Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (the “Act”), may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other then the payment by the registrant of expense incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
Certain legal matters in connection with the shares of common stock offered by this prospectus have been passed on for us by Golenbock Eiseman Assor Bell & Peskoe LLP, New York, New York.
The financial statements for the years ended December 31, 2007 and 2006 have been audited by Margolis & Company P.C., independent auditors, as stated in their reports appearing herein (which reports express an unqualified opinion and include an explanatory paragraph referring to the Company’s ability to continue as a going concern), and are included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.
We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You can receive copies of such reports, proxy and information statements, and other information, at prescribed rates, from the Securities and Exchange Commission by addressing written requests to the Public Reference Section of the Securities and Exchange Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. The Securities and Exchange Commission also maintains a Web site that contains reports, proxy and information statements and other information regarding registrants such as Cicero Inc. that file electronically with the Securities and Exchange Commission. The address of the Securities and Exchange Commission Web site is http://www.sec.gov. We have filed with the Securities and Exchange Commission a Registration Statement on Form S-1 to register the shares that we will issue in this offering. This prospectus is a part of the Registration Statement. This prospectus does not include all of the information contained in the Registration Statement. For further information about us and the securities offered in this prospectus, you should review the Registration Statement. You can inspect or copy the Registration Statement, at prescribed rates, at the Securities and Exchange Commission’s public reference facilities at the addresses listed above.
Report of Independent Registered Public Accounting Firm | | F-2 |
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Consolidated Financial Statements (audited): | | |
| | |
Consolidated Balance Sheets as of December 31, 2007 and 2006 | | F-3 |
Consolidated Statements of Operations for the years ended December 31, 2007, 2006, and 2005 | | F-4 |
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2007, 2006, and 2005 | | F-5 |
Consolidated Statements of Comprehensive Loss for the years ended December 31, 2007, 2006, and 2005 | | F-6 |
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006, and 2005 | | F-7 |
Notes to Consolidated Financial Statements | | F-9 |
| | |
| | |
Consolidated Financial Statements (unaudited): | | |
| | |
Consolidated Balance Sheets as of March 31,September 30, 2008 and December 31, 2007 | | F-29F-27 |
Consolidated Statements of Operations for the three and nine months ended March 31,September 30, 2008 and 2007 | | F-30F-28 |
Consolidated Statements of Cash Flows for the threenine months ended March 31,September 30, 2008 and 2007 | | F-31F-29 |
Consolidated Statements of Comprehensive Loss for the three and nine months ended March 31,September 30, 2008 and 2007 | | F-32F-30 |
Notes to Consolidated Financial Statements | | F-33F-31 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Cicero Inc.
Cary, North Carolina
We have audited the accompanying consolidated balance sheets of Cicero Inc. and subsidiaries (the "Company") as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' equity (deficit), comprehensive loss and cash flows for each of the years in the three-year period ended December 31, 2007. Cicero Inc.’s management is responsible for these financial statements. 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, 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 10, 2008
CICERO INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
| | December 31, 2007 | | | December 31, 2006 | |
ASSETS | | | | | | |
Current assets: | | | | | | |
Cash and cash equivalents | | $ | 250 | | | $ | 310 | |
Assets of operations to be abandoned | | | 79 | | | | 80 | |
Trade accounts receivable, net | | | 692 | | | | 170 | |
Prepaid expenses and other current assets | | | 208 | | | | 22 | |
Total current assets | | | 1,229 | | | | 582 | |
Property and equipment, net | | | 22 | | | | 15 | |
Total assets | | $ | 1,251 | | | $ | 597 | |
LIABILITIES AND STOCKHOLDERS' DEFICIT | | | | | | | | |
Current liabilities: | | | | | | | | |
Short-term debt (Note 5) | | $ | 1,235 | | | $ | 2,899 | |
Accounts payable | | | 2,489 | | | | 2,360 | |
Accrued expenses: | | | | | | | | |
Salaries, wages, and related items | | | 1,002 | | | | 1,012 | |
Other | | | 2,072 | | | | 1,732 | |
Liabilities of operations to be abandoned | | | 455 | | | | 435 | |
Deferred revenue | | | 108 | | | | 38 | |
Total current liabilities | | | 7,361 | | | | 8,476 | |
Long-term debt (Note 6) | | | 1,323 | | | | 33 | |
Total liabilities | | | 8,684 | | | | 8,509 | |
Commitments and contingencies (Notes 14 and 15) | | | | | | | | |
Stockholders' deficit: | | | | | | | | |
Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized Series A-1 – 1,603.6 shares issued and outstanding at December 31, 2007, $500 per share liquidation preference (aggregate liquidation value of $802) and 1,763.5 shares issued and outstanding at December 31, 2006, $500 per share liquidation preference (aggregate liquidation value of $880) | | | -- | | | | -- | |
Common stock, $0.001 par value, 215,000,000 shares authorized at December 31, 2007 and 2006, respectively; 43,805,508 and 35,182,406 issued and outstanding at December 31, 2007 and 2006, respectively (Note 2) | | | 44 | | | | 35 | |
Additional paid-in-capital | | | 228,858 | | | | 226,407 | |
| | | | | | | | |
Accumulated deficit | | | (236,320 | ) | | | (234,345 | ) |
Accumulated other comprehensive loss | | | (15 | ) | | | (9 | ) |
Total stockholders' deficit | | | (7,433 | ) | | | (7,912 | ) |
Total liabilities and stockholders' deficit | | $ | 1,251 | | | $ | 597 | |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
| | Years Ended December 31, | |
| | 2007 | | | 2006 | | | 2005 | |
Revenue: | | | | | | | | | |
Software | | $ | 501 | | | $ | 208 | | | $ | 407 | |
Maintenance | | | 300 | | | | 120 | | | | 147 | |
Services | | | 1,007 | | | | 644 | | | | 231 | |
Total operating revenue | | | 1,808 | | | | 972 | | | | 785 | |
Cost of revenue: | | | | | | | | | | | | |
Software | | | 19 | | | | 9 | | | | 16 | |
Maintenance | | | 264 | | | | 212 | | | | 350 | |
Services | | | 654 | | | | 546 | | | | 822 | |
Total cost of revenue | | | 937 | | | | 767 | | | | 1,188 | |
Gross margin (loss) | | | 871 | | | | 205 | | | | (403 | ) |
Operating expenses: | | | | | | | | | | | | |
Sales and marketing | | | 786 | | | | 346 | | | | 627 | |
Research and product development | | | 569 | | | | 533 | | | | 891 | |
General and administrative | | | 1,356 | | | | 1,206 | | | | 1,137 | |
(Gain) on disposal of assets | | | - | | | | (24 | ) | | | - | |
Total operating expenses | | | 2,711 | | | | 2,061 | | | | 2,655 | |
Loss from operations | | | (1,840 | ) | | | (1,856 | ) | | | (3,058 | ) |
Other income (charges): | | | | | | | | | | | | |
Interest expense | | | (257 | ) | | | (853 | ) | | | (593 | ) |
Other | | | 122 | | | | (288 | ) | | | (30 | ) |
| | | (135 | ) | | | (1,141 | ) | | | (623 | ) |
| | | | | | | | | | | | |
Net loss | | $ | (1,975 | ) | | $ | (2,997 | ) | | $ | (3,681 | ) |
| | | | | | | | | | | | |
Accretion of preferred stock and deemed dividends | | | - | | | | 5,633 | | | | - | |
Net loss applicable to common stockholders | | $ | (1,975 | ) | | $ | (8,630 | ) | | $ | (3,681 | ) |
Loss per share: | | | | | | | | | | | | |
Net loss applicable to common stockholders - basic and diluted | | $ | (0.05 | ) | | $ | (0.25 | ) | | $ | (8.27 | ) |
| | | | | | | | | | | | |
Weighted average common shares outstanding - basic and diluted | | | 36,771 | | | | 35,182 | | | | 445 | |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
| | Common Stock | | | Preferred Stock | | | Additional Paid-in Capital | | | Accumulated (Deficit) | | | Accumulated Other Comprehensive Income (Loss) | | | Total | |
| | Shares | | | Amount | | | Shares | | | Amount | | | | | | | | | |
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 | | | | | | | | | | | | -- | |
Balance at December 31, 2005 as adjusted for stock split | | | 481 | | | | -- | | | | -- | | | | -- | | | | 210,642 | | | | (225,715 | ) | | | (3 | ) | | | (15,076 | ) |
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 | ) |
Shares issued for private placement | | | 5,892 | | | | 6 | | | | | | | | | | | | 1,034 | | | | | | | | | | | | 1,040 | |
Shares issued for litigation settlement | | | 25 | | | | | | | | | | | | | | | | 50 | | | | | | | | | | | | 50 | |
Conversion of preferred shares to common | | | 160 | | | | | | | | | | | | | | | | | | | | | | | | | | | | -- | |
Options issued as compensation | | | | | | | | | | | | | | | | | | | 650 | | | | | | | | | | | | 650 | |
Restricted shares issued as compensation | | | | | | | | | | | | | | | | | | | 36 | | | | | | | | | | | | 36 | |
Warrant issued | | | | | | | | | | | | | | | | | | | 34 | | | | | | | | | | | | 34 | |
Shares issued with refinancing of debt | | | 2,546 | | | | 3 | | | | | | | | | | | | 647 | | | | | | | | | | | | 650 | |
Foreign currency translation adjustment | | | | | | | | | | | | | | | | | | | | | | | | | | | (6 | ) | | | (6 | ) |
Net loss | | | | | | | | | | | | | | | | | | | | | | | (1,975 | ) | | | | | | | (1,975 | ) |
Balance at December 31, 2007 | | | 43,805 | | | $ | 44 | | | | 2 | | | | -- | | | $ | 228,858 | | | $ | (236,320 | ) | | $ | (15 | ) | | $ | (7,433 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
| | Years Ended December 31, | |
| | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Net loss | | $ | (1,975 | ) | | $ | (2,997 | ) | | $ | (3,681 | ) |
Other comprehensive income (loss), net of tax: | | | | | | | | | | | | |
Foreign currency translation adjustment | | | (6 | ) | | | (6 | ) | | | 5 | |
Comprehensive loss | | $ | (1,981 | ) | | $ | (3,003 | ) | | $ | (3,676 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| | Years Ended December 31, | |
| | 2007 | | | 2006 | | | 2005 | |
Cash flows from operating activities: | | | | | | | | | |
Net loss | | $ | (1,975 | ) | | $ | (2,997 | ) | | $ | (3,681 | ) |
Adjustments to reconcile net loss to net cash (used in) operating activities: | | | | | | | | | | | | |
Depreciation and amortization | | | 10 | | | | 12 | | | | 11 | |
Stock compensation expense | | | 720 | | | | 614 | | | | 149 | |
Provision (credit) for doubtful accounts | | | 50 | | | | 60 | | | | (12 | ) |
Gain on disposal of assets | | | -- | | | | 24 | | | | -- | |
Changes in assets and liabilities, net of assets acquired and liabilities assumed: | | | | | | | | | | | | |
Trade accounts receivable and related party receivables | | | (622 | ) | | | (212 | ) | | | 146 | |
Assets and liabilities of operations to be abandoned | | | 21 | | | | (27 | ) | | | (29 | ) |
Prepaid expenses and other assets | | | (136 | ) | | | 31 | | | | 55 | |
Accounts payable and accrued expenses | | | 478 | | | | 311 | | | | 804 | |
Deferred revenue | | | 70 | | | | (40 | ) | | | (7 | ) |
Net cash (used in) operating activities | | | (1,384 | ) | | | (2,224 | ) | | | (2,564 | ) |
Cash flows from investing activities: | | | | | | | | | | | | |
Purchases of property and equipment | | | (17 | ) | | | (17 | ) | | | (6 | ) |
Net cash (used in) investing activities | | | (17 | ) | | | (17 | ) | | | (6 | ) |
Cash flows from financing activities: | | | | | | | | | | | | |
Proceeds from issuance of common shares, net of issuance costs | | | 1,040 | | | | 380 | | | | -- | |
Borrowings under credit facility, term loans and notes payable | | | 984 | | | | 2,148 | | | | 2,542 | |
Repayments of term loans, credit facility and notes payable | | | (677 | ) | | | -- | | | | (55 | ) |
Net cash provided by financing activities | | | 1,347 | | | | 2,528 | | | | 2,487 | |
Effect of exchange rate changes on cash | | | (6 | ) | | | (6 | ) | | | 5 | |
Net increase (decrease) in cash and cash equivalents | | | (60 | ) | | | 281 | | | | (78 | ) |
Cash and cash equivalents at beginning of year | | | 310 | | | | 29 | | | | 107 | |
Cash and cash equivalents at end of year | | $ | 250 | | | $ | 310 | | | $ | 29 | |
| | | | | |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | | | | | |
Cash paid during the year for: | | | | | | | | | | | | |
Income taxes | | $ | 5 | | | $ | 20 | | | $ | 1 | |
Interest | | $ | 264 | | | $ | 865 | | | $ | 645 | |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Non-Cash Investing and Financing Activities
2007
During 2007, the Company issued 24,793 shares of common stock to Critical Mass Mail as part of a litigation settlement valued at $50,000.
In October 2007, the Company issued 2,546,149 shares of common stock to BluePhoenix (formerly Liraz Systems Ltd.) in exchange for $650,000 paid to Bank Hapoalim to retire a portion of that indebtedness.
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 9,613 shares of common stock to vendors for outstanding liabilities valued at $103,000.
In November 2005, the Company issued 24,000 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 9,564 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 3,947 shares of Level 8 Systems common stock.
CICERO 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 $1,975,000 for the year ended December 31, 2007 and has experienced negative cash flows from operations for each of the years ended December 31, 2007, 2006 and 2005. At December 31, 2007, the Company had a working capital deficiency of approximately $6,132,000. 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. Management expects that it will be able to raise additional capital and to continue to fund operations and also expects that increased revenues will reduce its operating losses in future periods, however, there can be no assurance that management’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.
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 institutions. 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 product development expense.
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 5.)
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”.
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 $104,000, $88,000, and $16,000 for the years ended December 31, 2007, 2006 and 2005, 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, 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 2007, 2006, and 2005, 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:
| | 2007 | | | 2006 | | | 2005 | |
Stock options | | | 2,529,025 | | | | 45,315 | | | | 59,009 | |
Warrants | | | 445,387 | | | | 323,623 | | | | 193,761 | |
Preferred stock | | | 1,603,618 | | | | 1,763,478 | | | | 85,046 | |
| | | 4,578,030 | | | | 2,132,416 | | | | 337,816 | |
In 2007, 2006 and 2005, 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 granted 2,756,173 options in August 2007 at an exercise price of $0.51 per share. The Company recognized $650,000 of stock-based compensation. The Company did not grant options during 2006.
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.
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 (in thousands):
| | Years Ended December 31, | |
| | 2005 | |
Net loss applicable to common stockholders, as reported | | $ | (3,681 | ) |
Less: Total stock-based employee compensation expense underfair value based method for all awards, net of related tax effects | | | (180 | ) |
| | | | |
Pro forma loss applicable to common stockholders | | $ | (3,861 | ) |
| | | | |
Loss per share: | | | | |
Basic and diluted, as reported | | $ | (8.27 | ) |
Basic and diluted, pro forma | | $ | (8.68 | ) |
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:
| | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Expected life (in years) | | 10.0 years | | | 3.6 years | | | 6.0 years | |
Expected volatility | | | 166 | % | | | 140 | % | | | 149 | % |
Risk free interest rate | | | 5.25 | % | | | 4.93 | % | | | 4.48 | % |
Expected dividend yield | | | 0 | % | | | 0 | % | | | 0 | % |
Reclassifications:
Certain prior year amounts in the accompanying financial statements have been reclassified to conform to the 2007 presentation. Such reclassifications had no effect on previously reported net loss or stockholders’ deficit.
Recent Accounting Pronouncements:
In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities – an amendment of FASB Statement 115”. The statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge provisions. Most of the provisions of this statement apply only to entities that elect the fair value option; however , the amendment to FASB Statement 115, “Accounting for Certain Investment in Debt and Equity Services,” applies to all entities with available-for-sale and trading securities. The Company does not believe adoption of this statement will have a material impact on the Company’s financial statements.
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 adoption of this new standard did not 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 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 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.
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. | ACCOUNTS RECEIVABLE |
Trade accounts receivable was composed of the following at December 31 (in thousands):
| | 2007 | | | 2006 | |
Current trade accounts receivable | | $ | 792 | | | $ | 230 | |
Less: allowance for doubtful accounts | | | 100 | | | | 60 | |
| | $ | 692 | | | $ | 170 | |
The (credit) provision for uncollectible amounts was $50,000, $60,000, and ($12,000), for the years ended December 31, 2007, 2006, and 2005, respectively. Write-offs (net of recoveries) of accounts receivable were ($0) for the years ended December 31, 2007, 2006 and 2005.
NOTE 4. | PROPERTY AND EQUIPMENT |
Property and equipment was composed of the following at December 31 (in thousands):
| | 2007 | | | 2006 | |
Computer equipment | | $ | 263 | | | $ | 252 | |
Furniture and fixtures | | | 8 | | | | 8 | |
Office equipment | | | 154 | | | | 149 | |
| | | 425 | | | | 409 | |
Less: accumulated depreciation and amortization | | | (403 | ) | | | (394 | ) |
| | | | | | | | |
| | $ | 22 | | | $ | 15 | |
Depreciation and amortization expense of property and equipment was $10,000, $12,000, and $11,000, for the years ended December 31, 2007, 2006, and 2005, respectively.
Term loan, notes payable, and notes payable to related party consist of the following at December 31(in thousands):
| | 2007 | | | 2006 | |
Term loan (a) | | $ | -- | | | $ | 1,971 | |
Note payable related party (b) | | | 49 | | | | 9 | |
Notes payable (c) | | | 1,186 | | | | 919 | |
| | $ | 1,235 | | | $ | 2,899 | |
(a) | The Company had a $1,971 term loan bearing interest at LIBOR plus 1.5%. Interest was payable quarterly. There are no financial covenants and the term loan was guaranteed by Liraz Systems Ltd. (now known as BluePhoenix Solutions), the Company’s former principal stockholder. The loan matured on October 31, 2007. In October 2007, the Company, in conjunction with Blue Phoenix Solutions, retired the term loan. (See Note 14.) |
(b) | In November 2007, the Company entered into a short term note payable with John L. (Launny) Steffens, the Chairman of the Board of Directors, for various working capital needs. The Note bears interest at 6% per year and is unsecured. At December 31, 2007, the Company was indebted to Mr. Steffens in the amount of $40,000. |
From time to time the Company entered into promissory notes with one of the Company’s directors and the former Chief Information Officer, Anthony Pizi. The notes bear interest at 12% per annum. As of December 31, 2007 and 2006, the Company was indebted to Anthony Pizi 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 by accounts receivable and unsecured. In addition, the Company has settled certain litigation and agreed to issue a series of promissory notes to support its obligations in the aggregate principal amount of $88,000. The notes bear interest between 10% and 36% per annum. |
Long-term loan and notes payable to related party consist of the following at December 31(in thousands):
| | 2007 | | | 2006 | |
Term loan (a) | | $ | 1,021 | | | $ | -- | |
Note payable; related party (b) | | | 300 | | | | -- | |
Other long-term debt | | | 2 | | | | 33 | |
| | $ | 1,323 | | | $ | 33 | |
(a) | In October 2007, the Company, in conjunction with Blue Phoenix Solutions, retired the note payable to Bank Hapoalim and entered into a new note with Blue Phoenix Solutions in the principal amount of $1,021,000 with interest at Libor plus 1% (approximately 5.86% at December 31, 2007) maturing in December 2011. Interest is payable quarterly. |
(b) | In October 2007, the Company entered into a long-term note with John L. (Launny) Steffens, the Chairman on the Board of Directors, as part of the restructuring of the Note payable to Bank Hapoalim. The Note bears interest of 3% and matures in October 2009. At December 31, 2007, the Company was indebted to Mr. Steffens in the amount of $300,000. |
Scheduled maturities of the above debt are as follows:
Year | | | |
2008 | | $ | 2 | |
2009 | | $ | 300 | |
2011 | | $ | 1,021 | |
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):
| | 2007 | | | 2006 | | | 2005 | |
Expected income tax benefit at statutory rate (34%) | | $ | (672 | ) | | $ | (1,019 | ) | | $ | (1,251 | ) |
State taxes, net of federal tax benefit. | | | (118 | ) | | | (180 | ) | | | (308 | ) |
Effect of change in valuation allowance | | | 788 | | | | 1,073 | | | | 1,537 | |
Non-deductible expenses | | | 2 | | | | 126 | | | | 22 | |
Total | | $ | -- | | | $ | -- | | | $ | -- | |
Significant components of the net deferred tax asset (liability) at December 31 were as follows:
| | 2007 | | | 2006 | |
Current assets: | | | | | | |
Allowance for doubtful accounts | | $ | 44 | | | $ | 24 | |
Accrued expenses, non-tax deductible | | | 222 | | | | 279 | |
Deferred revenue | | | 44 | | | | 15 | |
Noncurrent assets: | | | | | | | | |
Stock Compensation Expense | | | 287 | | | | -- | |
Loss carryforwards | | | 92,337 | | | | 91,016 | |
Depreciation and amortization | | | 5,119 | | | | 5,931 | |
| | | 98,053 | | | | 97,265 | |
| | | | | | | | |
Less: valuation allowance | | | (98,053 | ) | | | (97,265 | ) |
| | | | | | | | |
| | $ | -- | | | $ | -- | |
At December 31, 2007, the Company had net operating loss carryforwards of approximately $230,847,000, which may be applied against future taxable income. These carryforwards will expire at various times between 2008 and 2027. 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, 2007 and 2006 since management does not believe that it is more likely than not that these assets will be realized.
NOTE 8. | STOCKHOLDERS’ EQUITY |
Common Stock:
During 2007, the Company completed two common stock financing rounds wherein it raised a total of $1,033,000 of capital from several new investors as well as certain members of its Board of Directors. In February 2007, the Company sold 3,723,007 shares of its common stock for $0.1343 per share for a total of $500,000. In October 2007, the Company completed a private sale of shares of its common stock to a group of investors, four of which are members of our Board of Directors. Under the terms of that agreement, the Company sold 2,169,311 shares of its common stock for $0.2457 per share for a total of $533,000. 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.
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 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:
In August 2007, the Company issued Mr. John P. Broderick, our Chief Executive Officer, a restricted stock award in the amount of 549,360 shares which will vest to him upon his resignation or termination. The Company used the Black-Scholes method to value these shares and assumed a life of 10 years. The Company recorded compensation expense of approximately $36,000 for fiscal 2007.
Stock Options:
In 2007, the Board of Directors approved the 2007 Cicero Employee Stock Option Plan which permits the issuance of incentive and nonqualified stock options, stock appreciation rights, performance shares, and restricted and unrestricted stock to employees, officers, directors, consultants, and advisors. The aggregate number of shares of common stock which may be issued under this Plan shall not exceed 4,500,000 shares upon the exercise of awards and provide that the term of each award be determined by the Board of Directors. 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. The Company's 1997 Employee Stock Option Plan expired during 2007.
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.
Activity for stock options issued under these plans for the fiscal years ending December 31, 2007, 2006 and 2005 was as follows:
| | Plan Activity | | | Option Price Per Share | | | Weighted Average Exercise Price | |
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 | |
Granted | | | 2,756,173 | | | | 0.51 | | | | 0.51 | �� |
Forfeited | | | (270,413 | ) | | | 0.51-612.50 | | | | 12.21 | |
Expired | | | (2,050 | ) | | | 1,473.00 | | | | 1,473.00 | |
Balance at December 31, 2007 | | | 2,529,025 | | | | 0.51-3,931.00 | | | | 1.35 | |
There were 2,756,173 options granted during 2007 and none during 2006. The weighted average grant date fair value of options issued during the years ended December 31, 2007 and 2005 was equal to $0.51 and $9.00 per share, respectively. There were no option grants issued below fair market value during 2007 and 2005.
At December 31, 2007, 2006, and 2005, options to purchase 888,634, 45,315, and 5,237 shares of common stock were exercisable, respectively, pursuant to the plans at prices ranging from $0.51 to $3,931.25. The following table summarizes information about stock options outstanding at December 31, 2007:
EXERCISE PRICE | | | NUMBER OUTSTANDING | | | REMAINING CONTRACTUAL LIFE FOR OPTIONS OUTSTANDING | | | NUMBER EXERCISABLE | | | WEIGHTED AVERAGE EXERCISE PRICE | |
| | | | | | | | | | | | | |
$ | 0.51-0.51 | | | | 2,500,760 | | | | 9.6 | | | | 860,369 | | | $ | 0.51 | |
| 0.52-393.12 | | | | 26,680 | | | | 5.5 | | | | 26,680 | | | | 40.60 | |
| 393.13-786.25 | | | | 1,350 | | | | 3.2 | | | | 1,350 | | | | 532.20 | |
| 786.26-1,179.37 | | | | 165 | | | | 2.0 | | | | 165 | | | | 944.41 | |
| 1,179.38-3,538.12 | | | | 40 | | | | 2.6 | | | | 40 | | | | 1,881.25 | |
| 3,538.13-3,931.25 | | | | 30 | | | | 2.2 | | | | 30 | | | | 3,931.25 | |
| | | | | | | | | | | | | | | | | | |
| | | | | 2,529,025 | | | | 9.6 | | | | 888,634 | | | $ | 2.91 | |
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 approval 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, 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 the former 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 an 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.
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 13,511 shares of the Company's common stock and 4,686 shares of preferred stock converted into 70,375 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 2007, 2006 and 2005 were valued using the following assumptions:
| | Expected Life in Years | | | Expected Volatility | | | Risk Free Interest Rate | | Expected Dividend | | Fair Value of Common Stock | |
| | | | | | | | | | | | | |
Preferred Series D-1 Warrants | | | 5 | | | | 117 | % | | | 3 | % | None | | $ | 7.00 | |
Preferred Series D-2 Warrants | | | 5 | | | | 102 | % | | | 3 | % | None | | $ | 20.00 | |
Early Adopter Warrants | | | 4 | | | | 104 | % | | | 4 | % | None | | $ | 1.50 | |
Long Term Promissory Note Warrants | | | 10 | | | | 168 | % | | | 5.25 | % | None | | $ | 0.18 | |
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 9. | EMPLOYEE BENEFIT PLANS |
The Company sponsors one defined contribution plan for its U.S. employees - the Cicero Inc 401(K) Plan. Under the terms of the Plan, the Company, at its discretion, 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 Statements of Operations totaled $0, $0 and $30,000, for the years ended December 31, 2007, 2006, and 2005, 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’s foreign subsidiaries are no longer active.
NOTE 10. | SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK |
In 2007, one customer accounted for 87.2% of operating revenues and represented 100% of accounts receivable at December 31, 2007. 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.
NOTE 11. | FOREIGN CURRENCIES |
The Company’s net foreign currency transaction losses/ (gains) were $15,000, $14,000, and $(23,000), for the years ended 2007, 2006, and 2005, respectively.
NOTE 12. | SEGMENT INFORMATION AND GEOGRAPHIC INFORMATION |
Based upon the current business environment in which the Company operates, the economic characteristics of its operating segments and management’s view of the business, a revision in terms of aggregation of its segments was appropriate. Therefore the segment discussion outlined below clarifies the adjusted segment structure as determined by management under SFAS No. 131. All prior year amounts have been restated to conform to the new reporting segment structure.
Management makes operating decisions and assesses performance of the Company’s operations based on one reportable segment, it’s the Software product segment. Prior to this change the Company had segregated into two separate segments: Desktop Integration and Messaging. The Messaging business has always been an immaterial part of the Company’s overall business and generally all its sales efforts are focused on the Cicero product. As such, the Company has elected to combine the two products into one reportable segment.
The Software product segment is comprised of the Cicero® product and the Ensuredmail 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.Ensuredmail is an encrypted email technology that can reside on either the server or the desktop.
The table below presents information about reported segments for the year ended December 31, 2007, 2006 and 2005 (in thousands):
| | For the year ended December 31, | |
| | 2007 | | | 2006 | | | 2005 | |
Total revenue | | $ | 1,808 | | | $ | 972 | | | $ | 785 | |
Total cost of revenue | | | 937 | | | | 767 | | | | 1,188 | |
Gross margin (loss) | | | 871 | | | | 205 | | | | (403 | ) |
Total operating expenses | | | 2,711 | | | | 2,085 | | | | 2,655 | |
Segment loss | | $ | (1,840 | ) | | $ | (1,880 | ) | | $ | (3,058 | ) |
A reconciliation of segment operating expenses to total operating expense follows (numbers are in thousands):
| | 2007 | | | 2006 | | | 2005 | |
Segment operating expenses | | $ | 2,711 | | | $ | 2,085 | | | $ | 2,655 | |
(Gain) on disposal of assets | | | -- | | | | (24 | ) | | | -- | |
Total operating expenses | | $ | 2,711 | | | $ | 2,061 | | | $ | 2,655 | |
A reconciliation of total segment profitability to net loss for the fiscal years ended December 31(in thousands):
| | 2007 | | | 2006 | | | 2005 | |
Total segment profitability (loss) | | $ | (1,840 | ) | | $ | (1,880 | ) | | $ | (3,058 | ) |
Gain on disposal of assets | | | -- | | | | 24 | | | | -- | |
| | | | | | | | | | | | |
Interest and other income/(expense), net | | | (135 | ) | | | (1,141 | ) | | | (623 | ) |
Net loss | | $ | (1,975 | ) | | $ | (2,997 | ) | | $ | (3,681 | ) |
The following table presents a summary of revenue by geographic region for the years ended December 31(in thousands):
| | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
USA | | | 1,808 | | | | 972 | | | | 783 | |
Italy | | | - | | | | - | | | | 2 | |
| | | | | | | | | | | | |
| | $ | 1,808 | | | $ | 972 | | | $ | 785 | |
Presentation of revenue by region is based on the country in which the customer is domiciled. As of December 31, 2007, 2006 and 2005, all of the long-lived assets of the Company are located in the United States.
NOTE 13. | RELATED PARTY INFORMATION |
BluePhoenix Solutions, formerly Liraz Systems Ltd., the Company’s former principal stockholder, guaranteed certain debt obligations of the Company. In October 2007, the Company agreed to restructure the note payable to Bank Hapoalim and guaranty by BluePhoenix Solutions. Under a new agreement with BluePhoenix, the Company made a principal reduction payment to Bank Hapoalim in the amount of $300,000. Simultaneously, BluePhoenix paid $1,671,000 to Bank Hapoalim, thereby discharging that indebtedness. The Company and BluePhoenix entered into a new Note in the amount of $1,021,000, bearing interest at LIBOR plus 1.0% and maturing on December 31, 2011. In addition, BluePhoenix acquired 2,546,149 shares of the Company’s common stock in exchange for $650,000 paid to Bank Hapoalim to retire that indebtedness. Of the new note payable to BluePhoenix, approximately $350,000 is due on January 31, 2009 and the balance is due on December 31, 2011. In November 2006, the Company and Liraz agreed to extend the guaranty and with the approval of the lender, agreed to extend the maturity of the debt obligation until October 31, 2007. The Company issued 60,000 shares of common stock to Liraz in exchange for this debt extension.
In October 2007, the Company entered into a long-term note with John L. (Launny) Steffens, the Chairman on the Board of Directors, as part of the restructuring of the Note payable to Bank Hapoalim. The Note bears interest of 3% and matures in October 2009. At December 31, 2007, the Company was indebted to Mr. Steffens in the amount of $300,000.
In November 2007, the Company entered into a short term note payable with John L. (Launny) Steffens, the Chairman of the Board of Directors, for various working capital needs. The Note bears interest at 6% per year and is unsecured. At December 31, 2007, the Company was indebted to Mr. Steffens in the amount of $40,000.
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, 2007, the receivable was still outstanding and the Company has reserved 100% of the balance as doubtful.
From time to time during 2005 and 2004, the Company entered into short term notes payable with Anthony Pizi, the Company’s former Chief Information Officer. The Notes bear interest at 1% per month and are unsecured. At December 31, 2007, 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 a director and the Company’s former Chairman of the Board and Mr. and Mrs. Landis are parents-in-law to Mr. Pizi, the Company’s former 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 Mr. and Mrs. 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 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 5,716 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 4,423 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 1,122 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 1,145 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 2,898 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:
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 14. | 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, 2007 consisted of only one lease as follows (in thousands):
| | Lease Commitments | |
| | | |
2008 | | $ | 103 | |
2009 | | | 97 | |
2010 | | | 101 | |
| | $ | 301 | |
Rent expense for the years ended December 31, 2007, 2006, and 2005 was $74,000, $60,000, and $122,000, respectively. As of December 31, 2007, 2006, and 2005, the Company had no sublease arrangements.
Various lawsuits and claims have been brought against us in the normal course of our business.
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.
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 16. | SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) |
| | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
| | (In thousands, except per share data) | |
2007: | | | | | | | | | | | | |
Net revenues | | $ | 232 | | | $ | 316 | | | $ | 387 | | | $ | 873 | |
Gross margin | | | 65 | | | | 160 | | | | 82 | | | | 564 | |
Net income/(loss) | | | (529 | ) | | | (452 | ) | | | (966 | ) | | | (29 | ) |
Net loss/share –basic and diluted attributedto common stockholders | | $ | (0.01 | ) | | $ | (0.01 | ) | | $ | (0.02 | ) | | | -- | |
| | | | | | | | | | | | | | | | |
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 attributed to common stockholders | | $ | (0.01 | ) | | $ | (0.01 | ) | | $ | (0.01 | ) | | $ | (0.22 | ) |
NOTE 17. | SUBSEQUENT EVENTS |
In March 2008, the Company was notified that a group of investors including two members of the Board of Directors acquired a short term promissory note due SDS Merchant Fund in the principal amount of $250,000. The note is unsecured and bears interest at 10% per annum. Also in March, our Board of Directors approved a resolution to convert this debt plus accrued interest into common stock of the Company. The total principal and interest amounted to $361,827 and is being converted into 1,417,264 shares of common stock. Mr. John Steffens, the Company’s Chairman, will acquire 472,516 shares and Mr. Bruce Miller, also a member of our Board of Directors, will acquire 472,374 shares.
In March 2008, the Company amended the terms of its Note Payable with BluePhoenix Solutions. Under the terms of the original Note, the Company was to make a principal reduction payment in the amount of $350,000 on January 30, 2009. The Company and BluePhoenix agreed to accelerate that principal payment to March and April 2008 in return for a conversion of $50,000 into 195,848 shares of the Company’s common stock. In March, the Company paid $200,000 plus accrued interest and in April, the Company will pay $100,000 plus accrued interest.
CICERO INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
| | March 31, 2008 | | | December 31, 2007 | |
ASSETS | | (unaudited) | | | | |
Current assets: | | | | | | |
Cash and cash equivalents | | $ | 68 | | | $ | 250 | |
Assets of discontinued operations | | | 83 | | | | 79 | |
Trade accounts receivable, net | | | 283 | | | | 692 | |
Prepaid expenses and other current assets | | | 186 | | | | 208 | |
Total current assets | | | 620 | | | | 1,229 | |
Property and equipment, net | | | 21 | | | | 22 | |
Total assets | | $ | 641 | | | $ | 1,251 | |
LIABILITIES AND STOCKHOLDERS' DEFICIT | | | | | | | | |
Current liabilities: | | | | | | | | |
Short-term debt | | $ | 558 | | | $ | 1,235 | |
Accounts payable | | | 2,315 | | | | 2,489 | |
Accrued expenses: | | | | | | | | |
Salaries, wages, and related items | | | 1,007 | | | | 1,002 | |
Other | | | 1,864 | | | | 2,072 | |
Liabilities of discontinued operations | | | 474 | | | | 455 | |
Deferred revenue | | | 732 | | | | 108 | |
Total current liabilities | | | 6,950 | | | | 7,361 | |
Long-term debt | | | 1,122 | | | | 1,323 | |
Total liabilities | | | 8,072 | | | | 8,684 | |
Stockholders' (deficit): | | | | | | | | |
Preferred stock | | | -- | | | | -- | |
Common stock | | | 45 | | | | 44 | |
Additional paid-in capital | | | 229,347 | | | | 228,858 | |
Accumulated deficit | | | (236,805 | ) | | | (236,320 | ) |
Accumulated other comprehensive loss | | | (18 | ) | | | (15 | ) |
Net stockholders' (deficit) | | | (7,431 | ) | | | (7,433 | ) |
Total liabilities and stockholders' (deficit) | | $ | 641 | | | $ | 1,251 | |
| | September 30, 2008 | | | December 31, 2007 | |
ASSETS | | (unaudited) | | | | |
Current assets: | | | | | | |
Cash and cash equivalents | | $ | 228 | | | $ | 250 | |
Assets of discontinued operations | | | 76 | | | | 79 | |
Trade accounts receivable, net | | | 333 | | | | 692 | |
Prepaid expenses and other current assets | | | 186 | | | | 208 | |
Total current assets | | | 823 | | | | 1,229 | |
Property and equipment, net | | | 48 | | | | 22 | |
Total assets | | $ | 871 | | | $ | 1,251 | |
LIABILITIES AND STOCKHOLDERS' DEFICIT | | | | | | | | |
Current liabilities: | | | | | | | | |
Short-term debt | | $ | 702 | | | $ | 1,235 | |
Accounts payable | | | 2,127 | | | | 2,489 | |
Accrued expenses: | | | | | | | | |
Salaries, wages, and related items | | | 1,048 | | | | 1,002 | |
Other | | | 2,037 | | | | 2,072 | |
Liabilities of discontinued operations | | | 446 | | | | 455 | |
Deferred revenue | | | 502 | | | | 108 | |
Total current liabilities | | | 6,862 | | | | 7,361 | |
Long-term debt | | | 971 | | | | 1,323 | |
Total liabilities | | | 7,833 | | | | 8,684 | |
Stockholders' (deficit): | | | | | | | | |
Preferred stock | | | -- | | | | -- | |
Common stock | | | 47 | | | | 44 | |
Additional paid-in capital | | | 229,909 | | | | 228,858 | |
Accumulated deficit | | | (236,929 | ) | | | (236,320 | ) |
Accumulated other comprehensive income/(loss) | | | 11 | | | | (15 | ) |
Net stockholders' (deficit) | | | (6,962 | ) | | | (7,433 | ) |
Total liabilities and stockholders' (deficit) | | $ | 871 | | | $ | 1,251 | |
The accompanying notes are an integral part of the consolidated financial statements.statements
CICERO INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
| | Three Months Ended March 31, | |
| | 2008 | | | 2007 | |
Revenue: | | | | | | |
Software | | $ | 200 | | | $ | -- | |
Maintenance | | | 133 | | | | 41 | |
Services | | | 137 | | | | 191 | |
Total operating revenue | | | 470 | | | | 232 | |
| | | | | | | | |
Cost of revenue | | | | | | | | |
Software | | | 7 | | | | -- | |
Maintenance | | | 71 | | | | 53 | |
Services | | | 162 | | | | 114 | |
Total cost of revenue | | | 240 | | | | 167 | |
| | | | | | | | |
Gross margin | | | 230 | | | | 65 | |
| | | | | | | | |
Operating expenses: | | | | | | | | |
Sales and marketing | | | 253 | | | | 137 | |
Research and product development | | | 155 | | | | 138 | |
General and administrative | | | 298 | | | | 258 | |
Total operating expenses | | | 706 | | | | 533 | |
Loss from operations | | | (476 | ) | | | (468 | ) |
| | | | | | | | |
Other income (expense): | | | | | | | | |
Interest expense | | | (78 | ) | | | (62 | ) |
Other income/(expense) | | | 69 | | | | 1 | |
Loss before provision for income taxes | | | (485 | ) | | | (529 | ) |
Income tax provision | | | -- | | | | -- | |
| | | | | | | | |
Net loss | | $ | (485 | ) | | $ | (529 | ) |
| | | | | | | | |
Net loss per share applicable to common stockholders—basic and diluted | | $ | (0.01 | ) | | $ | (0.01 | ) |
| | | | | | | | |
Weighted average common shares outstanding -- basic and diluted | | | 43,879 | | | | 38,930 | |
| | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Revenue: | | | | | | | | | | | | |
Software | | $ | 72 | | | $ | 1 | | | $ | 1,204 | | | $ | 1 | |
Maintenance | | | 249 | | | | 84 | | | | 596 | | | | 202 | |
Services | | | 257 | | | | 302 | | | | 675 | | | | 732 | |
Total operating revenue | | | 578 | | | | 387 | | | | 2,475 | | | | 935 | |
| | | | | | | | | | | | | | | | |
Cost of revenue | | | | | | | | | | | | | | | | |
Software | | | 4 | | | | -- | | | | 40 | | | | -- | |
Maintenance | | | 55 | | | | 94 | | | | 182 | | | | 201 | |
Services | | | 255 | | | | 211 | | | | 605 | | | | 427 | |
Total cost of revenue | | | 314 | | | | 305 | | | | 827 | | | | 628 | |
| | | | | | | | | | | | | | | | |
Gross margin | | | 264 | | | | 82 | | | | 1,648 | | | | 307 | |
| | | | | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | | | | |
Sales and marketing | | | 233 | | | | 241 | | | | 678 | | | | 572 | |
Research and product development | | | 160 | | | | 217 | | | | 474 | | | | 475 | |
General and administrative | | | 338 | | | | 546 | | | | 959 | | | | 1,069 | |
Total operating expenses | | | 731 | | | | 1,004 | | | | 2,111 | | | | 2,116 | |
Loss from operations | | | (467 | ) | | | (922 | ) | | | (463 | ) | | | (1,809 | ) |
| | | | | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | | | | |
Interest expense | | | (64 | ) | | | (64 | ) | | | (187 | ) | | | (186 | ) |
Other income/(expense) | | | (22 | ) | | | 21 | | | | 41 | | | | 49 | |
Loss before provision for income taxes | | | (553 | ) | | | (965 | ) | | | (609 | ) | | | (1,946 | ) |
Income tax provision | | | -- | | | | 1 | | | | -- | | | | 1 | |
| | | | | | | | | | | | | | | | |
Net loss | | $ | (553 | ) | | $ | (966 | ) | | $ | (609 | ) | | $ | (1,947 | ) |
| | | | | | | | | | | | | | | | |
Loss per share: | | | | | | | | | | | | | | | | |
Basic loss per share | | $ | (0.01 | ) | | $ | (0.02 | ) | | $ | (0.01 | ) | | $ | (0.06 | ) |
Diluted loss per share | | $ | (0.01 | ) | | $ | (0.02 | ) | | $ | (0.01 | ) | | $ | (0.06 | ) |
| | | | | | | | | | | | | | | | |
Average shares outstanding: | | | | | | | | | | | | | | | | |
Basic | | | 46,404 | | | | 39,020 | | | | 45,682 | | | | 34,785 | |
Potential dilutive common shares | | | 52 | | | | -- | | | | 24 | | | | -- | |
Diluted | | | 46,456 | | | | 39,020 | | | | 45,706 | | | | 34,785 | |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| | Three Months Ended March 31, | |
| | 2008 | | | 2007 | |
Cash flows from operating activities: | | | | | | |
Net loss | | $ | (485 | ) | | $ | (529 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | | | | | | | | |
Depreciation and amortization | | | 3 | | | | 2 | |
Stock compensation expense | | | 129 | | | | -- | |
Changes in assets and liabilities: | | | | | | | | |
Trade accounts receivable | | | 409 | | | | 1 | |
Assets and liabilities – discontinued operations | | | 15 | | | | 1 | |
Prepaid expenses and other assets | | | 22 | | | | (36 | ) |
Accounts payable and accrued expenses | | | (266 | ) | | | (48 | ) |
Deferred revenue | | | 624 | | | | 224 | |
Net cash provided by (used in) operating activities | | | 451 | | | | (385 | ) |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Purchases of equipment | | | (2 | ) | | | (6 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Proceeds from the issuance of common stock | | | -- | | | | 500 | |
Borrowings under credit facility, term loans, notes payable | | | 45 | | | | -- | |
Repayments of term loans, credit facility and notes payable | | | (673 | ) | | | -- | |
Net cash provided by (used in) financing activities | | | (628 | ) | | | 500 | |
Effect of exchange rate changes on cash | | | (3 | ) | | | (1 | ) |
Net increase (decrease) in cash and cash equivalents | | | (182 | ) | | | 108 | |
Cash and cash equivalents: | | | | | | | | |
Beginning of period | | | 250 | | | | 310 | |
End of period | | $ | 68 | | | $ | 418 | |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)
| | Three Months Ended March 31, | |
| | 2008 | | | 2007 | |
Net loss | | $ | (485 | ) | | $ | (529 | ) |
Other comprehensive income, net of tax: | | | | | | | | |
Foreign currency translation adjustment | | | (6 | ) | | | (1 | ) |
Comprehensive loss | | $ | (491 | ) | | $ | (530 | ) |
| | Nine Months Ended September 30 | |
| | 2008 | | | 2007 | |
Cash flows from operating activities: | | | | | | |
Net loss | | $ | (609 | ) | | $ | (1,947 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | | | | | | | | |
Depreciation and amortization | | | 12 | | | | 2 | |
Stock compensation expense | | | 344 | | | | 582 | |
Stock issuance | | | 15 | | | | -- | |
Changes in assets and liabilities: | | | | | | | | |
Trade accounts receivable | | | 359 | | | | (99 | ) |
Assets and liabilities – discontinued operations | | | (6 | ) | | | 18 | |
Prepaid expenses and other assets | | | 22 | | | | (42 | ) |
Accounts payable and accrued expenses | | | (56 | ) | | | (21 | ) |
Deferred revenue | | | 394 | | | | 109 | |
Net cash provided by (used in) operating activities | | | 475 | | | | (1,398 | ) |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Purchases of equipment | | | (38 | ) | | | (7 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Proceeds from the issuance of common stock | | | -- | | | | 1,023 | |
Borrowings under credit facility, term loans and notes payable | | | 935 | | | | 156 | |
Repayments of term loans, credit facility and notes payable | | | (1,420 | ) | | | (61 | ) |
Net cash provided by (used in) financing activities | | | (485 | ) | | | 1,118 | |
Effect of exchange rate changes on cash | | | 26 | | | | (6 | ) |
Net decrease in cash and cash equivalents | | | (22 | ) | | | (293 | ) |
Cash and cash equivalents: | | | | | | | | |
Beginning of period | | | 250 | | | | 310 | |
End of period | | $ | 228 | | | $ | 17 | |
Non-Cash Investing and Financing Activities:
During MarchJuly 2008, the Company issued 1,417,264391,696 shares of common stock in exchange for a $100,000 principal payment on a promissory note.
During July 2008, the Company issued 195,848 shares of common stock in exchange for a $50,000 principal payment on a promissory note.
During July 2008, the Company issued 80,993 shares of common stock to a vendor in exchange for the settlement of an accounts payable balance of $20,678.
During April 2008, the Company issued 623,214 shares of common stock to a vendor in exchange for the settlement of an accounts payable balance of $159,106.
During March, April and July 2008, the Company issued 1,425,137 shares of common stock in exchange for the conversion of debt and interest of $362,000$363,000 to a group of investors who had acquired the short term promissory note due to SDS Merchant Fund.
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Net loss | | $ | (553 | ) | | $ | (966 | ) | | $ | (609 | ) | | $ | (1,947 | ) |
Other comprehensive income/(loss), net of tax: | | | | | | | | | | | | | | | | |
Foreign currency translation adjustment | | | 32 | | | | (6 | ) | | | 26 | | | | (6 | ) |
Comprehensive loss | | $ | (521 | ) | | $ | (967 | ) | | $ | (583 | ) | | $ | (1,953 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
CICERO INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. INTERIM FINANCIAL STATEMENTS
The accompanying financial statements for the three and nine months ending March 31,ended September 30, 2008 and 2007 are unaudited, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles of the United States of America have been condensed or omitted pursuant to those rules and regulations. Accordingly, these interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in Cicero Inc.'s (the "Company") Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 31, 2008. The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for other interim periods or for the full fiscal year. In the opinion of management, the information contained herein reflects all adjustments necessary for a fair statement of the interim results of operations. All such adjustments are of a normal, recurring nature. Certain reclassifications have been made to the prior year amounts to conform to the current year presentation.
The year-end condensed balance sheet data was derived from audited financial statements in accordance with the rules and regulations of the SEC, but does not include all disclosures required for financial statements prepared in accordance with generally accepted accounting principles of the United States of America.
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.
Liquidity
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 losses of $1,975,000 and $2,997,000 in 2007 and 2006, respectively, and has experienced negative cash flows from operations for each of the past three years. For the threenine months ended March 31,September 30, 2008, the Company incurred a loss of $485,000$609,000 and had a working capital deficiency of $6,330,000.$6,039,000. The Company’s future revenues are entirely dependent on acceptance of Cicero® software, 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 planswill seek to raise additional capital or to enter into other strategic transactions 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.
Use of Accounting 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.
Stock-Based Compensation
During 2006, the Company adopted SFASStatement of Financial Accounting Standards (“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 Staff Accounting Bulletin 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 issued 150,000275,000 options in the first quartersix months of 2008 of which 50,00083,333 were vested immediately. The Company recognized $120,000 in stock-based compensation expense of $110,000 and $317,000, respectively, for the three and nine months ended March 31,September 30, 2008. The Company also recognized $9,000 in stock-based compensation expense of $9,000 and $27,000, respectively, for the three and nine months ended September 30, 2008, for the 549,360 restricted shares of stock reserved for Mr. John Broderick, the Company’s CEO, in accordance with his 2007 employment agreement.
The following table sets forth certain information as of March 31,September 30, 2008 about shares of the Company’s common stock, par value $.001 (the “Common Stock”), outstanding and available for issuance under the Company’s existing equity compensation plans: the Cicero Inc. 2007 Employee Stock Option Plan, the Cicero Inc. (formerly Level 8 Systems, Inc.) 1997 Stock Option Incentive Plan and the Outside Director Stock Option Plan. The Company’s stockholders approved all of the Company’s stock-based compensation plans.
| | Shares | | | Shares | |
Outstanding on January 1, 2008 | | | 2,529,025 | | | | 2,529,025 | |
Granted | | | 150,000 | | | | 400,000 | |
Exercised | | | -- | | | | -- | |
Forfeited | | (68,812 | ) | | | (268,812 | ) |
Outstanding on March 31, 2008 | | | 2,610,213 | | |
Outstanding on September 30, 2008 | | | | 2,660,213 | |
| | | | | | | | |
Weighted average exercise price of outstanding options | | $ | 1.28 | | | $ | 1.73 | |
Shares available for future grants on March 31, 2008 | | | 1,917,107 | | |
Shares available for future grants on September 30, 2008 | | | | 1,867,107 | |
Options to purchase shares of common stock are excluded from the calculation of diluted earnings per share when their inclusion would have an anti-dilutive effect on the calculation. No options were included for the three month periodand nine-month periods ended March 31,September 30, 2008 and 2007.2007, respectively. Basic earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the respective period. Diluted earnings per common share are computed by dividing net income by the weighted average number of shares of common stock and dilutive potential common shares outstanding during the respective period. The weighted average number of common shares is increased by the number of dilutive potential common shares issuable on the exercise of options less the number of common shares assumed to have been purchased with the proceeds from the exercise of the options pursuant to the treasury stock method; those purchases are assumed to have been made at the average price of the common stock during the respective period. The average price of Cicero common stock during the three months ending March 31,ended September 30, 2008 and March 31,2007 was $0.24 and $0.42, respectively. The average price of Cicero common stock during the nine months ended September 30, 2008 and 2007 was $0.20 and $1.09,$0.72, respectively.