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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001.
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
Commission File Number: 0-26392
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LEVEL 8 SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2920559
(State of incorporation) (I.R.S. Employer
Identification No.)
8000 Regency Parkway, Cary, North Carolina 27511
(Address of principal executive offices, including Zip Code)
(919) 380-5000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Aggregate market value of the outstanding voting stock held by
non-affiliates of the Registrant as of March 22, 2002 was approximately
$19,215,271. There were 19,035,017 shares of Common Stock outstanding as of
March 22, 2002.
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LEVEL 8 SYSTEMS, INC.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 2001
PART I
Item Page
Number Number
- ------ ------
1. Business............................................................................. 1
2. Properties........................................................................... 12
3. Legal Proceedings.................................................................... 12
4. Submission of Matters to a Vote of Security Holders.................................. 12
PART II
5. Market for Level 8 Common Stock and Related Shareholder Matters...................... 13
6. Selected Financial Data.............................................................. 14
7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15
7A. Quantitative and Qualitative Disclosures About Market Risk........................... 28
8. Financial Statements and Supplementary Data.......................................... 28
9. Changes in Accountants............................................................... 28
PART III
10. Directors and Executive Officers of Level 8.......................................... 29
11. Executive Compensation............................................................... 29
12. Security Ownership of Certain Beneficial Owners and Management....................... 29
13. Certain Relationships and Related Transactions....................................... 29
PART IV
14. Index Exhibits, Financial Statement Schedules, and Reports on Form 8-K............... 30
SIGNATURES.................................................................................. 35
INDEX TO FINANCIAL STATEMENTS............................................................... F-1
INDEX TO EXHIBITS........................................................................... E-1
PART I
Item 1. Business
BUSINESS
Overview
We provide a comprehensive set of integration products, including desktop
integration with our new Cicero(R)/ product and server integration and
messaging solutions with our Geneva line of products. Our flagship product
line, Cicero, is a business integration software product that maximizes
end-user productivity, streamlines business operations and integrates systems
and applications that would not otherwise work together. By using our Cicero
solution, companies can decrease their customer management costs, increase
their customer service level and more efficiently cross-sell the full range of
their products and services resulting in an overall increase in return on
information technology investments. /
The key component of the Cicero solution is visual integration at the
desktop that consolidates applications that do not inherently work together
into a cohesive, simplified work environment embodied in a single look and feel
desktop user interface. Cicero is designed to increase the productivity of
anyone requiring access to multiple applications and information sources.
Cicero provides a unique approach that allows companies to organize components
of their existing applications into processes required to complete common
tasks. Cicero streamlines all activities by providing a single, seamless user
interface for instant access to all systems associated with a task. Cicero
provides automatic information sharing among all line-of-business applications
and tools. Cicero is ideal for deployment in contact centers where its highly
productive, task-oriented user interface promotes user efficiency.
We also offer products under our Geneva brand name to provide organizations
with systems integration tools and messaging solutions. Our systems integration
products include Geneva Enterprise Integrator and Geneva Business Process
Automator. Our messaging solution is Geneva Integration Broker. Although we
plan to focus our marketing efforts principally on our Cicero solution, we will
continue to support our remaining Geneva products. Our Geneva Enterprise
Integrator and Business Process Automator products are currently being
rewritten in the Java programming language, scheduled to be completed in the
4th quarter of 2002. Until we release the new version of these products, many
potential customers may hold off purchasing our current versions. Accordingly,
in the short term, we anticipate that our Geneva line of products will generate
less revenue than in previous periods.
We were incorporated in New York in 1988, and re-incorporated in Delaware in
1999. Our principal executive offices are located at 8000 Regency Parkway,
Cary, North Carolina, 27511, and our telephone number is (919) 380-5000.
Strategic Realignment
Historically, we have been a global provider of software solutions to help
companies integrate new and existing applications as well as extend those
applications to the Internet. This market segment is commonly known as
"Enterprise Application Integration" or "EAI." Historically, EAI solutions work
directly at the server or back-office level allowing disparate applications to
communicate with each other.
Until early 2001, we focused primarily on the development, sale and support
of EAI solutions through our Geneva product suite. After extensive strategic
consultation with outside advisors and an internal analysis of our products and
services, we recognized that a new market opportunity had emerged. This
opportunity was represented by the increasing need to integrate applications
that are physically resident on different hardware platforms, a typical
situation in larger companies. In most cases, companies with large customer
bases utilize numerous different, or "disparate," applications that were not
designed to effectively communicate and pass information amongst themselves,
which leads to enterprise inefficiency. With Cicero, which integrates the
functionality of these disparate applications at the desktop, we believe that
we have found a novel solution to this disparate application problem. We
believe that our existing experience in and understanding of the EAI
marketplace coupled with the unique Cicero solution, which approaches
traditional EAI needs in a more effective manner, position us to be a
competitive provider of business integration solutions to the financial
services industry and other industries with large deployed call centers.
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We originally licensed the Cicero technology and related patents on a
worldwide, royalty-free basis from Merrill Lynch, Pierce, Fenner & Smith
Incorporated in August of 2000 under a license agreement containing standard
provisions and a two-year exclusivity period. On January 3, 2002, the license
agreement was amended to extend our exclusive worldwide marketing, sales and
development rights to Cicero in perpetuity (subject to Merrill Lynch's rights
to terminate in the event of bankruptcy or a change in control of Level 8) and
to grant ownership rights in the Cicero trademark. We are indemnified by
Merrill Lynch with regard to the rights granted to us by them. Consideration
for the original Cicero license consisted of 1,000,000 shares of our common
stock. In exchange for the amendment, we granted an additional 250,000 shares
of common stock to MLBC, Inc., a Merrill Lynch affiliate and entered into a
royalty sharing agreement. Under the royalty sharing agreement, we pay a
royalty of 3% of the sales price for each sale of Cicero or related maintenance
services. The royalties over the life of the agreement are not payable in
excess of $20,000,000.
In connection with executing our strategic realignment and focusing on
Cicero, we have restructured our business, reduced our number of employees and,
in the fourth quarter, sold assets associated with Geneva AppBuilder, Geneva
Message Queuing and Geneva XIPC. In April 2001, management reassessed the
methodology by which the Company would make operating decisions and allocate
resources. Operating decisions and performance assessments are currently based
on the following reportable segments: (1) Desktop Integration Products
(Cicero), (2) System Integration Products (Geneva Enterprise Integrator and
Geneva Business Process Automator) and (3) Messaging and Application
Engineering Products (Geneva Integration Broker, Geneva Message Queuing, Geneva
XIPC and Geneva AppBuilder). As noted above, we have sold most of the assets
comprising the Messaging and Application Engineering Products segment.
Accordingly, Geneva Integration Broker is the only current software product
represented in the Messaging and Application Engineering segment.
Market Opportunity
Desktop Integration Products--Cicero
Our initial target markets for Cicero are the customer contact centers of
large consumer oriented business, such as the financial services, insurance and
telecommunications industries. Large scale customer contact centers are
characterized by large numbers of customer service agents that process phone
calls, faxes, e-mails and other incoming customer inquiries and requests. Our
goal is to greatly increase the efficiency of customer service agents in our
target markets, thereby increasing customer retention and customer
satisfaction. This increased efficiency is attained in a non-invasive manner,
allowing companies to continue using their existing applications in a more
productive manner.
Generally, managers of customer contact centers are under pressure to
provide increased customer service at the lowest possible cost while dealing
with high employee turnover and increasing training costs. Some of the primary
challenges faced by customer contact centers include:
. Customer Service. Currently, most customer contact centers require
multiple transfers to different agents to deal with diverse customer
service issues. A one call, one contact system would enhance customer
service by avoiding these multiple transfers. Ideally, the customer
service agent could provide the call-in customer with multi-channel
customer interfaces with timely access to all information that the
customer needs. Increasing customer service and customer intimacy is one
of the primary metrics on which contact centers are evaluated by
management.
. Contact Center Staffing. The contact center industry is characterized by
increasing staff training costs and complexity, high annual turnover and
increasing costs per call. We believe these difficulties stem from
increased customer expectations, the ever-increasing complexity and
diversity of the computer applications used by customer service agents,
and the goals of decreasing training time and increasing the return on
investment in the customer service agent.
. Industry Consolidation. Many industries in our target market, including
the financial services industry, are in a constant state of
consolidation. When companies consolidate, the customer contact
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centers are generally merged to lower overall costs and to reduce
redundancies. This consolidation generally leads to re-training and the
use of multiple applications handling similar functions that can be quite
difficult to integrate successfully.
Systems Integration Products and Messaging and Application Engineering
Products--The Geneva Products
A significant challenge facing global 5000-sized organizations today is the
integration and management of critical business applications which run on
disparate or otherwise incompatible computer systems. Business and competitive
pressures are pushing companies to move towards an eBusiness model as quickly
as possible in order to remain competitive and viable in an increasingly
online, information-driven economy. eBusiness systems involve a combination of
consumer-oriented or business-to-business eCommerce, internal and external data
exchange, online customer service, customer relationship management and value
chain integration processes. Inter-operability and information exchange between
new and legacy systems within the extended enterprise are key components for a
successful eBusiness strategy, as is the ability to link those applications and
processes in extremely secure and highly reliable ways.
Enterprise application integration solutions, including the Geneva line of
products developed by Level 8, are designed to provide these capabilities
through an open, enterprise-wide infrastructure that can accomplish the
complete integration of a company's entire computing systems environment,
including technologies enabling eBusiness and eCommerce.
Our Solution
Cicero-Desktop Integration
We have been a provider of software that integrates an enterprise's
applications at the server level so that disparate applications can communicate
with each other. Based on our experience in the EAI industry, we determined
that a compelling product would be one that integrates disparate applications
at a visual level in addition to at the server level. As a result, we proceeded
to procure an exclusive license to develop and market Cicero. Cicero was
developed internally by Merrill Lynch, to increase the efficiency of 30,000
employees that have daily contact with Merrill Lynch customers. When coupled
with our existing technologies or with solutions from other EAI vendors, Cicero
becomes the comprehensive Cicero solution and provides our customers with a
front-to-back integrated system that appears as a single application to the
end-user.
Cicero is a software product that allows companies to integrate their
existing applications into a seamless integrated desktop. Cicero subordinates
and controls most Windows-based applications and provides a seamless
environment with a consistent look and feel. The end-user can navigate any
number of applications whether local, client-server, mainframe legacy or
web-browser in a consistent and intuitive way that is completely customizable
by their employer.
The Cicero solution provides the following key features:
. Integrated End-User Environment. The end-user can use all of the
applications necessary for his or her job function from a single
application with a consistent look and feel. Cicero integrates the
execution and functionality of a variety of custom or packaged
Windows-based applications. If a software product is designed to provide
output into a Windows GUI environment, Cicero can subordinate its
presentation and control it through the Cicero environment.
. Real-Time Information Center. Cicero is configurable to run a real-time
"information center" including incoming message alerts, scrolling
headlines and real-time video. Any information that is time-sensitive or
actionable can be displayed side-by-side with the currently selected
application page.
. Context Passing. Cicero carries "context" information between shared
applications through a publish and subscribe protocol. Performance
efficiency can be optimized by sharing between applications and
pre-filing commonly used information such as customer account numbers.
. Dynamic Configuration. The Cicero "shell" is constructed at run-time.
Selected screens and user interface components are dynamically created
and initialized. Existing features are easily added or removed.
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. Management Tools. Comprehensive tools are built into the system for
version management, automatic component updates and user preference
configuration. Remote control and diagnostic tools are integrated to
provide off-site help desk and troubleshooting.
Deployment of the Cicero solution can provide our customers with the
following key benefits:
. Lower Average Cost Per Call and Average Call Time. Cicero increases the
efficiency of the customer service agent by placing all productivity
applications within a few mouse clicks and consolidating all standard
applications into a single integrated desktop. Cost per call is lowered
because the customer service agent is more productive in moving between
disparate applications and is able to handle different requests without
having to transfer the customer to another customer service agent.
. Reduce Staff Cost. Cicero reduces staff cost in two ways. First, by
increasing the efficiency of each customer service agent, a contact
center can handle the same volume of customer service requests with a
smaller staff. Second, because Cicero simplifies the use of all contact
center applications, training costs and time can be reduced, placing
newly hired staff into productive positions faster than under the current
status quo.
. Increase Cross-Selling Efficiency. The consolidation of all customer
data and customer specific applications can increase the efficiency of
cross-selling of products and services. For instance, a Cicero enabled
contact center might be configured to inform the customer service agent
that the customer, while a brokerage services customer, does not use bill
paying or other offered services. On the other hand, Cicero can help
prevent customer service agents from selling a product that is
inappropriate for that customer or a product or service that the customer
already has through the company. Increasing the efficiency of
cross-selling can both increase revenues and avoid customer
dissatisfaction.
. Deliver Best in Class Customer Service. Increasing customer service is
one of the primary methods by which a company in highly competitive
customer focused industries such as financial services can differentiate
itself from its competition. By increasing the efficiency and training
level of its agents, decreasing average time per call and increasing
effective cross-selling, the Cicero enabled contact center presents its
customers with a more intimate and satisfying customer service experience
that can aid in both customer retention and as a differentiator for
customer acquisition.
. Preserve Existing Information Technology Investment. Cicero integrates
applications at the presentation level, which allows better use of
existing custom designed applications and divergent computing platforms
(e.g., midrange, client/server, LAN and Web), which are not readily
compatible with each other or with legacy mainframe systems. Linking
together the newer computing applications to existing systems helps
preserve and increase the return on the investments made by organizations
in their information technology systems.
Additionally, by visually and structurally linking the flexibility and
innovations available on newer computing platforms and applications to
the rich databases and functions that are typically maintained on the
larger mainframe computers, organizations can utilize this information in
new ways. The Cicero solution helps organizations bridge the gap between
legacy systems and newer platforms and the result is the extension of
existing capabilities to a modern streamlined interface in which the
underlying system architectures, such as the Web, mainframe, mid-range or
client-server, are transparent to the end-user customer service agent,
thereby preserving the existing information technology investment and
increasing efficiency between applications.
. Support a Broad Range of Applications, Platforms and Standards. The IT
departments of larger enterprises need solutions to integrate a broad
array of applications and platforms using a wide variety of industry
standards to ensure ease of implementation and integration with existing
applications. The Cicero solution provides visual application integration
solutions that support common industry standards and can handle a wide
array of disparate applications and data types while operating on a
Windows NT, Windows XP or Windows 2000 platform. The Cicero solution can
be used to link custom or packaged applications together regardless of
the tools or programming language used to create the application by
integrating those applications at the presentation level.
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. Ease of Implementation and Enhanced Information Technology
Productivity. The Cicero solution allows contact center and financial
services managers to create comprehensive data transformation and
information exchange solutions without the need for non-standard coding.
Our products provide pre-built adapters for a wide variety of different
systems that are pre-programmed for transforming data into the format
required by that system and transporting it using the appropriate
transport mechanism. This greatly simplifies and speeds implementation of
new solutions into the deployed Cicero framework. For instance, while in
operation at Merrill Lynch, Cicero was updated to include software for
Siebel Systems over a period of only two days when Merrill Lynch decided
to implement the Siebel Systems solution. The Cicero solution allows our
target markets to rapidly integrate new and existing applications with
little or no customization required.
The Geneva Products--Systems Integration and Messaging Solutions
Our Geneva software solutions are a line of products for integrating
enterprise applications both within the enterprise and between
business-to-business partners at the server level. Different computer systems
and applications vary widely in the ways in which they send, receive, view and
process information. As a result, diverse applications running on different
systems cannot work together because information cannot generally be exchanged
between them.
Our Geneva line of products is designed to enable the sharing of information
between disparate systems by automatically transforming the data from one
system into the formats and representations that can be used by other
application systems. This means organizations can link legacy systems to other
legacy systems, to new systems, and also to the Web. In this way, our products
can facilitate the delivery of timely enterprise-wide views of critical
business information while substantially reducing the need for complex and
costly manual programming and ongoing software program modifications.
Our software is flexible enough to link together a wide array of
applications operating on disparate systems, and can scale to meet the
challenges of growth and technological development in even the most
heterogeneous computing environments. Most significantly, our products allow
enterprises to utilize their core system functions for new uses including Web
access. This allows for the full support of eBusiness and eCommerce and closer
relationships with business-to-business partners and suppliers.
Our Geneva line of products enables rapid eBusiness implementations,
reducing installation and integration costs, including the extension of ERP
packages, and provides an open platform for integrating new or acquired
applications, systems or architectures. Furthermore, the Geneva line of
products can be used to link existing operational systems to the Internet,
transmitting communications via the Internet as well as between applications.
Our Strategy
Our short-term goal is to be the recognized global leader in providing
complete desktop level application integration to the financial services
industry. The following are the key elements of our strategy:
. Leverage Our Existing Customers and Experience in the Financial Services
Industry. We have had success in the past with our Geneva products in
the financial services industry. We intend to utilize these long-term
relationships and our understanding of the business to create
opportunities for sales of the Cicero solution.
. Build on Our Successes to Expand into New Markets. Our short-term goal
is to gain a significant presence in the financial services industry with
the Cicero solution. The financial services industry is ideal for Cicero
because each entity has a large base of installed users that use the same
general groups of applications. Cicero, however, can be used in any
industry that has large contact centers, such as telecommunications and
insurance.
. Develop Strategic Partnerships. The critical success factor for
customers implementing Customer Relationship Management (CRM) solutions
in their contact centers is to have the right balance of
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technology and service provision. We are implementing a tightly focused
strategic teaming approach with a selected group of well-known
consultancy firms that specialize in financial services as well as eCRM
integrated solutions. Leveraging these organizations, who will provide
such integration services as architecture planning, technology
integration and business workflow improvement, allows us to focus on core
application system needs and how Cicero best addresses them, while our
partners will surround the technology with appropriate industry and
business knowledge.
. Leverage our In-House Expertise in the Cicero Software. Although Cicero
was developed internally by Merrill Lynch for use by approximately 30,000
professionals worldwide, we have added members of the Merrill Lynch
development team to our Cicero development team. We recruited and hired
Anthony Pizi, First Vice President and Chief Technology Officer of
Merrill Lynch's Private Technology's Architecture and Service Quality
Group, and the Cicero project director as our Chairman, Chief Executive
Officer and Chief Technology Officer as well as several of the primary
Cicero engineers from Merrill Lynch to support our ongoing Cicero
development efforts.
Products
Desktop Integration Products--Cicero
Our flagship product, Cicero, runs on Windows NT, Windows XP, and Windows
2000 to organize applications under a book-chapter-section metaphor that keeps
all the application functionality that the user needs within easy reach. For
instance, selecting the "memo" tab might cause a Microsoft Word memo-template
to be created within the Cicero desktop. The end-user need not even know that
they are using Microsoft Word. Moreover, a customer tracking database can be
linked with customer relationship management software package. Virtually any
application that is used in a customer contact center can be integrated under
the Cicero book-chapter metaphor and be used in conjunction with other contact
center applications.
The patented Cicero technology, as exclusively licensed from Merrill Lynch,
consists of several components: The Event Manager, a Component Object Model
(COM)-based messaging service; The Context Manager, which administers the
"publish and subscribe" protocols; The Shell Script Interpreter, which supports
communication with applications that do not support the required COM
interfaces; and The Resource Manager, which starts and shuts down applications
and ensures recovery from system errors. The system is an application bus with
underlying mechanisms to handle the inter-application connections.
Functionally, if an end-user opens an application that uses customer account
number data, Cicero can display all the other customer account number related
applications on his or her desktop, so he or she can move information back and
forth between the relevant applications within the Cicero shell. The company
can change information providers and applications with minimal disruption to
the end-user's ultimate functionality.
Beneath its independent user interface, Cicero provides plug in capabilities
for other applications. All the applications can communicate with each other
through their COM interface or scripting.
Cicero allows end-users to access applications in the most efficient way
possible, by only allowing them to use the relevant portions of that
application. For instance, a contact center customer service representative
does not use 90% of the functionality of Microsoft Word, but might need access
to a memorandum and other custom designed forms as well as basic editing
functionality. Cicero can be set to control access to only those templates and,
in a sense, turn-off the unused functionality by not allowing the end-user
direct access to the underlying application. Under the same Cicero
implementation, however, a different Cicero configuration could allow the
employees in the Marketing department full access to Word because they have
need of the full functionality. The functionality of the applications that
Cicero integrates can be modulated by the business goals of the ultimate
client, the parent company. This ability to limit user access to certain
functions within applications enables companies to reduce their training burden
by limiting the portions of the applications on which they are required to
train their customer service representatives.
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Cicero is an ideal product for large customer contact centers. We believe
that Cicero, by combining ease of use, a shorter learning curve and consistent
presentation of information will allow our clients to leverage their exiting
investments in Customer Relationship Management or CRM applications and further
increase customer service, productivity, return on investment and decrease cost
both per seat and across the contact center.
System Integration Products
Our Systems Integration Products include Geneva Enterprise Integrator and
Geneva Business Process Automator.
Geneva Enterprise Integrator. Geneva Enterprise Integrator is an
integration tool that provides unified, real-time views of enterprise business
information for eBusiness applications. Real-time integration of back-end
enterprise business systems with Web-based applications is an essential
component in meeting rising customer expectations of eCommerce, Web-based
customer service and enterprise portal applications. Geneva Enterprise
Integrator also leverages a high performance, memory-based information cache to
provide an infrastructure that will support the performance demands of
Internet-style computing. Geneva Enterprise Integrator is currently being
rewritten in the Java programming language to improve its operability across
platforms and to modernize its functionality. We anticipate that the
Java-enabled version will be completed in the 4th quarter of 2002.
Geneva Business Process Automator. Geneva Business Process Automator is a
product designed for automating the many business processes that an
organization uses to run its operations. Business process automation enables
the automation of information workflows, designed by business experts, and
spanning front and back office systems. Business process automation provides
business analysts with a set of easy-to-use tools for defining, changing and
refining the exchange of information and the workflow for a domain-specific
business process. Geneva Business Process Automator is currently being
rewritten in the Java programming language to improve its operability across
platforms and to modernize its functionality. We anticipate that the
Java-enabled version will be completed in the 4th quarter of 2002.
Messaging and Application Engineering Products
Our Messaging and Application Engineering Products currently includes Geneva
Integration Broker.
Geneva Integration Broker. Geneva Integration Broker is a transport
independent message broker that enables an organization to rapidly integrate
diverse business systems regardless of platform, transport, format or protocol.
The key feature of Geneva Integration Broker is its support for XML and other
standards for open data exchange on the Internet. The product provides a robust
platform for building eBusiness applications that integrate with existing
back-office systems. Geneva Integration Broker's support for open data exchange
and secure Internet transports make it an excellent platform for building
Internet-based business-to-business solutions.
Services
We provide a full spectrum of technical support, training and consulting
services across all of our operating segments as part of our commitment to
providing our customers industry-leading business integration solutions.
Maintenance and Support
We offer customers varying levels of technical support tailored to their
needs, including periodic software upgrades, telephone support and twenty-four
hour, seven days a week access to support-related information via the Internet.
Training Services
Our training organization offers a full curriculum of courses and labs
designed to help customers become proficient in the use of our products and
related technology as well as enabling customers to take full advantage of our
field-tested best practices and methodologies.
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Consulting Services
We offer consulting services around our product offerings in project
management, applications and platform integration, application design and
development and application renewal, along with expertise in a wide variety of
development environments and programming languages. We also have an active
partner program in which we recruit leading IT consulting and system
integration firms to provide services for the design, implementation and
deployment of our customer contact center solutions. Our consulting
organization supports third party consultants by providing architectural and
enabling services.
Customers
Approximately 30,000 Merrill Lynch personnel are currently using the Cicero
technology. We licensed the Cicero technology from Merrill Lynch during 2000
and have developed it to initially sell to the financial services industry. We
have recently announced that Nationwide Financial Services has contracted to
install the Cicero technology in its Individual Annuities business unit. We
anticipate the value of this contract to be approximately $750,000.
Our existing Geneva installed customer base includes major corporations
around the world such as Amdocs Software Systems Limited, Paine Webber Inc.,
Siemens Power Transmission & Distribution, Inc., Sikorsky Aircraft Corporation,
Sunrider International, EDB 4tel AS, Wells Fargo Bank, N.A., Winstar Wireless,
Inc. and United Healthcare Services, Inc. Industries that are significantly
represented in our customer base include: financial services, insurance,
retail, manufacturing, telecommunications, transportation, and government. No
one customer accounted for more than ten percent (10%) of operating revenues in
1999. Merrill Lynch and Winstar Wireless, Inc. individually accounted for more
than ten percent (10%) of our operating revenues in 2000. Merrill Lynch holds
approximately seven percent (7%) of our outstanding shares of our common stock
and has an employee as a member of our Board of Directors. No one customer
accounted for more than ten percent (10%) of operating revenues in 2001.
Sales and Marketing
Sales
To reach our potential customer base, we are pursuing several distribution
channels, including a direct sales force, as well as third party relationships
with systems integrators and IT consulting firms.
Our direct sales force focuses on large customers and leverages our industry
experience to access target organizations within the financial services
vertical market. We believe the financial services' market is a business area
to which our products are particularly well suited and that its members possess
the financial resources and scale of operations necessary to support the
engagement.
An important element of our sales strategy is to expand our relationships
with third parties to increase market awareness and acceptance of our business
integration software solutions. As part of these relationships, we will jointly
sell and implement Cicero solutions with strategic partners such as systems
integrators. Level 8 will provide training and other support necessary to
systems integrators to aid in the promotion of our products. To date we have
signed partner agreements with Cisco Systems, Fusive Corp., Pyramid Consulting
Services, Inc., Computer Horizons Corp. and IP blue.
Our direct sales staff has substantial knowledge of our products and service
offerings as well as general experience in the software industry. If we augment
our direct sales force, we will recruit sales people with equivalent general
experience in the software industry and successful track records in selling
enterprise-class software products to the customer contact centers within
enterprise organizations.
We are organized worldwide into two major geographic divisions for sales of
our software products: the Americas and Europe. One general manager heads each
of these sales divisions. The international territories currently include the
United Kingdom, Italy and France. The General Managers' respective operations
include sales and consulting services for new and existing customers.
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Approximately $7.1 million or 31% of our 2001 revenues were generated from
the United States. Approximately $15.6 million or 69% was generated outside the
United States. The geographic distribution of our revenues may change in the
future.
Marketing
The target market for our products and services are large companies
providing financial services and or customer relationship management to a large
existing customer base. Increasing competitiveness and consolidation is driving
companies in such businesses to increase the efficiency and quality of their
customer contact centers. As a result, customer contact centers are compelled
by both economic necessity and internal mandates to find ways to increase
internal efficiency, increase customer satisfaction, increase effective
cross-selling, decrease staff turnover cost and leverage their investment in
current information technology.
Our marketing staff has an in-depth understanding of the financial services
customer contact center software marketplace and the needs of customers in that
marketplace, as well as experience in all of the key marketing disciplines. The
staff also has broad knowledge of our products and services and how they can
meet customer needs.
Core marketing functions include product marketing, marketing communications
and strategic alliances. We utilize focused marketing programs that are
intended to attract potential customers in our target vertical and to promote
Level 8 and our brands. Our programs are specifically directed at our target
market such as speaking engagements, public relations campaigns, focused trade
shows and web site marketing, while devoting substantial resources to
supporting the field sales team with high quality sales tools and collateral.
As product acceptance grows and our target markets increase, we will shift to
broader marketing programs. Public relations, which include investor and
industry analysts, are handled by the corporate marketing staff.
The marketing department also produces collateral material for distribution
to prospects including demonstrations, presentation materials, white papers,
case studies, articles, brochures and data sheets. We also intend to implement
a high level strategic partnership program to educate and support our partners
with a variety of programs, incentives and support plans.
As part of our increased focus on the Cicero product line and initially the
financial services customer contact center market, we have significantly
decreased our marketing costs while increasing our marketing focus. We intend
to continue to fine-tune our sales and marketing staff through continued
training to meet our revised needs. We have decreased the marketing and sales
budget to conserve financial resources and appropriately direct expenditures in
line with our revised business strategy.
Research and Product Development
In connection with the narrowing of our strategic focus, and in light of the
sale of our Geneva AppBuilder product line, we anticipate an overall reduction
in research and development costs. We anticipate a continued investment in
research and development costs for both our Cicero and remaining Geneva
products. Since Cicero is a new product in a relatively untapped market, it is
imperative to constantly enhance the feature sets and functionality of the
product.
Our Geneva products were developed under a proprietary language, which,
while protecting the integrity of the intellectual property, also inhibits the
sales process. As such, the Company and Amdocs Software Systems Limited
("Amdocs") have entered into a two-year agreement wherein Amdocs will partly
subsidize the migration of the Geneva Enterprise Integrator and Geneva Business
Process Automator products on the J2EE platform. Under the terms of the
agreement, Amdocs will fund approximately $6.5 million of the development
project, subject to achievement of certain milestones over a two-year period.
As of December 31, 2001, the Company had billed $3,667 of the total $6.5
million under the arrangement.
We incurred research and development expense of $7.9 million, $8.9 million
and $6.8 million in 2001, 2000 and 1999, respectively. The decrease in research
and development costs in 2001 is primarily attributable to the sale of the
AppBuilder line of business on October 1, 2001 offset by increased development
spending on Cicero. Approximately 100 employees including the AppBuilder
software development group were transferred to the new company at that time.
The increase in 2000 was the result of the addition of approximately
thirty-five developers from the acquisition of Template Software, Inc.
("Template").
9
The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. Our future success will depend to a substantial
degree upon our ability to enhance our existing products and to develop and
introduce, on a timely and cost-effective basis, new products and features that
meet changing customer requirements and emerging and evolving industry
standards.
Our budgets for research and development are based on planned product
introductions and enhancements. Actual expenditures, however, may significantly
differ from budgeted expenditures. Inherent in the product development process
are a number of risks. The development of new, technologically advanced
software products is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends.
The introduction of new or enhanced products also requires us to manage the
transition from older products in order to minimize disruption in customer
ordering patterns, as well as ensure that adequate supplies of new products can
be delivered to meet customer demand. There can be no assurance that we will
successfully develop, introduce or manage the transition to new products.
We have in the past, and may in the future, experience delays in the
introduction of our products, due to factors internal and external to our
business. Any future delays in the introduction or shipment of new or enhanced
products, the inability of such products to gain market acceptance or problems
associated with new product transitions could adversely affect our results of
operations, particularly on a quarterly basis.
Competition
The provision of custom contact center integration software includes a large
number of participants in various segments, is subject to rapid changes, and is
highly competitive. These markets are highly fragmented and served by numerous
firms, many of which address only specific contact center problems and
solutions. Clients may elect to use their internal information systems
resources to satisfy their needs, rather than using those offered by Level 8.
The rapid growth and long-term potential of the market for business
integration solutions to the contact centers of the financial services industry
make it an attractive market for new competition. Many of our current and
possible future competitors have greater name recognition, a larger installed
customer base and greater financial, technical, marketing and other resources
than we have.
Representative Competitors for Cicero
. Portal software offers the ability to aggregate information at a single
point, but not the ability to integrate transactions from a myriad of
information systems on the desktop. Plumtree is a representative company
in the Portal market.
Representative Competitors for Geneva
. In the Enterprise Application Integration market, primary competition
comes from NEON, WebMethods, Tibco, Mercator and IBM.
. In the Business Process Automation market, primary competition comes from
Vitria and IBM.
We believe that our ability to compete depends in part on a number of
competitive factors outside our control, including the ability of our
competitors to hire, retain and motivate senior project managers, the ownership
by competitors of software used by potential clients, the development by others
of software that is competitive with our products and services, the price at
which others offer comparable services and the extent of our competitors'
responsiveness to customer needs.
10
Intellectual Property
Our success is dependent upon developing, protecting and maintaining our
intellectual property assets. We rely upon combinations of copyright, trademark
and trade secrecy protections, along with contractual provisions, to protect
our intellectual property rights in software, documentation, data models,
methodologies, data processing systems and related written materials in the
international marketplace. In addition, Merrill Lynch holds a patent with
respect to the Cicero technology. Copyright protection is generally available
under United States laws and international treaties for our software and
printed materials. The effectiveness of these various types of protection can
be limited, however, by variations in laws and enforcement procedures from
country to country. We use the registered trademarks "Level 8 Systems" and
"Cicero", and the trademarks "Level 8", "Level 8 Technologies", "Geneva",
"Geneva Integration Suite", "Geneva Integration Broker", "Geneva Enterprise
Integrator", "Geneva Business Process Automator", "SNAP" and "MonitorMQ".
All other product and company names mentioned herein are for identification
purposes only and are the property of, and may be trademarks of, their
respective owners.
There can be no assurance that the steps we have taken will prevent
misappropriation of our technology, and such protections do not preclude
competitors from developing products with functionality or features similar to
our products. Furthermore, there can be no assurance that third parties will
not independently develop competing technologies that are substantially
equivalent or superior to our technologies. Additionally, with respect to the
Cicero line of products, there can be no assurance that Merrill Lynch will
protect its patents or that we will have the resources to successfully pursue
infringers.
Although we do not believe that our products infringe the proprietary rights
of any third parties, there can be no assurance that infringement claims will
not be asserted against our customers or us in the future. In addition, we may
be required to indemnify our distribution partners and end users for similar
claims made against them. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights or to
establish the validity of our proprietary rights. Litigation, either as a
plaintiff or defendant, would cause us to incur substantial costs and divert
management resources from productive tasks whether or not said litigation is
resolved in our favor, which could have a material adverse effect on our
business operating results and financial condition.
As the number of software products in the industry increases and the
functionality of these products further overlaps, we believe that software
developers and licensors may become increasingly subject to infringement
claims. Any such claims, with or without merit, could be time consuming and
expensive to defend and could adversely affect our business, operating results
and financial condition.
Employees
During the first quarter of 2001, we significantly reduced our number of
employees to decrease operating costs and streamline the organization in
connection with our newly focused strategy. As of January 31, 2002, we had a
total of 120 employees. Our continued success is dependant on our ability to
attract and retain qualified employees.
We believe that to fully implement our business plan we will be required to
enhance our ability to work with the Microsoft Windows NT, Windows XP, and
Windows 2000 operating systems by adding additional development personnel.
Although we believe that we will be successful in attracting and retaining
qualified employees to fill these positions, no assurance can be given that we
will be successful in attracting and retaining these employees now or in the
future.
Our employees are not represented by a union or a collective bargaining
agreement.
11
Forward Looking and Cautionary Statements
Certain statements contained in this Annual Report may constitute "forward
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995 ("Reform Act"). We may also make forward looking statements
in other reports filed with the Securities and Exchange Commission, in
materials delivered to shareholders, in press releases and in other public
statements. In addition, our representatives may from time to time make oral
forward-looking statements. Forward looking statements provide current
expectations of future events based on certain assumptions and include any
statement that does not directly relate to any historical or current fact.
Words such as "anticipates," "believes," "expects," "estimates," "intends,"
"plans," "projects," and similar expressions, may identify such forward looking
statements. In accordance with the Reform Act, set forth below are cautionary
statements that accompany those forward looking statements. Readers should
carefully review these cautionary statements as they identify certain important
factors that could cause actual results to differ materially from those in the
forward-looking statements and from historical trends. The following cautionary
statements are not exclusive and are in addition to other factors discussed
elsewhere in our filings with the Securities and Exchange Commission and in
materials incorporated therein by reference: there may be a question as to our
ability to operate as a going concern, our future success depends on the market
acceptance of the Cicero product and successful execution of the new strategic
direction; general economic or business conditions may be less favorable than
expected, resulting in, among other things, lower than expected revenues; an
unexpected revenue shortfall may adversely affect our business because our
expenses are largely fixed; our quarterly operating results may vary
significantly because we are not able to accurately predict the amount and
timing of individual sales and this may adversely impact our stock price;
trends in sales of our products and general economic conditions may affect
investors' expectations regarding our financial performance and may adversely
affect our stock price; our future results may depend upon the continued growth
and business use of the Internet; we may lose market share and be required to
reduce prices as a result of competition from its existing competitors, other
vendors and information systems departments of customers; we may not have the
ability to recruit, train and retain qualified personnel; rapid technological
change could render the Company's products obsolete; loss of any one of our
major customers could adversely affect our business; our business is subject to
a number of risks associated with doing business abroad including the effect of
foreign currency exchange fluctuations on our results of operations; our
products may contain undetected software errors, which could adversely affect
our business; because our technology is complex, we may be exposed to liability
claims; we may be unable to enforce or defend its ownership and use of
proprietary technology; because we are a technology company, our common stock
may be subject to erratic price fluctuations; and we may not have sufficient
liquidity and capital resources to meet changing business conditions.
Item 2. Properties
Our worldwide corporate headquarters is located in approximately 12,500
square feet in Cary, North Carolina pursuant to a lease expiring in 2004. The
United States operations groups are based in the Cary office, with field
offices under office leases in the following locations: Dulles, Virginia;
Berkeley, California and Princeton, New Jersey. The foreign operations groups
are based in Paris, France with field offices in the following locations:
Uxbridge, United Kingdom and Milan, Italy. We also maintain an office in
Limerick, Ireland on a set fee arrangement. The research and development and
customer support groups are located in Berkeley, California; Princeton, New
Jersey and Dulles, Virginia.
Item 3. Legal Proceedings
From time to time, the Company is a party to routine litigation incidental
to its business. As of the date of this Report, the Company was not engaged in
any legal proceedings that are expected, individually or in the aggregate, to
have a material adverse effect on the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None.
12
PART II
Item 5. Market For Registrant's Common Stock and Related Shareholder Matters.
Our common stock has been traded on the Nasdaq Stock Market under the symbol
"LVEL" Since 1996. We have never declared or paid any cash dividends on our
common stock. We anticipate that all of our earnings will be retained for the
operation and expansion of our business and do not anticipate paying any cash
dividends for common stock in the foreseeable future. The chart below sets
forth the high and low stock prices for the quarters of the fiscal years ended
December 31, 2000 and 2001.
2000 2001
------------- -----------
Quarter High Low High Low
------- ------ ------ ----- -----
First.. $49.13 $29.50 $6.38 $2.39
Second. $47.50 $11.25 $3.25 $2.75
Third.. $27.81 $16.00 $4.99 $1.45
Fourth. $18.50 $ 5.00 $3.10 $1.20
The closing price of the common stock on December 31, 2001 was $2.74 per
share. As of March 22, 2002, we had 177 registered shareholders of record.
Recent Sales of Unregistered Securities
On May 21, 2001, the Company issued Arik Kilman, former CEO and Chairman of
the Company, 250,000 shares of common stock as part of Mr. Kilman's severance
agreement with the Company. Such shares were issued in reliance upon the
exemption from registration under Rule 506 of Regulation D and on the exemption
from registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.
In October 2001, the Company entered into an exchange agreement with its
existing preferred shareholders. Under the terms of the agreement, the holders
of the Series A and Series B 4% convertible redeemable preferred stock and
related common stock warrants received an equal number of preferred shares of
the new Series A1 and Series B1 convertible redeemable preferred stock and
related warrants. The conversion price of both the Series A1 and Series B1
preferred stock was reduced by 16.7% and 50% respectively, which increased the
number of shares of common stock to be issued upon conversion of the preferred
shares by 1,428,512 shares to a total of 3,782,519 shares. Additionally, the
exercise price for the warrants received in the exchange was reduced to $1.77
per share and the call prices have been reduced accordingly to $5.00 per share
for the Series A1 warrants and $7.50 per share for the Series B1 warrants. At
total of 1,801,022 warrants were exchanged. The shares issued pursuant to the
exchange agreement were issued in reliance upon the exemption from registration
provided by Section 3(a)(9) of the Securities Act of 1933 for an exchange by an
issuer with its exiting security holders.
In December 2001, the Company issued 141,658 shares of common stock to a
former reseller of the company as part of a settlement agreement with that
company. Such shares were issued in reliance upon the exemption from
registration under Rule 506 of Regulation D and on the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.
At December 31, 2001, the Company had received approximately $1.6 million in
interest free bridge financing, which was convertible to common stock subject
to closing conditions. This amount has been reflected in the accompanying
consolidated balance sheet as long-term debt.
Subsequent to December 31, 2001, the Company entered into a Securities
Purchase Agreement with several investors wherein the Company agreed to sell up
to three million shares of its common stock and warrants. The common stock was
valued at $1.50 per share and warrants to purchase additional shares were
issued with an
13
exercise price of $2.75 per share. This offering closed on January 16, 2002. Of
the 3,000,000 shares, the Company sold 2,381,952 shares of common stock for a
total of $3.5 million and granted 476,396 warrants to purchase the Company's
common stock at an exercise price of $2.75 per share. The warrants expire in
three years from the date of grant and have a call feature that forces exercise
if the Company's common stock exceeds $5.50 per share. These shares were issued
in reliance upon the exemption from registration under Rule 506 of Regulation D
and on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933 for transactions by an issuer not involving a public
offering.
Subsequent to December 31, 2001, the Company entered into a purchase
agreement with MLBC, Inc., an affiliate of Merrill Lynch. Pursuant to the
Purchase Agreement, we have issued 250,000 shares of our common stock to MLBC,
Inc. These shares were issued in reliance on the exemption from registration
under Rule 506 of Regulation D and on the exemption from registration provided
by Section 4(2) of the Securities Act of 1933 for transactions by an issuer not
involving a public offering.
Item 6. Selected Financial Data.
The following selected financial data is derived from the consolidated
financial statements of the Company. The data should be read in conjunction
with the consolidated financial statements, related notes, and other financial
information included herein.
See Item 7 for a discussion of the entities included in operations.
Year Ended December 31,
(in thousands, except per share data)
-----------------------------------------------
1997 1998 1999 2000 2001
------- -------- -------- -------- ---------
SELECTED STATEMENT OF OPERATIONS DATA
Revenue......................................... $14,680 $ 10,685 $ 52,920 $ 82,591 $ 22,659
Net income (loss) from continuing operations.... $ 1,036 $(23,688) $(15,477) $(28,367) $(105,135)
Net income (loss) from continuing operations per
common and common equivalent share--basic..... $ .15 $ (3.14) $ (1.78) $ (2.10) $ (6.65)
Net income (loss) from continuing operations per
common and common share--diluted.............. $ .13 $ (3.14) $ (1.78) $ (2.10) $ (6.65)
Weighted average common and common equivalent
Shares outstanding--basic..................... 6,992 7,552 8,918 14,019 15,958
Weighted average common and common equivalent
Shares outstanding--diluted................... 7,561 7,552 8,918 14,019 15,958
At December 31,
-------------------------------------------
1997 1998 1999 2000 2001
------- -------- ------- -------- -------
SELECTED STATEMENT OF OPERATIONS DATA
Working capital (deficiency)........................... $15,826 $(19,554) $ (36) $ 28,311 $(4,968)
Total assets........................................... 23,482 70,770 133,58 169,956 35,744
Long-term debt, net of current maturities.............. 16 1,541 22,202 25,000 4,600
Loans from related companies, net of current maturities 202 12,519 4,000 -- --
Stockholders' equity................................... 20,371 8,892 72,221 117,730 13,893
14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General Information
Level 8 Systems is a global provider of business integration software that
enables organizations to integrate new and existing information and processes
at the desktop with Cicero and at the server level with the Geneva Integration
products. Business integration software addresses the emerging need for a
company's information systems to deliver enterprise-wide views of the company's
business information processes.
In addition to software products, Level 8 also provides technical support,
training and consulting services as part of its commitment to providing its
customers industry-leading integration solutions. Level 8's worldwide
consulting team has in-depth experience in developing successful
enterprise-class solutions as well as valuable insight into the business
information needs of customers in the Global 5000. Level 8 offers services
around its integration software products.
This discussion contains forward-looking statements relating to such matters
as anticipated financial performance, business prospects, technological
developments, new products, research and development activities, liquidity and
capital resources and similar matters. The Private Securities Litigation Reform
Act of 1995 provides a safe harbor for forward-looking statements. In order to
comply with the terms of the safe harbor, the Company notes that a variety of
factors could cause its actual results to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. See ''Item 1. Business--Forward Looking and
Cautionary Statements.''
The Company's results of operations include the operations of the Company
and its subsidiaries. Operations for the subsidiaries acquired during 2000 and
1999 are included from the date of acquisition. Accordingly, the 2001, 2000,
and 1999 results of operations include the operations of StarQuest Software,
Inc. ("StarQuest"), Template, Seer, and Momentum Software Corporation
("Momentum") since November 28, 2000, December 27, 1999, December 31, 1998, and
March 26, 1998, respectively. Unless otherwise indicated, all information is
presented in thousands ('000s) except share amounts.
As a result of the Company's acquisition activity, the nature of its
operations has changed significantly from 1998 to 2001. In March 1998 the
Company acquired Momentum, primarily for its XIPC messaging product. The XIPC
product has been sold on a stand-alone basis as well as incorporated into the
Company's Geneva Message Queuing product, which was internally developed. The
acquisition of Seer in December 1998 provided the Seer*HPS application
engineering technology as well as significant international operations.
Seer*HPS was subsequently renamed Geneva AppBuilder. In early 1999, the Company
introduced its first Enterprise Application Integration ("EAI") product, Geneva
Integration Broker, which was developed internally. As the Company moved more
solidly into the EAI market, it acquired Template in December 1999. The
acquisition of Template primarily provided the Company its Enterprise
Integration Template and Business Process Template and additional experienced
services professionals trained on Template's products. These products were
subsequently renamed Geneva Enterprise Integrator and Geneva Business Process
Automator. The Company disposed of certain Template consulting operations
during early 2000, which were not related to its products and determined to be
non-strategic to the Company's future.
In August 2000, the Company acquired the rights to Cicero, a
comprehensive integrated desktop computer environment from Merrill Lynch,
Pierce, Fenner & Smith Incorporated in exchange for 1,000,000 shares of its
common stock valued at $22,750. The cost of the technology acquired has been
capitalized and amortized over a three year period.
In November 2000, the Company acquired StarQuest. The total purchase price
of the acquisition was $11,638 and has been accounted for by the purchase
method of accounting. As a result of the acquisition of StarQuest, the Company
gained an additional product that would enhance its ability to provide
integration to Cisco platforms.
15
Due to the Company's acquisition and divestiture activities, year-to-year
comparisons of results of operations are not necessarily meaningful.
Additionally, as a result of the Company's pursuit of a growth strategy
focusing on its software product sales and synergies gained as a result of
eliminating duplicative functions, the results of operations are significantly
different than the result of combining the previous operations of each acquired
company into Level 8. Pro forma comparisons are therefore not necessarily
meaningful either. In 2001, the Company shifted its primary focus from selling
multiple Enterprise Application Integration ("EAI") products to selling Cicero,
a desktop integration package, to the financial services industry with a
decreased focus on services. Further, during the last two fiscal quarters of
2001, the Company sold most of the products that comprised its Messaging and
Application Engineering segment and thus will have significantly reduced
revenue streams within that segment.
Business Strategy
During the second quarter of 2001, management reassessed how the Company
would be managed and how resources would be allocated. Management now makes
operating decisions and assesses performance of the Company's operations based
on the following reportable segments: (1) Desktop Integration Products, (2)
System Integration Products and (3) Messaging and Application Engineering
Products. Previous reportable segments were: (1) software, (2) maintenance, (3)
services, and (4) research and development.
The principal product in the Desktop Integration segment is Cicero. Cicero
is a business integration software product that maximizes end-user
productivity, streamlines business operations and integrates disparate systems
and applications.
The products that make up the Systems Integration segment are Geneva
Enterprise Integrator and Geneva Business Process Automator. Geneva Enterprise
Integrator is an integration tool that provides unified, real-time views of
enterprise business information for eBusiness applications. Geneva Business
Process Automator is a product designed to work with Geneva Enterprise
Integrator for automating the many business processes that an organization uses
to run its operations and enables the automation of information workflows
spanning front and back office systems.
The products that comprise the Messaging and Application Engineering segment
are Geneva Integration Broker, Geneva Message Queuing, Geneva XIPC and Geneva
AppBuilder. Geneva Integration Broker is a transport independent message broker
that enables an organization to rapidly integrate diverse business systems
regardless of platform, transport, format or protocol. Geneva Message Queuing
is an enterprise connectivity product for Microsoft and non-Microsoft
applications. The primary use is for transactional, once and only once
connectivity of Window-based Web applications to back-office information
resources like mainframes and other legacy systems. Geneva XIPC provides
similar delivery of information between applications. While Geneva Message
Queuing is based around a Microsoft standard, Geneva XIPC is for use with Linux
and other brands of UNIX operating systems. Geneva AppBuilder is a set of
application engineering tools that assists customers in developing, adapting
and managing enterprise-wide computer applications for the Internet/intranets
and client/server networks.
On October 1, 2001, the Company completed the sale of its Geneva AppBuilder
product. Under the terms of the agreement, the Company sold the rights, title
and interest in the Geneva AppBuilder product along with all receivables,
unbilled and deferred revenues as well as all maintenance contracts. The Geneva
AppBuilder product accounted for approximately 79% of total revenue within the
Messaging and Application Engineering segment and approximately 59% of total
revenue for all segments. As more fully described in Notes 3 and 8 to the
Consolidated Financial Statements, the Company received approximately $19
million in cash plus a note receivable for $1 million due February 2002. The
Company subsequently liquidated $22 million of its short-term debt using the
proceeds received and cash on hand. As part of the sale transaction,
approximately 100 employees were transferred over to the acquiring company who
also assumed certain facility and operating leases and entered into a sublease
arrangement at the Cary, North Carolina facility. While future revenues will be
negatively impacted by the sale of Geneva AppBuilder, the associated costs of
doing business will be positively impacted by the overall reduction in
operating costs.
16
During the quarter ended September 30, 2001, the Company sold two of its
messaging products--Geneva Message Queuing and Geneva XIPC to Envoy
Technologies, Inc. for $50 in cash and a note receivable for $400. Under the
terms of the agreement, Envoy acquired all rights, title and interest to the
products along with all customer and maintenance contracts.
Results of Operations
The following table sets forth, for the years indicated, the Company's
results of continuing operations expressed as a percentage of revenue.
Year Ended December 31,
----------------------
2001 2000 1999
------ ----- -----
Revenue:
Software............................ 10.4 % 55.7 % 30.3 %
Maintenance......................... 50.0 % 19.3 % 28.3 %
Services............................ 39.6 % 25.0 % 41.4 %
------ ----- -----
Total........................... 100.0 % 100.0 % 100.0 %
Cost of revenue:
Software............................ 73.5 % 11.9 % 8.0 %
Maintenance......................... 16.4 % 6.9 % 10.2 %
Services............................ 34.5 % 22.6 % 36.4 %
------ ----- -----
Total........................... 124.4 % 41.4 % 54.6 %
Gross profit........................... (24.4)% 58.6 % 45.4 %
Operating expenses:
Sales and marketing................. 59.5 % 42.6 % 22.7 %
Research and product development.... 35.1 % 10.7 % 12.8 %
General and administrative.......... 54.9 % 15.3 % 12.9 %
Amortization intangible assets...... 45.1 % 17.2 % 13.2 %
In-process research and development. 0.0 % 2.2 % 5.6 %
Write-off of intangible assets...... 193.5 % -- --
Loss on disposal of asset........... (28.0)% 0.5 % --
Restructuring, net.................. 38.2 % -- 0.7 %
------ ----- -----
Total........................... 398.3 % 88.5 % 67.9 %
Loss from operations................ (422.7)% (29.9)% (22.5)%
Other income (expense), net......... (39.1)% (3.1)% (5.4)%
------ ----- -----
Loss before taxes................... (461.8)% (33.0)% (27.9)%
Income tax provision................ 2.2 % 1.3 % 1.4 %
------ ----- -----
Net loss............................ (464.0)% (34.3)% (29.3)%
====== ===== =====
17
The following table sets forth unaudited data for total revenue by
geographic origin as a percentage of total revenue for the periods indicated:
2001 2000 1999
---- ---- ----
United States 31% 54% 33%
Europe....... 60% 35% 56%
Asia Pacific. 3% 2% 7%
Middle East.. 4% 8% 3%
Other........ 2% 1% 1%
--- --- ---
Total..... 100% 100% 100%
=== === ===
The table below presents information about reported segments for the twelve
months ended December 31, 2001:
Desktop Systems Messaging/Application
Integration Integration Engineering TOTAL
----------------- ----------------- --------------------- -----------------
December 31, 2001 December 31, 2001 December 31, 2001 December 31, 2001
Twelve Months Twelve Months Twelve Months Twelve Months
Ended Ended Ended Ended
----------------- ----------------- --------------------- -----------------
Total revenue........... $ 134 $ 5,744 $16,781 $ 22,659
Total cost of revenue... 9,427 5,103 13,667 28,197
Gross profit/(loss)..... (9,293) 641 3,114 (5,538)
Total operating expenses 18,858 7,840 7,179 33,877
EBITA................... $(28,151) $(7,199) $(4,065) $(39,415)
A reconciliation of segment operating expenses to total operating expense
for fiscal year 2001:
2001
-------
Segment operating expenses....... $33,877
Amortization of intangible assets 10,212
Impairment of intangible assets.. 43,853
(Gain)/loss on disposal of assets (6,346)
Restructuring, net............... 8,650
-------
Total operating expenses......... $90,246
=======
The table below presents information about previously reported segments for
the fiscal years ended December 31:
2001 2000 1999
---------------- ---------------- ---------------
Total Total Total Total Total Total
Revenue EBITA Revenue EBITA Revenue EBITA
------- -------- ------- -------- ------- -------
Software................ $ 2,367 $(35,120) $45,998 $ (6,338) $16,030 $(2,549)
Maintenance............. 11,328 5,987 15,967 9,312 14,981 8,819
Services................ 8,964 (2,336) 20,626 (958) 21,909 (116)
Research and development -- (7,946) -- (10,324) -- (7,767)
------- -------- ------- -------- ------- -------
Total................... $22,659 $(39,415) $82,591 $ (8,308) $52,920 $(1,613)
======= ======== ======= ======== ======= =======
18
A reconciliation of total segment EBITA to net loss for the fiscal years
ended December 31:
2001 2000 1999
--------- -------- --------
Total EBITA............................... $ (39,415) $ (8,308) $ (1,613)
Amortization of intangible assets......... (10,212) (14,191) (6,959)
Impairment of intangible assets........... (43,853) -- --
Gain/(loss) on disposal of assets......... 6,346 (379) --
In-process research and development....... -- (1,800) (2,944)
Restructuring............................. (8,650) -- (383)
Interest and other income/(expense), net.. (8,850) (2,626) (2,858)
--------- -------- --------
Net loss before provision for income taxes $(104,634) $(27,304) $(14,757)
========= ======== ========
EBITA represents loss before income taxes, interest and other income
(expense), amortization of goodwill, restructuring charges, gain (loss) on sale
of assets and impairment charges. The Company uses EBITA to measure segment
performance and profitability. EBITA is not a measure of performance under
accounting principles generally accepted in the United States of America, and
should not be considered as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared in
accordance with accounting principles generally accepted in the United States
of America, or as a measure of profitability or liquidity. We have included
information concerning EBITA one measure of our cash flow and historical
ability to service debt and because we believe investors find this information
useful. EBITA as defined herein may not be comparable to similarly titled
measures reported by other companies.
Years Ended December 31, 2001, 2000, and 1999
Revenue and Gross Margin. The Company has three categories of revenue:
software products, maintenance, and services. Software products revenue is
comprised primarily of fees from licensing the Company's proprietary software
products. Maintenance revenue is comprised of fees for maintaining, supporting,
and providing periodic upgrades to the Company's software products. Services
revenue is comprised of fees for consulting and training services related to
the Company's software products.
The Company's revenues vary from quarter to quarter, due to market
conditions, the budgeting and purchasing cycles of customers and the
effectiveness of the Company's sales force. The Company typically does not have
any material backlog of unfilled software orders and product revenue in any
quarter is substantially dependent upon orders received in that quarter.
Because the Company's operating expenses are based on anticipated revenue
levels and are relatively fixed over the short term, variations in the timing
of the recognition of revenue can cause significant variations in operating
results from quarter to quarter. Fluctuations in operating results may result
in volatility of the price of the Company's common stock.
Total revenues decreased 73% in 2001 from 2000 and increased 56% from 1999
to 2000. The significant decrease in revenues in 2001 is the result of the
Company's new focus on its newly developed Cicero product, the redevelopment of
the Geneva Enterprise Integrator and Business Process Automator products under
the J2EE platform which has delayed sales of such products, the sale of
substantially all of its Messaging and Application Engineering products as well
as a general slowing of the economy. The increase in revenues in 2000 over 1999
is primarily attributable to the acquisitions of companies and technologies
disclosed above. Gross profit margins were (24)%, 59% and 45% for 2001, 2000,
and 1999, respectively.
Software Products. Software product revenue decreased approximately 95% in
2001 from those results achieved in 2000 and increased 187% in 2000 as compared
to 1999. The substantial decrease in 2001 is the direct result of the Company's
change in strategic focus to the Cicero product and the desktop integration
market, a general slowing of the economy and the sale of the Messaging and
Application Engineering products during the year. The increase in revenues in
fiscal 2000 from fiscal 1999 is primarily attributable to the impact of the
acquisitions discussed earlier. For the twelve months ended December 31, 2001,
the Systems Integration segment accounted for 25% of total revenues while the
Messaging and Application Engineering segment accounted for 74% of revenues.
The Company changed its approach to managing and analyzing the business in May
2001 and adopted the line of business approach. Accordingly, there is no
comparative data for the year ending December 31, 2000.
19
The gross margin on software products was (604)%, 79% and 74% for the 2001,
2000 and 1999 years ended, respectively. Cost of software is composed primarily
of amortization of software product technology, amortization of capitalized
software costs for internally developed software and royalties to third
parties, and to a lesser extent, production and distribution costs. The
increase in cost of software was primarily due to amortization of capitalized
software from the acquisition of the Cicero technology and StarQuest which was
purchased in the third and fourth quarters of 2000, respectively and the $3,070
write-down of CTRC software to its net realizable value during the third
quarter of 2001. The increase in gross margin dollars in fiscal 2000 from
fiscal 1999 is the result of significant increases in product revenue from the
Seer and Template acquisitions.
The software product gross margin for the Desktop Integration segment was
(19,602)%. The software product gross margin for the Systems Integration
segment was (210)%. The software product gross margin on the Messaging and
Application Engineering segment was (312)%. The Systems Integration and
Messaging and Application Engineering segments experienced relatively high
amounts of amortization of capitalized software.
The Company expects to see significant increases in software sales related
to the Desktop Integration segment coupled with improving margins on software
products as Cicero gains acceptance in the marketplace. The Systems Integration
segment revenue is anticipated to increase slightly from fiscal 2001 levels
with gross margin remaining relatively consistent. The Messaging and
Application Engineering segment revenue is expected to decrease significantly
along with related expenses as the majority of the products comprising this
segment have been sold.
Maintenance. Maintenance revenue for the year ended December 31, 2001
decreased by approximately 29% or $4,639 as compared to the results for the
year ended December 31, 2000. The decline in overall maintenance revenues is
primarily due to the sale of the majority of the Messaging and Application
Engineering products at the beginning of the fourth quarter of 2001 as well as
the attrition effect of maintenance customers not offset by new product sales.
The Desktop Integration segment accounted for approximately .5% of total
maintenance revenue for the year as Cicero was not launched until the late
summer. The Systems Integration segment accounted for 64.4% of total
maintenance revenues and the Messaging and Application Engineering segment
accounted for approximately 35.1% of total maintenance revenues.
Cost of maintenance is comprised of personnel costs and related overhead and
the cost of third-party contracts for the maintenance and support of the
Company's software products. Gross margins on maintenance products increased
slightly for the year ended December 31, 2001 to 67%, up from 64% in the
previous two years.
The Desktop Integration segment had a negative gross margin for the year
ended December 31, 2001 as the Cicero product is still in its infancy. The
Systems Integration segment had a gross margin of 76.7% for the year while the
Messaging and Application Engineering segment had a gross margin of 69.6% for
the year. As above, the Company adopted the line of business approach in
managing its operations in April 2001 and as such, there is no comparative data
for prior years.
Maintenance revenues are expected to increase, primarily in the Desktop
Integration segment and the System Integration segment. The majority of the
products comprising the Messaging and Application Engineering segment have been
sold and thus future revenues will be significantly lower as will the cost of
maintenance associated with this segment. The cost of maintenance should
increase slightly for the Desktop Integration segment while remaining constant
for the System Integration segment.
Services. Services revenue for the year ended December 31, 2001 decreased
by approximately 57% over the same period in 2000 and decreased by 6% in 2000
from 1999. The decline in service revenues in 2001 is primarily attributable to
the decline in software sales as well as a reduction in capacity. The decline
in service revenues in 2000 from those achieved in 1999 is attributable to a
general under utilization of service personnel in the period.
20
The Systems Integration segment accounted for approximately 33% of the total
services revenue while the Messaging and Application Engineering segment
accounted for approximately 67% of service revenue.
Cost of services primarily includes personnel and travel costs related to
the delivery of services. Services gross margins were 13%, 10% and 12% for the
years ended 2001, 2000 and 1999 respectively.
Services revenues are expected to increase for the Desktop Integration
segment as the Cicero product gains acceptance. The service revenues in the
System Integration segment are expected to remain fairly constant with improved
margins from a more efficient utilization of personnel. The Messaging and
Application Engineering segment service revenues will decrease dramatically as
the majority of the relevant products have been sold.
Sales and Marketing. Sales and marketing expenses primarily include
personnel costs for salespeople, marketing personnel, travel and related
overhead, as well as trade show participation and promotional expenses. Sales
and marketing expenses decreased by 62% or approximately $21,692 due to a
reduction in the Company's sales and marketing workforce as well as decreased
promotional activities. Sales and marketing expenses increased by 193% or
approximately $23,168 in 2000 due to increased promotional costs resulting from
the Seer and Template acquisitions.
Sales and marketing expenses are expected to continue to decrease along all
product lines, primarily due to the restructuring efforts completed in the
first and second quarters of 2001. The Company's emphasis for the sales and
marketing groups will be the Desktop Integration segment.
Research and Development. Research and development expenses primarily
include personnel costs for product authors, product developers and product
documentation and related overhead. Research and development expense decreased
by 10% in 2001 over the same period in 2000 and increased by 30% in 2000 as
compared to the same period in 1999. The decrease in costs in 2001 are the
result of the restructuring efforts completed during the first two quarters of
that year and the ability to capitalize certain development costs during the
year. The increase in costs in 2000 as compared to 1999 is the result of
increased head counts in the development staff as a result of the Template
Software acquisition.
The Company intends to continue to make a significant investment in research
and development while enhancing efficiencies in this area.
General and Administrative. General and administrative expenses consist of
personnel costs for the executive, legal, financial, human resources, IT and
administrative staff, related overhead, and all non-allocable corporate costs
of operating the Company. General and administrative expenses for the year
ended December 31, 2001 decreased by 2% over the prior year. In fiscal 2000,
general and administrative expenses increased by 86%. Although the percentage
increase in general and administrative costs for fiscal 2001 was minimal, the
expenses do include a charge of approximately $3.8 million from a significant
customer who filed for Chapter 11 Bankruptcy. The increase in general and
administrative expenses in 2000 from 1999 is the result of increased
professional fees and personnel costs primarily from the Company's acquisition
activities.
General and administrative expenses are expected to decrease going forward
primarily due to the restructuring plan implemented in the first two quarters
of 2001 as well as a reduction in costs associated with the sale of Geneva
AppBuilder, which was sold on October 1, 2001.
Amortization of Goodwill and Other Intangible Assets. Amortization of
goodwill and other intangible assets was $10.2 million, a decrease of 28% over
the same period in 2000. The reduction in amortization expense is primarily
attributable to the sale of Geneva AppBuilder on October 1, 2001 as well as the
effect of an impairment on the intangible assets acquired from Template
Software and an impairment on the intangible assets acquired from StarQuest. At
December 31, 2001, there is no remaining goodwill on the Company's balance
sheet.
21
Restructuring. In the first quarter of 2001, the Company announced and
began implementation of an operational restructuring to reduce its operating
costs and streamline its organizational structure. As a result of this
initiative, the Company recorded restructuring charges of $6,650 during the
quarter ended March 31, 2001 and an additional charge of $2,000 for the quarter
ended June 30, 2001. Restructuring charges have been classified in
"Restructuring" on the consolidated statements of operations. This operational
restructuring involves the reduction of employee staff throughout the Company
in all geographical regions in sales, marketing, services, development and all
administrative functions.
The restructuring plan included the termination of 191 employees, all of
whom had been notified by June 30, 2001 and terminated by December 31, 2001.
The plan included a reduction of 83 personnel in the European operations and
108 personnel in the US operations. Employee termination costs comprised of
severance-related payments for all employees terminated in connection with the
operational restructuring. Termination benefits do not include any amounts for
employment-related services prior to termination.
Premises obligations primarily relate to the continuation of lease
obligations, brokers commissions and leasehold improvements for approximately
60,000 square feet of facilities no longer deemed necessary and costs to exit
short-term leases for various sales offices. Amounts expensed relating to lease
obligations represent estimates of undiscounted future cash outflows, offset by
anticipated third-party sub-lease payments.
Marketing obligations related to contracts and services relating to the
prior focus of the Company and are no longer expected to be utilized.
Other miscellaneous restructuring costs include professional fees, royalty
commitments, recruiting fees, excess equipment and other miscellaneous expenses
directly attributable to the restructuring.
The following table sets forth a summary by category of accrued expenses and
cash paid as of December 31, 2001:
Expense Non-Cash Cash Paid Accrued
------- -------- --------- -------
Employee termination................... $5,319 $(1,045) $(4,231) $ 43
Excess office facilities............... 2,110 (156) (1,307) 647
Marketing obligations.................. 288 -- (235) 53
Royalty commitments.................... 725 (360) (365) --
Other miscellaneous restructuring costs 208 -- (98) 110
------ ------- ------- ----
Total.................................. $8,650 $(1,561) $(6,236) $853
====== ======= ======= ====
The Company believes the accrued restructuring costs of $853 of December 31,
2001 represents its remaining cash obligations for the restructuring charges
indicated above.
During the fourth quarter of 1999, the Company reorganized its existing
operations due to its acquisition of Template. The Company's restructuring
included a management change in its development and operations areas, the
abandonment of certain leased facilities, and closure of its French subsidiary.
The Company recorded a restructuring charge of $.55 million, which consisted of
approximately $.28 million in costs associated with improving leased space to
be subleased, approximately $.23 million in personnel-related charges, and
approximately $.04 million in legal and accounting fees to close its French
subsidiary.
Impairment of Intangible Assets. In May 2001, management reevaluated and
modified its approach to managing the business and opted to conduct business
and assess the performance of operations under a line-of-business approach. As
such, the Company performed an assessment of the recoverability of its
long-lived assets under a line-of-business approach, representing a change in
accounting principle inseparate from the effect of the change in accounting
estimates. This represents an accounting change from the Company's previous
policy of assessing impairment of intangible assets at the enterprise level
which is accounted for as a change in estimate.
22
The change is reflects management's changed approach to managing the business.
The results of an analysis of undiscounted cash flows for each reporting
segment indicated that an impairment had occurred in the Systems Integraton
segment (i.e. intangible assets acquired in the Template acquisition). The
Company then estimated the fair market value of the related assets through a
discounted future cash flow valuation technique. The results of this analysis
indicated that the carrying values of these assets exceeded their fair market
values. The Company reduced the carrying value of these intangible assets by
approximately $21,824 as of March 31, 2001 which approximates a net income
affect of $1.37 per share.
During the third quarter of 2001, the Company was notified by one of its
resellers that they would no longer engage in re-sales of the Company's CTRC
product, a component of the Messaging and Application Engineering segment. This
reseller accounted for substantially all of the CTRC product sales. As a
result, the Company performed an assessment of the recoverability of the
Messaging and Application Engineering segment. The results of the Company's
analysis of undiscounted cash flows indicated an impairment. The Company
estimated the fair market value of the related assets through a discounted
future cash flow valuation technique. The results of this analysis indicated
the carrying value of these intangible assets exceeded their fair market
values. The Company has reduced the carrying value of the intangible assets and
software product technology by approximately $7,929 and 3,070, respectively, as
of September 30, 2001.
At December 31, 2001, the Company reassessed the recoverability of its
long-lived assets. Using actual undiscounted cash flows where applicable and
adjusting projections to reflect updated market conditions and industry trends,
the Company identified that a further impairment had occurred with regards to
the intangible assets recorded in the Systems Integration segment. Using a
discounted future cash flow technique, it was determined that the carrying
value of these assets exceeded their fair market value by approximately
$14,100. Accordingly, the Company reduced the carrying value of those
intangible assets by that amount at December 31, 2001.
Provision for Taxes. The Company's effective income tax rate for continuing
operations differs from the statutory rate primarily because an income tax
benefit was not recorded for the net loss incurred in 2001 or 2000. Because of
the Company's inconsistent earnings history, the deferred tax assets have been
fully offset by a valuation allowance. The income tax provision for the year
ended December 31, 2001 is primarily related to income taxes from profitable
foreign operations and foreign withholding taxes.
EBITA. EBITA represents loss before income taxes, interest and other income
(expense), amortization of goodwill, restructuring charges, gain (loss) on sale
of assets, and impairment charges. EBITA for the twelve months ended December
31, 2001 was ($39.4) million as compared to ($8.3) million for the same period
of the previous year. The increase in the loss before income taxes, interest
and other income and expense, amortization of goodwill, restructuring charges,
gain or loss on sale of assets and impairment charges is primarily attributable
to the decline in revenues as noted above.
EBITA is not a measure of performance under accounting principles generally
accepted in the United States of America, and should not be considered as a
substitute for net income, cash flows from operating activities and other
income or cash flow statement data prepared in accordance with accounting
principles generally accepted in the United States of America, or as a measure
of profitability or liquidity. We have included information concerning EBITA
one measure of our cash flow and historical ability to service debt and because
we believe investors find this information useful. EBITA as defined herein may
not be comparable to similarly titled measures reported by other companies.
Impact of Inflation. Inflation has not had a significant effect on the
Company's operating results during the periods presented.
Liquidity and Capital Resources
Operating and Investing Activities
The Company utilized $23.2 million of cash for the twelve months ended
December 31, 2001.
23
Operating activities utilized approximately $19.4 million of cash, which is
primarily comprised of the loss from operations of $105 million, offset by
non-cash charges for depreciation and amortization of approximately $27.8
million and non-cash charges for impairment of intangible assets and software
product technology of $46.9 million, $3.8 million for the realized loss on
certain marketable securities, and a provision for bad debts in the amount of
$3.8 million. In addition, the company, had a reduction in accounts receivable
of $10.5 million and used approximately $5.3 million in fulfillment of its
obligations to its creditors through its accounts payable.
On April 18, 2001, a significant customer voluntarily filed for protection
under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for
the District of Delaware. Due to the uncertainty of collection of this debt,
the Company wrote-off $3.8 million of related accounts receivable, which was
charged to general and administrative expenses in the consolidated statements
of operations.
The Company generated approximately $20.2 million in cash from investing
activities, which is comprised of approximately $19.8 million in proceeds from
the sale of assets, including Geneva AppBuilder, and $2.2 million from assets
being held for resale offset by capitalization of product software technology
of $2.3 million. Geneva AppBuilder accounted for approximately 79% of total
revenue within the Messaging and Application Engineering segment and
approximately 59% of total revenue for all segments. The Messaging and
Application Engineering segment for the year ended December 31, 2001 generated
EBITA of $(4,065).
The Company utilized approximately $23.6 million of cash during the year for
financing activities for the payment of bank debt ($24.0 million) and the
payment of dividends (approximately $1.3 million) offset by $1.6 million from
bridge financing arrangements.
By comparison, in 2000, the Company generated approximately $17.3 million in
cash during the year.
Net cash used in operations during 2000 was approximately $5.9 million,
which is primarily comprised of the net loss for the period of $28.4 million
and approximately $4.7 million for fulfillment of vendor obligations and
restructuring charges, offset by non-cash charges for depreciation and
amortization of approximately $26.1 million, a provision for doubtful accounts
of approximately $.5 million and a $2.3 million reduction in accounts
receivable.
Net cash used for investing activities during 2000 was $8.6 million which
consisted of approximately $4.0 million for the purchase of marketable
securities, approximately $2.0 million for capital equipment purchases, an
investment in a privately held concern for approximately $.4 million,
capitalization of software technology of approximately $.7 million and
approximately $2.6 million for businesses acquired offset by $1.8 million of
cash received from those acquisitions.
Financing Activities
The Company funded its cash needs during the year ended December 31, 2001
with cash on hand from December 31, 2000 and with cash from operations.
The Company has a $3,000 term loan bearing interest at LIBOR plus 1%
(approximately 3.13% at December 31, 2001), which is payable quarterly. There
are no financial covenants and the term loan is guaranteed by Liraz, the
Company's principal shareholder. During 2000, the loan and guaranty were
amended to extend the due date from May 31, 2001 to November 30, 2001 and to
provide the Company with additional borrowings. In exchange for the initial and
amended guarantees, the Company issued Liraz a total of 170,000 shares of the
Company's common stock. Based upon the fair market value of the issued, the
Company has recorded total deferred costs of $4,013 related to the guaranty.
These costs are being amortized in the as a component of interest expense over
the term of the guaranty.
The Company is attempting to secure a revolving credit facility and on an
interim basis has entered into an agreement with two of the executive officers
of the Company, which provides for borrowings up to $250 and is
24
secured by accounts and notes receivable. The Company is in negotiations with
several external lenders to replace the interim revolving credit facility.
In October 2001, the Company entered into an exchange agreement with its
existing preferred shareholders. Under the terms of the agreement, the holders
of the Series A and Series B 4% Convertible Redeemable Preferred Stock and
related warrants received an equal number of newly issued Series A1 and Series
B1 Convertible Redeemable Preferred Stock and related warrants. The conversion
price of both the Series A1 and Series B1 Preferred Stock has been reduced by
16.7% and 50% respectively, which increases the number of shares of common
stock to be issued upon conversion of the Preferred Stock by approximately 1.4
million shares. Additionally, the exercise price for the warrants received in
the exchange has been reduced to $1.77 per share and the call prices have been
reduced accordingly to $5.00 per share for the Series A1 warrants and $7.50 per
share for the Series B1 warrants. The difference in the fair value of the
instruments prior to the exchange and subsequent to the exchange has been
recorded as a dividend to preferred shareholders in the accompanying Statement
of Stockholders Equity.
In return, the preferred shareholders have agreed to waive all future
dividend payments which approximated $1.7 million per year and modify the
anti-dilution provisions that existed under the Series A and Series B Preferred
Stock. The Company may issue up to 3 million shares of common stock, warrants,
preferred stock or other securities without triggering any anti-dilution
provisions.
Subsequent to December 31, 2001, the Company entered into a Securities
Purchase Agreement with several investors wherein the Company agreed to sell up
to three million shares of its common stock and warrants. The common stock was
sold at $1.50 per share and warrants to purchase additional shares were issued
at an exercise price of $2.75 per share. This offering closed on January 16,
2002. The Company sold 2,381,952 shares of common stock for a total of $3.5
million and granted 476,396 warrants to purchase the Company's common stock at
an exercise price of $2.75 per share. The warrants expire in three years from
the date of grant and have a call feature that forces exercise if the Company's
common stock exceeds $5.50 per share. Further offerings of securities by the
Company would trigger the anti-dilution provisions of the Series A1 and Series
B1 Preferred Stock and related warrants.
At December 31, 2001, the Company had received approximately $1.6 million in
interest free bridge financing, which was convertible to common stock subject
to closing conditions. This amount has been reflected in the accompanying
consolidated balance sheet as short-term debt.
The Company has incurred a loss of $105 million and has experienced negative
cash flows from operations for the year ended December 31, 2001. At December
31, 2001, the Company had a working capital deficiency of approximately $5.0
million. The Company's future revenues are largely dependent on acceptance of a
newly developed and marketed product--Cicero. Accordingly, there may be doubt
that the Company can continue as a going concern. To address these issues, the
Company is actively promoting and expanding its product line and has entered
into preliminary sales negotiations with several significant new customers.
Additionally, the Company has successfully completed a private financing round
wherein it raised approximately $3.5 million of new funds from several
investors. Management is evaluating non-strategic asset sales with third
parties and has retained an investment banker to assist in the evaluation.
Management expects that it would be successful, if deemed appropriate, in the
sale of non-strategic assets. The Company closed the financing disclosed above,
expects to be able to raise additional capital and to continue to fund
operations and also expects that increased revenues will reduce its operating
losses in future periods, however, there can be no assurance that management
will be successful in executing as anticipated or in a timely enough manner.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The financial statements
presented herein do not include any adjustments relating to the recoverability
of assets and classification of liabilities that might be necessary should
Level 8 be unable to continue as a going concern.
25
Contractual Obligations
Future minimum lease commitments on operating leases that have initial or
remaining noncancelable lease terms in excess of one year as of December 31,
2001 are as follows:
Lease Lease
Commitments Sublease Commitments
Total Income Net
----------- -------- -----------
2002 $3,305 $(1,198) $2,107
2003 2,780 (974) 1,806
2004 2,022 (436) 1,586
2005 1,821 (290) 1,531
2006 1,537 (274) 1,263
------
$8,293
------
Euro Conversion
Several European countries adopted a Single European Currency (the "Euro")
as of January 1, 1999 with a transition period continuing through January 1,
2002. The Company believes its internal systems are Euro capable.
Further, the Company does not presently expect the introduction of the Euro
currency to have material adverse impact on the Company's financial condition,
cash flows, or results of operations.
Significant Accounting Policies and Estimates
The policies discussed below are considered by us to be critical to an
understanding of our financial statements because they require us to apply the
most judgment and make estimates regarding matters that are inherently
uncertain. Specific risks for these critical accounting policies are described
in the following paragraphs. With respect to the policies discussed below, we
note that because of the uncertainties inherent in forecasting, the estimates
frequently require adjustment.
Our financial statements and related disclosures, which are prepared to
conform with accounting principles generally accepted in the United States of
America, require us to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and accounts receivable and expenses
during the period reported. We are also required to disclose amounts of
contingent assets and liabilities at the date of the financial statements. Our
actual results in future periods could differ from those estimates. Estimates
and assumptions are reviewed periodically, and the effects of revisions are
reflected in the Consolidated Financial Statements in the period they are
determined to be necessary.
We consider the most significant accounting policies and estimates in our
financial statements to be those surrounding: (1) revenues; (2) allowance for
doubtful accounts; (3) valuation of notes receivable; (4) valuation of goodwill
and long-lived assets; (5) capitalization and valuation of software product
technology; (6) valuation of deferred tax assets; and (7) restructuring
reserves. These accounting policies, the basis for any estimates and potential
impact to our Consolidated Financial Statements, should any of the estimates
change, are further described as follows:
Revenues. Our revenues are derived principally from three sources: (i)
license fees for the use of our software products; (ii) fees for consulting
services and training; and (iii) fees for maintenance and technical support. We
generally recognize revenue from software license fees when a license agreement
has been signed by both parties, the fee is fixed or determinable, collection
of the fee is probable, delivery of our products has occurred and no other
significant obligations remain. For multiple-element arrangements, we apply the
"residual method". According to the residual method, revenue allocated to the
undelivered elements is allocated based on vendor specific objective evidence
("VSOE") of fair value of those elements. VSOE is determined by reference
26
to the price the customer would be required to pay when the element is sold
separately. Revenue applicable to the delivered elements is deemed equal to the
remainder of the contract price. The revenue recognition rules pertaining to
software arrangements are complicated and certain assumptions are made in
determining whether the fee is fixed and determinable and whether
collectability is probable. For instance, in our license arrangements with
resellers, estimates are made regarding the reseller's ability and intent to
pay the license fee. Our estimates may prove incorrect if, for instance,
subsequent sales by the reseller do not materialize. Should our actual
experience with respect to collections differ from our initial assessment,
there could be adjustments to future results.
Revenues from services include fees for consulting services and training.
Revenues from services are recognized on a time and materials basis as the
services are performed and amounts due from customers are deemed collectible
and non-refundable. Revenues from fixed price service agreements are recognized
on a percentage of completion basis in direct proportion to the services
provided. To the extent the actual time to complete such services varies from
the estimates made at any reporting date, our revenue and the related gross
margins may be impacted in the following period.
Allowance for Doubtful Accounts. In addition to assessing the probability
of collection in conjunction with revenue arrangements, we continually assess
the collectability of outstanding invoices. Assumptions are made regarding the
customer's ability and intent to pay and are based on histor