UNITED
STATES 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, 2006.
o TRANSITION
REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For
the transition period from
to
Commission
File Number: 0-26392
CICERO
INC.
(Exact
name of registrant as specified in its charter)
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Delaware
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11-2920559
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(State
of incorporation)
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(I.R.S.
Employer Identification No.)
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1433
State Highway 34, Building C, Farmingdale, New Jersey 07727
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(Address
of principal executive offices, including Zip
Code)
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(732)
919-3150
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(Registrant’s
telephone number, including area
code)
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_____________
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Securities
registered pursuant to Section 12(b) of the Act:
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NONE
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Securities
registered pursuant to Section 12(g) of the Act:
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Common
Stock, $.001 par value
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_____________
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes
o No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the above Act. Yes
o No x
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 o
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. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o Accelerated
filer o Non
- accelerated filer x
Aggregate
market value of the outstanding shares of common stock held by non-affiliates
of
the Registrant as of June 30, 2006 was approximately $2,153,345 based upon
the
closing price quoted on the Over The Counter Bulletin Board.
There
were 38,873,793 shares of Common Stock outstanding as of March 13, 2007.
CICERO
INC.
(Formerly
Level 8 Systems, Inc.)
Annual
Report on Form 10-K
For
the Fiscal Year Ended December 31, 2006
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Item
Number
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Page
Number
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PART
I
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1.
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1
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1A.
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9
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1B
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14
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2.
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14
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3.
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14
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4.
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15
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PART
II
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5.
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16
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6.
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17
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7.
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18
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7A.
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28
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8.
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28
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9.
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28
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9A.
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28
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9B.
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29
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PART
III
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10.
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30
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11.
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33
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12.
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34
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13.
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36
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14.
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40
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PART
IV
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15.
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41
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48
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F-1
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PART
I
Item
1.
Business
Overview
Cicero
Inc, formerly known as Level 8 Systems, Inc. (the “Company”) is
a provider
of business integration software, which enables organizations to integrate
new
and existing information and processes at the desktop. Our business integration
software addresses the emerging need for companies’ information systems to
deliver enterprise-wide views of their business information
processes. In
addition to software products, the Company also provides technical support,
training and consulting services as part of its commitment to providing its
customers with industry-leading integration solutions. The Company’s consulting
team has in-depth experience in developing successful enterprise-class solutions
as well as valuable insight into the business information needs of customers
in
the largest 500 corporations worldwide (the “Global 5000”).
The
Company’s focus is on the growing desktop integration and business process
automation market with our Cicero®
product. Cicero® is a business application integration platform that enhances
end-user productivity, streamlines business operations and integrates systems
and applications that would not otherwise work together. Cicero® software offers
a proven, innovative departure from traditional, costly and labor-intensive
enterprise application integration, which occurs at the server level. Cicero®
provides non-invasive application integration at the desktop level. Desktop
level integration provides the user with a single environment with a consistent
look and feel for diverse applications across multiple operating environments,
reduces enterprise integration implementation cost and time, and supports a
Service-Oriented Architecture (“SOA”). Cicero®’s desktop level integration also
enables clients to transform applications, business processes and human
expertise into a seamless, cost effective business solution that provides a
cohesive, task-oriented and role-centric interface that works the way people
think.
By
using Cicero® software, companies can decrease their customer management costs,
improve their customer service and more efficiently cross-sell the full range
of
their products and services resulting in an overall increase in return on their
information technology investments. In addition, Cicero® software enables
organizations to reduce the business risks inherent in replacement or
re-engineering of mission-critical applications and extend the productive life
and functional reach of their application portfolio.
Cicero®
software is engineered to integrate diverse business applications and shape
them
to more effectively serve the people who use them. Cicero® provides an intuitive
integration and development environment, which simplifies the integration of
complex multi-platform applications. Cicero® provides a unique approach that
allows companies to organize components of their existing applications to better
align them with tasks and operational processes. In addition, Cicero® can
streamline end-user tasks by providing a single, seamless user interface for
simple access to multiple systems or be configured to display one or more
composite applications to enhance productivity. Cicero® software enables
automatic information sharing among line-of-business applications and tools.
It
is ideal for deployment in contact centers where its highly productive,
task-oriented user interface promotes user efficiency. Finally, Cicero®
software, by integrating diverse applications across multiple operating systems,
is ideal for the financial services, for which Cicero® was initially developed,
insurance, telecommunications, intelligence, security, law enforcement,
governmental and other industries requiring a cost-effective, proven application
integration solution. Cicero® is also an integration solution for merger and
acquisition events where the sharing of data and combining of systems is
imperative.
Some
of the companies and other users that have implemented or are implementing
our
Cicero® software product include Merrill Lynch Pierce Fenner & Smith
Incorporated, Nationwide Financial Services, IBM and N.E.W. Customer Service
Companies. We have also sold to intelligence, security, law enforcement and
other government users.
In
addition to our Cicero® product, our Ensuredmail email encryption products
address information and security compliance requirements from the individual
to
the enterprise. The Ensuredmail suite of products includes the Enterprise Email
Encryption Server, and Email Encryption Desktop for individual use. All of
the
Ensuredmail products use 3-DES or AES encryption technology and are tested
and
federally certified FIPS 140-1. Ensuredmail products are easy to install, use
and administer. They also use rules and other utilities that allow users to
flag
messages including attachments for encryption. Unlike other secure email
encryption software applications, Ensuredmail products do not require the
recipient to install software or use special secure keys to open and read
messages and attachments. In conjunction with Cicero® software, Ensuredmail
email encryption technology has been used to secure information shared in
Cicero® integration projects.
1
Some
of the companies using Ensuredmail server products include the United Postal
Service, E-Loan, the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives,
Science Application International Association, Wilmington Trust, Delta Dental,
Truog-Ryding Company, and hundreds of individual users with the Ensuredmail
Email Desktop product. Ensuredmail customers use email encryption primarily
to
secure outbound messages with confidential information for compliance (e.g.,
HIPAA) and security purposes.
Cicero
Inc. was incorporated in New York in 1988 as, Level 8 Systems, Inc. and
re-incorporated in Delaware in 1999. Our principal executive offices are located
at 1433 State Highway 34, Building C, Farmingdale, New Jersey 07727 and our
telephone number is (732) 919-3150. Our web site is
www.ciceroinc.com.
Strategic
Realignment
Historically,
the Company has been a global provider of software solutions designed to help
companies integrate new and existing applications as well as extend those
applications to the Internet. This market segment is commonly known as
Enterprise Application Integration or EAI. Historically, EAI solutions work
directly at the server or back-office level allowing disparate applications
to
communicate with each other.
Until
early 2001, we focused primarily on the development, sale and support of EAI
solutions through our Geneva product suite. After extensive strategic
consultation with outside advisors and an internal analysis of our products
and
services, we recognized that a new market opportunity had emerged. This
opportunity was represented by the increasing need to integrate applications
that are physically resident on different platforms, a typical situation in
larger companies. In most cases, companies with large customer bases utilize
numerous different, or "disparate," applications that were not designed to
effectively communicate and pass information. In addition, traditional EAI
is
often times too costly and time-consuming to implement. It also requires a
group
of programmers with the necessary skills and ongoing invasive changes to
application software code throughout the enterprise. With Cicero® software,
which non-invasively integrates the functionality of these disparate
applications at the desktop, we believe that we have found a unique solution
to
this disparate application problem. We believe that our existing experience
in
and understanding of the EAI marketplace coupled with the unique Cicero®
software solution, which approaches traditional EAI needs in a more effective
manner, position us to be a competitive provider of business integration
solutions to the financial services and other industries with large deployed
contact centers, as well as our other target markets.
We
originally licensed the Cicero® technology and related patents on a worldwide
basis from Merrill Lynch, Pierce, Fenner & Smith Incorporated in August of
2000 under a license agreement containing standard provisions and a two-year
exclusivity period. On January 3, 2002, the license agreement was amended to
extend our exclusive worldwide marketing, sales and development rights to
Cicero® in perpetuity (subject to Merrill Lynch's rights to terminate in the
event of bankruptcy or a change in control of the Company) and to grant
ownership rights in the Cicero® trademark. Merrill Lynch indemnifies us with
regard to the rights granted to us by them. Consideration for the original
Cicero® license we issued to Merrill Lynch consisted of 1,000,000 shares of our
common stock. In consideration for the amendment, we issued an additional
250,000 shares of common stock to MLBC, Inc., a Merrill Lynch affiliate and
entered into a royalty sharing agreement. Under the royalty sharing agreement,
we pay a royalty of 3% of the sales price for each sale of Cicero® or related
maintenance services. The royalties over the life of the agreement are not
payable in excess of $20 million. We have completely re-engineered the Cicero®
software to provide increased functionality and much more powerful integration
capabilities.
The
Company’s future revenues are entirely dependent on acceptance of Cicero® which
has had limited success in commercial markets to date. The Company has
experienced negative cash flows from operations for the past three years.
As of
December 31, 2006, the Company had a working capital deficiency of approximately
$7,894,000. Accordingly, there is substantial doubt that the Company can
continue as a going concern, as is expressed in the independent auditor’s report
accompanying our financial statements. In order to address these issues and
to
obtain adequate financing for the Company’s operations for the next twelve
months, the Company is actively promoting and expanding its product line
and
continues to negotiate with significant customers who have demonstrated interest
in the Cicero® technology. The Company is experiencing difficulty increasing
sales revenue largely because of the inimitable nature of the product as
well as
customer concerns about the Company’s financial viability. Cicero® software is a
new “category defining” product in that most EAI projects are performed at the
server level and Cicero®’s integration occurs at the desktop level without the
need to open and modify the underlying code for those applications being
integrated. Many companies are not aware of this new technology or tend to
look
toward more traditional and accepted approaches. The Company is attempting
to
solve the former problem by improving the market’s knowledge and understanding
of Cicero® through increased marketing and leveraging its limited number of
reference accounts while enhancing its list of resellers and system integrators
to assist in the sales and marketing
2
process.
Additionally, the Company is seeking additional equity capital or other
strategic transactions in the near term to provide additional liquidity.
Plan
of Recapitalization
In
December 2006, the Company completed its Plan of Recapitalization which was
approved by shareholders at a Special Shareholder Meeting held on November
16,
2006. The Plan provided the Company’s Board of Directors with discretionary
authority to affect a reverse stock split ratio from 20:1 to 100:1 and on
November 20, 2006, the Board of directors set that reverse stock ratio to be
100:1. In addition, the Company’s shareholders approved an amendment to change
the name of the Company from Level 8 Systems, Inc. to Cicero Inc., to increase
the authorized common stock of the Company from 85 million shares to 215 million
shares and to convert existing preferred shares into a new Series A-1 preferred
stock. Senior Reorganization Notes in the aggregate principal amount of
$2,309,000, were cancelled and converted into 3,438,473 shares of common stock.
Senior Reorganization Notes were issued pursuant to a Note and Warrant Offering
in 2004 wherein warrant holders of the Company’s common stock were offered a
one-time conversion of their existing warrants at a conversion price of $0.10
per share. Those warrant holders who elected to convert, tendered their
conversion price in cash and received a Note Payable in exchange. In addition,
holders of Senior Reorganization Notes were granted additional warrants to
acquire the Company’s common stock. The Company also converted $3,915,000 of
Convertible Bridge Notes into 30,508,448 shares of common stock. The Plan of
Recapitalization also included an exchange of existing preferred shares into
a
new Series A-1 preferred shares for Cicero Inc. As part of that exchange and
part of the plan of recapitalization, $992,000 of Convertible Promissory Notes
were converted into 1,591 Series A-1 preferred shares and $1,061,000 of Series
D
preferred stock recorded as mezzanine financing was converted into 53 preferred
shares.
The
Company expects that increased revenues will reduce its operating losses in
future periods; however, there can be no assurance that management will be
successful in executing its strategy as anticipated or in a timely manner.
If
these strategies are unsuccessful, the Company may have to pursue other means
of
financing that may not be on terms favorable to the Company or its stockholders.
If the Company is unable to increase cash flow or obtain financing, it may
not
be able to generate enough capital to fund operations for the next twelve
months. At our current rate of expenses and assuming revenues for the next
twelve months at an annualized rate of our revenue for the year ended 2006,
we
will be able to fund planned operations with existing capital resources for
a
minimum of four months and experience negative cash flow of approximately
$2,000,000 during the next twelve months to maintain planned operations. The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. The financial statements presented herein
do
not include any adjustments relating to the recoverability of assets and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
Products
Desktop
Integration Segment
Cicero®.
Cicero® software integrates disparate applications regardless of the platform,
enables rapid development of effective, simple-to-maintain composite
applications, accelerates time to value and deploys cost-effective,
"best-of-breed" business solutions by leveraging existing IT investments.
Cicero® software helps the architect maintain consistent integration project
design and implementation by providing extensible, standardized software methods
for interacting with Windows applications, COM objects, web pages, commercial
software packages, legacy applications, and Java applications among others.
Cicero® software can integrate applications running on the server or desktop,
giving the architect complete flexibility in determining where, when, and how
application integration occurs. Cicero® software can also be used to capture and
aggregate data from many different applications, apply business rules as needed,
such as data transformation rules, and share that data bi-directionally via
a
composite view. An event in one application can cause processing in another
unrelated application, even if these were implemented using differing
technologies, such as Windows and Java.
The
patented Cicero® software technology, as exclusively licensed from Merrill
Lynch, consists of several components, including the following: The Resource
Manager, which manages the starting, stopping, and status of applications;
the
Event Manager, a Component Object Model (COM)-based messaging service; the
Context Manager which administers the “publish and subscribe” protocols; and a
Graphical User Interface (GUI) manager which allows applications to be presented
to the user in one or more flexible formats selected by the user organization.
In 2004, we released a version of the Cicero® product which included our newly
developed Cicero® Studio integration tool, to allow applications to be
integrated using point-and-click methods. Cicero® software incorporates an
Application Bus with code modules to handle the inter-application connections.
There are additional tools that provide ancillary functions for the integrator
including toolset to debug, view history and trace logs.
3
Cicero®
Studio provides a nontraditional approach to application integration. By
providing a high level of object-oriented integration, Cicero® Studio eliminates
the need for source code modification. It includes high-level integration
objects called genes (which translate disparate application interface protocols
to one common interface used by Cicero® software), an event processor, a context
manager and a publish-subscribe information bus that enables applications to
share data. It also includes a set of integration wizards that greatly simplify
the task of application integration.
Cicero®
Studio is a powerful integration tool that eliminates most of the technical
complexity associated with application integration. Integrators avoid the high
cost and complexity of invasive code modifications and extend the scope of
their
integration capabilities into new and legacy environments. Cicero® Studio
provides an open architecture that can be extended to incorporate new behaviors
by adding genes and communicating with COM objects. This enables Cicero®
software to be extended to accommodate new platforms and interface requirements
as needed and provides a rich paradigm for evolving integration behaviors over
time. It also means that Cicero® software can be implemented in both the desktop
and n-tier server of a service-oriented architecture.
Cicero®
software runs on Vista, Windows XP, and Windows 2000 to organize applications
in
a flexible graphical configuration that keeps all the application functionality
that the user needs within easy reach. For instance, selecting the “memo” tab
might cause a Microsoft Word memo-template to be created within the Cicero®
desktop. The end-user need not even know that they are using Microsoft Word.
Moreover, a customer-tracking database can be linked with a customer
relationship management software package.
Cicero®
technology provides non-intrusive integration of desktop and web applications,
portals, third-party business tools, and even legacy mainframe and client server
applications, so all co-exist and share their information seamlessly. Cicero®’s
non-invasive technology means that clients don’t risk modifying either fragile
source code or sensitive application program interfaces - and they can easily
integrate off-the-shelf products and emerging technologies.
Cicero®
software allows end-users to access applications in the most efficient way
possible, by only allowing them to use the relevant portions of that
application. For instance, a contact center customer service representative
may
not use 90% of the functionality of Microsoft Word, but might need access to
a
memorandum and other custom designed forms as well as basic editing
functionality. Cicero® can be set to control access to only those templates and,
in a sense, turn-off the unused functionality by not allowing the end-user
direct access to the underlying application. Under the same Cicero®
implementation, however, a different Cicero® configuration could allow the
employees in the Marketing department full access to Word because they have
need
of the full functionality. The functionality of the applications that Cicero®
integrates can be modulated by the business goals of the ultimate client, the
parent company. This ability to limit user access to certain functions within
applications enables companies to reduce their training burden by limiting
the
portions of the applications on which they are required to train their customer
service representatives.
Messaging
and Application Engineering Segment
Ensuredmail.Our
Ensuredmail products provide encrypted email capabilities such as security,
proof-of-delivery and non-repudiation of origination. The recipient of
an
Ensuredmail message does not need to be an
4
Ensuredmail
licensee or install software. When an Ensuredmail user sends a message
to
another user, the recipient receives an email message with an attached
encrypted
message. The recipient opens the attached, which starts their web browser,
enters a password, and can read the message and attachments. If the recipient
replies to the message, the message is fully encrypted and sent back securely
to
the original sender. Organizations typically use our server-based Ensuredmail
products, whereas individuals can use a person-to-person desktop
variation.
Ensuredmail
is FIPS140-1 certified, and in use by agencies of the Federal Government, in
addition to private sector organizations.
Services
We
provide a full spectrum of technical support, training and consulting services
across all of our operating segments as part of our commitment to providing
our
customers industry-leading business integration solutions. Experts in the field
of systems integration with backgrounds in development, consulting, and business
process reengineering staff our services organization. In addition, our services
professionals have substantial industry specific backgrounds with extraordinary
depth in our focus marketplace of financial services.
Maintenance
and Support
We
offer customers varying levels of technical support tailored to their needs,
including periodic software upgrades, and telephone support. Cicero® and
Ensuredmail software are frequently used in mission-critical business
situations, and our maintenance and support services are accustomed to the
critical demands that must be met to deliver world-class service to our clients.
Many of the members of our staff have expertise in lights-out mission critical
environments and are ready to deliver service commensurate with those unique
client needs.
Training
Services
Our
training organization offers a full curriculum of courses and labs designed
to
help customers become proficient in the use of our products and related
technology as well as enabling customers to take full advantage of our
field-tested best practices and methodologies. Our training organization seeks
to enable client organizations to gain the proficiency needed in our products
for full client self-sufficiency but retains the flexibility to tailor their
curriculum to meet specific needs of our clients.
Consulting
Services
We
offer consulting services around our product offerings in project management,
applications and platform integration, application design and development and
application renewal, along with expertise in a wide variety of development
environments and programming languages. We also have an active partner program
in which we recruit leading IT consulting and system integration firms to
provide services for the design, implementation and deployment of our solutions.
Our consulting organization supports third party consultants by providing
architectural and enabling services.
Customers
Our
customers include both end-users to whom we sell our products and services
directly and distributors and other intermediaries who either resell our
products to end-users or incorporate our products into their own product
offerings. Typical end-users of our products and services are large businesses
with sophisticated technology requirements for contact centers, in the financial
services, insurance and telecommunications industries, and intelligence,
security, law enforcement and other governmental organizations.
Our customers are using our solutions to rapidly deploy applications. Some
examples of customers' uses of our products include:
| · |
Business
Process Outsourcers
- use our Cicero®
solution in contact centers to provide real time integration among
existing back-office systems, eliminate redundant data entry, shorten
call
times, provide real-time data access and enhance customer service
and
service levels.
|
| · |
A
financial institution
- uses our Cicero®
solution to provide real-time integration among market data, customer
account information, existing back-office systems and other legacy
applications, eliminate redundant data entry, provide real-time data
access and processing, and enhance customer service and service
levels.
|
5
| · |
An
insurance company
- uses our Cicero®
solution to integrate their customer information systems with over
thirty
software applications including a CRM
application.
|
| · |
A
law enforcement organization
- uses our Cicero®
solution to streamline and automate support for arrests and investigations
while merging federal, state and local systems within a unified
process.
|
Other
customers are systems integrators, which use our Cicero® product to develop
integration solutions for their customers.
Merrill
Lynch, N.E.W. Customer Service Companies, IBM, and Pilar Services, Inc. each
accounted for more than ten percent (10%) of our operating revenues in 2006.
In
2005, NEW Customer Service Companies and Innovative System Solutions Corporation
accounted for more than ten percent (10%) of our operating revenue. Bank of
America, Convergys, IBM, Nationwide Financial Services and SAIC each accounted
for more than ten percent (10%) of our operating revenue in 2004.
Sales
and Marketing
Sales
An
important element of our sales strategy is to supplement our direct sales force
by expanding our relationships with third parties to increase market awareness
and acceptance of our business integration software solutions. As part of these
relationships, we continue to jointly sell and implement Cicero® software
solutions with strategic partners such as systems integrators and embed Cicero®
along with other products through reseller relationships. We provide training
and other support necessary to systems integrators and Resellers to aid in
the
promotion of our products. To date we have entered into strategic partnerships
with the following resellers, for integrated business solutions: ThinkCentric,
Hewlett Packard and House of Code. In addition, we have entered into strategic
partnerships with Silent Systems, Inc., ADPI LLC, and Pilar Services, Inc.
These
organizations have relationships with existing customers or have access to
organizations requiring top secret or classified access. In addition, several
of
these partners can bundle Cicero® with other software to provide a comprehensive
solution to customers. We are not materially dependent on any of these
organizations. Generally, our agreements with such partners provide for price
discounts based on their sales volume, with no minimum required
volume.
Marketing
The
target market for our products and services are large companies operating
contact centers and in the financial services, insurance and telecommunications
industries, as well as users in the intelligence, security and law enforcement
communities and other governmental organizations. Increasing competitiveness
and
consolidation is driving companies in such businesses to increase the efficiency
and quality of their customer contact centers. As a result, customer contact
centers are compelled by both economic necessity and internal mandates to find
ways to increase internal efficiency, increase customer satisfaction, increase
effective cross-selling, decrease staff turnover cost and leverage their
investment in current information technology.
Our
marketing staff has an in-depth understanding of the customer contact center
software marketplace and the needs of these customers, as well as experience
in
all of the key marketing disciplines. They also have knowledge of the financial
services industry and government organizations that have focused on application
integration solutions to address needs in mergers and acquisitions and homeland
security.
Core
marketing functions include product marketing, marketing communications and
strategic alliances. We utilize focused marketing programs that are intended
to
attract potential customers in our target vertical industries and to promote
our
company and our brands. Our marketing programs are specifically directed at
our
target markets, and include speaking engagements, public relations campaigns,
focused trade shows and web site marketing, while devoting substantial resources
to supporting the field sales team with high quality sales tools and ancillary
material. As product acceptance grows and our target markets increase, we will
shift to broader marketing programs.
The
marketing department also produces ancillary material for presentation or
distribution to prospects, including demonstrations, presentation materials,
white papers, case studies, articles, brochures, and data sheets.
6
Research
and Product Development
In
connection with the narrowing of our strategic focus, we have experienced an
overall reduction in research and development costs. Since Cicero® is a new
product in a relatively untapped market, it is imperative to constantly enhance
the feature sets and functionality of the product.
We
incurred research and development expense of approximately $533,000, $891,000
and $1,111,000 in 2006, 2005, and 2004, respectively. The decrease in costs
reflects the reduction in the number of employees by two plus associated
overheads in 2006, and two employees, plus associated overheads in 2005.
Our
budgets for research and development are based on planned product introductions
and enhancements. Actual expenditures, however, may significantly differ from
budgeted expenditures. Inherent in the product development process are a number
of risks. The development of new, technologically advanced software products
is
a complex and uncertain process requiring high levels of innovation, as well
as
the accurate anticipation of technological and market trends.
Competition
The
markets in which we compete are highly competitive and subject to rapid change.
These markets are highly fragmented and served by numerous firms. We believe
that the competitive factors affecting the markets for our products and services
include:
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·
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Product
functionality and features;
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Availability
and quality of support services;
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·
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Ease
of product implementation;
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Price;
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Product
reputation; and
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Our
financial stability.
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The
relative importance of each of these factors depends upon the specific
customer
environment. Although we believe that our products and services can compete
favorably, we may not be able to increase our competitive position against
current and potential competitors. In addition, many companies choose to
deploy
their own information technology personnel or utilize system integrators
to
write new code or rewrite existing applications in an effort to develop
integration solutions. As a result, prospective customers may decide against
purchasing and implementing externally developed and produced solutions
such as
ours.
We
compete with companies that utilize varying approaches to modernize, web-enable
and integrate existing software applications:
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Portal
software offers the ability to aggregate information at a single
point,
but not the ability to integrate transactions from a myriad of
information
systems on the desktop. Plumtree is a representative company
in the
market.
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Middleware
software provides integration of applications through messages
and data
exchange implemented typically in the middle tier of the application
architecture. This approach requires modification of the application
source code and substantial infrastructure investments and operational
expense. Reuters, TIBCO and IBM MQSeries are competitors in the
middleware
market.
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CRM
software offers application tools that allow developers to build
product
specific interfaces and custom applications. This approach is
not designed
to be product neutral and is often dependent on deep integration
with our
technology. Siebel is a representative product in the CRM software
category.
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Recently,
there have been several companies that offer capabilities similar
to our
Cicero® software in that these companies advertise that they integrate
applications without modifying the underlying code for those
applications.
OpenSpan is one company who advertises that they can non-invasively
integrate at the point of contact or on the
desktop.
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7
Other
competitors include Above All Software, Attachmate Corporation, Seagull Software
Ltd. and Oracle. Our Cicero® product competes directly with other contact center
solutions offered by Microsoft, Corizon and Jacada. We expect additional
competition from other established and emerging companies. Furthermore, our
competitors may combine with each other, or other companies may enter our
markets by acquiring or entering into strategic relationships with our
competitors. Many of our current and possible future competitors have greater
name recognition, a larger installed customer base and greater financial,
technical, marketing and other resources than we have.
Intellectual
Property
Our
success is dependent upon developing, protecting and maintaining our
intellectual property assets. We rely upon combinations of copyright, trademark
and trade secrecy protections, along with contractual provisions, to protect
our
intellectual property rights in software, documentation, data models,
methodologies, data processing systems and related written materials in the
international marketplace. In addition, Merrill Lynch holds a patent with
respect to the Cicero® technology. Copyright protection is generally available
under United States laws and international treaties for our software and printed
materials. The effectiveness of these various types of protection can be
limited, however, by variations in laws and enforcement procedures from country
to country. We use the registered trademarks “Cicero®” and ,
“Ensuredmail”
All
other product and company names mentioned herein are for identification purposes
only and are the property of, and may be trademarks of, their respective
owners.
Employees
As
of December 31, 2006, we employed 18 employees. Our employees are not
represented by a union or a collective bargaining agreement.
We
believe that to fully implement our business plan we will be required to enhance
our ability to work with the Microsoft Vista, Windows XP, and Windows 2000
operating systems as well as the Linux operating system by adding additional
development personnel as well as additional direct sales personnel to complement
our sales plan. Although we believe that we will be successful in attracting
and
retaining qualified employees to fill these positions, no assurance can be
given
that we will be successful in attracting and retaining these employees now
or in
the future.
Available
Information
Our
web address is www.ciceroinc.com. We make available free of charge through
our
web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after such material is electronically filed with or furnished to
the
Securities and Exchange Commission.
Forward
Looking and Cautionary Statements
Certain
statements contained in this Annual Report may constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform
Act
of 1995 ("Reform Act"). We may also make forward looking statements in other
reports filed with the Securities and Exchange Commission, in materials
delivered to shareholders, in press releases and in other public statements.
In
addition, our representatives may from time to time make oral forward-looking
statements. Forward looking statements provide current expectations of future
events based on certain assumptions and include any statement that does not
directly relate to any historical or current fact. Words such as "anticipates,"
"believes," "expects," "estimates," "intends," "plans," "projects," and similar
expressions, may identify such forward looking statements. In accordance with
the Reform Act, set forth below are cautionary statements that accompany those
forward looking statements. Readers should carefully review these cautionary
statements as they identify certain important factors that could cause actual
results to differ materially from those in the forward-looking statements and
from historical trends. The following cautionary statements are not exclusive
and are in addition to other factors discussed elsewhere in our filings with
the
Securities and Exchange Commission and in materials incorporated therein by
reference: there may be a question as to our ability to operate as a going
concern, our future success depends on the market acceptance of the Cicero®
product and successful execution of the new strategic direction; general
economic or business conditions may be less favorable than expected, resulting
in, among other things, lower than expected revenues; an unexpected revenue
shortfall may adversely affect our business because our expenses are largely
fixed; our quarterly operating results may vary significantly because we are
not
able to accurately predict the amount and timing of individual sales and this
may adversely impact our stock price; trends in sales of our products and
general economic conditions may affect investors' expectations regarding our
financial performance and may adversely affect our stock price; our
future
8
results
may depend upon the continued growth and business use of the Internet; we may
lose market share and be required to reduce prices as a result of competition
from our existing competitors, other vendors and information systems departments
of customers; we may not have the ability to recruit, train and retain qualified
personnel; rapid technological change could render the Company's products
obsolete; loss of any one of our major customers could adversely affect our
business; our products may contain undetected software errors, which could
adversely affect our business; because our technology is complex, we may be
exposed to liability claims; we may be unable to enforce or defend our ownership
and use of proprietary technology; because we are a technology company, our
common stock may be subject to erratic price fluctuations; and we may not have
sufficient liquidity and capital resources to meet changing business conditions.
Item
1A.
Risk Factors
There
is substantial doubt as to whether we can continue as a going
concern.
Because
we incurred net operating losses of approximately $3.0 million for the year
ended December 31, 2006 in addition to losses from continuing operations of
approximately $13.4 million for the previous two fiscal years we experienced
negative cash flows from operations, had significant working capital
deficiencies at December 31, 2006, and because we are relying on acceptance
of a
newly developed and marketed product, there is substantial doubt that we can
continue to operate as a going concern. While we have attracted some additional
capital to continue to fund operations, there can be no assurance that we can
obtain additional financing and if we do obtain financing that it will be on
terms that are favorable to us or our stockholders.
We
have a history of losses and expect that we will continue to experience losses
at least through mid 2007.
We
experienced operating losses and net losses for each of the years from 1998
through 2006. We incurred a net loss of $25.1 million for 1998, $15.5 million
for 1999, $28.4 million for 2000, $105.1 million for 2001, $18.2 million for
2002, $10.0 million for 2003, $9.76 million in 2004, $3.68 million in 2005
and
$3.0 million in 2006. As of December 31, 2006, we had a working capital deficit
of $7.9 million and an accumulated deficit of $234 million. Our ability to
generate positive cash flow is dependent upon sustaining certain cost reductions
and generating sufficient revenues.
Therefore,
due to these and other factors, we expect that we will continue to experience
net losses through the first quarter of 2007. We have not generated sufficient
revenues to pay for all of our operating costs or other expenses and have relied
on financing transactions over the last several fiscal years to pay our
operating costs and other expenses. We cannot predict with accuracy our future
results of operations and believe that any period-to-period comparisons of
our
results of operations are not meaningful. Furthermore, there can be no assurance
that if we are unable to generate sufficient revenue from operations that we
will be able to continue to access the capital markets to fund our operations,
or that if we are able to do so that it will be on satisfactory
terms.
As
the number of software products in the industry increases and the functionality
of these products further overlaps, we believe that software developers and
licensors may become increasingly subject to infringement claims. Any such
claims, with or without merit, could be time consuming and expensive to defend
and could adversely affect our business, operating results and financial
condition.
We
develop new and unproven technology and products.
Historically,
the Company has been a global provider of software solutions to help companies
integrate new and existing applications as well as extend those applications
to
the Internet. This market segment is commonly known as Enterprise Application
Integration or EAI. Historically, EAI solutions work directly at the server
or
back-office level allowing disparate applications to communicate with each
other.
Until
early 2001, we focused primarily on the development, sale and support of EAI
solutions through our Geneva product suite. After extensive strategic
consultation with outside advisors and an internal analysis of our products
and
services, we decided to focus on the growing desktop and business process
automation market with our Cicero® product. Our technology and our products are
unproven and we have been actively marketing them since 2001. The markets for
our products are characterized by rapidly changing technologies, evolving
industry standards, frequent new product introductions and short product life
cycles. Our future success will depend to a substantial degree upon our ability
to market and enhance our existing products and to develop and introduce, on
a
timely and cost-effective basis, new products and features that meet changing
customer requirements and emerging and evolving industry
standards.
9
We
depend on an unproven strategy for ongoing revenue.
The
Company’s future revenues are entirely dependent on acceptance of Cicero® which
had limited success in commercial markets to date. The Company has experienced
negative cash flows from operations for the past three years. At December 31,
2006, the Company had a working capital deficiency of approximately $7,894,000.
Accordingly, there is substantial doubt that the Company can continue as a
going
concern, and the independent auditor’s report accompanying our financial
statements raises doubt about our ability to continue as a going concern. In
order to address these issues and to obtain adequate financing for the Company’s
operations for the next twelve months, the Company is actively promoting and
expanding its product line and continues to negotiate with significant customers
who have demonstrated interest in the Cicero® technology. The Company is
experiencing difficulty increasing sales revenue largely because of the
inimitable nature of the product as well as customer concerns about the
Company’s financial viability. Cicero® software is a new “category defining”
product in that most EAI projects are performed at the server level and
Cicero®’s integration occurs at the desktop level without the need to open and
modify the underlying code for those applications being integrated. Many
companies are not aware of this new technology or tend to look toward more
traditional and accepted approaches. The Company is attempting to solve the
former problem by improving the market’s knowledge and understanding of Cicero®
through increased marketing and leveraging its limited number of reference
accounts while enhancing its list of resellers and system integrators to assist
in the sales and marketing process. Additionally, the Company is seeking
additional equity capital or other strategic transactions in the near term
to
provide additional liquidity.
Our
new strategy is subject to the following specialized risks that may adversely
affect our long-term revenue and profitability prospects:
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·
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Cicero®
was originally developed internally by Merrill Lynch and has no
track
record of successful sales to organizations within the financial
services
industry and may not gain market acceptance;
|
|
·
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We
are approaching a different segment of the financial services industry,
the customer contact center, compared to our sales and marketing
efforts
in the past and there can be no assurance that we can successfully
sell
and market into this industry; and
|
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·
|
We
have had very limited success because the financial condition of
the
Company has caused concern for enterprise customers that would
be
dependent on Cicero® for their long-term
needs.
|
Economic
conditions could adversely affect our revenue growth and cause us not to achieve
desired revenue.
Our
ability to generate revenue depends on the overall demand for desktop
integration software and services. Our business depends on overall economic
conditions, the economic and business conditions in our target markets and
the
spending environment for information technology projects, and specifically
for
desktop integration in those markets. A weakening of the economy in one or
more
of our geographic regions, unanticipated major events and economic uncertainties
may make more challenging the spending environment for our software and
services, reduce capital spending on information technology projects by our
customers and prospective customers, result in longer sales cycles for our
software and services or cause customers or prospective customers to be more
cautious in undertaking larger transactions. Those situations may cause a
decrease in our revenue. A decrease in demand for our software and services
caused, in part, by an actual or anticipated weakening of the economy, may
result in a decrease in our revenue rates.
The
so-called “penny stock rule” could make it cumbersome for brokers and dealers to
trade in our common stock, making the market for our common stock less liquid
which could cause the price of our stock to decline.
The
Company was delisted from the NASDAQ SmallCap market effective January 23,
2003.
The Company’s common stock presently is quoted on the Over-the-Counter Bulletin
Board.
Trading
of our common stock on the OTCBB may be subject to certain provisions of the
Securities Exchange Act of 1934, as amended, commonly referred to as the "penny
stock" rule. A penny stock is generally defined to be any equity security that
has a market price less than $5.00 per share, subject to certain exceptions.
If
our stock is deemed to be a penny stock, trading in our stock will be subject
to
additional sales practice requirements on broker-dealers. These may require
a
broker-dealer to:
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make
a special suitability determination for purchasers of our
shares;
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·
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receive
the purchaser's written consent to the transaction prior to the
purchase;
and
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deliver
to a prospective purchaser of our stock, prior to the first transaction,
a
risk disclosure document relating to the penny stock
market.
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10
Consequently,
penny stock rules may restrict the ability of broker-dealers to trade and/or
maintain a market in our common stock. Also, prospective investors may not
want
to get involved with the additional administrative requirements, which may
have
a material adverse effect on the trading of our shares.
Because
we cannot accurately predict the amount and timing of individual sales, our
quarterly operating results may vary significantly, which could adversely impact
our stock price.
Our
quarterly operating results have varied significantly in the past, and we expect
they will continue to do so in the future. We have derived, and expect to
continue to derive in the near term, a significant portion of our revenue from
relatively large customer contracts or arrangements. The timing of revenue
recognition from those contracts and arrangements has caused and may continue
to
cause fluctuations in our operating results, particularly on a quarterly basis.
Our quarterly revenues and operating results typically depend upon the volume
and timing of customer contracts received during a given quarter and the
percentage of each contract, which we are able to recognize as revenue during
the quarter. Each of these factors is difficult to forecast. As is common in
the
software industry, the largest portion of software license revenues are
typically recognized in the last month of each fiscal quarter and the third
and
fourth quarters of each fiscal year. We believe these patterns are partly
attributable to budgeting and purchasing cycles of our customers and our sales
commission policies, which compensate sales personnel for meeting or exceeding
periodic quotas.
Furthermore,
individual Cicero® sales are large and each sale can or will account for a large
percentage of our revenue and a single sale may have a significant impact on
the
results of a quarter. The sales of both our historical products and Cicero® can
be classified as generally large in size to a small discrete number of
customers. In addition, the substantial commitment of executive time and
financial resources that have historically been required in connection with
a
customer’s decision to purchase Cicero® and our historical products increases
the risk of quarter-to-quarter fluctuations. Cicero® sales require a significant
commitment of time and financial resources because it is an enterprise product.
Typically, the purchase of our products involves a significant technical
evaluation by the customer and the delays frequently associated with customers’
internal procedures to approve large capital expenditures and to test, implement
and accept new technologies that affect key operations. This evaluation process
frequently results in a lengthy sales process of several months. It also
subjects the sales cycle for our products to a number of significant risks,
including our customers’ budgetary constraints and internal acceptance reviews.
The length of our sales cycle may vary substantially from customer to customer.
We
typically do not have any material backlog of unfilled software orders, and
product revenue may fluctuate from quarter to quarter due to the completion
or
commencement of significant assignments, the number of working days in a quarter
and the utilization rate of services personnel. As a result of these factors,
we
believe that a period-to-period comparison of our historical results of
operations is not necessarily meaningful and should not be relied upon as
indications of future performance. In particular, our revenues in the third
and
fourth quarters of our fiscal years may not be indicative of the revenues for
the first and second quarters. Moreover, if our quarterly results do not meet
the expectations of our securities analysts and investors, the trading price
of
our common stock would likely decline.
Loss
of key personnel associated with Cicero®
development could adversely affect our business.
Loss
of key executive personnel or the software engineers we have hired with
specialized knowledge of the Cicero® technology could have a significant impact
on our execution of our new strategy given that they have specialized knowledge
developed over a long period of time with respect to the Cicero® technology.
Furthermore, because of our restructuring and reduction in the number of
employees, we may find it difficult to recruit new employees in the
future.
Different
competitive approaches or internally developed solutions to the same business
problem could delay or prevent adoption of Cicero®.
Cicero®
is designed to address in a novel way the problems that large companies face
integrating the functionality of different software applications by integrating
these applications at the desktop. To effectively penetrate the market for
solutions to this disparate application problem, Cicero® will compete with
traditional Enterprise Application Integration, or EAI, solutions that attempt
to solve this business problem at the server or back-office level. Server
level
EAI solutions are currently sold and marketed by companies such as NEON,
Mercator, Vitria, and BEA. There can be no assurance that our potential
customers will determine that Cicero®’s desktop integration methodology is
superior to traditional middleware EAI solutions provided by the competitors
described above in addressing this business problem. Moreover, the information
systems departments of our target customers, large financial institutions,
are
large and may elect to attempt to internally develop an internal solution
to
11
this
business problem rather than to purchase the Cicero® product. Cicero® itself was
originally developed internally by Merrill Lynch to solve these integration
needs.
Our
ability to compete may be subject to factors outside our
control.
We
believe that our ability to compete depends in part on a number of competitive
factors outside our control, including the ability of our competitors to hire,
retain and motivate senior project managers, the ownership by competitors of
software used by potential clients, the development by others of software that
is competitive with our products and services, the price at which others offer
comparable services and the extent of our competitors’ responsiveness to
customer needs.
The
markets for our products are characterized by rapidly changing technologies,
evolving industry standards, frequent new product introductions and short
product life cycles.
Our
future success will depend to a substantial degree upon our ability to enhance
our existing products and to develop and introduce, on a timely and
cost-effective basis, new products and features that meet changing customer
requirements and emerging and evolving industry standards.
The
introduction of new or enhanced products also requires us to manage the
transition from older products in order to minimize disruption in customer
ordering patterns, as well as ensure that adequate supplies of new products
can
be delivered to meet customer demand. There can be no assurance that we will
successfully develop, introduce or manage the transition to new
products.
We
have in the past, and may in the future, experience delays in the introduction
of our products, due to factors internal and external to our business. Any
future delays in the introduction or shipment of new or enhanced products,
the
inability of such products to gain market acceptance or problems associated
with
new product transitions could adversely affect our results of operations,
particularly on a quarterly basis.
We
may face damage to the reputation of our software and a loss of revenue if
our
software products fail to perform as intended or contain significant defects.
Our
software products are complex, and significant defects may be found following
introduction of new software or enhancements to existing software or in product
implementations in varied information technology environments. Internal quality
assurance testing and customer testing may reveal product performance issues
or
desirable feature enhancements that could lead us to reallocate product
development resources or postpone the release of new versions of our software.
The reallocation of resources or any postponement could cause delays in the
development and release of future enhancements to our currently available
software, require significant additional professional services work to address
operational issues, damage the reputation of our software in the marketplace
and
result in potential loss of revenue. Although we attempt to resolve all errors
that we believe would be considered serious by our partners and customers,
our
software is not error-free. Undetected errors or performance problems may be
discovered in the future, and known errors that we consider minor may be
considered serious by our partners and customers. This could result in lost
revenue, delays in customer deployment or legal claims and would be detrimental
to our reputation. If our software experiences performance problems or ceases
to
demonstrate technology leadership, we may have to increase our product
development costs and divert our product development resources to address the
problems.
We
may be unable to enforce or defend our ownership and use of proprietary and
licensed technology.
We
originally licensed the Cicero® technology and related patents on a worldwide
basis from Merrill Lynch, Pierce, Fenner & Smith Incorporated in August of
2000 under a license agreement containing standard provisions and a two-year
exclusivity period. On January 3, 2002, the license agreement was amended
to
extend our exclusive worldwide marketing, sales and development rights to
Cicero® in perpetuity (subject to Merrill Lynch's rights to terminate in the
event of bankruptcy or a change in control of the Company) and to grant
ownership rights in the Cicero® trademark. Merrill Lynch indemnifies us with
regard to the rights granted to us by them. Consideration for the original
Cicero® license consisted of 1,000,000 shares of our common stock. In exchange
for the amendment, we granted an additional 250,000 shares of common stock
to
MLBC, Inc., a Merrill Lynch affiliate and entered into a royalty sharing
agreement. Under the royalty sharing agreement, we pay a royalty of 3% of
the
sales price for each
12
sale
of Cicero® or related maintenance services. The royalties over the life of the
agreement are not payable in excess of $20 million. We have completely
re-engineered the Cicero® software to provide increased functionality and much
more powerful integration capabilities.
We
do not believe that any of our products infringe the proprietary rights of
third
parties. However, companies in the software industry have experienced
substantial litigation regarding intellectual property and third parties could
assert claims that we have infringed their intellectual property rights. In
addition, we may be required to indemnify our distribution partners and end-
users for similar claims made against them. Any claims against us would divert
management resources, and could require us to spend significant time and money
in litigation, pay damages, develop new intellectual property or acquire
licenses to intellectual property that is the subject of the infringement
claims. These licenses, if required, may not be available on acceptable terms.
As a result, intellectual property claims against us could have a material
adverse effect on our business, operating results and financial condition.
Our
business may be adversely impacted if we do not provide professional services
to
implement our solutions.
Customers
that license our software typically engage our professional services staff
or
third-party consultants to assist with product implementation, training and
other professional consulting services. We believe that many of our software
sales depend, in part, on our ability to provide our customers with these
services and to attract and educate third-party consultants to provide similar
services. New professional services personnel and service providers require
training and education and take time and significant resources to reach full
productivity. Competition for qualified personnel and service providers is
intense within our industry. Our business may be harmed if we are unable to
provide professional services to our customers to effectively implement our
solutions of if we are unable to establish and maintain relationships with
third-party implementation providers.
Because
our software could interfere with the operations of customers, we may be subject
to potential product liability and warranty claims by these customers.
Our
software enables customers’ software applications to integrate and is often used
for mission critical functions or applications. Errors, defects or other
performance problems in our software or failure to provide technical support
could result in financial or other damages to our customers. Customers could
seek damages for losses from us. In addition, the failure of our software and
solutions to perform to customers’ expectations could give rise to warranty
claims. The integration of our software with our customer’s applications,
increase the risk that a customer may bring a lawsuit us. Even if our software
is not at fault, a product liability claim brought against us, even if not
successful, could be time consuming and costly to defend and could harm our
reputation.
We
have not paid any dividends on our common stock and it is likely that no
dividends will be paid in the future.
We
have never declared or paid cash dividends on our common stock and we do not
anticipate paying any cash dividends on our common stock in the foreseeable
future.
Provisions
of our charter and Bylaws and Delaware law could deter takeover
attempts.
Section
203 of the Delaware General Corporation Law, which prohibits certain persons
from engaging in business combinations with the Company, may have anti-takeover
effects and may delay, defer or prevent a takeover attempt that a stockholder
may consider to be in the holder’s best interests. These provisions of Delaware
law also may adversely affect the market price of our common stock. Our
certificate of incorporation authorizes the issuance, without stockholder
approval, of preferred stock, with such designations, rights and preferences
as
the board of directors may determine preferences as from time to time. Such
designations, rights and preferences
13
established
by the board may adversely affect our stockholders. In the event of issuance,
the preferred stock could be used, under certain circumstances, as a means
of
discouraging, delaying or preventing a change of control of the Company.
Although we have no present intention to issue any shares of preferred stock
in
addition to the currently outstanding preferred stock, we may issue preferred
stock in the future.
Not
Applicable
Item
2.
Properties
Our
corporate headquarters are located in approximately 1,300 square feet of office
space in Farmingdale, New Jersey, pursuant to a month-to-month sublease from
one
of our resellers. The United States operations group and administrative
functions are based in offices of approximately 2,956 square feet in our Cary,
North Carolina office pursuant to a lease expiring in 2007. The research and
development and customer support groups are located in the Farmingdale, New
Jersey and Cary, North Carolina facilities.
Item
3. Legal
Proceedings
Various
lawsuits and claims have been brought against us in the normal course of our
business. In January 2003, an action was filed in the Circuit Court of Loudon
County, Virginia, for a breach of a real estate lease. The case was settled
in
August 2003. Under the terms of the settlement agreement, we agreed to assign
a
note receivable with recourse equal to the unpaid portion of the note should
the
note obligor default on future payments. The unpaid balance of the note was
$545,000, of which the current unpaid principal portion is approximately
$123,000 and it matures in December 2007. At the maturity date of the note,
the
Company will be liable for additional payments totaling approximately $31,000
which we have recognized as a non-current liability.
In
October 2003, we were served with a summons and complaint in the Superior Court
of North Carolina regarding unpaid invoices for services rendered by one of
our
subcontractors. The amount in dispute was approximately $200,000 and is recorded
as part of our accounts payable. Subsequent to March 31, 2004, we settled this
litigation. Under the terms of the settlement agreement, we agreed to pay a
total of $189,000 plus interest over a 19-month period ending November 15,
2005.
The Company is in the process of negotiating a series of payments for the
remaining liability of approximately $80,000.
In
March 2004, we were served with a summons and complaint in the Superior Court
of
North Carolina regarding a security deposit for a sublease in Virginia. The
amount in dispute is approximately $247,000. In October 2004, we reached a
settlement agreement wherein we agreed to pay $160,000 over a 36-month period
ending October 2007.
In
August 2004, we were notified that we were in default under an existing lease
agreement for office facilities in Princeton, New Jersey. The amount of the
default is approximately $65,000. Under the terms of the lease agreement, we
may
be liable for future rents should the space remain vacant. We have reached
a
settlement agreement with the landlord which calls for a total payment of
$200,000 over a 36-month period ending October 2007.
In
October 2005, we were notified that Critical Mass Mail, Inc. had filed a claim
against us in the amount of $45,000 for failure to pay certain liabilities
under
an Asset Purchase Agreement dated January 9, 2004. We in turn filed a counter
claim that Critical Mass Mail, Inc. failed to deliver certain assets and other
documents under the same Asset Purchase Agreement. We had already reserved
the
potential liability under this action as part of the asset purchase accounting.
In February, 2006, Critical Mass Mail amended their complaint and was seeking
damages of approximately $600,000 for our failure to timely register the
underlying securities issued in the Asset Purchase Agreement. In November 2006,
we negotiated a settlement with Critical Mass Mail that provides for monthly
payments of the amounts already accrued. In December 2006 we settled the amended
complaint and agreed to issue $50,000 worth of the Company’s common stock. The
Company has recorded stock compensation expense as of December 31, 2006 in
this
amount.
Under
the indemnification clause of the Company’s standard reseller agreements and
software license agreements, the Company agrees to defend the reseller/licensee
against third party claims asserting infringement by the Company’s products of
certain intellectual property rights, which may include patents, copyrights,
trademarks or trade secrets, and to pay any judgments entered on such claims
against the reseller/licensee.
14
Item
4. Submission
of Matters to a Vote of Security Holders
The
annual meeting of Stockholders was held on November 16, 2006 in Cary, North
Carolina. The agenda for the meeting was (i) to ratify the name of the change
of
the Corporation to Cicero Inc., (ii) to ratify a consolidation (a reverse split)
of the common stock of the Company within a ratio of 20:1 to 100:1 as determined
by the Board of Directors of the Company, (iii) to ratify an increase in the
number of authorized shares of common stock of the Company from eighty-five
million (85,000,000) to two hundred fifteen million (215,000,000) shares, and
(iv) to ratify the amendment of the conversion prices at which all of the
outstanding shares of Series A-3, B-3, C and D preferred stock of the Company
convert into shares of common stock of the Company and then convert such
outstanding shares into a single class of Series A-1 preferred stock of the
Company. The record date for the meeting was set for October 1, 2006, at which
there were 56,544,577 shares of Company stock entitled to vote at the Meeting.
An aggregate of at least 28,272,280 shares of stock, representing at least
50.0001% of the shares of votable stock, were represented at the
Meeting.
The
votes were tabulated as follows:
|
Motion
to ratify the name of the change of the Corporation to Cicero
Inc:
|
|||||
|
VOTES
FOR
|
VOTES
AGAINST
|
ABSTAIN
|
|||
|
Common
stock and equivalents
|
48,855,828
|
252,752
|
244,006
|
||
|
Motion
to ratify a consolidation (a reverse split) of the common stock of
the
Company within a ratio of 20:1 to 100:1 as determined by the Board
of
Directors of the Company:
|
|||||
|
VOTES
FOR
|
VOTES
AGAINST
|
ABSTAIN
|
|||
|
Common
stock and equivalents
|
48,579,012
|
583,358
|
190,216
|
||
|
Series
A-3 Preferred Stock
|
188,408
|
--
|
--
|
||
|
Series
B-3 Preferred Stock
|
2,394,062
|
--
|
--
|
||
|
Series
C Preferred Stock
|
2,607,895
|
--
|
--
|
||
|
Series
D Preferred Stock
|
3,314,125
|
--
|
--
|
||
|
Motion
to ratify an increase in the number of authorized shares of common
stock
of the Company from eighty-five million (85,000,000) to two hundred
fifteen million (215,000,000) shares:
|
|||||
|
VOTES
FOR
|
VOTES
AGAINST
|
ABSTAIN
|
|||
|
Common
stock and equivalents
|
48,136,737
|
1,028,465
|
187,384
|
||
|
Series
A-3 Preferred Stock
|
188,408
|
--
|
--
|
||
|
Series
B-3 Preferred Stock
|
2,394,062
|
--
|
--
|
||
|
Series
C Preferred Stock
|
2,607,895
|
--
|
--
|
||
|
Series
D Preferred Stock
|
3,314,125
|
--
|
--
|
||
|
Motion
to ratify the amendment of the conversion prices at which all of
the
outstanding shares of Series A-3, B-3, C and D preferred stock of
the
Company convert into shares of common stock of the Company and then
convert such outstanding shares into a single class of Series A-1
preferred stock of the Company:
|
|||||
|
VOTES
FOR
|
VOTES
AGAINST
|
ABSTAIN
|
|||
|
Common
stock and equivalents
|
32,012,164
|
489,259
|
249,802
|
||
|
Series
A-3 Preferred Stock
|
188,408
|
--
|
--
|
||
|
Series
B-3 Preferred Stock
|
2,394,062
|
--
|
--
|
||
|
Series
C Preferred Stock
|
2,607,895
|
--
|
--
|
||
|
Series
D Preferred Stock
|
3,314,125
|
--
|
--
|
||
15
PART
II
Item
5. Market
For Registrant's Common Stock, Related Shareholder Matters and Issuer Purchases
of Equity Securities.
Our
common stock had been traded on the Nasdaq National Market under the symbol
''LVEL” from 1996 until December 23, 2002. From December 24, 2002, until January
23, 2003, our common stock traded on the Nasdaq SmallCap Market. As of January
23, 2003, our common stock was delisted from the Nasdaq SmallCap Market and
is
currently quoted on the Over-The-Counter Bulletin Board. In January 2007 we
formally changed our name to Cicero Inc. and now trade under the ticker CICN.
We
have never declared or paid any cash dividends on our common stock. We
anticipate that all of our earnings will be retained for the operation and
expansion of our business and do not anticipate paying any cash dividends on
our
common stock in the foreseeable future. In accordance with Staff Accounting
Bulletin Topic 4(c), the chart below sets forth the high and low stock prices
for the quarters of the fiscal years ended December 31, 2006 and 2005 as
retroactively adjusted for the 100:1 reverse stock split.
|
2006
|
2005
|
||||||||||||
|
Quarter
|
High
|
Low
|
High
|
Low
|
|||||||||
|
First
|
$
|
3.00
|
$
|
1.80
|
$
|
16.00
|
$
|
7.00
|
|||||
|
Second
|
$
|
2.50
|
$
|
1.00
|
$
|
9.00
|
$
|
4.00
|
|||||
|
Third
|
$
|
2.10
|
$
|
1.10
|
$
|
5.00
|
$
|
2.00
|
|||||
|
Fourth
|
$
|
4.50
|
$
|
1.30
|
$
|
5.00
|
$
|
1.00
|
|||||
The
closing price of the common stock on December 31, 2006 was $2.30 per share.
As
of March 16, 2007 we had 228 registered stockholders of record.
Recent
Sales of Unregistered Securities
In
2004, pursuant to a Note and Warrant Offering that was part of a
recapitalization plan, warrant holders of the Company’s common stock were
offered a one-time conversion of their existing warrants at a conversion price
of $0.10. The
Senior Secured Notes issued in the aggregate principal amount of $2,559,000
to
holders of warrants of the Company who loaned to the Company the exercise price
of their warrants and other investors who lent funds to the Company in exchange
for Senior Reorganization Notes and additional warrants, pursuant to note and
warrant offerings in December 2004 ($1,615,000, of which $67,000 was received
in
2005) and March 2005 ($944,000) (the “Note and Warrant Offerings”), will be
cancelled and the existing warrants in respect of which the exercise price
was
loaned to the Company, as evidenced by the Senior Reorganization Notes, will
be
exercised. Such warrant holders were offered a special one-time exercise price
of the lesser of $0.10 per share and the original exercise price as part of
the
merger agreement. The exercise price of the warrants at that time ranged from
$0.07 to $0.60.
As
part of the Note and Warrant Offering and approval of the Plan of
Recapitalization, the Company issued Additional Warrants to Senior
Reorganization Noteholders in connection with their loans to the Company,
exercisable at $0.04. Under the terms of the Note and Warrant Offering, the
warrants have been automatically exercised by applying the accrued interest
on
the Senior Reorganization Notes to the exercise or strike price and by cashless
exercise to the extent of the balance of the exercise price. The aggregate
number of shares issued upon exercise of the Additional Warrants was 3,438,473
shares of Cicero common stock.
Senior
Reorganization Noteholders who loaned the Company the first $1,000,000 in
respect of the exercise price of their warrants, pursuant to the Note and
Warrant Offering will receive warrants of Cicero (“Early Adopter Warrants”) at a
ratio of 2:1 for shares issuable upon exercise of each existing warrant
exercised at the special exercise price (before adjustment by the reverse stock
ratio) of $0.10 per share, as part of the Recapitalization Plan. In the
Recapitalization Plan, Early Adopter Warrants will convert into warrants of
Cicero for an aggregate of 201,115 shares of Cicero, at the exercise price
of
$10.00 per share.
As
part of the Plan of Recapitalization, Noteholders of $992,000 of Convertible
Promissory Notes were offered reduced conversion prices to convert their notes
into shares of the Company’s new Series A-1 Preferred Stock. All Noteholders
have agreed to convert their notes. The Company has cancelled these notes and
issued 1,591 shares of its Series A-1 Preferred Stock.
During
2005 and 2006, the Company issued several Convertible Bridge Notes to a
consortium of investors. These notes bear interest at an annual rate of 10%
and
matured at various dates beginning on September 15, 2005. The Notes are
convertible into shares of the Company’s common stock upon approval of the Plan
of Recapitalization at conversion rates of $0.125 and $0.133. As of December
31,
2006, the Company had raised $3,915,000 from the sale of Convertible Bridge
Notes of which the aggregate principal amount of $746,000 was
16
from
various members of the Company’s Board of Directors. These notes automatically
converted into 30,508,448 shares of the common stock upon approval of the
Plan
of Recapitalization. Accordingly, this conversion has been reflected in the
Company’s accompanying Balance Sheet as of December 31, 2006.
These
securities were issued pursuant to an exemption from registration under Rule
506
of Regulation D promulgated under Section UW of the Securities Act of 1933
as
amended.
The
Company has not repurchased any shares of its stock.
Equity
Compensation Plan Information
The
following table sets forth certain information as of December 31, 2006, about
shares of Common Stock outstanding and available for issuance under the
Company’s existing equity compensation plans: the Level 8 Systems, Inc. 1997
Stock Option Incentive Plan, the 1995 Non-Qualified Option Plan and the Outside
Director Stock Option Plan. All of the Company’s Equity Compensation Plans were
approved by the Company’s stockholders.
|
Plan
Category
|
Number
of Securities to
be
issued upon exercise of outstanding
options
|
Weighted-average
exercise
price of outstanding
options
|
Number
of securities
remaining
available under
equity
compensation plans
(excluding
securities reflected in
the first column)
|
|||||||
|
Equity
compensation plans approved by stockholders
|
45,315
|
$
|
120.61
|
37,830
|
||||||
|
Equity
compensation plans not approved by stockholders (1)
|
--
|
--
|
--
|
|||||||
|
Total
|
45,315
|
$
|
120.61
|
37,830
|
||||||
| (1) |
The
Company does not have any Equity Compensation Plans that were not
approved
by stockholders.
|
Item
6. Selected
Financial Data.
The
following selected financial data is derived from the consolidated financial
statements of the Company. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included herein.
See
Item 7 for a discussion of the entities included in operations (in thousands).
Weighted average shares outstanding have been restated retroactively to reflect
the 100:1 reverse stock split.
|
Year
Ended December 31,
(in
thousands, except per share data)
|
||||||||||||||||
|
2002
|
2003
|
2004
|
2005
|
2006
|
||||||||||||
|
SELECTED
STATEMENT OF OPERATIONS DATA
|
||||||||||||||||
|
Revenue
|
$
|
3,101
|
$
|
530
|
$
|
775
|
$
|
785
|
$
|
972
|
||||||
|
Loss
from continuing operations
|
$
|
(13,142
|
)
|
$
|
(9,874
|
)
|
$
|
(9,731
|
)
|
$
|
(3,681
|
)
|
$
|
(2,997
|
)
|
|
|
Loss
from continuing operations per common share - basic and
diluted
|
$
|
(74.89
|
)
|
$
|
(54.00
|
)
|
$
|
(27.05
|
)
|
$
|
(8.27
|
)
|
$
|
(0.25
|
)
|
|
|
Weighted
average common and common equivalent shares outstanding- basic and
diluted
|
189
|
215
|
360
|
445
|
35,182
|
|||||||||||
|
December
31,
|
||||||||||||||||
|
2002
|
2003
|
2004
|
2005
|
2006
|
||||||||||||
|
SELECTED
BALANCE SHEET DATA
|
||||||||||||||||
|
Working
capital (deficiency)
|
$
|
(6,254
|
)
|
$
|
(6,555
|
)
|
$
|
(10,255
|
)
|
$
|
(13,894
|
)
|
$
|
(7,894
|
)
|
|
|
Total
assets
|
11,852
|
5,362
|
530
|
241
|
597
|
|||||||||||
|
Long-term
debt, including current maturities
|
2,893
|
2,756
|
5,444
|
7,931
|
2,932
|
|||||||||||
|
Senior
convertible redeemable preferred stock
|
--
|
3,355
|
1,367
|
1,061
|
--
|
|||||||||||
|
Stockholders'
equity (deficiency)
|
1,653
|
(6,103
|
)
|
(11,857
|
)
|
(15,076
|
)
|
(7,912
|
)
|
|||||||
17
Item
7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations
General
Information
Cicero
Inc. is a global provider of business integration software that enables
organizations to integrate new and existing information and processes at the
desktop with our Cicero® software product. Business integration software
addresses the emerging need for a company's information systems to deliver
enterprise-wide views of the company's business
information processes. The Company also provides email encryption products
that
address information and security compliance from the individual to the
enterprise.
In
addition to software products, the Company also provides technical support,
training and consulting services as part of its commitment to providing its
customers industry-leading integration solutions. The Company’s consulting team
has in-depth experience in developing successful enterprise-class solutions
as
well as valuable insight into the business information needs of customers in
the
Global 5000. Cicero offers services around our integration and encryption
software products.
This
discussion contains forward-looking statements relating to such matters as
anticipated financial performance, business prospects, technological
developments, new products, research and development activities, liquidity
and
capital resources and similar matters. The Private Securities Litigation Reform
Act of 1995 provides a safe harbor for forward-looking statements. In order
to
comply with the terms of the safe harbor, the Company notes that a variety
of
factors could cause its actual results to differ materially from the anticipated
results or other expectations expressed in the Company's forward-looking
statements. See ''Item 1. Business—Forward Looking and Cautionary Statements.''
Business
Strategy
Management
makes operating decisions and assesses performance of the Company’s operations
based on the following reportable segments: (1) Desktop Integration and (2)
Messaging and Application Engineering.
The
Desktop Integration segment is comprised of the Cicero® product. Cicero® is a
business integration software product that maximizes end-user productivity,
streamlines business operations and integrates disparate systems and
applications, while renovating or rejuvenating older legacy systems by making
them usable in the business processes.
The
product that comprises the Messaging and Application Engineering segment is
Ensuredmail. Ensuredmail is an encrypted email technology that can reside on
either the server or the desktop.
18
Results
of Operations
The
following table sets forth, for the years indicated, the Company's results
of
continuing operations expressed as a percentage of revenue and presents
information for the three categories of revenue.
|
Year
Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Revenue:
|
||||||||||
|
Software
|
21.4
|
%
|
51.9
|
%
|
30.8
|
%
|
||||
|
Maintenance
|
12.3
|
%
|
18.7
|
%
|
39.5
|
%
|
||||
|
Services
|
66.3
|
%
|
29.4
|
%
|
29.7
|
%
|
||||
|
Total
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
||||
|
Cost
of revenue:
|
||||||||||
|
Software
|
0.9
|
%
|
2.0
|
%
|
577.8
|
%
|
||||
|
Maintenance
|
21.8
|
%
|
44.6
|
%
|
49.3
|
%
|
||||
|
Services
|
56.2
|
%
|
104.7
|
%
|
131.0
|
%
|
||||
|
Total
|
78.9
|
%
|
151.3
|
%
|
758.1
|
%
|
||||
|
Gross
margin (loss)
|
21.1
|
%
|
(51.3
|
)%
|
(658.1
|
)%
|
||||
|
Operating
expenses:
|
||||||||||
|
Sales
and marketing
|
35.6
|
%
|
79.9
|
%
|
140.4
|
%
|
||||
|
Research
and product development
|
54.8
|
%
|
113.5
|
%
|
143.3
|
%
|
||||
|
General
and administrative
|
124.1
|
%
|
144.8
|
%
|
196.4
|
%
|
||||
|
Impairment
of intangible assets
|
0.0
|
%
|
0.0
|
%
|
75.7
|
%
|
||||
|
(Gain)
on disposal of assets
|
(2.5
|
)%
|
0.0
|
%
|
(0.6
|
)%
|
||||
|
Total
|
212.0
|
%
|
338.2
|
%
|
555.2
|
%
|
||||
|
Loss
from operations
|
(190.9
|
)%
|
(389.5
|
)%
|
(1,213.3
|
)%
|
||||
|
Other
(expense), net
|
(117.5
|
)%
|
(79.4
|
)%
|
(42.3
|
)%
|
||||
|
Loss
before taxes
|
(308.4
|
)%
|
(468.9
|
)%
|
(1,255.6
|
)%
|
||||
|
Income
tax provision (benefit)
|
0.0
|
%
|
0.0
|
%
|
0.0
|
%
|
||||
|
Loss
from continuing operations
|
(308.4
|
)%
|
(468.9
|
)%
|
(1,255.6
|
)%
|
||||
|
Loss
from discontinued operations
|
0.0
|
%
|
0.0
|
%
|
(3.9
|
)%
|
||||
|
Net
loss
|
(308.4
|
)%
|
(468.9
|
)%
|
(1,259.5
|
)%
|
||||
The
following table sets forth data for total revenue for continuing operations
by
geographic origin as a percentage of total revenue for the periods
indicated:
|
2006
|
2005
|
2004
|
||||||||
|
United
States
|
100
|
%
|
100
|
%
|
98
|
%
|
||||
|
Europe
|
--
|
--
|
2
|
%
|
||||||
|
Total
|
100
|
%
|
100
|
%
|
100
|
%
|
||||
19
The
table below presents information about reported segments for the twelve months
ended December 31, 2006, 2005, and 2004 (in thousands):
|
For
the year ended December 31,
|
||||||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
Desktop
Integration
|
Messaging
and Application Engineering
|
Total
|
Desktop
Integration
|
Messaging
and Application Engineering
|
Total
|
Desktop
Integration
|
Messaging
and Application Engineering
|
Total
|
||||||||||||||||||||
|
Total
revenue
|
$
|
965
|
$
|
7
|
$
|
972
|
$
|
760
|
$
|
25
|
$
|
785
|
$
|
707
|
$
|
68
|
$
|
775
|
||||||||||
|
Total
cost of revenue
|
767
|
--
|
767
|
1,188
|
--
|
1,188
|
5,662
|
213
|
5,875
|
|||||||||||||||||||
|
Gross
margin (loss)
|
198
|
7
|
205
|
(428
|
)
|
25
|
(403
|
)
|
(4,955
|
)
|
(145
|
)
|
(5,100
|
)
|
||||||||||||||
|
Total
operating expenses
|
1,964
|
121
|
2,085
|
2,536
|
119
|
2,655
|
3,348
|
373
|
3,721
|
|||||||||||||||||||
|
Segment
profitability (loss)
|
$
|
(1,766
|
)
|
$
|
(114
|
)
|
$
|
(1,880
|
)
|
$
|
(2,964
|
)
|
$
|
(94
|
)
|
$
|
(3,058
|
)
|
$
|
(8,303
|
)
|
$
|
(518
|
)
|
$
|
(8,821
|
)
|
|
A
reconciliation of segment operating expenses to total operating expense follows
(in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Segment
operating expenses
|
$
|
2,085
|
$
|
2,655
|
$
|
3,721
|
||||
|
Write-off
of intangible assets
|
--
|
--
|
587
|
|||||||
|
(Gain)
on disposal of assets
|
(24
|
)
|
--
|
(5
|
)
|
|||||
|
Total
operating expenses
|
$
|
2,061
|
$
|
2,655
|
$
|
4,303
|
||||
A
reconciliation of total segment profitability to net loss from continuing
operations follows for the fiscal years ended December 31 (in
thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Total
segment profitability (loss)
|
$
|
(1,880
|
)
|
$
|
(3,058
|
)
|
$
|
(8,821
|
)
|
|
|
Write-off
of intangible assets
|
--
|
--
|
(587
|
)
|
||||||
|
Gain
on disposal of assets
|
24
|
--
|
5
|
|||||||
|
Interest
and other income/(expense), net
|
(1,141
|
)
|
(623
|
)
|
(328
|
)
|
||||
|
Net
loss before provision for income taxes
|
$
|
(2,997
|
)
|
$
|
(3,681
|
)
|
$
|
(9,731
|
)
|
|
Years
Ended December 31, 2006, 2005, and 2004
Revenue
and Gross Margin.
The Company has three categories of revenue: software products, maintenance,
and
services. Software products revenue is comprised primarily of fees from
licensing the Company's proprietary software products. Maintenance revenue
is
comprised of fees for maintaining, supporting, and providing periodic upgrades
to the Company's software products. Services revenue is comprised of fees for
consulting and training services related to the Company's software products.
The
Company's revenues vary from quarter to quarter, due to market conditions,
the
budgeting and purchasing cycles of customers and the effectiveness of the
Company’s sales force. The Company does not have any material backlog of
unfilled software orders and product revenue in any period is substantially
dependent upon orders received in that quarter. Because the Company's operating
expenses are based on anticipated revenue levels and are relatively fixed over
the short term, variations in the timing of the recognition of revenue can
cause
significant variations in operating results from period to period. Fluctuations
in operating results may result in volatility of the price of the Company's
common stock.
20
Total
revenues increased 24% from $785,000 in 2005 to $972,000 in 2006. Revenues
increased slightly, or 1% from $775,000 in 2004 to $785,000 in 2005. The
increase in revenues in 2006 is primarily due to increased labor billings from
integration contracts with the Company’s professional services staff. The small
increase in revenues in 2005 over 2004 reflects a change in the mix of revenues,
wherein license revenues increased and annual maintenance revenues decreased.
Gross profit margin (loss) was 21%, (51)% and (658)% for 2006, 2005, and 2004,
respectively.
The
Desktop Integration segment had a gross margin (loss) of 21% for the year ended
December 31, 2006, (56)% for the year ended December 31, 2005, and (701)% for
the year ended December 31, 2004. The improvement in gross margin from 2005
to
2006 reflects a reduction in professional services headcount and an overall
increase in revenues. In 2004, the Company had recognized a final impairment
of
the excess of the unamortized book value of the Cicero® technology in excess of
the expected net realizable value in accordance with SFAS 86, “Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed”.
A
charge in the amount of $2,844,000 was recorded as cost of software revenue
in
the Statement of Operations for the year ended December 31, 2004.
The
Messaging and Application Engineering segment gross margin for the years ended
December 31, 2006 and 2005 was 100%. The gross margin (loss) for the year ended
December 31, 2004 was (213%). In January 2004 the Company acquired substantially
all of the assets and assumed certain liabilities of Critical Mass Mail, Inc.,
d/b/a Ensuredmail, a federally certified encryption software company. The total
purchase price of the assets being acquired plus assumption of certain
liabilities was $750,000. The purchase price was allocated to the assets
acquired and liabilities assumed based on the Company’s estimates of fair value
at the acquisition date. The Company assessed the net realizable value of the
Ensuredmail software technology acquired and determined the purchase price
exceeded the amounts allocated to the software technology acquired less
liabilities assumed by approximately $587,000. This excess of the purchase
price
over the fair values of the assets acquired less liabilities assumed was
allocated to goodwill, and, because it was deemed impaired, charged to the
Statement of Operations for the period ended March 31, 2004. The Company
completed an assessment of the recoverability of the Ensuredmail product
technology, as of June 30, 2004 in accordance with SFAS 86, “Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed”. This
assessment was completed due to the Company’s revised cash flow projections from
software revenue. These revised cash flow projections did not support the
long-lived asset and accordingly the Company impaired the excess of the
unamortized book value of the technology in excess of the expected net
realizable value as of June 30, 2004. This charge, in the amount of $154,000,
was recorded as software amortization for the period ended June 30,
2004.
Software
Products.
Software product revenue decreased from $407,000 in 2005 to $208,000 in 2006
or
approximately 49%. Software product revenue increased approximately 70% in
2005
from those results achieved in 2004. The decrease in software revenues in 2006
is attributed the Company entering into only one significant license contract
during the year. The Company had another pilot installation in-process, however,
acceptance was not assured by December 31, 2006. In 2005, the Company was able
to successfully deploy its software to several smaller integration engagements.
The
gross margin (loss) on software products was 96% for each of the years ended
December 31, 2006 and 2005, and (1,773%), for the year ended December 31, 2004.
Cost of software is composed primarily of amortization of software product
technology, amortization of capitalized software costs for internally developed
software, impairment of software product technology, and royalties to third
parties, and to a lesser extent, production and distribution costs. All software
costs have been fully amortized as of December 31, 2004. The Cicero® software
technology and related patents was licensed by the Company on a worldwide basis
from Merrill Lynch in August of 2000 under a license agreement containing
standard provisions and a two-year exclusivity period. On January 3, 2002,
the
license agreement was amended to extend the Company’s exclusive worldwide
marketing, sales and development rights to Cicero® in perpetuity (subject to
Merrill Lynch’s rights to terminate in the event of bankruptcy or a change in
control of the Company) and to grant ownership rights in the Cicero® trademark.
The Company is indemnified by Merrill Lynch with regard to the rights granted
to
Cicero® by them. In consideration for the original Cicero® license we issued to
Merrill Lynch 1,000,000 shares of the Company’s common stock. In consideration
for the amendment, the Company issued an additional 250,000 shares of common
stock to MLBC, Inc., a Merrill Lynch affiliate and entered into a royalty
sharing agreement pursuant to which, the Company pays a royalty of 3% of the
sales price for each sale of Cicero® software or related maintenance services.
The royalties over the life of the agreement are not payable in excess of
$20,000,000.
The
software product gross margin (loss) for the Desktop Integration segment was
96%
for the years ended December 31, 2006 and 2005, and (1,950%) for the year ended
December 31, 2004. The software product gross margin (loss) on the Messaging
and
Application Engineering segment was 100% for the years ended December 31, 2006
and 2005 and (587%) for year ended December 31, 2004.
21
The
Company expects to see significant increases in software sales related to the
Desktop Integration segment coupled with improving margins on software products
as Cicero® gains acceptance in the marketplace. The Company’s expectations are
based on its review of the sales cycle that has developed around the Cicero®
product since being released by the Company, its review of the pipeline of
prospective customers and their anticipated capital expenditure commitments
and
budgeting cycles, as well as the status of in-process proof of concepts or
beta
sites with select corporations. The Messaging and Application Engineering
segment revenue is expected to increase marginally with on-line sales of its
products.
Maintenance.
Maintenance
revenues for the year ended December 31, 2006 decreased by approximately 18%
or
$27,000 from 2005. Maintenance revenues for the year ended December 31,
2005 decreased
by approximately 52% or $159,000 from 2004. The decline in maintenance revenues
in 2006 and in 2005 is primarily due to the non-renewal of one maintenance
contract for the Cicero® product in each of those years within the Desktop
Integration segment.
The
Desktop Integration segment accounted for approximately 95% of total maintenance
revenue and the Messaging and Application Engineering segment accounted for
approximately 5% of total maintenance revenues in 2006.
Cost
of maintenance is comprised of personnel costs and related overhead and the
cost
of third-party contracts for the maintenance and support of the Company’s
software products. The Company experienced a gross margin (loss) on maintenance
products of (77%) for 2006. Gross margin (loss) on maintenance products for
2005
and 2004 were (138%) and (25%) respectively.
Maintenance
revenues are expected to increase, primarily in the Desktop Integration segment
as a result of our expected increase in sales of the Cicero® product. The
Messaging and Application Engineering segment is now composed of the new
Ensuredmail encryption technology and maintenance revenues should increase
as
the product achieves market acceptance. The cost of maintenance should increase
slightly for the Desktop Integration segment.
Services.
Services
revenue for the year ended December 31, 2006 increased by approximately 179%
or
$413,000 over the same period in 2005. Services revenue for the year ended
December 31, 2005 were approximately the same as in 2004. The increase in
service revenues as compared to 2005 is attributable to the pilot engagements
that were incurred during the past two years.
Cost
of services primarily includes personnel and travel costs related to the
delivery of services. Services gross margin (loss) was 15%, (256%), and (341%)
for the years ended 2006, 2005, and 2004 respectively.
Services
revenues are expected to increase for the Desktop Integration segment as the
Cicero® product gains acceptance. The Messaging and Application Engineering
segment service revenues will continue to be deminimus as the new products
that
comprise that segment do not require substantial service oriented work.
Sales
and Marketing. Sales
and marketing expenses primarily include personnel costs for salespeople,
marketing personnel, travel and related overhead, as well as trade show
participation and promotional expenses. Sales and marketing expenses decreased
by 45% or approximately $281,000 in 2006 and decreased by 42% or approximately
$461,000 in 2005 due to a continued reduction in the Company’s sales and
marketing workforce, decreased promotional activities and a change in the sales
compensation structure. Specifically, the Company changed the compensation
structure to lower fixed costs and increase variable success-based
costs.
Sales
and marketing expenses are expected to increase as the Company adds additional
direct sales personnel and supports the sales function with collateral marketing
materials. The Company's emphasis for the sales and marketing groups will be
the
Desktop Integration segment.
Research
and Development. Research
and development expenses primarily include personnel costs for product authors,
product developers and product documentation and related overhead. Research
and
development expense decreased by 40% or $358,000 in 2006 as compared to 2005
and
decreased by 20% or $220,000 in 2005 as compared to 2004. The decrease in costs
reflects the reduction in headcount by two employees plus associated overheads
in 2006 and two employees, plus associated overheads in 2005.
The
Company intends to continue to make a significant investment in research and
development while enhancing efficiencies in this area.
General
and Administrative. General
and administrative expenses consist of personnel costs for the executive, legal,
financial, human resources, investor relations and administrative staff, related
overhead, and all
22
non-allocable
corporate costs of operating the Company. General and administrative expenses
for the year ended December 31, 2006 increased by 6% or $69,000 over the prior
year. The increase in general administrative costs is primarily due to costs
associated with the Company’s recapitalization plan in 2006. In fiscal 2005,
general and administrative expenses decreased by 25% or $385,000 as compared
to
2004. The decline in general and administrative costs in 2005 reflects the
general downsizing conducted by the Company in 2005.
General
and administrative expenses are expected to slightly increase going forward
as
the Company’s revenues increase.
Write-Off
of Goodwill and Other Intangible Assets. Write-off
of goodwill was $0 for the years ended December 31, 2006 and 2005, and $587,000
for the year ended December 31, 2004. During 2004, the Company acquired
substantially all of the assets and assumed certain liabilities of Critical
Mass
Mail, Inc., d/b/a Ensuredmail, a federally certified encryption software
company. The total purchase price of the assets being acquired plus certain
liabilities assumed was $750,000. The purchase price was allocated to the assets
acquired and liabilities assumed based on the Company’s estimates of fair value
at the acquisition date. The Company assessed the net realizable value of the
Ensuredmail software technology acquired and determined the purchase price
exceeded the amounts allocated to the software technology acquired less
liabilities assumed by approximately $587,000. This excess of the purchase
price
over the fair values of the assets acquired less liabilities assumed was
allocated to goodwill, and, because it was deemed impaired, charged to the
Statement of Operations for the period ended March 31, 2004. At December 31,
2006, 2005 and 2004, there was no remaining goodwill on the Company’s balance
sheet.
Warrants
Liability. The
Company has issued warrants to holders of preferred stock designated Series
A3
and Series B3 preferred stockholders which allow the warrant holders to force
a
cash redemption for events outside the control of the Company. The fair value
of
the warrants is accounted for as a liability and is re-measured at each balance
sheet date. As of December 31, 2006 and December 31, 2005, the warrant liability
had a fair value of $0.
Provision
for Taxes. The
Company’s effective income tax rate for continuing operations differs from the
statutory rate primarily because an income tax benefit was not recorded for
the
net loss incurred in 2006, 2005, or 2004. Because of the Company’s inconsistent
earnings history, the deferred tax assets have been fully offset by a valuation
allowance.
Impact
of Inflation. Inflation
has not had a significant effect on the Company’s operating results during the
periods presented.
Liquidity
and Capital Resources
Operating
and Investing Activities
The
Company generated $281,000 of cash for the year ended December 31,
2006
Operating
activities utilized approximately $2,224,000 in cash, which was primarily
comprised of the loss from operations of $2,997,000, offset by non-cash charges
for depreciation and amortization of approximately $12,000, and stock
compensation expense of $615,000 and a provision for doubtful accounts of
$50,000. In addition, the Company had an increase in accounts receivable of
$202,000, offset by a reduction of prepaid expenses and other assets of $31,000.
The Company generated approximately $311,000 in cash through an increase in
the
amount owing its creditors.
The
Company utilized approximately $17,000 in cash in the purchase of updating
the
Company’s network equipment.
The
Company generated approximately $2,528,000 of cash during the year from
financing activities from increases in Convertible Bridge notes of $2,148,000
and from approximately $380,000 resulting from the conversion of other debt
to
e quity.
The
Company utilized cash of $78,000 for the year ended December 31,
2005.
Operating
activities utilized approximately $2,564,000 in cash, which was primarily
comprised of the loss from operations of $3,681,000, offset by non-cash charges
for depreciation and amortization of approximately $11,000, and stock
compensation expense of $149,000. In addition, the Company had a reduction
in
accounts receivable of $146,000, as well as a reduction of prepaid expenses
and
other assets of $55,000. The Company generated approximately $804,000 in cash
through an increase in the amount owing its creditors. The Company had a
23
decrease
of $29,000 in assets and liabilities of discontinued operations, a decrease
in
$12,000 for its provision for uncollectible accounts, and a decrease of $7,000
in deferred revenue.
The
Company utilized approximately $6,000 in cash in the purchase of updating the
Company’s network equipment.
The
Company generated approximately $2,487,000 of cash during the year from
financing activities of the extension to its Note and Warrant offering of
$944,000 and $1,615,000 of financing from its Convertible bridge notes offset
by
repayments of the Company’s short-term debt in the amount of $55,000.
Financing
Activities
The
Company funded its cash needs during the year ended December 31, 2006 with
cash
on hand from December 31, 2005, as well as through the use of proceeds from
borrowings under convertible debt agreements.
The
Company has a term loan in the principal amount of $1,971,000 from Bank Hapoalim
bearing interest at LIBOR plus 1.5% (approximately 6.37% at December 31, 2006),
which is payable quarterly. There are no financial covenants and the term loan
is guaranteed by Liraz Systems, Ltd., the Company’s former principal
shareholder. In September 2004, The Company and Liraz Systems Ltd. agreed to
extend its guaranty on the term loan with Bank Hapoalim, and to extend the
maturity date on the loan to November 3, 2005. Under the terms of the agreement
with Liraz, the Company agreed to issue 3,942,000 shares of its common stock.
In
November 2005, The Company and Liraz Systems Ltd. agreed to extend its guaranty
on the term loan with Bank Hapoalim, and to extend the maturity date on the
loan
to November 15, 2006. Under the terms of the agreement with Liraz, the Company
agreed to issue 2,400,000 shares of its common stock and granted a warrant
to
purchase an additional 3,600,000 shares of our common stock at an exercise
price
of $0.002 per share. Based upon fair market value at the time of issuance,
the
Company recognized $48,000 as loan amortization costs in the Statement of
Operations for the year ended December 31, 2005. Because the warrants are
contingently issuable upon an event outside the control of the Company (the
proposed Plan of Recapitalization), the Company did not recognized any value
to
these warrants until the contingency is removed. In November 2006, The Company
and Liraz Systems Ltd. agreed to extend its guaranty on the term loan with
Bank
Hapoalim, and to extend the maturity date on the loan to October 31, 2007.
Under
the terms of the agreement with Liraz, the Company agreed to issue 6,000,000
shares of its common stock. Based upon fair market value at the time of
issuance, the Company recognized $240,000 as loan amortization costs in the
Statement of Operations for the year ended December 31, 2006. In addition,
since
the contingency surrounding the warrants granted in the prior years’ debt
extension was removed, the Company also recognized $72,000 as the value of
these
warrants and as loan amortization costs in the Statement of Operations for
the
year ended December 31, 2006.
In
2004, the Company announced a Note and Warrant Offering in which warrant holders
of the Company’s common stock were offered a one-time conversion of their
existing warrants at a conversion price of $0.10 per share as part of a
recapitalization plan. Under the terms of the Offer, which expired on December
31, 2004, warrant holders who elected to convert, would tender their conversion
price in cash and receive a Note Payable in exchange. As of December 31, 2004
the Company had raised $1,615,000. Upon approval of the plan of recapitalization
at a Shareholders meeting, these Notes would convert into common shares of
Cicero Inc. In addition, those warrant holders who elected to convert the first
$1 million of warrants would receive additional replacement warrants at a ratio
of 2:1 for each warrant converted, with a strike price of $10.00 per share.
In
addition, upon approval of the plan of recapitalization, each warrant holder
would be entitled to additional warrants to purchase common stock in Cicero
Inc.
In early 2005, the Company announced an extension to the Note and Warrant
offering and as of December 31, 2005, the Company has raised an additional
$944,000 for a total of approximately $2,559,000. Upon effectiveness of the
plan
of recapitalization, $2,309,000 of the Note and Warrant holders agreed to
convert their notes into 3,438,473 shares of the Company’s common
stock.
From
July through December 2006, the Company issued several Convertible Bridge Notes
with a consortium of investors. The Company had raised a total of $3,915,000
of
Convertible Bridge Notes of which $746,000 was from various members of the
Company’s Board of Directors. Under the terms of these Notes, holders have
converted their Notes into 30,508,448 shares of Cicero Inc. common stock upon
effectiveness of the plan of recapitalization approved by stockholders on
November 16, 2006.
The
Company believes that the plan of recapitalization will have a positive impact
on the future operations of the Company and its ability to raise additional
capital that it will need to continue operations, however, there can be no
assurance that management will be successful in executing as anticipated or
in a
timely enough manner. If these strategies are unsuccessful, the Company may
have
to pursue other means of financing that may not be on terms favorable to the
Company or its stockholders. If the Company is unable to increase cash flow
or
obtain financing, it
24
may
not be able to generate enough capital to fund operations for the next twelve
months. We do not believe that we currently have sufficient cash on hand to
finance operations for the next twelve months. At our current rates of expense
and assuming revenues for the next twelve months at the annualized rate of
revenue for the year ended 2006, we will be able to fund planned operations
with
existing capital resources for a minimum of four months and experience negative
cash flow of approximately $2.0 million during the next twelve months to
maintain planned operations. The accompanying financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The
financial statements presented herein do not include any adjustments relating
to
the recoverability of assets and classification of liabilities that might be
necessary should the Company be unable to continue as a going
concern.
In
April 2005, the Company borrowed $30,000 from a director of the Company pursuant
to a convertible loan agreement. Under the term of this agreement, the loan
bears interest at 1% per month and is convertible upon the option of the
director into 428,571 shares of our common stock at a conversion price of $0.07
per share which was the fair market value of the Company’s stock at the time the
loan was made (pre-reverse stock split ratio). As part of the Plan of
Recapitalization, this debt together with all other convertible promissory
notes
totaling $992,000 was converted into 1,591 shares of preferred stock designated
Series A-1.
In
January 2004, the Company completed a common stock financing round wherein
it
raised $1,247,000 of capital from several new investors as well as certain
investors of Critical Mass Mail, Inc. The Company sold 3,369,192 shares of
common stock at a price of $0.37 per share. As part of the financing, the
Company has also issued warrants to purchase 3,369,192 shares of the Company’s
common stock at an exercise price of $0.37. The warrants expire three years
from
the date of grant. The shares issued and the conversion price reflected the
fair
market value of the Company’s stock on the date of the transaction and are prior
to effecting the reverse stock split ratio.
The
Company incurred a loss from continuing operations of approximately $2,997,000
for the year ended December 31, 2006 in addition to losses from continuing
operations of approximately $13,412,000 for the previous two fiscal years.
The
Company has experienced negative cash flows from operations for the past three
years. At December 31, 2006, the Company had a working capital deficiency of
approximately $7,894,000. The Company’s future revenues are entirely dependent
on acceptance of Cicero®, which has had limited success in commercial markets to
date. Accordingly, there is substantial doubt that the Company can continue
as a
going concern and the independent auditor’s report accompanying our financial
statements raises doubts about our ability to continue as a going concern.
In
order to address these issues and to obtain adequate financing for the Company’s
operations for the next twelve months, the Company is actively promoting and
expanding its product line and continues to negotiate with significant customers
that have expressed interest in the Cicero® technology. The Company is
experiencing difficulty increasing sales revenue largely because of the
inimitable nature of the product as well as customer concerns about the
financial viability of the Company. Cicero® software is a new “category
defining” product in that most Enterprise Application Integration (EAI) projects
are performed at the server level and Cicero®’s integration occurs at the
desktop level without the need to open and modify the underlying code for those
applications being integrated. Many companies are not aware of this new
technology or tend to look toward more traditional and accepted approaches.
The
Company is attempting to solve the former problem by improving the market’s
knowledge and understanding of Cicero® software through increased marketing and
leveraging our limited number of reference accounts, while enhancing our list
of
resellers and systems integrators to assist in the sales and marketing process.
Additionally, we must seek additional equity capital or other strategic
transactions in the near term to provide additional liquidity.
Contractual
Obligations
Future
minimum payments for all contractual obligations for years subsequent to
December 31, 2006 are as follows (in thousands):
|
2007
|
2008
|
2009
|
2010
|
Total
|
||||||||||||
|
Short
and long-term debt, including interest payments
|
$
|
3,212
|
$
|
31
|
$
|
--
|
$
|
--
|
$
|
3,243
|
||||||
|
Service
purchase commitments
|
275
|
--
|
--
|
--
|
275
|
|||||||||||
|
Operating
leases
|
65
|
6
|
--
|
--
|
71
|
|||||||||||
|
Capital
leases
|
2
|
1
|
--
|
--
|
3
|
|||||||||||
|
Total
|
$
|
3,554
|
$
|
38
|
$
|
--
|
$
|
--
|
$
|
3,592
|
||||||
25
Short
and long-term debt, including interest payments, includes an outstanding
indebtedness of approximately $1,971,000 term loan with Bank Hapoalim guaranteed
by Liraz Systems Inc, and $250,000 short-term note with SDS Merchant Fund.
Under
the employment agreement between the Company and Mr. Pizi effective January
1,
2006, the Company will pay Mr. Pizi an annual base salary of $150,000, and
performance bonuses in cash of up to $350,000 per annum based upon certain
revenue goals and operating metrics, as determined by the Compensation Committee
of the Board of Directors of the Company, in its discretion. Upon termination
of
Mr. Pizi's employment by the Company without cause, the Company has agreed
to
pay Mr. Pizi (a) a lump sum payment of one year of Mr. Pizi's then current
base
salary and all deferred but unpaid salaries and bonuses within thirty (30)
days
of termination, and (b) all then outstanding but unvested stock options shall
vest one hundred percent (100%).
Under
the employment agreement between the Company and Mr. Broderick effective January
1, 2006, the Company will pay Mr. Broderick a base salary of $150,000 and
performance bonuses in cash of up to $350,000 per annum based upon certain
revenue goals and operating metrics as determined by the Compensation Committee
of the Board of Directors of the Company. Upon termination of Mr. Broderick's
employment by the Company without cause, the Company has agreed to provide
Mr.
Broderick with a lump sum payment of one year of Mr. Broderick’s then current
base salary and payment of all deferred salaries and bonuses within thirty
(30)
days of termination. In addition, all then outstanding but unvested stock
options shall vest one hundred percent (100%).
Off
Balance Sheet Arrangements
The
Company does not have any off balance sheet arrangements. We have no
subsidiaries or other unconsolidated limited purpose entities, and we have
not
guaranteed or otherwise supported the obligations of any other entity.
Significant
Accounting Policies and Estimates
The
policies discussed below are considered by us to be critical to an understanding
of our financial statements because they require us to apply the most judgment
and make estimates regarding matters that are inherently uncertain. Specific
risks for these critical accounting policies are described in the following
paragraphs. With respect to the policies discussed below, we note that because
of the uncertainties inherent in forecasting, the estimates frequently require
adjustment.
Our
financial statements and related disclosures, which are prepared to conform
to
accounting principles generally accepted in the United States of America,
require us to make estimates and assumptions that affect the reported amounts
of
assets, liabilities, revenues and accounts receivable and expenses during the
period reported. We are also required to disclose amounts of contingent assets
and liabilities at the date of the financial statements. Our actual results
in
future periods could differ from those estimates. Estimates and assumptions
are
reviewed periodically, and the effects of revisions are reflected in the
Consolidated Financial Statements in the period they are determined to be
necessary.
We
consider the most significant accounting policies and estimates in our financial
statements to be those surrounding: (1) revenue recognition; (2) allowance
for
doubtful trade accounts receivable; and (3) valuation of deferred tax assets.
These accounting policies, the basis for any estimates and potential impact
to
our Consolidated Financial Statements, should any of the estimates change,
are
further described as follows:
Revenue
Recognition. Our
revenues are derived principally from three sources: (i) license fees for the
use of our software products; (ii) fees for consulting services and training;
and (iii) fees for maintenance and technical support. We generally recognize
revenue from software license fees when a license agreement has been signed
by
both parties, the fee is fixed or determinable, collection of the fee is
probable, delivery of our products has occurred and no other significant
obligations remain. For multiple-element arrangements, we apply the “residual
method”. According to the residual method, revenue allocated to the undelivered
elements is allocated based on vendor specific objective evidence (“VSOE”) of
fair value of those elements. VSOE is determined by reference to the price
the
customer would be required to pay when the element is sold separately. Revenue
applicable to the delivered elements is deemed equal to the remainder of the
contract price. The revenue recognition rules pertaining to software
arrangements are complicated and certain assumptions are made in determining
whether the fee is fixed and determinable and whether collectability is
probable. For instance, in our license arrangements with resellers, estimates
are made regarding the reseller’s ability and intent to pay the license fee. Our
estimates may prove incorrect if, for instance, subsequent sales by the reseller
do not materialize. Should our actual experience with respect to collections
differ from our initial assessment, there could be adjustments to future
results.
26
Revenues
from services include fees for consulting services and training. Revenues from
services are recognized on either a time and materials or percentage of
completion basis as the services are performed and amounts due from customers
are deemed collectible and non-refundable. Revenues from fixed price service
agreements are recognized on a percentage of completion basis in direct
proportion to the services provided. To the extent the actual time to complete
such services varies from the estimates made at any reporting date, our revenue
and the related gross margins may be impacted in the following
period.
Allowance
for Doubtful Trade Accounts Receivable.
In addition to assessing the probability of collection in conjunction with
revenue arrangements, we continually assess the collectability of outstanding
invoices. Assumptions are made regarding the customer’s ability and intent to
pay and are based on historical trends, general economic conditions, and current
customer data. Should our actual experience with respect to collections differ
from our initial assessment, there could be adjustments to bad debt
expense.
Capitalization
and Valuation of Software Product Technology.
Our policy on capitalized software costs determines the timing of our
recognition of certain development costs. In addition, this policy determines
whether the cost is classified as development expense or cost of software
revenue. Management is required to use professional judgment in determining
whether development costs meet the criteria for immediate expense or
capitalization. Additionally, we review software product technology assets
for
net realizable value at each balance sheet date. Should we experience reductions
in revenues because our business or market conditions vary from our current
expectations, we may not be able to realize the carrying value of these assets
and will record a write down at that time. For the year ended December 31,
2004,
the Company recorded a write down of software product technology totaling
$3,585,000 and as of December 31, 2006 and 2005 the Company had $0 in
capitalized software product technology.
Valuation
of Deferred Tax Assets.
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred income tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in
the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred income tax assets and liabilities of a change
in
tax rates is recognized in income in the period that includes the enactment
date. A valuation allowance is established to the extent that it is more likely
than not, that we will be unable to utilize deferred income tax assets in the
future. At December 31, 2006, we had a valuation allowance of $97,265,000
against $97,265,000 of gross deferred tax assets. We considered all of the
available evidence to arrive at our position on the net deferred tax asset;
however, should circumstances change and alter our judgment in this regard,
it
may have an impact on future operating results.
At
December 31, 2006, the Company has net operating loss carryforwards of
approximately $227,539,000, which may be applied against future taxable income.
These carryforwards will expire at various times between 2006 and 2025. A
substantial portion of these carryforwards is restricted to future taxable
income of certain of the Company’s subsidiaries or limited by Internal Revenue
Code Section 382. Thus, the utilization of these carryforwards cannot be
assured.
Recent
Accounting Pronouncements:
In
July 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income
Taxes - An Interpretation of SFAS No. 109”. FIN No. 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprise’s financial
statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN
No. 48 also prescribes a recognition threshold and measurement attribute for
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. In addition, FIN No. 48 provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The provisions of FIN No. 48 are to be
applied to all tax positions upon initial adoption of this standard. Only tax
positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized as an adjustment
to the opening balance of accumulated deficit (or other appropriate components
of equity) for that fiscal year. The provisions of FIN No. 48 are effective
for
fiscal years beginning after December 15, 2006. The Company is evaluating the
impact of the adoption of FIN 48 but does not currently expect the adoption
of
this new standard to have a material impact on our financial position, results
of operations, or cash flows.
In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulleting (“SAB”) 108, to address diversity in practice in
quantifying financial statement misstatements. SAB 108 requires that the Company
quantify misstatements based on their impact on each of its financial statements
and related
27
disclosures.
SAB 108 is effective for fiscal years
ending after November 15, 2006. The Company has adopted SAB 108 effective as
of
December 31, 2006. The adoption of this bulletin did not have a material impact
on our financial position, results of operations, or cash flows.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS
No. 157 provides guidance for using fair value to measure assets and
liabilities. It also responds to investors’ requests for expanded information
about the extent to which companies measure assets and liabilities at fair
value, the information used to measure fair value, and the effect of fair value
measurements on earnings. SFAS No. 157 applies whenever other standards require
(or permit) assets or liabilities to be measured at fair value, and does not
expand the use of fair value in any new circumstances. SFAS No. 157 is effective
for financial statements issued for fiscal years beginning after November 15,
2007 and is required to be adopted by the Company in the first quarter of 2008.
The Company is currently evaluating the effect that the adoption of SFAS No.
157
will have on our financial position, results of operations, or cash
flows.
In
December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based
Payment, (SFAS 123R). SFAS 123R addresses the accounting for share-based
payments to employees, including grants of employee stock options. Under
the new standard, companies will no longer be able to account for share-based
compensation transactions using the intrinsic method in accordance with APB
Opinion No. 25, “Accounting For Stock Issued To Employees”. Instead,
companies will be required to account for such transactions using a fair-value
method and recognize the expense in the consolidated statement of income.
SFAS 123R is effective for periods beginning after June 15, 2005 and
allows, but does not require, companies to restate the full fiscal year of
2005
to reflect the impact of expensing share-based payments under SFAS 123R.
The Company uses the Black-Scholes option-pricing model to determine the
fair-value of stock-based awards under SFAS No. 123R, consistent with that
used
for pro forma disclosures under SFAS No. 123, “Accounting for Stock-Based
Compensation”. The Company has elected to use the modified prospective
transition method as permitted by SFAS No. 123R and, accordingly, prior periods
have not been restated to reflect the impact of SFAS No. 123R. The modified
prospective transition method requires that stock-based compensation expense
be
recorded for all new and unvested stock options that are ultimately expected
to
vest as the requisite service is rendered beginning on the first day of the
Company’s year ended December 31, 2006. Stock-based compensation expense for
awards granted prior to 2006 is based on the grant-date fair-value as determined
under the pro forma provisions of SFAS No. 123.
Item
7A. Quantitative
and Qualitative Disclosures about Market Risk
As
the Company has disposed of or closed most of its European offices and
operations, the majority of revenues are generated from US sources. The Company
expects that trend to continue for the next year. As such, there is minimal
foreign currency risk at present. Should the Company continue to develop a
reseller presence in Europe and Asia, that risk will be increased.
Item
8. Financial
Statements and Supplementary Data
The
information required by this item appears beginning on page F-1 of this report.
Item
9. Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
During
the two most recent fiscal years there were no changes in or disagreements
with
the Company’s independent public accountants.
Item
9A.
Controls
and Procedures
The
Company, under the supervision and with the participation of the Company’s
management, including the Company’s Chief Executive Officer, President and Chief
Operating Officer and Chief Financial Officer, carried out an evaluation of
the
effectiveness of the design and operation of the Company’s disclosure controls
and procedures (the “Evaluation”) as of the end of the period covered by this
Report. Based upon the Evaluation, the Company’s Chief Executive Officer,
President and Chief Operating Officer and Chief Financial Officer concluded
that
the Company’s disclosure controls and procedures are effective to ensure that
information required to be disclosed in our periodic reports filed with the
Securities and Exchange Commission is recorded, processed, summarized and
reported as and when required. In addition, they concluded that there were
no
significant deficiencies or material
28
weaknesses
in the design or operation of internal controls which could significantly affect
the Company’s ability to record, process, summarize and report financial
information. It should be noted that any system of controls, however well
designed and operated, can provide only reasonable, and not absolute, assurance
that the objectives of the system will be met. In addition, the design of any
control system is based in part upon certain assumptions about the likelihood
of
future events. Because of these and other inherent limitations of control
systems, there is only reasonable assurance that the Company’s controls will
succeed in achieving their stated goals under all potential future conditions.
In
addition, the management of the Company, with the participation of the Company's
Chief Executive Officer and the Chief Financial Officer, has evaluated whether
any change in the Company's internal control over financial reporting (as
defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred
during the Company's fourth fiscal quarter. Based on that evaluation, the
Company's Chief Executive Officer and Acting Chief Financial
Officer
have concluded that there has been no change in the Company's internal control
over financial reporting during the fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
Item
9B. Other
Information
The
following disclosure has been filed on Form 8-K under the heading “Item 5.02.
Departure of Directors or Principal Officers, Election of Directors, Appointment
of Principal Officers.
On
January 10, 2006, Mr. Bruce Percelay was elected by the Board of Directors
to
serve as a member of the Board of Directors of Level 8 Systems,
Inc.
On
March 9, 2006, the Company reported the resignation of Mr. Fredric Mack from
the
Board of Directors.
On
May 15, 2006, Mr. John W. Atherton was elected by the Board of Directors to
serve as a member of the Board of Directors of Level 8 Systems,
Inc.
29
PART
III
Item
10. Directors and Executive Officers of the
Registrant
Set
forth below with respect to each director is his name, age, principal occupation
and business experience for the past five years and length of service as a
director of the Company.
Mark
Landis
Director
since July 2005. Age: 65
Mr.
Mark Landis is the Senior Managing Member of the Security Growth Fund, a newly
established private equity firm focused on the electronic security industry.
Prior to joining the Security Growth Fund and since 2003, Mr. Landis was the
Executive in Residence of The Jordan Company, a private equity firm based in
New
York. Mr. Landis retired from being President of the North American Security
Division of Siemens Building Technologies, Inc. in July of 2003, having spent
16
years with the company.
Anthony
C. Pizi
Director
since August 2000. Age: 47
Mr.
Pizi has served as Chairman of the Board of Directors from December 1, 2000
until March 7, 2005 and from June 1, 2005 until July 22, 2005. Mr. Pizi
currently is Chief Information Officer. He served as Chief Executive Officer
and
Chief Technology Officer from February 1, 2001 to July 22, 2005. Mr. Pizi has
been a director since August 2000. Until December 2000, he was First Vice
President and Chief Technology Officer of Merrill Lynch’s Private Client
Technology Architecture and Service Quality Group. Mr. Pizi’s 16 years with
Merrill Lynch included assignments in Corporate MIS, Investment Banking and
Private Client. Mr. Pizi earned his B.S. in Engineering from West Virginia
University.
Bruce
W. Hasenyager
Director
since October 2002. Age: 65
Mr.
Hasenyager has been a director of the Company since October 2002. Since November
2004, Mr. Hasenyager has served as Principal of Bergen & Webster Executive
Communications. Prior to that, he served as Director of Business and Technology
Development at the Hart eCenter at Southern Methodist University (SMU) and
Chief
Operating Officer of the Guildhall at SMU. From April 1996 to April 2002, Mr.
Hasenyager was a founder and served as Senior Vice President of Technology
and
Operations and Chief Technology Officer at MobilStar Network Corporation. Prior
to April 1996, Mr. Hasenyager held executive and senior management positions
in
information technology at Chemical Bank, Merrill Lynch, Kidder Peabody, and
Citibank.
Jay
R. Kingley
Director
since November 2002. Age: 45
Mr.
Kingley has been a director of the Company since November 2002. Mr. Kingley
is
currently the Chief Executive Officer of Kingley Institute LLC, a medical
wellness company. Prior to that, Mr. Kingley has served as CEO of Warren
Partners, LLC, a software development and consultancy company. Mr. Kingley
was
Managing Director of a business development function of Zurich Financial
Services Group from 1999-2001. Prior to joining Zurich Financial Services Group,
Mr. Kingley was Vice President of Diamond Technology Partners, Inc., a
management-consulting firm.
Charles
B. Porciello
Director
since June 2005. Age: 71
Mr.
Porciello has been a director since June 6, 2005.
Mr. Porciello graduated from the U.S. Military Academy with a B.S. in
Engineering and received his Masters Degree in Management from the University
of
Nebraska. Mr.
30
Porciello
is the Chief Executive Officer of Pilar
Services, Inc. Mr. Porciello retired from the U.S. Air Force in 1982 after
serving his country for twenty five years.
Bruce
D. Miller
Director
since July 2005. Age: 56
Mr.
Bruce D. Miller is a General Partner of Delphi Partners, Ltd. a privately-owned
investment partnership since 1989. He is the treasurer and a director of
American Season Corporation. Mr. Miller is a board member of Cape Air/Nantucket
Airlines, Inc. Mr. Miller is a trustee of the Egan Maritime Foundation and
is
involved in other non-profit activities. Mr. Miller received his B.S. in Finance
from Lehigh University and subsequently earned an M.B.A. from
Lehigh.
Bruce
A. Percelay
Director
since January 2006. Age: 51
Mr.
Percelay has been a director since January 10, 2006.
Mr. Percelay is the Founder and Chairman of the Mount Vernon Company, a real
estate investment company specializing in the acquisition and renovation of
multi-family and commercial properties in Greater Boston Communities. Since
2000
Mr. Percelay has been President of the Board of Habitat for Humanity in Greater
Boston. Mr. Percelay is currently Chairman of the Board of Make-A-Wish
Foundation of Greater Boston and Eastern Massachusetts. Since 2002 Mr. Percelay
has been a Board Member of the Nantucket Historic Association. Mr. Percelay
received his B.S. from Boston University School of Management, and a BA in
Business and Economics from City of London Polytechnic, Special Studies in
Economics.
John
P. Broderick
Director
since July 2005. Age: 57
Mr.
Broderick is currently the Chief Executive Officer and Chief Financial Officer
of the Company. Mr. Broderick has served as the Chief Operating Officer of
the
Company since June 2002, as the Chief Financial Officer of the Company since
April 2001, and as Corporate Secretary since August 2001. Prior to joining
the
Company, Mr. Broderick was Executive Vice President of Swell Inc., a sports
media e-commerce company where he oversaw the development of all commerce
operations and served as the organization's interim Chief Financial Officer.
Previously, Mr. Broderick served as Chief Financial Officer and Chief Operating
Officer for Programmer's Paradise, a publicly held (NASDAQ: PROG) international
software marketer. Mr. Broderick received his B.S. in accounting from Villanova
University.
John
W. Atherton
Director
since May 2006. Age: 64
Mr.
Atherton has been a director since May 12, 2006. Since 1990, Mr. Atherton is
the
Chairman of CityFed Financial, a publicly held financial
holding company, based in Nantucket,
Massachusetts. Mr. Atherton received his BA degree from Wesleyan University
(Middletown, Connecticut) and an MBA with Distinction from Babson College
(Wellesley, Massachusetts).
Compensation
Committee Interlocks and Insider Participation
The
Compensation Committee for 2006 was comprised of Messrs. Kingley and Porciello.
None of the current members of the Compensation Committee has served as an
executive officer of the Company, and no executive officer of the Company has
served as a member of the Compensation Committee of any other entity of which
Messrs. Kingley and Porciello have served as executive officers. Mr. Porciello
is the Chief Executive Office of Pilar Services Inc., a reseller partner of
the
Company. The Company has recognized approximately $100,000 in revenues with
Pilar Services Inc. during 2006. There were no interlocking relationships
between the Company
and other entities that might affect the determination of the compensation
of
the directors and executive officers of the Company.
Director
Compensation
In
May 1999, stockholders of the Company approved the Outside Director Stock
Incentive Plan of the Company. Under this plan, the outside directors may be
granted an option to purchase 12,000 shares of common stock at a price equal
to
the fair market value of the common stock as of the grant date. In January
2002,
the board of directors approved an amendment to the Outside Director Stock
Incentive Plan to provide an increase in the number of options to be granted
to
outside directors to 24,000. These options vest over a three-year period in
equal
31
increments
upon the eligible director’s election to the
Board, with the initial increment vesting on the date of grant. The Outside
Director Stock Incentive Plan also permits eligible directors to receive partial
payment of director fees in common stock in lieu of cash, subject to approval
by
the board of directors. In addition, the plan permits the board of directors
to
grant discretionary awards to eligible directors under the plan. None
of the Company’s directors received additional monetary compensation for serving
on the Board of Directors of the Company in 2001, other than reimbursement
of
reasonable expenses incurred in attending meetings.
In
October 2002, the board of directors approved an amendment to the stock
incentive plan for all non-management directors. Under the amendment, each
non-management director will receive 100,000 options to purchase common stock
of
the Company at the fair market value of the common stock on the date of grant.
These shares will vest in three equal increments with the initial increment
vesting on the date of grant. The option grant contains an acceleration of
vesting provision should the Company incur a change in control. A change in
control is defined as a merger or consolidation of the Company with or into
another unaffiliated entity, or the merger of an unaffiliated entity into the
Company or another subsidiary thereof with the effect that immediately after
such transaction the stockholders of the Company immediately prior to the
transaction hold less than fifty percent (50%) of the total voting power of
all
securities generally entitled to vote in the election of directors, managers
or
trustees of the entity surviving such merger or consolidation. Under the
amendment, there will be no additional compensation awarded for committee
participation. The shares allocated to the Board of Directors were issued out
of
the Level 8 Systems, Inc. 1997 Employee Stock Plan. All of the options issued
are prior to a 100:1 reverse stock split which was affected at December 31,
2006.
Executive
Officers
The
Company’s current executive officers are listed below, together with their age,
position with the Company and business experience for the past five
years.
Anthony
C. Pizi. Age:
47
Mr.
Pizi currently serves as the Chief Information Officer of the Company. He served
as the Chief Executive Officer and Chief Technology Officer of the Company
from
February 1, 2001 until July 22, 2005. Prior to joining our Company, Mr.
Pizi
was First Vice President and Chief Technology Officer of Merrill Lynch’s Private
Client Technology Architecture and Service Quality Group. Mr. Pizi’s 16 years
with Merrill Lynch included assignments in Corporate MIS, Investment Banking
and
Private Client. Mr. Pizi earned his B.S. in Engineering from West Virginia
University.
John
P. Broderick. Age:
57
Mr.
Broderick serves as the Chief Executive Officer since July 22, 2005 and as
the
Chief Financial Officer of the Company since April 2001. He has served as the
Chief Operating Officer of the Company since June 2002 and as Corporate
Secretary since August 2001. Prior to joining our Company, Mr. Broderick was
Executive Vice President of Swell Inc., a sports media e-commerce company where
he oversaw the development of all commerce operations and served as the
organization's interim Chief Financial Officer. Previously, Mr. Broderick served
as Chief Financial Officer and Chief Operating Officer for Programmer's
Paradise, a publicly held (NASDAQ: PROG) international software marketer. Mr.
Broderick received his B.S. in accounting from Villanova
University.
Audit
Committee
The
Board of Directors has determined that the members of the Audit Committee are
independent as defined in Rule 4200(a)(15) of the National Association of
Securities Dealers’ listing standards. Mr. John W. Atherton was designated the
“audit committee financial expert” as defined in Item 401(h) of Regulation S-K.
Code
of Ethics and Conduct
Our
Board of Directors has adopted a code of ethics and a code of conduct that
applies to all of our directors, Chief Executive Officer, Chief Financial
Officer, and employees. We will provide copies of our code of conduct and code
of ethics without charge upon request. To obtain a copy of the code of ethics
or
code of conduct, please send your written request to Cicero Inc., Suite 542,
8000 Regency Pkwy, Cary, North Carolina 27511,
Attn: Corporate Secretary. The code of ethics is also available on the Company’s
website at www.ciceroinc.com.
32
Compliance with
Section
16(a)
of the Exchange
Act
Section
16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s
officers, directors and persons who own more than ten percent of the Company’s
Common Stock (collectively, “Reporting Persons”) to file reports of ownership
and changes in ownership with the SEC and Nasdaq. Reporting Persons are required
by SEC regulations to furnish the Company with copies of all Section 16(a)
reports they file. Based solely on its review of the copies of such reports
received by it and written representations all Section 16(a) reports were filed
in a timely manner with the exception of Mr. John W. Atherton. At the time
Mr.
Atherton joined the Board, the Company was not aware that he owned 100 shares
of
the Company’s common stock in a self -directed IRA. The Company filed Form 3,
Initial Statement of Beneficial Ownership of Securities, on January 4,
2007.
Item
11. Executive Compensation.
The
following summary compensation table sets forth the compensation earned by
all
persons serving as the Company’s executive officers during fiscal year
2006, serving
or having served at the end of fiscal 2005 whose salary and bonus exceeded
$100,000 for services rendered to the Company during the fiscal year 2006.
The
table reflects compensation earned for each of the last three years or for
such
shorter period of service as an executive officer as is reflected below. For
the
principal terms of the options granted during fiscal 2006, see “Option Grants in
Fiscal 2006.”
Summary
Compensation Table
|
Name
and
Principal
Position
|
|
|
Fiscal
Year
|
|
|
Salary
|
|
|
Bonus
|
|
|
Stock
Awards
|
|
|
Option
Awards
|
|
|
Non-
Equity
Incentive
Plan
Compensation
|
|
|
Nonqualified
Deferred Compensation Earnings
|
|
|
All
Other
Compensation
|
|
|
Total
|
|
|
Anthony
C. Pizi
Chief
Information Officer
|
2006
2005
2004
|
$
$
$
|
150,000(1
150,000(2
200,000(3
|
)
)
)
|
$
$
$
|
--
--
--
|
--
--
--
|
---
--
5,000
|
--
--
--
|
--
--
--
|
$
$
$
|
--
--
--
|
$
$
$
|
150,000
150,000
200,000
|
||||||||||||||
|
John
P. Broderick
Chief
Executive Officer Chief Financial Officer, Corporate
Secretary
|
2006
2005
2004
|
$
$
$
|
150,000(4
150,000(5
200,000(6
|
)
)
)
|
$
$
$
|
--
--
60,000
|
--
--
--
|
--
--
5,000
|
--
--
--
|
--
--
--
|
$
$
$
|
--
--
--
|
$
$
$
|
150,000
150,000
200,000
|
Mr.
Pizi’s base salary for fiscal 2006 was $150,000. As of December 31, 2006, Mr.
Pizi is owed approximately $94,935 of deferred salary and $100,000 of his earned
bonus from 2003.
| (1) |
Mr.
Pizi’s base salary for fiscal 2005 was $200,000. Mr. Pizi had voluntarily
elected to defer $31,250 of salary from 2005. In August 2005 Mr.
Pizi
voluntarily reduced his annual salary to $150,000 for the year. Mr.
Pizi
was the Company’s Chief Executive Officer and Chairman until July 22,
2005.
|
| (2) |
Mr.
Pizi’s base salary for fiscal 2004 was $200,000. Mr. Pizi had voluntarily
elected to defer $50,000 of salary from 2004. In December 2004, Mr.
Pizi
received approximately $55,000 of deferred salary from 2004 and 2003
and
used those proceeds to participate in the Note and Warrant
Offering.
|
| (3) |
Mr.
Broderick’s base salary for fiscal 2006 was $150,000. As of December 31,
2006, Mr. Broderick is owed approximately $112,500 of deferred salary
and
$40,000 of earned bonus from 2003.
|
| (4) |
Mr.
Broderick’s base salary for 2005 was $200,000. Mr. Broderick had
voluntarily elected to defer $31,250 of salary from 2005. In August
2005,
Mr. Broderick voluntarily reduced his annual salary to $150,000 for
the
year. Mr. Broderick was appointed the Company’s Chief Executive Officer in
addition to being the Chief Financial Officer in July 2005. During
2005,
Mr. Broderick was paid $13,000 of his accrued bonus from
2003.
|
| (5) |
Mr.
Broderick’s base salary for 2004 was $200,000. Mr. Broderick voluntarily
elected to defer $50,000 of salary from 2004 and all earned bonus
($60,000) from 2003.
|
33
The
Company did not award any grants of stock options to the named executives during
fiscal 2006. The Company did not award any stock appreciation rights (“SARs”)
during fiscal 2006.
The
following table sets forth information concerning the options exercised during
fiscal 2006 and held at December 31, 2006 by the Named Executives.
Fiscal
2006 Year-End Option Holdings and Values
|
Number
of Securities
Underlying
Unexercised
Options
at December 31, 2006
|
Value
of Unexercised In-the-Money
Options
at December 31, 2006(1)
|
||||||||||||||||||
|
Name
|
Shares
Acquired on
Exercise
|
Value
Realized
|
Exercisable
|
Unexercisable
|
Exercisable
|
Unexercisable
|
|||||||||||||
|
Anthony
C. Pizi
|
--
|
--
|
15,000
|
-0-
|
-0-
|
-0-
|
|||||||||||||
|
John
P. Broderick
|
--
|
--
|
12,609
|
-0-
|
-0-
|
-0-
|
|||||||||||||
| (1) |
Based
on $2.30 per share, the December 31, 2006, closing price as quoted
on the
OTC Bulletin Board.
|
Employment
Agreements, Termination of Employment and Change-In-Control
Arrangements
Under
the employment agreement between the Company and Mr. Pizi effective January
1,
2006, the Company will pay Mr. Pizi an annual base salary of $150,000 and
performance bonuses in cash of up to $350,000 per annum based upon certain
revenue goals and operating metrics, as determined by the Compensation Committee
of the Board of Directors of the Company, in its discretion. Upon termination
of
Mr. Pizi’s employment by the Company without cause, the Company has agreed to
pay Mr. Pizi a lump sum payment equal to one year of Mr. Pizi’s then current
base salary within thirty (30) days of termination and any unpaid deferred
salaries and bonuses. In the event there occurs a substantial change in Mr.
Pizi’s job duties, there is a decrease in or failure to provide the compensation
or vested benefits under the employment agreement or there is a change in
control of the Company, the Company has agreed to pay Mr. Pizi one year salary
within 30 days of such notice of termination. If Mr. Pizi’s employment is
terminated for any reason, Mr. Pizi has agreed that, for one (1) year after such
termination, he will not directly or indirectly solicit or divert business
from
the Company or assist any business in attempting to do so or solicit or hire
any
person who was an employee of the Company during the term of his employment
agreement or assist any business in attempting to do so.
Under
the employment agreement between the Company and Mr. Broderick effective January
1, 2006, the Company will pay Mr. Broderick a base salary of $150,000 and he
is
eligible for performance bonuses in cash of up to $350,000 per annum based
upon
certain revenue goals and operating metrics, as determined by the Compensation
Committee of the Board of Directors of the Company, in its discretion. Upon
termination of Mr. Broderick’s employment by the Company without cause, the
Company has agreed to provide Mr. Broderick with one year of his then current
salary payable within 30 days of termination and any accrued but unpaid deferred
salaries and bonuses. In the event there occurs a substantial change in Mr.
Broderick’s job duties, there is a decrease in or failure to provide the
compensation or vested benefits under the employment agreement or there is
a
change in control of the Company, the Company has agreed to pay Mr. Broderick
a
lump sum payment of one year of Mr. Broderick’s then base salary within thirty
(30) days of termination Mr. Broderick will have thirty (30) days from the
date
written notice is given about either a change in his duties or the announcement
and closing of a transaction resulting in a change in control of the Company
to
resign and execute his rights under this agreement. If Mr. Broderick’s
employment is terminated for any reason, Mr. Broderick has agreed that, for
one
(1) year after such termination, he will not directly or indirectly solicit
or
divert business from the Company or assist any business in attempting to do
so
or solicit or hire any person who was an employee of the Company during the
term
of his employment agreement or assist any business in attempting to do so.
Item
12. Security
Ownership of Certain Beneficial Owners and Management.
The
following
table sets forth information as of December 31, 2006 with respect to beneficial
ownership of shares by (i) each person known to the Company to be the
beneficial owner of more than 5% of the outstanding common stock, (ii) each
of the Company’s directors, (iii) the executive officers of the Company
named in the
34
Summary
Compensation Table (the “Named Executives”) and (iv) all current directors
and executive officers of the Company as a group. Unless otherwise indicated,
the address for each person listed is c/o Cicero Inc., 1433 State Highway 34,
Farmingdale, New Jersey 07727.
The
named person has furnished stock ownership information to the Company.
Beneficial ownership as reported in this section was determined in accordance
with Securities and Exchange Commission regulations and includes shares as
to
which a person possesses sole or shared voting and/or investment power and
shares that may be acquired on or before December 31, 2006 upon the exercise
of
stock options as well as exercise of warrants. The chart is based on 35,294,810
common shares outstanding as of December 31, 2006. Except as otherwise stated
in
the footnotes below, the named persons have sole voting and investment power
with regard to the shares shown as beneficially owned by such
persons.
|
Common
Stock
|
|||||||
|
Name
of Beneficial Owner
|
No.
of Shares
|
Percent
of Class
|
|||||
|
QueeQueg
Partners, L.P. (1)
|
4,562,465
(2
|
)
|
12.2
|
%
|
|||
|
Queequeg
Ltd. (1)
|
1,504,938
(3
|
)
|
5
|
%
|
|||
|
Mark
and Carolyn P. Landis (4)
|
5,069,153
(5
|
)
|
13.8
|
%
|
|||
|
Anthony
C. Pizi
|
1,416,241
(6
|
)
|
4.0
|
%
|
|||
|
Bruce
Miller
|
1,337,118
(7
|
)
|
3.8
|
%
|
|||
|
Bruce
Percelay
|
1,032,786
(8
|
)
|
2.9
|
%
|
|||
|
John
P. Broderick
|
15,857
(9
|
)
|
*
|
||||
|
John
W. Atherton
|
148,884
(10
|
)
|
*
|
||||
|
Bruce
W. Hasenyager
|
33,652
(11
|
)
|
*
|
||||
|
Charles
Porciello
|
80,286
(12
|
)
|
*
|
||||
|
Jay
R. Kingley
|
1,000
(13
|
)
|
*
|
||||
|
All
current directors and executive officers as a group (9
persons)
|
9,134,977(14
|
)
|
24.8
|
%
|
|||
__________________
| · |
Represents
less than one percent of the outstanding
shares.
|
|
1.
|
The
address of QueeQueg Partners and QueeQueg Ltd. is 299 Park Avenue
New
York, New York 10071.
|
|
2.
|
As
of December 31, 2006, QueeQueg Partners, L.P. owns 4,539,475 shares
of
common stock, 9.643 shares of the Series A-1 Convertible Preferred
Stock,
and 13,347 shares issuable upon the exercise of warrants. The exercise
prices of the warrants are as follows: 586 at $37.00 per share,
249 at
$38.00 per share 3,194 at $40.00 per share, and 9,318 at $10.00
per share.
QueeQueg Partners, L.P disclaims beneficial ownership of 4,029
warrant
shares because they are
anti-dilutive.
|
|
3.
|
As
of December 31, 2006, QueeQueg, Ltd. owns 1,492,558 shares of common
stock, 5.193 shares of the Series A-1 Convertible Preferred Stock,
and
7,187 shares issuable upon the exercise of warrants. The exercise
prices
of the warrants are as follows: 315 at $37.00 per share, 134 at
$38.00 per
share 1,720 at $40.00 per share, and 5,018 at $10.00 per share.
QueeQueg
Ltd disclaims beneficial ownership of 2,169 warrant shares because
they
are anti-dilutive.
|
|
4.
|
The
address of Mark and Carolyn P. Landis is 503 Lake Drive, Princeton,
New
Jersey 08540.
|
|
5.
|
Includes
3,673,695 shares of common stock, 1,326.136 shares of the Series
A-1
Convertible Preferred Stock, and 69,322 shares issuable upon the
exercise
of warrants. The
exercise prices of the warrants are as follows: 18,750 at $8.00
per share,
20,000 at $10.00 per share, and 30,572 at $10.00 per share. Disclaims
beneficial ownership of 38,750 shares because they are anti-dilutive.
|
|
6.
|
Includes
1,274,951 shares of common stock, 111.016 shares
of the Series A-1 Convertible Preferred Stock,
15,000 shares subject to stock options exercisable within sixty
(60) days,
and 15,274 shares of common stock issuable upon the exercise of
warrants.
The exercise price of warrants is as follows: 901 shares at $17.00
per
share of common stock; 2,706 shares at $20.00 per share of common
stock;
and 11,667 shares at $10.00 per share of common stock. Disclaims
beneficial ownership of 18,607 shares of common stock because they
are
anti-dilutive.
|
|
7.
|
Consists
of 758,624 shares of common stock, 49.418
shares of the Series A-1 Convertible Preferred Stock, and 16,295
shares
of common stock issuable upon the exercise of warrants. The
exercise prices of the warrants are as follows: 451 at $37.00 per
share,
192 at $38.00 per share 2,457 at $40.00 per share, and 13,195 at
$10.00
per
|
35
share.
Mr. Miller has sole or shared voting or dispositive power with respect to the
securities held by Delphi Partners, Ltd., which holds 491,267 shares of common
stock, 18.000
shares of the Series A-1 Convertible Preferred Stock, and 3,514 shares
of common stock issuable upon the exercise of warrants at $10.00 per
share.
|
8.
|
Consists
of 1,032,786 shares of common
stock.
|
|
9.
|
Includes
3,248 shares of common stock and 12,609 shares subject to stock
options
exercisable within sixty (60) days. Disclaims beneficial ownership
of
12,609 shares of common stock because they are
anti-dilutive.
|
|
10.
|
Includes
148,784 shares of common stock, and 100 shares of common stock
held in a
self-directed IRA.
|
|
11.
|
Consists
of 32,652 shares of common stock and 1,000 shares subject to stock
options
exercisable within sixty (60) days. Disclaims
beneficial ownership of 1,000 shares of common stock because they
are
anti-dilutive.
|
|
12.
|
Consists
of 80,286 shares of common stock.
|
|
13.
|
Consists
of 1,000
shares subject to stock options exercisable within sixty (60) days.
Disclaims
beneficial ownership of 1,000 shares of common stock because they
are
anti-dilutive.
|
|
14.
|
Includes
shares issuable upon exercise of options and warrants exercisable
within
sixty (60) days as described in Notes 7-14 to our financial
statements.
|
Item
13. Certain
Relationships and Related Transactions.
Loan
from Related Parties
During
2005, the Company entered into short term notes payable
with Anthony Pizi, the Company’s former Chief Executive Officer, and current
Chief Information Officer, for various working capital needs. The Notes bear
interest at 1% per month and are unsecured. At December 31, 2006, the Company
was indebted to Mr. Pizi in the amount of $9,000.
Convertible
Promissory Notes. Directors and executive officers made several loans to us
in exchange for convertible promissory notes. As part of the Plan of
Recapitalization which was approved by our shareholders, the Company offered
to
adjust the conversion rates and terms on these notes. As a result of the Plan
of
Recapitalization, these notes were automatically converted into shares of the
preferred stock designated as Series A-1 Preferred stock. Each share of Series
A-1 Preferred Stock is convertible into 1,000 shares of the Company’s common
stock. Because the conversion rates were adjusted, the Company calculated the
amount of the beneficial conversion resulting from the adjusted conversion
rate
and recorded that amount as a deemed dividend and additional paid in capital.
See Note 2 to the Consolidated Financial Statements.
In
June,
2004, the Company entered into a convertible promissory note with Mr. Pizi
in
the face amount of $100,000, bearing interest at 1% per month which was
converted into 14 shares of the Company’s Series A-1 Preferred Stock. In
addition, Mr. Pizi was granted 270,270 warrants to purchase the Company’s common
stock at $0.37 per share. As part of the Note and Warrant Offering, Mr. Pizi
elected to convert these warrants by loaning the Company the reduced exercise
price.
In
July
2004, the Company entered into a convertible promissory note with Mr. Pizi
in
the face amount of $112,000, bearing interest at 1% per month which was
converted into 78.4 shares of the Company’s Series A-1 Preferred Stock upon
approval of the Plan of Recapitalization. In addition, at the time of the loan,
Mr. Pizi was granted warrants to purchase 560,000 shares of our common stock
at
$0.20 per share. As part of the Note and Warrant Offering, Mr. Pizi elected
to
convert 289,376 of these warrants by loaning the Company the reduced exercise
price. Mr. Pizi elected not to exercise 270,624 warrants and after the reverse
stock ratio now total 2,706 warrants with an exercise price of $20 per share.
Also in July 2004, Mr. Pizi entered into a second convertible promissory note
in
the face amount of $15,000 which was converted into 12.62 shares of the
Company’s Series A-1 Preferred Stock. In addition, at the time of the loan, Mr.
Pizi was granted warrants to purchase 90,118 shares of the Company’s common
stock at $0.17 per share. Mr. Pizi has not elected to exercise these warrants
and after the reverse stock ratio now total 901 warrants with an exercise price
of $17.
In
March
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Landis in the amount of $125,000. Under the terms of the note, the loan bore
interest at 1% per month, and was converted into
36
62.5
shares of Series A-1 Preferred stock. In addition, Mr. and Mrs. Landis were
granted warrants to purchase 446,429 shares of the Company’s common stock
exercisable at $0.28 per share. As part of the Note and Warrant Offering, Mr.
and Mrs. Landis elected to convert these warrants by loaning the Company the
reduced exercise price.
In
June
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Landis in the amount of $125,000. Under the terms of the note, the loan bore
interest at 1% per month and was converted into 113.64 shares of Series A-1
Preferred stock. In addition, Mr. and Mrs. Landis were granted warrants to
purchase 781,250 shares of the Company’s common stock exercisable at $0.16 per
share. As part of the Note and Warrant Offering, Mr. and Mrs. Landis elected
to
convert these warrants by loaning the Company the reduced exercise
price.
In
October 2004, the Company entered into a convertible promissory note with Mr.
and Mrs. Landis in the amount of $100,000. Under the terms of the agreement,
the
loan bore interest at 1% per month and was converted into 400 shares of Series
A-1 Preferred stock. In addition, Mr. and Mrs. Landis were granted 2,000,000
warrants to purchase the Company’s common stock exercisable at $0.10 per share.
Mr. and Mrs. Landis elected not to exercise these warrants as part of the Note
and Warrant Offering and after the reverse stock split ratio these warrants
total 20,000 with an exercise price of $10.00.
In
November 2004, the Company entered into a convertible promissory note with
Mr.
and Mrs. Landis in the amount of $150,000. Under the terms of the agreement,
the
loan bore interest at 1% per month and was converted into 18,750 shares of
common stock after the reverse stock split ratio. In addition, Mr. and Mrs.
Landis were granted 1,875,000 warrants to purchase the Company’s common stock
exercisable at $0.08 per share. Mr. and Mrs. Landis elected not to exercise
these warrants as part of the Note and Warrant Offering and after the reverse
stock split ratio these warrants total 18,750 with an exercise price of
$8.00.
In
June
2004, the Company entered into a convertible promissory note with Fredric Mack,
a former director of the Company, in the amount of $125,000. Under the terms
of
the note, the loan bore interest at 1% per month, and was converted into 54.69
shares of Series A-1 Preferred stock. In addition, Mr. Mack was granted warrants
to purchase 390,625 shares of the Company’s common stock exercisable at $0.32
per share. As part of the Note and Warrant Offering, Mr. Mack elected to convert
these warrants by loaning the Company the reduced exercise price.
In
April
2005, the Company entered into a convertible promissory note with Bruce Miller,
a director of the Company, in the amount of $30,000. Under the terms of the
note, the loan bore interest at 1% per month and was converted into 60 shares
of
Series A-1 Preferred stock.
In
July
2004, the Company entered into a convertible promissory note with Nicholas
Hatalski, who until July 22, 2005 (during the period when the terms of the
recapitalization plan were being negotiated and at the time of approval of
the
plan by our board of directors), was a director of the Company, in the amount
of
$25,000. Under the terms of the note, the loan bore interest at 1% per month
and
was converted into 10.94 shares of Series A-1 Preferred stock. In addition,
Mr.
Hatalski was granted warrants to purchase 78,125 shares of the Company’s common
stock exercisable at $0.32 per share. Mr. Hatalski elected not to exercise
these
warrants as part of the Note and Warrant Offering and after the reverse stock
split ratio these warrants total 781 with an exercise price of $32.
All
of
such warrants expire three years from date of grant.
Senior
Reorganization Notes. From March 2004 to April 2005, directors and
executive officers made the following loans to the Company evidenced by Senior
Reorganization Notes: Mr. Pizi held $423,333 of Senior Reorganization Notes,
which were converted into warrants to purchase an additional 571,659 shares
of
Cicero common stock at a purchase price of $0.20 per
share.
Mr.
Landis held $327,860 of Senior Reorganization Notes, which were converted into
warrants to purchase an additional 442,345 shares of Cicero common stock at
an
exercise price of $0.20 per share.
Mr.
Mack
held, together with his affiliates, $88,122 of Senior Reorganization Notes,
which were converted into warrants to purchase an additional 112,205 shares
of
Cicero common stock at a purchase price of $0.20 per share.
Mr.
Miller held, together with his affiliates, $77,706 of Senior Reorganization
Notes, which were converted into warrants to purchase an additional 114,597
shares of Cicero common stock at a purchase price of $0.20.
Mr.
Atherton holds $20,000 of Senior Reorganization Notes which were converted
into
warrants to purchase an additional 289,856 shares of Cicero common stock at
a
purchase price of $0.20.
37
Mr.
Broderick, Chief Executive Officer and Chief Financial Officer of the Company,
held $2,300 of Senior Reorganization Notes, which were converted into warrants
to purchase 3,222 shares of Cicero Inc. common stock at a purchase price of
$0.20 per share, and options to purchase 12,609 shares of common stock under
the
Company’s stock option plan that will convert into options to purchase Cicero
common stock.
Convertible
Bridge Notes. From July 2005 to November 2006, directors and executive
officers made the following loans to us for Convertible Bridge Notes:
Mr.
Pizi
held $85,000 of Convertible Bridge Notes which bear interest at 10% and matured
on September 15, 2005. These notes automatically converted into 680,000 shares
of Cicero common stock upon approval of the recapitalization plan by
stockholders.
Mr.
Landis held $395,000 of Convertible Bridge Notes which bear interest at 10%
and
matured on various dates in 2005 and 2006. These notes automatically converted
into 3,160,000 shares of Cicero common stock upon approval of the
recapitalization plan by stockholders.
Mr.
Mack
held, together with his affiliates, $114,000 of Convertible Bridge Notes which
bear interest at 10% and matured on various dates in 2005 and 2006. These notes
automatically converted into 897,564 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
Mr.
Miller held, together with his affiliates, $120,000 of Convertible Bridge Notes
which bear interest at 10% and matured on various dates in 2005 and 2006. These
notes automatically converted into 947,273 shares of Cicero common stock upon
approval of the recapitalization plan by stockholders.
Mr.
Hasenyager, a member of our Board of Directors, held $4,061 of Convertible
Bridge Notes which bear interest at 10% and matured on September 15, 2005.
These
notes automatically converted into 32,485 shares of Cicero common stock upon
approval of the recapitalization plan by stockholders.
Mr.
Percelay, a member of our Board of Directors, held $130,000 of Convertible
Bridge Notes which bear interest at 10% and matured on various dates in 2005
and
2006. These notes automatically converted into 1,027,273 shares of Cicero common
stock upon approval of the recapitalization plan by stockholders.
Mr.
Atherton, a member of our Board of Directors, held $15,000 of convertible Bridge
Notes which bear interest at 10% and matured during 2006. These notes
automatically converted into 120,000 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
Mr.
Porciello, a member of our Board of Directors, held $10,000 of Convertible
Bridge Notes which bear interest at 10% and matured during 2006. These notes
automatically converted into 80,000 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
Transactions
with Merrill Lynch
On
January 3, 2002, the Company entered into a Purchase Agreement with MLBC, Inc.,
an affiliate of Merrill Lynch. Pursuant to the Purchase Agreement, the Company
issued 250,000 shares of its common stock to MLBC and entered into a royalty
sharing agreement for sales of Cicero®.
Under the royalty sharing agreement, the Company is obligated to pay a royalty
of 3% of the sales price for each sale of Cicero®
or related maintenance services. The royalties are not payable in excess of
$20
million. As consideration for the issuance of the shares and the royalty
payments, Merrill Lynch has entered into an amendment to the Cicero®
license agreement, which extends our exclusive worldwide marketing, sales,
and
development rights to Cicero®
and granted us certain ownership rights in the Cicero®
trademark. Pursuant to the Purchase Agreement, the Company also entered into
a
Registration Rights Agreement granting MLBC certain rights to have the shares
of
common stock it received under the Purchase Agreement registered under the
Securities Act of 1933, as amended.
Preferred
Stock Exchange
As
part of the Company’s plan of recapitalization presented to shareholders for
approval, the Company proposed to amend the conversion prices of the existing
Series A-3, B-3, C and D preferred shareholders and convert each of those shares
into Series A-1 Preferred stock. The new conversion prices with respect to
the
Series A-3, B-3 and D preferred stock were negotiated with the holders of each
series based upon such factors as the current conversion price in relation
to
the market, the dollar amount represented by such series and, waiver of
anti-dilution, liquidation preferences, seniority and other senior rights.
The
conversion price for the Series C preferred
38
stock
was determined in relation to the conversion price for the Series D preferred
stock. The board of directors determined the new conversion price of each series
of Level 8 preferred stock after discussion and review of those rights, ranks
and privileges that were being waived by the present holders of preferred stock.
Among those rights being waived are anti-dilution protection, liquidation
preferences and seniority.
The
holders of the Series A-1 preferred stock shall have the rights and preferences
set forth in the Certificate of Designations filed with the Secretary of State
of the State of Delaware upon the approval of the Recapitalization. The rights
and interests of the Series A-1 preferred stock of the Company will be
substantially similar to the rights interests of each of the series of Level
8
preferred stock other than for (i) anti-dilution protections that have been
permanently waived and (ii) certain voting, redemption and other rights that
holders of Series A-1 preferred stock will not be entitled to. All shares of
Series A-1 preferred stock will have a liquidation preference pari
passu
with all other Series A-1 preferred stock.
The
Series A-1 preferred stock is convertible at any time at the option of the
holder into an initial conversion ratio of 1,000 shares of Common Stock for
each
share of Series A-1 preferred stock. The initial conversion ratio shall be
adjusted in the event of any stock splits, stock dividends and other
recapitalizations. The Series A-1 preferred stock is also convertible on a
automatic basis in the event that (i) the Company closes on an additional
$5,000,000 equity financing from strategic or institutional investors, or (ii)
the Company has four consecutive quarters of positive cash flow as reflected
on
the Company’s financial statements prepared in accordance with generally
accepted accounting principals (“GAAP”) and filed with the Commission. The
holders of Series A-1 preferred stock are entitled to receive equivalent
dividends on an as-converted basis whenever the Company declares a dividend
on
its Common Stock, other than dividends payable in shares of Common Stock. The
holders of the Series A-1 preferred stock are entitled to a liquidation
preference of $500 per share of Series A-1 preferred stock upon the liquidation
of the Company. The Series A-1 preferred stock is not redeemable.
The
holders of Series A-1 preferred stock also possess the following voting rights.
Each share of Series A-1 preferred stock shall represent that number of votes
equal to the number of shares of Common Stock issuable upon conversion of a
share of Series A-1 preferred stock. The holders of Series A-1 preferred stock
and the holders of Common Stock shall vote together as a class on all matters
except: (i) regarding the election of the board of directors of the Company
(as set forth below); (ii) as required by law; or (iii) regarding certain
corporate actions to be taken by the Company (as set forth below).
The
approval of at least two-thirds of the holders of Series A-1 preferred stock
voting together as a class, shall be required in order for the Company to:
(i)
merge or sell all or substantially all of its assets or to recapitalize or
reorganize; (ii) authorize the issuance of any equity security having any right,
preference or priority superior to or on parity with the Series A-1 preferred
stock; (iii) redeem, repurchase or acquire indirectly or directly any of its
equity securities, or to pay any dividends on the Company’s equity securities;
(iv) amend or repeal any provisions of its certificate of incorporation or
bylaws that would adversely affect the rights, preferences or privileges of
the
Series A-1 preferred stock; (v) effectuate a significant change in the principal
business of the Company as conducted at the effective time of the
Recapitalization; (vi) make any loan or advance to any entity other than in
the
ordinary course of business unless such entity is wholly owned by the Company;
(vii) make any loan or advance to any person, including any employees or
directors of the Company or any subsidiary, except in the ordinary course of
business or pursuant to an approved employee stock or option plan; and (viii)
guarantee, directly or indirectly any indebtedness or obligations, except for
trade accounts of any subsidiary arising in the ordinary course of business.
In
addition, the unanimous vote of the board of directors is required for any
liquidation, dissolution, recapitalization or reorganization of the Company.
The
voting rights of the holders of Series A-1 preferred stock set forth in this
paragraph shall be terminated immediately upon the closing by the Company of
at
least an additional $5,000,000 equity financing from strategic or institutional
investors.
In
addition to the voting rights described above, the holders of a majority of
the
shares of Series A-1 preferred stock are entitled to appoint two observers
to
the Company’s board of directors who shall be entitled to receive all
information received by members of the board of directors, and shall attend
and
participate without a vote at all meetings of the Company’s board of directors
and any committees thereof. At the option of a majority of the holders of Series
A-1 preferred stock, such holders may elect to temporarily or permanently
exchange their board observer rights for two seats on the Company’s board of
directors, each having all voting and other rights attendant to any member
of
the Company’s board of directors. As part of the Recapitalization, the right of
the holders of Series A-1 preferred stock to elect a majority of the voting
members of the Company’s board of directors shall be terminated.
As
a result of the reduced conversion prices and exchange of the Series A-3, B-3,
C
and D preferred stock into Series A-1 preferred stock and using Black-Scholes,
we calculated a beneficial conversion in the exchange of the
39
Series
A-3, B-3, C and D shares for Series A-1 preferred stock. The beneficial
conversion of $21,000 is treated as a deemed dividend in the Statement of
Operations for the year ended December 31, 2006.
Borrowings
and Commitments from Liraz
Liraz
Systems Ltd. guarantees certain debt obligations of the Company. In November
2005, the Company and Liraz Systems Ltd. agreed to extend its guaranty on the
term loan and with Bank Hapoalim, to extend the maturity date on the loan to
October 30, 2006. Under the terms of the agreement with Liraz, the Company
agreed to issue 2,400,000 shares of its common stock and granted a warrant
to
purchase an additional 3,600,000 shares of our common stock at an exercise
price
of $0.002 per share. Based upon fair market value at the time of issuance,
the
Company recognized $48,000 as loan amortization costs in the Statement of
Operations for the year ended December 31, 2005. In November 2006, the Company
and Liraz Systems Ltd. agreed to extend its guaranty on the term loan and with
Bank Hapoalim, to extend the maturity date on the loan until October 31, 2007.
Under the terms of the agreement with Liraz, the Company agreed to issue
6,000,000 shares of its common stock. Based upon the fair market value at the
time of issuance, the Company recognized $240,000 as loan amortization costs
in
the Statement of Operations for the year ended December 31, 2006.
Transactions
with Board members
During
2006, under an existing reseller agreement, the Company recognized $100,000
of
software revenue with Pilar Services, Inc. Pilar Services is presently owned
and
managed by Charles Porciello who is a member of our Board of Directors. As
of
December 31, 2006, the receivable was still outstanding and the Company has
reserved for possible doubtful accounts.
Item
14. Principal
Accountant Fees and Services
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
Margolis
& Company P.C. audited our financial statements for each of the years ended
December 31, 2006 and 2005.
AUDIT
FEES
Audit
fees include fees for the audit of the Company’s annual financial statements,
fees for the review of the Company’s interim financial statements, and fees for
services that are normally provided by the Independent Registered Public
Accounting Firm in connection with statutory and regulatory filings or
engagements. The aggregate fees billed by Margolis & Company P.C. for
professional services rendered to our company for the audit of the Company's
annual financial statements for fiscal years 2006 (and reviews of quarterly
financial statements on form 10-Q), 2005 and 2004 was $36,000 for each year.
AUDIT-RELATED
FEES
Audit-related
fees include fees for assurance and related services that are reasonably related
to the performance of the audit or review of the Company’s financial statements.
There were no audit-related fees paid to Margolis & Company P.C. for fiscal
years 2006 and 2005.
TAX
FEES
Tax
fees include fees for tax compliance, tax advice and tax planning. There were
no
fees billed by either Margolis & Company P.C. for these services in 2006 and
2005.
OTHER
FEES
All
other fees include fees for all services except those described above. There
were no other fees paid to Margolis & Company P.C. for fiscal year 2006. The
aggregate other fees billed by Margolis & Company P.C. was $18,000 related
to the review of the Company’s S-4 filing in 2005, and $6,100 for the Company’s
S-1 filing in 2004. In addition, other fees billed by Deloitte & Touche in
2005 amounted to $27,500. These fees relate to the review of the Company’s S-4
filing during 2005.
40
DETERMINATION
OF AUDITOR INDEPENDENCE
The
Audit Committee considered the provision of non-audit services by Margolis
&
Company P.C. and determined that the provision of such services was consistent
with maintaining the independence of Margolis & Company P.C.
AUDIT
COMMITTEE'S PRE-APPROVAL POLICIES
The
Audit Committee has adopted a policy that all audit, audit-related, tax and
any
other non-audit service to be performed by the Company’s Independent Registered
Public Accounting Firm must be pre-approved by the Audit Committee. It is the
Company’s policy that all such services be pre-approved prior to commencement of
the engagement. The Audit Committee is also required to pre-approve the
estimated fees for such services, as well as any subsequent changes to the
terms
of the engagement.
PART
IV
|
(A)
1.
|
FINANCIAL
STATEMENTS
|
The
following financial statements of the Company and the related reports of
Independent Registered Public Accounting Firms thereon are set forth immediately
following the Index of Financial Statements which appears on page F-1 of
this
report:
Independent
Registered Public Accounting Firm Report
Consolidated
Balance Sheets as of December 31, 2006 and 2005
Consolidated
Statements of Operations for the years ended December 31, 2006, 2005 and
2004
Consolidated
Statements of Stockholders' Equity for the years ended December 31, 2006,
2005
and 2004
Consolidated
Statements of Comprehensive Loss for the years ended December 31, 2006, 2005
and
2004
Consolidated
Statements of Cash Flows for the years ended December 31, 2006, 2005 and
2004
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.
|
EXHIBITS
|
The
exhibits listed under Item 15(c) hereof are filed as part of this Annual
Report
on Form 10-K.
|
(B)
|
REPORTS
ON FORM 8-K
|
On
November 21, 2006, the Company filed a Form 8-K reporting that shareholders
approved an amendment to the Certificate of Incorporation to provide the
Company’s Board of Directors with discretionary authority to effect a reverse
stock split ratio from 20:1 to 100:1 and that on November 20, 2006, the Board
of
directors set that reverse stock ratio to be 100:1. In addition, the Company
also reported that shareholders approved an amendment to change the name of
the
Company from Level 8 Systems, Inc. to Cicero Inc., to increase the authorized
common stock of the Company from 85 million shares to 215 million shares and
to
convert existing preferred shares into a new Series A-1 preferred stock of
Cicero Inc The proposals at the Special Meeting of Stockholders of Level 8
comprised a proposed recapitalization of Level 8 which is also subject to the
receipt of amendments to outstanding convertible promissory notes, senior
reorganization notes and the convertible bridge notes.
41
On
May 15, 2006 the Company filed a Form 8-K reporting the election of Mr. John
W.
Atherton to the Board of Directors.
On
March 9, 2006 the Company filed a Form 8-K reporting the resignation of Frederic
Mack as a member of the Board of Directors.
On
January 13, 2006 the Company filed a Form 8-K reporting the election of Mr.
Bruce Percelay to the Board of Directors.
On
December 12, 2005 the Company filed a Form 8-K reporting the filing of
participation in a recapitalization reorganization merger filed on Form S-4/A
on
December 9, 2005, an amendment to Form S-4 filed May 13, 2005, subject to
approval by the stockholders, of a recapitalization reorganization merger of
the
Company to Cicero Inc.
On
December 5, 2005, Level 8 Systems filed a Form 8-K reporting the Company reached
an agreement with Liraz Systems, Ltd. (“Liraz”), the guarantor of the Bank
Hapoalim term loan, to extend the guaranty and maturity of the Bank Hapoalim
debt until November 2006.
On
March 10, 2005, Level 8 Systems filed a Form 8-K reporting the election of
Mr.
Ralph Martino as Chairman of the Board of Directors replacing Mr. Anthony Pizi
who remains as a director.
On
June 3, 2005, the Company filed a Form 8-K reporting the resignation of Mr.
Ralph Martino as Chairman of the Board of Directors.
On
June 6, 2005 the Company filed a Form 8-K reporting the election of Mr. Charles
B. Porciello to the Board of Directors.
On
June 17, 2005 the Company filed a Form 8-K reporting the approval by the Board
of Directors, subject to approval by the stockholders, of a recapitalization
reorganization merger of the Company to Cicero Inc.
On
July 27, 2005, the Company filed a Form 8-K reporting the resignations and
appointments of members to the Company’s Board of Directors.
(C)
EXHIBITS
|
Exhibit
Number
|
Description
|
|
2.1
|
Asset
Purchase Agreement, dated as of January 9, 2004, by and among Level
8
Systems, Inc. and Critical Mass Mail, Inc. (incorporated by reference
to
exhibit 2.1 to Level 8’s Form 8-K filed January 23, 2004).
|
|
3.1
|
Certificate
of Incorporation of Level 8 Systems, Inc., a Delaware corporation,
as
amended and restated December 29, 2006 (incorporated by reference
to
exhibit 3.1 to Level 8’s Form 8-K filed January 17,
2007).
|
|
3.2
|
Certificate
of Designation relating to Series A1 Convertible Redeemable Preferred
Stock (incorporated by reference to exhibit 3.2 to Level 8’s Form 8-K
filed January 17, 2007).
|
|
3.3
|
Certificate
of Designation relating to Series A3 Convertible Redeemable Preferred
Stock, as amended December 29, 2006 (incorporated by reference to
exhibit
3.3 to Level 8’s Level 8’s Form 8-K filed January 17,
2007).
|
|
3.4
|
Certificate
of Designation relating to Series B3 Convertible Redeemable Preferred
as
amended December 29, 2006 (incorporated by reference to exhibit 3.4
to
Level 8’s Level 8’s Form 8-K filed January 17,
2007).
|
42
|
3.5
|
Certificate
of designation relating to Series C Convertible Redeemable Preferred
Stock
as amended December 29, 2006 (incorporated by reference to exhibit
3.5 to
Level 8’s Level 8’s Form 8-K filed January 17, 2007).
|
|
3.6
|
Certificate
of designation relating to Series C Convertible Redeemable Preferred
Stock
as amended December 29, 2006 (incorporated by reference to exhibit
3.5 to
Level 8’s Level 8’s Form 8-K filed January 17, 2007).
|
|
3.7
|
Certificate
of designation relating to Series D Convertible Redeemable Preferred
Stock
as amended December 29, 2006 (incorporated by reference to exhibit
3.5 to
Level 8’s Level 8’s Form 8-K filed January 17, 2007).
|
|
3.8
|
Certificate
of Incorporation of Level 8 Systems, Inc., a Delaware corporation,
as
amended August 4, 2003 (incorporated by reference to exhibit 3.1
to Level
8’s Form 10-K filed March 31, 2004).
|
|
3.9
|
Bylaws
of Level 8 Systems, Inc., a Delaware corporation (incorporated by
reference to exhibit 3.2 to Level 8’s Form 10-K filed April 2,
2002).
|
|
3.10
|
Certificate
of Designations, Preferences and Rights dated March 19, 2003 relating
to
Series D Convertible Redeemable Preferred Stock (incorporated by
reference
to exhibit 3.1 to Level 8's Form 8-K, filed March 31,
2003).
|
|
3.11
|
Certificate
of Designation relating to Series A3 Convertible Redeemable Preferred
Stock (incorporated by reference to exhibit 3.1 to Level 8’s Form 10-Q
filed November 15, 2002).
|
|
3.12
|
Certificate
of Designation relating to Series B3 Convertible Redeemable Preferred
Stock (incorporated by reference to exhibit 3.1 to Level 8’s Form 10-Q
filed November 15, 2002).
|
|
3.13
|
Certificate
of designation relating to Series C Convertible Redeemable Preferred
Stock
(incorporated by reference to exhibit 3.1 to Level 8’d Form 8-K filed
August 27, 2002).
|
|
4.1
|
Registration
Rights Agreement dated July 2006, by and among Level 8 Systems, Inc.
and
the Purchasers in the Senior Placement listed on Schedule I thereto
relating to the Security Purchasers Agreement (filed
herewith).
|
|
4.2
|
Registration
Rights Agreement, dated January 2004, by and among Level 8 Systems,
Inc.
and the Purchasers in the January 2004 Private Placement listed on
Schedule I thereto relating to the Security Purchasers Agreement
(incorporated by reference to exhibit 4.1 to Level 8’s Form 10-K/A filed
April 21, 2004).
|
|
4.3
|
Registration
Rights Agreement dated as of March 19, 2003 by and among Level 8
Systems,
Inc. and the Purchasers listed on Schedule I thereto relating to
the
Series D Convertible Redeemable Preferred Stock (incorporated by
reference
to exhibit 4.1 to Level 8’s Form 8-K, filed March 31,
2003).
|
|
4.4
|
Registration
Rights Agreement dated as of October 15, 2003 by and among Level
8
Systems, Inc. and the Purchasers in the October Private Placement
listed
on schedule I thereto (incorporated by reference to exhibit 4.2 to
Level
8’s Form 10-K, filed March 31, 2004).
|
|
4.5
|
Registration
Rights Agreement, dated as of January 16, 2002, by and among Level
8
Systems, Inc. and the Purchasers in the January Private Placement
listed
on Schedule I thereto (incorporated by reference to exhibit 4.1 to
Level
8's Report on Form 8-K, filed January 25, 2002).
|
|
4.6
|
Registration
Rights Agreement, dated as of January 3, 2002, between Level 8 Systems,
Inc. and MLBC, Inc. (incorporated by reference to exhibit 4.1 to
Level 8's
Report on Form 8-K, filed January 11, 2002).
|
|
4.7
|
Registration
Rights Agreement, dated as of August 29, 2002, entered into by and
between
Level 8 Systems, Inc. and the holders of Series A2/A3 Preferred Stock
and
Series B2/B3 Preferred Stock (incorporated by reference to exhibit
10.4 to
Level 8’s Form 8-K filed August 30,
2002).
|
43
|
4.7A
|
First
Amendment to Registration Rights Agreement, dated as of October 25,
2002,
entered into by and between Level 8 Systems, Inc. and the holders
of
Series A2/A3 Preferred Stock and Series B2/B3 Preferred Stock
(incorporated by reference to exhibit 10.4 to Level 8’s Form 10-Q filed
November 15, 2002).
|
|
4.8
|
Registration
Rights Agreement, dated as of June 13, 1995, between Level 8 Systems,
Inc.
and Liraz Systems Ltd. (incorporated by reference to exhibit 10.24
to
Across Data Systems, Inc.'s (Level 8's predecessor) Registration
Statement
on Form S-1, filed May 12, 1995, File No. 33-92230).
|
|
4.8A
|
First
Amendment to Registration Rights Agreement, dated as of August 8,
2001, to
the Registration Rights Agreement dated as of June 13, 1995, by and
between Across Data Systems, Inc. (Level 8's predecessor) and Liraz
Systems Ltd. (incorporated by reference to exhibit 4.1 to Level 8's
Report
on Form 8-K, filed August 14, 2001).
|
|
4.9
|
Registration
Rights Agreement, dated as of August 14, 2002, entered into by and
between
Level 8 Systems, Inc. and the investors in Series C Preferred Stock
(incorporated by reference to exhibit 4.1 to Level 8’s Form 8-K filed
August 27, 2002).
|
|
4.10
|
Form
of Registration Rights Agreement, dated January 2004, by and among
Level 8
Systems, Inc. and the Purchasers of Convertible Promissory Note
(incorporated by reference to exhibit 4.2 to Level 8's Report on
Form
10-Q, filed May 12, 2004).
|
|
4.11
|
Form
of Stock Purchase Warrant issued to Purchasers in the January 2004
Private
Placement (incorporated by reference to exhibit 4.3 to Level 8's
Report on
Form 10-Q, filed May 12, 2004).
|
|
4.12
|
Form
of Stock Purchase Warrant issued to Purchasers of Convertible Promissory
Note (incorporated by reference to exhibit 4.3 to Level 8's Report
on Form
10-Q, filed May 12, 2004).
|
|
4.13
|
Form
of Warrant issued to the Purchasers in the Series D Preferred Stock
transaction dated as of March 19, 2003 (incorporated by reference
to
exhibit 4.2 to Level 8's Form 8-K, filed March 31,
2003).
|
|
4.13A
|
Form
of Warrant issued to the Purchasers in the Series D Preferred Stock
transaction dated as of March 19, 2003 (incorporated by reference
to
exhibit 4.2 to Level 8's Form 8-K, filed March 31,
2003).
|
|
4.14
|
Form
of Stock Purchase Warrant issued to Purchasers in the October 2003
Private
Placement (incorporated by reference to exhibit 4.9 to Level 8’s Form
10-K, filed March31, 2004).
|
|
4.15
|
Form
of Stock Purchase Warrant issued to the Purchasers in the January
Private
Placement (incorporated by reference to exhibit 10.2 to Level 8's
Report
on Form 8-K, filed January 25, 2002).
|
|
4.16
|
Form
of Series A3 Stock Purchase Warrant (incorporated by reference to
exhibit
10.2 of Level 8’s Form 10-Q filed November 15, 2002).
|
|
4.17
|
Form
of Series B3 Stock Purchase Warrant (incorporated by reference to
exhibit
10.3 of Level 8’s Form 10-Q filed November 15, 2002).
|
|
4.18
|
Form
of Series C Stock Purchase Warrant (incorporated by reference to
exhibit
10.2 to Level 8’s Form 8-K filed August 27, 2002)
|
|
10.1
|
Securities
Purchase Agreement for Consortium IV (filed herewith).
|
|
10.2
|
Securities
Purchase Agreement dated January 2004 by and among Level 8 Systems,
Inc.
and the Purchasers in the January 2004 Private Placement (incorporated
by
reference to exhibit 10.1 to Level 8’s Form 10-K/A filed April 21,
2004).
|
|
10.3
|
Securities
Purchase Agreement dated March 2004 by and among Level 8 Systems,
Inc. and
the Purchasers of Convertible Promissory Note (incorporated by reference
to exhibit 10.2 to Level 8's Form 10-Q, filed May 12,
2004).
|
44
|
10.3
|
Form
of Convertible Promissory Note dated March 2004 by and among Level
8
Systems, Inc. and the Purchasers of Convertible Promissory Note
(incorporated by reference to exhibit 10.3 to Level 8's Form 10-Q,
filed
May 12, 2004).
|
|
10.4
|
Securities
Purchase Agreement dated as of March 19, 2003 by and among Level
8
Systems, Inc. and the Purchasers (incorporated by reference to exhibit
10.1 to Level 8's Form 8-K, filed March 31, 2003).
|
|
10.5
|
Securities
Purchase Agreement dated as of October 15, 2003 by and among Level
8
Systems, Inc. and the Purchasers in the October Private Placement
(incorporated by reference to exhibit 10.2 to Level 8’s Form 10-K, filed
March 31, 2004).
|
|
10.6
|
Securities
Purchase Agreement, dated as of January 16, 2002, by and among Level
8
Systems, Inc. and the Purchasers in the January Private Placement
(incorporated by reference to exhibit 10.1 to Level 8's Report on
Form
8-K, filed January 25, 2002).
|
|
10.7
|
Purchase
Agreement, dated as of January 3, 2002, between Level 8 Systems,
Inc. and
MLBC, Inc. (incorporated by reference to exhibit 10.1 to Level 8's
Report
on Form 8-K, filed January 11, 2002).
|
|
10.7A
|
Purchase
Agreement, dated as of July 31, 2000, between Level 8 Systems, Inc.
and
Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated by
reference to Exhibit 10.1 to Level 8's Report on Form 8-K, filed
August
11, 2000).
|
|
10.8
|
Securities
Purchase Agreement, dated as of August 14, 2002, by and among Level
8
Systems, Inc. and the purchasers of the Series C Preferred Stock
(incorporated by reference to exhibit 10.1 to Level 8’s Form 8-K filed
August 27, 2002).
|
|
10.9
|
Agreement
by and among Level 8 Systems, Inc. and the holders of Series A1/A2/A3
and
B1/B2/B3 Preferred Stock, dated as of August 14, 2002 (incorporated
by
reference to exhibit 10.3 to Level 8’s Form 8-K filed August 27,
2002).
|
|
10.10
|
Exchange
Agreement among Level 8 Systems, Inc., and the various stockholders
identified and listed on Schedule I, dated as of August 29, 2002
(incorporated by reference to exhibit 10.1 to Level 8’s Form 8-K filed
August 30, 2002).
|
|
10.11A
|
First
Amendment to Exchange Agreement, dated as of October 25, 2002, among
Level
8 Systems, Inc., and the various stockholders identified and listed
on
Schedule I to that certain Exchange Agreement, dated as of August
29, 2002
(incorporated by reference to exhibit 10.1 to Level 8’s Form 10-Q filed
November 15, 2002).
|
|
10.11B
|
Securities
Purchase Agreement, dated as of June 29, 1999, among Level 8 Systems,
Inc.
and the investors named on the signature pages thereof for the purchase
of
Series A Preferred Stock (incorporated by reference to exhibit 10.1
to
Level 8's Form 8-K filed July 23, 1999).
|
|
10.11C
|
Securities
Purchase Agreement, dated as of July 20, 2000, among Level 8 Systems,
Inc.
and the investors named on the signature pages thereof for the purchase
of
Series B Preferred Stock (incorporated by reference to Exhibit 10.1
to
Level 8's Report on Form 8-K filed July 31, 2000).
|
|
10.12
|
Amended
PCA Shell License Agreement, dated as of January 3, 2002, between
Level 8
Systems, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated
(incorporated by reference to exhibit 10.2 to Level 8's Form 8-K,
filed
January 11, 2002).
|
|
10.12A
|
PCA
Shell License Agreement between Level 8 Systems, Inc. and Merrill
Lynch,
Pierce, Fenner & Smith Incorporated (incorporated by reference to
exhibit 10.2 to Level 8’s Report on Form 8-K, filed September 11,
2000).
|
45
|
10.14
|
Promissory
Note of Level 8 Systems, Inc., dated as of September 28, 2001, among
Level
8 Systems, Inc. and Bank Hapoalim (incorporated by reference to exhibit
10.2 to Level 8’s Form 10-K filed April 2, 2002).
|
|
10.14
A
|
Amendment
No. 1 to Promissory Note of Level 8 Systems, Inc., dated as of October
30,
2006, letter dated October 30, 2006, and Late Payment Rider among
Level 8
Systems, Inc. and Bank Hapoalim (filed herewith).
|
|
10.14
A
|
Amendment
No. 2 to Promissory Note of Level 8 Systems, Inc., dated as of November
30, 2005 and letter dated November 3, 2005 among Level 8 Systems,
Inc. and
Bank Hapoalim (filed herewith).
|
|
10.14
B
|
Amendment
No. 1 to Promissory Note of Level 8 Systems, Inc., dated as of November
8,
2004 and letter dated November 8, 2004 among Level 8 Systems, Inc.
and
Bank Hapoalim (incorporated by reference to exhibit 10.14A to Level
8’s
Form 10-K/A filed April 21, 2004).
|
|
10.14
C
|
Amendment
to Promissory Note of Level 8 Systems, Inc., dated as of November
15, 2003
among Level 8 Systems, Inc. and Bank Hapoalim (incorporated by reference
to exhibit 10.10 A to Level 8’s Form 10-K, filed March 31,
2004).
|
|
10.15
|
Employment
Agreement between Anthony Pizi and the Company effective January
1, 2006
(filed herewith).*
|
|
10.16
|
Employment
Agreement between John P. Broderick and the Company effective January
1,
2006 (filed herewith).*
|
|
10.18
|
Level
8 Systems Inc. 1997 Stock Option Plan, as Amended and Restated
(incorporated by reference to exhibit 10.2 to Level 8’s Registration
Statement of Form S-1/A, filed September 22, 2000, File No.
333-44588).*
|
|
10.18A
|
Fifth
Amendment to Level 8 Systems Inc. 1997 Stock Option Plan (incorporated
by
reference to exhibit 10.9A to Level 8’s Form 10-K filed April 2,
2002).*
|
|
10.18B
|
Seventh
Amendment to Level 8 Systems Inc. 1997 Stock Option Plan (incorporated
by
reference to exhibit 10.14 B to Level 8’s Form 10-K, filed March 31,
2004).*
|
|
10.20
|
Lease
Agreement for Cary, N.C. offices, dated March 31, 1997, between Seer
Technologies, Inc. and Regency Park Corporation (incorporated by
reference
to exhibit 10.47 to Seer Technologies, Inc.'s Quarterly Report on
Form
10-Q for the period ended March 31, 1997, File No.
000-26194).
|
|
10.16A
|
Addendum
#1 to the Lease Agreement for Cary, N.C. offices, dated July 6, 1998
(incorporated by reference to exhibit 10.58 to Seer Technology Inc.'s
Quarterly Report on Form 10-Q for the period ended June 30, 1998,
File No.
000-26194).
|
|
10.16B
|
Amendment
to Lease Agreement for Cary, N.C. offices, dated January 21, 1999
(incorporated by reference to exhibit 10.21A to Level 8's Annual
Report on
Form 10-K for the fiscal year ended December 31, 1998).
|
|
10.17
|
Lease
Agreement for Cary, N.C. offices, dated November 7, 2003, between
Level 8
Systems, Inc. and Regency Park Corporation (incorporated by reference
to
exhibit 10.17 to Level 8’s Form 10-K, filed March 31,
2004).
|
|
10.18
|
Office
Lease Agreement, dated April 25, 1996, between Template Software,
Inc. and
Vintage Park Two Limited Partnership (incorporated by reference to
an
exhibit to Template Software, Inc.'s Registration Statement on Form
S-1,
File No. 333-17063).
|
46
|
10.18A
|
Amendment
to Office Lease Agreement, dated August 18, 1997, between Template
Software, Inc. and Vintage Park Two Limited Partnership (incorporated
by
reference to an exhibit to Template Software, Inc.'s Annual Report
on Form
10-K for the fiscal year ended December 31, 1997, File No.
000-21921).
|
|
10.19
|
Lease
Agreement, dated February 23, 2001, between Level 8 Systems, Inc.
and
Carnegie 214 Associates Limited Partnership (incorporated by reference
to
exhibit 10.15 to Level 8's Annual Report on Form 10-K, filed March
29,
2001).
|
|
14.1
|
Code
of Ethics (incorporated by reference to exhibit 14.1 to Level 8’s Form
10-K/A, filed March 31, 2004).
|
|
16.1
|
Letter
from Margolis & Company PC regarding change of accountant
(incorporated by reference to Exhibit 16.1 to Level 8’s Current Report on
Form 8-K, filed February 6, 2004).
|
|
21.1
|
List
of subsidiaries of the Company (filed herewith).
|
|
22.1
|
Consent
of Margolis & Company P.C. (filed herewith).
|
|
31.1
|
Certification
of Chief Executive and Financial Officer pursuant to Rule 13a-14(a)
(filed
herewith).
|
|
32.1
|
Certification
of John P. Broderick pursuant to 18 USC § 1350, as adopted pursuant to
§906 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
|
*
Management contract or compensatory agreement.
47
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of
1934, the Registrant has duly caused this Report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
|
CICERO
INC.
|
||
|
|
||
|
|
|
|
|
By:
/s/
John P. Broderick
|
||
|
John
P. Broderick
|
||
|
Chief
Executive Officer
|
||
|
Date:
March 30, 2007
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated have signed this Report below.
|
Signature
|
Title
|
Date
|
||
|
/s/
Mark Landis
|
Chairman
of the Board
|
March
30, 2007
|
||
|
Mark
Landis
|
||||
|
/s/
John P. Broderick
|
Chief
Executive Officer/Chief Financial Officer
|
March
30, 2007
|
||
|
John
P. Broderick
|
(Principal Executive Officer) | |||
|
/s/
Anthony C. Pizi
|
Chief
Information Officer
|
March
30, 2007
|
||
|
Anthony
C. Pizi
|
||||
|
/s/
Bruce Hasenyager
|
Director
|
March
30, 2007
|
||
|
Bruce
Hasenyager
|
||||
|
/s/
Jay Kingley
|
Director
|
March
30, 2007
|
||
|
Jay
Kingley
|
||||
|
/s/
Bruce D. Miller
|
Director
|
March
30, 2007
|
||
|
Bruce
D. Miller
|
||||
|
/s/
Charles Porciello
|
Director
|
March
30, 2007
|
||
|
Charles
Porciello
|
||||
|
/s/
Bruce Percelay
|
Director
|
March
30, 2007
|
||
|
Bruce
Percelay
|
||||
|
/s/
John W. Atherton
|
Director
|
March
30, 2007
|
||
|
John
W. Atherton
|
49
48
INDEX
TO FINANCIAL STATEMENTS
|
Report
of Independent Registered Public Accounting Firm
|
F-2
|
|
Financial
Statements:
|
|
|
Consolidated
Balance Sheets
|
F-3
|
|
Consolidated
Statements of Operations
|
F-4
|
|
Consolidated
Statements of Stockholders' Equity (Deficit)
|
F-5
|
|
Consolidated
Statements of Comprehensive Loss
|
F-6
|
|
Consolidated
Statements of Cash Flows
|
F-7
|
|
Notes
to Consolidated Financial Statements
|
F-9
|
F-1
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the Board of Directors and Stockholders of
Cicero
Inc.
Farmingdale,
New Jersey
We
have audited the accompanying consolidated balance sheet of Cicero Inc.
(formerly Level 8 Systems, Inc.) and subsidiaries (the "Company") as of December
31, 2006 and 2005, and the related consolidated statements of operations,
stockholders' equity (deficit), comprehensive loss and cash flows, for the
years
then ended. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Cicero Inc. and
subsidiaries as of December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company's recurring losses from
operations and working capital deficiency raise substantial doubt about its
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The consolidated financial statements
do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/
Margolis &
Company P.C.
Certified
Public
Accountants
Bala
Cynwyd, PA
March
16, 2007
F-2
CICERO
INC.
(Formerly
LEVEL 8 SYSTEMS, INC.)
CONSOLIDATED
BALANCE SHEETS
(in
thousands, except share and per share amounts)
|
December
31, 2006
|
December
31, 2005
|
||||||
|
ASSETS
|
|||||||
|
Current
assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
310
|
$
|
29
|
|||
|
Assets
of operations to be abandoned
|
80
|
131
|
|||||
|
Trade
accounts receivable, net
|
170
|
18
|
|||||
|
Prepaid
expenses and other current assets
|
22
|
53
|
|||||
|
Total
current assets
|
582
|
231
|
|||||
|
Property
and equipment, net
|
15
|
10
|
|||||
|
Total
assets
|
$
|
597
|
$
|
241
|
|||
|
LIABILITIES
AND STOCKHOLDERS' DEFICIT
|
|||||||
|
Current
liabilities:
|
|||||||
|
Senior
reorganization debt
(Note 2)
|
$
|
--
|
$
|
2,559
|
|||
|
Convertible
bridge notes (Note 2)
|
--
|
1,760
|
|||||
|
Short-term
debt
(Note 2)
|
2,899
|
3,481
|
|||||
|
Accounts
payable
|
2,360
|
2,528
|
|||||
|
Accrued
expenses:
|
|||||||
|
Salaries,
wages, and related items
|
1,012
|
1,036
|
|||||
|
Other
|
1,732
|
2,193
|
|||||
|
Liabilities
of operations to be abandoned
|
435
|
490
|
|||||
|
Deferred
revenue
|
38
|
78
|
|||||
|
Total
current liabilities
|
8,476
|
14,125
|
|||||
|
Long-term
debt
|
33
|
131
|
|||||
|
Senior
convertible redeemable preferred stock
(Note 2)
|
--
|
1,061
|
|||||
|
Total
liabilities
|
8,509
|
15,317
|
|||||
|
Commitments
and contingencies (Notes 15 and 16)
|
|||||||
|
Stockholders'
equity (deficit):
|
|||||||
|
Convertible
preferred stock, $0.001 par value, 10,000,000 shares
authorized.
|
|||||||
|
Series
A-1 - 1,763.5 shares issued and outstanding at December 31, 2006,
$500 per
share liquidation preference (aggregate liquidation value of
$880)
|
-- | -- | |||||
|
Series
A3 - no shares outstanding at December 31, 2006, 10,070 shares issued
and
1,571 shares outstanding at December 31, 2005 , $1,000 per share
liquidation preference (aggregate liquidation value of
$1,571)
|
-- | -- | |||||
|
Series
B3 - no shares outstanding at December 31, 2006, 30,000
shares issued and outstanding at December 31, 2005, $1,000 per share
liquidation preference (aggregate liquidation value of
$30,000)
|
-- | -- | |||||
|
Series
C - no shares outstanding at December 31, 2006, 1,590 shares issued
and
991 outstanding at December 31, 2005, $1,000 per share liquidation
preference (aggregate liquidation value of $991)
|
--
|
--
|
|||||
|
Common
stock, $0.001 par value, 215,000,000 shares authorized at December
31,
2006, 85,000,000 shares authorized at December 31, 2005; 35,182,406
and
480,399 issued and outstanding at December 31, 2006 and 2005, respectively
(Note 2)
|
35
|
48
|
|||||
|
Additional
paid-in-capital
|
226,407
|
210,594
|
|||||
|
Accumulated
deficit
|
(234,345
|
)
|
(225,715
|
)
|
|||
|
Accumulated
other comprehensive loss
|
(9
|
)
|
(3
|
)
|
|||
|
Total
stockholders' (deficit)
|
(7,912
|
)
|
(15,076
|
)
|
|||
|
Total
liabilities and stockholders' deficit
|
$
|
597
|
$
|
241
|
|||
The
accompanying notes are an integral part of the consolidated financial
statements.
F-3
CICERO
INC.
(
Formerly LEVEL
8 SYSTEMS, INC.)
CONSOLIDATED
STATEMENTS OF OPERATIONS
(in
thousands, except per share amounts)
|
Years
Ended December 31,
|
||||||||||
|
2006
|
|
2005
|
|
2004
|
||||||
|
Revenue:
|
||||||||||
|
Software
|
$
|
208
|
$
|
407
|
$
|
239
|
||||
|
Maintenance
|
120
|
147
|
306
|
|||||||
|
Services
|
644
|
231
|
230
|
|||||||
|
Total
operating revenue
|
972
|
785
|
775
|
|||||||
|
Cost
of revenue:
|
||||||||||
|
Software
|
9
|
16
|
4,478
|
|||||||
|
Maintenance
|
212
|
350
|
382
|
|||||||
|
Services
|
546
|
822
|
1,015
|
|||||||
|
Total
cost of revenue
|
767
|
1,188
|
5,875
|
|||||||
|
Gross
margin (loss)
|
205
|
(403
|
)
|
(5,100
|
)
|
|||||
|
Operating
expenses:
|
||||||||||
|
Sales
and marketing
|
346
|
627
|
1,088
|
|||||||
|
Research
and product development
|
533
|
891
|
1,111
|
|||||||
|
General
and administrative
|
1,206
|
1,137
|
1,522
|
|||||||
|
Write-off
of intangible assets
|
-
|
-
|
587
|
|||||||
|
(Gain)
on disposal of assets
|
(24
|
)
|
-
|
(5
|
)
|
|||||
|
Total
operating expenses
|
2,061
|
2,655
|
4,303
|
|||||||
|
Loss
from operations
|
(1,856
|
)
|
(3,058
|
)
|
(9,403
|
)
|
||||
|
Other
income (charges):
|
||||||||||
|
Interest
expense
|
(853
|
)
|
(593
|
)
|
(264
|
)
|
||||
|
Change
in fair value of warrant liability
|
-
|
-
|
198
|
|||||||
|
Other
expense
|
(288
|
)
|
(30
|
)
|
(262
|
)
|
||||
|
(1,141
|
)
|
(623
|
)
|
(328
|
)
|
|||||
|
Loss
from continuing operations
|
(2,997
|
)
|
(3,681
|
)
|
(9,731
|
)
|
||||
|
Loss
from discontinued operations
|
-
|
-
|
(30
|
)
|
||||||
|
Net
loss
|
($2,997
|
)
|
($3,681
|
)
|
($9,761
|
)
|
||||
|
Accretion
of preferred stock and deemed dividends
|
5,633
|
-
|
-
|
|||||||
|
Net
loss applicable to common stockholders
|
($8,630
|
)
|
($3,681
|
)
|
($9,761
|
)
|
||||
|
Loss
per share:
|
||||||||||
|
Net
loss applicable to common stockholders - basic and diluted
|
($0.25
|
)
|
($8.27
|
)
|
($27.11
|
)
|
||||
|
Weighted
average common shares outstanding - basic and diluted
|
35,182
|
445
|
360
|
|||||||
The
accompanying notes are an integral part of the consolidated financial
statements.
F-4
CICERO
INC.
(Formerly
LEVEL 8 SYSTEMS, INC.)
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in
thousands)
|
Common
Stock
|
Preferred
Stock
|
Additional
Paid-in
|
Accumulated
|
Accumulated
Other
Comprehensive
|
|||||||||||||||||||||
|
Shares
|
Amount
|
Shares
|
Amount
|
Capital
|
(Deficit)
|
Income
(Loss)
|
Total
|
||||||||||||||||||
|
Balance
at December 31, 2003
|
26,645
|
$
|
27
|
36
|
--
|
$
|
206,149
|
($212,273
|
)
|
($6
|
)
|
($6,103
|
)
|
||||||||||||
|
Conversion
of preferred shares to common
|
824
|
1
|
(3
|
)
|
--
|
1
|
|||||||||||||||||||
|
Shares
issued as compensation
|
1,068
|
1
|
188
|
189
|
|||||||||||||||||||||
|
Shares
issued for bank guarantee
|
5,579
|
5
|
603
|
608
|
|||||||||||||||||||||
|
Conversion
of senior convertible redeemable preferred stock
|
3,792
|
4
|
1,210
|
1,214
|
|||||||||||||||||||||
|
Shares
issued in private placement of common stock
|
3,369
|
3
|
1,244
|
1,247
|
|||||||||||||||||||||
|
Issuance
of common stock from acquisition
|
2,027
|
2
|
748
|
750
|
|||||||||||||||||||||
|
Foreign
currency translation adjustment
|
(2
|
)
|
(2
|
)
|
|||||||||||||||||||||
|
Net
loss
|
|
|
|
(9,761
|
)
|
(9,761
|
)
|
||||||||||||||||||
|
Balance
at December 31, 2004
|
43,304
|
43
|
33
|
--
|
210,142
|
(222,034
|
)
|
(8
|
)
|
(11,857
|
)
|
||||||||||||||
|
Conversion
of preferred shares to common
|
395
|
--
|
--
|
||||||||||||||||||||||
|
Shares
issued as compensation
|
961
|
2
|
101
|
103
|
|||||||||||||||||||||
|
Shares
issued for bank guarantee
|
2,400
|
2
|
45
|
47
|
|||||||||||||||||||||
|
Conversion
of senior convertible redeemable preferred stock
|
957
|
1
|
306
|
307
|
|||||||||||||||||||||
|
Foreign
currency translation adjustment
|
5
|
5
|
|||||||||||||||||||||||
|
Net
loss
|
|
|
|
(3,681
|
)
|
(3,681
|
)
|
||||||||||||||||||
|
Balance
at December 31, 2005
|
48,017
|
48
|
33
|
--
|
210,594
|
(225,715
|
)
|
(3
|
)
|
(15,076
|
)
|
||||||||||||||
|
Reversed
stock split 100:1
|
(47,536
|
)
|
(48
|
)
|
(33
|
)
|
|
48
|
--
|
||||||||||||||||
|
Shares
issued from conversion of senior reorganization debt
|
3,438
|
3
|
1,705
|
1,708
|
|||||||||||||||||||||
|
Shares
issued from conversion of convertible bridge notes
|
30,508
|
32
|
3,877
|
3,909
|
|||||||||||||||||||||
|
Shares
issued for bank guarantee
|
96
|
312
|
312
|
||||||||||||||||||||||
|
Shares
issued from short term debt conversion
|
224
|
190
|
190
|
||||||||||||||||||||||
|
Shares
issued from conversion of convertible promissory notes
|
2
|
992
|
992
|
||||||||||||||||||||||
|
Conversion
of senior convertible redeemable preferred stock
|
1,061
|
1,061
|
|||||||||||||||||||||||
|
Conversion
of warrants
|
99
|
1,086
|
1,086
|
||||||||||||||||||||||
|
Shares
issued for interest conversion
|
211
|
629
|
629
|
||||||||||||||||||||||
|
Shares
issued as compensation
|
125
|
280
|
280
|
||||||||||||||||||||||
|
Accretion
of preferred stock
|
529
|
(529
|
)
|
--
|
|||||||||||||||||||||
|
Deemed
dividend
|
5,104
|
(5,104
|
)
|
--
|
|||||||||||||||||||||
|
Foreign
currency translation adjustment
|
(6
|
)
|
(6
|
)
|
|||||||||||||||||||||
|
Net
loss
|
(2,997
|
)
|
(2,997
|
)
|
|||||||||||||||||||||
|
Balance
at December 31, 2006
|
35,182
|
$
|
35
|
2
|
--
|
$
|
226,407
|
($234,345
|
)
|
($9
|
)
|
($7,912
|
)
|
||||||||||||
The
accompanying notes are an integral part of the consolidated financial
statements.
F-5
CICERO
INC.
(Formerly
LEVEL 8 SYSTEMS, INC.)
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE LOSS
(in
thousands)
|
Years
Ended December 31,
|
||||||||||
|
|
2006
|
2005
|
2004
|
|||||||
|
Net
loss
|
($2,997
|
)
|
($3,681
|
)
|
($
9,761
|
)
|
||||
|
Other
comprehensive income (loss), net of tax:
|
||||||||||
|
Foreign
currency translation adjustment
|
(6
|
)
|
5
|
(2
|
)
|
|||||
|
Comprehensive
loss
|
($3,003
|
)
|
($3,676
|
)
|
($
9,763
|
)
|
||||
The
accompanying notes are an integral part of the consolidated financial
statements.
F-6
CICERO
INC.
(Formerly
LEVEL 8 SYSTEMS, INC.)
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
|
Years
Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Cash
flows from operating activities:
|
||||||||||
|
Net
loss
|
($2,997
|
)
|
($3,681
|
)
|
($9,761
|
)
|
||||
|
Adjustments
to reconcile net loss to net cash (used in) operating
activities:
|
||||||||||
|
Depreciation
and amortization
|
12
|
11
|
4,287
|
|||||||
|
Change
in fair value of warrant liability
|
--
|
--
|
(198
|
)
|
||||||
|
Stock
compensation expense
|
615
|
149
|
635
|
|||||||
|
Impairment
of intangible assets and software product technology
|
--
|
--
|
587
|
|||||||
|
Provision
(credit) for doubtful accounts
|
60
|
(12
|
)
|
(4
|
)
|
|||||
|
Gain
on disposal of assets
|
23
|
--
|
--
|
|||||||
|
Changes
in assets and liabilities, net of assets acquired and liabilities
assumed:
|
||||||||||
|
Trade
accounts receivable and related party receivables
|
(212
|
)
|
146
|
(143
|
)
|
|||||
|
Assets
and liabilities of operations to be abandoned
|
(27
|
)
|
(29
|
)
|
86
|
|||||
|
Prepaid
expenses and other assets
|
31
|
55
|
216
|
|||||||
|
Accounts
payable and accrued expenses
|
311
|
804
|
884
|
|||||||
|
Deferred
revenue
|
(40
|
)
|
(7
|
)
|
46
|
|||||
|
Net
cash (used in) operating activities
|
(2,224
|
)
|
(2,564
|
)
|
(3,365
|
)
|
||||
|
Cash
flows from investing activities:
|
||||||||||
|
Purchases
of property and equipment
|
(17
|
)
|
(6
|
)
|
--
|
|||||
|
Net
cash (used in) investing activities
|
(17
|
)
|
(6
|
)
|
--
|
|||||
|
Cash
flows from financing activities:
|
||||||||||
|
Proceeds
from issuance of common shares, net of issuance costs
|
380
|
--
|
1,250
|
|||||||
|
Proceeds
from exercise of warrants
|
--
|
--
|
112
|
|||||||
|
Borrowings
under credit facility, term loans and notes payable
|
2,148
|
2,542
|
2,540
|
|||||||
|
Repayments
of term loans, credit facility and notes payable
|
--
|
(55
|
)
|
(447
|
)
|
|||||
|
Net
cash provided by financing activities
|
2,528
|
2,487
|
3,455
|
|||||||
|
Effect
of exchange rate changes on cash
|
(6
|
)
|
5
|
(2
|
)
|
|||||
|
Net
increase (decrease) in cash and cash equivalents
|
281
|
(78
|
)
|
88
|
||||||
|
Cash
and cash equivalents at beginning of year
|
29
|
107
|
19
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
310
|
$
|
29
|
$
|
107
|
||||
|
SUPPLEMENTAL
DISCLOSURES OF CASH FLOW INFORMATION
|
||||||||||
|
Cash
paid (refunds) during the year for:
|
||||||||||
|
Income
taxes
|
$
|
20
|
$
|
1
|
$
|
2
|
||||
|
Interest
|
$
|
865
|
$
|
645
|
$
|
749
|
||||
The
accompanying notes are an integral part of the consolidated financial
statements.
F-7
CICERO
INC.
(Formerly
LEVEL 8 SYSTEMS, INC.)
CONSOLIDATED
STATEMENTS OF CASH FLOWS - CONTINUED
Non-Cash
Investing and Financing Activities
2006
During
2006, the Company issued 111,000 shares of common stock to vendors for
outstanding liabilities valued at $237,000.
In
November 2006, the Company issued 60,000 shares of common stock to Liraz Systems
Ltd. as compensation for extension of a bank debt guaranty valued at
$240,000.
In
December 2006, the Company issued 224,000 shares of common stock to Liraz
Systems Ltd. for its short term debt and interest of $191,000.
In
December 2006, the Company issued 50,000 shares of common stock to Brown Simpson
Partners I, Ltd. as compensation for assisting in its
recapitalization.
2005
During
2005, the Company issued 961,329 shares of common stock to vendors for
outstanding liabilities valued at $103,000.
In
November 2005, the Company issued 2,400,000 shares of common stock to a
designated subsidiary of Liraz Systems Ltd. as compensation for extension of
a
bank debt guarantee valued at $48,000.
During
2005, the Company issued 956,375 shares of Level 8 Systems common stock upon
conversion of 1,367 shares of Series D Convertible Redeemable Preferred Stock.
During
2005, 150 shares of Series C Convertible Redeemable Preferred Stock were
converted into 394,737 shares of Level 8 Systems common stock.
2004
During
2004, the Company issued 600,948 shares of common stock to vendors for
outstanding liabilities valued at $92,000. The Company also issued 466,668
shares of common stock to contractors for compensation valued at
$47,000.
In
January 2004, the Company acquired substantially all assets and certain
liabilities of a federally certified encryption software company. The Company
issued 2,027,027 shares of common stock valued at $750,000.
During
2004, the Company issued 4,092,000 shares of common stock to a designated
subsidiary of Liraz Systems Ltd. as compensation for extension of a bank debt
guarantee valued at $447,000.
In
October 2004, 750 shares of Series D Convertible Redeemable Preferred Stock
were
redeemed in
return for $775,000 as a condition of escrow in the event that a joint venture
for the Asian market was not formed or operational by July 17, 2003. Such
redemption was concluded in November 2004 and the escrowed proceeds, including
$4,000 of interest, were distributed back to the holders of Series D Preferred
Stock. During
2004, the Company issued 3,791,999 shares of Level 8 Systems common stock upon
conversion of 1,213 shares of Series D Convertible Redeemable Preferred Stock.
During
2004, 179 shares of Series C Convertible Redeemable Preferred Stock were
converted into 523,684 shares of Level 8 Systems common stock.
In
May 2004, the Company issued 135,135 shares of common stock on conversion of
a
$50,000 convertible note.
F-8
CICERO
INC.
(Formerly
LEVEL 8 SYSTEMS, INC.)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
NOTE
1.
|
SUMMARY
OF OPERATIONS, SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING
PRONOUNCEMENTS
|
Cicero
Inc., formerly Level 8 Systems, Inc. (''Cicero'' or the ''Company''), is a
provider of business integration software which enables organizations to
integrate new and existing information and processes at the desktop. Business
integration software addresses the emerging need for a company's information
systems to deliver enterprise-wide views of the company's business information
processes.
Going
Concern:
The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. The Company has incurred an operating loss
of
approximately $2,997,000 for the year ended December 31, 2006 and has
experienced negative cash flows from operations for each of the years ended
December 31, 2006, 2005 and 2004. At December 31, 2006, the Company had a
working capital deficiency of approximately $7,894,000. The Company’s future
revenues are entirely dependent on acceptance of a newly developed and marketed
product, Cicero®, which has had limited success in commercial markets to date.
These factors among others raise substantial doubt about the Company’s ability
to continue as a going concern for a reasonable period of time.
The
financial statements presented herein do not include any adjustments relating
to
the recoverability of assets and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern. In order
to address these issues and to obtain adequate financing for the Company’s
operations for the next twelve months, the Company is actively promoting and
expanding its Cicero®-related product line and continues to negotiate with
significant customers who have expressed interest in the Cicero® software
technology. The Company is experiencing difficulty increasing sales revenue
largely because of the inimitable nature of the product as well as customer
concerns about the financial viability of the Company. Cicero® software is a new
“category defining” product in that most Enterprise Application Integration
(EAI) projects are performed at the server level and Cicero®’s integration
occurs at the desktop without the need to open and modify the underlying code
for those applications being integrated. Many companies are not aware of this
new technology or tend to look toward more traditional and accepted approaches.
The Company is attempting to solve the former problem by improving the market’s
knowledge and understanding of Cicero® software through increased marketing and
leveraging its limited number of reference accounts while enhancing its list
of
resellers and system integrators to assist in the sales and marketing process.
Additionally, the Company is seeking additional equity capital or other
strategic transactions in the near term to provide additional liquidity. In
2004, the Company announced a Note and Warrant Offering in which warrant holders
of the Company’s common stock were offered a one-time conversion of their
existing warrants at a conversion price of $0.10 per share as part of a
recapitalization plan. Under the terms of the Offer, warrant holders who elect
to convert, would tender their conversion price in cash and receive a Note
Payable in exchange. Upon approval of the recapitalization plan at a
Shareholders meeting, these Notes would convert into common shares of the
Company. The Company raised a total of $2,559,000 from the Note and Warrant
Offering. During 2005 and 2006, the Company also entered into several
Convertible Bridge Notes with a consortium of investors. The Company raised
a
total of $3,915,000 of Convertible Bridge Notes. The Convertible Bridge Notes
convert into common stock of the Company upon approval of the recapitalization
plan. The Recapitalization was approved by stockholders at a special meeting
on
November 16, 2006. Management expects that it will be able to raise additional
capital, post stockholder approval of the recapitalization plan, and to continue
to fund operations and also expects that increased revenues will reduce its
operating losses in future periods, however, there can be no assurance that
management’s plan will be executed as anticipated.
Principles
of Consolidation:
The
accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. All of the Company's subsidiaries are wholly-owned
for the periods presented.
All
significant inter-company accounts and transactions are eliminated in
consolidation.
F-9
Use
of Estimates:
The
preparation of financial statements in conformity with accounting principals
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual amounts could differ from these estimates.
Financial
Instruments:
The
carrying amount of the Company’s financial instruments, representing accounts
receivable, notes receivable, accounts payable and debt approximate their fair
value.
Foreign
Currency Translation:
The
assets and liabilities of foreign subsidiaries are translated to U.S. dollars
at
the current exchange rate as of the balance sheet date. The resulting
translation adjustment is recorded in other comprehensive income as a component
of stockholders' equity. Statements of operations items are translated at
average rates of exchange during each reporting period.
Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in
the
results of operations as incurred.
Cash
and Cash Equivalents:
Cash
and cash equivalents include all cash balances and highly liquid investments
with maturity of three months or less from the date of purchase. For these
instruments, the carrying amount is considered to be a reasonable estimate
of
fair value. The Company places substantially all cash and cash equivalents
with
various financial. At times, such cash and cash equivalents may be in excess
of
FDIC insurance limits.
Trade
Accounts Receivable:
Trade
accounts receivable are stated in the amount management expects to collect
from
outstanding balances. Management provides for probable uncollectible amounts
through a charge to earnings and a credit to a valuation allowance based on
its
assessment of the current status of individual accounts. Balances that are
still
outstanding after management has used reasonable collection efforts are written
off through a charge to the valuation allowance and a credit to trade accounts
receivable. Changes in the valuation allowance have not been material to the
financial statements.
Property
and Equipment:
Property
and equipment purchased in the normal course of business is stated at cost,
and
property and equipment acquired in business combinations is stated at its fair
market value at the acquisition date. All property and equipment is depreciated
using the straight-line method over estimated useful lives.
Expenditures
for repairs and maintenance are charged to expense as incurred. The cost and
related accumulated depreciation of property and equipment are removed from
the
accounts upon retirement or other disposition and any resulting gain or loss
is
reflected in the Consolidated Statements of Operations.
Software
Development Costs:
The
Company capitalizes certain software costs after technological feasibility
of
the product has been established. Generally, an original estimated economic
life
of three years is assigned to capitalized software costs, once the product
is
available for general release to customers. Costs incurred prior to the
establishment of technological feasibility are charged to research and
development expense.
Additionally,
the Company has recorded software development costs for its purchases of
developed technology through acquisitions. (See Note 3.)
F-10
Capitalized
software costs are amortized over related sales on a product-by-product basis
using the straight-line method over the remaining estimated economic life of
the
product. (See Note 6.)
The
establishment of technological feasibility and the ongoing assessment of
recoverability of capitalized software development costs require considerable
judgment by management with respect to certain external factors, including,
but
not limited to, technological feasibility, anticipated future gross revenue,
estimated economic life and changes in software and hardware technologies.
Long-Lived
Assets:
The
Company reviews the recoverability of long-lived intangible assets when
circumstances indicate that the carrying amount of assets may not be
recoverable. This evaluation is based on various analyses including undiscounted
cash flow projections. In the event undiscounted cash flow projections indicate
impairment, the Company would record an impairment based on the fair value
of
the assets at the date of the impairment. The Company accounts for impairments
under the Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”. During 2004 the Company recorded impairments
associated with its Cicero® technology and for its Ensuredmail technology
acquired in 2004.
Revenue
Recognition:
The
Company recognizes license revenue from end-users and third party resellers
in
accordance with the American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, “Software Revenue Recognition”, as amended
by SOP 98-9, ''Modification of SOP 97-2, 'Software Revenue Recognition,' with
Respect to Certain Transactions''. The Company reviews each contract to identify
elements included in the software arrangement. SOP 97-2 and SOP 98-9 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. VSOE of the fair value
of
undelivered elements is established on the price charged for that element when
sold separately. Software customers are given no rights of return and a
short-term warranty that the products will comply with the written
documentation. The Company has not experienced any product warranty
returns.
Revenue
from recurring maintenance contracts is recognized ratably over the maintenance
contract period, which is typically twelve months. Maintenance revenue that
is
not yet earned is included in deferred revenue.
Revenue
from consulting and training services is recognized as services are performed.
Any unearned receipts from service contracts result in deferred revenue.
Cost
of Revenue:
The
primary components of the Company's cost of revenue for its software products
are software amortization on internally developed and acquired technology,
royalties on certain products, and packaging and distribution costs. The primary
component of the Company's cost of revenue for maintenance and services is
compensation expense.
Advertising
Expenses:
The
Company expenses advertising costs as incurred. Advertising expenses were
approximately $88,000, $16,000, and $7,000 for the years ended December 31,
2006, 2005 and 2004, respectively.
Research
and Product Development:
Research
and product development costs are expensed as incurred.
Income
Taxes:
The
Company uses SFAS No. 109, ''Accounting for Income Taxes'', to account for
income taxes. This statement requires an asset and liability approach that
recognizes deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences,
F-11
all
expected future events, other than enactments of changes in the tax law or
rates, are generally considered. A valuation allowance is recorded when it
is
''more likely than not'' that recorded deferred tax assets will not be realized.
(See Note 8.)
Stock
Split:
As
discussed in Note 2, the Company’s stockholders approved a 100 to 1 reverse
stock split in November 2006. The Company retained the current par value of
$.001 per share for all common shares. All references in the financial
statements and notes to the number of shares outstanding, per share amounts,
and
stock option data of the Company’s common shares have been restated to reflect
the effect of the reverse stock split for the periods presented.
Loss
Per Share:
Basic
loss per share is computed based upon the weighted average number of common
shares outstanding. Diluted loss per share is computed based upon the weighted
average number of common shares outstanding and any potentially dilutive
securities. During 2006, 2005, and 2004, potentially dilutive securities
included stock options, warrants to purchase common stock, and preferred stock.
The
following table sets forth the potential shares that are not included in the
diluted net loss per share calculation because to do so would be anti-dilutive
for the periods presented. The amounts have been restated in accordance with
SAB
Topic 4 (c ) to reflect the adjustment to the Company’s capitalization as a
result of the 100:1 reverse stock split which was approved by the Company in
November 2006:
|
2006
|
2005
|
2004
|
||||||||
|
Stock
options
|
45,315
|
59,009
|
74,886
|
|||||||
|
Warrants
|
323,623
|
193,761
|
199,534
|
|||||||
|
Preferred
stock
|
1,763,478
|
85,046
|
98,557
|
|||||||
|
2,132,416
|
337,816
|
372,977
|
||||||||
In
2006, 2005 and 2004, no dividends were declared on preferred stock.
Stock-Based
Compensation:
During
2006, the Company adopted SFAS No. 123 (revised 2004) (SFAS No. 123R”),
“Share-Based Payment”, which addresses the accounting for stock-based payment
transactions in which an enterprise receives employee services in exchange
for
(a) equity instruments of the enterprise or (b) liabilities that are based
on
the fair value of the enterprise’s equity instruments or that may be settled by
the issuance of such equity instruments. In January 2005, the SEC issued SAB
No.
107, which provides supplemental implementation guidance for SFAS No. 123R.
SFAS
No. 123R eliminates the ability to account for stock-based compensation
transactions using the intrinsic value method under Accounting Principles Board
(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and instead
generally requires that such transactions be accounted for using a
fair-value-based method. The Company uses the Black-Scholes option-pricing
model
to determine the fair-value of stock-based awards under SFAS No. 123R,
consistent with that used for pro forma disclosures under SFAS No. 123,
“Accounting for Stock-Based Compensation”. The Company has elected to use the
modified prospective transition method as permitted by SFAS No. 123R and,
accordingly, prior periods have not been restated to reflect the impact of
SFAS
No. 123R. The modified prospective transition method requires that stock-based
compensation expense be recorded for all new and unvested stock options that
are
ultimately expected to vest as the requisite service is rendered beginning
on
the first day of the Company’s year ended December 31, 2006. Stock-based
compensation expense for awards granted prior to 2006 is based on the grant-date
fair-value as determined under the pro forma provisions of SFAS No. 123. The
Company did not grant options during 2006, therefore there were no diluted
earnings per common share due to the adoption of SFAS No. 123R.
Prior
to the adoption of SFAS No. 123R, the Company measured compensation expense
for
its employee stock-based compensation plans using the intrinsic value method
prescribed by APB Opinion No. 25. The Company applied the disclosure provisions
of SFAS No. 123 as amended by SFAS No. 148, “Accounting for Stock-Based
Compensation - Transition and Disclosure”, as if the fair-value-based method had
been applied in measuring compensation expense. Under APB Opinion No. 25, when
the exercise price of the Company’s employee stock options was equal to the
market price of the underlying stock on the date of the grant, no compensation
expense was recognized.
F-12
The
following table illustrates the effect on net loss and net loss per common
share
as if the Company had applied the fair value recognition provisions of SFAS
No.
123 to stock-based compensation during 2005 and 2004 (in
thousands):
|
Years
Ended December 31,
|
|||||||
|
2005
|
2004
|
||||||
|
Net
loss applicable to common stockholders, as reported
|
$
|
(3,681
|
)
|
$
|
(9,761
|
)
|
|
|
Less:
Total stock-based employee compensation expense under
fair
value based method for all awards, net of related tax
effects
|
(180
|
)
|
(777
|
)
|
|||
|
Pro
forma loss applicable to common stockholders
|
$
|
(3,861
|
)
|
$
|
(10,538
|
)
|
|
|
Loss
per share:
|
|||||||
|
Basic
and diluted, as reported
|
$
|
(8.27
|
)
|
$
|
(27.11
|
)
|
|
|
Basic
and diluted, pro forma
|
$
|
(8.68
|
)
|
$
|
(29.27
|
)
|
|
The
fair value of the Company's stock-based awards to employees was estimated as
of
the date of the grant using the Black-Scholes option-pricing model, using the
following weighted-average assumptions:
|
2006
|
|
2005
|
|
2004
|
||||||
|
Expected
life (in years)
|
3.6
years
|
6.0
years
|
4.19
years
|
|||||||
|
Expected
volatility
|
140
|
%
|
149
|
%
|
138
|
%
|
||||
|
Risk
free interest rate
|
4.93
|
%
|
4.48
|
%
|
4.75
|
%
|
||||
|
Expected
dividend yield
|
0
|
%
|
0
|
%
|
0
|
%
|
||||
Warrants
Liability:
The
Company had issued warrants to Series A3 and Series B3 preferred stockholders
which contain provisions that allow the warrant holders to force a cash
redemption for events outside the control of the Company. The fair value of
the
warrants are accounted for as a liability and are re-measured through the
Consolidated Statements of Operations at each balance sheet date. As of December
31, 2006 and 2005, the fair value of these warrants was $0.
Reclassifications:
Certain
prior year amounts in the accompanying financial statements have been
reclassified to conform to the 2006 presentation. Such reclassifications had
no
effect on previously reported net loss or stockholders’ deficit.
Recent
Accounting Pronouncements:
In
July 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income
Taxes - An Interpretation of SFAS No. 109”. FIN No. 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprise’s financial
statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN
No. 48 also prescribes a recognition threshold and measurement attribute for
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. In addition, FIN No. 48 provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The provisions of FIN No. 48 are to be
applied to all tax positions upon initial adoption of this standard. Only tax
positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized as an adjustment
to the opening balance of accumulated deficit (or other appropriate components
of equity) for that fiscal year. The provisions of FIN No. 48 are effective
for
fiscal years beginning after December 15, 2006. The Company is evaluating the
impact of the adoption of FIN 48 but does not currently expect the adoption
of
this new standard to have a material impact on our financial position, results
of operations, or cash flows.
In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulleting (“SAB”) 108, to address diversity in practice in
quantifying financial statement misstatements. SAB 108 requires that the Company
quantify
F-13
misstatements
based on their impact on each of its financial statements and related
disclosures. SAB 108 is effective for fiscal years ending after November 15,
2006. The Company has adopted SAB 108 effective as of December 31, 2006. The
adoption of this bulletin did not have a material impact on our financial
position, results of operations, or cash flows.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS
No. 157 provides guidance for using fair value to measure assets and
liabilities. It also responds to investors’ requests for expanded information
about the extent to which companies measure assets and liabilities at fair
value, the information used to measure fair value, and the effect of fair value
measurements on earnings. SFAS No. 157 applies whenever other standards require
(or permit) assets or liabilities to be measured at fair value, and does not
expand the use of fair value in any new circumstances. SFAS No. 157 is effective
for financial statements issued for fiscal years beginning after November 15,
2007 and is required to be adopted by the Company in the first quarter of 2008.
The Company is currently evaluating the effect that the adoption of SFAS No.
157
will have on our financial position, results of operations, or cash
flows.
In
December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based
Payment, (“SFAS 123R”). SFAS 123R addresses the accounting for share-based
payments to employees, including grants of employee stock options. Under
the new standard, companies will no longer be able to account for share-based
compensation transactions using the intrinsic method in accordance with APB
Opinion No. 25, “Accounting for Stock Issued to Employees”. Instead,
companies will be required to account for such transactions using a fair-value
method and recognize the expense in the consolidated statements of
operations. SFAS 123R is effective for periods beginning after
June 15, 2005 and allows, but does not require, companies to restate the
full fiscal year of 2005 to reflect the impact of expensing share-based payments
under SFAS 123R. The Company uses the Black-Scholes option-pricing model
to determine the fair-value of stock-based awards under SFAS No. 123R,
consistent with that used for pro forma disclosures under SFAS No. 123,
“Accounting for Stock-Based Compensation”. The Company has elected to use the
modified prospective transition method as permitted by SFAS No. 123R and,
accordingly, prior periods have not been restated to reflect the impact of
SFAS
No. 123R. The modified prospective transition method requires that stock-based
compensation expense be recorded for all new and unvested stock options that
are
ultimately expected to vest as the requisite service is rendered beginning
on
the first day of the Company’s year ended December 31, 2006. Stock-based
compensation expense for awards granted prior to 2006 is based on the grant-date
fair-value as determined under the pro forma provisions of SFAS No. 123. The
Company recognized incremental stock-based compensation expense of $14,000
during 2006 as a result of the adoption of SFAS No. 123R.
NOTE
2. RECAPITALIZATION
In
November 2006, the Company’s stockholders approved an amendment to the
Certificate of Incorporation to provide the Company’s Board of Directors with
discretionary authority to effect a reverse stock split ratio from 20:1 to
100:1
and on November 20, 2006, the Board of Directors set that reverse stock ratio
to
be 100:1. In addition, the Company’s stockholders approved an amendment to
change the name of the Company from Level 8 Systems, Inc. to Cicero Inc., to
increase the authorized common stock of the Company from 85 million shares
to
215 million shares and to convert existing preferred shares into a new Series
A-1 preferred stock of Cicero Inc. The proposals at the Special Meeting of
Stockholders of Level 8 comprised a proposed recapitalization of Level 8 which
was also subject to the receipt of amendments to outstanding convertible
promissory notes, senior reorganization notes and the convertible bridge notes.
As
part of the plan of recapitalization, Senior Reorganization Notes in the
aggregate principal amount of $2,559,000 to Senior Reorganization Noteholders
who had loaned funds to the Company in exchange for Senior Reorganization Notes
and Additional Warrants at a special one-time exercise price of $0.10 per share,
(i) will receive and have automatically exercised Additional Warrants
exercisable into shares of Common Stock, by applying the accrued interest on
their Senior Reorganization Notes and by cashless exercise to the extent of
the
balance of the exercise price, (ii) if a holder of existing warrants who
advanced the exercise price of their warrants to the Company, will have their
existing warrants automatically exercised and (iii) those Senior Reorganization
Noteholders who loaned the Company the first $1,000,000 in respect of the
exercise price of their existing warrants will receive Early Adopter Warrants
of
the Company at a ratio of 2:1 for shares issuable upon exercise of each existing
warrant exercised at the special exercise price of $10.00 per share. At the
time
of issuance of the Senior Reorganization Notes, the trigger for conversion
into
exercisable warrants was an anticipated recapitalization merger. Since the
recapitalization plan was amended, the Company solicited Senior Noteholders
for
their consent to convert upon approval of the plan of recapitalization by
stockholders. Approximately $2,309,000 of the Senior Reorganization Noteholders
have consented to the change in the “trigger” and have cancelled their notes and
converted into 3,438,473 shares of the Company’s common stock.
F-14
In
accordance with EITF 98-5, “Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”,
the Company has allocated the proceeds received from the Note and Warrant
Offering between the warrants exercised and the future warrants granted and
has
employed the Black-Scholes valuation method to determine the fair value of
the
warrants exercised and the additional warrants issued. The Senior Reorganization
Noteholders who have consented to convert their debt amounted to approximately
$2,309,000. Of that amount, approximately $979,000 represents the exercise
price
of existing warrants that was loaned to the Company for which the warrant
holders will receive both additional warrants and early adopter warrants. Using
the Black-Scholes formula, the Company has determined that the fair value of
the
warrants granted to this tranche is approximately $440,000. The difference
between the fair value of the additional warrants and the total invested in
this
tranche, or $539,000, is treated as a beneficial conversion and fully
amortizable. The second tranche of investment that consisted of those warrant
holders who loaned the exercise price of their existing warrants, and will
receive additional warrants but no early adopter warrants, amounted to
approximately $107,000. Using Black-Scholes, the Company has determined that
the
fair value of the warrants granted to this tranche is approximately $32,000
and
the beneficial conversion amount is $75,000. The third tranche consisted of
investors who had no existing warrants and will only receive additional warrants
upon consummation of the Recapitalization. The total investment in this tranche
is $1,223,000. Using Black-Scholes, the Company has determined that the fair
value of the warrants granted to this tranche is approximately $570,000 and
the
beneficial conversion amount is $653,000. Since this beneficial conversion
feature is immediately convertible upon issuance, the Company has fully
amortized this beneficial conversion feature in the Statement of Operations
for
the year ended December 31, 2006.
Also
as part of the recapitalization plan, Convertible Bridge Notes in the principal
amount of $3,915,000 are automatically cancelled and converted into 30,508,448
shares of the Company’s common stock. Also in accordance with EITF 98-5, using
the Black-Scholes formula, the Company has calculated the fair value of the
common stock resulting from conversion of the Convertible Bridge Notes. Based
upon that calculation, the fair value of the stock received was $195,000. The
difference between the total of the Convertible Bridge Notes and the fair value
of the stock ($3,720,000) is treated as a beneficial conversion. Since this
beneficial conversion feature is immediately convertible upon issuance, the
Company has fully amortized this beneficial conversion feature in the Statement
of Operations for the year ended December 31, 2006.
The
Company had issued $992,000 aggregate principal amount of Convertible Promissory
Notes. As part of the recapitalization plan, these Noteholders were offered
reduced conversion prices to convert their notes into shares of the Company’s
new series A-1 preferred stock. All Noteholders have agreed to convert their
notes into shares of Series A-1 preferred stock. The Company has cancelled
these
notes and issued 1,591 shares of its Series A-1 preferred stock. In accordance
with EITF 98-5 and specifically paragraph 8, the Company has utilized the
Black-Scholes formula to determine the fair value of the stock received. The
Company has calculated the fair value of the stock received to be $484,000
resulting in a beneficial conversion of $508,000. Since this beneficial
conversion is immediately recognizable by the holders, the Company has fully
amortized this conversion and recorded an accretion to preferred stock in the
Statement of Operations for the year ended December 31, 2006.
Holders
of the Company’s Series A-3, B-3, C and D preferred stock were offered reduced
conversion rates on their existing preferred stock in exchange for shares in
a
new Series A-1 preferred stock for Cicero Inc. as part of the recapitalization
plan. As a result of stockholder approval, the Company affected an exchange
of
existing preferred shares into 172.15 Series A-1 preferred shares. In exchange
for the reduced conversion prices, holders of the series A-3, B-3 and D shares
forfeited their anti-dilution protection along with certain other rights, ranks
and privileges. The Company’s Series D preferred stock contained a redemption
feature which required that the Company account for same as a liability. The
Company’s Series A-1 preferred stock contains no redemption features and
accordingly, upon exchange, the fair value of these shares were converted to
equity. The Company employed the Black-Scholes formula to value the shares
exchanged and have determined that the reduced conversion prices and exchange
has created a beneficial conversion of $21,000. As the new Series A-1 preferred
shares are immediately convertible, the Company has recorded this beneficial
conversion as a deemed dividend in the Statement of Operations for the year
ended December 31, 2006.
NOTE
3. ACQUISITIONS
In
January 2004, the Company acquired substantially all of the assets and certain
liabilities of Critical Mass Mail, Inc., d/b/a Ensuredmail, a federally
certified encryption software company. Under the terms of the purchase
agreement, the Company issued 2,027,027 shares of common stock at a price of
$0.37. The total purchase price of the assets being acquired plus certain
liabilities assumed was $750,000, and has been accounted for by the purchase
method of accounting. The Company agreed to register the common stock for resale
under the Securities Act of 1933, as amended.
F-15
The
purchase price was allocated to the assets acquired and liabilities assumed
based on the Company’s estimates of fair value at the acquisition date. The
Company assessed the net realizable value of the Ensuredmail software technology
acquired and determined the purchase price exceeded the amounts allocated to
the
software technology acquired less liabilities assumed by approximately $587,000.
This excess of the purchase price over the fair values of the assets acquired
less liabilities assumed was allocated to goodwill, and, because it was deemed
impaired, charged to the Statements of Operations for the year ended December
31, 2004. (See Note 6.)
NOTE
4. ACCOUNTS
RECEIVABLE
Trade
accounts receivable was composed of the following at December 31 (in
thousands):
|
2006
|
2005
|
||||||
|
Current
trade accounts receivable
|
$
|
230
|
$
|
18
|
|||
|
Less:
allowance for doubtful accounts
|
60
|
--
|
|||||
|
$
|
170
|
$
|
18
|
||||
The
(credit) provision for uncollectible amounts was $60,000, ($12,000), and
($4,000) for the years ended December 31, 2006, 2005, and 2004,
respectively. Write-offs (net of recoveries) of accounts receivable were ($0)
for the years ended December 31, 2006, 2005 and 2004.
NOTE
5. PROPERTY
AND EQUIPMENT
Property
and equipment was composed of the following at December 31 (in thousands):
|
2006
|
2005
|
||||||
|
Computer
equipment
|
$
|
252
|
$
|
246
|
|||
|
Furniture
and fixtures
|
8
|
8
|
|||||
|
Office
equipment
|
149
|
140
|
|||||
|
409
|
394
|
||||||
|
Less:
accumulated depreciation and amortization
|
(394
|
)
|
(384
|
)
|
|||
|
$
|
15
|
$
|
10
|
||||
Depreciation
and amortization expense of property and equipment was $12,000, $11,000, and
$11,000 for the years ended December 31, 2006, 2005, and 2004, respectively.
NOTE
6. SOFTWARE
PRODUCT TECHNOLOGY
In
accordance with SFAS 86, "Accounting for the Costs of Computer Software to
Be
Sold, Leased, or Otherwise Marketed", the
Company periodically completed an assessment of the recoverability of the
Cicero® product technology. This assessment was performed during 2004, due to
the Company’s continued operating losses and the limited software revenue
generated by the Cicero® technology over the previous twelve to eighteen months.
The Company was in negotiations with customers to purchase licenses, which
would
have a significant impact on the cash flows from the Cicero® technology and the
Company. Since the negotiations had been in process for several months and
expected completion of the transactions had been delayed, the Company had
reduced its cash flow projections. Historical cash flows generated by the
Cicero® technology do not support the long-lived asset and accordingly the
Company impaired the excess of the unamortized book value of the technology
in
excess of the expected net realizable value for the year ended December 31,
2004. This charge, in the amount of $2,844,000 was recorded as software
amortization for the year ended December 31, 2004. As of December 31, 2006
and
2005, the Company has no capitalized costs for the Cicero®
technology.
F-16
Also
in accordance with SFAS 86, the
Company completed an assessment of the recoverability of the Ensuredmail product
technology. This assessment was also completed during 2004, due to the Company’s
revised cash flow projections from software revenue. These revised cash flow
projections do not support the long-lived asset and accordingly the Company
has
impaired the excess of the unamortized book value of the technology in excess
of
the expected net realizable value. This charge, in the amount of $154,000,
was
recorded as software amortization for the year ended December 31, 2004. As
of
December 31, 2005, the Company has no capitalized costs for the Ensuredmail
software technology.
NOTE
7. SHORT-TERM
DEBT AND CONVERTIBLE NOTES
Notes
payable, long-term debt, and notes payable to related party consist of the
following at December 31(in thousands):
|
2006
|
2005
|
||||||
|
Term
loan (a)
|
$
|
1,971
|
$
|
1,971
|
|||
|
Note
payable; related party (b)
|
9
|
9
|
|||||
|
Notes
payable (c)
|
950
|
509
|
|||||
|
Short
term convertible note (d)
|
--
|
265
|
|||||
|
Short
term convertible notes, related party (e)
|
--
|
727
|
|||||
|
$
|
2,930
|
$
|
3,481
|
||||
|
(a)
|
The
Company has a $1,971 term loan bearing interest at LIBOR plus 1.5%
(approximately 6.38% at December 31, 2006). Interest is payable quarterly.
There are no financial covenants and the term loan is guaranteed
by Liraz
Systems Ltd., the Company’s former principal stockholder. The loan matures
on October 31, 2007. (See Note 14.)
|
|
(b)
|
From
time to time the Company borrowed money from the Company's Chief
Information Officer. The notes bear interest at 12% per annum. As
of
December 31, 2006, the Company is indebted to Anthony Pizi, the Company’s
former Chairman and CEO and current Chief Information Officer, in
the
amount of $9,000.
|
|
(c)
|
The
Company does not have a revolving credit facility and from time to
time
has issued a series of short term promissory notes with private lenders,
which provide for short term borrowings both secured and unsecured
by
accounts receivable. In addition, the Company has settled certain
litigation and agreed to a series of promissory notes to support
the
obligations. The notes bear interest between 10% and 12% per annum.
|
|
(d)
|
The
Company entered into convertible notes with private lenders. The
notes
bear interest between 12% and 18% per annum and allow for the conversion
of the principal amount due into common stock of the Company. In
April
2005, the Company entered into a convertible loan in the amount
of $30,000
with a member of the Company’s Board of Directors. Under the term of this
agreement, the loan bears interest at 1% per month and was convertible
upon the option of the note holder into 428,571 shares of our common
stock
at a conversion price of $0.07 per share. As part of the recapitalization
plan, the Company has offered to lower that conversion rate and
exchange
the note for 60 shares of Series A-1 preferred stock. In November
2006,
the Noteholder consented to the amended conversion rate and the
Note has
been cancelled. In May 2004, the Company entered into convertible
loans
aggregating $185,000 from several investors including a member
of the
Company’s Board of Directors. Under the terms of these agreements, the
loans bear interest between 1% and 1.5% per month and are convertible
upon
the option of the Noteholder into an aggregate of 578,125 shares
of our
common stock and warrants to purchase an aggregate of 578,125 shares
of
our common stock exercisable at $0.32. The warrants expire three
years
from grant. As part of the recapitalization plan, the Company has
offered
to lower that conversion rate and exchange the note for 80.94 shares
of
Series A-1 preferred stock. In November 2006, the Noteholders consented
to
the amended conversion rate and the Notes have been cancelled.
Also in
March 2004, the Company entered into a convertible loan in the
amount of
$50,000. Under the terms of this agreement, the loan bears interest
at 1%
per month and is convertible upon the option of the note holder
into
135,135 shares of our common stock and warrants to purchase 135,135
shares
of our common stock at an exercisable price of $0.37 per share.
All such
warrants expire three years from the date of grant. As part of
the
recapitalization plan, the Company has offered to lower that conversion
rate and exchange the note for 19.23 shares of Series A-1 preferred
stock.
In November 2006, the Noteholder consented to the amended conversion
rate
and the Note has been
cancelled.
|
F-17
|
(e)
|
The
Company entered into convertible promissory notes with Anthony
Pizi, the
Company’s Chief Information Officer and Mark and Carolyn Landis, who are
related by marriage to Anthony Pizi, and Mr. Landis is the Company’s
Chairman of the Board of Directors.
|
In
June 2004, the Company entered into a convertible loan agreement with Mr. Pizi
in the amount of $100,000. Under the terms of the agreement, the loan bears
interest at 1% per month and is convertible upon the option of the note holder
into 270,270 shares of our common stock and warrants to purchase 270,270 shares
of our common stock exercisable at $0.37. The warrants expire in three years
from the date of grant. As part of the recapitalization plan, the Company has
offered to lower that conversion rate and exchange the note for 14 shares of
Series A-1 preferred stock. In November 2006, the Noteholder consented to the
amended conversion rate and the Note has been cancelled. In July 2004, the
Company entered into a convertible promissory note with Mr. Pizi in the face
amount of $112,000. Under the terms of the agreement, the loan bears interest
at
1% per month and is convertible upon the option of the note holder into 560,000
shares of our common stock and warrants to purchase 560,000 shares of our common
stock at $0.20 per share. As part of the recapitalization plan, the Company
has
offered to lower that conversion rate and exchange the note for 78.4 shares
of
Series A-1 preferred stock. In November 2006, the Noteholder consented to the
amended conversion rate and the Note has been cancelled. Also in July 2004,
Mr.
Pizi entered into a second convertible promissory note in the face amount of
$15,000 which bears interest at 1% per month and is convertible into 90,118
shares of our common stock and warrants to purchase 90,118 shares of our common
stock at $0.17 per share. All such warrants expire three years from the date
of
grant. As part of the recapitalization plan, the Company has offered to lower
that conversion rate and exchange the note for 12.62 shares of Series A-1
preferred stock. In November 2006, the Noteholder consented to the amended
conversion rate and the Note has been cancelled.
In
March 2004, the Company entered into a convertible loan agreement with Mark
and
Carolyn Landis, in the principal amount of $125,000. Under the terms of the
agreement, the loan bears interest at 1% per month and is convertible upon
the
option of the note holder into 446,429 shares of our common stock and warrants
to purchase 446,429 shares of our common stock exercisable at $0.28. The
warrants expire in three years from the date of grant. As part of the
recapitalization plan, the Company has offered to lower that conversion rate
and
exchange the note for 62.5 shares of Series A-1 preferred stock. In November
2006, the Noteholder consented to the amended conversion rate and the Note
has
been cancelled. In June 2004, we entered into a convertible loan agreement
with
Mark and Carolyn Landis, in the amount of $125,000. Under the terms of the
agreement, the loan bears interest at 1% per month and also is convertible
upon
the option of the note holder into 781,250 shares of our common stock and
warrants to purchase 781,250 shares of our common stock exercisable at $0.16.
The warrants expire in three years from the date of grant. As part of the
recapitalization plan, the Company has offered to lower that conversion rate
and
exchange the note for 113.64 shares of Series A-1 preferred stock. In November
2006, the Noteholder consented to the amended conversion rate and the Note
has
been cancelled. In October 2004, the Company entered into a convertible loan
agreement with Mark and Carolyn Landis in the amount of $100,000. Under the
terms of the agreement, the loan bears interest at 1% per month and is
convertible upon the option of the note holder into 1,000,000 shares of our
common stock and warrants to purchase 2,000,000 shares of the Company’s common
stock exercisable at $0.10. The warrants expire in three years. As part of
the
recapitalization plan, the Company has offered to lower that conversion rate
and
exchange the note for 400 shares of Series A-1 preferred stock. In November
2006, the Noteholder consented to the amended conversion rate and the Note
has
been cancelled. In November 2004, the Company entered into a convertible loan
agreement with Mark and Carolyn Landis in the amount of $150,000. Under the
terms of the agreement, the loan bears interest at 1% per month and is
convertible upon the option of the note holder into 1,875,000 shares of our
common stock and warrants to purchase 1,875,000 shares of the Company’s common
stock exercisable at $0.08. All such warrants expire three years from the date
of grant. As part of the recapitalization plan, the Company has offered to
lower
that conversion rate and exchange the note for 750 shares of Series A-1
preferred stock. In November 2006, the Noteholder consented to the amended
conversion rate and the Note has been cancelled.
F-18
NOTE
8. INCOME TAXES
A
reconciliation of expected income tax at the statutory federal rate with the
actual income tax provision is as follows for the years ended December 31 (in
thousands) :
|
2006
|
2005
|
2004
|
||||||||
|
Expected
income tax benefit at statutory rate (34%)
|
$
|
(1,019
|
)
|
$
|
(1,251
|
)
|
$
|
(3,319
|
)
|
|
|
State
taxes, net of federal tax benefit.
|
(180
|
)
|
(308
|
)
|
(219
|
)
|
||||
|
Effect
of foreign operations including withholding taxes
|
--
|
--
|
12
|
|||||||
|
Effect
of change in valuation allowance
|
1,073
|
1,537
|
3,357
|
|||||||
|
Non-deductible
expenses
|
126
|
22
|
169
|
|||||||
|
Total
|
$
|
--
|
$
|
--
|
$
|
--
|
||||
Significant
components of the net deferred tax asset (liability) at December 31 were as
follows:
|
2006
|
2005
|
||||||
|
Current
assets:
|
|||||||
|
Allowance
for doubtful accounts
|
$
|
34
|
$
|
4
|
|||
|
Accrued
expenses, non-tax deductible
|
279
|
145
|
|||||
|
Deferred
revenue
|
15
|
31
|
|||||
|
Noncurrent
assets:
|
|||||||
|
Loss
carryforwards
|
91,016
|
89,528
|
|||||
|
Depreciation
and amortization
|
5,931
|
6,746
|
|||||
|
97,275
|
96,454
|
||||||
|
Less:
valuation allowance
|
(97,275
|
)
|
(96,454
|
)
|
|||
|
|
$ | -- |
$
|
--
|
|||
At
December 31, 2006, the Company had net operating loss carryforwards of
approximately $227,539,000, which may be applied against future taxable income.
These carryforwards will expire at various times between 2006 and 2025. A
substantial portion of these carryforwards are restricted to future taxable
income of certain of the Company's subsidiaries or limited by Internal Revenue
Code Section 382. Thus, the utilization of these carryforwards cannot be
assured. Net operating loss carryforwards include tax deductions for the
disqualifying dispositions of incentive stock options. When the Company utilizes
the net operating loss related to these deductions, the tax benefit will be
reflected in additional paid-in capital and not as a reduction of tax expense.
The total amount of these deductions included in the net operating loss
carryforwards is $21,177,000.
The
undistributed earnings of certain foreign subsidiaries are not subject to
additional foreign income taxes nor considered to be subject to U.S. income
taxes unless remitted as dividends. The Company intends to reinvest such
undistributed earnings indefinitely; accordingly, no provision has been made
for
U.S. taxes on those earnings. The determination of the amount of the
unrecognized deferred tax liability related to the undistributed earnings is
not
practicable.
The
Company provided a full valuation allowance on the total amount of its deferred
tax assets at December 31, 2006 and 2005 since management does not believe
that it is more likely than not that these assets will be realized.
NOTE
9. STOCKHOLDERS’
EQUITY
Common
Stock:
As
part
of the recapitalization plan described in Note 2, the Company converted
outstanding convertible promissory notes, senior reorganization notes and
convertible bridge notes. Senior reorganization debt amounting to $2,309,000
was
cancelled and converted into 3,438,473 shares of the Company’s common stock. The
Company also converted $3,915,000 of Convertible Bridge Notes into 30,508,448
shares of Cicero common stock. These shares were issued in reliance upon the
F-19
exemption
from registration under Rule 506 of Regulation D and on the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.
In
January 2004, the Company completed a common stock financing round wherein
it
raised $1,247,000 of capital from several new investors as well as certain
investors of Critical Mass Mail, Inc. The Company sold 3,369,192 shares of
common stock at a price of $0.37 per share. As part of the financing, the
Company has also issued warrants to purchase 3,369,192 shares of the Company’s
common stock at an exercise price of $0.37. The warrants expire three years
from
the date of grant. These shares were issued in reliance upon the exemption
from
registration under Rule 506 of Regulation D and on the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.
Stock
Grants:
During
2006 and 2005, no stock awards were made to employees.
Stock
Options:
The
Company maintains two stock option plans, the 1995 and 1997 Stock Incentive
Plans, which permit the issuance of incentive and nonstatutory stock options,
stock appreciation rights, performance shares, and restricted and unrestricted
stock to employees, officers, directors, consultants, and advisors. In July
2003, stockholders approved a proposal to increase the number of shares reserved
within these plans to a combined total of 109,000 shares of common stock for
issuance upon the exercise of awards and provide that the term of each award
be
determined by the Board of Directors. In December 2005, the remaining options
under the 1995 Stock Incentive Plan expired. The Company also has a stock
incentive plan for outside directors and the Company has set aside 1,200 shares
of common stock for issuance under this plan.
Under
the terms of the Plans, the exercise price of the incentive stock options may
not be less than the fair market value of the stock on the date of the award
and
the options are exercisable for a period not to exceed ten years from date
of
grant. Stock appreciation rights entitle the recipients to receive the excess
of
the fair market value of the Company's stock on the exercise date, as determined
by the Board of Directors, over the fair market value on the date of grant.
Performance shares entitle recipients to acquire Company stock upon the
attainment of specific performance goals set by the Board of Directors.
Restricted stock entitles recipients to acquire Company stock subject to the
right of the Company to repurchase the shares in the event conditions specified
by the Board are not satisfied prior to the end of the restriction period.
The
Board may also grant unrestricted stock to participants at a cost not less
than
85% of fair market value on the date of sale. Options granted vest at varying
periods up to five years and expire in ten years.
F-20
Activity
for stock options issued under these plans for the fiscal years ending December
31, 2006, 2005 and 2004 was as follows:
|
Plan
Activity
|
Option
Price
Per
Share
|
Weighted
Average
Exercise
Price
|
||||||||
|
Balance
at December 31, 2003
|
56,259
|
20.00-3,931.00
|
243.00
|
|||||||
|
Granted
|
31,392
|
12.00
-39.00
|
26.00
|
|||||||
|
Exercised
|
(5,192
|
)
|
8.00
-37.00
|
17.00
|
||||||
|
Forfeited
|
(7,572
|
)
|
22.00-3,788.00
|
812.00
|
||||||
|
Balance
at December 31, 2004
|
74,887
|
12.00-3,931.00
|
111.00
|
|||||||
|
Granted
|
2,529
|
7.00
- 12.00
|
9.00
|
|||||||
|
Exercised
|
(2,529
|
)
|
7.00
- 12.00
|
9.00
|
||||||
|
Forfeited
|
(15,877
|
)
|
22.00-3,931.00
|
75.00
|
||||||
|
Balance
at December 31, 2005
|
59,010
|
12.00-3,931.00
|
124.00
|
|||||||
|
Forfeited
|
(13,695
|
)
|
22.00-3,931.00
|
137.14
|
||||||
|
Balance
at December 31, 2006
|
45,315
|
12.00-3,931.00
|
120.61
|
|||||||
There
were no option grants issued during 2006. The weighted average grant date fair
value of options issued during the years ended December 31, 2005, and 2004
was
equal to $9.00 and $26.00 per share, respectively. There were no option grants
issued below fair market value during 2005 and 2004.
At
December 31, 2006, 2005, and 2004, options to purchase approximately 45,315,
5,237, and 4,775 shares of common stock were exercisable, respectively, pursuant
to the plans at prices ranging from $12.00 to $3,931.25. The following table
summarizes information about stock options outstanding at December 31, 2006:
|
EXERCISE
PRICE
|
NUMBER
OUTSTANDING/
EXERCISABLE
|
REMAINING
CONTRACTUAL
LIFE
FOR OPTIONS
OUTSTANDING
|
WEIGHTED
AVERAGE
EXERCISE
PRICE
|
|||||||
|
$
12.00 - 393.12
|
39,680
|
6.4
|
$
|
48.03
|
||||||
|
393.13
-786.25
|
5,350
|
4.1
|
586.35
|
|||||||
|
786.26-1,179.37
|
165
|
3.0
|
944.41
|
|||||||
|
1,179.38-1,572.50
|
50
|
1.0
|
1,473.00
|
|||||||
|
1,572.60-1,965.62
|
40
|
3.6
|
1,881.25
|
|||||||
|
1,965.62-3,538.12
|
0
|
0.0
|
0.00
|
|||||||
|
3,538.13-3,931.25
|
30
|
3.2
|
3,931.25
|
|||||||
|
45,315
|
6.1
|
$
|
120.61
|
|||||||
Preferred
Stock:
As
part
of the recapitalization plan approved by shareholders in November 2006, the
Company offered to exchange its existing Series A-3, B-3, C and D preferred
shares at reduced conversion rates in exchange for shares of a new Series A-1
preferred stock in Cicero Inc. This proposal also required approved by existing
preferred shareholders as a class. The new conversion prices with respect to
the
Series A-3, B-3 and D preferred stock were negotiated with the holders of each
series based upon such factors as the current conversion price in relation
to
the market, the dollar amount represented by such series and, waiver of
anti-dilution, liquidation preferences, seniority and other senior rights.
The
conversion price for the Series C preferred stock was determined in relation
to
the conversion price for the Series D preferred stock. The Board of Directors
determined the new conversion price of each series of Level 8 preferred stock
after discussion and review of those rights,
F-21
ranks
and privileges that were being waived by the present holders of preferred stock.
Among those rights being waived are anti-dilution protection, liquidation
preferences and seniority.
The
holders of the Series A-1 preferred stock shall have the rights and preferences
set forth in the Certificate of Designations filed with the Secretary of State
of the State of Delaware upon the approval of the Recapitalization. The rights
and interests of the Series A-1 preferred stock of the Company will be
substantially similar to the rights interests of each of the series of Level
8
preferred stock other than for (i) anti-dilution protections that have been
permanently waived and (ii) certain voting, redemption and other rights that
holders of Series A-1 preferred stock will not be entitled to. All shares of
Series A-1 preferred stock will have a liquidation preference pari
passu
with all other Series A-1 preferred stock.
The
Series A-1 preferred stock is convertible at any time at the option of the
holder into an initial conversion ratio of 1,000 shares of Common Stock for
each
share of Series A-1 preferred stock. The initial conversion ratio shall be
adjusted in the event of any stock splits, stock dividends and other
recapitalizations. The Series A-1 preferred stock is also convertible on a
automatic basis in the event that (i) the Company closes on an additional
$5,000,000 equity financing from strategic or institutional investors, or (ii)
the Company has four consecutive quarters of positive cash flow as reflected
on
the Company’s financial statements prepared in accordance with generally
accepted accounting principals (“GAAP”) and filed with the Commission. The
holders of Series A-1 preferred stock are entitled to receive equivalent
dividends on an as-converted basis whenever the Company declares a dividend
on
its Common Stock, other than dividends payable in shares of Common Stock. The
holders of the Series A-1 preferred stock are entitled to a liquidation
preference of $500 per share of Series A-1 preferred stock upon the liquidation
of the Company. The Series A-1 preferred stock is not redeemable.
The
holders of Series A-1 preferred stock also possess the following voting rights.
Each share of Series A-1 preferred stock shall represent that number of votes
equal to the number of shares of Common Stock issuable upon conversion of a
share of Series A-1 preferred stock. The holders of Series A-1 preferred stock
and the holders of Common Stock shall vote together as a class on all matters
except: (i) regarding the election of the Board of Directors of the Company
(as set forth below); (ii) as required by law; or (iii) regarding certain
corporate actions to be taken by the Company (as set forth below).
The
approval of at least two-thirds of the holders of Series A-1 preferred stock
voting together as a class, shall be required in order for the Company to:
(i)
merge or sell all or substantially all of its assets or to recapitalize or
reorganize; (ii) authorize the issuance of any equity security having any right,
preference or priority superior to or on parity with the Series A-1 preferred
stock; (iii) redeem, repurchase or acquire indirectly or directly any of its
equity securities, or to pay any dividends on the Company’s equity securities;
(iv) amend or repeal any provisions of its certificate of incorporation or
bylaws that would adversely affect the rights, preferences or privileges of
the
Series A-1 preferred stock; (v) effectuate a significant change in the principal
business of the Company as conducted at the effective time of the
Recapitalization; (vi) make any loan or advance to any entity other than in
the
ordinary course of business unless such entity is wholly owned by the Company;
(vii) make any loan or advance to any person, including any employees or
directors of the Company or any subsidiary, except in the ordinary course of
business or pursuant to an approved employee stock or option plan; and (viii)
guarantee, directly or indirectly any indebtedness or obligations, except for
trade accounts of any subsidiary arising in the ordinary course of business.
In
addition, the unanimous vote of the board of directors is required for any
liquidation, dissolution, recapitalization or reorganization of the Company.
The
voting rights of the holders of Series A-1 preferred stock set forth in this
paragraph shall be terminated immediately upon the closing by the Company of
at
least an additional $5,000,000 equity financing from strategic or institutional
investors.
In
addition to the voting rights described above, the holders of a majority of
the
shares of Series A-1 preferred stock are entitled to appoint two observers
to
the Company’s Board of Directors who shall be entitled to receive all
information received by members of the Board of Directors, and shall attend
and
participate without a vote at all meetings of the Company’s Board of Directors
and any committees thereof. At the option of a majority of the holders of Series
A-1 preferred stock, such holders may elect to temporarily or permanently
exchange their board observer rights for two seats on the Company’s Board of
Directors, each having all voting and other rights attendant to any member
of
the Company’s Board of Directors. As part of the Recapitalization, the right of
the holders of Series A-1 preferred stock to elect a majority of the voting
members of the Company’s Board of Directors shall be terminated.
As
a result of the reduced conversion prices the Company exchanged all of the
Series A-3, B-3, C and D preferred stock into 172 shares of Series A-1 preferred
stock and using Black-Scholes, we calculated a beneficial conversion in the
exchange of the Series A-3, B-3, C and D shares for Series A-1 preferred stock.
The beneficial conversion of $21,000 is treated as a deemed dividend in the
Statement of Operations for the year ended December 31, 2006.
F-22
As
part of the recapitalization plan, Noteholders of $992,000 of Convertible
Promissory Notes were offered reduced conversion prices to convert their notes
into shares of the Company’s new series A-1 preferred stock. All Noteholders
have agreed to convert their notes into shares of Series A-1 preferred stock.
The Company has cancelled these notes and issued 1,591 shares of its Series
A-1
preferred stock. In accordance with EITF 98-5 and specifically paragraph 8,
the
Company has utilized the Black-Scholes formula to determine the fair value
of
the stock received. The Company has calculated the fair value of the stock
received to be $484,000 resulting in a beneficial conversion of $508,000. Since
this beneficial conversion is immediately recognizable by the holders, the
Company has fully amortized this conversion and recorded an accretion to
preferred stock in the Statement of Operations for the year ended December
31,
2006.
During
2005 and 2004, there were 456 shares of preferred stock converted into 1,351,112
shares of the Company's common stock and 4,686 shares of preferred stock
converted into 7,037,451 shares of the Company’s common stock, respectively.
There were 1,571 shares of the Series A3 Preferred Stock and 30,000 shares
of
Series B3 Preferred Stock, 991 shares of Series C Preferred Stock, and 1,061
shares of Series D Preferred Stock outstanding at December 31,
2005.
Stock
Warrants:
The
Company values warrants based on the Black-Scholes pricing model. Warrants
granted in 2006, 2005, and 2004 were valued using the following
assumptions:
|
Expected
Life
in Years
|
Expected
Volatility
|
Risk
Free
Interest
Rate
|
Expected
Dividend
|
Fair
Value of
Common
Stock
|
||||||||||||
|
2002-2003
Financing Warrants
|
5
|
97
|
%
|
2
|
%
|
None
|
$
|
0.40
|
||||||||
|
Preferred
Series C Warrants
|
5
|
117
|
%
|
3
|
%
|
None
|
$
|
0.38
|
||||||||
|
Preferred
Series D-1 Warrants
|
5
|
117
|
%
|
3
|
%
|
None
|
$
|
0.07
|
||||||||
|
Preferred
Series D-2 Warrants
|
5
|
102
|
%
|
3
|
%
|
None
|
$
|
0.20
|
||||||||
|
Private
Placement - January 2004
|
3
|
101
|
%
|
3
|
%
|
None
|
$
|
0.36
|
||||||||
|
Early
Adopter Warrants
|
4
|
104
|
%
|
4
|
%
|
None
|
$
|
1.50
|
||||||||
Increase
in Capital Stock:
In
November 2006, the stockholders approved a proposal to amend the Amended and
Restated Certificate of Incorporation to increase the aggregate number of shares
of Common Stock that the Company is authorized to issue from 85,000,000 to
215,000,000.
NOTE
10. EMPLOYEE
BENEFIT PLANS
The
Company sponsors one defined contribution plan for its U.S. employees - the
Level 8 Systems 401(k). Under the terms of the Plan, the Company provides a
50%
matching contribution up to 6% of an employee’s salary. Participants must be
eligible Company plan participants and employed at December 31 of each calendar
year to be eligible for employer matching contributions. Matching contributions
to the Plan included in the Consolidated Statement of Operations totaled $0,
$30,000 and $54,000, for the years ended December 31, 2006, 2005, and 2004,
respectively. On December 1, 2005 the company suspended further contributions
to
the defined contribution plan.
The
Company also had employee benefit plans for each of its foreign subsidiaries,
as
mandated by each country's laws and regulations. The Company no longer maintains
foreign subsidiaries.
F-23
NOTE
11. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT
RISK
In
2006, four customers accounted for 50.0%, 18.7%, 13.3% and 10.0% of operating
revenue. In 2005, two customers accounted for 52.4% and 13.0% of operating
revenues. In 2004, five customers accounted for 24.6%, 22.4%, 13.5%, 11.8%
and
11.4% of operating revenues.
NOTE
12. FOREIGN
CURRENCIES
The
Company’s net foreign currency transaction losses/ (gains) were $14,000,
$(23,000), and $13,000 for the years ended 2006, 2005, and 2004,
respectively.
NOTE
13. SEGMENT
INFORMATION AND GEOGRAPHIC INFORMATION
The
Company makes operating decisions and assesses performance of the Company’s
operations based on the following reportable segments: (1) Desktop Integration
segment, and (2) Messaging and Application Engineering segment. The Company
previously had three reportable segments but the Company has reported the
Systems Integration segment as discontinued operations.
The
principal product in the Desktop Integration segment is Cicero®. Cicero® is a
business integration software product that maximizes end-user productivity,
streamlines business operations and integrates disparate systems and
applications.
The
products that comprise the Messaging and Application Engineering segment are
Ensuredmail, Geneva Integration Broker, CTRC and Star/SQL.
Segment
data includes a charge allocating all corporate headquarters costs to each
of
its operating segments based on each segment's proportionate share of expenses.
The Company evaluates the performance of its segments and allocates resources
to
them based on earnings (loss) before interest and other income/(expense), taxes,
in-process research and development, and restructuring.
The
table below presents information about reported segments for the twelve months
ended December 31, 2006, 2005 and 2004 (in thousands):
|
For
the year ended December 31,
|
||||||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
Desktop
Integration
|
Messaging
and Application Engineering
|
Total
|
Desktop
Integration
|
Messaging
and Application Engineering
|
Total
|
Desktop
Integration
|
Messaging
and Application Engineering
|
Total
|
||||||||||||||||||||
|
Total
revenue
|
$
|
965
|
$
|
7
|
$
|
972
|
$
|
760
|
$
|
25
|
$
|
785
|
$
|
707
|
$
|
68
|
$
|
775
|
||||||||||
|
Total
cost of revenue
|
767
|
--
|
767
|
1,188
|
--
|
1,188
|
5,662
|
213
|
5,875
|
|||||||||||||||||||
|
Gross
margin (loss)
|
198
|
7
|
205
|
(428
|
)
|
25
|
(403
|
)
|
(4,955
|
)
|
(145
|
)
|
(5,100
|
)
|
||||||||||||||
|
Total
operating expenses
|
1,964
|
121
|
2,085
|
2,536
|
119
|
2,655
|
3,348
|
373
|
3,721
|
|||||||||||||||||||
|
Segment
profitability (loss)
|
$
|
(1,766
|
)
|
$
|
(114
|
)
|
$
|
(1,880
|
)
|
$
|
(2,964
|
)
|
$
|
(94
|
)
|
$
|
(3,058
|
)
|
$
|
(8,303
|
)
|
$
|
(518
|
)
|
$
|
(8,821
|
)
|
|
F-24
A
reconciliation of segment operating expenses to total operating expense follows
(numbers are in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Segment
operating expenses
|
$
|
2,085
|
$
|
2,655
|
$
|
3,721
|
||||
|
Write-off
of intangible assets
|
--
|
--
|
587
|
|||||||
|
(Gain)
on disposal of assets
|
(24
|
)
|
--
|
(5
|
)
|
|||||
|
Total
operating expenses
|
$
|
2,061
|
$
|
2,655
|
$
|
4,303
|
||||
A
reconciliation of total segment profitability to net loss for the fiscal years
ended December 31(in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Total
segment profitability (loss)
|
$
|
(1,880
|
)
|
$
|
(3,058
|
)
|
$
|
(8,821
|
)
|
|
|
Write-off
of intangible assets
|
--
|
--
|
(587
|
)
|
||||||
|
Gain/
on disposal of assets
|
24
|
--
|
5
|
|||||||
|
Interest
and other income/(expense), net
|
(1,141
|
)
|
(623
|
)
|
(328
|
)
|
||||
|
Net
loss before provision for income taxes
|
$
|
(2,997
|
)
|
$
|
(3,681
|
)
|
$
|
(9,731
|
)
|
|
The
following table presents a summary of long-lived assets by segment as of
December 31 (in thousands):
|
2006
|
2005
|
||||||
|
Desktop
Integration
|
$
|
15
|
$
|
10
|
|||
|
Messaging/Application
Engineering
|
-
|
-
|
|||||
|
Total
assets
|
$
|
15
|
$
|
10
|
|||
The
following table presents a summary of revenue by geographic region for the
years
ended December 31(in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Denmark
|
$
|
-
|
$
|
-
|
$
|
7
|
||||
|
Italy
|
-
|
2
|
4
|
|||||||
|
United
Kingdom
|
-
|
-
|
1
|
|||||||
|
USA
|
972
|
783
|
762
|
|||||||
|
Other
|
-
|
-
|
1
|
|||||||
|
$
|
972
|
$
|
785
|
$
|
775
|
|||||
Presentation
of revenue by region is based on the country in which the customer is domiciled.
As of December 31, 2006, 2005 and 2004, all of the long-lived assets of the
Company are located in the United States.
NOTE
14. RELATED PARTY INFORMATION
Liraz
Systems Ltd., the Company’s former principal stockholder guarantees certain debt
obligations of the Company. In November 2006, the Company and Liraz agreed
to
extend the guarantee and with the approval of the lender, agreed to extend
the
maturity of the debt obligation until October 31, 2007. The Company issued
6,000,000 shares of common stock (pre reverse stock split) to Liraz in exchange
for this debt extension. In November 2005, the Company and Liraz agreed to
extend the guarantee and with the approval of the lender, agreed to extend
the
maturity of the debt obligation until October 30, 2006. The Company issued
2,400,000 shares of common stock and granted a warrant to purchase an additional
3,600,000 shares of our common stock at an exercise price of $0.002 per share
to
Liraz in exchange for this debt extension. In 2004, the Company
F-25
and
Liraz also agreed to extend the guarantee and maturity of the debt obligation
until November 2005. The Company agreed to issue Liraz 3,942,000 shares of
stock
for that extension.
During
2006, under an existing reseller agreement, the Company recognized $100,000
of
software revenue with Pilar Services, Inc. Pilar Services is presently owned
and
managed by Charles Porciello who is a member of our Board of Directors. As
of
December 31, 2006, the receivable was still outstanding and the Company has
reserved for possible doubtful accounts.
From
time to time during 2005 and 2004, the Company entered into short term notes
payable with Anthony Pizi, the Company’s former Chief Executive Officer and
current Chief Information Officer. The Notes bear interest at 1% per month
and
are unsecured. At December 31, 2006, the Company was indebted to Mr. Pizi in
the
amount of $9,000.
Convertible
Promissory Notes: Directors and executive officers made the following loans
to the Company for convertible promissory notes: In June 2004, the Company
entered into a convertible loan agreement with Mr. Pizi in the amount of
$100,000. Under the terms of the agreement, the loan bears interest at 1% per
month and is convertible upon the option of the note holder into 270,270 shares
of our common stock and warrants to purchase 270,270 shares of our common stock
exercisable at $0.37. The warrants expire in three years from the date of grant.
As part of the recapitalization plan, the Company has offered to lower that
conversion rate and exchange the note for 14 shares of Series A-1 preferred
stock. In November 2006, the Noteholder consented to the
amended conversion rate and the Note has been cancelled.
In
July
2004, the Company entered into a convertible promissory note with Mr. Pizi
in
the face amount of $112,000. Under the terms of the agreement, the loan bears
interest at 1% per month and is convertible upon the option of the note holder
into 560,000 shares of our common stock and warrants to purchase 560,000 shares
of our common stock at $0.20 per share. As part of the recapitalization plan,
the Company has offered to lower that conversion rate and exchange the note
for
78.4 shares of Series A-1 preferred stock. In November
2006, the Noteholder consented to the amended conversion rate and the Note
has
been cancelled. Also in July 2004, Mr. Pizi entered into a second convertible
promissory note in the face amount of $15,000 which bears interest at 1% per
month and is convertible into 90,118 shares of our common stock and warrants
to
purchase 90,118 shares of our common stock at $0.17 per share. All such warrants
expire three years from the date of grant. As part of the recapitalization
plan,
the Company has offered to lower that conversion rate and exchange the note
for
12.62 shares of Series A-1 preferred stock. In November 2006,
the Noteholder consented to the amended conversion rate and the Note has been
cancelled.
In
March
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Mark Landis in the amount of $125,000. Mr. Landis is the Company’s Chairman of
the Board and Mr. and Mrs. Landis are parents-in-law to Mr. Pizi, the Company’s
Chief Information Officer. Under the terms of the
agreement, the loan bears interest at 1% per month and is convertible upon
the
option of the note holder into 446,429 shares of our common stock and warrants
to purchase 446,429 shares of our common stock exercisable at $0.28. The
warrants expire in three years from the date of grant. As part of the
recapitalization plan, the Company has offered to lower that conversion rate
and
exchange the note for 62.5 shares of Series A-1 preferred
stock. In November 2006, the Noteholder consented to the
amended conversion rate and the Note has been cancelled.
In
June
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Landis in the amount of $125,000. Under the terms of the note, the loan bears
interest at 1% per month and is convertible into 781,250 shares of the Company’s
common stock and warrants to purchase 781,250 shares of Level 8 common stock
exercisable at $0.16 per share. The warrants expire in three years from the
date
of grant. As part of the recapitalization plan, the Company has offered to
lower
that conversion rate and exchange the note for 113.64 shares of Series A-1
preferred stock. In November 2006, the Noteholder consented to the amended
conversion rate and the Note has been cancelled.
In
October 2004, the Company entered into a convertible promissory note with Mr.
and Mrs. Landis in the amount of $100,000. Under the terms of the agreement,
the
loan bears interest at 1% per month and is convertible into 1,000,000 shares
of
our common stock and warrants to purchase 2,000,000 shares of the Company’s
common stock exercisable at $0.10 per share. The warrants expire in three years.
As part of the recapitalization plan, the Company has offered to lower that
conversion rate and exchange the note for 400 shares of Series A-1 preferred
stock. In November 2006, the Noteholder consented to the
amended conversion rate and the Note has been cancelled.
In
November 2004, the Company entered into a convertible promissory note with
Mark
and Carolyn Landis, in the amount of $150,000. Under the terms of the agreement,
the loan bears interest at 1% per month and is convertible into 1,875,000 shares
F-26
of
our
common stock and warrants to purchase 1,875,000 shares of the Company’s common
stock exercisable at $0.08 per share. All such warrants expire three years
from
the date of grant. As part of the recapitalization plan, the Company has offered
to lower that conversion rate and exchange the note for 750 shares of Series
A-1
preferred stock. In November 2006, the Noteholder consented to the amended
conversion rate and the Note has been cancelled.
In
June
2004, the Company entered into a convertible promissory note with Fredric Mack,
a former director of the Company, in the amount of $125,000. Under the terms
of
the note, the loan bears interest at 1% per month, and is convertible into
390,625 shares of the Company’s common stock and warrants to purchase 390,625
shares of the Company’s common stock exercisable at $0.32 per share. As part of
the recapitalization plan, the Company has offered to lower that conversion
rate
and exchange the note for 54.69 shares of Series A-1 preferred stock. In
November 2006, the Noteholder consented to the amended conversion rate and
the
Note has been cancelled.
In
April
2005, the Company entered into a convertible promissory note with Bruce Miller,
a director of the Company, in the amount of $30,000. Under the terms of the
note, the loan bears interest at 1% per month and is convertible into 428,571
shares of the Company’s common stock. As part of the recapitalization plan, the
Company has offered to lower that conversion rate and exchange the note for
60
shares of Series A-1 preferred stock. In November 2006,
the Noteholder consented to the amended conversion rate and the Note has been
cancelled.
In
July
2004, the Company entered into a convertible promissory note with Nicholas
Hatalski, who until July 22, 2005 (during the period when the terms of the
recapitalization merger were being negotiated and at the time of approval of
the
recapitalization merger by our board of directors), was a director of the
Company, in the amount of $25,000. Under the terms of the note, the loan bears
interest at 1% per month and is convertible into 78,125 shares of the Company’s
common stock and warrants to purchase 78,125 shares of the Company’s common
stock exercisable at $0.32 per share. As part of the recapitalization plan,
the
Company has offered to lower that conversion rate and exchange the note for
10.94 shares of Series A-1 preferred stock. In November
2006, the Noteholder consented to the amended conversion rate and the Note
has
been cancelled.
All
of
such warrants expire three years from date of grant.
Senior
Reorganization Notes. From March 2004 to April 2005, directors and
executive officers made the following loans to us for Senior Reorganization
Notes: Mr. Pizi held $423,333 of Senior Reorganization Notes, which were
converted into warrants to purchase an additional 571,659 shares of Cicero
common stock at a purchase price of $0.20 per
share.
Mr.
Landis held $327,860 of Senior Reorganization Notes, which were converted into
warrants to purchase an additional 442,345 shares of Cicero common stock at
an
exercise price of $0.20 per share.
Mr.
Mack
held, together with his affiliates, $88,122 of Senior Reorganization Notes,
which were converted into warrants to purchase an additional 112,205 shares
of
Cicero common stock at a purchase price of $0.20 per share.
Mr.
Miller held, together with his affiliates, $77,706 of Senior Reorganization
Notes, which were converted into warrants to purchase an additional 114,597
shares of Cicero common stock at a purchase price of $0.20.
Mr.
Atherton held, together with his affiliates, $20,000 of Senior Reorganization
Notes which were converted into warrants to purchase an additional 289,856
shares of Cicero common stock at a purchase price of $0.20.
Mr.
Broderick, Chief Executive Officer and Chief Financial Officer of the Company,
held $2,300 of Senior Reorganization Notes, which were converted into warrants
to purchase 3,222 shares of the Cicero Inc. common stock at a purchase price
of
$0.20 per share, and options to purchase 12,609 shares of common stock under
the
Company’s stock option plan that will convert into options to purchase Cicero
common stock.
Such
warrants are only issuable upon approval of the recapitalization merger, and
were automatically exercised in connection with the consummation of the
recapitalization plan.
Convertible
Bridge Notes. From July 2005 to December 2006, directors and executive
officers made the following loans to the Company for Convertible Bridge Notes:
F-27
Mr.
Pizi
held $85,000 of Convertible Bridge Notes which bore interest at 10% and matured
on September 15, 2005. These notes automatically converted into 680,000 shares
of Cicero common stock upon approval of the recapitalization plan by
stockholders.
Mr.
Landis held $395,000 of Convertible Bridge Notes which bore interest at 10%
and
matured on various dates in 2005 and 2006. These notes automatically converted
into 3,160,000 shares of Cicero common stock upon approval of the
recapitalization plan by stockholders.
Mr.
Mack
held, together with his affiliates, $114,000 of Convertible Bridge Notes which
bear interest at 10% and matured on various dates in 2005 and 2006. These notes
automatically converted into 897,564 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
Mr.
Miller held, together with his affiliates, $120,000 of Convertible Bridge Notes
which bear interest at 10% and matured on various dates in 2005 and 2006. These
notes automatically converted into 947,273 shares of Cicero common stock upon
approval of the recapitalization plan by stockholders.
Mr.
Bruce
Hasenyager, a member of our Board of Directors, held $4,061 of Convertible
Bridge Notes which bear interest at 10% and matured on September 15, 2005.
These
notes automatically converted into 32,485 shares of Cicero common stock upon
approval of the recapitalization plan by stockholders.
Mr.
Bruce
Percelay, a member of our Board of Directors, held $130,000 of Convertible
Bridge Notes which bear interest at 10% and matured on various dates in 2005
and
2006. These notes automatically converted into 1,027,273 shares of Cicero common
stock upon approval of the recapitalization plan by stockholders.
Mr.
John W. Atherton, a member of our Board of Directors, held $15,000 of
convertible Bridge Notes which bear interest at 10% and matured during 2006.
These notes automatically converted into 120,000 shares of Cicero common stock
upon approval of the recapitalization plan by stockholders.
Mr.
Charles Porciello, a member of our Board of Directors, held $10,000 of
Convertible Bridge Notes which bear interest at 10% and matured during 2006.
These notes automatically converted into 80,000 shares of Cicero common stock
upon approval of the recapitalization plan by stockholders.
NOTE
15. LEASE
COMMITMENTS
The
Company leases certain facilities and equipment under various operating leases.
Future minimum lease commitments on operating leases that have initial or
remaining non-cancelable lease terms in excess of one year as of December 31,
2006 consisted of only one lease as follows (in thousands):
|
Lease
Commitments
|
||||
|
2007
|
$
|
59
|
||
|
2008
|
6
|
|||
|
$
|
65
|
|||
Rent
expense for the years ended December 31, 2006, 2005 and 2004 was $60,000,
$122,000, and $197,000, respectively. As of December 31, 2006, 2005 and
2004, the Company had no sublease arrangements.
NOTE
16. CONTINGENCIES
Various
lawsuits and claims have been brought against us in the normal course of our
business. In January 2003, an action was brought against us in the Circuit
Court
of Loudon County, Virginia, for a breach of a real estate lease. The case was
settled in August 2003. Under the terms of the settlement agreement, we agreed
to assign a note receivable with recourse equal to the unpaid portion of the
note should the note obligor default on future payments. The unpaid balance
of
the note was $545,000, of which the current unpaid principal portion is
approximately $123,000 and it matures in December 2007. At the maturity of
the
Note, the Company will be liable for approximately $31,000 which we have
recognized in our non current debt.
F-28
In
October 2003, we were served with a summons and complaint in Superior Court
of
North Carolina regarding unpaid invoices for services rendered by one of our
subcontractors. The amount in dispute was approximately $200,000 and is included
in accounts payable. Subsequent to March 31, 2004, we settled this litigation.
Under the terms of the settlement agreement, we agreed to pay a total of
$189,000 plus interest over a 19-month period ending November 15, 2005. The
Company is in the process of negotiating a series of payments for the remaining
liability of approximately $80,000.
In
March 2004, we were served with a summons and complaint in Superior Court of
North Carolina regarding a security deposit for a sublease in Virginia. The
amount in dispute is approximately $247,000. In October 2004, we reached a
settlement agreement wherein we agreed to pay $160,000 over a 36-month period
ending October 2007.
In
August 2004, we were notified that we were in default under an existing lease
agreement for office facilities in Princeton, New Jersey. The amount of the
default is approximately $65,000. Under the terms of the lease agreement, we
may
be liable for future rents should the space remain vacant. We have reached
a
settlement agreement with the landlord which calls for a total payment of
$200,000 over a 36-month period ending October 2007.
In
October 2005, we were notified that Critical Mass Mail, Inc. had filed a claim
against us in the amount of $45,000 for failure to pay certain liabilities
under
an Asset Purchase Agreement dated January 9, 2004. We in turn filed a counter
claim that Critical Mass Mail, Inc. failed to deliver certain assets and other
documents under the same Asset Purchase Agreement. We had already reserved
the
potential liability under this action as part of the asset purchase accounting.
In February, 2006, Critical Mass Mail amended their complaint and is seeking
damages of approximately $600,000 for our failure to timely register the
underlying securities issued in the Asset Purchase Agreement. In November 2006,
we negotiated a settlement with Critical Mass Mail that provides for monthly
payments of the amounts already accrued. In December 2006 we settled the amended
complaint and agreed to issue $50,000 worth of the Company’s common stock. The
Company has recorded stock compensation expense as of December 31, 2006 in
this
amount.
Under
the indemnification clause of the Company’s standard reseller agreements and
software license agreements, the Company agrees to defend the reseller/licensee
against third party claims asserting infringement by the Company’s products of
certain intellectual property rights, which may include patents, copyrights,
trademarks or trade secrets, and to pay any judgments entered on such claims
against the reseller/licensee.
NOTE
17. SELECTED QUARTERLY FINANCIAL DATA
(UNAUDITED)
|
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||
|
(In
thousands, except per share data)
|
|||||||||||||
|
2006:
|
|||||||||||||
|
Net
revenues
|
$
|
281
|
$
|
320
|
$
|
248
|
$
|
123
|
|||||
|
Gross
margin/(loss)
|
75
|
114
|
60
|
(44
|
)
|
||||||||
|
Net
loss
|
(576
|
)
|
(515
|
)
|
(647
|
)
|
(1,259
|
)
|
|||||
|
Net
loss/share -basic and diluted
|
$
|
(1.20
|
)
|
$
|
(1.07
|
)
|
$
|
(1.35
|
)
|
$
|
(0.25
|
)
|
|
|
2005:
|
|||||||||||||
|
Net
revenues
|
$
|
153
|
$
|
461
|
$
|
84
|
$
|
87
|
|||||
|
Gross
margin/(loss)
|
(179
|
)
|
106
|
(201
|
)
|
(129
|
)
|
||||||
|
Net
loss
|
(1,031
|
)
|
(738
|
)
|
(943
|
)
|
(969
|
)
|
|||||
|
Net
loss/share -basic and diluted
|
$
|
(2.37
|
)
|
$
|
(1.70
|
)
|
$
|
(2.12
|
)
|
$
|
(2.08
|
)
|
|
NOTE
18. SUBSEQUENT
EVENTS
In
February 2007, the Company raised a total of $500,000 from a private sale of
its
common stock. Under the terms of the sale, the Company issued 3,723,008 shares
of common stock to a consortium of investors. These
securities were issued under the exemption offered by Rule 506 of Regulation
D
under Section 4(2) of the Securities Act of 1933.
F-29