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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, 1999.
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number: 0-26392
LEVEL 8 SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2920559
(State 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,
$.01 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 voting stock held by non-affiliates of the
Registrant as of March 20, 2000 was approximately $296,742,688. There were
13,364,222 shares of Common Stock outstanding as of March 20, 2000.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 2000 Annual Meeting of
Shareholders are incorporated by reference in Part III hereof.
Exhibit Index appears on Page E-1.
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LEVEL 8 SYSTEMS, INC.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 1999
Table of Contents
PART I
Item Page
Number Number
------ ------
1. Business...................................................... 1
2. Properties.................................................... 14
3. Legal Proceedings............................................. 14
4. Submission of Matters to a Vote of Security Holders........... 15
PART II
Market for Registrant's Common Stock and Related Shareholder
5. Matters....................................................... 16
6. Selected Financial Data....................................... 16
Management's Discussion and Analysis of Financial Condition
7. and Results of Operations..................................... 17
7A. Quantitative and Qualitative Disclosures About Market Risk.... 25
8. Financial Statements and Supplementary Data................... 26
Changes in and Disagreements with Accountants on Accounting
9. and Financial Disclosure...................................... 26
PART III
10. Directors and Executive Officers of the Registrant............ 27
11. Executive Compensation........................................ 27
Security Ownership of Certain Beneficial Owners and
12. Management.................................................... 27
13. Certain Relationships and Related Transactions................ 27
PART IV
Exhibits, Financial Statement Schedules, and Reports on Form
14. 8-K........................................................... 28
SIGNATURES............................................................ 34
INDEX TO FINANCIAL STATEMENTS......................................... F-1
INDEX TO EXHIBITS..................................................... E-1
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PART I
Item 1. Business.
Overview
Level 8's software products and enabling services address three of the most
pervasive eBusiness challenges facing global 5000-sized organizations today:
.Using the Internet as the primary communications medium ("eBusiness")
.Using the Internet to enable buying and selling ("eCommerce")
.Optimizing an enterprise's value through the rapid adoption of digital
technology
These eBusiness challenges are driven by intensifying competition in the
global marketplace, which is forcing companies to make better and faster
business decisions and find new ways to attract and retain customers. To
accomplish this, a company must have access to enterprise-wide views of
business information and processes, and mechanisms for extending their
business applications to reach customers and business partners via the
Internet. Providing these capabilities requires an integration of existing
computer applications and platforms, enabling them to communicate with one
another and the Internet. However, the evolution of computing from mainframes
to client/server systems and then to the Internet and intranets has resulted
in these applications running on a diverse and typically incompatible mix of
new and legacy computing platforms.
Level 8 specializes in delivering software solutions that help companies
integrate new and existing computer applications and extend these applications
to the Internet to support eBusiness and eCommerce. This specialization is
called enterprise application integration or "EAI." Level 8's products and
services are designed to enable organizations to address business process
automation, application integration and application engineering in a simple
and cost effective way. Level 8 provides customers with software to link their
critical business applications internally across the enterprise and externally
directly with strategic business-to-business partners and business-to-business
consumers via the Internet.
Level 8 offers a suite of products for eBusiness and eCommerce under the
Geneva brand name. The Geneva Integration Suite has six core components which,
together, the Company believes provide the most complete suite of integration
software products available for eBusiness integration. These components
include Geneva Enterprise Integrator (formerly Enterprise Integration
Template), Geneva Business Process Automator (formerly Business Process
Template), Geneva Integration Broker (formerly Geneva Integrator), Geneva
Message Queuing, Geneva AppBuilder, and Geneva XIPC (formerly XIPC).
In addition to these products, Level 8 also provides technical support,
training and consulting services as part of its commitment to providing its
customers industry-leading enterprise application integration solutions. Level
8's worldwide consulting team has in-depth experience in developing successful
enterprise-class solutions as well as valuable insight into the business
information needs of customers in the Global 5000. Level 8 offers consulting
services around its products for eBusiness and eCommerce enablement. These
services include project management, application and platform integration,
application design and development, and application renewal along with
expertise in a wide variety of development environments and programming
languages.
In April 1999, the Company completed its acquisition of Seer Technologies,
Inc. ("Seer"). In connection with the acquisition of Seer, Level 8 acquired
significant intellectual property assets, including Geneva AppBuilder
(formerly Seer *HPS).
1
In December 1999, the Company acquired Template Software, Inc. ("Template").
Level 8's management team identified Template as a provider of technologies
that would enable Level 8 to be one of the first to market with a comprehensive
product portfolio representing the next generation of EAI solutions for
eBusiness. In connection with the acquisition of Template, Level 8 acquired
significant intellectual property assets, including Geneva Enterprise
Integrator and Geneva Business Process Automator. These products, together with
Level 8's existing software portfolio, provide customers a comprehensive suite
of eBusiness integration software.
To date, Level 8's products and services have been utilized by companies in a
wide variety of industries including financial services, insurance, retail,
manufacturing, telecommunications, transportation, and government. Level 8's
customer base includes major corporations around the world such as ABN AMRO
Information Technology Services Company, Action Performance Companies, Allstate
Insurance Company, AT&T Corp., Bell Atlantic Network Services, Inc., Citibank,
N.A., Borders Group, Inc., Credit Suisse, CVS Corporation, Drugstore.com, Inc.,
Telecom Italia S.p.A., Lockheed Martin Corporation, Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Michelin North America, Inc., Montgomery Ward &
Co., Incorporated, National Association of Securities Dealers, Inc., Prudential
Insurance Company of America, Sikorsky Aircraft Corporation, Sprint
Communications Company LP, Sunrider International, EDB 4tel AS, and WinStar
Telecommunications, Inc.
Level 8 was incorporated in New York in 1988, and re-incorporated in Delaware
in 1999. The principal executive offices of Level 8 are located at 8000 Regency
Parkway, Cary, North Carolina, 27511, telephone number (919) 380-5000.
Industry Background
A significant challenge facing global 5000-sized organizations today is the
integration and management of critical business applications which run on
disparate or otherwise incompatible computer systems. Business and competitive
pressures are pushing companies to move towards an eBusiness model as quickly
as possible in order to remain competitive and viable in an increasingly
online, information-driven economy. eBusiness systems involve a combination of
consumer-oriented or business-to-business eCommerce, internal and external data
exchange, online customer service, customer relationship management, and value
chain integration processes. Inter-operability and information exchange between
new and legacy systems within the extended enterprise are key components for a
successful eBusiness strategy, as is the ability to link those applications and
processes in extremely secure and highly reliable ways. Organizations must also
ensure that large volumes of eBusiness transactions can be processed in
Internet time and incorporate the entire extended, integrated enterprise
processing environment into a reliable, scalable, robust, and manageable
infrastructure. The eBusiness model and the competitive need for rapid access
to business-critical information from across the enterprise are together
driving an increasing demand for Internet-enabled information systems that can
also offer enterprise-wide views of a company's business information. Further,
information systems departments of global 5000-sized companies are compelled by
both economic necessity and internal mandates to find ways to leverage their
existing investments in information technology.
Enterprise application integration solutions, including those developed by
Level 8, are designed to provide these capabilities through an open,
enterprise-wide infrastructure that can accomplish the complete integration of
a company's entire computing systems environment, including technologies
enabling eBusiness and eCommerce.
There is currently a movement toward "virtual enterprises" that must link
application systems from different companies in the supply chain. Additionally,
e-Commerce and customer service on the Web require communication between Web-
based, front-end systems (e.g., payment systems) and back-end systems, for
example inventory, accounts receivable, and invoicing systems.
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Key factors driving the current need for enterprise application integration
solutions in the eBusiness integration software market include:
. The current computer systems of most companies were developed in an era
when systems tended to be self-contained and were not developed with the
Internet in mind. The ability of the systems to communicate with other
systems was not emphasized. As a result, many current systems are not
designed to accommodate communications with different systems. The
ability to integrate the Internet and Web-based technologies with a
company's core business systems provides business value by adding new
revenue models (eCommerce) and improving customer service.
. Web-based customer self-service is becoming the standard for forging
more meaningful customer relationships.
. Integrating with company business partners and supply chain partners is
now a key differentiator for business inventory costs and increases
profitability.
. Many global 5000-sized companies have made significant investments in
ensuring that their existing computer systems will function properly in
the Year 2000 and beyond. The size of the investments made by these
companies addressing Year 2000 problems is forcing information systems
departments to find ways to leverage such investments by extending the
life of current systems. By providing Web-based access to core business
systems, companies can leverage these investments.
. Many Global 5000-sized companies addressed computer system development
problems by adopting new technologies as they have emerged. This
approach has resulted in increasingly diverse computing environments
that mix a variety of hardware platforms, operating systems and
programming languages.
. Global 5000-sized companies have dramatically increased their use of the
Internet and intranets both to expedite internal communication and to
support business-to-business and business-to-consumer transactions. This
increased use has created strong demand for an entirely new class of
enterprise-wide computer applications. Meeting this demand in a cost
efficient manner requires modernizing existing systems to enable them to
support eBusiness and eCommerce applications, as well as developing new
applications.
. As a result of mergers and acquisitions, the computer systems of many
companies have become considerably more complex at an enterprise-wide
level. The increased complexity results from the fact that the newly-
acquired computer systems are rarely compatible with the existing
computer systems. Furthermore, there are often redundancies between the
respective systems that make integration more difficult.
The Level 8 Solution
Level 8 is a leading provider of eBusiness integration software for
integrating enterprise applications both within the enterprise and between
business-to-business partners. Different computer systems and the applications
developed for them vary widely in the ways in which they send, receive, view
and process information. As a result, diverse applications running on
different systems cannot work together because information cannot generally be
exchanged between them.
Level 8's products are designed to enable the sharing of information between
disparate systems by automatically transforming the data from one system into
the formats and representations that can be used by other application systems.
This means organizations can link legacy systems to other legacy systems, to
new systems, and also to the Web. In this way the Company's 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.
Level 8's 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
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heterogeneous computing environments. Most significantly, Level's 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.
Level 8's solution to solving business integration challenges provides the
following key benefits:
Supports Rapid Implementation of eBusiness Solutions. Level 8's Geneva
Integration Suite enables rapid eBusiness implementations, reducing
installation and integration costs, including the extension of ERP
packages, and provides an open platform for integrating new or acquired
applications, systems and architectures.
Links Existing Operational Systems to The Internet. The Geneva Integration
Suite can transmit communications via the Internet as well as between
applications. It can automatically collect messages or packets of
information and processing instructions, from existing legacy systems and
transform them into forms that can be exchanged via the Internet with other
applications running on diverse platforms, and vice versa. These powerful
features allow organizations to Web-enable existing application systems,
expanding their functionality and extending their life cycles by opening
them up for intranet and Internet-based eBusiness and eCommerce.
Preserves Existing Information Technology Investment. Traditionally, larger
organizations have relied on mainframe computers to run their core business
programs. To date, there has been a tremendous investment in these
mainframe legacy systems. More recently, there has been large investments
made in other computing platforms (e.g., midrange, client/server, LANS and
Web), which are not readily compatible with each other or with legacy
mainframe systems. Linking together newer computing platforms and
applications to existing systems helps preserve and increase the return on
the investments made by organizations in their information technology
systems.
Additionally, by linking the flexibility and innovations available on newer
computing platforms and applications to the rich databases and functions
that are typically maintained on the larger mainframe computers,
organizations can utilize this information in new ways. The Geneva
Integration Suite helps organizations bridge the gap between legacy systems
and newer platforms and the result is the extension of existing
capabilities to modern architectures, such as the Web, thereby preserving
the existing information technology investment.
Improves Efficiency of Existing Enterprise Infrastructure. The high
throughput capability of the Geneva Integration Suite of products enables
organizations to provide just-in-time data delivery across a wide variety
of systems and among people in a unified business process. By removing the
bottlenecks to the integration of people, process and data, Level 8's
software products support numerous business critical computing operations
such as business process automation, data replication, data warehousing and
transaction-based processing.
Supports Broad Range of Applications, Platforms and Standards. The IT
departments of larger enterprises need solutions to integrate a broad array
of applications and platforms using a wide variety of industry standards to
ensure ease of implementation and integration into existing environments.
Level 8's products provide enterprise application integration solutions
that support common industry standards and can handle a wide array of
disparate applications, platforms and data types. The Geneva Integration
Suite can be used to link custom or packaged applications together
regardless of the tools or programming language used. The Geneva
Integration Suite ties together applications running on a variety of
popular operating systems including; Windows NT, UNIX, Solaris, MVS, VMS,
OS/400 and many other operating systems that run on hardware platforms from
vendors such as Hewlett Packard, Sun, Compaq/Digital, Dell and IBM.
Ease of Implementation and Enhanced Information Technology
Productivity. The Geneva Integration Suite allows IT departments to create
comprehensive data transformation and information exchange solutions
without the need for custom coding. Level 8's 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
4
development of enterprise application integration solutions. The Geneva
Integration Suite allows the IT department to instantly integrate new and
existing systems with little or no customization required.
The Level 8 Strategy
Level 8's goal is to be a recognized global leader in the growing market for
enterprise application integration solutions for eBusiness and eCommerce. The
following are key elements of the Level 8 strategy:
The Geneva Integration Suite. No single product, technology or paradigm
answers all of a large organization's integration challenges. Level 8's
eBusiness integration software portfolio provides the most comprehensive
suite of integration software products available for eBusiness integration.
Level 8 offers a suite of integration products under the Geneva brand name.
The Geneva Integration Suite is a set of eBusiness integration software
products that supports business process automation, application
integration, enterprise messaging and application engineering. The
Company's strategy for evolving the Geneva Integration Suite is threefold:
1) make substantial investments in research and development focusing on
integrating the components of the suite, 2) add market-driven functionality
based on customer requirements and feedback, and 3) add complimentary
products and technologies via strategic acquisitions.
Expand Worldwide Sales and Marketing Capability. Level 8 is making
considerable investments in worldwide sales and marketing in an attempt to
acquire market share in a high growth market. Specifically, the Company is
increasing its sales and marketing personnel and programs around the globe.
Worldwide sales personnel grew approximately 230% during the third and
fourth quarter of 1999, and Worldwide marketing personnel grew 200% in the
same period. The sales team includes account executives, inside sales (or
telephone sales) personnel and sales engineers. Level 8 also intends to
continue to expand its global sales coverage through additional direct
sales offices and the expansion of indirect channels. To support indirect
sales Level 8 has already established joint marketing relationships with
original equipment manufacturers, independent software vendors and value
added resellers, including IBM, Microsoft, Hewlett-Packard, Unisys,
Cambridge Technology Partners, Clarus Corporation, Catalyst, and Crystal
Solutions.
Maintain Global Presence. Level 8's strategy for sales and marketing is to
become recognized among IT professionals as a global provider of eBusiness
integration software. More than 50 percent of Fortune Magazine's 1999
Global 500 were headquartered outside of the US. In recognition of this,
Level 8 continues to support its international sales and marketing efforts.
Level 8 had a strong international presence during 1999, accounting for 67%
of revenue.
Leverage Strategic Partners. Level 8 intends to expand sales through both
direct and indirect sales channels. As part of this strategy, Level 8
continues to work on strengthening and growing its relationships with
Microsoft, IBM, Hewlett-Packard and other strategic partners. Level 8's
strategy is to use the market visibility of key customers to engage
strategic partners to then leverage their lead generation capacity to
create new sales opportunities for Level 8's eBusiness integration
software.
Since 1996, Level 8 has been working with Microsoft to meet the
interoperability needs of enterprise developers. Microsoft is committed to
ensuring that the Windows platform works with other key platforms and
systems in the heterogeneous computing environment of its customers. To
that end, Microsoft has included a software product developed by Level 8 on
its Windows 2000 CD. By including the Level 8 Geneva Message Queuing
connector, Microsoft has made it easier for Windows developers to create
cross-platform applications.
Level 8 has also aggressively pursued original equipment manufacturer
("OEM") partners who wish to embed Level 8 eBusiness integration software
products into their own products or solutions. These OEM partners include
Clarus Corporation, which embedded Geneva Integration Broker into the
Company's eProcurement application; Catalyst, which embedded Geneva Message
Queuing into is warehouse management application; and Crystal Solutions,
which is using the Geneva products in their eBusiness solutions.
5
Expand into New Markets. In the past, Level 8 has served many customers
in the highly demanding financial services, insurance and
telecommunications markets. Level 8's strategy is to apply its experience
with these customers to other vertical markets. Specifically, Level 8
intends to further penetrate the retail and transportation sectors as well
as providing Internet integration solutions for any company trying to
establish a presence in the emerging eCommerce sector. Level 8 plans to
accomplish this objective by redirecting its sales and marketing efforts
worldwide.
Products
Geneva Integration Suite
Level 8 offers a suite of products under the Geneva brand name. These
products, ranging from business process automation, application integration,
enterprise messaging and application engineering, are all components of the
Geneva Integration Suite. The Geneva Integration Suite makes information
systems work together seamlessly for a totally connected, eBusiness-enabled
extended enterprise.
The primary use of Geneva technology is to provide an end-to-end
infrastructure for eBusiness, including:
. Integrating Web and legacy applications
. Real-time access to enterprise information over the Internet
. Linking business partners in an integrated supply chain across the
Internet
The primary benefits of the Geneva technology are:
. Acceleration of the creation and deployment of new eBusiness systems
. The leveraging of existing information systems when building new
eBusiness systems
. Robust, transactional infrastructures for eBusiness
Geneva Products
The Geneva Integration Suite has six core components which provide the most
complete suite of integration software products available for eBusiness
integration. These components include Geneva Enterprise Integrator (formerly
Enterprise Integration Template), Geneva Business Process Automator (formerly
Business Process Template), Geneva Integration Broker (formerly Geneva
Integrator), Geneva Message Queuing, Geneva AppBuilder and Geneva XIPC
(formerly XIPC).
Geneva Enterprise Integrator. Geneva Enterprise Integrator is an
integration tool that provides unified, real-time views of enterprise
business information for eBusiness applications. Real-time integration of
back-end enterprise business systems with Web-based applications is an
essential component in meeting rising customer expectations of eCommerce,
Web-based customer service, and enterprise portal applications. Geneva
Enterprise Integrator also leverages a high performance, memory-based
information cache to provide an infrastructure that will support the
performance demands of Internet-style computing.
Geneva Business Process Automator. Geneva Business Process Automator is a
product designed to work with Geneva Enterprise Integrator for automating
the many business processes that an organization uses to run its
operations. Business process automation enables the automation of
information workflows, designed by business experts, and spanning front and
back office systems. Business process automation provides business analysts
with a set of easy-to-use tools for defining, changing, and refining the
exchange of information and the workflow for a domain-specific business
process.
6
Geneva Integration Broker. Geneva Integration Broker is a transport
independent message broker that enables an organization to rapidly
integrate diverse business systems regardless of platform, transport,
format or protocol. The key feature of Geneva Integration Broker is its
support for XML and other standards for open data exchange on the Internet.
The product provides a robust platform for building eBusiness applications
that integrate with existing back-office systems. Geneva Integration
Broker's support for open data exchange and secure Internet transports make
it an excellent platform for building Internet-based business-to-business
solutions.
Geneva Message Queuing. Geneva Message Queuing is a reliable enterprise
connectivity product for Microsoft and non-Microsoft applications. The
primary use is for guaranteed, transactional, once and only once
connectivity of Windows-based Web applications to back-office information
resources like mainframes and other legacy systems. Microsoft's Web
application platform, called Windows DNA, is one of the dominant
architectural models for building eBusiness applications. Geneva Message
Queuing provides native interoperability essential for deploying Windows
DNA applications in a heterogeneous environment.
Geneva XIPC. Geneva XIPC (formerly XIPC) provides similar, guaranteed
delivery of information between applications. The difference being that
where Geneva Message Queuing is based around a Microsoft standard, Geneva
XIPC is for use with Linux and other brands of UNIX servers. The Linux
platform was the largest growing server platform during 1999. The
UNIX/Linux family of servers, from companies like Sun Microsystems, IBM and
Hewlett Packard, are the dominant Web Server and Web Application Server
platforms. Geneva XIPC enables Linux and UNIX Web and Applications Servers
to communicate reliably.
Geneva AppBuilder. Geneva AppBuilder is a set of application engineering
tools that assists customers in developing, adapting and managing
enterprise-wide computer applications for the Internet/intranets and
client/server networks. The product is designed to enable users to define
in a high level, simplified language tasks and operations the users would
like an application to perform. Users can then simply "push a button" and
Geneva AppBuilder automatically generates the necessary software
programming to perform the tasks and operations defined. This significantly
accelerates the development and deployment of highly complex, large-scale,
custom enterprise applications and greatly enhances the productivity of
programming resources.
Future Integration and Product Development
Level 8 intends to enhance the Geneva suite of products to meet marketplace
needs as they evolve. Level 8 is making substantial investments into all areas
of research and development to meet the demands of current and future markets.
Tighter integration between the Company's products, including the products
originating as a result of the Seer and Template acquisitions, is currently
the Company's key focus.
The Company feels that the strength of the Company's products is its
diversity. The Company believes that by creating native integration between
the different components of the Geneva Integration Suite, Level 8 will be able
to provide more comprehensive solutions for its customers, such as the use of
Geneva XIPC to enhance the functionality of Geneva Message Queuing Version
2.0.
Similarly, the Company's two primary application integration technologies,
Geneva Integration Broker and Geneva Enterprise Integrator, include a base
level of integration. Native robust integration between the two products will
provide the ability for customers to leverage the best attributes of both
products.
Other areas of product enhancement include monitoring the emerging Internet
standards such as XML and Java to provide the proper level of support and
integration for all our products.
Services
Level 8 provides a full spectrum of technical support, training and
consulting services as part of its commitment to providing its customers
industry-leading enterprise application integration solutions. Level 8
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believes its worldwide consulting team has in-depth experience in developing
successful enterprise-class solutions as well as valuable insight into the
business information needs of Global 5000 companies.
Maintenance and Support
Level 8 offers 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
Level 8's training organization offers a full curriculum of courses and labs
designed to help customers become proficient in the use of Level 8's products
and related technology as well as enabling customers to take full advantage of
Level 8's field-tested best practices and methodologies.
Consulting Services
Level 8 offers consulting services around its product offerings in project
management, applications and platform integration, application design and
development, application renewal and eBusiness and eCommerce enablement, along
with expertise in a wide variety of development environments and programming
languages. Level 8 also has a very active partner program for recruiting
leading IT consulting and system integration firms to provide services for the
design, implementation and deployment of Level 8 eBusiness solutions. Level
8's consulting organization supports third party consultants by providing
architectural and enabling services.
Government Contracts
As a result of the acquisition of Template, the Company provides certain
technical services to federal government agencies under certain contracts,
some of which are classified. The nature of this work is technical design and
software development which was historically performed by Template since 1977.
On a proforma basis, including Template's operations approximately 13% and 19%
of total revenues in fiscal years 1998 and 1999, respectively, were derived
from contracts with the federal government.
Government contracts, by their terms, generally can be terminated at any
time by the government, without cause, for the convenience of the government.
If a government contract is so terminated, the Company would be entitled to
receive compensation for the services provided or costs incurred at the time
of termination and a negotiated amount of the profit on the contract to the
date of termination. In addition, all government contracts require compliance
with various contract provisions and procurement regulations. The adoption of
new or modified procurement regulations could adversely affect the Company or
increase its costs of competing for or performing government contracts. Any
violation (intentional or otherwise) of these regulations could result in the
termination of such government contracts, imposition of fines, and/or
debarment from award of additional government contracts.
Customers
Level 8's products and services are currently used by thousands of software
developers. In addition, hundreds of enterprise-wide applications built and
integrated through Level 8's products are used daily by over a million end
users worldwide. Level 8's customer base includes major corporations around
the world such as ABN AMRO Information Technology Services Company, Action
Performance Companies, Allstate Insurance Company, AT&T Corp., Bell Atlantic
Network Services, Inc., Citibank, N.A., Borders Group, Inc., Credit Suisse,
CVS Corporation, Drugstore.com, Inc., Telecom Italia S.p.A., Lockheed Martin
Corporation, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Michelin
North America, Inc., Montgomery Ward & Co., Incorporated, National Association
of Securities Dealers, Inc., Prudential Insurance Company of America, Sikorsky
Aircraft Corporation, Sprint Communications Company LP, Sunrider
International, EDB 4tel AS, and WinStar
8
Telecommunications, Inc. Industries that are significantly represented in
Level 8's customer base include: financial services, insurance, retail,
manufacturing, telecommunications, transportation, and government. ABN AMRO
was Level 8's only customer accounting for more than 10% of 1997 and 1998
historical operating revenue. No one customer accounted for more than 10% of
operating revenues in 1999.
Level 8 seeks strong relationships with its customers in order to gain an
in-depth understanding of the business and technology challenges they face.
Level 8 has established an international customer advisory board that will
follow the Geneva Integration Suite. It will be used to present new
information, address customer requirements and concerns, and provide a
constructive and open forum for interaction. The volunteer members of the
customer advisory board will represent Level 8's global customer base and act
as a sounding board for new ideas and initiatives, as well as provide a means
for information flow and feedback regarding Level 8's products and services.
In many areas around the world, local customers also hold periodic regional
user group meetings that are supported and encouraged by Level 8.
Additionally, Level 8 receives a great deal of feedback through its consulting
services and technical support organization regarding the effectiveness of
Level 8's products in meeting customer needs.
Sales and Marketing
Sales
To reach a broad potential customer base, Level 8 has pursued multiple
distribution channels, including a direct sales force, as well as third party
relationships with distributors, value-added resellers, systems integrators
and IT consulting firms.
The Company's direct sales force focuses on large customers and leverages
its industry experience to access target organizations within particular
vertical markets. These markets are characterized by business areas to which
Level 8's products are particularly well suited, and businesses that possess
the financial resources and scale of operations necessary to support the
engagement.
Level 8 identifies leading organizations in each focus industry and seeks to
provide an initial solution that builds on one of Level 8's eBusiness
integration software products. After initial success, Level 8 will attempt to
sell a broader set of software solutions to the customer. Level 8 intends to
target additional industries in which its business area expertise and advanced
software technology can be applied.
An important element of Level 8's sales strategy is to expand its
relationships with third parties to increase market awareness and acceptance
of Level 8's integration software solutions. As part of these relationships,
Level 8 generally provides training and other support necessary to promote the
market acceptance of Level 8 products.
Level 8's current direct sales staff has substantial knowledge of Level 8's
products and service offerings as well as general experience in the software
industry. As the Company expands its direct sales force, it is recruiting
sales people with equivalent general experience in the software industry and
successful track records in selling enterprise-class software products.
Level 8 is organized worldwide into two major geographic divisions for sales
of its software products: the Americas and Europe/Asia Pacific. One general
manager heads each of these sales divisions. The international territories
currently include the United Kingdom, Germany, Scandinavia, Italy, France and
Australia. The General Managers' respective operations include sales and
consulting services for new and existing customers.
Approximately $18 million or 35% of Level 8's 1999 revenues were generated
from the Americas and approximately $35 million or 65% was generated outside
the Americas. The geographic distribution of Level 8's revenues may change in
the future.
9
Marketing
The target market for Level 8's products and services are Global 5000
companies. The rapid deployment of the Internet and intranet technology is
driving companies to find ways to take advantage of these new technologies out
of competitive necessity. As a result, information systems departments are
compelled by both economic necessity and internal mandates to find ways to
leverage their investment in current information technology.
In addition, the lines between "new" development and what has in the past
been considered "maintenance" are blurring. Level 8 believes more and more of
the "new" development going forward will be in the area of enhancing the
functionality of existing operational systems in an enterprise's current
computing infrastructure. This will result in the identification of new and
emerging opportunities for enterprise application integration solutions.
Level 8's marketing staff has an in-depth understanding of the global
software marketplace and the needs of customers in that marketplace, as well
as experience in all of the key marketing disciplines. The staff also has
broad knowledge of Level 8's products and services and how they can meet
customer needs.
Marketing is headed by a senior vice president of worldwide marketing who
manages an international staff. Core marketing functions including product
management, product marketing, marketing communications, strategic alliances
and public, which include investor and industry analysts, relations are
handled by the corporate marketing staff. Regional marketing programs are
supported by corporate staff as well as by marketing staff based in the
Company's European headquarters in the UK, with support from local marketing
resources in the regional offices.
Level 8 utilizes a wide variety of marketing programs that are intended to
attract potential customers and to promote Level 8 and its brands. Level 8
uses a mix of market research, analyst updates, seminars, advertising,
telemarketing, direct mail, tradeshows, webcasts, speaking engagements, public
relations, and website marketing in order to achieve these goals.
The marketing department also produces collateral material for distribution
to prospects including demonstrations, presentation materials, white papers,
case studies, articles, brochures and data sheets. Level 8 also intends to
implement an alliance cooperative marketing program to support its channel
partners with a variety of programs, incentives and support plans.
Level 8 intends to increase its investment in marketing significantly.
Management intends to continue to increase the Company's sales and marketing
staff worldwide and significantly increase the marketing budget.
Level 8 has a key strategic relationship with Microsoft. Microsoft has
licensed from Level 8 software originally developed by Level 8 that enables
its Windows NT server platforms to integrate with IBM's MQ Series message-
oriented middleware, which currently represents a significant share of the
worldwide message-oriented middleware market. Microsoft has shipped this
software as part of its Windows 2000 operating system and will make it
available to its Windows NT server platform customers through its website.
Microsoft also currently recommends Geneva Message Queuing as its preferred
implementation of the MSMQ functionality on operating systems other than
Microsoft Windows.
Research and Product Development
Level 8 has made substantial investments in research and development. Level
8 conducts research and development to enhance its existing products and to
develop new products. Level 8 intends to focus its research and development
efforts on integrating and evolving its Geneva product line in such a manner
that all products can interact with each other to provide customers a
comprehensive enterprise application integration solution. The Company had
research and development expense of $6.8 million, $2.8 million, and $1.1
million during 1999, 1998, and 1997, respectively. This resulted in increases
in research and development expenses of 145%
10
from 1998 to 1999, and 163% from 1997 to 1998. The increase in 1999 is
primarily attributable to the acquisitions of Seer and Template Software and
the Company's investments in new products, primarily version 2.0 of Geneva
Integration Broker, which was released in the second quarter of 1999 and
version 2.0 of Geneva Message Queuing, which was released in the fourth
quarter of 1999. This trend is expected to continue with the acquisition of
Template and the Company's ongoing efforts to strengthen and evolve its
messaging, enterprise application integration and application engineering
products.
The markets for Level 8's products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. Level 8's future success will depend to a
substantial degree upon its ability to enhance its 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.
Level 8 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 Level 8 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 Level
8 will successfully develop, introduce or manage the transition to new
products.
Level 8 has in the past, and may in the future, experience delays in the
introduction of its products, due to factors internal and external to Level 8.
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 Level 8's
results of operations, particularly on a quarterly basis. For additional
information, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Years Ended December 31, 1999, 1998, and 1997--
Research and Development."
Competition
The eBusiness integration software market includes a large number of
participants, is subject to rapid changes, and is highly competitive. These
markets are highly fragmented and served by numerous firms, many of which
address only their respective local markets. Clients may elect to use their
internal information systems resources to satisfy their needs, rather than
using those offered by Level 8.
The rapid growth and long-term potential of the market for enterprise
application integration solutions make it attractive to new competition. Many
of the Company's comptetitors have greater name recognition, a larger
installed customer base and greater financial, technical, marketing, and other
resources than the Company. Level 8 believes it offers a broader range of
enterprise application integration solutions than its competitors, and
therefore generally competes on a product-by-product basis.
Representative Competitors
. In the Message Queuing market, primary competition comes from IBM with
its MQSeries product
. In the Enterprise Application Integration market, primary competition
comes from NEON, Active Software, Tibco, Mercator, IBM and Candle
. In the Business Process Automation market, primary competition comes
from Vitria and IBM
. In the Application Engineering market primary competition comes from
Sterling Software and Platinum Technology
11
Level 8 believes that its ability to compete depends in part on a number of
competitive factors outside its control, including the ability of its
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 Level 8's products
and services, the price at which others offer comparable services and the
extent of its competitor's responsiveness to customer needs.
Intellectual Property
Level 8's success is dependent upon developing, protecting and maintaining
its intellectual property assets. Level 8 relies upon combinations of
copyright, trademark and trade secrecy protections, along with contractual
provisions, to protect its intellectual property rights in software,
documentation, data models, methodologies, data processing systems and related
written materials in the international marketplace. In addition, Level 8 has
patents with respect to certain of its products. Copyright protection is
generally available under United States laws and international treaties for
Level 8's 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.
Level 8 uses the trademarks "Level 8", "Level 8 Systems", "Level 8
Technologies", "Geneva", "Geneva Integration Suite", "Geneva Message Queuing",
"Geneva XIPC", "Geneva Integration Broker", "Geneva Enterprise Integrator",
"Geneva Business Process Automator", "Geneva AppBuilder" and "MonitorMQ".
There can be no assurance that the steps taken by Level 8 will prevent
misappropriation of its technology, and such protections do not preclude
competitors from developing products with functionality or features similar to
Level 8's products. Furthermore, there can be no assurance that third parties
will not independently develop competing technologies that are substantially
equivalent or superior to Level 8's technologies. Any failure by or inability
of Level 8 to protect its proprietary technology could have a material adverse
effect on Level 8's business, operating results and financial condition.
Although Level 8 does not believe its products infringe the proprietary
rights of any third parties, there can be no assurance that infringement
claims will not be asserted against Level 8 or its customers in the future. In
addition, Level 8 may be required to indemnify its distribution partners and
end users for similar claims made against them. Furthermore, Level 8 may
initiate claims or litigation against third parties for infringement of
Level 8's proprietary rights or to establish the validity of Level 8's
proprietary rights. Litigation, either as a plaintiff or defendant, would
cause Level 8 to incur substantial costs and divert management resources from
productive tasks whether or not said litigation is resolved in Level 8's
favor, which could have a material adverse effect on Level 8's business
operating results and financial condition.
As the number of software products in the industry increases and the
functionality of these products further overlaps, Level 8 believes that
software developers may become increasingly subject to infringement claims.
Any such claims, with or without merit, could be time consuming and expensive
to defend and could adversely affect Level 8's business, operating results and
financial condition.
Employees
As of February 29, 2000, Level 8 had a total of 470 employees. Of these
employees: 120 were engaged in software sales and marketing and technical
support; 60 in administration; 115 in research, development and technical
support; and 175 in consulting and training.
12
Level 8's continued success is dependent on its ability to attract and
retain qualified employees. During the second half of 1999, the Company
significantly increased its number of employees through the Template
acquisition and through internal hiring. Due to the competitiveness in the
market for employees, the Company may experience future difficulty in
recruiting and retaining staff.
Level 8 believes that to fully implement its business plan it will be
required to enhance its marketing functions by adding additional marketing
personnel. In addition, Level 8 believes additional sales executives will be
required to support Level 8's sales operations. Although Level 8 believes it
will be successful in attracting and retaining qualified employees to fill
these positions, no assurance can be given that Level 8 will be successful in
attracting and retaining these employees now or in the future.
Level 8's employees are not represented by a union or a collective
bargaining agreement.
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"). The Company 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, the Company's 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 the Company's filings with the Securities and
Exchange Commission and in materials incorporated therein by reference: the
Company's future success depends on the market acceptance of the new Geneva
Integration Suite; 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 the Company's
business because its expenses are largely fixed; the Company's quarterly
operating results may vary significantly because the Company is not able to
accurately predict the amount and timing of individual sales and this may
adversely impact the Company's stock price; trends in sales of the Company's
products and general economic conditions may affect investors' expectations
regarding the Company's financial performance and may adversely affect the
Company's stock price; the Company's future results may depend upon the
continued growth and business use of the Internet; the Company's government
contracts business is subject to a number of risks associated with doing
business with the federal government; the Company 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;
the Company may not have the ability to recruit, train and retain qualified
personnel; the Company may not have the resources to successfully manage the
integration of Template; the Company's future results may depend upon the
successful integration of future acquisitions; the Company may not have the
resources to successfully manage additional growth; rapid technological change
could render the Company's products obsolete; if the Company's relationship
with Microsoft weakens, it could adversely affect the Company's business; the
loss of any one of the Company's major customers could adversely affect the
Company's business; the Company's business is subject to a number of risks
associated with doing business abroad including the effect of foreign currency
exchange fluctuations on the Company's results of operations; the Company's
products may contain undetected software errors, which could adversely affect
its business; because the Company's technology is complex, the Company may be
exposed to liability claims; year 2000 issues may cause problems with the
Company's systems and expose the Company to liability; the failure of the
Company to meet product delivery dates could adversely affect its business;
the Company may be unable to enforce or defend its ownership and use of
proprietary technology; because the Company is a technology company, its
common stock may be subject to erratic price fluctuations; and the Company may
not have sufficient liquidity and capital resources to meet changing business
conditions.
13
Item 2. Properties.
The Company's worldwide corporate headquarters is located in approximately
54,000 square feet in Cary, North Carolina pursuant to a lease expiring in
2004. The United States operations groups are based in the Cary office, with
field offices in the following locations: Dulles and Arlington, Virginia;
Atlanta, Georgia; Boca Raton, Florida; California, Maryland; Chicago,
Illinois; Denver, Colorado; New Orleans, Louisiana, and Northtown,
Pennsylvania. The foreign operations groups are based in London, England with
field offices in the following locations: Sydney, Australia; Copenhagen,
Denmark; Manchester, England; Paris, France; Frankfurt, Germany; Milan, Italy;
Stockholm and Malmo, Sweden; and Nieuwegein, The Netherlands. The Company also
maintains an office in Limerick, Ireland on a set fee arrangement. The
research and development and customer support groups are located in New York,
New York; Dulles, Virginia; Cary, and London.
As of December 27, 1999, the Company owns a building in Windsor, England due
to the acquisition of Template. The Company is in the process of selling this
building.
Item 3. Legal Proceedings.
In December 1997, Seer , instituted litigation in London, England against
Saadi Abbas ("Abbas") and Cambridge Business Solutions (UK) Ltd. ("CBS")
concerning a dispute over a license agreement between Seer, CBS and Abbas.
These entities counterclaimed against Seer. The case has proceeded through
discovery and various other procedural events and all that remains of the
litigation at this point in time are various claims against Seer by Abbas and
CBS. In July, most of those claims were struck out by the court in London as
unarguable or otherwise time barred. The Company intends to continue to
vigorously defend against the few remaining claims. The Company has made
provision for its estimated costs to resolve this matter. Management does not
believe at this point in the litigation that any additional amounts required
to ultimately resolve this matter will have a material effect on the financial
position, cash flows, or results of operations of the Company.
During April 1998, the Company sold substantially all assets and operations
of its wholly owned subsidiary ProfitKey International, Inc. ("ProfitKey").
According to the terms of the ProfitKey sale agreement, the purchase price is
subject to adjustment to reflect any variance in working capital from a
specified amount. The purchaser has notified the Company that it believes
there are substantial adjustments which would require a reduction in the
purchase price. The Company and the purchaser pursuant to the terms of the
settlement agreement, entered arbitration proceedings to resolve this matter
and a discussion from the arbitrator is expected soon. The Company has made a
provision for its estimate of the purchase price adjustment and the costs to
resolve this matter. Management believes at this time that any additional
provision required to ultimately resolve this matter will not have a material
effect on the financial position, cash flows, or results of operations of the
Company.
On June 30, 1999, Template, filed a claim with the National Association of
Securities Dealers, Inc. for arbitration against Merrill Lynch Pierce Fenner &
Smith ("Merrill Lynch") seeking compensatory damages of $950,000, plus
attorney's fees and lost income resulting from advice rendered by Merrill
Lynch to purchase, and the failure of Merrill Lynch to divest at Template's
instruction, a portfolio of zero coupon long-term bonds held by Template. On
December 27, 1999, Template Software, Inc. was merged into TSAC, Inc., a
wholly owned subsidiary of the Company. Discovery has commenced in the
arbitration. TSAC expects that the arbitration will be completed by the end of
summer 2000. TSAC cannot at this time predict the outcome of these
proceedings. Management does not believe that the results of this arbitration
will have a material effect on the financial position, cash flows, or results
of operations of TSAC or the Company.
On July 15, 1999, Template filed an action against Manugistics, Inc. in the
United States District Court for the Eastern District of Virginia, seeking
compensatory damages of approximately $1.25 million resulting from breach of
certain representations contained in a license agreement for Manugistics-
developed software. Manugistics filed a counterclaim against the Company,
asserting breach of contract, breach of alleged settlement, and wrongful
hiring. On October 19, 1999, the Company filed an amended complaint to include
two additional claims, fraud in the inducement and constructive fraud, seeking
additional damages of $2 million. Subsequent to December 31, 1999, the Company
settled this litigation.
14
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.
The following matters were submitted to the Company's shareholders for a vote
at a special meeting of shareholders held on December 24, 1999:
To approve the issuance of shares of Level 8 common stock in accordance with
the merger agreement between Template Software, Inc. and TSAC, Inc., a wholly
owned subsidiary of the Company.
For: 6,618,229
Against: 1,100
Abstain: 1,370
Broker non-votes: 1,890,106
To consider and vote upon an amendment to the Company's 1997 Stock Option
Plan increasing the number of shares of Level 8 common stock subject to awards
thereunder from 2,600,000 to 4,000,000.
For: 6,346,629
Against: 273,105
Abstain: 2,965
Broker non-votes: 1,890,106
There were 8,909,572 voting shares outstanding on November 15, 1999, the date
of record.
15
PART II
Item 5. Market For Registrant's Common Stock and Related Shareholder Matters.
During fiscal years 1998 and 1999, the common stock of the Company was
traded on the Nasdaq Stock Market under the symbol "LVEL." The Company has
never declared or paid any cash dividends on its Common Stock. The Company
anticipates that all of its earnings will be retained for the operation and
expansion of the Company's business and does not anticipate paying any cash
dividends in the foreseeable future. The Company's credit agreements require
the Company to obtain approval from its lenders prior to declaration or
payment of any cash dividends on its common stock. The chart below sets forth
the high and low stock prices for the quarters of the fiscal years ended
December 31, 1998 and 1999.
1998 1999
--------------- ---------------
Quarter High Low High Low
------- ------- ------- ------- -------
First........................................ $16.313 $10.375 $16.250 $ 7.625
Second....................................... $14.000 $ 8.375 $13.125 $ 7.938
Third........................................ $11.000 $ 6.563 $14.000 $ 9.375
Fourth....................................... $ 9.875 $ 5.000 $46.438 $11.500
The closing price of the common stock on December 31, 1999 was $34.563 per
share. As of February 25, 1999, the Company had 127 registered shareholders of
record.
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.
For 1999, the following data includes the Company, Level 8 Technologies,
Seer and Template since its acquisition on December 27, 1998. For 1998, the
following data includes the Company, Level 8 Technologies and Momentum since
its acquisition on March 26, 1998. For 1997, the following data includes the
Company, ASU, and Level 8 Technologies. For 1996, the following data includes
the Company, ASU, and Level 8 Technologies. For 1995, the following data
includes the Company for the full year and Level 8 Technologies since its
acquisition on April 1, 1995.
16
Year Ended December 31,
(in thousands, except per share data)
----------------------------------------------
1995 1996 1997 1998 1999
------- -------- -------- -------- --------
SELECTED STATEMENT OF
OPERATIONS DATA
Revenue....................... $ 3,012 $ 7,272 $ 14,680 $ 10,685 $ 52,920
Net income (loss) from
continuing operations........ (429) (845) 1,036 (23,688) (15,477)
Net income (loss) from
continuing operations per
common and common equivalent
share--basic................. (.10) (.14) .16 (3.14) (1.78)
Net income (loss) from
continuing operations per
common and common share--
diluted...................... (.10) (.14) .14 (3.14) (1.78)
Weighted average common and
common equivalent shares
outstanding--basic........... 4,314 6,076 6,992 7,552 8,918
Weighted average common and
common equivalent shares
outstanding--diluted......... 4,314 6,076 7,561 7,552 8,918
At December 31,
----------------------------------------------
1995 1996 1997 1998 1999
------- -------- -------- -------- --------
SELECTED STATEMENT OF
OPERATIONS DATA
Working capital (deficiency).. $ 4,103 $ 11,007 $ 15,826 ($19,554) 1,464
Total assets.................. 15,059 20,787 23,482 70,770 133,581
Long-term debt, net of current
maturities................... 43 23 16 1,541 22,202
Loans from related companies,
net of current maturities.... 454 331 202 12,519 4,000
Stockholders' equity.......... 11,499 18,300 20,371 8,892 72,221
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General Information and Recent Developments
Level 8 specializes in delivering software solutions that help companies
integrate new and existing computer applications and extend these applications
to the Internet to support eBusiness and eCommerce. This specialization is
called enterprise application integration or "EAI." Level 8's products and
services are designed to enable organizations to address business process
automation and application integration in a simple and cost effective way.
Level 8 provides customers with software to link their critical business
applications internally across the enterprise and externally with strategic
business-to-business partners and business-to-business consumers via the
Internet.
Level 8 offers a suite of products for eBusiness and eCommerce under the
Geneva brand name. The Geneva Integration Suite has six core components which,
together, provide the most complete suite of integration software products
available for eBusiness integration. These components include Geneva
Enterprise Integrator (formerly Enterprise Integration Template), Geneva
Business Process Automator (formerly Business Process Template), Geneva
Integration Broker (formerly Geneva Integrator), Geneva Message Queuing,
Geneva AppBuilder, and Geneva XIPC (formerly XIPC).
In addition to these products, Level 8 also provides technical support,
training and consulting services as part of its commitment to providing its
customers industry-leading enterprise application integration solutions. Level
8's worldwide consulting team has in-depth experience in developing successful
enterprise-class solutions as well as valuable insight into the business
information needs of customers in the Global 5000. Level 8 offers consulting
services around its products for eBusiness and eCommerce enablement. These
services include project management, application and platform integration,
application design and development, and application renewal along with
expertise in a wide variety of development environments and programming
languages.
17
During April 1999, the Company completed its acquisition of Seer
Technologies, Inc. ("Seer"). The Company purchased the remaining minority
interest in Seer, for $0.35 per share of the outstanding common stock in cash.
The total purchase price for the remaining 31% of Seer was $1.7 million. As a
result of the completion of acquisition, Seer became a wholly owned subsidiary
of the Company.
In December 1999, the Company acquired Template for approximately $64
million in cash and stock. Level 8's management team identified Template as a
provider of technologies that enables Level 8 to be one of the first to market
with a comprehensive product portfolio representing the next generation of EAI
solutions for eBusiness. As part of the Template transaction, the Company
obtained an additional $10 million in financing in the form of a 17 month term
loan. The financing was guaranteed by Liraz Systems, Ltd. ("Liraz"), the
Company's principal stockholder, in return for 60,000 shares of the Company's
common stock. The number of shares of common stock provided in exchange for
the guarantee, was determined by the independent directors of the Company
based on market conditions and the Company's anticipated financing needs at
closing. The commitment provides for an interest rate equal to the London
InterBank Offered Rate plus 1% annually.
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, Year 2000 issues 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."
Results Of Operations
The Company's results of operations include the operations of the Company
and its subsidiaries. Operations for the subsidiaries acquired during 1999 and
1998 are included from the date of acquisition. Accordingly, the 1999 and 1998
results of operations include the operations of Template, Seer, and Momentum
since December 27, 1999, December 31, 1998, and March 26, 1998, respectively.
The 1998 results of operations do not reflect any of Seer's operations since
the Company's 69% interest in Seer was not acquired until December 31, 1998.
The shareholders of the remaining 31% of the outstanding voting stock were
considered to have shared in the losses of Seer only for their proportionate
share of Seer's net assets. No minority interest for Seer is reflected in the
Company's consolidated balance sheet at December 31, 1998 because Seer had net
liabilities of $25 million at December 31, 1998. As of December 31, 1998, the
Company has only recorded 69% of the value of the Company's intangible assets,
including the value of in-process technology, which has been written off. On
April 15, 1999, the Company completed a tender offer for the remaining 31% of
Seer and recorded the remainder of the intangible assets, including an
additional write-off of in-process technology. Until the completion of the
tender offer, the Company reported only 69% of any net earnings and 100% of
any net losses of Seer.
Except as otherwise indicated, the discussion below relates to the actual
results of operations without giving pro forma effect to the acquisitions and
dispositions in 1998. Pro forma combined data assumes the acquisition of
Momentum and Seer had each occurred as of January 1, 1998 and does not purport
to be indicative of the results which would have actually been obtained had
the transactions taken place as of such date or of future results of
operations. The acquisitions made in 1998 make it difficult to compare the
actual results of operations for the periods presented. A discussion of 1999
to 1998 comparative results of operations on a pro forma combined basis has
been included below where considered meaningful for an understanding of the
Company's results of operations for the 1999 periods. However, pro forma
combined results reflect the operations of Level 8, Momentum, and Seer on a
separate basis without consideration for any synergies obtained through the
integration of the companies' operations. The operations of Template did not
have a material effect on the 1999 results; therefore, Template is not
included in the pro forma comparisons.
18
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,
----------------------
1999 1998 1997
----- ------ -----
Revenue:
Software.............................................. 30.3 % 14.5 % 29.7%
Maintenance........................................... 28.3 % 10.2 % 0.2%
Services.............................................. 41.4 % 75.3 % 70.1%
----- ------ -----
Total............................................... 100.0 % 100.0 % 100.0%
Cost of revenue:
Software.............................................. 8.0 % 19.3 % 17.4%
Maintenance........................................... 10.2 % 4.5 % 0.1%
Services.............................................. 36.4 % 54.1 % 34.2%
----- ------ -----
Total............................................... 54.6 % 77.9 % 51.7%
Gross profit............................................ 45.4 % 22.1 % 48.3%
Operating expenses:
Sales and marketing................................... 22.7 % 22.3 % 10.4%
Research and product development...................... 12.8 % 26.0 % 7.2%
General and administrative............................ 12.9 % 60.3 % 20.0%
Amortization of goodwill and intangibles.............. 13.2 % 18.1 % 2.9%
Write-off of in-process research and development...... 5.6 % 55.1 % --
Write-off of goodwill................................. -- 43.1 % --
Restructuring charges................................. 0.7 % 14.4 % --
----- ------ -----
Total............................................... 67.9 % 239.3 % 40.5%
Income (loss) from Operations......................... (22.5)% (217.2)% 7.8%
Other income (expense), net........................... (5.4)% (0.8)% 3.0%
----- ------ -----
Income (loss) before taxes............................ (27.9)% (218.0)% 10.8%
Income tax provision.................................. 1.4 % 3.8 % 3.8%
----- ------ -----
Net income (loss) from continuing operations.......... (29.3)% (221.8)% 7.0%
===== ====== =====
The following table sets forth unaudited data for total revenue by
geographic origin as a percentage of total revenue for the periods indicated:
1999 1998 1997
----- ------ -----
United States........................................... 33% 99% 99%
Europe.................................................. 58% -- --
Asia Pacific............................................ 7% -- --
Other................................................... 2% 1% 1%
----- ------ -----
Total............................................... 100% 100% 100%
===== ====== =====
Years Ended December 31, 1999, 1998, and 1997
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, with the largest
portion of revenue typically recognized in the last month of each quarter. The
Company believes that these patterns are attributable to the
19
budgeting and purchasing cycles of customers and also, the Company's sales
commission policies, which compensate sales personnel for meeting or exceeding
quarterly quotas. The Company typically does not have any material backlog of
unfilled software orders, and product revenue in any quarter is substantially
dependent upon orders received in that quarter. Because the Company's
operating expenses are based on anticipated revenue levels and are relatively
fixed over the short term, variations in the timing of recognition revenue can
cause significant variations in operating results from quarter to quarter.
Fluctuations in operating results may result in volatility in the price of the
Company's common stock.
Total revenues increased 395% from 1998 to 1999 and decreased 27% from 1997
to 1998. Total revenues increased significantly from 1998 to 1999 primarily
due to the acquisitions of Momentum and Seer during 1998 and increased sales
of software products. The decrease from 1997 to 1998 was primarily
attributable to a decrease in software products revenue, along with a
reduction in services revenue. The gross margins were 45%, 22%, and 48% for
1999, 1998, and 1997, respectively.
On a pro forma combined basis, total revenues for 1998 were $67.2 million.
The $14.3 million decline in revenue on a pro forma combined basis is
primarily due to a decline in the number of former Seer consulting resources
employed in 1999 compared to 1998. The gross margin for 1998 on a pro forma
combined basis was approximately 23%.
Software Products. Software products revenue increased 933% in 1999 in
comparison to 1998 and decreased 64% from 1997 to 1998. The significant
increase from 1998 to 1999 is primarily due to the sales of products acquired
from Seer in 1998 coupled with sales of the Company's new Geneva Integration
Broker product (formerly Geneva Integrator).
During 1997, the Company's product sales were primarily resales of IBM's MQ
Series licenses. During 1998, the Company's software sales were primarily
resales of IBM's MQ Series licenses and sales of Geneva Message Queing
(formerly FalconMQ) and Geneva XIPC (formerly XIPC) messaging products. The
decrease in software revenue from 1997 to 1998 is the result of the Company's
shift in strategic direction primarily relating to the Company's dispositions
and acquisitions in 1998, as well as reduced emphasis on resales of IBM's MQ
Series licenses in favor of the Company's messaging products developed by the
Company.
Through its acquisitions in 1998, the Company acquired Momentum's XIPC
messaging product and Seer's HPS products, now known as Geneva AppBuilder,
which is used for application engineering. As discussed above, the Company
began selling Geneva Integration Broker, an EAI solution, during the second
quarter of 1999. Additionally, with the acquisition of Template, the Company
added their products to its offering and recorded initial sales of Template's
former Enterprise Integration Template and Business Process Template products
in the fourth quarter of 1999.
Software products revenue has continued to grow as a percentage of total
revenue, reflecting the Company's emphasis on expanding product sales.
Management believes software products revenue will continue to increase over
the next several quarters.
The gross margin on software products was 74%, (33)%, and 41% for the 1999,
1998, and 1997 fiscal periods, respectively. The improvement in gross margins
from 1998 to 1999 was due to the significant increase in software products
revenue. Cost of software is composed primarily of amortization of capitalized
software and royalties to third parties for the Company's Geneva Message
Queuing product and to a lesser extent production and distribution costs. This
increase in cost of software was primarily due to amortization of capitalized
software from Momentum's and Seer's developed technology, which was valued as
part of the purchase accounting for these business combinations, and royalties
which are principally for technology acquired in 1998 from Liraz, the
Company's principal shareholder. The decrease in gross margins between 1997
and 1998 is the effect of increased amortization costs, lower software product
revenues, royalties to Liraz under the joint development agreement, and a
write-off of approximately $.3 million of capitalized technology costs.
Software amortization will increase in 2000 due to the $12.2 million of
developed technology acquired in the Template acquisition resulting in
approximately $.5 million per quarter.
20
Services. Services revenue increased 172% from 1998 to 1999 and decreased by
22% from 1997 to 1998. Services gross margins were 12%, 28%, and 51% for 1999,
1998, and 1997 respectively. Cost of services primarily includes personnel and
travel costs related to the delivery of services.
The increase in services revenue from 1998 to 1999 was primarily a result of
the Seer acquisition, which resulted in adding an average of 115 consultants
during 1999. Changes in the composition of the Company's services revenue have
caused margins to decline in 1999, since the Geneva AppBuilder-related
services have historically generated lower margins than the Company's other
service offerings. The Company is seeking to improve its consulting margins
through improvement in the utilization of its consultants and attempting to
provide higher margin services for the Company's Geneva Integration Broker,
Geneva Message Queuing, and recently acquired Template products.
The services revenue decline from 1997 to 1998 was primarily attributable to
the decline in software products revenue and the resultant decline in
utilization of billable services. The decline in software products revenue
impacted services revenue as there were fewer new customers than in the prior
year, reducing the base of the customers utilizing the Company's consulting
and training services as part of an overall technology solution purchase.
Gross margins decreased in 1998 in relation to 1997 due to lower than normal
billable utilization of consultants caused by project delays.
On a pro forma combined basis, services revenue for 1998 was $47 million.
The decrease from 1998 to 1999 is chiefly due to a decline in the amount of
Geneva AppBuilder related services provided, due to the low level of software
products sold by Seer in the year preceding the acquisition, as well as a
decline in the number of consulting personnel on a pro forma basis.
Maintenance. Maintenance revenue increased significantly from 1998 to 1999
primarily due to the addition of Geneva AppBuilder to the Company's products,
which has historically had a significant revenue stream from maintenance. The
increase from 1997 to 1998 is primarily due to the addition of the Geneva XIPC
product acquired from Momentum. Prior to the Momentum acquisition, the Company
did not have a significant amount of maintenance revenue as its primary source
of license revenue was from reselling IBM's MQ Series licenses. On a pro forma
combined basis, maintenance revenue for 1998 was $14.4 million, which is
relatively consistent with 1999.
Gross margins on maintenance were 64%, 56%, and 47% for 1999, 1998, and
1997, respectively. Cost of maintenance is comprised of personnel costs and
related overhead, and beginning in 1999 includes the cost of third-party
contracts for the maintenance and support of the Company's Geneva AppBuilder
products. The increase in gross margins is primarily due to the addition of
the Geneva AppBuilder and Geneva XIPC to the Company's products from which the
Company has created additional economies of scale in 1999.
Sales and Marketing. Sales and marketing expenses primarily include
personnel costs for salespeople, travel, and related overhead, as well as
analyst subscriptions, trade show participation, and other promotional
expenses. Sales and marketing expenses increased fourfold from 1998 to 1999
and 57% from 1997 to 1998 due to an increase in the size of the Company's
sales force, both through acquisition and recruiting. During 1999, the number
of sales and marketing personnel doubled from the beginning of the year to the
end. This increase in personnel is due to the reorganization of the Company's
sales and promotional activities to correspond with its new product strategy,
as well as the Company's expansion into the global marketplace with the
acquisitions of Seer and Template. The Company intends to continue to increase
its spending in the sales and marketing area in an effort to increase software
products revenue through heightened market awareness and improved acceptance
of its products and expanding its indirect distribution network.
Research and Development. Research and development expenses primarily
include personnel costs for product authors, product developers and product
documentation personnel. Research and development expense increased 145% from
1998 to 1999 and 163% from 1997 to 1998. The increases in 1998 and 1999 are a
result of the Company's investment in new products, primarily Geneva
Integration Broker, which was released in the
21
second quarter of 1999 and Version 2.0 of Geneva Message Queuing which was
released in the fourth quarter of 1999. The expense increase in 1999 is also
attributable to the acquisition of Seer and the personnel added to this area
of the Company as a result of the acquisition. Management expects this trend
to continue and has increased the number of personnel by approximately 50%
with the acquisition of Template, as the Company's continues to more tightly
integrate its products and attempts to strengthen its position in the EAI
marketplace.
General and Administrative. General and administrative expenses consist of
personnel costs for the executive, legal, financial, human resources, and
administrative staff and related overhead and non-allocable corporate costs of
operating the Company. General and administrative expenses increased 6% from
1998 to 1999 and 118% from 1997 to 1998. These expenses decreased as a
percentage of revenue for 1999 due to synergies obtained through the
integration of Seer and management's focus to bring general and administrative
expenses to a more reasonable level in relation to revenue.
Amortization of Goodwill and Other Intangible Assets. Amortization of
intangible assets, primarily goodwill, was $7 million, $1.9 million, and $.4
million for 1999, 1998, and 1997, respectively. The amortization of goodwill
in 1997 was related to the purchase of Level 8 Technologies in April 1995. The
amortization of goodwill in 1998 was related to the purchase of Level 8
Technologies and beginning in the second quarter included amortization related
to the purchase of Momentum in March, 1998. In 1999, amortization of
intangible assets also includes the amortization of goodwill and other
intangible assets related to the purchase of Seer. Due to the acquisition of
Template, the Company will incur approximately $1.8 million per quarter in
additional amortization expense beginning in the first quarter of 2000.
Purchased Research and Development. Based on the results of third-party
appraisals, the Company recorded charges in 1998 of $1.2 million in the first
quarter and $4.7 million in the fourth quarter in order to expense purchased
in-process research and development costs related to the acquisition of
Momentum and Seer, respectively. As a result of completing the acquisition of
the remaining 31% of Seer, the Company recorded a charge of $.7 million for
in-process research and development costs in the second quarter of 1999. As
part of the acquisition of Template, the Company recorded a charge to expense
in-process research and development costs related to the acquisition of
Template in the amount of $2.2 million.
For all in-process research and development charges recorded in 1998 and
1999, it was determined that the acquired in-process research and development
had not yet reached technological feasibility and had no alternative future
uses. The value of the in-process projects was adjusted to reflect the
relative value and contribution of the acquired research and development. In
doing so, management gave consideration to the stage of completion, the
difficulty of completing the remaining development costs already incurred, and
the projected cost to complete the projects. The value assigned to purchased
in-process technology was based on key assumptions, including revenue growth
rates for each technology considering, among other things, current and
expected industry trends, acceptance of the technologies and historical growth
rates for similar industry products.
Other charges. As a result of the acquisitions of Template, Momentum, and
Seer, the Company recorded several charges. In 1998, as a consequence of the
Company's transition to an enterprise application integration solutions
provider, the Company abandoned certain planned development efforts for
products acquired in the Momentum transaction and reassessed the remaining
undiscounted projected cash flows related to the identifiable and
unidentifiable intangible assets acquired from Momentum. It was concluded
that, with the principal exception of the Momentum technology utilized in the
Level 8's product suite and the Geneva XIPC products, the goodwill and
intangible acquired in the Momentum transaction should be written off.
Accordingly, during the fourth quarter of 1998, the Company adjusted the
carrying value of its identifiable and unidentifiable assets to their fair
value of $32.2 million, resulting in a non-cash impairment loss of $4.6
million.
During the fourth quarter of 1999, the Company reorganized its existing
operations due to its acquisition of Template. The Company's restructuring,
included a management change in its development and operations areas, the
abandonment of certain leased facilities, and the closure of its French
subsidiary. The Company recorded a restructuring charge of $.55 million, which
consisted of approximately $.28 million in costs associated with
22
improving leased space to be subleased, approximately $.23 million in
personnel-related charges, and approximately $.04 million in professional fees
to close its French subsidiary. Through December 31, 1999, the Company had not
paid any cash related to these restructuring charges.
At December 31, 1999, the Company revised its estimate of the 1998
restructuring charge by reducing it by $.16 million based on a review of the
costs paid through December 31, 1999 and the remaining estimated costs. The
change in estimate is reflected in the 1999 Consolidated Statement of
Operations as a reduction of the restructuring charge for 1999.
During the fourth quarter of 1998, the Company reorganized its existing
operations due to its acquisition of Seer. The restructuring included a staff
reduction in its development and administrative areas of 20% (15 employees),
the abandonment of certain leased facilities, and the write-down to fair value
of certain capitalized software costs for product lines which were being
discontinued. The Company recorded a restructuring charge of approximately
$1.54 million, which consisted of approximately $.71 million in personnel-
related charges, approximately $.29 million in costs associated with carrying
vacated space until the lease expiration date, approximately $.19 million of
property and equipment related charges, approximately $.24 million in write-
down of capitalized software costs, approximately $.1 million in professional
fees related to the restructuring, and approximately $.01 million for other
charges. Through December 31, 1999, the Company has paid approximately $.86
million in cash related to the restructuring.
The Company believes the accrued restructuring cost of $.63 million at
December 31, 1999 represents its remaining cash obligations for the
restructuring charges included above.
Provision for Income Taxes. The Company's effective income tax rate for
continuing operations differs from the statutory rate primarily because an
income tax benefit was not recorded for the net losses incurred during 1999
and 1998. The provision for income taxes in 1997, was approximately 35% due to
income from operations. Because of the Company's inconsistent earnings
history, the deferred tax assets have been fully offset by a valuation
allowance. The income tax provision for 1999 is primarily related to income
taxes from profitable foreign operations and foreign withholding taxes.
Discontinued Operations. The loss on disposal of ProfitKey during 1998 was
approximately $1.2 million. The loss on discontinued operations related to
ProfitKey was $.14 million for 1998.
Impact Of Inflation. Inflation has not had a significant effect on the
Company's operating results during the periods presented.
Liquidity and Capital Resources
Cash and cash equivalents increased $3.7 million during 1997 to $7.0 million
at year end. The increase was due primarily to the Company's redemption of
investments in marketable securities offset by a $1.7 million investment for
capitalized software development costs and equipment, and a $.9 million use of
cash in investing activities by the Company's discontinued operations. The
Company funded its operations in 1997 with cash remaining from the $9.1
million in net proceeds from its 1996 offering.
During 1998, cash and cash equivalents decreased by $1 million to $6 million
at year end. The decrease in cash was due to the purchase of $.9 million in
equipment, spending of $1.2 million for capitalized software development
costs, and debt service of $1.5 million. This decrease was offset by $1.7
million of cash provided by operations, $.5 million from the sale of
ProfitKey, and $.4 million of net cash acquired from acquisitions.
Additionally, the Company borrowed $12 million from Liraz which was used to
pay down Seer's bank debt on December 31, 1998.
During 1999, cash and cash equivalents increased by $.4 million to $6.5
million at year end. The increase in cash is due to cash provided by financing
activities, including $19.2 million in net proceeds from issuance of
23
shares of preferred stock and $17.3 million in proceeds from the issuance of
shares of common stock due to the exercise of stock options and warrants.
These financing inflows, combined with approximately $16.7 million of
additional borrowings, were used to retire $12.6 million of debt obligations,
fund additional acquisition activity, and fund the $12.9 million net cash used
in operations.
On December 27, 1999, the Company acquired all of the outstanding common
stock of Template for a combination of stock and cash. Purchase consideration
was $21.6 million in cash. The Company partially funded this acquisition with
a $10 million term loan from a commercial bank, which was guaranteed by the
Company's principal shareholder in exchange for 60,000 shares of common stock.
The term loan is due on May 31, 2001 and has an interest rate of LIBOR plus
1%, approximately 7.2% at December 31, 1999.
In June 1999, the Company agreed to sell 21,000 shares of Series A 4%
Convertible Redeemable Preferred Stock, for $21 million, convertible into an
aggregate of 2,100,000 shares of the Company's common stock. During the second
quarter, the Company used $4 million to pay down the Credit Facility. During
the third quarter, the Company paid down $8 million of the $12 million loan
from Liraz.
Holders of the Series A Preferred Stock are entitled to receive 4% annual
cash dividends payable quarterly. The Series A Preferred Stock may be redeemed
at the option of the Company at a redemption price equal to the original
purchase price at any time after June 29, 2000 if the closing price of the
Company's common stock over 20 consecutive trading days is greater than $20
per share. In the event the Company breaches its obligations to pay dividends
when due or issue common stock upon conversion, or the Company's common stock
is delisted, the dividend rate on the Series A Preferred Stock would increase
to 18% per annum (partially payable in shares of common stock at the option of
Level 8 during the first 60 days of such increased dividend rate). As part of
the $21 million financing, the Company also issued the investors warrants to
purchase 2.1 million shares of common stock at an exercise price of $10 per
share. These warrants are callable by the Company on the same terms as the
preferred stock, which is outlined above. Investors in the Series A Preferred
Stock and warrants include Advanced Systems Europe B.V., which purchased $10
million of Series A Preferred Stock and warrants in the transaction, and is a
subsidiary of Liraz Systems, Ltd., Level 8's the Company's principal
stockholder.
Subsequent to the issuance of the Series A Preferred Stock, shareholders
have exercised warrants resulting in the issuance of approximately 1.26
million shares of the Company's common stock and resulting in net proceeds of
approximately $12.6 million.
On April 15, 1999, the Company acquired the remaining 31% minority interest
in Seer, through a tender offer and merger for approximately $1.7 million in
cash.
During the fourth quarter of 1998, the Company issued $3 million in notes to
the sellers of Momentum as additional consideration, as provided for in the
purchase agreement. These notes bear interest at 10% per year retroactive to
the Momentum acquisition date of March 26, 1998, payable in four equal
installments plus interest on December 1, 1998, November 26, 1999, November
20, 2000, and November 15, 2001. There are no financial covenants in these
notes. As of December 31, 1999 $2.25 million was outstanding. Subsequent to
December 31, 1999, the Company offered to exchange notes held by former
Momentum stockholders for shares of the Company's common stock based on the
average market price of the common stock for a set period prior to the date of
offer acceptance. The Company converted $1.9 million of the Momentum notes to
common stock in the first quarter of 2000.
In addition to the debt obligations related to its acquisitions activity,
the Company uses an asset-based lending arrangement to finance working capital
needs from operations, if necessary. As of December 31, 1999, the Company had
outstanding borrowings of $15 million under a credit facility with a
commercial bank shared between the Company and it's wholly-owned subsidiary,
Seer, (the "Credit Facility") at an interest rate of 10.5%. The Credit
Facility was amended and currently provides for borrowings up to the lesser of
$25 million or the sum of 80% of eligible receivables and a $10 million term
loan payable on December 31, 2001. The receivables-based borrowings under the
Credit Facility are due on demand. The Credit Facility bears interest at the
prime
24
rate plus 2% per annum and has no financial covenant provisions. The
receivables based borrowing instrument terminates on September 1, 2000;
however, it is automatically renewed for successive additional terms of one
year each, unless terminated by either party. The Credit Facility is
collateralized by the Company's accounts receivable, equipment and
intangibles, including intellectual property. All debt payable to Liraz and
other lenders is subordinate in right of payment to the Credit Facility.
As of December 31, 1999, the Company did not have any material commitments
for capital expenditures. Future maturities on the Company's outstanding debt
at December 31, 1999 include $5.9 million in 2000 and $26.2 million in 2001.
Of such amounts, $.5 million in 2000 and $4 million in 2001 are due to Liraz,
the Company's principal shareholder.
During 1999, the Company had EBITDA, exclusive of acquisition related
charges, of $3.1 million and incurred a net loss of $15.5 million. The Company
has working capital of $1.5 million and an accumulated deficit of $41.1
million at December 31, 1999. The Company believes that existing cash on hand,
cash provided by future operations and additional borrowings under the Credit
Facility will be sufficient to finance its operations and expected working
capital and capital expenditure requirements for at least the next twelve
months so long as the Company continues to perform to its operating plan.
However, there can be no assurance that the Company will be able to continue
to meet its cash requirements through operations or, if needed, obtain
additional financing on acceptable terms, and the failure to do so may have an
adverse impact on the Company's business and operations. The Company may also
explore additional debt or equity financing to expand its operations and take
advantage of market opportunities.
Year 2000
The Company was aware of the issues associated with the programming code in
existing computer systems as the Year 2000 approached. The "Year 2000 Problem"
was perceived to be pervasive and complex as virtually every computer
operation was affected in some way by the rollover of the two digit year value
to 00. The issue is whether computer systems would properly recognize date
sensitive information when the year changed to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail.
To date, the Company has not suffered any disruptions in its computer
systems or software when the expanded date code field was first used on
January 1, 2000. In addition, to date, the Company has not been made aware
that any third-party systems relied on by the Company, the manufacturing
systems of its vendors or the systems its customers use to order its services
have suffered disruptions in their systems.
Although the costs of the steps to achieve Year 2000 compliance were not
separately tracked, management believes the costs specifically incurred to
obtain Year 2000 compliance were not material. At this time, the Company does
not expect to incur future material expenditures relating to Year 2000
compliance matters.
Euro Conversion
Several European countries adopted a Single European Currency (the "Euro")
as of January 1, 1999 with a transition period continuing through January 1,
2002. The Company is reviewing the anticipated impact the Euro may have on its
internal systems and on its competitive environment. The Company believes its
internal systems will be Euro capable without material modification cost.
Further, the Company does not presently expect the introduction of the Euro
currency to have an adverse material impact on the Company's financial
condition, cash flows, or results of operations.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Approximately 67% of the Company's 1999 revenues were generated by sales
outside the United States. The Company is exposed to significant risks of
foreign currency fluctuation primarily from receivables
25
denominated in foreign currency and are subject to transaction gains and
losses, which are recorded as a component in determining net income.
Additionally, the assets and liabilities of the Company's non-U.S. operations
are translated into U.S. dollars at exchange rates in effect as of the
applicable balance sheet dates, and revenue and expense accounts of these
operations are translated at average exchange rates during the month the
transactions occur. Unrealized translation gains and losses will be included
as an adjustment to shareholders' equity.
Based upon the foregoing, the Company began hedging its foreign currency
receivables in the third quarter of 1999 in an effort to reduce its exposure
to currency exchange rates. However, as a matter of procedure, the Company
will not invest in speculative financial instruments as a means of hedging
against such risk. The Company's accounting policies for these contracts are
based on the Company's designation of the contracts as hedging transactions.
The criteria the Company uses for designating a contract as a hedge include
the contract's effectiveness in risk reduction and one-to-one matching of
derivative instruments to underlying transactions. Gains and losses on forward
foreign exchange contracts are recognized in income in the same period as
gains and losses on the underlying transactions. If an underlying hedged
transaction is terminated earlier than initially anticipated, the offsetting
gain or loss on the related forward exchange contract would be recognized in
income in the same period. In addition, since the Company enters into forward
contracts only as a hedge, any change in currency rates would not result in
any material net gain or loss, as any gain or loss on the underlying foreign
currency denominated balance would be offset by the gain or loss on the
forward contract. Information regarding the Company's foreign currency forward
exchange contracts is set forth in Note 13 of Item 14(a)(1) of this Form 10-K
and is incorporated herein by reference.
Item 8. Financial Statements And Supplementary Data.
The information required by this item appears beginning on page F-1 of this
report. See Items 14(a)(1) and (2).
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure.
On January 21, 1999, the Company engaged PricewaterhouseCoopers LLP to
replace Grant Thornton LLP as its independent auditors. For further
information regarding this change, reference is made to the Company's Forms 8-
K filed with the Securities and Exchange Commission (the "Commission") on
December 22, 1998 and January 21, 1999 and the Form 8-K/A filed with the
Commission on January 11, 1999. Reference is also made to the Letter to the
Commission from Grant Thornton LLP dated January 11, 1999 and filed as Exhibit
99.2 to the Form 8-K/A on January 11, 1999.
26
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by this item is incorporated by reference to
information to be included under the captions "Election of Directors,"
"Executive Officers" and "Compliance with Section 16(a) of the Securities
Exchange Act of 1934" in the Company's Proxy Statement for the 2000 Annual
Meeting of Shareholders.
Item 11. Executive Compensation.
The information required by this item is incorporated by reference to
information to be included under the captions "Election of Directors--Director
Compensation" and "--Compensation Committee Interlocks and Insider
Participation," "Executive Compensation," "Compensation Committee Report on
Executive Compensation" and "Stock Performance Graph" in the Company's Proxy
Statement for the 2000 Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is incorporated by reference to
information to be included under the caption "Beneficial Ownership of Common
Stock" in the Company's Proxy Statement for the 2000 Annual Meeting of
Shareholders.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is incorporated by reference to
information to be included under the caption, "Certain Relationships and
Related Party Transactions" and "Election of Directors--Compensation Committee
Interlocks and Insider Participation" in the Company's Proxy Statement for the
2000 Annual Meeting of Shareholders.
27
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as part of this Report:
1.Financial Statements:
The Company's financial statements were previously filed with a Form
8-K on March 17, 2000. The Company is including the same financial
statements within this Form 10-K for the readers' convenience.
The following financial statements of the Company and the related
report of independent accountants thereon are set forth immediately
following the Index of Financial Statements which appears on page F-
1 of this report:
Reports of Independent Certified Public Accountants
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Operations for the years ended December
31, 1999, 1998 and 1997
Consolidated Statements of Changes in Shareholders' Equity for the
years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended December
31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
2.Financial Statement Schedules:
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.
3. (a) Exhibits: The following exhibits are filed as part of this
Report. Parenthetical references indicate incorporation by reference
to documents previously filed by the Company with the Securities and
Exchange Commission.
2.1 Agreement and Plan of Reorganization by and among Level 8,
Middleware Acquisition Corporation, Momentum Software Corporation,
and Robert Brill, Bruns Grayson and Hubertus Vandervoort, as
Trustees of the Momentum Liquidating Trust, on Behalf of the
Securityholders of Momentum Software Corporation dated February 27,
1998 (filed as exhibit 10.42 to Level 8's Annual Report on Form 10-K
February 27, 1998 (filed as exhibit 10.42 to Level 8's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997, filed
March 31, 1998, File No. 000-26392).
2.2 Agreement dated November 23, 1998 among Level 8 and Welsh, Carson,
Anderson & Stowe VI L.P. ("WCAS") and related parties (the "WCAS
Parties") named therein relating to the acquisition of capital stock
of Seer Technologies, Inc. by the Company (filed as exhibit 2.1 to
the Seer Technologies, Inc. Annual Report on Form 10-K405 for the
fiscal year ended September 30, 1998, filed January 12, 1999, File
No. 000-26194).
2.2A Amendment No. 1 to the Agreement dated November 23, 1998 among the
Level 8 and WCAS and the WCAS Parties relating to the acquisition of
capital stock of Seer (filed as exhibit (c)(2) to Seer Technologies,
Inc.'s Schedule 13e-3 filed on April 8, 1999, File No. 005-54373).
2.3 Agreement and Plan of Merger providing for the reincorporation of
Level 8 Systems under Delaware Law (filed as Appendix A (page 48) to
Level 8's definitive proxy statement for its 1999 annual meeting
filed on Form DEF 14A, filed April 30, 1999, File No. 000-26392).
28
2.4 Agreement and Plan of Merger, dated as of October 19, 1999, by and
among Level 8 Systems, Inc., TSAC, Inc., and Template Software, Inc.
(filed as exhibit 2.1 to Level 8's Report on Form 8-K, filed
November 5, 1999, File No. 000-26392 (exhibits and schedules 15
omitted but will be furnished supplementally to the Securities and
Exchange Commission upon request)).
3.1 Certificate of Incorporation of Level 8 Systems, Inc., a Delaware
corporation (filed as Annex B to Level 8's definitive proxy
statement for its 1999 annual meeting filed on Form DEF 14A, filed
April 30, 1999, File No. 000-26392).
3.2 Bylaws of Level 8 Systems, Inc., a Delaware corporation (filed as
Annex C to Level 8's definitive proxy statement for its 1999 annual
meeting filed on Form DEF 14A, filed April 30, 1999, File No. 000-
26392).
3.3 Certificate of Designation relating to Series A 4% Convertible
Redeemable Preferred Stock (filed as exhibit 3.3 Level 8's Form 8-K
filed July 23, 1999, File No. 000-26392).
4.1 Warrant to Purchase Common Stock, dated September 1, 1998, between
Template Software, Inc. and Eagle Eye Technologies, Inc. (filed as
Exhibit 10.26 to Template Software, Inc.'s Quarterly Report on Form
10-Q for the period ended August 31, 1998, File No. 000-21921).
4.2 Form of Warrant Agreement, between the Company and Hampshire
Securities Corporation for 135,000 shares of common stock (filed as
exhibit 10.27 to Across Data Systems, Inc.'s (Level 8's predecessor)
Registration Statement on Form S-1, filed May 12, 1995, File No. 33-
92230).
4.3 Form of Warrants issued June 29, 1999 in connection with the sale of
Series A 4% Convertible Redeemable Preferred Stock (filed as exhibit
10.2 to Level 8's Form 8-K filed July 23, 1999, File No. 0-26392).
4.4 Form of Warrant(s) representing the 250,000 Level 8 warrants issued
to the WCAS Parties (filed as exhibit 8.2(A) to the Seer
Technologies, Inc. Annual Report on Form 10-K for the year ended
September 30, 1998, filed on January 12, 1999, File No. 000-26194).
4.5 Registration Rights Agreement dated June 29, 1999 among Level 8
Systems, Inc. and the investors named on the signature pages thereof
(filed as exhibit 10.3 to Level 8's Form 8-K filed July 23, 1999,
File No. 0-26392).
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