chief Executive Officer of ProfitKey from May 1994 to July 1996 and Director of ProfitKey since November 1984, Chairman of the Board of Land and Sea, Inc. since March 1990, and Chief Executive Officer of Land and Sea, Inc. from March 1990 to December 1994. As of February 10, Robert MacDonald has served as President and General Manager of Bios Group, LP.
Joseph J. Di Zazzo 38 Controller; Chief Chief Accounting Officer, Accounting Officer; Treasurer and Secretary Treasurer and Secretary of the Company since April 1995, Controller since January 1995, Vice President, Finance of ProfitKey since January 1995, Controller of ProfitKey from May 1992 to January 1995,
self-employed in video business from June 1991 to May 1992, Controller of Workstation
Technologies from April 1987 to June 1991.
Samuel Somech 44 President and Director President of the Company since October 1996, Director of the Company since April 1995, Vice President of the Company from April 1995 to October 1996, President and Chief Operating Officer of Level Technologies since April 1995, Co-founder of Level 8 in February 1994, Technical Director, Messaging Group of Apertus
Technologies, Inc. from January 1994 to March 1994, Technical Director, Messaging Group of NYNEX from September 1990 to December 1993.
Item 2.
Item 2. Properties
The Company leases approximately 29,000 square feet of administrative space. The Company's facilities are as follows:
Ownership Square Location Function Status Feet
Salem, New Hampshire Corporate offices ProfitKey Leased 15,600
New York, New York Corporate office of Level 8 and Leased 5,125 Level 8 Technologies
Framingham, Development office for Level 8 Leased Massachusetts Technologies
Boca Raton, Florida Development office for Level 8 Leased 3,950 Technologies
Boca Raton, Florida Training facility for Level 8 Leased 1,740 Technologies
Santa Clara, California Corporate office of ASU Leased 1,750
The corporate offices of Level 8 and Level 8 Technologies in New York are covered by a lease that expires in November 2000. The lease for the ProfitKey office in Salem, New Hampshire expires in October 1999. The Level 8 Technologies development office lease in Framingham can be terminated by either party on 30 days notice. The Level 8 Technologies development office lease in Boca Raton expires in July 1999 and the training office lease in Boca Raton can be terminated by either party on 15 days notice. The lease for the ASU office in Santa Clara expires in May 1997.
Item 3.
Item 3. Legal Proceedings
From time to time the Company is involved in litigation relating to claims arising from its operations in the normal course of business. As of the date of this filing, neither the Company nor any of its subsidiaries is a party to any legal proceedings, the adverse outcome of which, in management's opinion, would have a material adverse effect on the Company's results of operations or financial position.
Item 4.
Item 4. Submission of Matters To A Vote of Security Holders
No matters were submitted to a vote to the Company's security holders during the fourth quarter of 1996.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the NASDAQ National Market System under the symbol "LEVEL". The following table sets forth the high and low last reported sale prices for the Common Stock for the periods indicated, as reported by the NASDAQ National Market.
Period High Low
1995: Third Quarter (from July 27) 10 3/8 6 1/2 Fourth Quarter 8 5 1/2 1996: First Quarter 8 1/8 5 1/2 Second Quarter 15 1/2 Third Quarter 12 1/2 8 1/8 Fourth Quarter 15 7/8 9 1/4
The Company has never declared or paid a cash dividend on its Common Stock, and it is anticipated that the Company will continue to retain its earnings for use in its business. Declaration of dividends is within the discretion of the Company's Board of Directors and will depend upon the earnings, capital requirements and financial position of the Company, general economic conditions and other pertinent factors.
As of March 11, 1997, there were 92 holders of record of the Common Stock of the Company.
Item 6.
Item 6. Selected Financial Data
For 1996, the following data includes ASU, ProfitKey and Level 8 Technologies for the full year and Bizware until its sale in September 1996. For 1995, the following data includes ASU, ProfitKey and Bizware for the full year and Level 8 Technologies since its acquisition on April 1, 1995. For 1994, the following data includes ASU, ProfitKey since its acquisition on October 3, 1994 and Bizware since its acquisition on October 28, 1994. Periods prior to 1994 include only the operations of ASU.
SELECTED STATEMENT OF OPERATIONS DATA
Year Ended December 31,
1992 1993 1994 1995
Revenue $948,505 $1,312,935 $3,596,602 $10,139,024 $13,075,338
Net income (loss) ($ 59,443) ($ 32,712)$ 563,590 $ 618,049 ($ 2,369,397)
Net income (loss) per common and common equivalent share ($ .02) ($ .01) $ .15 $ .13 ($ .39)
Weighted average common and common equivalent shares outstanding 3,839,166 3,839,166 3,839,166 4,777,758 6,076,013
SELECTED BALANCE SHEET DATA
At December 31,
1992 1993 1994 1995
Working capital (deficiency) $181,812 $290,991 ($1,679,294) $4,103,621 $11,007,583
Total assets 338,213 438,340 5,848,838 15,059,198 22,112,453
Long-term debt, net 16,253 6,771 19,053 43,975 23,297
Loans from related companies, net 273,900 418,900 2,015,165 453,847 330,706
Shareholders' equity (deficit) (52,695) (85,407) 489,729 11,498,535 18,300,153
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
General
The Company's only operations prior to the acquisitions of ProfitKey and Bizware in October 1994 and Level 8 Technologies in April 1995 were certain limited consulting services through its ASU consulting division. The following discussion reflects the activities of ProfitKey from its acquisition date of October 3, 1994, Bizware from its acquisition date of October 28, 1994 through its sale on September 9, 1996 and Level 8 Technologies from its acquisition date of April 1, 1995.
Prior to the acquisition of ProfitKey in October 1994, the Company did not have any substantial non-cash charges to earnings. Upon the acquisition of ProfitKey and the subsequent acquisitions of Bizware and Level 8 Technologies, the Company began to incur substantial non-cash charges to earnings due to amortization of goodwill associated with the acquisitions of Level 8 and Bizware, amortization of service contracts of ProfitKey and amortization of software development costs of ProfitKey and Bizware. As a consequence of the amortization of intangible assets, the Company will record amortization expense of approximately $529,000 each year through 2001, and a reduced amount each year for 13 years thereafter.
In July 1996, the Company decided to focus on the middleware activities of Level 8 Technologies. As part of that strategy, on September 9, 1996, the Company sold substantially all the assets of Bizware, for $230,000, and, in that connection, the Company recognized a loss of $1,484,061.
Results of Operations
1996 and 1995
Revenue increased from $10,139,024 in 1995 to $13,075,338 in 1996, an increase of approximately 29%. The increase was primarily due to an increase in Level 8 Technologies revenue of approximately $4,144,000 (201%). Approximately $618,000 of the increase in revenue of Level 8 Technologies was attributable to inclusion of the revenue of Level 8 Technologies for the entire year in 1996 compared to only nine months in 1995 following the acquisition of Level 8 Technologies on April 1, 1995, and approximately $3,526,000 was attributable to an increase in Level 8 Technologies revenue during the comparable nine-month period. The increase in revenue of Level 8 Technologies was offset, in part, by a decrease in revenue of Bizware of approximately $1,043,000.
Cost of revenue increased from $4,514,207 in 1995 to $7,220,106 in 1996, an increase of approximately 60%. The increase was primarily related to an increase in cost of revenue at Level 8 Technologies of approximately $2,319,000 (199%). Approximately $379,000 of the increase in cost of revenue of Level 8 Technologies was attributable to the inclusion of cost of revenue of Level 8 Technologies for the entire year of 1996 compared to only nine months of 1995 following the acquisition of Level 8 Technologies on April 1, 1995, and approximately $1,940,000 was attributable to an increase in cost of revenue of Level 8 Technologies during the comparable nine- month period. As a percentage of revenue, cost of revenue increased from approximately 45% in 1995 to approximately 55% in 1996. This increase was primarily attributable to an 84% cost of revenue for sales in 1996 of $1,485,000 of third-party software licenses.
Operating expenses for 1996 increased approximately $3,728,000 (78%) from 1995. The increase in operating expenses includes a one time charge of $1,484,000 related to the sale of substantially all the assets of Bizware. Operating expenses net of the one time charge related to the sale Bizware increased approximately $2,244,000 (47%) from 1995 to 1996. The increase was attributable primarily to Level 8 Technologies opening a new office in Boca Raton, Florida and related staffing expenses and an additional three months of operations in 1996 for Level 8 Technologies totaling approximately $1,778,000. The balance of the increase was due to increased sales and marketing expenses at ProfitKey and increased general corporate overhead. Operating expense for 1996 includes amortization of goodwill and service contracts acquired of $527,786 and $108,271, respectively, compared to $430,144 and $144,951, respectively, in 1995. As a percentage of revenue, operating expenses, including the one time charge related to the sale of Bizware, increased from 47% in 1995 to 65% in 1996. Operating expenses, net of the one time charge related to the sale of Bizware, increased from 47% in 1995 to 54% in 1996.
Other income increased from 1995 to 1996 by approximately $68,000. The increase was attributable primarily to an approximately $48,000 increase in interest earned from investment of cash remaining from the Company's initial public offering and the Candle investment and a decrease of approximately $21,000 interest expense from 1995 to 1996 related to a decrease in the Company's debt.
Income tax expense (benefit) was (6%) and 31% of income before taxes and minority interest for 1996 and 1995, respectively. The effective tax rate differed from the federal statutory tax rate (i.e., 34%) in 1996 primarily due to the nondeductibility of the loss on the sale of Bizware and the change in the non-deductible goodwill amortization.
Minority interest in income of consolidated subsidiary was eliminated starting April 3, 1995, when the Company acquired the minority interest in ProfitKey.
1995 and 1994
Revenue for 1995 increased by approximately $6,500,000 (182%) over the prior year. The increase was attributable primarily to the acquisitions of ProfitKey on October 3, 1994, Bizware on October 28, 1994 and Level 8 Technologies on April 1, 1995.
Cost of revenue for 1995 increased by approximately $2,800,000 (165%) over the prior year. The increase was attributable primarily to the acquisitions of ProfitKey, Bizware and Level 8 Technologies. As a percentage of revenue, cost of revenue decreased from 47% in 1994 to 45% in 1995. This decrease was attributable primarily to lower cost of revenue for Bizware, which resulted from a high margin contract that concluded during the second quarter of 1995.
Operating expense for 1995 increased by approximately $3,600,000 (289%) over the prior year. The increase was attributable primarily to the acquisitions of ProfitKey, Bizware and Level 8 Technologies. As a percentage of revenue, operating expense increased from 34% during 1994 to 47% during 1995. This increase was attributable to an increase in amortization of goodwill and service contracts from approximately $55,000 during 1994 to approximately $575,000 during 1995, higher operating expenses at Bizware and Level 8 Technologies, which only had an impact after their dates of acquisition, and the addition of corporate overhead starting in October 1994.
Income tax expense was 31% and 19% of income before taxes and minority interest for 1995 and 1994, respectively. The effective tax rate for 1994 differs from the federal statutory tax rate (i.e., 34%) primarily due to the effect of foreign tax rates and credits and the utilization of net operating loss carryforwards.
Liquidity and Capital Resources
In 1996, the Company funded its operations with cash remaining from its initial public offering. During 1996, the Company used approximately $1,556,000 of cash for operations, approximately $2,057,000 for capitalized software development costs and approximately $677,000 for equipment. In July 1996, Candle acquired 246,800 shares of Common Stock for $11.00 per share. The proceeds from the Candle investment and the proceeds from the Company's public offering in December 1996 (approximately $7 million) have been invested primarily in short-term, interest-bearing securities. At December 31, 1996, the Company had working capital of approximately $11,008,000 and a current ratio of 4.28.
The Company intends to accelerate its software development, expand its sales force and increase its marketing activities, and the Company may acquire software businesses and software licenses. To the extent that funds from operations are not sufficient for these purposes, the Company will fund those activities from its existing working capital resource.
The Company believes that its existing working capital and anticipated funds generated from operations will be sufficient to fund its working capital and capital expenditure requirements through June 1998.
Item 8.
Item 8. Financial Statements and Supplementary Data
The Company's Consolidated Financial Statements and the Report of Independent Public Accountants are presented in the following pages. The Consolidated Financial Statements filed in Item 8 are as follows:
Independent Auditor's Report.
Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994.
Consolidated Balance Sheets as of December 31, 1996 and 1995.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31 1996, 1995 and 1994.
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994.
Notes to Consolidated Financial Statements.
Item 9.
Item 9. Change in and Disagreements With Accountants on Accounting and Financial Disclosure
Not Applicable.
INDEPENDENT AUDITOR'S REPORT
Shareholders and Board of Directors LEVEL 8 SYSTEMS, INC. Salem, New Hampshire
We have audited the accompanying consolidated balance sheets of LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES (formally Across Data Systems, Inc.) as of December 31, 1996 and 1995, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(b)2. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
LURIE, BESIKOF, LAPIDUS & CO., LLP
Minneapolis, Minnesota January 31, 1997
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, 1996, 1995, and
1996 1995
REVENUE Consulting and service $ 9,357,493 $ 7,060,590 $ 2,574,108 Software 2,856,455 2,257,286 896,268 Other 861,390 821,148 126,226 13,075,338 10,139,024 3,596,602
COST OF REVENUE Consulting and service 4,558,098 3,571,535 1,428,400 Software 2,142,423 341,655 162,090 Other 519,585 601,017 111,927 7,220,106 4,514,207 1,702,417
GROSS MARGIN 5,855,232 5,624,817 1,894,185
OPERATING EXPENSES Selling, general and administrative 6,388,971 4,205,943 1,173,071 Amortization of goodwill and service contracts acquired 636,057 575,095 54,724 7,025,028 4,781,038 1,227,795
OPERATING INCOME (LOSS) BEFORE LOSS ON SALE OF SUBSIDIARY (1,169,796) 843,779 666,390
LOSS ON SALE OF SUBSIDIARY (1,484,061) - -
OPERATING INCOME (LOSS) (2,653,857) 843,779 666,390
OTHER INCOME (EXPENSE) Interest income 170,963 122,994 Interest expense (34,203) (54,733) (8,720) Gain on settlement of accounts payable - - 58,330 136,760 68,261 50,287
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST (2,517,097) 912,040 716,677
INCOME TAX EXPENSE (BENEFIT) (147,700) 278,700 133,200
INCOME (LOSS) BEFORE MINORITY INTEREST (2,369,397) 633,340 583,477
MINORITY INTEREST IN INCOME OF CONSOLIDATED SUBSIDIARY - 15,291 19,887 NET INCOME (LOSS) ($2,369,397) $ 618,049 $ 563,590
NET INCOME (LOSS) PER COMMON SHARE ($ .39) $ .13 $ .15
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES 6,076,013 4,777,758 3,839,166
See notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS December 31, 1996 and 1995 ASSETS 1996
CURRENT ASSETS Cash and cash equivalents $ 3,531,102 $3,147,509 Marketable securities 6,524,758 2,044,962 Accounts receivable, less allowance for doubtful accounts of $282,000 and $75,000, respectively 2,977,260 1,423,603 Income taxes receivable 591,004 - Inventory 143,874 125,334 Prepaid expenses and other assets 261,182 157,054 Deferred income taxes 331,200 268,000 TOTAL CURRENT ASSETS 14,360,380 7,166,462
PROPERTY AND EQUIPMENT 958,110 586,881 OTHER ASSETS Excess of cost over net assets of businesses acquired, net 2,215,347 3,717,393 Service contracts acquired, net 1,834,469 2,016,850 Software development costs, net 2,693,114 1,505,169 Deposits and deferred costs 51,033 40,043 Deferred income taxes - 26,400 6,793,963 7,305,855 $ 22,112,453 $ 15,059,198 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of loan from related company $ 122,000 $ 117,000 Current maturities of long-term debt 8,593 36,131 Accounts payable 1,120,070 514,249 Accrued expenses 549,172 444,841 Income taxes payable - 88,412 Customer deposits 153,816 213,221 Deferred revenue 1,399,146 1,648,987 TOTAL CURRENT LIABILITIES 3,352,797 3,062,841
OTHER LIABILITIES Loan from related company, net of current maturities 330,706 453,847 Long-term debt, net of current maturities 23,297 43,975 Deferred income taxes 105,500 - 459,503 497,822
COMMITMENTS
SHAREHOLDER'S EQUITY Preferred stock, $.01 par value (authorized - 1,000,000 shares; no shares issued and outstanding) - - Common stock, $.01 par value (authorized - 15,000,000 shares; issued and outstanding - 6,954,366 and 5,922,410, respectively) 69,543 59,224 Additional paid-in capital 19,506,914 10,371,302 Retained earnings (deficit) (1,273,175) 1,096,222 Unearned compensation (3,129) (33,323) Foreign currency translation adjustments - 5,110 18,300,153 11,498,535 $ 22,112,453 $ 15,059,198
See notes to consolidated financial statements.
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years Ended December 31, 1996, 1995 and 1994
Foreign Additional Retained Unearned Currency Common Stock Paid-in Earnings Compen- Translation Shares Amount Capital (Deficit) sation Adjustments Total
BALANCE AT DECEMBER 31, 1993 2,911,863 $ 10 $ - ($ 85,417)$ - $- ($ 85,407) Common Stock issued 97,256 16,700 - - - - 16,700 Net income - - - 563,590 - - 563,590 Foreign currency trans- lation ad- justment - - - - - (5,154) (5,154)
BALANCE AT DECEMBER 31, 1994 3,009,119 16,710 - 478,173 - (5,154) 489,729 Recapitalization - 10,179 (10,179) - - - - Common stock issued: Prior to initial public offering 394,315 3,943 521,057 - - - 525,000 Level 8 Technologies acquisition 525,159 5,252 1,570,225 - - - - 1,575,477 Conversion of loan from related company to equity 471,264 4,713 2,045,287 - - - - 2,050,000 Initial Public Offering 1,430,000 14,300 5,913,063 - - - - 5,927,363 Conversion of minority common shares of ProfitKey 91,344 913 273,119 - - - - 274,032 Stock Options 1,209 12 988 - - - - 1,000 Other 19,801 3,400 - - - - - 3,400 Common stock repurchased (19,801) (198) (3,202) - - - - (3,400) Net income - - - 618,049 - - - 618,049 Unearned compensation related to issuance of stock options - - 68,285 - (68,285) - - - Adjustment of unearned compensation - - (7,341) - 34,962 - 27,621 Foreign currency translation adjustment - - - - - 10,264 10,264
BALANCE AT DECEMBER 31, 1995 5,922,410 59,224 10,371,302 1,096,222 (33,323) 5,110 11,498,535 Common stock issued: Candle Corporation 246,800 2,468 2,607,274 - - - - 2,609,742 Public offering 705,000 7,050 6,470,147 - - - - 6,477,197 Stock options 80,156 801 58,191 - - - - 58,992 Net loss - - - (2,369,397) - - - (2,369,397) Adjustment of unearned compensation - - - - 30,194 - - 30,194 Foreign currency translation adjustment - - - - - (5,110) (5,110) - - - - - - -
BALANCE AT - - - - - - - DECEMBER 31, 1996 6,954,366 $69,543 $19,506,914 ($1,273,175) ($3,129) $- $18,300,153
See notes to consolidated financial statements.
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1996, 1995 and 1994
1996 1995
OPERATING ACTIVITIES Net income (loss) ($2,369,397) $ 618,049 $ 563,590 Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Depreciation 226,808 135,942 35,475 Amortization 1,031,413 640,646 68,918 Loss on sale of subsidiary 1,484,061 - - Tax effect of utilizing deferred tax assets reserved at date of acquisition 49,600 448,700 289,700 Deferred income taxes 19,100 (529,700) (266,700) Minority interest in consolidated subsidiary income - 15,291 19,887 Accrued interest income - (45,190) - Gain on settlement of accounts payable - - (58,300) Gain on sale of automobile - - (2,099) Expenses paid by and included in loans from related companies - - 13,486 Changes in operating assets and liabilities, exclusive of those arising from business acquisitions and sale: Accounts receivable (1,481,163) 941,612 (46,782) Income taxes receivable (592,491) - - Inventory and unbilled revenue and client costs (18,540) (61,647) 144,266 Prepaid expenses and other assets (125,350) (77,789) 15,835 Deposits and deferred costs (15,796) (19,051) 21,193 Accounts payable 660,834 (252,954) (226,528) Accrued expenses 73 (282,237) (4,134) Income taxes payable (115,605) (218,307) 173,175 Customer deposits (59,405) (77,185) (472,086) Deferred revenue (249,949) 50,757 (853) Net cash provided (used) by operating activities (1,555,807) 1,286,937 268,013
INVESTING ACTIVITIES Purchase of marketable securities (6,524,758) (1,999,772) - Redemption of marketable securities 2,044,962 - - Purchase of property and equipment (676,914) (380,686) (68,976) Software development costs (2,057,345) (836,852) (16,073) Employee advances (repayments) 21,225 (9,033) 6,401 Proceeds from sales of subsidiary 156,667 - - Payments and advances to former shareholders of acquired subsidiary - (739,678) - Payments received on advances to former shareholders of acquired subsidiary - 236,708 - Cost of acquisitions - (2,151,302) (1,190,956) Cash acquired in acquisitions - 5,669 1,439,932 Net cash provided (used) by investing activities (7,036,163) (5,874,946) 170,328
(continued) See notes to consolidated financial statements. LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued Years Ended December 31, 1996, 1995 and 1994
1996 1995
FINANCING ACTIVITIES Proceeds from issuance of common stock $10,469,800 $ 8,393,400 $ 16,700 Cost of issuance of common stock (1,382,861) (1,937,637) - Proceeds from exercise of stock options 58,992 1,000 - Repurchase of common stock - (3,400) - Repayments on loans from related companies (118,141) (907,325) - Loans from related companies - 1,513,007 195,000 Payments on long-term debt (48,216) (82,307) (34,118) Proceeds from long-term debt - 72,095 - Net cash provided by financing activities 8,979,574 7,048,833 177,582
EFFECT OF EXCHANGE RATE CHANGES ON CASH (4,011) (4,620) 17,826
NET INCREASE IN CASH AND CASH EQUIVALENTS 383,593 2,456,204 633,749
CASH AND CASH EQUIVALENTS Beginning of year 3,147,509 691,305 57,556
End of year $ 3,531,102 $ 3,147,509 $ 691,305
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest $ 34,203 $ 54,733 $ 8,720 Cash paid (received) for income taxes 183,467 375,916 (63,141)
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING AND INVESTING ACTIVITIES
The Company acquired companies as follows:
Cost of net assets acquired (Note 2) $ 3,575,477 $ 2,424,275 Additional direct costs 151,302 154,669 Common stock issued (1,575,477) - Paid directly by parent company (noncash) - (1,387,988)
Cash cost of acquisition $ 3,531,102 $ 2,151,302 $ 1,190,956
In 1995, the Company converted $2,050,000 of loans from related companies into 471,264 shares of common stock.
The Company financed the sale of a subsidiary and has a receivable of $73,333 at December 31, 1996.
See notes to consolidated financial statements.
(continued) LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the Company and Summary of Significant Accounting Policies -
The Company
Level 8 Systems, Inc. (Level 8, formerly Across Data Systems, Inc.) develops and sells proprietary vertical application software packages and provides software consulting and support services to customers located primarily in the United States and Canada. On October 3, 1994, Level 8 acquired 92% (100%-owned at April 3, 1995) of ProfitKey International, Inc. (ProfitKey). ProfitKey provides computer consulting services and sells turnkey manufacturing resource planning (MRP II) and scheduling software packages to manufacturing companies. On October 28, 1994, Level 8 also incorporated a 100%-owned Canadian subsidiary, 3077934 Canada, Inc., which in turn acquired 99% (100%-owned at June 30, 1995) of Bizware Computer Systems (Canada) Inc. (Bizware). Bizware sold software packages that provide cost information used by the petroleum and retail industries to manage and control individual retail outlets and groups of outlets. On September 9, 1996, Level 8 sold Bizware (Note 8). Effective April 1, 1995, Level 8 acquired 100% of Level 8 Technologies, Inc. (Level 8 Technologies, formerly Level 8 Systems, Inc.). Level 8 Technologies specializes in transactional messaging middleware and distributed object technology. Level 8 Technologies provides consulting services to the financial services industry and to computer hardware and software providers, and has begun to package portions of its distributed objects for sale to the financial services industry. Level 8 Technologies also sell third party software through licensing agreements.
Liraz Systems Ltd. and its wholly-owned subsidiaries own approximately 53% of Level 8's common stock at December 31, 1996.
Principals of Consolidation
The consolidated financial statements include the accounts of Level 8, its U.S. subsidiaries, ProfitKey and Level 8 Technologies, and its Canadian subsidiaries, 3077934 Canada, Inc. and Bizware (through September 9, 1996), collectively referred to as the Company. All subsidiaries financial information is included from the date of acquisition. All intercompany accounts and transactions are eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures in these financial statements. Actual results could differ from those estimates. Significant management estimates relate to the amortization periods for intangible assets, the allowance for doubtful accounts, and the valuation allowance for deferred tax assets.
Foreign Currency Translation
Assets and liabilities of Bizware were translated at the exchange rate in effect at the balance sheet date. Revenue and expenses were translated at the average exchange rate prevailing during the year. Translation adjustments arising from the use of differing exchange rates were included as foreign currency translation adjustments in shareholders' equity through the date of sale.
(continued)
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the Company and Summary of Significant Accounting Policies - (continued)
Fair Value of Financial Instruments
The carrying amounts of financial instruments consisting of cash, receivables, long-term debt, and accounts payable approximate their fair values. It is not practicable to determine the fair value of the loan from the related company due to the related party nature of the transaction.
Revenue Recognition
The Company recognizes revenue from the sale of a software and hardware system at the time of the installation of the system, provided no significant obligations remain and collection of the resulting receivable is deemed probable. Revenue from add-on hardware sales is recognized when the hardware is shipped to the customer. Revenue related to service contracts is recognized ratably over the terms of the contracts. Consulting and specialized software development revenue is recognized in accordance with the terms of the contract.
Cash Equivalents and Marketable Securities
The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Investments with original maturities in excess of three months are classified as marketable securities based on the maturity date.
Marketable securities at December 31, 1996, consisting of U.S. Government agency bonds, are considered to be "available for sale," and are reported at cost which approximates fair market value. Marketable securities at December 31, 1995, consisting of U.S. Treasury Bills, were considered by management to be "held to maturity," and therefore were reported at amortized cost which approximates market value. The U.S. Treasury Bills were redeemed at maturity resulting in no gain or loss.
The Company maintains cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe it is exposed to any significant credit risk on cash.
Inventory
Inventory is valued at the lower of cost (first-in, first-out) or market and consists of purchased computers, software and related equipment.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation is provided using primarily the straight-line method over estimated useful lives of the assets, primarily five to seven years.
(continued) LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the Company and Summary of Significant Accounting Policies - (continued)
Excess of Cost Over Net Assets Acquired
The excess of the purchase price and related costs over the fair value of the net assets of businesses acquired (goodwill) is amortized on a straight-line basis over ten and seven years for the Bizware and Level 8 Technologies acquisitions, respectively. The Company periodically assesses the recoverability of goodwill by determining whether the amortization of the balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operations. Accumulated amortization of goodwill was $738,450 and $445,306 at December 31, 1996 and 1995, respectively. In connection with the sale of Bizware, the Company wrote off goodwill totaling $999,126.
Service Contracts Acquired
Service contracts acquired in connection with the acquisition of ProfitKey are amortized over 20 years based on the past history of customer retention for service contracts and the Company's commitment to continually update its product. Upon the cancellation of any service contract acquired, a pro rata portion of the cost is expensed. Accumulated amortization was $317,944 and $185,163 at December 31, 1996 and 1995, respectively.
Software Development Costs
The Company capitalizes qualifying software development costs after having established technological feasibility and ends capitalization when the product is available for release to customers, consistent with Statement of Financial Accounting Standards No. 86. The Company amortizes such costs over a three-year period or the expected useful life of the product, whichever is shorter. Development costs which are principally attributable to enhancements and modifications of existing products, and which are expected to provide little or no future revenue, are charged to current period operations. Accumulated amortization was $362,248 and $-0- at December 31, 1996 and 1995, respectively. Amortization of in-process software development costs totaling 2,330,866 has not begun as of December 31, 1996.
Accounting for Stock-Based Compensation
The Company accounts for employee stock options under Accounting Principles Board Opinion No. 25 and provides the pro forma disclosures required by Statement of Financial Accounting Standards Board No. 123.
Net Income (Loss) Per Common Share
Primary earnings per share is determined by dividing the net income (loss) by the weighted average number of shares of common stock outstanding and dilutive common equivalent shares from stock options and warrants. Prior to the initial public offering, in accordance with Securities and Exchange Commission Regulations, common equivalent shares issued by the Company during the twelve-month period immediately preceding the Company's initial public offering were included in the calculation of shares used in computing net income (loss) per share as if they were outstanding for all periods presented, using the treasury stock method, even if the effect was anti-dilutive. (continued) LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the Company and Summary of Significant Accounting Policies - (continued)
Reclassifications
Certain reclassifications were made to the 1995 and 1994 financial statements to present them on a basis comparable with the current year. The reclassifications had no effect on previously reported net income, stockholders' equity, or net cash flows.
2. Acquisition -
Effective April 1, 1995, the Company purchased all of the stock of Level 8 Technologies, Inc. (Level 8 Technologies) for cash of $2,000,000 and 525,159 shares of common stock valued at $1,575,477 ($3.00 per share). Employees and shareholders of Level 8 Technologies also received options to purchase an aggregate of 39,164 shares at $1.37 per share and an aggregate of 116,707 shares at $5.00 per share, respectively. Additional direct costs of the acquisition totaled $132,032. Level 8 Technologies was incorporated and commenced operations on February 24, 1994. The acquisition was accounted for as a purchase and, accordingly, the 1995 consolidated statement of operations includes the results of Level 8 Technologies since the date of acquisition.
The cost was allocated as follows:
Cash $ 5,669 Accounts receivable 1,826,602 Property and equipment 53,626 Excess of cost over net assets acquired 2,828,391 Accounts payable and accrued expenses (586,811) Other liabilities, primarily deferred income taxes (552,000) Cost of net assets acquired $3,575,477
The following unaudited pro forma financial information shows the results of operations of the Company as if the Level 8 Technologies acquisition had occurred on January 1, 1995. The pro forma information is provided for information purposes only. It is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of operations of the consolidated companies.
Revenue $12,080,000 Net income $ 798,200 Net income per common share $ .17 Weighted average common and common equivalent shares 4,777,758 (continued)
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Property and Equipment -
Property and equipment consist of the following:
1996 1995 Computer equipment $ 937,583 $598,169 Furniture 211,066 88,921 Office equipment 160,726 111,910 Leasehold improvements 50,909 48,236 1,360,284 847,236 Less accumulated depreciation 402,174 260,355 $ 958,110 $ 586,881
4. Accrued Expenses -
Accrued expenses consist of the following:
1996 1995 Accrued compensation $ 132,712 $ 287,418 Accrued professional fees 138,969 83,091 Accrued costs on sale of subsidiary 143,000 - Other accrued expenses 134,491 74,332 $ 549,172 $ 444,841
5. Long-Term Debt - Long-term debt consists of various bank and finance company loans, with interest at 10.5% to 18.4% and collateralized by equipment. Future maturities of long-term debt are as follows: 1997 - $8,593; 1998 - $9,491; 1999 - $9,074; 2000 - $4,732.
6. Transactions With Related Companies - Loans from Liraz Systems Ltd. (Liraz) and Liraz Export (1990) Ltd. (significant shareholders) totaling $3,528,172 were noninterest bearing through June 30, 1995. On July 1, 1995, the Company converted $2,050,000 of these loans to equity by issuing 471,264 shares of common stock. The Company paid $250,000 on the loan in April 1995 and made an additional payment of $600,000 from the initial public offering proceeds.
The remaining balance owed to Liraz was converted to a note due in equal quarterly installments of $34,822, including interest at 4%. Interest expense on the loan for 1996 and 1995 was $21,132 and $12,319, respectively.
(continued)
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Transactions With Related Companies - (continued)
Future maturities of the loan are as follows:
Year Amount 1997 $ 122,000 1998 127,964 1999 133,177 2000 69,565 $ 452,706
In December 1995, the Company and Liraz entered into a development agreement for the joint development of certain software for a Microsoft contract obtained in July 1995. Liraz and the Company will each pay 50% of the total project development costs. In exchange for providing 50% of the project development costs, Liraz will receive royalties of 30% of the first $2,000,000 in contract revenue, 20% of the next $1,000,000, and 8% thereafter.
In addition, the Company and Liraz were awarded an Israel - U.S. Binational Industrial Research and Development Foundation ("BIRD") grant totaling $432,000. The BIRD grant will reimburse up to 50% of the development costs of the above project. Once the products are sold, BIRD will be paid a royalty of 2.5% of related sales in the first year and 5% in subsequent years until BIRD has recovered 110% to 150% (depending on the elapsed time) of its payments. The Company estimates its 50% share of the total project development costs to be $600,000 before reimbursement of its BIRD funds of $216,000. The Company is capitalizing the software development costs associated with the project and reduces the capitalized costs by any grant funds received from BIRD. As of December 31, 1996, the Company had capitalized approximately $460,000 before reimbursement of BIRD funds totaling approximately $48,300.
Liraz provided software development and management service totaling $293,463 and $60,503, respectively, in 1996. At December 31, 1996, the Company had a receivable of $35,000 from and a payable of $60,503 to Liraz.
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants -
Preferred Stock
On May 31, 1995, the Board of Directors and on June 16, 1995, the shareholders authorized the Company to issue up to 1,000,000 shares of preferred stock, $.01 par value. No shares are issued or outstanding.
Common Stock
On March 10, 1995, the Board of Directors and shareholders voted to change the no par value common stock to $.01 par value, to increase the authorized common stock from 200 shares to 8,000,000 shares, and to declare a stock split resulting in the issuance of 200,000 shares for each share outstanding at the time. On May 12, 1995, the Board of Directors authorized a 1.45593157 to 1 common stock split. Accordingly, all share information was retroactively adjusted to reflect the recapitalization and stock splits. On May 31, 1995, the Board of Directors and on June 16, 1995, the shareholders approved an increase in the authorized shares of common stock from 8,000,000 shares to 15,000,000 shares.
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Common Stock - (continued)
On April 3, 1995, minority common shares of ProfitKey totaling 1,254,725 were converted into 91,344 common shares of Level 8 at an exchange rate of 13.74 shares of ProfitKey stock for one share of Level 8 stock. The effect of the conversion increased service contracts acquired by $238,854, common stock by $913 and additional paid-in capital by $273,119, and reduced minority interest by $35,178.
On July 27, 1995, the Company completed its public offering of 1,430,000 shares (including 30,000 shares sold pursuant to the underwriter's exercise of its over-allotment option) at a price of $5.50 per share. The proceeds from the initial public offering totaled $7,865,000 before costs of $1,937,637.
On July 26, 1996, the Company sold 246,800 shares of common stock to Candle Corporation at $11.00 per share before costs of sale of $105,058.
On December 17, 1996, the Company completed a public offering of 705,000 shares (including 45,000 shares sold pursuant to the underwriter's exercise of its over-allotment option) at a price of $11.00 per share before costs of $1,277,803.
Unearned Compensation
Unearned compensation relates to stock options issued to employees and represents the difference between the fair market value of the stock at the grant date and the price to be paid by the officer or employee. The original amount of unearned compensation was $68,285. Compensation is recognized as an expense over the period the employee performs related services and totaled $30,194 and $27,621 for 1996 and 1995, respectively.
Stock Options
On February 2, 1995, the Company adopted the 1995 Stock Incentive Plan, which permits the issuance of incentive and nonstatutory stock options, stock appreciation rights, performance shares, and restricted and unrestricted stock to employees, officers, directors, consultants and advisors. The Plan reserves 900,000 shares of common stock for issuance upon the exercise of awards and provides that the term of each award be determined by the Board of Directors.
Under the terms of the Plan, the exercise price of the incentive stock options may not be less than the fair market value of the stock on the date of the award and the options are exercisable for a period not to exceed five years from date of grant. Stock appreciation rights entitle the recipients to receive the excess of the fair market value of the Company's stock on the exercise date, as determined by the Board of Directors, over the fair market value on the date of grant. Performance shares entitle recipients to acquire Company stock upon the attainment of specific performance goals set by the Board of Directors. Restricted stock entitles recipients to acquire Company stock subject to the right of the Company to repurchase the shares in the event conditions specified by the Board are not satisfied prior to the end of the restriction period. The Board may also grant unrestricted stock to participants at a cost not less than 85% of fair market value on the date of sale.
Options granted vest at varying periods up to 5 years and expire in 10 years.
(continued)
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Stock Options - (continued)
Stock option activity during the years ended December 31, 1996 and 1995, was as follows:
1996 1995 Weighted Weighted Average Average Exercise Exercise Options Price Options Price
OUTSTANDING, beginning of year 489,678 $4.23 - $-
Granted 496,620 9.74 432,459 4.70 ProfitKey options converted - - 72,742 .69 Exercised (80,156) .73 (1,209) .69 Forfeited (122,987) 9.10 (14,314) .90
OUTSTANDING, end of year 783,155 7.31 489,678 4.23
1996 1995 Weighted Weighted Average Average Options Fair Options Fair Granted Value Granted Value
Weighted Average Grant Date Fair Value:
Option price less than stock price 187,420 $6.36 275,300 $3.88 Option price equals stock price 309,200 7.15 229,901 1.80
496,620 $6.85 505,201 $2.93
Options outstanding and exercisable as of December 31, 1996, are as follows:
Options Outstanding Options Exercisable
Weighted Average
Weighted Range of Remaining Average Exercise Exercise Contractual Exercise Prices Options Price Life-Years Options Price
$.69 to $1.37 49,293 $1.17 8.2 17,030 $1.15 $5.00 to $6.60 362,862 5.57 8.4 199,543 5.72 $8.82 to 10.25 371,000 9.83 9.4 63,675 9.98 $.69 to $10.25 783,155 7.31 8.9 280,248 6.41 (continued)
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Stock Options - (continued)
If the Company recognized compensation expense based on the fair value at the grant dates for options under the Plan, consistent with the method prescribed by Statement of Financial Accounting Standards No. 123, net income (loss) and per share disclosures would change to the pro forma amounts below:
1996 1995
Net income (loss): As reported ($2,369,397) $618,049 Pro forma ( 3,524,984) 107,698
Net income (loss) per common share: As reported ( .39) .13 Pro forma ( .58) .02
The fair value of stock options used to compute pro forma net income (loss) and per share disclosures is the estimated present value at grant date using the Black-Scholes Option-Pricing model with the following weighted average assumptions:
1996 1995
Risk-free interest rate 6.44% 6.32% Expected life - years 5 5 Expected volatility 75% 68% Expected dividend 0% 0%
Stock Warrants
In connection with the renegotiation of ProfitKey's bank loan in 1992, warrants were issued to the bank to purchase 85,000 shares of ProfitKey's common stock at a price of $.50 per share. On April 3, 1995, the warrants were converted into 6,188 Level 8 stock warrants at an exchange rate of 13.74 ProfitKey stock warrants for one Level 8 stock warrant. The warrants are exercisable at $6.87 per share, have a grant date fair value of $.53 per share, and expire on March 31, 1997.
In connection with the initial and second public offerings, the Company issued 140,000 and 110,000 warrants, respectively, to the underwriter. These warrants are exercisable for four years, commencing one year from the effective dates of the public offerings of July 27, 1995 and December 17, 1996, at exercise prices of $7.425 and $14.85 per share, respectively, and have grant date fair values of $3.82 and $6.85 per share, respectively.
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants -
Preferred Stock
On May 31, 1995, the Board of Directors and on June 16,1995, the shareholders authorized the Company to issue up to 1,000,000 shares of preferred stock, $.01 par value. No shares are issued or outstanding.
Common Stock
On March 10, 1995, the Board of Directors and shareholders voted to change the no par value common stock to $.01 par value, to increase the authorized common stock from 200 shares to 8,000,000 shares, and to declare a stock split resulting in the issuance of 200,000 shares for each share outstanding at the time. On May 12, 1995, the Board of Directors authorized a 1.45593157 to 1 common stock split. Accordingly, all share information was retroactively adjusted to reflect the recapitalization and stock splits. On May 31, 1995, the Board of Directors and on June 16, 1995, the shareholders approved an increase in the authorized shares of common stock from 8,000,000 shares to 15,000,000 shares.
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Common Stock - (continued)
On April 3, 1995, minority common shares of ProfitKey totaling 1,254,725 were converted into 91,344 common shares of Level 8 at an exchange rate of 13.74 shares of ProfitKey stock for one share of Level 8 stock. The effect of the conversion increased service contracts acquired by $238,854, common stock by $913 and additional paid-in capital by $273,119, and reduced minority interest by $35,178.
On July 27, 1995, the Company completed its public offering of 1,430,000 shares (including 30,000 shares sold pursuant to the underwriter's exercise of its over-allotment option) at a price of $5.50 per share. The proceeds from the initial public offering totaled $7,865,000 before costs of $1,937,637.
On July 26, 1996, the Company sold 246,800 shares of common stock to Candle Corporation at $11.00 per share before costs of sale of $105,058.
On December 17, 1996, the Company completed a public offering of 705,000 shares (including 45,000 shares sold pursuant to the underwriter's exercise of its over-allotment option) at a price of $11.00 per share before costs of $1,277,803.
Unearned Compensation
Unearned compensation relates to stock options issued to employees and represents the difference between the fair market value of the stock at the grant date and the price to be paid by the officer or employee. The original amount of unearned compensation was $68,285. Compensation is recognized as an expense over the period the employee performs related services and totaled $30,194 and $27,621 for 1996 and 1995, respectively.
Stock Options
On February 2, 1995, the Company adopted the 1995 Stock Incentive Plan, which permits the issuance of incentive and nonstatutory stock options, stock appreciation rights, performance shares, and restricted and unrestricted stock to employees, officers, directors, consultants and advisors. The Plan reserves 900,000 shares of common stock for issuance upon the exercise of awards and provides that the term of each award be determined by the Board of Directors.
Under the terms of the Plan, the exercise price of the incentive stock options may not be less than the fair market value of the stock on the date of the award and the options are exercisable for a period not to exceed five years from date of grant. Stock appreciation rights entitle the recipients to receive the excess of the fair market value of the Company's stock on the exercise date, as determined by the Board of Directors, over the fair market value on the date of grant. Performance shares entitle recipients to acquire Company stock upon the attainment of specific performance goals set by the Board of Directors. Restricted stock entitles recipients to acquire Company stock subject to the right of the Company to repurchase the shares in the event conditions specified by the Board are not satisfied prior to the end of the restriction period. The Board may also grant unrestricted stock to participants at a cost not less than 85% of fair market value on the date of sale.
Options granted vest at varying periods up to 5 years and expire in 10 years.
(continued)
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Stock Options - (continued)
Stock option activity during the years ended December 31, 1996 and 1995, was as follows:
Weighted
Weighted Average
Average Exercise
Exercise Options Price Options Price
OUTSTANDING, beginning of year 489,678 $4.23 - $-
Granted 496,620 9.74 432,459 4.70 ProfitKey options converted - - 72,742 .69 Exercised (80,156) .73 (1,209) .69 Forfeited (122,987) 9.10 (14,314) .90
OUTSTANDING, end of year 783,155 7.31 489,678 4.23
Weighted
Weighted Average
Average Options Fair Options Fair Granted Value Granted Value
Weighted Average Grant Date Fair Value:
Option price less than stock price 187,420 $6.36 275,300 $3.88 Option price equals stock price 309,200 7.15 229,901 1.80
496,620 $6.85 505,201 $2.93
Options outstanding and exercisable as of December 31, 1996, are as follows:
Options Outstanding Options Exercisable
Weighted Average
Weighted Remaining
Average Range of Exercise Exercise Contractual
Exercise Prices Options Price Life-Years Options Price $.69 to $1.37 49,293 $1.17 8.2 17,030 $1.15 $5.00 to $6.60 362,862 5.57 8.4 199,543 5.72 $8.82 to 10.25 371,000 9.83 9.4 63,675 9.98
$.69 to $10.25 783,155 7.31 8.9 280,248 6.41 (continued)
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Stock Options - (continued)
If the Company recognized compensation expense based on the fair value at the grant dates for options under the Plan, consistent with the method prescribed by Statement of Financial Accounting Standards No. 123, net income (loss) and per share disclosures would change to the pro forma amounts below:
Net income (loss): As reported ($2,369,397) $618,049 Pro forma ( 3,524,984) 107,698
Net income (loss) per common share: As reported ( .39) .13 Pro forma ( .58) .02
The fair value of stock options used to compute pro forma net income (loss) and per share disclosures is the estimated present value at grant date using the Black-Scholes Option-Pricing model with the following weighted average assumptions:
Risk-free interest rate 6.44% 6.32% Expected life - years 5 Expected volatility 75% 68% Expected dividend rate 0% 0%
Stock Warrants
In connection with the renegotiation of ProfitKey's bank loan in 1992, warrants were issued to the bank to purchase 85,000 shares of ProfitKey's common stock at a price of $.50 per share. On April 3, 1995, the warrants were converted into 6,188 Level 8 stock warrants at an exchange rate of 13.74 ProfitKey stock warrants for one Level 8 stock warrant. The warrants are exercisable at $6.87 per share, have a grant date fair value of $.53 per share, and expire on March 31, 1997.
In connection with the initial and second public offerings, the Company issued 140,000 and 110,000 warrants, respectively, to the underwriter. These warrants are exercisable for four years, commencing one year from the effective dates of the public offerings of July 27, 1995 and December 17, 1996, at exercise prices of $7.425 and $14.85 per share, respectively, and have grant date fair values of $3.82 and $6.85 per share, respectively.
All warrants issued were exercisable and outstanding at December 31, 1996, and had a weighted average exercise price and grant date fair value of $10.60 and $5.04, respectively.
(continued)
7. Preferred Stock, Common Stock, Unearned Compensation, Stock Options, and Warrants - (continued)
Stock Warrants - (continued)
Weighted average assumptions used to price grant date fair value of warrants are primarily the same as for stock options with the following exceptions.
1996 1995
Risk-free interest rate 6.50% 5.92% Expected life-years 4 3.92 Expected volatility 76% 68%
8. Sale of Subsidiary - Bizware
On September 9, 1996, the Company sold Bizware for $230,000, resulting in a loss on the sale of the subsidiary of $1,484,601. The sales price consisted of $120,000 in cash and $110,000 due in six equal monthly installments through March 1997. In connection with the sale, the Company wrote off goodwill of $999,126, software development costs of $501,665, property and equipment of $78,877, and other costs were accrued or expended in connection with the sale totaling $134,933.
9. Income Taxes -
Income tax expense (benefit) consists of the following:
1996 1995 1994
Current: Federal ($97,800) $320,600 $ - State (17,200) 60,000 20,000 Foreign (101,400) (20,900) 90,200 (216,400) 359,700 110,200
Deferred: Federal 130,700 (141,100) 4,800 State 23,000 (24,900) 18,200 Foreign (85,000) 85,000 - 68,700 (81,000) 23,000 ($147,700) $278,700 $133,200 (continued)
9. Income Taxes - (continued)
Income tax expense (benefit) computed at the statutory federal income tax rate is as follows: 1996 1995 1994 Tax at statutory federal rate - 34% ($855,800) $310,100 $243,600 State taxes, net of federal tax benefit 300 17,900 (19,700) Effect of foreign tax rates and credits 7,500 (126,100) (40,400) Change in deferred tax asset valuation allowance - (129,000) - Net operating loss carryforward not recognized (utilized) for financial statement purposes - - (87,700) Rate differences 14,900 38,800 19,600 Nondeductible goodwill amortization 181,500 159,100 13,900 Nondeductible expenses 14,200 7,600 - Nondeductible loss on sale of foreign subsidiary 487,100 - - Other 2,600 300 3,900
Income tax expense (benefit) ($147,700) $278,700 $133,200
Significant components of net deferred tax asset (liability) are as follows: 1996 1997 Current Long-Term Current Long-Term Assets Assets Assets Assets Deferred tax assets: Allowance for uncollect- ible accounts receivable $113,000 - $ 22,600 - Accrued expenses not currently deductible for tax purposes 51,600 - 63,300 - Deferred revenue 381,400 - 451,200 - Net operating loss carryforwards 35,200 334,800 35,200 370,200 Unearned compensation - 22,000 - 11,000 581,200 356,800 572,300 381,200 Deferred tax liabilities: Depreciation and amortization - (455,800) (39,200) (98,300) Change from cash to accrual basis (6,400) (6,500) (265,100) (12,900) (6,400) (462,300) (304,300) (111,200)
Deferred tax asset valuation allowance 243,600 (243,600) - (243,600)
Net deferred tax asset (liability) $331,200) ($105,500) $268,000 $26,400 (continued)
9. Income taxes - (continued)
At December 31, 1996, the Company has approximate net operating loss carryforwards of $925,000 from the acquisition of ProfitKey, which may be applied against future taxable income. Under Internal Revenue Code Section 382, as a result of the change in controlling interest of ProfitKey, the Company's ability to utilize these acquired net operating loss carryforwards is limited to approximately $88,000 each year. The carryforwards are cumulative if not utilized each year and expire primarily in the year 2008.
10. Commitments -
Operating Leases
The Company leases facilities under operating leases expiring through November 2000. The leases provide for base monthly rents totaling approximately $35,000 plus an adjustment based on the increase in operating expenses or lessor's property taxes over the base amounts, as defined in the leases. Some leases contain renewal options.
Rent expense was approximately $464,000, $272,000, and $80,000 for 1996, 1995, and 1994, respectively.
Approximate future minimum leases payments are as follows:
Year Amount
1997 $ 412,000 1998 398,000 1999 309,000 2000 113,000 $1,232,000
Employment Agreements
The Company has employment agreements with four officers of the Company for salaries totaling $475,000 annually through May 1998, plus performance bonuses for three of the officers.
11. Significant Customers -
Information regarding revenue from significant customers is as follows: Years Ended December 31, 1996 1995 1994
Customer A 10.6% - -
Customer B - - 24.0% Customer C - - 11.8% (continued)
12. Employee Benefit Plan -
The Company adopted a 401(k) retirement plan for qualified employees. The Company has not made any contributions to the Plan.
13. Foreign Operations -
Foreign operations consist of the operations of Bizware, a Canadian subsidiary, acquired October 28, 1994 and sold September 9, 1996. All Bizware sales were to customers located in North America. Financial information as of and for the years ended December 31, 1996, 1995 and 1994, is as follows:
Years Ended December 31, 1996 1995 1994
Revenues $363,200 $1,405,900 $565,400 Operating income (loss) (350,600) 581,900 378,200 Identifiable assets - 706,600 309,000
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Certain information relating to directors and executive officers of the Company is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on May 6, 1997, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1996.
Item 11.
Item 11. Executive Compensation
Certain information relating to remuneration of directors and executive officers and other transactions involving management is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held May 6, 1997, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1996.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Certain information relating to security ownership of certain beneficial owners and management is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on May 6, 1997, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1996.
Item 13.
Item 13. Certain Relationships and Related Transactions
Certain information relating to certain relationships and related transactions is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on May 6, 1997, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1996.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)1. Financial Statements
The following consolidated financial statements are included in Item 8:
Independent Auditor's Report
Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994.
Consolidated Balance Sheets as of December 31, 1996 and 1995.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994.
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994.
Notes to Consolidated Financial Statements.
(b)1. Reports on Form-8K
On September 9, 1996 the Company filed Form 8-K to record the sale of substantially all of the assets of Bizware Computer Systems (Canada) Inc.
2. Financial Statement Schedule
The following consolidated financial statement schedule is included in Item 14 (b):
Schedule II - Valuation and Qualifying Accounts.
Schedules other than those listed above have been omitted since they are either not required or the information is otherwise included.
3. Listing of Exhibits
Exhibits
3.1 Restated Certificate of Incorporation of Registrant (filed as exhibit 3.1 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference).
3.2 By-Laws of Registrant. (filed as exhibit 3.2 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.1 1995 Stock Incentive Plan, as amended (filed as exhibit 10.1 to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.2 Stock Purchase Warrant issued by ProfitKey to Fleet Bank-NH for 85,000 shares of common stock of ProfitKey dated January 28, 1992 (filed as exhibit 10.2 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.3 Letter of agreement, dated May 14, 1993, between Fleet Bank-NH and ProfitKey (filed as exhibit 10.3 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.4 Consulting Services Agreement, dated March 17, 1994, between Norwest Technical Services, Inc. and Level 8 (filed as exhibit 10.4 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.5 Letter of Engagement, dated August 16, 1994, between Norwest Mortgage, Inc. and Level 8 (filed as exhibit 10.5 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.6 Stock Purchase Agreement, dated September 28, 1994 among Liraz, R.W. Allsop & Associates II, L.P., HLM Partners, L.P., Kitty Hawk Capital, Ltd. and the United States Small Business Administration (filed as exhibit 10.6 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.7 Amendment to Stock Purchase Agreement, dated September 29, 1994 among Liraz, R.W. Allsop & Associates II, L.P., HLM Partners, L.P., Kitty Hawk Capital, Ltd. and the United States Small Business Administration (filed as exhibit 10.7 to Registration Statement No. 33- 92230 on Form S-1 and incorporated herein by reference). Exhibits
10.8 Letter Agreement, dated February 19, 1995, between Bizware and Joel Leonoff (filed as exhibit 10.8 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.9 Software Acquisition Agreement dated February 23, 1995 among SASI, Bizware and Registrant (filed as exhibit 10.9 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.10 Service Agreement, dated March 31, 1995, between Level 8 and Transaction Information Systems, Inc. (filed as exhibit 10.10 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference).
10.11 Form of Amended and Restated Contribution Agreement, effective April 1, 1995, among Registrant and the shareholders of Level 8 (filed as exhibit 10.11 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.12 Employment Agreement, effective April 1, 1995, between Level 8 and Samuel Somech (filed as exhibit 10.11 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.12A Form of Amendment, dated June , 1995, among Level 8, Registrant and Samuel Somech (filed as exhibit 10.12A to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.13 Consulting Agreement, effective April 1, 1995, between Level 8 and Theodore Fine (filed as exhibit to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.13A Form of Amendment, dated June , 1995, among Level 8, Registrant and Theodore Fine (filed as exhibit 10.13A to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.14 Consulting Agreement, dated April 4, 1995, among Bizware and Daimin Investments Ltd. (filed as exhibit 10.14 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.15 Employment Agreement, dated May 1, 1995, between Registrant and Arie Kilman (filed as exhibit to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.15A Amendment to Employment Agreement, dated as of September 18, 1996, between Registrant and Arie Kilman (filed as exhibit 10.14A to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.15B Amendment No.2 to Employment Agreement, dated as of December 16, 1996, between Registrant and Arie Kilman (filed as exhibit 10.14B to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.16 Employment Agreement, dated May 1, 1995, between Registrant and Robert R. MacDonald (filed as exhibit 10.16 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.16A Amendment to Employment Agreement, dated as of February 21, 1996, between Registrant and Robert MacDonald (filed
Exhibits
as exhibit 10.15A to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.16B Amendment to Employment Agreement, dated as of July 30, 1996, between Registrant and Robert MacDonald (filed as exhibit 10.15B to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.17 Employment Agreement, dated May 1, 1995, between Registrant and Joseph J. Di Zazzo (filed as exhibit 10.18 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.17A Amendment to Employment Agreement, dated as of October 23, 1996, between Registrant and Joseph J. Di Zazzo (filed as exhibit 10.18A to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.18 Agreement AD/Ventures and Liraz Export Systems Ltd. (filed as exhibit 10.19 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.19 Standard Program Product License Agreement of ProfitKey (filed as exhibit 10.20 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.20 Standard Computer Hardware Purchase Agreement of ProfitKey (filed as exhibit 10.21 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.21 Standard Software License Agreement of Bizware and Standard Escrow Agreement (filed as exhibit 10.22 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.22 Agreement, dated June 13, 1995, between Registrant and Liraz (filed as exhibit 10.23 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.23 Registration Rights Agreement, dated June 13, 1995 between Registrant and Liraz (filed as exhibit 1 to Registration Statement 33-92230 on Form S-1 and incorporated herein by reference). 10.24 Agreement of Purchase and Sale, dated October 28, 1994 among Joel Leonoff, Russell Rothstein, Mitchell Wasserman, Daimin Investments Ltd., 2993031 Canada Inc., 2962594 Canada Inc., 3077934 Canada Inc. and Bizware Computer Systems (Canada) Inc. (filed as exhibit 10.25 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.25 Addendum dated February 14, 1995 among Joel Leonoff, Russell Rothstein, Mitchell Wasserman, Daimin Investments Ltd., 2993031 Canada Inc., 2962594 Canada Inc., 3077934 Canada Inc. and Bizware Computer Systems (Canada) Inc. (filed as exhibit 10.26 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.26 Form of Warrant Agreement between the Registrant and Hampshire Securities Corporation for 135,000 shares of common stock (filed as exhibit 10.27 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.27 Form of Loan Agreement, dated June , 1995, between Registrant and Liraz regarding Registrant's agreement to repay the principal amount of $1,228,172 (filed as exhibit 10.28 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.28 Form of Loan Agreement, dated 1995, between Registrant and Liraz regarding Registrant's agreement to repay the Exhibits
principal amount of $628,172 (filed as exhibit 10.29 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.29 Form of exchange agreement dated 1995, between Registrant and Liraz (filed as exhibit to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference).
10.30 Consulting Agreement dated May 15, 1995 between Registrant and Nellcor Incorporated (filed as exhibit 10.31 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.31 Stock Purchase Agreement dated September 9, 1994 by and among Liraz Systems, Ltd., Richard T. Lilly and the other individuals whose names appear on the signature page thereto (filed as exhibit 10.32 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.32 Exchange Agreement dated September , 1994 between Liraz and the individuals whose names appear on the signature page thereto (filed as exhibit 10.33 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.33 Stock Purchase Agreement dated October 17, 1994 by and among Liraz and Gary E. Frashier (filed as exhibit 10.34 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.34 Stock Purchase Agreement dated October , 1994 by and among Liraz and William Dockins (filed as exhibit 10.35 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.35 Stock Purchase Agreement dated October 24, 1994 by and among Liraz and Alfred L. Whiting (filed as exhibit 10.36 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.36 Certificate of Ownership and Merger of PK Holdings Inc. into ProfitKey International, Inc. dated March 30, 1995 (filed as exhibit 10.37 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.37 Development Agreement dated July 17, 1995 between Microsoft Corporation and Level 8 (filed as exhibit 10.38 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.38 Letter Agreement dated June 1, 1995 from Visa International Service Association to Level 8 (filed as exhibit 10.39 to Registration Statement No. 33-92230 on Form S-1 and incorporated herein by reference). 10.39 Development Agreement dated December 19, 1995 between Liraz and Level 8. 10.40 Development Agreement dated October 23, 1995 between Liraz and ProfitKey. 10.41 Product Purchase Agreement, dated August 30, 1996, between Candle Corporation and Level 8 (filed as exhibit 10.40 to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.42 Investment Agreement, dated July 26, 1996, among Registrant, Liraz and Candle Corporation (filed as exhibit 10.41 to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference).
Exhibits
10.43 Candle Corporation Software Agency Agreement, dated October 7, 1996, between Candle Corporation and Level 8 (filed as exhibit 10.42 to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 10.44 IBM Licensing Agreement: NT Client Bridge, dated February 28, 1996, by and between International Business Machines and Level 8 (filed as exhibit 10.43 to Registration Statement No. 333-15455 on Form S-1 and incorporated herein by reference). 11.0 Statement re: computation of per share income (loss). 21.1 List of Subsidiaries of Registrant (filed as exhibit 21.1 to Registration Statement No. 33- 92230 on Form S-1 and incorporated herein by reference). 23.2 Consent of Lurie, Besikof, Lapidus & Co., LLP.
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/ Arie Kilman Arie Kilman Chief Executive Officer and Director
Dated: March 13, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrants and in the capacities and on the date indicated.
Signature Title Date
s/ Arie Kilman Chief Executive Officer March 13, (Arie Kilman) and Director
s/ Robert R. MacDonald Chairman of the Board March 13, 1997 (Robert R. MacDonald)
s/ Samuel Somech President and Director March 13, 1997 (Samuel Somech)
S/ Joseph J. Di Zarro Controller, Chief March 13, 1997 (Joseph J. Di Zarro) Accounting Officer, Treasurer and Secretary
s/ Theodore Fine Director March 13, (Theodore Fine)
S/ Lenny Recanati Director March 13, (Lenny Recanati)
s/ Frank J. Klein Director March 13, (Frank J. Klein)
SCHEDULE II
LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E Additions
Charged Balance Charged to Other Deduc- at Be- to Costs Accounts- tions- Balance ginning and Ex- Describe Describe at End Description of Period penses (1) (2) of Period
Year ended December 31, Deducted from asset accounts: Allowance for doubtful accounts $ - $ 39,319 $102.286 ($85,605) $ 56,000
Year ended December 31, Deducted from asset accounts: Allowance for doubtful accounts $56,000 $ 96,613 $ - ($77,613) $ 75,000
Year ended December 31, Deducted from asset accounts: Allowance for doubtful accounts $75,000 $231,000 $ - ($26,000) $282,000
(1) Allowance for doubtful accounts acquired in connection with ProfitKey International, Inc. and Bizware Computer Systems (Canada) Inc. (2) Uncollectible accounts written off, net of recoveries.