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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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, 1998.
[ ] 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)
NEW YORK 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)
--------------------
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
----------------------------
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 26, 1999 was approximately $28,131,936. There were
8,720,994 shares of Common Stock outstanding as of March 26, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 1999 Annual Meeting of
Shareholders are incorporated by reference in Part III hereof.
Exhibit Index appears on Page E-1.
LEVEL 8 SYSTEMS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Item Page
Number Number
- ------ ------
PART I
1. Business........................................................... 1
2. Properties......................................................... 11
3. Legal Proceedings.................................................. 11
4. Submission of Matters to a Vote of Security Holders................ 12
PART II
5. Market for Registrant's Common Stock and Related Shareholder
Matters........................................................... 13
6. Selected Financial Data............................................ 13
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 14
7A. Quantitative and Qualitative Disclosures About Market Risk......... 23
8. Financial Statements and Supplementary Data........................ 23
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................. 23
PART III
10. Directors and Executive Officers of the Registrant................. 23
11. Executive Compensation............................................. 23
12. Security Ownership of Certain Beneficial Owners and Management..... 24
13. Certain Relationships and Related Transactions..................... 24
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K... 24
SIGNATURES............................................................... 29
INDEX TO FINANCIAL STATEMENTS............................................ F-1
INDEX TO EXHIBITS........................................................ E-1
PART I
ITEM 1. BUSINESS.
OVERVIEW
Level 8 Systems, Inc. (the "Company" or "Level 8") is a leading provider
of scaleable enterprise application integration solutions. As new computer
technologies have proliferated in enterprise computing environments, the
integration and management of the applications which rely on them has grown in
complexity. Enterprise application integration (or "EAI") solutions address the
emerging need for information systems to deliver enterprise-wide views of a
company's business information and processes. The Company's products and
services are designed to enable organizations to address information systems
integration and management problems in a simple and cost effective way. The
Company provides customers with solutions to link their critical business
applications internally across the enterprise and externally with strategic
business partners. The Company's products and services also enable organizations
to engage in electronic commerce. Electronic commerce or "E-commerce" refers to
business conducted over the Internet. Currently, Level 8's products and services
are sold worldwide through a network of regional sales offices. To date, the
Company's products and services have been utilized by companies in a wide
variety of industries including banking and financial services, insurance,
retail, manufacturing, data processing, public utilities, and transportation.
Specifically, Level 8's customer base includes major corporations around the
world such as ABN AMRO, Information Technology Services Company, Charles Schwab
& Company, Inc., Credit Suisse First Boston, Italia Telecom, Prudential
Insurance Company of America, Sikorsky Aircraft, TeleDenmark A/S, Telenor A/S
and Montgomery Ward & Co., Incorporated.
From inception in 1988 through 1997, the Company provided systems
integration consulting services, primarily to manufacturing businesses in the
State of California. In October 1994, the Company acquired ProfitKey
International, Inc. ("ProfitKey") and Bizware Computer Systems (Canada) Inc.
and, in April 1995, the Company acquired Level 8 Technologies, Inc. ("Level 8
Technologies"). The Company decided to focus on the middleware business of
Level 8 Technologies and sold substantially all the assets of Bizware for
$230,000 on September 9, 1996, and subsequently changed the Company's name to
Level 8 Systems, Inc. In early 1998, the Company sold its ProfitKey
subsidiary and completed the acquisition of Momentum Software Corporation
("Momentum"). See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -General Information and Recent
Developments."
On November 23, 1998, the Company entered into an agreement with Welsh,
Carson, Anderson & Stowe VI L.P. ("WCAS") and certain other parties affiliated
or associated with WCAS pursuant to which the Company agreed to acquire
approximately 69% of the outstanding voting stock of Seer Technologies, Inc., a
Delaware corporation ("Seer"), from WCAS and its affiliates in exchange for
1,000,000 shares of common stock of the Company and warrants to purchase an
additional 250,000 shares of common stock of the Company at an exercise price of
$12 per share. Pursuant to its agreement with WCAS, the Company acquired 69% of
the voting stock of Seer on December 31, 1998 and has commenced a tender offer
to acquire all of the remaining shares of Seer for $0.35 per share in cash. The
Company has also agreed to acquire any remaining shares of Seer following
completion of the tender offer through a merger at the same $0.35 cash price per
share. The Company expects to complete its acquisition of the entire equity
interest in Seer in the second quarter of 1999.
The Company was incorporated under New York law in 1988 under the name
Advanced Systems U.S.A. (LSU) Inc., and was initially a wholly owned
subsidiary of Liraz Systems Ltd. ("Liraz"), an Israeli public company in the
systems integration business. The Company's principal executive offices are
located at 8000 Regency Parkway, Cary, North Carolina 27511, telephone number
(919) 380-5000.
INDUSTRY BACKGROUND
A significant challenge facing global 5000-sized companies today is the
integration of critical business applications which run on disparate computer
systems. Business and competitive pressures are driving the demand for
information systems that 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 investment in information technology.
EAI solutions, including those developed by the Company, are designed to
provide these capabilities through an open, enterprise-wide infrastructure
that can accomplish the complete integration of a Company's entire
1
computing systems environment, including technologies enabling E-commerce. In
addition, EAI encompasses extending the productive life cycle of existing
systems by adding new functionality and by cost-effectively managing all aspects
of the development, deployment, and continued enhancement of existing systems.
Indeed, the Company believes that lines between "new" development and what has
in the past been considered "maintenance" are blurring. More and more of the
"new" development going forward is going to be in the area of enhancing the
functionality of existing systems in an enterprise's computing infrastructure.
Key factors driving the current need for EAI solutions include:
- The current computer systems of many companies were developed in
an era when systems tended to be self-contained. The ability of
the systems to communicate with other systems was not considered
important. As a result, many current systems were not designed to
accommodate communications with different systems.
- 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.
- Many global 5000-sized companies have made significant recent
investments in ensuring that their existing systems will be able
to function properly in the year 2000 and beyond. The size of the
investment 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.
- 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 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 operate
intranet and E-commerce 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.
PRODUCTS AND SERVICES
The Company's goal is to be a recognized leader in the growing market for
EAI solutions. The Company's solutions combine software products and consulting
services to help enterprises meet their application development, integration and
management needs. FalconMQ, first introduced in early 1998, replicates Microsoft
Corporation's Message Queue Server ("MSMQ") capability on non-Microsoft systems,
thereby enabling non-Microsoft systems to communicate freely with Windows NT
systems using MSMQ. The new Geneva Integration Server, scheduled for official
launch in April 1999 and expected to become one of the Company's leading
products, is designed to provide comprehensive, secure and reliable
interoperability between applications running on disparate and otherwise
incompatible computer systems. As a result of the Seer acquisition, the Company
also offers the Seer*HPS product, which is a set of application development
tools that assists customers in developing and adapting enterprise-wide computer
applications for client/server networks. In addition to its products, the
Company offers a broad range of consulting services in the EAI solutions area.
The Company's consulting staff is highly experienced in large-scale,
enterprise-wide applications and the complex networked computing environments in
which they run. To position the Company as a leading global provider of EAI
solutions, the Company has developed a plan for staged product development and
integration as well as service enhancements which management believes will
enable the Company to effectively accomplish its objectives.
FALCONMQ
In client/server networks, messages that contain information and/or
processing instructions are passed from one system to one or more other systems
for processing. A completion message is returned to the originating system
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when all of the steps in the transaction are completed. In the synchronous
communication model traditionally used within client/server networks, the system
sending the message must wait until it receives a return message that the
transaction was completed before sending the next message to start a new
transaction. This results in a significant amount of wasted system capacity,
since both the client and server systems must sit idle waiting for a response
before moving on to the next task.
Message queuing technology, such as that found in Microsoft's MSMQ
product and IBM's MQ Series, was developed to eliminate the wasted capacity
problem associated with synchronous communication by enabling more sophisticated
asynchronous communication. In asynchronous communication, a client or server
performs a function and then dispatches that function in the form of a "message"
to its opposite member and immediately moves on to perform the next function.
Once the dispatched function has been processed by the opposite member, the
result is then "messaged" back to the client or server for further processing.
In addition, message queuing is used by developers to guarantee reliable data
delivery in applications, even if the network goes down.
FalconMQ is message-oriented middleware technology intended to provide
the asynchronous communication capability of MSMQ on non-Microsoft systems, such
as UNIX systems, MVS operating systems for IBM mainframe computers, IBM AS/400
systems, Sun Microsystems' SOLARUS systems and LINUX systems. FalconMQ is
designed for developers to leverage the power and flexibility of message queuing
on the systems mentioned above. Accordingly, FalconMQ permits the free exchange
of messages over a network between any MSMQ application and any FalconMQ client
applications.
The current version of the FalconMQ product requires that the message
queues themselves reside on a Microsoft Windows NT system. The Company is
developing version 2.0 of FalconMQ, currently targeted for release in early
2000, that will allow message queues to reside on all non-Microsoft systems
supported by FalconMQ. This additional capability of FalconMQ version 2.0 is
designed to enable seamless interconnectivity between applications running on a
broad spectrum of systems on an enterprise-wide basis.
GENEVA INTEGRATION SERVER
The Company's new Geneva Integration Server, scheduled for official
launch in April 1999, has been deployed at a limited number of customer sites
since early 1998 in connection with the implementation of fully integrated
enterprise application systems. The Geneva Integration Server is designed to
provide comprehensive, secure and reliable interoperability between applications
running on disparate and otherwise incompatible computer systems. Because
different computer systems and the applications developed for them vary widely
in the ways in which they send, receive, view and process information,
information can not generally be exchanged between diverse applications running
on different systems. The Geneva Integration Server, which runs on Windows NT
server systems, will enable the sharing of information between disparate systems
by automatically transforming the data from one system into formats and
representations that can be used by other systems. In this way, Geneva
Integration Server can enable timely access to enterprise-wide critical business
information without the need for complex and costly ongoing software program
modifications. Geneva Integration Server's extensive message transformation
capabilities allow Geneva Integration Server to collect messages from existing
systems and transform them into forms that can be exchanged via the Internet and
vice versa, which makes it well-suited to enable existing applications for
E-commerce.
The Company believes that Geneva Integration Server provides the
following advantages to corporate information services departments:
- Improved customer service and reduced time to market by promoting
reuse of the knowledge base embodied in existing applications.
- Reduced time to market in delivering scalable, cost-effective
E-commerce applications.
- Enhanced agility and flexibility of information technology assets
in addressing changing business conditions.
- Improved utilization and the ability to leverage the skills of the
rapidly growing number of developers with Windows NT expertise,
reducing the need for more costly and specialized expertise.
-3-
Geneva Integration Server embodies a core set of translation services,
together with "adapter" modules that allow it to link to many popular systems,
to middleware such as Microsoft's MSMQ and IBM's MQ Series, and to Internet
interfaces such as HTTP, HTML, XML and others. The combination of the
translation services and adapters allows Geneva Integration Server to act as a
liaison with respect to three fundamental elements of inter-system communication
that vary widely between disparate systems: the technical protocols required for
the delivery of messages, the message formats that set forth the manner in which
data will appear in a communication, and the actual content of the message
itself, which often must be transformed in order to permit communication between
incompatible systems.
Geneva Integration Server enhances the ability of information systems
departments to monitor and manage the flow of transactions and tasks across
various applications by providing and tracking information about the nature and
character of data, or "metadata," in a secure medium separate from the data
message itself. This supports system and workflow management to optimize system
performance. For example, metadata may tell a computer that the first four
digits of a particular communication represent the identification code for loan
recipients. If a bank using a traditional system switched from 4-digit to
6-digit identification codes, a labor-intensive search and recoding of the
bank's software programs would be required to process 6-digit codes accurately.
Geneva Integration Server's use of metadata allows a user simply to modify the
definition of that particular type of communication to tell it about 6-digit
codes and Geneva Integration Server automatically ensures that all affected
applications will accurately process the new 6-digit codes.
Geneva Integration Server also has the ability to contain system workflow
procedures in a medium that is separate from the tasks that need to be performed
in order to complete an application requirement. "System workflow procedures"
refers to information regarding the order in which a series of tasks must be
completed in order to complete a given application. For example, when a customer
orders a product the complete transaction may entail a series of interdependent
steps. Geneva Integration Server's workflow management capability tracks the
dependencies between the serial steps in the transaction process. If any of the
serial steps are not completed successfully, Geneva Integration Server would
automatically reset to the beginning before any applications or databases are
updated.
The Company believes that the Geneva Integration Server product is
currently the most comprehensive product of its kind to provide enterprise
application integration capabilities for Microsoft NT server-based environments.
SEER*HPS
Seer*HPS is a set of application development tools that assists customers
in developing, adapting and managing enterprise-wide computer applications for
client/server networks. The product enables users to define in a high level,
simplified language the tasks and operations the users would like an application
to perform. Users can then simply "push a button" and Seer*HPS automatically
generates the necessary software programming to perform the tasks and operations
defined. This significantly speeds the development and deployment of highly
complex, large-scale, custom enterprise applications and greatly enhances the
productivity of programming resources.
Unlike its primary competitors, Seer*HPS includes its own embedded
middleware, enabling communications among Seer*HPS developed application
components across various systems throughout a client/server network. Seer*HPS
enables users to specify which applications or portions of an application are to
be executed on a given system within the computing environment. This enables
workload balancing among systems, which allows customers to utilize available
resources in their respective computing environments more efficiently and
improve system performance.
Seer*HPS stores all of the information pertaining to each
Seer*HPS-developed application in its own centrally located repository. Use of
repository facilitates the efficient enhancement of the functionality of
Seer*HPS applications. Since the repository contains all relevant system data,
Seer*HPS is able to assess automatically the potential impact of any such
proposed changes in functionality. As a result, not only are initial development
time and costs reduced, but on-going system maintenance and enhancement efforts
are simplified as well.
FUTURE INTEGRATION AND DEVELOPMENT OF COMPANY PRODUCTS
FALCONMQ. Currently, FalconMQ requires that all message queues reside on
a Microsoft Windows NT system. FalconMQ Version 2.0, scheduled for release in
early 2000, will permit the message queues to reside on all systems supported by
FalconMQ. The Company also intends to ensure continued compatibility between
FalconMQ
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and Microsoft's MSMQ. As a result, companies can safely build and link
applications using FalconMQ with confidence that their systems will continue to
operate without disruption, with no need for manual programming updates as new
versions of MSMQ are released by Microsoft.
GENEVA INTEGRATION SERVER. The Company intends to enhance Geneva
Integration Server to meet marketplace needs as they evolve. Enhancements
planned through the second quarter of 2000 include strengthening Geneva
Integration Server's ability to support and interact with the MVS operating
system for IBM mainframe computers and the UNIX operating system as well as
applications components based on the Java language, which is typically used for
web-based applications. In the longer term, the Company plans to incorporate the
repository capability found in Seer*HPS into Geneva Integration Server. Among
other things, expanding Geneva Integration Server repository capabilities will
allow information regarding system workflow procedures to be stored in a
comprehensive, enterprise-wide repository and retrieved as needed by the Geneva
Integration Server product. The Company also plans to introduce a new graphical
user interface that will facilitate a customer's reconfiguration of its system.
This interface will represent a customer's system as a schematic diagram, and
reconfiguration of the system will be accomplished by a customer changing the
way the different elements of its system are linked through the schematic
diagram.
SEER*HPS. The Company is currently adapting Seer*HPS to support common
industry standards in order to interact with applications and components that
are not part of a Seer*HPS system. The first step, scheduled for mid-1999, will
be the development of an adapter to link the Seer*HPS middleware layer with
Geneva Integration Server. This link will make available all of the capabilities
of Geneva Integration Server to Seer*HPS customers. Other planned extensions
include providing support for the Java language and "Java Beans" architecture
plus support for other middleware products, such as CORBA and the FalconMQ and
MQ Series products. Longer term product development plans include the creation
of an Information Systems Warehouse based on leading industry standard "core
repository" technologies. The Information Systems Warehouse will manage the
development and interaction of applications across the entire enterprise. The
repository for the current version of Seer*HPS manages the development and
interaction of applications only for Seer*HPS-generated applications.
OTHER PRODUCTS
The XIPC product is an advanced software toolset that greatly simplifies
the development, deployment and management of distributed applications in
complex client/server networks. XIPC manages the different forms of network
communication while showing the developer only a single, simple unified view or
model of the communications taking place. This means that XIPC effectively
shields developers from the complexity of diverse computing environments while
letting them take advantage of all of the capabilities and functionality that
these environments can provide in developing efficient and sophisticated
applications.
In addition, the Company offers other products which it intends to
continue to support and further enhance, but which management does not believe
are material to the Company's business.
SERVICES
The Company provides a full spectrum of consulting services as part of
its commitment to providing its customers industry-leading EAI solutions. The
Company'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 global 5000-size companies. The
Company offers consulting services in project management, applications and
platform integration, application design and development, application renewal
and web- and E-commerce enablement, along with expertise in a wide variety of
development environments and programming languages.
In addition, the Company's training organization offers a full curriculum
of courses and labs designed to help customers become proficient in the use of
the Company's products and related technology as well as enabling customers to
take full advantage of the Company's field-tested best practices methodologies.
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SALES AND MARKETING
SALES
The Company derives revenue primarily from software licenses, consulting
services and software maintenance. Presently, almost all of the Company's
revenue is derived from sales of Seer*HPS and related maintenance and consulting
services. Management believes this mix will change significantly over time to
reflect an increasing proportion of revenue resulting from sales of FalconMQ and
Geneva Integration Server.
Seer*HPS and Geneva Integration Server are designed for use primarily in
large-scale, complex computing environments. A customer's decision to use such
products involves a substantial commitment of financial and personnel resources.
Accordingly, a decision to purchase these products typically involves a lengthy
internal review process, often involving a customer's senior management. As a
result, the sales cycle for these products is relatively lengthy, averaging nine
to twelve months. The Company's sales strategy for such products will continue
to involve a complete evaluation of the customer's business, followed by the
identification and sale of solutions incorporating software and related
services. These products and their related services also provide customers the
flexibility to scale up or down and integrate new component products, whether
created by the Company or a third party.
The FalconMQ and XIPC products are by design more project-oriented in
scope. As a result, they are typically sold in smaller configurations than
Seer*HPS or Geneva Integration Server. FalconMQ is typically sold through the
Internet and by telephone and the sales cycle has averaged two to six months.
The Company is evaluating alternative sales strategies for FalconMQ, including a
mix of outsourced telephone sales and indirect channels such as sales through
strategic partners and independent software vendors (known as "ISV's") who could
bundle FalconMQ with applications they develop and sell.
The Company's direct sales staff has substantial knowledge of the
Company's products and service offerings as well as general experience in the
software industry. The Company's direct field sales force is headed by two
general managers -- one for the Americas and one for all other territories that
are the focus of active sales efforts. These currently include the United
Kingdom, France, Spain, Italy, Greece, the Benelux countries, Germany, Austria,
Switzerland, the Scandinavian and eastern bloc countries, Australia and
Asia-Pacific Rim countries. The general managers' respective operations include
sales and consulting services for new and existing customers. On a pro forma
basis, taking into account the business combination between Seer and Level 8,
$26 million (39%) of the Company's 1998 revenue was generated from the Americas
and $41 million (61%) was generated outside the Americas. Since substantially
all of the Company's 1998 revenues were derived from sales of Seer*HPS and
related services, the geographic distribution of the Company's revenues may
change as the Company's revenue mix changes.
MARKETING
The target market for the Company's products and services is global
5000-sized companies. Around the world, global 5000-sized companies are making
substantial expenditures in renovating existing applications for year 2000
compliance. In addition, the rapid development 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 information technology.
In addition, the lines between "new" development and what has in the past
been considered "maintenance" are blurring. The Company 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, resulting in the identification of new and emerging
markets for EAI solutions.
The Company's marketing staff has an in-depth understanding of the global
software marketplace and the needs of customers in that marketplace. The staff
also has broad knowledge of the Company's products and services and how they can
meet these customer needs, as well as experience in all of the key marketing
disciplines. Marketing is headed by a vice president of worldwide marketing who
manages an international staff, with corporate marketing and core functions
performed by the majority of the staff which is based at corporate headquarters.
Regional marketing programs are supported by corporate staff as well as locally
by staff located in the various regions. The Company also has a vice president
of alliances who identifies potential strategic alliance partners and develops
and manages the Company's relationships with these alliance partners.
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The Company utilizes a wide variety of marketing programs which are
intended to attract potential customers and to promote the Company and its brand
names. The Company uses a mix of market research, analyst updates, seminars,
telemarketing, direct mail, tradeshows, 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, fact sheets, and materials that are specific to the area of interest.
The Company is also implementing an alliance program to support its channel
partners with a variety of programs, incentives, and support plans.
The Company has a key strategic relationship with Microsoft. Microsoft
has licensed from the Company software originally developed by the Company that
enables its Windows NT server platforms to integrate with IBM's MQ Series
message-oriented middleware ("MOM"), which currently represents a significant
share of the worldwide MOM market. Microsoft intends to ship this software as
part of its Windows 2000 operating system and to make it available to its
Windows NT server platform customers through its website. Microsoft recommends
FalconMQ as its preferred implementation of the MSMQ functionality on operating
systems other than Microsoft Windows. The Company is actively exploring
opportunities to continue and expand its relationship with Microsoft in EAI
related areas.
The Company is also actively seeking alliances with other third parties
who provide complementary products and services. In particular, the Company is
targeting the hundreds of companies active in Microsoft's Solution Providers
partner program as potential partners with complementary products and services.
In addition, the Company's Seer subsidiary has an important historical
relationship with IBM in Europe, which in the past has been a major marketer and
distributor of Seer*HPS in Europe.
COMPETITION
The Company competes in markets that are intensely competitive and
characterized by rapidly changing technology and evolving standards. The rapid
growth and long-term potential of the market for EAI solutions make it
attractive to new competition. Many of the Company's competitors have greater
name recognition, a longer installed customer base and significantly greater
financial, technical, marketing, and other resources than the Company. The
Company believes it offers a broader range of EAI solutions than its
competitors, and therefore generally competes on a product-by-product basis.
FALCONMQ
The competition in the message-oriented middleware market is primarily
between Microsoft's MSMQ and IBM's MQ Series. However, since FalconMQ is
designed to link MSMQ-based applications, FalconMQ indirectly competes with
middleware technology designed for IBM's MQ Series message queues product,
including middleware marketed by IBM itself.
GENEVA INTEGRATION SERVER
Geneva Integration Server competes most directly with the MQIntegrator
product from New Era of Networks (known as "NEON"), which enables the
integration of both existing and packaged enterprise resource planning (known as
"ERP") applications through IBM's MQ Series middleware. IBM and NEON recently
announced an agreement whereby NEON's MQIntegrator product will be sold through
IBM's distribution and reseller network. Geneva Integration Server also competes
against a number of other early entrants in the EAI solutions market, such as
the Mercator product line from TSI International Software, Ltd.; TIB
ActiveEnterprise from TIBCO Software, Inc.; and BusinessWare from Vitria
Technology, Inc.
The majority of these competitors focus on the integration of a
customer's existing applications to large ERP packaged applications such as
those provided by SAP, PeopleSoft, Baan and JD Edwards. The most successful of
these competitors have focused their products primarily on mainframe and UNIX
systems. Because Geneva Integration Server takes advantage of advanced features
of Windows NT such as superior security for E-commerce, the Company believes
Geneva Integration Server has a competitive advantage in the current
marketplace.
SEER*HPS
Historically, the primary competitor to Seer*HPS has been Sterling
Software with its Cool:GEN product lines. As the Company repositions Seer*HPS as
one of its EAI solution offerings, it will face new and different
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competitors such as Viasoft and Platinum, who offer repository technologies and
consulting services that they promote as addressing the application renewal and
life cycle management aspects of EAI.
SERVICES
In the system integration and consulting services market, the Company
competes with providers of systems integration services, such as Andersen
Consulting and Logica PLC, and with numerous local and regional providers of
consulting and integration services. In this area, the Company also competes
with providers of software packages for particular markets, such as Fourth Shift
Corporation and Symix Systems, Inc. Some of the Company's competitors,
particularly systems integrators, generally have substantially larger
operations, broader product lines with greater name recognition and market
acceptance and significantly greater resources than the Company. However, the
Company's consulting staff's expertise is focused primarily on supporting and
accelerating the productivity of purchasers of the Company's software products.
The Company believes this offers the Company a competitive advantage in selling
services to new and existing customers of the Company's software products.
CUSTOMERS
The Company's products and services are currently used by thousands of
software developers. Hundreds of enterprise-wide applications built and
integrated through the Company's products are used daily by over a million end
users worldwide. The Company's customer base includes major corporations around
the world such as ABN AMRO, Information Technology Services Company, Charles
Schwab & Company, Inc., Credit Suisse First Boston, Italia Telecom, Prudential
Insurance Company of America, Sikorsky Aircraft, TeleDenmark A/S, Telenor A/S
and Montgomery Ward & Co., Incorporated. Industries that are significantly
represented in the Company's customer base include banking and financial
services, insurance, retail, manufacturing, data processing, public utilities,
and transportation. ABN AMRO was the Company's only customer accounting for 10%
or more of 1998 historical operating revenue. On a pro forma basis, after giving
effect to the acquisition of Seer, no one customer accounted for more than 10%
of operating revenues in 1998.
The Company seeks to form strong partnering relationships with customers
in order to gain an in-depth understanding of the business and technology
challenges they face. Notably, the Company maintains a customer advisory board
for Seer*HPS customers that meets regularly. The volunteer members of the
customer advisory board represent the Company's global customer base and act as
a sounding board for new ideas and initiatives, as well as providing a means for
information flow and feedback regarding the Company's products and services. In
conjunction with the customer advisory board, the Company supports several
internet-based special interest groups providing discussion forums focused on
specific areas of technology. The Company also intends to provide customers of
its other products the opportunity to participate in a customer advisory board.
In addition, the Company holds periodic international customer
conferences to present new information, address customer questions and concerns
and provide constructive open forums for customer interaction. In many areas
around the world, local customers hold periodic regional user group meetings
that are supported and encouraged by the Company. The Company also receives a
great deal of feedback through its consulting services and technical support
organization regarding the effectiveness of the Company's products in meeting
customer needs.
RESEARCH AND PRODUCT DEVELOPMENT
The Company has made substantial investments in research and development.
The Company conducts research and development to enhance its existing products
and to develop new products. The Company intends to focus its research and
development efforts on integrating and evolving its Geneva Integration Server,
FalconMQ and Seer*HPS product lines in such a manner that all of these products
can interact with each other to provide customers a comprehensive EAI solution.
Research and development expense increased 100% from 1997 to 1998 and 99% from
1996 to 1997. The increase in 1998 is partially attributable to the acquisition
of Momentum and the personnel added in this area of the Company. The trend in
increasing research and development expenses is a result of the Company's
investment in new products, primarily Geneva Integration Server and Version 2.0
of FalconMQ. This trend is expected to continue with the purchase of Seer, the
Company's continuing attempts to strengthen its messaging products and
completion of the transition into the EAI marketplace.
-8-
The markets for the Company's products are characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles. The Company'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. The Company budgets for research and development 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 the Company 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 the Company will successfully develop, introduce
or manage the transition to new products. The Company has in the past, and may
in the future, experience delays in the introduction of its products, due to
factors internal and external to the Company. 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 the Company's results of operations,
particularly on a quarterly basis.
For additional information, see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Years Ended December
31, 1998, 1997 and 1996 - Research and Development."
INTELLECTUAL PROPERTY
The Company's success is dependent upon developing, protecting and
maintaining its intellectual property assets. The Company 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,
the Company has patents with respect to certain of Seer's products. The
effectiveness of these various types of protection can be limited, however,
by variations in laws and enforcement procedures from country to country.
There can be no assurance that the steps taken by the Company will prevent
misappropriation of its technology, and such protections do not preclude
competitors from developing products with functionality or features similar
to the Company's products. Furthermore, there can be no assurance that third
parties will not independently develop competing technologies that are
substantially equivalent or superior to the Company's technologies. Any
failure by or inability of the Company to protect its proprietary technology
could have a material adverse effect on the Company's business, operating
results and financial condition.
Copyright protection is generally available under United States laws
and international treaties for the Company's software and printed materials.
Seer has obtained patents in the United States and Australia with regard to
the basic application development and deployment technology in the Seer*HPS
product line, and has related patents pending in various countries. Seer has
registered the trademarks "SEER", "Archetype", "CASIM", "Freeway", "NewArc
2000", "Seer*HPS", and "TurboCycler" in the United States, and has active
programs to register the "SEER" mark in other countries where it does
business. The Company has registered the trademark "Level 8 Systems," and
uses the trademarks "Monitor MQ", "Monitor XIPC", "Level 8", "XIPC",
"FalconMQ", "Geneva", "Geneva Integration Server", "NetEssential",
"SeerTalk", "SmartPak" and "The Seer*Method". The Company intends to seek
registration of some of the trademarks including "FalconMQ", "Geneva", and
"Geneva Integration Server."
Although the Company 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 the Company or its customers in
the future. In addition, the Company may be required to indemnify its
distribution partners and end users for similar claims made against them.
Furthermore, the Company may initiate claims or litigation against third parties
for infringement of the Company's proprietary rights or to establish the
validity of the Company's proprietary rights. Litigation, either as a plaintiff
or defendant, would cause the Company to incur substantial costs and divert
management resources from productive tasks whether or not such litigation is
resolved in the Company's favor, which could have a material adverse effect on
the Company's business, operating results and financial condition. Parties
making claims against the Company could secure substantial damages, as well as
injunctive or other equitable relief which could effectively block the Company's
ability to license its products in the United States or abroad. Such a judgment
could have a material adverse effect on the Company's business, operating
results and financial condition. If it appears necessary or desirable, the
Company may seek licenses to intellectual property that
-9-
it is allegedly infringing. There can be no assurance, however, that licenses
could be obtained on commercially reasonable terms, if at all, or that the terms
of any offered license would be acceptable to the Company. The failure to obtain
the necessary licenses or other rights could have a material adverse effect on
the Company'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, the Company believes that software developers may
become increasingly subject to infringement claims. Any such claims, with or
without merit, can be time consuming and expensive to defend and could adversely
affect the Company's business, operating results and financial condition. The
Company is not aware of any currently pending claims that the Company's
products, trademarks or other proprietary rights infringe upon the proprietary
rights of third parties.
EMPLOYEES
As of March 15, 1999, the Company had a total of 366 employees. Of these
employees, 35 were engaged in software sales and marketing, and technical
support; 50 in administration; 102 in research, development, and technical
support; and 179 in consulting and training. The Company's continued success is
dependent on its ability to attract and retain qualified employees. During 1998,
Seer experienced difficulties in recruiting and retaining qualified employees
due, in part, to the uncertainty of its financial position. Seer also reduced
its headcount as part of its revision of its business plan. The Company also
experienced difficulty in recruiting and retaining consultants and research and
development employees during fiscal 1998 due to the intense competition for such
personnel in the software industry. The Company believes that to fully implement
its business plan it will be required to enhance its marketing functions by
adding additional marketing personnel. In addition, the Company believes
additional sales associates will be required to support the Company's sales
operations following the acquisition of Seer. Although the Company believes it
will be successful in attracting and retaining qualified employees to fill these
positions, no assurance can be given that the Company will be successful in
attracting and retaining these employees now or in the future. The Company's
employees are not represented by a union or a collective bargaining agreement.
-10-
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 Server; 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 cannot
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; because a substantial amount of the Company's revenues
have historically been derived from Seer*HPS, decreased demand for services
relating to this product could adversely affect the Company's business; the
Company's future results may depend upon the continued growth and business use
of the Internet; 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
resources to successfully manage the integration of Seer; the Company's future
results may depend upon the successful integration of 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.
ITEM 2. PROPERTIES.
The Company maintains its principal executive offices in approximately
54,000 square feet of leased space in Cary, North Carolina. The Company also
maintains executive offices in approximately 13,500 square feet of leased space
in New York, New York. As of December 31, 1998, the Company also leased 14
additional offices to provide consulting services to its clients and to
facilitate the development, sale and distribution of its products. The Company
leases office space abroad in Canberra, Melbourne and Sydney, Australia;
Toronto, Canada; Copenhagen, Denmark; London, England; Paris, France; Frankfurt,
Germany; Rome, Italy; Milan, Italy; Madrid, Spain; and Nieuwegein, The
Netherlands. The Company also maintains an office in Limerick, Ireland on a set
fee arrangement.
ITEM 3. LEGAL PROCEEDINGS.
Seer, the Company's 69% subsidiary acquired December 31, 1998, filed a
lawsuit against Saadi Abbas and Cambridge Business Solutions (UK) Limited
("CBS") in December 1997 alleging that Mr. Abbas and CBS had injured Seer by
interfering with Seer's ability to market and sublicense the LightSpeed
Financial Model. Seer obtained a preliminary injunction against Mr. Abbas and
CBS halting their actions. Mr. Abbas and CBS filed counterclaims against Seer
claiming wrongful dismissal of Abbas and breach of the license agreement. Due to
the erosion of the market for the LightSpeed Financial Model, Seer voluntarily
dismissed its claims against Mr. Abbas and CBS in the summer of 1998. Mr. Abbas
and CBS are continuing to pursue their claims against Seer. At the present point
in the litigation, it is impossible to calculate the chances of success in this
litigation. However, Seer
-11-
intends to continue to vigorously defend against the counterclaim. Seer has made
provisions 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 Seer or the Company.
From time to time, the Company is a party to routine litigation
incidental to its business. As of the date of this Report, the Company was not
engaged in any legal proceedings that are expected, individually or in the
aggregate, to have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
-12-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
During fiscal years 1997 and 1998, 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, 1997 and 1998.
1997 1998
---------------------- -----------------------
Quarter High Low High Low
------- --------- --------- --------- ----------
First $ 18.2500 $ 10.2500 $ 16.3125 $ 10.3750
Second $ 18.5000 $ 10.6250 $ 14.0000 $ 8.3750
Third $ 25.8750 $ 15.8750 $ 11.0000 $ 6.5625
Fourth $ 23.8750 $ 11.5000 $ 9.8750 $ 5.0000
The closing price of the Common Stock on December 31, 1998 was $9.6875 per
share. As of March 26, 1999, the Company had 122 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 1998, the following data includes the Company, ASU, 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. For 1994, the
following data includes the Company and ASU.
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
SELECTED STATEMENT OF OPERATIONS DATA
Revenue $ 1,660 $ 3,012 $ 7,272 $ 14,680 $ 10,685
Net income (loss) from continuing operations 26 (429) (845) 1,036 (23,688)
Net income (loss) from continuing operations
per common and common
equivalent share - basic .01 (.10) (.14) .16 (3.15)
Net income (loss) from continuing operations
per common and common equivalent share - diluted .01 (.10) (.14) .14 (3.15)
Weighted average common and common equivalent
shares outstanding - basic 3,839 4,314 6,076 6,992 7,552
Weighted average common and common equivalent
shares outstanding - diluted 3,839 4,403 6,076 7,561 7,552
-13-
AT DECEMBER 31,
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
SELECTED BALANCE SHEET DATA
Working capital (deficiency) $(1,679) $ 4,103 $ 11,007 $ 15,826 $(19,774)
Total assets 5,848 15,059 20,787 23,482 70,770
Long-term debt, net of current maturities 19 43 23 16 1,541
Loans from related companies, net 2,015 454 331 202 12,519
Shareholders' equity 489 11,499 18,300 20,371 8,892
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL INFORMATION AND RECENT DEVELOPMENTS
The Company is a leading provider of scaleable enterprise application
integration solutions. As new computer technologies have proliferated in
enterprise computing environments, the integration and management of the
applications which rely on them has grown in complexity. Enterprise application
integration (or "EAI") solutions address the emerging need for information
systems to deliver enterprise-wide views of a company's business information and
processes. The Company's products and services are designed to enable
organizations to address information systems integration and management problems
in a simple and cost effective way. The Company provides customers with
solutions to link their critical business applications internally across the
enterprise and externally with strategic business partners. The Company's
products and services also enable organizations to engage in electronic
commerce. Currently, Level 8's products and services are sold worldwide through
a network of regional sales offices. To date, the Company's products and
services have been utilized by companies in a wide variety of industries
including banking and financial services, insurance, retail, manufacturing, data
processing, public utilities, and transportation.
As part of the Company's strategic shift to the EAI market in the
first quarter of 1998, the Company decided to sell its wholly owned
subsidiary, ProfitKey International Inc. (which sale was completed on April
6, 1998). See Note 3 to Consolidated Financial Statements.
The Company thereupon, on March 26, 1998, acquired Momentum Software
Corporation ("Momentum") in return for 594,866 shares of the Company's common
stock and warrants to purchase 200,000 common shares at an exercise price of
$13.11 per share, subject to additional consideration based on the market value
of the Company's stock on December 1, 1998. In December 1998, the Company issued
notes totaling $3 million in payment of such additional consideration. Momentum
was purchased primarily for its technology, some of which has been integrated
into Level 8's Falcon product set.
The Company's most significant step to date into the EAI marketplace was
the acquisition of a controlling interest in Seer Technologies, Inc. ("Seer") on
December 31, 1998. Seer is one of the software industry's earliest pioneers and
a long-time leader in software application development tools. During 1998, Seer
redirected its focus on emerging market demand for extending the life cycle of
enterprise applications through enterprise application renewal. On November 23,
1998, the Company entered into an agreement with Welsh, Carson, Anderson & Stowe
VI L.P. ("WCAS") and certain other parties affiliated or associated with WCAS
pursuant to which the Company agreed to acquire approximately 69% of the
outstanding voting stock of Seer from WCAS and its affiliates in exchange for
1,000,000 shares of common stock of the Company and warrants to purchase an
additional 250,000 shares of common stock of the Company at an exercise price of
$12 per share. Pursuant to its agreement with WCAS, the Company acquired 69% of
the voting stock of Seer on December 31, 1998 and has commenced a tender offer
to acquire all of the remaining shares of Seer for $0.35 per share in cash. The
Company has also agreed to acquire any remaining shares of Seer following
completion of the tender offer through a merger at the same $0.35 cash price per
share. The Company expects to complete its acquisition of the entire equity
interest in Seer in the second quarter of 1999.
As a result of (i) the purchase of Momentum at the end of the first
quarter of 1999, (ii) the purchase of 69% of the voting stock of Seer on
December 31, 1998, (iii) the pending completion of the purchase of the remaining
31% of the voting stock of Seer, and (iv) the disposition of ProfitKey, the
information within this report is not necessarily indicative of future operating
results. Also, these changes make it difficult to compare the results for the
years presented as the direction of the business has evolved throughout the
period. Unless otherwise specifically indicated, the information in this report
is stated as of December 31, 1998 and does not give effect to the remaining
portion of the pending acquisition of the remaining 31% of Seer. The Company
expects that its results of
-14-
operations will significantly change with its acquisition of Seer and through
the development of its other technologies as it continues to attempt to
strengthen its position in the EAI marketplace.
This report contains forward-looking statements relating to such matters
as anticipated financial performance, business prospects, technological
developments, new products, research and development activities, the pending
transaction with Seer, 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."
[remainder of page intentionally left blank]
-15-
RESULTS OF OPERATIONS
The Company's 1998 results of operations include the operations of the
Company and its subsidiaries. Operations for the subsidiaries acquired during
1998 are included from the date of acquisition. Accordingly, the 1998 results of
operations include the operations of Momentum since March 26, 1998. 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. 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. Subsequent to December 31,
1998, the Company commenced a tender offer for the remaining 31% of Seer. Until
the tender offer is completed, the Company will report only 69% of any net
earnings and 100% of any net losses of Seer. The Company anticipates completing
the tender offer and acquiring the remaining minority interest in Seer during
the second quarter of 1999. Following the acquisition of the minority interest
in Seer, the Company's operations will include all of Seer's operations and the
Company will record the remaining intangible assets of Seer, including an
additional write-off for in-process technology.
The following table sets forth, for the years indicated, the Company's
results of continuing operations expressed as a percentage of revenue.
Years Ended December 31,
1998 1997 1996
----- ----- -----
Revenue:
Software products 14.5% 29.7% 20.4%
Services 85.5% 69.3% 75.9%
Other -- 1.0% 3.7%
----- ----- -----
Total 100.0% 100.0% 100.0%
Cost of revenue:
Software products 19.3% 17.4% 19.6%
Services 55.9% 34.0% 42.0%
Other -- 0.3% 0.5%
----- ----- -----
Total 75.2% 51.7% 62.1%
----- ----- -----
Gross profit 24.8% 48.3% 37.9%
Operating expenses:
Research and product development 19.8% 7.2% 7.3%
Selling, general and administrative 91.5% 30.5% 40.8%
Amortization of goodwill and 18.1% 2.9% 5.8%
intangibles
Write-off of in-process research and 55.1% -- --
development
Write-off of goodwill 43.1% -- --
Restructuring charges 14.4%
----- ----- -----
Total 242.0% 40.5% 53.9%
Other income (expense), net (0.7)% 3.0% 2.0%
----- ----- -----
Income (loss) before taxes (217.9)% 10.8% (14.0%)
Income tax provision (benefit) 3.8% 3.8% (2.4)%
----- ----- -----
Net income (loss) from continuing operations (221.7)% 7.0% (11.6)%
----- ----- -----
----- ----- -----
-16-
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
REVENUE AND GROSS MARGIN. The Company has two categories of
revenue: software products and services. Software products revenue is comprised
primarily of fees from licensing the Company's proprietary software products
and, to a lesser extent, from product development contracts. Services revenue is
comprised of fees for maintaining, supporting, providing periodic upgrades and
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 partly attributable to the Company's
sales commission policies, which compensate sales personnel for meeting or
exceeding quarterly quotas, and to the budgeting and purchasing cycles of
customers. 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.
Effective January 1, 1998, the Company adopted Statement of Position
97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended by Statement of
Position 98-4 "Deferral of the Effective Date of Certain Provisions of SOP
97-2." SOP 97-2 requires each element of a software sale arrangement to be
separately identified and accounted for based on the relative fair value of such
element. Revenue cannot be recognized on any element of the sale arrangement if
undelivered elements are essential to the functionality of the delivered
elements.
Adoption of SOP 97-2 resulted in the deferral of license revenue of
approximately $262. In addition, the unique nature of a significant contract
resulted in the deferral of $3,700 of software revenue as of December 31,
1998. At least a portion of the license revenue for these contracts may have
been recognized under SOP 91-1 "Software Revenue Recognition", which was
effective in previous years.
Statement of Position 98-9, "Modification of SOP 97-2, 'Software Revenue
Recognition,' with Respect to Certain Transactions" ("SOP 98-9") will be
effective for the Company's fiscal year beginning January 1, 1999. Retroactive
application is prohibited. SOP 98-9 amends SOP 97-2 to require that an entity
recognize revenue for multiple element arrangements by means of the "residual
method" when (1) there is vendor-specific objective evidence ("VSOE") of the
fair values of all of the undelivered elements that are not accounted for by
means of long-term contract accounting, (2) VSOE of fair value does not exist
for one or more of the delivered elements, and (3) all revenue recognition
criteria of SOP 97-2 (other than the requirement for VSOE of the fair value of
each delivered element) are satisfied. The provisions of SOP 98-9 that extend
the deferral of certain passages of SOP 97-2 became effective December 15, 1998.
The Company is evaluating the future requirements of SOP 98-9 and the effects,
if any, on the Company's current revenue recognition policies.
Total revenues decreased 27% from 1997 to 1998 and increased 102% from
1996 to 1997. The decrease from 1997 to 1998 was primarily attributable to a
decrease in software products revenue, along with a reduction in services
revenue. The increase from 1996 to 1997 was a result of significant increases in
both software products and services. The gross margins were 25%, 48%, and 38%
for 1998, 1997, and 1996, respectively.
Results for 1998 do not reflect any revenue from an agreement the
Company entered into with Microsoft in August, 1998. Under the agreement, the
Company has agreed to license to Microsoft the source and object codes for
certain software products that enable interoperability between Microsoft's
Message Queue Server running on Microsoft's Windows NT operating systems and
IBM Corporation's MQ Series message software running on a variety of
operating systems. Microsoft accepted the English version of the product in
September and the Japanese version in November. The Company received cash
equal to the $3.7 million total contract value from Microsoft in 1998. Due to
certain limitations with respect to available "vendor specific objective
evidence," all other associated contract revenue has been deferred and will
be recognized beginning in 1999 ratably over the contract's period.
SOFTWARE PRODUCTS. Software products revenue decreased 64% in 1998 in
comparison to 1997 and increased 193% from 1996 to 1997. The gross margins on
software products was (33%), 41%, and 4% for the 1998, 1997, and 1996 fiscal
periods, respectively. Cost of software is composed of production and
distribution costs, amortization of capitalized software and royalties to third
parties.
-17-
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 FalconMQ
Products developed by the Company. The decrease in gross margins between 1997
and 1998 is the effect of increased amortization costs, lower software
product revenues, $.38 million of royalties to Liraz under the joint
development agreement described under "-Research and Development." and a
write-off of approximately $.3 million of capitalized technology costs.
Software revenue increased from 1996 to 1997 from sales of products
introduced in 1997 and the resale of IBM's MQ Series. The increase in gross
margins is primarily a result of the increased software revenue, somewhat offset
by increased amortization expense related to products becoming generally
available in 1997.
SERVICES. Services revenue decreased by 10% from 1997 to 1998 and
increased by 84% from 1996 to 1997. Services gross margins were 35%, 51%, and
45% for 1998, 1997, and 1996 respectively. Cost of services primarily includes
personnel and travel costs related to the delivery of services.
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 impacts services revenue as there are 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.
The significant increase in services revenues increase from 1996 to 1997
was a result of the addition of a combination of new consulting and training
services and increases in maintenance services in correlation with the
introduction of new products that created increased market demand. Gross profits
increased in 1997 due to the Company's ability to obtain higher billing rates
than previously earned and high utilization of staff during this growth period.
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 100% from
1997 to 1998 and 99% from 1996 to 1997. The increase in 1998 is partially
attributable to the acquisition of Momentum and the personnel added in this area
of the Company. The trend in increasing research and development expenses is a
result of the Company's investment in new products, primarily Geneva Integration
Server, which is scheduled to be released in the second quarter of 1999 and
Version 2.0 of FalconMQ which is expected to be released in early 2000. This
trend is expected to continue with the purchase of Seer, the Company's
continuing attempts to strengthen its messaging products and completion of the
transition into the EAI marketplace.
The Company and Liraz previously had an agreement for the joint
development of certain software for a Microsoft contract. Under the
agreement, Liraz and the Company were each to pay 50% of the total project
development costs. In exchange for providing 50% of such costs, Liraz was
previously entitled to receive royalties of 30% of the first $2 million in
contract revenue, 20% of the next $1 million, and 8% thereafter. On April 1,
1998, the agreement was amended to provide that the Company would reimburse
Liraz's costs of development of $1.5 million and would pay Liraz royalties of
3% of program revenues generated from January 1, 1998 until December 31,
2000. The $1.5 million reimbursement is being amortized over the term of the
revised royalty agreement and was paid to Liraz by the delivery of an 8% note
payable in three installments in 1998, 1999 and 2000. Additional royalties of
$.13 million are payable to Liraz for 1998 sales.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling expenses consist of sales
and marketing expenses for personnel, travel, trade show participation, and
other promotional expenses. General and administrative expenses consist of
personnel costs for the executive, legal, financial, human resources, and
administrative staff and all overhead expenses. Overhead expenses primarily
include office rent, depreciation and lease costs on machinery and equipment,
communications expenses, insurance, allowances for bad debts and other expenses
of operating the Company and its facilities.
Selling, general, and administrative expenses increased 51% in 1997 in
comparison to 1996 and 119% in 1998 in relation to 1997. The increases are
primarily related to additional sales and marketing expenses for new products,
the additional general and administrative support necessary following the
purchase of Momentum, and continued efforts to build a supporting infrastructure
for further acquisitions, such as Seer.
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AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS. Amortization of
goodwill and other intangible assets was $1.9 million in 1998 and $.4 million in
each of 1997 and 1996. The amortization of goodwill in 1997 and 1996 was related
to the purchase of Level 8 Technologies. In 1998, the amortization of goodwill
and other intangible assets related to the purchase of Momentum as well as Level
8 Technologies.
OTHER ITEMS. As a result of the acquisitions of Momentum and Seer, the
Company recorded several nonrecurring charges in 1998. Based on the results
of third-party appraisals, the Company recorded charges totaling $5.9 million
to expense purchased in-process research and development costs, consisting of
$1.2 million and $4.7 million related to the acquisition of Momentum and
Seer, respectively. In the opinion of management and the appraiser, 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 complexity of
the work completed to date, 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. 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 Falcon product set and the 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 $32,217, resulting in a non-cash impairment
loss of $4,601.
During the fourth quarter of 1998, the Company reorganized its
existing operations due to its acquisition of Seer. The restructuring
included a staff reduction 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 $1.5 million, which
consisted of approximately $.7 million in personnel-related charges,
approximately $.3 million in costs associated with carrying vacated space
until the lease expiration date, approximately $.2 million of property and
equipment related charges, approximately $.2 million in write-down of
capitalized software costs, and approximately $.1 million in professional
fees related to the restructuring. To date, the Company has paid
approximately $.1 million in cash related to the restructuring. The Company
believes the accrued restructuring cost of $1.0 million at December 31, 1998
represents its remaining cash obligations.
PROVISION FOR INCOME TAXES. The Company accounts for income taxes in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." The effective income tax rate for continuing operations
decreased from 35% for 1997 to (2%) for 1998 primarily because an income tax
benefit was not recorded for the net loss incurred in 1998. The Company provided
a full valuation allowance on the total amount of its deferred tax assets at
December 31, 1998 since management does not believe that it is more likely than
not that these assets will be realized.
DISCONTINUED OPERATIONS. The loss on disposal of ProfitKey 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 $.7 million in 1996 to $3.3 million
at year end. During 1996, the Company completed a second public offering of
common stock for net proceeds of $9.1 million. Net cash outflow of $1.1 million
used in operating activities in 1996 was partially funded through the 1996
public offering. The net cash used by operations in 1996 consisted of increases
in operating expenses to support headcount growth, principally for sales and
marketing in new functions and regions. Net cash used in investing activities
was $7.2 million, primarily as a result of a net $4.5 million investment in
marketable securities. The Company also invested $1.5 million in property and
capitalized software costs, and $1.2 million was used by the Company's
discontinued operations.
During 1997, cash and cash equivalents increased $3.7 million to $7.0
million at year end. The increase was due primarily to the Company's investment
activities in marketable securities offset by a $1.7 million
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investment for capitalized software development costs and equipment, and
a $1 million use of cash by the Company's discontinued operations. The Company
funded its operations in 1997 with cash remaining from the 1996 offering.
During 1998, cash and cash equivalents decreased by $1 million to $6
million at year end. The decrease in cash is 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.
As of December 31, 1998, the Company did not have any material
commitments for capital expenditures. Future maturities on the Company's
outstanding debt at December 31, 1998 include $13.7 million in 1999, $13.3
million in 2000 and $.7 million in 2001. Of such amounts, $.6 million in 1999
and $12.5 million in 2000 are due to Liraz, the Company's controlling
shareholder.
The Company has agreed to acquire the remaining equity of Seer and
expects to complete the acquisition of the remaining Seer shares in the second
quarter of 1999 for approximately $1.7 million. In connection with the
acquisition of Seer, the Company committed to fund Seer's operations through
January 15, 2000, if necessary.
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.
In connection with the acquisition of 69% of Seer on December 31, 1998,
the Company issued a $12 million note payable to Liraz and applied the proceeds
to pay off Seer's bank debt. In connection therewith, the Company and Liraz
agreed that the Company would effect a pro rata offering to its shareholders of
shares of preferred stock intended to have an aggregate liquidation preference
initially equal to the principal and accrued interest under the note and to be
convertible into an aggregate number of common stock determined by dividing the
aggregate liquidation preference (which will accrete at the rate of 12% a year,
compounded quarterly) by the conversion price. The conversion price would be an
amount equal to the greater of $5.00 and two-third of the average closing price
of a share of the Company's common stock during the 20 trading days ending on
the fifth trading day before the rights offering. Each share of preferred stock
would be entitled to two votes for each share of common stock into which it is
convertible. The preferred stock would be redeemable at the Company's option at
any time after June 30, 2000, upon at least 30 days' notice, at a redemption
price equal to the preferred stock's accreted liquidation preference. The
purchase price for each share of preferred stock to be offered to the Company's
shareholders would equal its initial liquidation preference. Liraz would be
permitted to pay the purchase price for any preferred stock it purchases in the
offering with cash or by reducing the amount payable to it under the $12 million
note. If the rights offering is consummated before June 30, 1999, the Company is
required to use the net proceeds of the rights offering to prepay the unpaid
balance under the $12 million note. In the context of reviewing other financing
alternatives, the Company and Liraz are currently reevaluating the proposed
rights offering and may determine not to proceed with the rights offering.
As of December 31, 1998, Seer had outstanding borrowings of $12.3 million
under its credit facility with a commercial bank (the "Credit Facility") at an
interest rate of 7.75%. Subsequent to December 31, 1998, the Credit Facility was
amended to include the Company as a borrower. As amended, the Credit Facility
provides for borrowings up to the lesser of $25 million or the sum of (i)
eligible receivables, (ii) a $7 million term loan payable in monthly
installments over two years, commencing on January 1, 2000, and (iii) a $2.5
million equipment loan payable over two and one-half years, commencing on April
1, 1999. There are no other financial covenants. The Credit Facility will bear
interest at Prime Rate through June 30, 1999, Prime Rate plus 1% per annum
through June 30, 2000, and Prime Rate plus 2% per annum thereafter. The Credit
Facility as amended is due on demand and terminates on December 31, 1999;
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. The $12 million note and other debt payable to Liraz is
subordinate in right of payment to the Credit Facility.
In early 1999, management began both to effect the various restructuring
actions discussed previously and to implement other cost control and cost
reduction efforts. Management's planned actions also include the sale of
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certain technologies that are not closely related to the Company's current
strategic direction and positioning the Company for the proposed rights offering
or an alternative financing transaction.
The Company incurred a net loss of $26.2 million and has negative
working capital of $20.3 million and an accumulated deficit of $26.4 million
at December 31, 1998. Additionally, Seer, in which the Company acquired a 69%
interest on December 31, 1998, reported a loss of $62.4 million for its most
recent fiscal year. The Company's ability to generate positive cash flow is
dependent upon the Company achieving and sustaining certain cost reductions
and generating sufficient revenues for the year. The Company already
implemented certain steps to, among other things, reduce headcount,
restructure operations and eliminate various costs from the business. As
discussed above, the Company has also renegotiated the Credit Facility to
increase borrowing capacity. Liraz has committed to provide the Company up to
$7.5 million of working capital on an as needed basis, upon thirty days
notice. Advances, if any, made under the commitment would become due and
payable upon the earlier of March 31, 2000 or the successful completion of an
equity financing which provides more than $7.5 million in proceeds to the
Company. The advancement of funds under the commitment is subject to the
Company's acceptance of certain terms including possible conversion of the
outstanding balance, if any, to common stock of the Company and the execution
of appropriate documentation. Management's plans also include the possibility
of raising additional equity financing. The Company believes that existing
cash on hand, cash provided by future operations and additional borrowings
under the Credit Facility and Liraz commitment 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.
YEAR 2000
The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium (Year 2000) approaches. The "Year
2000 Problem" is pervasive and complex as virtually every computer operation
will be affected in some way by the rollover of the two digit year value to 00.
The issue is whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
SOFTWARE SOLD TO CONSUMERS. The Company believes that it has
substantially identified potential Year 2000 Problems with the software products
that it develops and markets. See "Item 1. Business - Products and Services,"
for a further discussion of the Company's products. The Company's Seer*HPS
toolset products are designed to allow developers to develop applications that
are Year 2000 compliant, through the use of four-digit year fields which can
accept and accurately represent dates both before and after the Year 2000. Once
a four-digit year is properly input, applications built with the Seer*HPS
toolset can properly process the dates.
Dates may be input into these applications either by entering a
four-digit year or, as a shortcut, by entering the last two digits of the year.
In the latter case, the application assigns a century to the date and "feeds
back" a four-digit year to the user by displaying it on the screen. For all
versions of Seer*HPS above 5.2.3K, the century is assigned according to a moving
100-year window. The Company has made available documentation to its customers
that explains how this moving 100-year window can be adjusted, both on the
workstation platform and on the host. For version 5.2.3K, the century is
assigned a default value of "19". In either case, the user can either accept the
proposed four-digit date or correct it, if the application has assigned the
wrong century in a particular case.
The foregoing description related to Seer*HPS versions 5.2.4S and higher
(for the workstation) and 5.2.3K and higher (for the host), which were released
in December 1995. The Company believes that if operated properly, applications
constructed with these versions in accordance with the product documentation
should not manifest Year 2000-related errors traceable to the Seer*HPS product.
The Company does not believe any of its customers are using earlier versions of
the software.
The Company cannot, however, eliminate the possibility of input errors,
where input is in the form of two-digit years. Among other potential errors, it
is possible to introduce incorrect dates into applications using the shortcut
mentioned above if the operator is inattentive to the feedback, or if the
operator or batch data inputs dates represented as two-digit years, without any
way for the operator to determine which century a given year falls in. The
Company has attempted to identify the possible errors by making documentation
available to its customers.
With respect to the Company's Seer*HPS development environment itself,
the Company is not aware of any Year 2000 issues except the following. The tools
store certain information with respect to objects created using the tools (such
as the dates the object was created or last modified) as two-digit dates.
Because of the way the tools use these dates, the Company does not believe this
will cause any Year 2000-related problems except in the limited instance of
migrations spanning the century boundary. The Company has made available to its
customers documentation calling their attention to this issue and a workaround.
Accordingly, the Company believes that it has fulfilled its obligations
to its customers with respect to Year 2000 functionality. However, the law in
this area is still evolving and lawsuits are being filed against software
companies on an ongoing basis, many of them asserting novel theories of damage
and liability. Accordingly, no assurance can be given that claims will not be
made against the Company relating to date-processing issues or that the effect
of such claims on the Company will not be material.
INTERNAL INFRASTRUCTURE. The Company is currently identifying
substantially all of the major computers, software applications, and related
equipment used in connection with its internal operations that must be modified,
upgraded, or replaced to minimize the possibility of a material disruption to
its business and has commenced the process of modifying, upgrading, and
replacing major systems that have been identified as adversely affected, and
expects to complete this process by the middle of 1999.
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SYSTEMS OTHER THAN INFORMATION TECHNOLOGY SYSTEMS. In addition to
computers and related systems, the operation of office and facilities equipment,
such as fax machines, photocopiers, telephone switches, security systems,
elevators, and other common devices may be affected by the Year 2000 Problem.
The Company is currently assessing the potential effect of, and costs of
remediating, the Year 2000 Problem on its office and facilities equipment.
The Company's assessment of its internal systems is approximately 80%
complete. Based on its current assessment, the Company does not believe the
total cost to the Company of completing any required modifications, upgrades, or
replacements of these internal systems will have a material adverse effect on
the Company's financial condition, cash flows, or results of operations.
SUPPLIERS. The Company has reviewed information from third party
suppliers of the major computers, software, and other equipment used, operated,
or maintained by the Company to identify and, to the extent possible, to resolve
issues involving the Year 2000 Problem. However, the Company has limited or no
control over the actions of these third party suppliers. Thus, there can be no
assurance that these suppliers will resolve any or all Year 2000 Problems with
these systems before the occurrence of a material disruption to the business of
the Company or any of its customers. Any failure of these third parties to
resolve Year 2000 problems with their systems in a timely manner could have a
material adverse effect on the Company's business, financial condition, and
results of operation.
MOST LIKELY CONSEQUENCES OF YEAR 2000 PROBLEMS. The Company does not
believe that the Year 2000 Problem will have a material adverse effect on the
Company's business or results of operations. However, management believes that
it is not possible to determine with complete certainty that all Year 2000
Problems affecting the Company have been identified or corrected. The number of
devices that could be affected and the interactions among these devices are
simply too numerous. In addition, one cannot accurately predict how many Year
2000 Problem-related failures will occur or the severity, duration, or financial
consequences of these perhaps inevitable failures. As a result, management
expects that the Company could suffer the following consequences:
1. a significant number of operational inconveniences and
inefficiencies for the Company and its clients that may divert
management's time and attention and financial and human resources from
its ordinary business activities; and
2. a lesser number of serious system failures that may require
significant efforts by the Company or its clients to prevent or alleviate
material business disruptions.
CONTINGENCY PLANS. The Company is currently developing contingency plans
to be implemented as part of its efforts to identify and correct Year 2000
Problems affecting its internal systems. The Company expects to complete its
contingency plans by the middle of 1999. Depending on the systems affected,
these plans could include accelerated replacement of affected equipment or
software, short to medium-term use of backup equipment and software, increased
work hours for Company personnel or use of contract personnel to correct on an
accelerated schedule any Year 2000 Problems that arise or to provide manual
workarounds for information systems, and similar approaches. If the Company is
required to implement any of these contingency plans, it could have a material
adverse effect on the Company's financial condition and results of operations.
DISCLAIMER. The discussion of the Company's efforts, and management's
expectations, relating to Year 2000 compliance are forward-looking statements.
The Company's ability to achieve Year 2000 compliance and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' ability to modify proprietary software, and unanticipated problems
identified in the ongoing compliance review.
-22-
EURO CONVERSION
Several European countries will adopt 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
Prior to the acquisition of Seer, the Company was not exposed to
significant risks of foreign currency fluctuation. Following the acquisition of
Seer, the Company's US-based operations now have significant receivables
denominated in foreign currency and are subject to transactions 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
intends to begin hedging transactions 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
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. On January 28, 1998, the Company engaged Grant Thornton LLP to
replace Lurie, Besikof, Lapidus & Co., LLP. For further information regarding
this change, reference is made to the Company's Forms 8-K filed with the
Securities and Exchange Commission on January 30, 1998.
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 1999 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 1999 Annual Meeting of Shareholders.
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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 1999 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
1999 Annual Meeting of Shareholders.
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 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, 1998 and
1997
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
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.
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2.1 Agreement dated November 23, 1998 among the Company
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. Form 10-K
for the fiscal year ended September 30, 1998, No.
0-26194, and incorporated herein by reference.)
2.2 Amendment No. 1 to the Agreement dated
November 23, 1998 among the Company and WCAS
and the WCAS Parties relating to the
acquisition of capital stock of Seer (filed
as Exhibit (c)(2) to the Company' s Schedule
13e-3 filed on March 29, 1999 and
incorporated herein by reference).
3.1 Restated Certificate of Incorporation of the
Company (filed as exhibit 3.1 to Registration
Statement No. 33-92230 on Form S-1 and
incorporated herein by reference.)
3.2 By-Laws of the Company (filed as exhibit 3.2
to Registration Statement No. 33-92230 on
Form S-1 and incorporated herein by
reference).
4.1 Form of Warrant(s) representing the 250,000
Level 8 warrants issued to the WCAS Parties
(filed as exhibit 8.2(A) to Seer's Annual
Report on Form 10-K for the year ended
September 30, 1998, No. 0-26194, and
incorporated herein by reference).
10.1 The Company's February 2, 1995 Non-Qualified
Option Plan (filed as exhibit 10.1 to
Registration Statement No. 33-92230 on Form
S-1 and incorporated herein by reference).*
10.2 Amended and Restated Employment Agreement,
effective November 8, 1996, between Level 8
Technologies, Inc. ("Level 8 Technologies")
and Samuel Somech (filed as exhibit 10.12 to
Registration Statement No. 33-92230 on Form
S-1/A and incorporated herein by reference).*
10.2A Amendment dated February 26, 1999 to the
Employment Agreement between the Company and
Samuel Somech dated November 8, 1996 (filed
herewith).*
10.3 Consulting Agreement, effective April 1,
1995, between the Company and Theodore Fine
(filed as exhibit 10.13 to Registration
Statement No. 33-92230 on Form S-1 and
incorporated herein by reference).*
10.4 Form of Amendment, dated June, 1995, among
the Company, Registrant and Theodore Fine
(filed as exhibit 10.13A to Registration
Statement No. 33-92230 on Form S-1 and
incorporated herein by reference).*
10.5 Employment Agreement, dated May 1, 1995,
between the Company and Arie Kilman (filed as
exhibit 10.14 to Registration Statement No.
33-92230 on Form S-1 and incorporated herein
by reference).
10.5A Amendment to Employment Agreement, dated as
of September 18, 1996 between the Company and
Arie Kilman (filed as exhibit 10.14A to
Registration Statement No. 33-9230 on Form
S-1 and incorporated herein by reference).*
10.5B Amendment to Employment Agreement, dated
December 16, 1996, between the Company and
Arie Kilman (filed as exhibit 10.14B to