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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the fiscal year ended December 31, 2001.

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from to

Commission File Number: 0-26392

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LEVEL 8 SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

Delaware 11-2920559
(State of incorporation) (I.R.S. Employer
Identification No.)

8000 Regency Parkway, Cary, North Carolina 27511
(Address of principal executive offices, including Zip Code)

(919) 380-5000
(Registrant's telephone number, including area code)

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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.001 par value

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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

Aggregate market value of the outstanding voting stock held by
non-affiliates of the Registrant as of March 22, 2002 was approximately
$19,215,271. There were 19,035,017 shares of Common Stock outstanding as of
March 22, 2002.
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LEVEL 8 SYSTEMS, INC.

Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 2001

PART I

Item Page
Number Number
- ------ ------

1. Business............................................................................. 1

2. Properties........................................................................... 12

3. Legal Proceedings.................................................................... 12

4. Submission of Matters to a Vote of Security Holders.................................. 12

PART II

5. Market for Level 8 Common Stock and Related Shareholder Matters...................... 13

6. Selected Financial Data.............................................................. 14

7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15

7A. Quantitative and Qualitative Disclosures About Market Risk........................... 28

8. Financial Statements and Supplementary Data.......................................... 28

9. Changes in Accountants............................................................... 28

PART III

10. Directors and Executive Officers of Level 8.......................................... 29

11. Executive Compensation............................................................... 29

12. Security Ownership of Certain Beneficial Owners and Management....................... 29

13. Certain Relationships and Related Transactions....................................... 29

PART IV

14. Index Exhibits, Financial Statement Schedules, and Reports on Form 8-K............... 30

SIGNATURES.................................................................................. 35

INDEX TO FINANCIAL STATEMENTS............................................................... F-1

INDEX TO EXHIBITS........................................................................... E-1

PART I

Item 1. Business

BUSINESS

Overview

We provide a comprehensive set of integration products, including desktop
integration with our new Cicero(R)/ product and server integration and
messaging solutions with our Geneva line of products. Our flagship product
line, Cicero, is a business integration software product that maximizes
end-user productivity, streamlines business operations and integrates systems
and applications that would not otherwise work together. By using our Cicero
solution, companies can decrease their customer management costs, increase
their customer service level and more efficiently cross-sell the full range of
their products and services resulting in an overall increase in return on
information technology investments. /

The key component of the Cicero solution is visual integration at the
desktop that consolidates applications that do not inherently work together
into a cohesive, simplified work environment embodied in a single look and feel
desktop user interface. Cicero is designed to increase the productivity of
anyone requiring access to multiple applications and information sources.
Cicero provides a unique approach that allows companies to organize components
of their existing applications into processes required to complete common
tasks. Cicero streamlines all activities by providing a single, seamless user
interface for instant access to all systems associated with a task. Cicero
provides automatic information sharing among all line-of-business applications
and tools. Cicero is ideal for deployment in contact centers where its highly
productive, task-oriented user interface promotes user efficiency.

We also offer products under our Geneva brand name to provide organizations
with systems integration tools and messaging solutions. Our systems integration
products include Geneva Enterprise Integrator and Geneva Business Process
Automator. Our messaging solution is Geneva Integration Broker. Although we
plan to focus our marketing efforts principally on our Cicero solution, we will
continue to support our remaining Geneva products. Our Geneva Enterprise
Integrator and Business Process Automator products are currently being
rewritten in the Java programming language, scheduled to be completed in the
4th quarter of 2002. Until we release the new version of these products, many
potential customers may hold off purchasing our current versions. Accordingly,
in the short term, we anticipate that our Geneva line of products will generate
less revenue than in previous periods.

We were incorporated in New York in 1988, and re-incorporated in Delaware in
1999. Our principal executive offices are located at 8000 Regency Parkway,
Cary, North Carolina, 27511, and our telephone number is (919) 380-5000.

Strategic Realignment

Historically, we have been a global provider of software solutions to help
companies integrate new and existing applications as well as extend those
applications to the Internet. This market segment is commonly known as
"Enterprise Application Integration" or "EAI." Historically, EAI solutions work
directly at the server or back-office level allowing disparate applications to
communicate with each other.

Until early 2001, we focused primarily on the development, sale and support
of EAI solutions through our Geneva product suite. After extensive strategic
consultation with outside advisors and an internal analysis of our products and
services, we recognized that a new market opportunity had emerged. This
opportunity was represented by the increasing need to integrate applications
that are physically resident on different hardware platforms, a typical
situation in larger companies. In most cases, companies with large customer
bases utilize numerous different, or "disparate," applications that were not
designed to effectively communicate and pass information amongst themselves,
which leads to enterprise inefficiency. With Cicero, which integrates the
functionality of these disparate applications at the desktop, we believe that
we have found a novel solution to this disparate application problem. We
believe that our existing experience in and understanding of the EAI
marketplace coupled with the unique Cicero solution, which approaches
traditional EAI needs in a more effective manner, position us to be a
competitive provider of business integration solutions to the financial
services industry and other industries with large deployed call centers.

We originally licensed the Cicero technology and related patents on a
worldwide, royalty-free basis from Merrill Lynch, Pierce, Fenner & Smith
Incorporated in August of 2000 under a license agreement containing standard
provisions and a two-year exclusivity period. On January 3, 2002, the license
agreement was amended to extend our exclusive worldwide marketing, sales and
development rights to Cicero in perpetuity (subject to Merrill Lynch's rights
to terminate in the event of bankruptcy or a change in control of Level 8) and
to grant ownership rights in the Cicero trademark. We are indemnified by
Merrill Lynch with regard to the rights granted to us by them. Consideration
for the original Cicero license consisted of 1,000,000 shares of our common
stock. In exchange for the amendment, we granted an additional 250,000 shares
of common stock to MLBC, Inc., a Merrill Lynch affiliate and entered into a
royalty sharing agreement. Under the royalty sharing agreement, we pay a
royalty of 3% of the sales price for each sale of Cicero or related maintenance
services. The royalties over the life of the agreement are not payable in
excess of $20,000,000.

In connection with executing our strategic realignment and focusing on
Cicero, we have restructured our business, reduced our number of employees and,
in the fourth quarter, sold assets associated with Geneva AppBuilder, Geneva
Message Queuing and Geneva XIPC. In April 2001, management reassessed the
methodology by which the Company would make operating decisions and allocate
resources. Operating decisions and performance assessments are currently based
on the following reportable segments: (1) Desktop Integration Products
(Cicero), (2) System Integration Products (Geneva Enterprise Integrator and
Geneva Business Process Automator) and (3) Messaging and Application
Engineering Products (Geneva Integration Broker, Geneva Message Queuing, Geneva
XIPC and Geneva AppBuilder). As noted above, we have sold most of the assets
comprising the Messaging and Application Engineering Products segment.
Accordingly, Geneva Integration Broker is the only current software product
represented in the Messaging and Application Engineering segment.

Market Opportunity

Desktop Integration Products--Cicero

Our initial target markets for Cicero are the customer contact centers of
large consumer oriented business, such as the financial services, insurance and
telecommunications industries. Large scale customer contact centers are
characterized by large numbers of customer service agents that process phone
calls, faxes, e-mails and other incoming customer inquiries and requests. Our
goal is to greatly increase the efficiency of customer service agents in our
target markets, thereby increasing customer retention and customer
satisfaction. This increased efficiency is attained in a non-invasive manner,
allowing companies to continue using their existing applications in a more
productive manner.

Generally, managers of customer contact centers are under pressure to
provide increased customer service at the lowest possible cost while dealing
with high employee turnover and increasing training costs. Some of the primary
challenges faced by customer contact centers include:

. Customer Service. Currently, most customer contact centers require
multiple transfers to different agents to deal with diverse customer
service issues. A one call, one contact system would enhance customer
service by avoiding these multiple transfers. Ideally, the customer
service agent could provide the call-in customer with multi-channel
customer interfaces with timely access to all information that the
customer needs. Increasing customer service and customer intimacy is one
of the primary metrics on which contact centers are evaluated by
management.
. Contact Center Staffing. The contact center industry is characterized by
increasing staff training costs and complexity, high annual turnover and
increasing costs per call. We believe these difficulties stem from
increased customer expectations, the ever-increasing complexity and
diversity of the computer applications used by customer service agents,
and the goals of decreasing training time and increasing the return on
investment in the customer service agent.

. Industry Consolidation. Many industries in our target market, including
the financial services industry, are in a constant state of
consolidation. When companies consolidate, the customer contact

centers are generally merged to lower overall costs and to reduce
redundancies. This consolidation generally leads to re-training and the
use of multiple applications handling similar functions that can be quite
difficult to integrate successfully.

Systems Integration Products and Messaging and Application Engineering
Products--The Geneva Products

A significant challenge facing global 5000-sized organizations today is the
integration and management of critical business applications which run on
disparate or otherwise incompatible computer systems. Business and competitive
pressures are pushing companies to move towards an eBusiness model as quickly
as possible in order to remain competitive and viable in an increasingly
online, information-driven economy. eBusiness systems involve a combination of
consumer-oriented or business-to-business eCommerce, internal and external data
exchange, online customer service, customer relationship management and value
chain integration processes. Inter-operability and information exchange between
new and legacy systems within the extended enterprise are key components for a
successful eBusiness strategy, as is the ability to link those applications and
processes in extremely secure and highly reliable ways.

Enterprise application integration solutions, including the Geneva line of
products developed by Level 8, are designed to provide these capabilities
through an open, enterprise-wide infrastructure that can accomplish the
complete integration of a company's entire computing systems environment,
including technologies enabling eBusiness and eCommerce.

Our Solution

Cicero-Desktop Integration

We have been a provider of software that integrates an enterprise's
applications at the server level so that disparate applications can communicate
with each other. Based on our experience in the EAI industry, we determined
that a compelling product would be one that integrates disparate applications
at a visual level in addition to at the server level. As a result, we proceeded
to procure an exclusive license to develop and market Cicero. Cicero was
developed internally by Merrill Lynch, to increase the efficiency of 30,000
employees that have daily contact with Merrill Lynch customers. When coupled
with our existing technologies or with solutions from other EAI vendors, Cicero
becomes the comprehensive Cicero solution and provides our customers with a
front-to-back integrated system that appears as a single application to the
end-user.

Cicero is a software product that allows companies to integrate their
existing applications into a seamless integrated desktop. Cicero subordinates
and controls most Windows-based applications and provides a seamless
environment with a consistent look and feel. The end-user can navigate any
number of applications whether local, client-server, mainframe legacy or
web-browser in a consistent and intuitive way that is completely customizable
by their employer.

The Cicero solution provides the following key features:

. Integrated End-User Environment. The end-user can use all of the
applications necessary for his or her job function from a single
application with a consistent look and feel. Cicero integrates the
execution and functionality of a variety of custom or packaged
Windows-based applications. If a software product is designed to provide
output into a Windows GUI environment, Cicero can subordinate its
presentation and control it through the Cicero environment.

. Real-Time Information Center. Cicero is configurable to run a real-time
"information center" including incoming message alerts, scrolling
headlines and real-time video. Any information that is time-sensitive or
actionable can be displayed side-by-side with the currently selected
application page.

. Context Passing. Cicero carries "context" information between shared
applications through a publish and subscribe protocol. Performance
efficiency can be optimized by sharing between applications and
pre-filing commonly used information such as customer account numbers.

. Dynamic Configuration. The Cicero "shell" is constructed at run-time.
Selected screens and user interface components are dynamically created
and initialized. Existing features are easily added or removed.

. Management Tools. Comprehensive tools are built into the system for
version management, automatic component updates and user preference
configuration. Remote control and diagnostic tools are integrated to
provide off-site help desk and troubleshooting.

Deployment of the Cicero solution can provide our customers with the
following key benefits:

. Lower Average Cost Per Call and Average Call Time. Cicero increases the
efficiency of the customer service agent by placing all productivity
applications within a few mouse clicks and consolidating all standard
applications into a single integrated desktop. Cost per call is lowered
because the customer service agent is more productive in moving between
disparate applications and is able to handle different requests without
having to transfer the customer to another customer service agent.

. Reduce Staff Cost. Cicero reduces staff cost in two ways. First, by
increasing the efficiency of each customer service agent, a contact
center can handle the same volume of customer service requests with a
smaller staff. Second, because Cicero simplifies the use of all contact
center applications, training costs and time can be reduced, placing
newly hired staff into productive positions faster than under the current
status quo.

. Increase Cross-Selling Efficiency. The consolidation of all customer
data and customer specific applications can increase the efficiency of
cross-selling of products and services. For instance, a Cicero enabled
contact center might be configured to inform the customer service agent
that the customer, while a brokerage services customer, does not use bill
paying or other offered services. On the other hand, Cicero can help
prevent customer service agents from selling a product that is
inappropriate for that customer or a product or service that the customer
already has through the company. Increasing the efficiency of
cross-selling can both increase revenues and avoid customer
dissatisfaction.

. Deliver Best in Class Customer Service. Increasing customer service is
one of the primary methods by which a company in highly competitive
customer focused industries such as financial services can differentiate
itself from its competition. By increasing the efficiency and training
level of its agents, decreasing average time per call and increasing
effective cross-selling, the Cicero enabled contact center presents its
customers with a more intimate and satisfying customer service experience
that can aid in both customer retention and as a differentiator for
customer acquisition.

. Preserve Existing Information Technology Investment. Cicero integrates
applications at the presentation level, which allows better use of
existing custom designed applications and divergent computing platforms
(e.g., midrange, client/server, LAN and Web), which are not readily
compatible with each other or with legacy mainframe systems. Linking
together the newer computing applications to existing systems helps
preserve and increase the return on the investments made by organizations
in their information technology systems.

Additionally, by visually and structurally linking the flexibility and
innovations available on newer computing platforms and applications to
the rich databases and functions that are typically maintained on the
larger mainframe computers, organizations can utilize this information in
new ways. The Cicero solution helps organizations bridge the gap between
legacy systems and newer platforms and the result is the extension of
existing capabilities to a modern streamlined interface in which the
underlying system architectures, such as the Web, mainframe, mid-range or
client-server, are transparent to the end-user customer service agent,
thereby preserving the existing information technology investment and
increasing efficiency between applications.

. Support a Broad Range of Applications, Platforms and Standards. The IT
departments of larger enterprises need solutions to integrate a broad
array of applications and platforms using a wide variety of industry
standards to ensure ease of implementation and integration with existing
applications. The Cicero solution provides visual application integration
solutions that support common industry standards and can handle a wide
array of disparate applications and data types while operating on a
Windows NT, Windows XP or Windows 2000 platform. The Cicero solution can
be used to link custom or packaged applications together regardless of
the tools or programming language used to create the application by
integrating those applications at the presentation level.

. Ease of Implementation and Enhanced Information Technology
Productivity. The Cicero solution allows contact center and financial
services managers to create comprehensive data transformation and
information exchange solutions without the need for non-standard coding.
Our products provide pre-built adapters for a wide variety of different
systems that are pre-programmed for transforming data into the format
required by that system and transporting it using the appropriate
transport mechanism. This greatly simplifies and speeds implementation of
new solutions into the deployed Cicero framework. For instance, while in
operation at Merrill Lynch, Cicero was updated to include software for
Siebel Systems over a period of only two days when Merrill Lynch decided
to implement the Siebel Systems solution. The Cicero solution allows our
target markets to rapidly integrate new and existing applications with
little or no customization required.

The Geneva Products--Systems Integration and Messaging Solutions

Our Geneva software solutions are a line of products for integrating
enterprise applications both within the enterprise and between
business-to-business partners at the server level. Different computer systems
and applications vary widely in the ways in which they send, receive, view and
process information. As a result, diverse applications running on different
systems cannot work together because information cannot generally be exchanged
between them.

Our Geneva line of products is designed to enable the sharing of information
between disparate systems by automatically transforming the data from one
system into the formats and representations that can be used by other
application systems. This means organizations can link legacy systems to other
legacy systems, to new systems, and also to the Web. In this way, our products
can facilitate the delivery of timely enterprise-wide views of critical
business information while substantially reducing the need for complex and
costly manual programming and ongoing software program modifications.

Our software is flexible enough to link together a wide array of
applications operating on disparate systems, and can scale to meet the
challenges of growth and technological development in even the most
heterogeneous computing environments. Most significantly, our products allow
enterprises to utilize their core system functions for new uses including Web
access. This allows for the full support of eBusiness and eCommerce and closer
relationships with business-to-business partners and suppliers.

Our Geneva line of products enables rapid eBusiness implementations,
reducing installation and integration costs, including the extension of ERP
packages, and provides an open platform for integrating new or acquired
applications, systems or architectures. Furthermore, the Geneva line of
products can be used to link existing operational systems to the Internet,
transmitting communications via the Internet as well as between applications.

Our Strategy

Our short-term goal is to be the recognized global leader in providing
complete desktop level application integration to the financial services
industry. The following are the key elements of our strategy:

. Leverage Our Existing Customers and Experience in the Financial Services
Industry. We have had success in the past with our Geneva products in
the financial services industry. We intend to utilize these long-term
relationships and our understanding of the business to create
opportunities for sales of the Cicero solution.

. Build on Our Successes to Expand into New Markets. Our short-term goal
is to gain a significant presence in the financial services industry with
the Cicero solution. The financial services industry is ideal for Cicero
because each entity has a large base of installed users that use the same
general groups of applications. Cicero, however, can be used in any
industry that has large contact centers, such as telecommunications and
insurance.

. Develop Strategic Partnerships. The critical success factor for
customers implementing Customer Relationship Management (CRM) solutions
in their contact centers is to have the right balance of

technology and service provision. We are implementing a tightly focused
strategic teaming approach with a selected group of well-known
consultancy firms that specialize in financial services as well as eCRM
integrated solutions. Leveraging these organizations, who will provide
such integration services as architecture planning, technology
integration and business workflow improvement, allows us to focus on core
application system needs and how Cicero best addresses them, while our
partners will surround the technology with appropriate industry and
business knowledge.

. Leverage our In-House Expertise in the Cicero Software. Although Cicero
was developed internally by Merrill Lynch for use by approximately 30,000
professionals worldwide, we have added members of the Merrill Lynch
development team to our Cicero development team. We recruited and hired
Anthony Pizi, First Vice President and Chief Technology Officer of
Merrill Lynch's Private Technology's Architecture and Service Quality
Group, and the Cicero project director as our Chairman, Chief Executive
Officer and Chief Technology Officer as well as several of the primary
Cicero engineers from Merrill Lynch to support our ongoing Cicero
development efforts.

Products

Desktop Integration Products--Cicero

Our flagship product, Cicero, runs on Windows NT, Windows XP, and Windows
2000 to organize applications under a book-chapter-section metaphor that keeps
all the application functionality that the user needs within easy reach. For
instance, selecting the "memo" tab might cause a Microsoft Word memo-template
to be created within the Cicero desktop. The end-user need not even know that
they are using Microsoft Word. Moreover, a customer tracking database can be
linked with customer relationship management software package. Virtually any
application that is used in a customer contact center can be integrated under
the Cicero book-chapter metaphor and be used in conjunction with other contact
center applications.

The patented Cicero technology, as exclusively licensed from Merrill Lynch,
consists of several components: The Event Manager, a Component Object Model
(COM)-based messaging service; The Context Manager, which administers the
"publish and subscribe" protocols; The Shell Script Interpreter, which supports
communication with applications that do not support the required COM
interfaces; and The Resource Manager, which starts and shuts down applications
and ensures recovery from system errors. The system is an application bus with
underlying mechanisms to handle the inter-application connections.

Functionally, if an end-user opens an application that uses customer account
number data, Cicero can display all the other customer account number related
applications on his or her desktop, so he or she can move information back and
forth between the relevant applications within the Cicero shell. The company
can change information providers and applications with minimal disruption to
the end-user's ultimate functionality.

Beneath its independent user interface, Cicero provides plug in capabilities
for other applications. All the applications can communicate with each other
through their COM interface or scripting.

Cicero allows end-users to access applications in the most efficient way
possible, by only allowing them to use the relevant portions of that
application. For instance, a contact center customer service representative
does not use 90% of the functionality of Microsoft Word, but might need access
to a memorandum and other custom designed forms as well as basic editing
functionality. Cicero can be set to control access to only those templates and,
in a sense, turn-off the unused functionality by not allowing the end-user
direct access to the underlying application. Under the same Cicero
implementation, however, a different Cicero configuration could allow the
employees in the Marketing department full access to Word because they have
need of the full functionality. The functionality of the applications that
Cicero integrates can be modulated by the business goals of the ultimate
client, the parent company. This ability to limit user access to certain
functions within applications enables companies to reduce their training burden
by limiting the portions of the applications on which they are required to
train their customer service representatives.

Cicero is an ideal product for large customer contact centers. We believe
that Cicero, by combining ease of use, a shorter learning curve and consistent
presentation of information will allow our clients to leverage their exiting
investments in Customer Relationship Management or CRM applications and further
increase customer service, productivity, return on investment and decrease cost
both per seat and across the contact center.

System Integration Products

Our Systems Integration Products include Geneva Enterprise Integrator and
Geneva Business Process Automator.

Geneva Enterprise Integrator. Geneva Enterprise Integrator is an
integration tool that provides unified, real-time views of enterprise business
information for eBusiness applications. Real-time integration of back-end
enterprise business systems with Web-based applications is an essential
component in meeting rising customer expectations of eCommerce, Web-based
customer service and enterprise portal applications. Geneva Enterprise
Integrator also leverages a high performance, memory-based information cache to
provide an infrastructure that will support the performance demands of
Internet-style computing. Geneva Enterprise Integrator is currently being
rewritten in the Java programming language to improve its operability across
platforms and to modernize its functionality. We anticipate that the
Java-enabled version will be completed in the 4th quarter of 2002.

Geneva Business Process Automator. Geneva Business Process Automator is a
product designed for automating the many business processes that an
organization uses to run its operations. Business process automation enables
the automation of information workflows, designed by business experts, and
spanning front and back office systems. Business process automation provides
business analysts with a set of easy-to-use tools for defining, changing and
refining the exchange of information and the workflow for a domain-specific
business process. Geneva Business Process Automator is currently being
rewritten in the Java programming language to improve its operability across
platforms and to modernize its functionality. We anticipate that the
Java-enabled version will be completed in the 4th quarter of 2002.

Messaging and Application Engineering Products

Our Messaging and Application Engineering Products currently includes Geneva
Integration Broker.

Geneva Integration Broker. Geneva Integration Broker is a transport
independent message broker that enables an organization to rapidly integrate
diverse business systems regardless of platform, transport, format or protocol.
The key feature of Geneva Integration Broker is its support for XML and other
standards for open data exchange on the Internet. The product provides a robust
platform for building eBusiness applications that integrate with existing
back-office systems. Geneva Integration Broker's support for open data exchange
and secure Internet transports make it an excellent platform for building
Internet-based business-to-business solutions.

Services

We provide a full spectrum of technical support, training and consulting
services across all of our operating segments as part of our commitment to
providing our customers industry-leading business integration solutions.

Maintenance and Support

We offer customers varying levels of technical support tailored to their
needs, including periodic software upgrades, telephone support and twenty-four
hour, seven days a week access to support-related information via the Internet.

Training Services

Our training organization offers a full curriculum of courses and labs
designed to help customers become proficient in the use of our products and
related technology as well as enabling customers to take full advantage of our
field-tested best practices and methodologies.

Consulting Services

We offer consulting services around our product offerings in project
management, applications and platform integration, application design and
development and application renewal, along with expertise in a wide variety of
development environments and programming languages. We also have an active
partner program in which we recruit leading IT consulting and system
integration firms to provide services for the design, implementation and
deployment of our customer contact center solutions. Our consulting
organization supports third party consultants by providing architectural and
enabling services.

Customers

Approximately 30,000 Merrill Lynch personnel are currently using the Cicero
technology. We licensed the Cicero technology from Merrill Lynch during 2000
and have developed it to initially sell to the financial services industry. We
have recently announced that Nationwide Financial Services has contracted to
install the Cicero technology in its Individual Annuities business unit. We
anticipate the value of this contract to be approximately $750,000.

Our existing Geneva installed customer base includes major corporations
around the world such as Amdocs Software Systems Limited, Paine Webber Inc.,
Siemens Power Transmission & Distribution, Inc., Sikorsky Aircraft Corporation,
Sunrider International, EDB 4tel AS, Wells Fargo Bank, N.A., Winstar Wireless,
Inc. and United Healthcare Services, Inc. Industries that are significantly
represented in our customer base include: financial services, insurance,
retail, manufacturing, telecommunications, transportation, and government. No
one customer accounted for more than ten percent (10%) of operating revenues in
1999. Merrill Lynch and Winstar Wireless, Inc. individually accounted for more
than ten percent (10%) of our operating revenues in 2000. Merrill Lynch holds
approximately seven percent (7%) of our outstanding shares of our common stock
and has an employee as a member of our Board of Directors. No one customer
accounted for more than ten percent (10%) of operating revenues in 2001.

Sales and Marketing

Sales

To reach our potential customer base, we are pursuing several distribution
channels, including a direct sales force, as well as third party relationships
with systems integrators and IT consulting firms.

Our direct sales force focuses on large customers and leverages our industry
experience to access target organizations within the financial services
vertical market. We believe the financial services' market is a business area
to which our products are particularly well suited and that its members possess
the financial resources and scale of operations necessary to support the
engagement.

An important element of our sales strategy is to expand our relationships
with third parties to increase market awareness and acceptance of our business
integration software solutions. As part of these relationships, we will jointly
sell and implement Cicero solutions with strategic partners such as systems
integrators. Level 8 will provide training and other support necessary to
systems integrators to aid in the promotion of our products. To date we have
signed partner agreements with Cisco Systems, Fusive Corp., Pyramid Consulting
Services, Inc., Computer Horizons Corp. and IP blue.

Our direct sales staff has substantial knowledge of our products and service
offerings as well as general experience in the software industry. If we augment
our direct sales force, we will recruit sales people with equivalent general
experience in the software industry and successful track records in selling
enterprise-class software products to the customer contact centers within
enterprise organizations.

We are organized worldwide into two major geographic divisions for sales of
our software products: the Americas and Europe. One general manager heads each
of these sales divisions. The international territories currently include the
United Kingdom, Italy and France. The General Managers' respective operations
include sales and consulting services for new and existing customers.

Approximately $7.1 million or 31% of our 2001 revenues were generated from
the United States. Approximately $15.6 million or 69% was generated outside the
United States. The geographic distribution of our revenues may change in the
future.

Marketing

The target market for our products and services are large companies
providing financial services and or customer relationship management to a large
existing customer base. Increasing competitiveness and consolidation is driving
companies in such businesses to increase the efficiency and quality of their
customer contact centers. As a result, customer contact centers are compelled
by both economic necessity and internal mandates to find ways to increase
internal efficiency, increase customer satisfaction, increase effective
cross-selling, decrease staff turnover cost and leverage their investment in
current information technology.

Our marketing staff has an in-depth understanding of the financial services
customer contact center software marketplace and the needs of customers in that
marketplace, as well as experience in all of the key marketing disciplines. The
staff also has broad knowledge of our products and services and how they can
meet customer needs.

Core marketing functions include product marketing, marketing communications
and strategic alliances. We utilize focused marketing programs that are
intended to attract potential customers in our target vertical and to promote
Level 8 and our brands. Our programs are specifically directed at our target
market such as speaking engagements, public relations campaigns, focused trade
shows and web site marketing, while devoting substantial resources to
supporting the field sales team with high quality sales tools and collateral.
As product acceptance grows and our target markets increase, we will shift to
broader marketing programs. Public relations, which include investor and
industry analysts, are handled by the corporate marketing staff.

The marketing department also produces collateral material for distribution
to prospects including demonstrations, presentation materials, white papers,
case studies, articles, brochures and data sheets. We also intend to implement
a high level strategic partnership program to educate and support our partners
with a variety of programs, incentives and support plans.

As part of our increased focus on the Cicero product line and initially the
financial services customer contact center market, we have significantly
decreased our marketing costs while increasing our marketing focus. We intend
to continue to fine-tune our sales and marketing staff through continued
training to meet our revised needs. We have decreased the marketing and sales
budget to conserve financial resources and appropriately direct expenditures in
line with our revised business strategy.

Research and Product Development

In connection with the narrowing of our strategic focus, and in light of the
sale of our Geneva AppBuilder product line, we anticipate an overall reduction
in research and development costs. We anticipate a continued investment in
research and development costs for both our Cicero and remaining Geneva
products. Since Cicero is a new product in a relatively untapped market, it is
imperative to constantly enhance the feature sets and functionality of the
product.

Our Geneva products were developed under a proprietary language, which,
while protecting the integrity of the intellectual property, also inhibits the
sales process. As such, the Company and Amdocs Software Systems Limited
("Amdocs") have entered into a two-year agreement wherein Amdocs will partly
subsidize the migration of the Geneva Enterprise Integrator and Geneva Business
Process Automator products on the J2EE platform. Under the terms of the
agreement, Amdocs will fund approximately $6.5 million of the development
project, subject to achievement of certain milestones over a two-year period.
As of December 31, 2001, the Company had billed $3,667 of the total $6.5
million under the arrangement.

We incurred research and development expense of $7.9 million, $8.9 million
and $6.8 million in 2001, 2000 and 1999, respectively. The decrease in research
and development costs in 2001 is primarily attributable to the sale of the
AppBuilder line of business on October 1, 2001 offset by increased development
spending on Cicero. Approximately 100 employees including the AppBuilder
software development group were transferred to the new company at that time.
The increase in 2000 was the result of the addition of approximately
thirty-five developers from the acquisition of Template Software, Inc.
("Template").

The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. Our future success will depend to a substantial
degree upon our ability to enhance our existing products and to develop and
introduce, on a timely and cost-effective basis, new products and features that
meet changing customer requirements and emerging and evolving industry
standards.

Our budgets for research and development are based on planned product
introductions and enhancements. Actual expenditures, however, may significantly
differ from budgeted expenditures. Inherent in the product development process
are a number of risks. The development of new, technologically advanced
software products is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends.

The introduction of new or enhanced products also requires us to manage the
transition from older products in order to minimize disruption in customer
ordering patterns, as well as ensure that adequate supplies of new products can
be delivered to meet customer demand. There can be no assurance that we will
successfully develop, introduce or manage the transition to new products.

We have in the past, and may in the future, experience delays in the
introduction of our products, due to factors internal and external to our
business. Any future delays in the introduction or shipment of new or enhanced
products, the inability of such products to gain market acceptance or problems
associated with new product transitions could adversely affect our results of
operations, particularly on a quarterly basis.

Competition

The provision of custom contact center integration software includes a large
number of participants in various segments, is subject to rapid changes, and is
highly competitive. These markets are highly fragmented and served by numerous
firms, many of which address only specific contact center problems and
solutions. Clients may elect to use their internal information systems
resources to satisfy their needs, rather than using those offered by Level 8.

The rapid growth and long-term potential of the market for business
integration solutions to the contact centers of the financial services industry
make it an attractive market for new competition. Many of our current and
possible future competitors have greater name recognition, a larger installed
customer base and greater financial, technical, marketing and other resources
than we have.

Representative Competitors for Cicero

. Portal software offers the ability to aggregate information at a single
point, but not the ability to integrate transactions from a myriad of
information systems on the desktop. Plumtree is a representative company
in the Portal market.

Representative Competitors for Geneva

. In the Enterprise Application Integration market, primary competition
comes from NEON, WebMethods, Tibco, Mercator and IBM.

. In the Business Process Automation market, primary competition comes from
Vitria and IBM.

We believe that our ability to compete depends in part on a number of
competitive factors outside our control, including the ability of our
competitors to hire, retain and motivate senior project managers, the ownership
by competitors of software used by potential clients, the development by others
of software that is competitive with our products and services, the price at
which others offer comparable services and the extent of our competitors'
responsiveness to customer needs.

Intellectual Property

Our success is dependent upon developing, protecting and maintaining our
intellectual property assets. We rely upon combinations of copyright, trademark
and trade secrecy protections, along with contractual provisions, to protect
our intellectual property rights in software, documentation, data models,
methodologies, data processing systems and related written materials in the
international marketplace. In addition, Merrill Lynch holds a patent with
respect to the Cicero technology. Copyright protection is generally available
under United States laws and international treaties for our software and
printed materials. The effectiveness of these various types of protection can
be limited, however, by variations in laws and enforcement procedures from
country to country. We use the registered trademarks "Level 8 Systems" and
"Cicero", and the trademarks "Level 8", "Level 8 Technologies", "Geneva",
"Geneva Integration Suite", "Geneva Integration Broker", "Geneva Enterprise
Integrator", "Geneva Business Process Automator", "SNAP" and "MonitorMQ".

All other product and company names mentioned herein are for identification
purposes only and are the property of, and may be trademarks of, their
respective owners.

There can be no assurance that the steps we have taken will prevent
misappropriation of our technology, and such protections do not preclude
competitors from developing products with functionality or features similar to
our products. Furthermore, there can be no assurance that third parties will
not independently develop competing technologies that are substantially
equivalent or superior to our technologies. Additionally, with respect to the
Cicero line of products, there can be no assurance that Merrill Lynch will
protect its patents or that we will have the resources to successfully pursue
infringers.

Although we do not believe that our products infringe the proprietary rights
of any third parties, there can be no assurance that infringement claims will
not be asserted against our customers or us in the future. In addition, we may
be required to indemnify our distribution partners and end users for similar
claims made against them. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights or to
establish the validity of our proprietary rights. Litigation, either as a
plaintiff or defendant, would cause us to incur substantial costs and divert
management resources from productive tasks whether or not said litigation is
resolved in our favor, which could have a material adverse effect on our
business operating results and financial condition.

As the number of software products in the industry increases and the
functionality of these products further overlaps, we believe that software
developers and licensors may become increasingly subject to infringement
claims. Any such claims, with or without merit, could be time consuming and
expensive to defend and could adversely affect our business, operating results
and financial condition.

Employees

During the first quarter of 2001, we significantly reduced our number of
employees to decrease operating costs and streamline the organization in
connection with our newly focused strategy. As of January 31, 2002, we had a
total of 120 employees. Our continued success is dependant on our ability to
attract and retain qualified employees.

We believe that to fully implement our business plan we will be required to
enhance our ability to work with the Microsoft Windows NT, Windows XP, and
Windows 2000 operating systems by adding additional development personnel.
Although we believe that we will be successful in attracting and retaining
qualified employees to fill these positions, no assurance can be given that we
will be successful in attracting and retaining these employees now or in the
future.

Our employees are not represented by a union or a collective bargaining
agreement.

Forward Looking and Cautionary Statements

Certain statements contained in this Annual Report may constitute "forward
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995 ("Reform Act"). We may also make forward looking statements
in other reports filed with the Securities and Exchange Commission, in
materials delivered to shareholders, in press releases and in other public
statements. In addition, our representatives may from time to time make oral
forward-looking statements. Forward looking statements provide current
expectations of future events based on certain assumptions and include any
statement that does not directly relate to any historical or current fact.
Words such as "anticipates," "believes," "expects," "estimates," "intends,"
"plans," "projects," and similar expressions, may identify such forward looking
statements. In accordance with the Reform Act, set forth below are cautionary
statements that accompany those forward looking statements. Readers should
carefully review these cautionary statements as they identify certain important
factors that could cause actual results to differ materially from those in the
forward-looking statements and from historical trends. The following cautionary
statements are not exclusive and are in addition to other factors discussed
elsewhere in our filings with the Securities and Exchange Commission and in
materials incorporated therein by reference: there may be a question as to our
ability to operate as a going concern, our future success depends on the market
acceptance of the Cicero product and successful execution of the new strategic
direction; general economic or business conditions may be less favorable than
expected, resulting in, among other things, lower than expected revenues; an
unexpected revenue shortfall may adversely affect our business because our
expenses are largely fixed; our quarterly operating results may vary
significantly because we are not able to accurately predict the amount and
timing of individual sales and this may adversely impact our stock price;
trends in sales of our products and general economic conditions may affect
investors' expectations regarding our financial performance and may adversely
affect our stock price; our future results may depend upon the continued growth
and business use of the Internet; we may lose market share and be required to
reduce prices as a result of competition from its existing competitors, other
vendors and information systems departments of customers; we may not have the
ability to recruit, train and retain qualified personnel; rapid technological
change could render the Company's products obsolete; loss of any one of our
major customers could adversely affect our business; our business is subject to
a number of risks associated with doing business abroad including the effect of
foreign currency exchange fluctuations on our results of operations; our
products may contain undetected software errors, which could adversely affect
our business; because our technology is complex, we may be exposed to liability
claims; we may be unable to enforce or defend its ownership and use of
proprietary technology; because we are a technology company, our common stock
may be subject to erratic price fluctuations; and we may not have sufficient
liquidity and capital resources to meet changing business conditions.

Item 2. Properties

Our worldwide corporate headquarters is located in approximately 12,500
square feet in Cary, North Carolina pursuant to a lease expiring in 2004. The
United States operations groups are based in the Cary office, with field
offices under office leases in the following locations: Dulles, Virginia;
Berkeley, California and Princeton, New Jersey. The foreign operations groups
are based in Paris, France with field offices in the following locations:
Uxbridge, United Kingdom and Milan, Italy. We also maintain an office in
Limerick, Ireland on a set fee arrangement. The research and development and
customer support groups are located in Berkeley, California; Princeton, New
Jersey and Dulles, Virginia.

Item 3. Legal Proceedings

From time to time, the Company is a party to routine litigation incidental
to its business. As of the date of this Report, the Company was not engaged in
any legal proceedings that are expected, individually or in the aggregate, to
have a material adverse effect on the Company.

Item 4. Submission of Matters to a Vote of Security Holders

None.

PART II

Item 5. Market For Registrant's Common Stock and Related Shareholder Matters.

Our common stock has been traded on the Nasdaq Stock Market under the symbol
"LVEL" Since 1996. We have never declared or paid any cash dividends on our
common stock. We anticipate that all of our earnings will be retained for the
operation and expansion of our business and do not anticipate paying any cash
dividends for common stock in the foreseeable future. The chart below sets
forth the high and low stock prices for the quarters of the fiscal years ended
December 31, 2000 and 2001.

2000 2001
------------- -----------
Quarter High Low High Low
------- ------ ------ ----- -----

First.. $49.13 $29.50 $6.38 $2.39
Second. $47.50 $11.25 $3.25 $2.75
Third.. $27.81 $16.00 $4.99 $1.45
Fourth. $18.50 $ 5.00 $3.10 $1.20

The closing price of the common stock on December 31, 2001 was $2.74 per
share. As of March 22, 2002, we had 177 registered shareholders of record.

Recent Sales of Unregistered Securities

On May 21, 2001, the Company issued Arik Kilman, former CEO and Chairman of
the Company, 250,000 shares of common stock as part of Mr. Kilman's severance
agreement with the Company. Such shares were issued in reliance upon the
exemption from registration under Rule 506 of Regulation D and on the exemption
from registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.

In October 2001, the Company entered into an exchange agreement with its
existing preferred shareholders. Under the terms of the agreement, the holders
of the Series A and Series B 4% convertible redeemable preferred stock and
related common stock warrants received an equal number of preferred shares of
the new Series A1 and Series B1 convertible redeemable preferred stock and
related warrants. The conversion price of both the Series A1 and Series B1
preferred stock was reduced by 16.7% and 50% respectively, which increased the
number of shares of common stock to be issued upon conversion of the preferred
shares by 1,428,512 shares to a total of 3,782,519 shares. Additionally, the
exercise price for the warrants received in the exchange was reduced to $1.77
per share and the call prices have been reduced accordingly to $5.00 per share
for the Series A1 warrants and $7.50 per share for the Series B1 warrants. At
total of 1,801,022 warrants were exchanged. The shares issued pursuant to the
exchange agreement were issued in reliance upon the exemption from registration
provided by Section 3(a)(9) of the Securities Act of 1933 for an exchange by an
issuer with its exiting security holders.

In December 2001, the Company issued 141,658 shares of common stock to a
former reseller of the company as part of a settlement agreement with that
company. Such shares were issued in reliance upon the exemption from
registration under Rule 506 of Regulation D and on the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.

At December 31, 2001, the Company had received approximately $1.6 million in
interest free bridge financing, which was convertible to common stock subject
to closing conditions. This amount has been reflected in the accompanying
consolidated balance sheet as long-term debt.

exercise price of $2.75 per share. This offering closed on January 16, 2002. Of
the 3,000,000 shares, the Company sold 2,381,952 shares of common stock for a
total of $3.5 million and granted 476,396 warrants to purchase the Company's
common stock at an exercise price of $2.75 per share. The warrants expire in
three years from the date of grant and have a call feature that forces exercise
if the Company's common stock exceeds $5.50 per share. These shares were issued
in reliance upon the exemption from registration under Rule 506 of Regulation D
and on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933 for transactions by an issuer not involving a public
offering.

Subsequent to December 31, 2001, the Company entered into a purchase
agreement with MLBC, Inc., an affiliate of Merrill Lynch. Pursuant to the
Purchase Agreement, we have issued 250,000 shares of our common stock to MLBC,
Inc. These shares were issued in reliance on the exemption from registration
under Rule 506 of Regulation D and on the exemption from registration provided
by Section 4(2) of the Securities Act of 1933 for transactions by an issuer not
involving a public offering.

Item 6. Selected Financial Data.

The following selected financial data is derived from the consolidated
financial statements of the Company. The data should be read in conjunction
with the consolidated financial statements, related notes, and other financial
information included herein.

See Item 7 for a discussion of the entities included in operations.

Year Ended December 31,
(in thousands, except per share data)
-----------------------------------------------
1997 1998 1999 2000 2001
------- -------- -------- -------- ---------

SELECTED STATEMENT OF OPERATIONS DATA
Revenue......................................... $14,680 $ 10,685 $ 52,920 $ 82,591 $ 22,659
Net income (loss) from continuing operations.... $ 1,036 $(23,688) $(15,477) $(28,367) $(105,135)
Net income (loss) from continuing operations per
common and common equivalent share--basic..... $ .15 $ (3.14) $ (1.78) $ (2.10) $ (6.65)
Net income (loss) from continuing operations per
common and common share--diluted.............. $ .13 $ (3.14) $ (1.78) $ (2.10) $ (6.65)
Weighted average common and common equivalent
Shares outstanding--basic..................... 6,992 7,552 8,918 14,019 15,958
Weighted average common and common equivalent
Shares outstanding--diluted................... 7,561 7,552 8,918 14,019 15,958

At December 31,
-------------------------------------------
1997 1998 1999 2000 2001
------- -------- ------- -------- -------

SELECTED STATEMENT OF OPERATIONS DATA
Working capital (deficiency)........................... $15,826 $(19,554) $ (36) $ 28,311 $(4,968)
Total assets........................................... 23,482 70,770 133,58 169,956 35,744
Long-term debt, net of current maturities.............. 16 1,541 22,202 25,000 4,600
Loans from related companies, net of current maturities 202 12,519 4,000 -- --
Stockholders' equity................................... 20,371 8,892 72,221 117,730 13,893

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.

General Information

Level 8 Systems is a global provider of business integration software that
enables organizations to integrate new and existing information and processes
at the desktop with Cicero and at the server level with the Geneva Integration
products. Business integration software addresses the emerging need for a
company's information systems to deliver enterprise-wide views of the company's
business information processes.

In addition to software products, Level 8 also provides technical support,
training and consulting services as part of its commitment to providing its
customers industry-leading integration solutions. Level 8's worldwide
consulting team has in-depth experience in developing successful
enterprise-class solutions as well as valuable insight into the business
information needs of customers in the Global 5000. Level 8 offers services
around its integration software products.

This discussion contains forward-looking statements relating to such matters
as anticipated financial performance, business prospects, technological
developments, new products, research and development activities, liquidity and
capital resources and similar matters. The Private Securities Litigation Reform
Act of 1995 provides a safe harbor for forward-looking statements. In order to
comply with the terms of the safe harbor, the Company notes that a variety of
factors could cause its actual results to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. See ''Item 1. Business--Forward Looking and
Cautionary Statements.''

The Company's results of operations include the operations of the Company
and its subsidiaries. Operations for the subsidiaries acquired during 2000 and
1999 are included from the date of acquisition. Accordingly, the 2001, 2000,
and 1999 results of operations include the operations of StarQuest Software,
Inc. ("StarQuest"), Template, Seer, and Momentum Software Corporation
("Momentum") since November 28, 2000, December 27, 1999, December 31, 1998, and
March 26, 1998, respectively. Unless otherwise indicated, all information is
presented in thousands ('000s) except share amounts.

As a result of the Company's acquisition activity, the nature of its
operations has changed significantly from 1998 to 2001. In March 1998 the
Company acquired Momentum, primarily for its XIPC messaging product. The XIPC
product has been sold on a stand-alone basis as well as incorporated into the
Company's Geneva Message Queuing product, which was internally developed. The
acquisition of Seer in December 1998 provided the Seer*HPS application
engineering technology as well as significant international operations.
Seer*HPS was subsequently renamed Geneva AppBuilder. In early 1999, the Company
introduced its first Enterprise Application Integration ("EAI") product, Geneva
Integration Broker, which was developed internally. As the Company moved more
solidly into the EAI market, it acquired Template in December 1999. The
acquisition of Template primarily provided the Company its Enterprise
Integration Template and Business Process Template and additional experienced
services professionals trained on Template's products. These products were
subsequently renamed Geneva Enterprise Integrator and Geneva Business Process
Automator. The Company disposed of certain Template consulting operations
during early 2000, which were not related to its products and determined to be
non-strategic to the Company's future.

In August 2000, the Company acquired the rights to Cicero, a
comprehensive integrated desktop computer environment from Merrill Lynch,
Pierce, Fenner & Smith Incorporated in exchange for 1,000,000 shares of its
common stock valued at $22,750. The cost of the technology acquired has been
capitalized and amortized over a three year period.

In November 2000, the Company acquired StarQuest. The total purchase price
of the acquisition was $11,638 and has been accounted for by the purchase
method of accounting. As a result of the acquisition of StarQuest, the Company
gained an additional product that would enhance its ability to provide
integration to Cisco platforms.

Due to the Company's acquisition and divestiture activities, year-to-year
comparisons of results of operations are not necessarily meaningful.
Additionally, as a result of the Company's pursuit of a growth strategy
focusing on its software product sales and synergies gained as a result of
eliminating duplicative functions, the results of operations are significantly
different than the result of combining the previous operations of each acquired
company into Level 8. Pro forma comparisons are therefore not necessarily
meaningful either. In 2001, the Company shifted its primary focus from selling
multiple Enterprise Application Integration ("EAI") products to selling Cicero,
a desktop integration package, to the financial services industry with a
decreased focus on services. Further, during the last two fiscal quarters of
2001, the Company sold most of the products that comprised its Messaging and
Application Engineering segment and thus will have significantly reduced
revenue streams within that segment.

Business Strategy

During the second quarter of 2001, management reassessed how the Company
would be managed and how resources would be allocated. Management now makes
operating decisions and assesses performance of the Company's operations based
on the following reportable segments: (1) Desktop Integration Products, (2)
System Integration Products and (3) Messaging and Application Engineering
Products. Previous reportable segments were: (1) software, (2) maintenance, (3)
services, and (4) research and development.

The principal product in the Desktop Integration segment is Cicero. Cicero
is a business integration software product that maximizes end-user
productivity, streamlines business operations and integrates disparate systems
and applications.

The products that make up the Systems Integration segment are Geneva
Enterprise Integrator and Geneva Business Process Automator. Geneva Enterprise
Integrator is an integration tool that provides unified, real-time views of
enterprise business information for eBusiness applications. Geneva Business
Process Automator is a product designed to work with Geneva Enterprise
Integrator for automating the many business processes that an organization uses
to run its operations and enables the automation of information workflows
spanning front and back office systems.

The products that comprise the Messaging and Application Engineering segment
are Geneva Integration Broker, Geneva Message Queuing, Geneva XIPC and Geneva
AppBuilder. Geneva Integration Broker is a transport independent message broker
that enables an organization to rapidly integrate diverse business systems
regardless of platform, transport, format or protocol. Geneva Message Queuing
is an enterprise connectivity product for Microsoft and non-Microsoft
applications. The primary use is for transactional, once and only once
connectivity of Window-based Web applications to back-office information
resources like mainframes and other legacy systems. Geneva XIPC provides
similar delivery of information between applications. While Geneva Message
Queuing is based around a Microsoft standard, Geneva XIPC is for use with Linux
and other brands of UNIX operating systems. Geneva AppBuilder is a set of
application engineering tools that assists customers in developing, adapting
and managing enterprise-wide computer applications for the Internet/intranets
and client/server networks.

On October 1, 2001, the Company completed the sale of its Geneva AppBuilder
product. Under the terms of the agreement, the Company sold the rights, title
and interest in the Geneva AppBuilder product along with all receivables,
unbilled and deferred revenues as well as all maintenance contracts. The Geneva
AppBuilder product accounted for approximately 79% of total revenue within the
Messaging and Application Engineering segment and approximately 59% of total
revenue for all segments. As more fully described in Notes 3 and 8 to the
Consolidated Financial Statements, the Company received approximately $19
million in cash plus a note receivable for $1 million due February 2002. The
Company subsequently liquidated $22 million of its short-term debt using the
proceeds received and cash on hand. As part of the sale transaction,
approximately 100 employees were transferred over to the acquiring company who
also assumed certain facility and operating leases and entered into a sublease
arrangement at the Cary, North Carolina facility. While future revenues will be
negatively impacted by the sale of Geneva AppBuilder, the associated costs of
doing business will be positively impacted by the overall reduction in
operating costs.

During the quarter ended September 30, 2001, the Company sold two of its
messaging products--Geneva Message Queuing and Geneva XIPC to Envoy
Technologies, Inc. for $50 in cash and a note receivable for $400. Under the
terms of the agreement, Envoy acquired all rights, title and interest to the
products along with all customer and maintenance contracts.

Results of Operations

The following table sets forth, for the years indicated, the Company's
results of continuing operations expressed as a percentage of revenue.

Year Ended December 31,
----------------------
2001 2000 1999
------ ----- -----

Revenue:
Software............................ 10.4 % 55.7 % 30.3 %
Maintenance......................... 50.0 % 19.3 % 28.3 %
Services............................ 39.6 % 25.0 % 41.4 %
------ ----- -----
Total........................... 100.0 % 100.0 % 100.0 %
Cost of revenue:
Software............................ 73.5 % 11.9 % 8.0 %
Maintenance......................... 16.4 % 6.9 % 10.2 %
Services............................ 34.5 % 22.6 % 36.4 %
------ ----- -----
Total........................... 124.4 % 41.4 % 54.6 %
Gross profit........................... (24.4)% 58.6 % 45.4 %
Operating expenses:
Sales and marketing................. 59.5 % 42.6 % 22.7 %
Research and product development.... 35.1 % 10.7 % 12.8 %
General and administrative.......... 54.9 % 15.3 % 12.9 %
Amortization intangible assets...... 45.1 % 17.2 % 13.2 %
In-process research and development. 0.0 % 2.2 % 5.6 %
Write-off of intangible assets...... 193.5 % -- --
Loss on disposal of asset........... (28.0)% 0.5 % --
Restructuring, net.................. 38.2 % -- 0.7 %
------ ----- -----
Total........................... 398.3 % 88.5 % 67.9 %
Loss from operations................ (422.7)% (29.9)% (22.5)%
Other income (expense), net......... (39.1)% (3.1)% (5.4)%
------ ----- -----
Loss before taxes................... (461.8)% (33.0)% (27.9)%
Income tax provision................ 2.2 % 1.3 % 1.4 %
------ ----- -----
Net loss............................ (464.0)% (34.3)% (29.3)%
====== ===== =====

The following table sets forth unaudited data for total revenue by
geographic origin as a percentage of total revenue for the periods indicated:

2001 2000 1999
---- ---- ----

United States 31% 54% 33%
Europe....... 60% 35% 56%
Asia Pacific. 3% 2% 7%
Middle East.. 4% 8% 3%
Other........ 2% 1% 1%
--- --- ---
Total..... 100% 100% 100%
=== === ===

The table below presents information about reported segments for the twelve
months ended December 31, 2001:

Desktop Systems Messaging/Application
Integration Integration Engineering TOTAL
----------------- ----------------- --------------------- -----------------
December 31, 2001 December 31, 2001 December 31, 2001 December 31, 2001
Twelve Months Twelve Months Twelve Months Twelve Months
Ended Ended Ended Ended
----------------- ----------------- --------------------- -----------------

Total revenue........... $ 134 $ 5,744 $16,781 $ 22,659
Total cost of revenue... 9,427 5,103 13,667 28,197
Gross profit/(loss)..... (9,293) 641 3,114 (5,538)
Total operating expenses 18,858 7,840 7,179 33,877
EBITA................... $(28,151) $(7,199) $(4,065) $(39,415)

A reconciliation of segment operating expenses to total operating expense
for fiscal year 2001:

2001
-------

Segment operating expenses....... $33,877
Amortization of intangible assets 10,212
Impairment of intangible assets.. 43,853
(Gain)/loss on disposal of assets (6,346)
Restructuring, net............... 8,650
-------
Total operating expenses......... $90,246
=======

The table below presents information about previously reported segments for
the fiscal years ended December 31:

2001 2000 1999
---------------- ---------------- ---------------
Total Total Total Total Total Total
Revenue EBITA Revenue EBITA Revenue EBITA
------- -------- ------- -------- ------- -------

Software................ $ 2,367 $(35,120) $45,998 $ (6,338) $16,030 $(2,549)
Maintenance............. 11,328 5,987 15,967 9,312 14,981 8,819
Services................ 8,964 (2,336) 20,626 (958) 21,909 (116)
Research and development -- (7,946) -- (10,324) -- (7,767)
------- -------- ------- -------- ------- -------
Total................... $22,659 $(39,415) $82,591 $ (8,308) $52,920 $(1,613)
======= ======== ======= ======== ======= =======

A reconciliation of total segment EBITA to net loss for the fiscal years
ended December 31:

2001 2000 1999
--------- -------- --------

Total EBITA............................... $ (39,415) $ (8,308) $ (1,613)
Amortization of intangible assets......... (10,212) (14,191) (6,959)
Impairment of intangible assets........... (43,853) -- --
Gain/(loss) on disposal of assets......... 6,346 (379) --
In-process research and development....... -- (1,800) (2,944)
Restructuring............................. (8,650) -- (383)
Interest and other income/(expense), net.. (8,850) (2,626) (2,858)
--------- -------- --------
Net loss before provision for income taxes $(104,634) $(27,304) $(14,757)
========= ======== ========

EBITA represents loss before income taxes, interest and other income
(expense), amortization of goodwill, restructuring charges, gain (loss) on sale
of assets and impairment charges. The Company uses EBITA to measure segment
performance and profitability. EBITA is not a measure of performance under
accounting principles generally accepted in the United States of America, and
should not be considered as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared in
accordance with accounting principles generally accepted in the United States
of America, or as a measure of profitability or liquidity. We have included
information concerning EBITA one measure of our cash flow and historical
ability to service debt and because we believe investors find this information
useful. EBITA as defined herein may not be comparable to similarly titled
measures reported by other companies.

Years Ended December 31, 2001, 2000, and 1999

Revenue and Gross Margin. The Company has three categories of revenue:
software products, maintenance, and services. Software products revenue is
comprised primarily of fees from licensing the Company's proprietary software
products. Maintenance revenue is comprised of fees for maintaining, supporting,
and providing periodic upgrades to the Company's software products. Services
revenue is comprised of fees for consulting and training services related to
the Company's software products.

The Company's revenues vary from quarter to quarter, due to market
conditions, the budgeting and purchasing cycles of customers and the
effectiveness of the Company's sales force. The Company typically does not have
any material backlog of unfilled software orders and product revenue in any
quarter is substantially dependent upon orders received in that quarter.
Because the Company's operating expenses are based on anticipated revenue
levels and are relatively fixed over the short term, variations in the timing
of the recognition of revenue can cause significant variations in operating
results from quarter to quarter. Fluctuations in operating results may result
in volatility of the price of the Company's common stock.

Total revenues decreased 73% in 2001 from 2000 and increased 56% from 1999
to 2000. The significant decrease in revenues in 2001 is the result of the
Company's new focus on its newly developed Cicero product, the redevelopment of
the Geneva Enterprise Integrator and Business Process Automator products under
the J2EE platform which has delayed sales of such products, the sale of
substantially all of its Messaging and Application Engineering products as well
as a general slowing of the economy. The increase in revenues in 2000 over 1999
is primarily attributable to the acquisitions of companies and technologies
disclosed above. Gross profit margins were (24)%, 59% and 45% for 2001, 2000,
and 1999, respectively.

Software Products. Software product revenue decreased approximately 95% in
2001 from those results achieved in 2000 and increased 187% in 2000 as compared
to 1999. The substantial decrease in 2001 is the direct result of the Company's
change in strategic focus to the Cicero product and the desktop integration
market, a general slowing of the economy and the sale of the Messaging and
Application Engineering products during the year. The increase in revenues in
fiscal 2000 from fiscal 1999 is primarily attributable to the impact of the
acquisitions discussed earlier. For the twelve months ended December 31, 2001,
the Systems Integration segment accounted for 25% of total revenues while the
Messaging and Application Engineering segment accounted for 74% of revenues.
The Company changed its approach to managing and analyzing the business in May
2001 and adopted the line of business approach. Accordingly, there is no
comparative data for the year ending December 31, 2000.

The gross margin on software products was (604)%, 79% and 74% for the 2001,
2000 and 1999 years ended, respectively. Cost of software is composed primarily
of amortization of software product technology, amortization of capitalized
software costs for internally developed software and royalties to third
parties, and to a lesser extent, production and distribution costs. The
increase in cost of software was primarily due to amortization of capitalized
software from the acquisition of the Cicero technology and StarQuest which was
purchased in the third and fourth quarters of 2000, respectively and the $3,070
write-down of CTRC software to its net realizable value during the third
quarter of 2001. The increase in gross margin dollars in fiscal 2000 from
fiscal 1999 is the result of significant increases in product revenue from the
Seer and Template acquisitions.

The software product gross margin for the Desktop Integration segment was
(19,602)%. The software product gross margin for the Systems Integration
segment was (210)%. The software product gross margin on the Messaging and
Application Engineering segment was (312)%. The Systems Integration and
Messaging and Application Engineering segments experienced relatively high
amounts of amortization of capitalized software.

The Company expects to see significant increases in software sales related
to the Desktop Integration segment coupled with improving margins on software
products as Cicero gains acceptance in the marketplace. The Systems Integration
segment revenue is anticipated to increase slightly from fiscal 2001 levels
with gross margin remaining relatively consistent. The Messaging and
Application Engineering segment revenue is expected to decrease significantly
along with related expenses as the majority of the products comprising this
segment have been sold.

Maintenance. Maintenance revenue for the year ended December 31, 2001
decreased by approximately 29% or $4,639 as compared to the results for the
year ended December 31, 2000. The decline in overall maintenance revenues is
primarily due to the sale of the majority of the Messaging and Application
Engineering products at the beginning of the fourth quarter of 2001 as well as
the attrition effect of maintenance customers not offset by new product sales.

The Desktop Integration segment accounted for approximately .5% of total
maintenance revenue for the year as Cicero was not launched until the late
summer. The Systems Integration segment accounted for 64.4% of total
maintenance revenues and the Messaging and Application Engineering segment
accounted for approximately 35.1% of total maintenance revenues.

Cost of maintenance is comprised of personnel costs and related overhead and
the cost of third-party contracts for the maintenance and support of the
Company's software products. Gross margins on maintenance products increased
slightly for the year ended December 31, 2001 to 67%, up from 64% in the
previous two years.

The Desktop Integration segment had a negative gross margin for the year
ended December 31, 2001 as the Cicero product is still in its infancy. The
Systems Integration segment had a gross margin of 76.7% for the year while the
Messaging and Application Engineering segment had a gross margin of 69.6% for
the year. As above, the Company adopted the line of business approach in
managing its operations in April 2001 and as such, there is no comparative data
for prior years.

Maintenance revenues are expected to increase, primarily in the Desktop
Integration segment and the System Integration segment. The majority of the
products comprising the Messaging and Application Engineering segment have been
sold and thus future revenues will be significantly lower as will the cost of
maintenance associated with this segment. The cost of maintenance should
increase slightly for the Desktop Integration segment while remaining constant
for the System Integration segment.

Services. Services revenue for the year ended December 31, 2001 decreased
by approximately 57% over the same period in 2000 and decreased by 6% in 2000
from 1999. The decline in service revenues in 2001 is primarily attributable to
the decline in software sales as well as a reduction in capacity. The decline
in service revenues in 2000 from those achieved in 1999 is attributable to a
general under utilization of service personnel in the period.

The Systems Integration segment accounted for approximately 33% of the total
services revenue while the Messaging and Application Engineering segment
accounted for approximately 67% of service revenue.

Cost of services primarily includes personnel and travel costs related to
the delivery of services. Services gross margins were 13%, 10% and 12% for the
years ended 2001, 2000 and 1999 respectively.

Services revenues are expected to increase for the Desktop Integration
segment as the Cicero product gains acceptance. The service revenues in the
System Integration segment are expected to remain fairly constant with improved
margins from a more efficient utilization of personnel. The Messaging and
Application Engineering segment service revenues will decrease dramatically as
the majority of the relevant products have been sold.

Sales and Marketing. Sales and marketing expenses primarily include
personnel costs for salespeople, marketing personnel, travel and related
overhead, as well as trade show participation and promotional expenses. Sales
and marketing expenses decreased by 62% or approximately $21,692 due to a
reduction in the Company's sales and marketing workforce as well as decreased
promotional activities. Sales and marketing expenses increased by 193% or
approximately $23,168 in 2000 due to increased promotional costs resulting from
the Seer and Template acquisitions.

Sales and marketing expenses are expected to continue to decrease along all
product lines, primarily due to the restructuring efforts completed in the
first and second quarters of 2001. The Company's emphasis for the sales and
marketing groups will be the Desktop Integration segment.

Research and Development. Research and development expenses primarily
include personnel costs for product authors, product developers and product
documentation and related overhead. Research and development expense decreased
by 10% in 2001 over the same period in 2000 and increased by 30% in 2000 as
compared to the same period in 1999. The decrease in costs in 2001 are the
result of the restructuring efforts completed during the first two quarters of
that year and the ability to capitalize certain development costs during the
year. The increase in costs in 2000 as compared to 1999 is the result of
increased head counts in the development staff as a result of the Template
Software acquisition.

The Company intends to continue to make a significant investment in research
and development while enhancing efficiencies in this area.

General and Administrative. General and administrative expenses consist of
personnel costs for the executive, legal, financial, human resources, IT and
administrative staff, related overhead, and all non-allocable corporate costs
of operating the Company. General and administrative expenses for the year
ended December 31, 2001 decreased by 2% over the prior year. In fiscal 2000,
general and administrative expenses increased by 86%. Although the percentage
increase in general and administrative costs for fiscal 2001 was minimal, the
expenses do include a charge of approximately $3.8 million from a significant
customer who filed for Chapter 11 Bankruptcy. The increase in general and
administrative expenses in 2000 from 1999 is the result of increased
professional fees and personnel costs primarily from the Company's acquisition
activities.

General and administrative expenses are expected to decrease going forward
primarily due to the restructuring plan implemented in the first two quarters
of 2001 as well as a reduction in costs associated with the sale of Geneva
AppBuilder, which was sold on October 1, 2001.

Amortization of Goodwill and Other Intangible Assets. Amortization of
goodwill and other intangible assets was $10.2 million, a decrease of 28% over
the same period in 2000. The reduction in amortization expense is primarily
attributable to the sale of Geneva AppBuilder on October 1, 2001 as well as the
effect of an impairment on the intangible assets acquired from Template
Software and an impairment on the intangible assets acquired from StarQuest. At
December 31, 2001, there is no remaining goodwill on the Company's balance
sheet.

Restructuring. In the first quarter of 2001, the Company announced and
began implementation of an operational restructuring to reduce its operating
costs and streamline its organizational structure. As a result of this
initiative, the Company recorded restructuring charges of $6,650 during the
quarter ended March 31, 2001 and an additional charge of $2,000 for the quarter
ended June 30, 2001. Restructuring charges have been classified in
"Restructuring" on the consolidated statements of operations. This operational
restructuring involves the reduction of employee staff throughout the Company
in all geographical regions in sales, marketing, services, development and all
administrative functions.

The restructuring plan included the termination of 191 employees, all of
whom had been notified by June 30, 2001 and terminated by December 31, 2001.
The plan included a reduction of 83 personnel in the European operations and
108 personnel in the US operations. Employee termination costs comprised of
severance-related payments for all employees terminated in connection with the
operational restructuring. Termination benefits do not include any amounts for
employment-related services prior to termination.

Premises obligations primarily relate to the continuation of lease
obligations, brokers commissions and leasehold improvements for approximately
60,000 square feet of facilities no longer deemed necessary and costs to exit
short-term leases for various sales offices. Amounts expensed relating to lease
obligations represent estimates of undiscounted future cash outflows, offset by
anticipated third-party sub-lease payments.

Marketing obligations related to contracts and services relating to the
prior focus of the Company and are no longer expected to be utilized.

Other miscellaneous restructuring costs include professional fees, royalty
commitments, recruiting fees, excess equipment and other miscellaneous expenses
directly attributable to the restructuring.

The following table sets forth a summary by category of accrued expenses and
cash paid as of December 31, 2001:

Expense Non-Cash Cash Paid Accrued
------- -------- --------- -------

Employee termination................... $5,319 $(1,045) $(4,231) $ 43
Excess office facilities............... 2,110 (156) (1,307) 647
Marketing obligations.................. 288 -- (235) 53
Royalty commitments.................... 725 (360) (365) --
Other miscellaneous restructuring costs 208 -- (98) 110
------ ------- ------- ----
Total.................................. $8,650 $(1,561) $(6,236) $853
====== ======= ======= ====

The Company believes the accrued restructuring costs of $853 of December 31,
2001 represents its remaining cash obligations for the restructuring charges
indicated above.

During the fourth quarter of 1999, the Company reorganized its existing
operations due to its acquisition of Template. The Company's restructuring
included a management change in its development and operations areas, the
abandonment of certain leased facilities, and closure of its French subsidiary.
The Company recorded a restructuring charge of $.55 million, which consisted of
approximately $.28 million in costs associated with improving leased space to
be subleased, approximately $.23 million in personnel-related charges, and
approximately $.04 million in legal and accounting fees to close its French
subsidiary.

Impairment of Intangible Assets. In May 2001, management reevaluated and
modified its approach to managing the business and opted to conduct business
and assess the performance of operations under a line-of-business approach. As
such, the Company performed an assessment of the recoverability of its
long-lived assets under a line-of-business approach, representing a change in
accounting principle inseparate from the effect of the change in accounting
estimates. This represents an accounting change from the Company's previous
policy of assessing impairment of intangible assets at the enterprise level
which is accounted for as a change in estimate.

The change is reflects management's changed approach to managing the business.
The results of an analysis of undiscounted cash flows for each reporting
segment indicated that an impairment had occurred in the Systems Integraton
segment (i.e. intangible assets acquired in the Template acquisition). The
Company then estimated the fair market value of the related assets through a
discounted future cash flow valuation technique. The results of this analysis
indicated that the carrying values of these assets exceeded their fair market
values. The Company reduced the carrying value of these intangible assets by
approximately $21,824 as of March 31, 2001 which approximates a net income
affect of $1.37 per share.

During the third quarter of 2001, the Company was notified by one of its
resellers that they would no longer engage in re-sales of the Company's CTRC
product, a component of the Messaging and Application Engineering segment. This
reseller accounted for substantially all of the CTRC product sales. As a
result, the Company performed an assessment of the recoverability of the
Messaging and Application Engineering segment. The results of the Company's
analysis of undiscounted cash flows indicated an impairment. The Company
estimated the fair market value of the related assets through a discounted
future cash flow valuation technique. The results of this analysis indicated
the carrying value of these intangible assets exceeded their fair market
values. The Company has reduced the carrying value of the intangible assets and
software product technology by approximately $7,929 and 3,070, respectively, as
of September 30, 2001.

At December 31, 2001, the Company reassessed the recoverability of its
long-lived assets. Using actual undiscounted cash flows where applicable and
adjusting projections to reflect updated market conditions and industry trends,
the Company identified that a further impairment had occurred with regards to
the intangible assets recorded in the Systems Integration segment. Using a
discounted future cash flow technique, it was determined that the carrying
value of these assets exceeded their fair market value by approximately
$14,100. Accordingly, the Company reduced the carrying value of those
intangible assets by that amount at December 31, 2001.

Provision for Taxes. The Company's effective income tax rate for continuing
operations differs from the statutory rate primarily because an income tax
benefit was not recorded for the net loss incurred in 2001 or 2000. Because of
the Company's inconsistent earnings history, the deferred tax assets have been
fully offset by a valuation allowance. The income tax provision for the year
ended December 31, 2001 is primarily related to income taxes from profitable
foreign operations and foreign withholding taxes.

EBITA. EBITA represents loss before income taxes, interest and other income
(expense), amortization of goodwill, restructuring charges, gain (loss) on sale
of assets, and impairment charges. EBITA for the twelve months ended December
31, 2001 was ($39.4) million as compared to ($8.3) million for the same period
of the previous year. The increase in the loss before income taxes, interest
and other income and expense, amortization of goodwill, restructuring charges,
gain or loss on sale of assets and impairment charges is primarily attributable
to the decline in revenues as noted above.

EBITA is not a measure of performance under accounting principles generally
accepted in the United States of America, and should not be considered as a
substitute for net income, cash flows from operating activities and other
income or cash flow statement data prepared in accordance with accounting
principles generally accepted in the United States of America, or as a measure
of profitability or liquidity. We have included information concerning EBITA
one measure of our cash flow and historical ability to service debt and because
we believe investors find this information useful. EBITA as defined herein may
not be comparable to similarly titled measures reported by other companies.

Impact of Inflation. Inflation has not had a significant effect on the
Company's operating results during the periods presented.

Liquidity and Capital Resources

Operating and Investing Activities

The Company utilized $23.2 million of cash for the twelve months ended
December 31, 2001.

Operating activities utilized approximately $19.4 million of cash, which is
primarily comprised of the loss from operations of $105 million, offset by
non-cash charges for depreciation and amortization of approximately $27.8
million and non-cash charges for impairment of intangible assets and software
product technology of $46.9 million, $3.8 million for the realized loss on
certain marketable securities, and a provision for bad debts in the amount of
$3.8 million. In addition, the company, had a reduction in accounts receivable
of $10.5 million and used approximately $5.3 million in fulfillment of its
obligations to its creditors through its accounts payable.

On April 18, 2001, a significant customer voluntarily filed for protection
under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for
the District of Delaware. Due to the uncertainty of collection of this debt,
the Company wrote-off $3.8 million of related accounts receivable, which was
charged to general and administrative expenses in the consolidated statements
of operations.

The Company generated approximately $20.2 million in cash from investing
activities, which is comprised of approximately $19.8 million in proceeds from
the sale of assets, including Geneva AppBuilder, and $2.2 million from assets
being held for resale offset by capitalization of product software technology
of $2.3 million. Geneva AppBuilder accounted for approximately 79% of total
revenue within the Messaging and Application Engineering segment and
approximately 59% of total revenue for all segments. The Messaging and
Application Engineering segment for the year ended December 31, 2001 generated
EBITA of $(4,065).

The Company utilized approximately $23.6 million of cash during the year for
financing activities for the payment of bank debt ($24.0 million) and the
payment of dividends (approximately $1.3 million) offset by $1.6 million from
bridge financing arrangements.

By comparison, in 2000, the Company generated approximately $17.3 million in
cash during the year.

Net cash used in operations during 2000 was approximately $5.9 million,
which is primarily comprised of the net loss for the period of $28.4 million
and approximately $4.7 million for fulfillment of vendor obligations and
restructuring charges, offset by non-cash charges for depreciation and
amortization of approximately $26.1 million, a provision for doubtful accounts
of approximately $.5 million and a $2.3 million reduction in accounts
receivable.

Net cash used for investing activities during 2000 was $8.6 million which
consisted of approximately $4.0 million for the purchase of marketable
securities, approximately $2.0 million for capital equipment purchases, an
investment in a privately held concern for approximately $.4 million,
capitalization of software technology of approximately $.7 million and
approximately $2.6 million for businesses acquired offset by $1.8 million of
cash received from those acquisitions.

Financing Activities

The Company funded its cash needs during the year ended December 31, 2001
with cash on hand from December 31, 2000 and with cash from operations.

The Company has a $3,000 term loan bearing interest at LIBOR plus 1%
(approximately 3.13% at December 31, 2001), which is payable quarterly. There
are no financial covenants and the term loan is guaranteed by Liraz, the
Company's principal shareholder. During 2000, the loan and guaranty were
amended to extend the due date from May 31, 2001 to November 30, 2001 and to
provide the Company with additional borrowings. In exchange for the initial and
amended guarantees, the Company issued Liraz a total of 170,000 shares of the
Company's common stock. Based upon the fair market value of the issued, the
Company has recorded total deferred costs of $4,013 related to the guaranty.
These costs are being amortized in the as a component of interest expense over
the term of the guaranty.

The Company is attempting to secure a revolving credit facility and on an
interim basis has entered into an agreement with two of the executive officers
of the Company, which provides for borrowings up to $250 and is

secured by accounts and notes receivable. The Company is in negotiations with
several external lenders to replace the interim revolving credit facility.

In October 2001, the Company entered into an exchange agreement with its
existing preferred shareholders. Under the terms of the agreement, the holders
of the Series A and Series B 4% Convertible Redeemable Preferred Stock and
related warrants received an equal number of newly issued Series A1 and Series
B1 Convertible Redeemable Preferred Stock and related warrants. The conversion
price of both the Series A1 and Series B1 Preferred Stock has been reduced by
16.7% and 50% respectively, which increases the number of shares of common
stock to be issued upon conversion of the Preferred Stock by approximately 1.4
million shares. Additionally, the exercise price for the warrants received in
the exchange has been reduced to $1.77 per share and the call prices have been
reduced accordingly to $5.00 per share for the Series A1 warrants and $7.50 per
share for the Series B1 warrants. The difference in the fair value of the
instruments prior to the exchange and subsequent to the exchange has been
recorded as a dividend to preferred shareholders in the accompanying Statement
of Stockholders Equity.

In return, the preferred shareholders have agreed to waive all future
dividend payments which approximated $1.7 million per year and modify the
anti-dilution provisions that existed under the Series A and Series B Preferred
Stock. The Company may issue up to 3 million shares of common stock, warrants,
preferred stock or other securities without triggering any anti-dilution
provisions.

Subsequent to December 31, 2001, the Company entered into a Securities
Purchase Agreement with several investors wherein the Company agreed to sell up
to three million shares of its common stock and warrants. The common stock was
sold at $1.50 per share and warrants to purchase additional shares were issued
at an exercise price of $2.75 per share. This offering closed on January 16,
2002. The Company sold 2,381,952 shares of common stock for a total of $3.5
million and granted 476,396 warrants to purchase the Company's common stock at
an exercise price of $2.75 per share. The warrants expire in three years from
the date of grant and have a call feature that forces exercise if the Company's
common stock exceeds $5.50 per share. Further offerings of securities by the
Company would trigger the anti-dilution provisions of the Series A1 and Series
B1 Preferred Stock and related warrants.

The Company has incurred a loss of $105 million and has experienced negative
cash flows from operations for the year ended December 31, 2001. At December
31, 2001, the Company had a working capital deficiency of approximately $5.0
million. The Company's future revenues are largely dependent on acceptance of a
newly developed and marketed product--Cicero. Accordingly, there may be doubt
that the Company can continue as a going concern. To address these issues, the
Company is actively promoting and expanding its product line and has entered
into preliminary sales negotiations with several significant new customers.
Additionally, the Company has successfully completed a private financing round
wherein it raised approximately $3.5 million of new funds from several
investors. Management is evaluating non-strategic asset sales with third
parties and has retained an investment banker to assist in the evaluation.
Management expects that it would be successful, if deemed appropriate, in the
sale of non-strategic assets. The Company closed the financing disclosed above,
expects to be able to raise additional capital and to continue to fund
operations and also expects that increased revenues will reduce its operating
losses in future periods, however, there can be no assurance that management
will be successful in executing as anticipated or in a timely enough manner.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The financial statements
presented herein do not include any adjustments relating to the recoverability
of assets and classification of liabilities that might be necessary should
Level 8 be unable to continue as a going concern.

Contractual Obligations

Future minimum lease commitments on operating leases that have initial or
remaining noncancelable lease terms in excess of one year as of December 31,
2001 are as follows:

Lease Lease
Commitments Sublease Commitments
Total Income Net
----------- -------- -----------

2002 $3,305 $(1,198) $2,107
2003 2,780 (974) 1,806
2004 2,022 (436) 1,586
2005 1,821 (290) 1,531
2006 1,537 (274) 1,263
------
$8,293
------

Euro Conversion

Several European countries adopted a Single European Currency (the "Euro")
as of January 1, 1999 with a transition period continuing through January 1,
2002. The Company believes its internal systems are Euro capable.

Further, the Company does not presently expect the introduction of the Euro
currency to have material adverse impact on the Company's financial condition,
cash flows, or results of operations.

Significant Accounting Policies and Estimates

The policies discussed below are considered by us to be critical to an
understanding of our financial statements because they require us to apply the
most judgment and make estimates regarding matters that are inherently
uncertain. Specific risks for these critical accounting policies are described
in the following paragraphs. With respect to the policies discussed below, we
note that because of the uncertainties inherent in forecasting, the estimates
frequently require adjustment.

Our financial statements and related disclosures, which are prepared to
conform with accounting principles generally accepted in the United States of
America, require us to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and accounts receivable and expenses
during the period reported. We are also required to disclose amounts of
contingent assets and liabilities at the date of the financial statements. Our
actual results in future periods could differ from those estimates. Estimates
and assumptions are reviewed periodically, and the effects of revisions are
reflected in the Consolidated Financial Statements in the period they are
determined to be necessary.

We consider the most significant accounting policies and estimates in our
financial statements to be those surrounding: (1) revenues; (2) allowance for
doubtful accounts; (3) valuation of notes receivable; (4) valuation of goodwill
and long-lived assets; (5) capitalization and valuation of software product
technology; (6) valuation of deferred tax assets; and (7) restructuring
reserves. These accounting policies, the basis for any estimates and potential
impact to our Consolidated Financial Statements, should any of the estimates
change, are further described as follows:

Revenues. Our revenues are derived principally from three sources: (i)
license fees for the use of our software products; (ii) fees for consulting
services and training; and (iii) fees for maintenance and technical support. We
generally recognize revenue from software license fees when a license agreement
has been signed by both parties, the fee is fixed or determinable, collection
of the fee is probable, delivery of our products has occurred and no other
significant obligations remain. For multiple-element arrangements, we apply the
"residual method". According to the residual method, revenue allocated to the
undelivered elements is allocated based on vendor specific objective evidence
("VSOE") of fair value of those elements. VSOE is determined by reference

to the price the customer would be required to pay when the element is sold
separately. Revenue applicable to the delivered elements is deemed equal to the
remainder of the contract price. The revenue recognition rules pertaining to
software arrangements are complicated and certain assumptions are made in
determining whether the fee is fixed and determinable and whether
collectability is probable. For instance, in our license arrangements with
resellers, estimates are made regarding the reseller's ability and intent to
pay the license fee. Our estimates may prove incorrect if, for instance,
subsequent sales by the reseller do not materialize. Should our actual
experience with respect to collections differ from our initial assessment,
there could be adjustments to future results.

Revenues from services include fees for consulting services and training.
Revenues from services are recognized on a time and materials basis as the
services are performed and amounts due from customers are deemed collectible
and non-refundable. Revenues from fixed price service agreements are recognized
on a percentage of completion basis in direct proportion to the services
provided. To the extent the actual time to complete such services varies from
the estimates made at any reporting date, our revenue and the related gross
margins may be impacted in the following period.

Allowance for Doubtful Accounts. In addition to assessing the probability
of collection in conjunction with revenue arrangements, we continually assess
the collectability of outstanding invoices. Assumptions are made regarding the
customer's ability and intent to pay and are based on historical trends,
general economic conditions, and current customer data. Should our actual
experience with respect to collections differ from our initial assessment,
there could be adjustments to bad debt expense.

Valuation of Notes Receivable. We continually assess the collectability of
outstanding notes receivable. Assumptions are made regarding the counter
party's ability and intent to pay and are based on historical trends and
general economic conditions, and current customer data. Should our actual
experience with respect to collections differ from our initial assessment, we
could incur expense in future periods.

Valuation of Goodwill and Long-Lived Assets. We review long-lived assets,
goodwill and certain identifiable intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. When factors indicate that an intangible or
long-lived asset should be evaluated for possible impairment, an estimate of
the related asset's undiscounted future cash flows over the remaining life of
the asset will be made to measure whether the carrying value is recoverable.
Any impairment is measured based upon the excess of the carrying value of the
asset over its estimated fair value which is generally based on an estimate of
future discounted cash flows. For the year ended December 31, 2001, we recorded
impairments of goodwill and intangible assets of $43,853, as a result of
several events occurring throughout 2001. As of December 31, 2001, the Company
had no remaining intangibles recorded.

Capitalization and Valuation of Software Product Technology. Our policy on
capitalized software costs determines the timing of our recognition of certain
development costs. In addition, this policy determines whether the cost is
classified as development expense or cost of software revenue. Management is
required to use professional judgment in determining whether development costs
meet the criteria for immediate expense or capitalization. Additionally, we
review software product technology assets for net realizable value at each
balance sheet date. For the year ended December 31, 2001, the Company recorded
a write down of software product technology totaling $3,070. Should we
experience reductions in revenues because our business or market conditions
vary from our current expectations, we may not be able to realize the carrying
value of these assets and will record a write down at that time.

Valuation of Deferred Tax Assets. Income taxes are accounted for under the
asset and liability method. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry forwards.
Deferred income tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are

expected to be recovered or settled. The effect on deferred income tax assets
and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. A valuation allowance is established to the
extent that it is more likely than not, that we will be unable to utilize
deferred income tax assets in the future. At December 31, 2001, we had a
valuation allowance of $68,324 against $68,324 of gross deferred tax assets. We
considered all of the available evidence to arrive at our position on the net
deferred tax asset; however, should circumstances change and alter our judgment
in this regard, it may have an impact on future operating results.

Restructuring Reserves. As mentioned in Note 19 of our consolidated
financial statements, we incurred restructuring charges totaling $8,650 during
the year ended 2001. At December 31, 2001, the restructuring liabilities that
remain totaled $853. Of this amount, $43 is related to employee termination
benefits that we expect to be paid in early 2002. The remaining $810 is for
estimated future payments, primarily for rent in excess of anticipated sublease
income. Certain assumptions went into this estimate including sublease income
expected to be derived from these facilities. Should we negotiate more
favorable subleases or reach a settlement with our landlords to be released
from our existing obligations, we could realize a favorable benefit to our
results of future operations. Should future lease costs, in excess of sublease
income, if any, related to these facilities exceed our estimates, we could
incur additional expense in future periods.

Item 7a. Quantitative and Qualitative Disclosures about Market Risk

Approximately 68% of the Company's 2001 revenues were generated by sales
outside the United States. The Company is exposed to risks of foreign currency
fluctuation primarily from receivables denominated in foreign currency and is
subject to transaction gains and losses, which are recorded as a component in
determining net income. Additionally, the assets and liabilities of the
Company's non-U.S. operations are translated into U.S. dollars at exchange
rates in effect as of the applicable balance sheet dates, and revenue and
expense accounts of these operations are translated at average exchange rates
during the month the transactions occur. Unrealized translation gains and
losses are included as a component of accumulated other comprehensive income or
loss in shareholders' equity.

Item 8. Financial Statements And Supplementary Data

The information required by this item appears beginning on page F-1 of this
report. See Items 14(a)(1) and (2).

Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure

On July 11, 2000, Level 8 appointed Deloitte & Touche LLP as its independent
auditors. On July 10, 2000, Level 8 dismissed PricewaterhouseCoopers LLP as its
independent auditors. The decision to change independent auditors was
recommended by the Audit Committee of the Board of Directors and approved by
the Board of Directors. During the two most recent fiscal years and any
subsequent interim period, none of the Company's independent accountant's
reports on the Company's financial statements contained an adverse opinion or a
disclaimer of opinion or was qualified or modified as to uncertainty, audit
scope or accounting principles.

PART III

Item 10. Directors and Executive Officers of the Registrant

The information required by this item is incorporated by reference to
information to be included under the captions "Election of Directors,"
"Executive Officers" and "Compliance with Section 16(a) of the Securities
Exchange Act of 1934" in the Company's Proxy Statement for the 2002 Annual
Meeting of Shareholders.

Item 11. Executive Compensation.

The information required by this item is incorporated by reference to
information to be included under the captions "Election of Directors--Director
Compensation" and "--Compensation Committee Interlocks and Insider
Participation," "Executive Compensation," "Compensation Committee Report on
Executive Compensation" and "Stock Performance Graph" in the Company's Proxy
Statement for the 2002 Annual Meeting of Shareholders.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

The information required by this item is incorporated by reference to
information to be included under the caption "Beneficial Ownership of Common
Stock" in the Company's Proxy Statement for the 2002 Annual Meeting of
Shareholders.

Item 13. Certain Relationships and Related Transactions.

The information required by this item is incorporated by reference to
information to be included under the caption, "Certain Relationships and
Related Party Transactions" and "Election of Directors--Compensation Committee
Interlocks and Insider Participation" in the Company's Proxy Statement for the
2002 Annual Meeting of Shareholders.

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) 1. Financial Statements

The following financial statements of the Company and the related
report of independent accountants thereon are set forth immediately
following the Index of Financial Statements which appears on page F-1
of this report:

Independent Auditors' Report

Report of Independent Accountants

Consolidated Balance Sheets as of December 31, 2001 and 2000

Consolidated Statements of Operations for the years ended December
31, 2001, 2000 and 1999

Consolidated Statements of Changes in Shareholders' Equity for the
years ended December 31, 2001, 2000 and 1999

Consolidated Statements of Comprehensive Loss for the years ended
December 31, 2001, 2000 and 1999

Consolidated Statements of Cash Flows for the years ended December
31, 2001, 2000 and 1999

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.

3. Exhibits

The exhibits listed under Item 14(c) hereof are filed as part of this
Annual Report on Form 10-K.

(b) Reports on Form 8-K

On October 17, 2001 Level 8 Systems filed a Form 8-K reporting the
exchange of its Series A Preferred Stock and Series B Preferred Stock
for newly issued Series A1 Preferred Stock and Series B1 Preferred
Stock.

On October 16, 2001 Level 8 Systems filed a Form 8-K reporting the
completion of its asset sale agreement by and between Level 8 and
BluePhoenix Solutions (formerly AppBuilder Solutions B.V.), a wholly
owned subsidiary of Liraz Systems Ltd.

Exhibit
Number Description
- ------ -----------

2.1 Agreement and Plan of Merger dated as of October 2, 2000 by and among Level 8 Systems, Inc.,
Level 8 Technologies Acquisition Corp. and StarQuest Software, Inc. (incorporated by reference to
exhibit 10.39 to Level 8's Quarterly Report on Form 10-Q for the period ended September 30, 2000
(exhibits and schedules omitted but will be furnished supplementally to the Securities and Exchange
Commission upon request)).

2.2 Asset Purchase Agreement dated as of August 8, 2001 by and between Level 8 Systems, Inc. and
AppBuilder Solutions B.V. (incorporated by reference to Exhibit 2.1 to Level 8's Form 8-K filed
August 8, 2001) (exhibits and schedules omitted but will be furnished supplementally to the
Securities and Exchange Commission upon request)).

3.1 Certificate of Incorporation of Level 8 Systems, Inc., a Delaware corporation (incorporated by
reference to exhibit 3.1 to Level 8's Registration Statement on Form S-1/A, filed September 22,
2000, File No. 333-44588).

3.2 Bylaws of Level 8 Systems, Inc., a Delaware corporation (filed herewith).

3.3 Certificate of Designation relating to Series A1 Convertible Redeemable Preferred Stock
(incorporated by reference to exhibit 3.1 to Level 8's Report on Form 8-K, filed October 17, 2001).

3.4 Certificate of Designation relating to Series B1 Convertible Redeemable Preferred Stock
(incorporated by reference to exhibit 3.2 to Level 8's Report on Form 8-K, filed October 17, 2001).

4.1 Registration Rights Agreement dated as of January 16, 2002 by and among Level 8 Systems, Inc. and
the Purchasers in the January Private Placement listed on Schedule I thereto (incorporated by
reference to exhibit 4.1 to Level 8's Report on Form 8-K, filed January 25, 2001).

4.2 Registration Rights Agreement dated as of January 3, 2002 between Level 8 Systems, Inc. and
MLBC, Inc. (incorporated by reference to exhibit 4.1 to Level 8's Report on Form 8-K, filed
January 11, 2002).

4.3 Registration Rights Agreement dated June 29, 1999 among Level 8 Systems, Inc. and the Series A
investors named on the signature pages thereof (incorporated by reference to exhibit 10.3 to
Level 8's Report on Form 8-K filed July 23, 1999).

4.3A First Amendment to Registration Rights Agreement dated as of October 16, 2001, to the Registration
Rights Agreement dated as of June 29, 1999, by and among Level 8 Systems, Inc. and the Series A1
investors named on the signature pages thereof (incorporated by reference to exhibit 10.4 to
Level 8's Form 8-K, filed October 17, 2001).

4.4 Registration Rights Agreement dated July 20, 2000 among Level 8 Systems, Inc. and the Series B
investors named on the signature pages thereof (incorporated by reference to exhibit 10.5 to
Level 8's Report on Form 8-K, filed July 31, 2000).

4.4A First Amendment to Registration Rights Agreement dated as of October 16, 2001, to the Registration
Rights Agreement dated as of July 20, 2000, by and among Level 8 Systems, Inc. and the Series B1
investors named on the signature pages thereof (incorporated by reference to exhibit 10.5 to
Level 8's Form 8-K, filed October 17, 2001).

4.5 Registration Rights Agreement, dated June 13, 1995, between Level 8 Systems, Inc. and Liraz
Systems Ltd. (incorporated by reference to exhibit 10.24 to Across Data Systems, Inc.'s (Level 8's
predecessor) Registration Statement on Form S-1, filed May 12, 1995, File No. 33-92230).

4.5A First Amendment to Registration Rights Agreement dated as of August 8, 2001, to the Registration
Rights Agreement dated as of June 13, 1995, by and between Across Data Systems, Inc. (Level 8's
predecessor) and Liraz Systems Ltd. (incorporated by reference to exhibit 4.1 to Level 8's Report on
Form 8-K, filed August 14, 2001).

Exhibit
Number Description
- ------ -----------

4.6 Form of Registration Rights Agreement among Level 8 Systems, Inc. and the former holders of
Series E Preferred Stock of StarQuest Software, Inc. (incorporated by reference to exhibit 4.11 to
Level 8's Annual Report on Form 10-K, filed March 29, 2001).

4.7 Form of Registration Rights Agreement among Level 8 Systems, Inc. and the former debtholders of
StarQuest Software, Inc. (incorporated by reference to exhibit 4.12 to Level 8's Annual Report on
Form 10-K, filed March 29, 2001).

4.8 Form of Stock Purchase Warrant issued to the Purchasers in the January Private Placement
(incorporated by reference to exhibit 10.2 to Level 8's Report on Form 8-K, filed January 25, 2002).

4.9 Form of Stock Purchase Warrant issued to the investors in Series A1 Preferred Stock (incorporated
by reference to exhibit 10.2 to Level 8's Report on Form 8-K, filed October 17, 2001).

4.10 Form of Stock Purchase Warrant issued to the investors in Series B1 Preferred Stock (incorporated
by reference to exhibit 10.3 to Level 8's Report on Form 8-K, filed October 17, 2001).

4.11 Form of Warrant issued to the former holders of Series E Preferred Stock of StarQuest Software, Inc.
(incorporated by reference to exhibit 4.10 to Level 8's Annual Report on Form 10-K, filed March 29,
2001).

4.12 Form of Warrant(s) representing the 250,000 Level 8 warrants issued to the WCAS Parties
(incorporated by reference to exhibit 8.2(A) to the Seer Technologies, Inc. Annual Report on
Form 10-K for the year ended September 30, 1998, File No. 000-26194).

10.1 Securities Purchase Agreement dated as of January 16, 2002 by and among Level 8 Systems, Inc. and
the Purchasers in the January Private Placement (incorporated by reference to exhibit 10.1 to Level
8's Report on Form 8-K, filed January 25, 2002).

10.2 Purchase Agreement dated as of January 3, 2002 between Level 8 Systems, Inc. and MLBC, Inc.
(incorporated by reference to exhibit 10.1 to Level 8's Report on Form 8-K, filed January 11, 2002).

10.2A Purchase Agreement dated July 31, 2000 between Level 8 Systems, Inc. and Merrill Lynch, Pierce,
Fenner & Smith Incorporated (incorporated by reference to Exhibit 10.1 to Level 8's Report on Form
8-K, filed August 11, 2000).

10.3 Exchange Agreement dated as of October 16, 2001 among the Company and the investors named on
the signature pages thereof (incorporated by reference to exhibit 10.1 to Level 8's Report on Form
8-K, filed October 17, 2001).

10.3A Securities Purchase Agreement dated June 29, 1999 among Level 8 Systems, Inc. and the investors
named on the signature pages thereof for the purchase of Series A Preferred Stock (incorporated by
reference to exhibit 10.1 to Level 8's Form 8-K filed July 23, 1999).

10.3B Securities Purchase Agreement dated July 20, 2000 among Level 8 Systems, Inc. and the investors
named on the signature pages thereof for the purchase of Series B Preferred Stock (incorporated by
reference to Exhibit 10.1 to Level 8's Report on Form 8-K filed July 31, 2000).

10.4 Amended PCA Shell License Agreement dated as of January 3, 2002 between Level 8 Systems, Inc.
and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (incorporated by reference to exhibit 10.2
to Level 8's Form 8-K, filed January 11, 2002).

10.4A PCA Shell License Agreement between Level 8 Systems, Inc. and Merrill Lynch, Pierce, Fenner &
Smith Incorporated (incorporated by reference to exhibit 10.2 to Level 8's Report on Form 8-K, filed
September 11, 2000).

10.5 Promissory Note of Level 8 Systems, Inc. dated September 28, 2001 among Level 8 Systems, Inc.
and Bank Hapoalim (filed herewith).

Exhibit
Number Description
- ------ -----------

10.6 Stockholders Agreement among Level 8 Systems, Inc., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Liraz Systems Ltd. and certain of its affiliates and Welsh, Carson, Anderson & Stowe
VI, L.P. and certain of its affiliates (incorporated by reference to exhibit 10.3 to Level 8's Report on
Form 8-K, filed September 11, 2000).

10.7 License Agreement, dated as of December 17, 1998, between BULL and Template Software, Inc.
(incorporated by reference to exhibit 10.31 to Template Software, Inc.'s Annual Report on Form
10-K for the fiscal year ended December 31, 1998).

10.8 Agreement, dated June 13, 1995, between the Company and Liraz (incorporated by reference to
exhibit 10.23 to Across Data Systems, Inc.'s (Level 8's predecessor) Registration Statement on Form
S-1, filed May 12, 1995, File No. 33-- 92230).

10.9 Master License Agreement dated October 24, 1996 by and between Merrill Lynch, Pierce, Fenner &
Smith Incorporated and Seer Technologies, Inc. (incorporated by reference to exhibit 10.23 to
Level 8's Annual Report on Form 10-K, filed March 29, 2001).

10.9A Schedule 4 to Master License Agreement dated September 30, 2000 by and between Merrill Lynch,
Pierce, Fenner & Smith Incorporated and Level 8 Technologies, Inc. (incorporated by reference to
exhibit 10.23A to Level 8's Annual Report on Form 10-K, filed March 29, 2001).

10.10 Employment Agreement between Anthony Pizi and the Company effective January 1, 2002 (filed
herewith).*

10.11 Employment Agreement between John P. Broderick and the Company effective January 1, 2002
(filed herewith).*

10.12 Employment Agreement between Paul Rampel and the Company effective January 1, 2002 (filed
herewith).*

10.13 Promissory Note dated January 27 , 2001 of Paul Rampel in favor of Level 8 Systems, Inc. in the
amount of $75,000 (incorporated by reference to exhibit 10.25 to Level 8's Annual Report on
Form 10-K, filed March 29, 2001).

10.13A Stock Pledge Agreement dated January 27, 2001 between Paul Rampel and Level 8 Systems, Inc.
(incorporated by reference to exhibit 10.25A to Level 8's Annual Report on Form 10-K, filed
March 29, 2001).

10.14 Level 8 Systems Inc. 1997 Stock Option Plan, as Amended and Restated (incorporated by reference
to exhibit 10.2 to Level 8's Registration Statement of Form S-1/A, filed September 22, 2000, File
No. 333-44588).*

10.14A Fifth Amendment to Level 8 Systems Inc. 1997 Stock Option Plan (filed herewith).*

10.15 Level 8's February 2, 1995 Non-Qualified Option Plan (incorporated by reference to exhibit 10.1 to
Across Data Systems, Inc.'s (Level 8's predecessor) Registration Statement on Form S-1, filed
May 12, 1995, File No. 33-92230).*

10.16 Template Software, Inc. 1992 Non-Statutory Stock Option Plan (incorporated by reference to an
exhibit to Template Software, Inc.'s Registration Statement on Form S-1, filed on November 27,
1996, File No. 333-17063).

10.17 Template Software, Inc. 1992 Incentive Stock Option Plan (incorporated by reference to an exhibit
to Template Software, Inc.'s Registration Statement on Form S-- 1, filed on November 27, 1996,
File No. 333-17063).

10.18 Lease Agreement for Cary, N.C. offices, dated March 31, 1997, between Seer Technologies, Inc. and
Regency Park Corporation (incorporated by reference to exhibit 10.47 to Seer Technologies, Inc.'s
Quarterly Report on Form 10-Q for the period ended March 31, 1997, File No. 000-26194).

Exhibit
Number Description
- ------ -----------

10.18A Addendum #1 to the Lease Agreement for Cary, N.C. offices, dated July 6, 1998 (incorporated by
reference to exhibit 10.58 to Seer Technology Inc.'s Quarterly Report on Form 10-Q for the period
ended June 30, 1998, File No. 000-26194).

10.18B Amendment to Lease Agreement for Cary, N.C. offices, dated January 21, 1999 (incorporated by
reference to exhibit 10.21A to Level 8's Annual Report on Form 10-K for the fiscal year ended
December 31, 1998).

10.19 Office Lease Agreement, dated April 25, 1996, between Template Software, Inc. and Vintage Park
Two Limited Partnership (incorporated by reference to an exhibit to Template Software, Inc.'s
Registration Statement on Form S-1, File No. 333-17063).

10.19A Amendment to Office Lease Agreement, dated August 18, 1997, between Template Software, Inc.
and Vintage Park Two Limited Partnership (incorporated by reference to an exhibit to Template
Software, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, File
No. 000-21921).

10.20 Lease Agreement, dated December 25, 1992, between Seer Technologies, Inc. and Capital &
Counties (London, England) (incorporated by reference to exhibit 10.22 to Seer Technologies, Inc.'s
Registration Statement on Form S-1, file No. 33-92050).

10.21 Lease Agreement, dated October 8, 1997, between StarQuest Software, Inc. and Smith and Walters
Inc. (incorporated by reference to exhibit 10.14 to Level 8's Annual Report on Form 10-K, filed
March 29, 2001).

10.22 Lease Agreement, dated February 23, 2001, between Level 8 Systems, Inc. and Carnegie 214
Associates Limited Partnership (incorporated by reference to exhibit 10.15 to Level 8's Annual
Report on Form 10-K, filed March 29, 2001).

16.1 Letter from PricewaterhouseCoopers LLP regarding change in certifying accountant, dated August 2,
2000 (incorporated by reference to Exhibit 16 to Level 8's Report on Form 8-K/A filed August 2,
2000, File No.000-26392).

21.1 List of subsidiaries of the Company (filed herewith).

23.1 Consent of Deloitte & Touche LLP (filed herewith).

23.2 Consent of PricewaterhouseCoopers LLP (filed herewith).

- --------
* Management contract or compensatory agreement.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.

LEVEL 8 SYSTEMS, INC.

By: /S/ ANTHONY C. PIZI
-----------------------------
ANTHONY C. PIZI
Chairman of the Board and
Chief Executive Officer

Date: April 1, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/S/ ANTHONY C. PIZI Chairman of the Board and April 1, 2002
- ----------------------------- Chief Executive Officer
Anthony C. Pizi (Principal Executive
Officer)

/S/ PAUL RAMPEL President and Director April 1, 2002
- -----------------------------
Paul Rampel

/S/ JOHN P. BRODERICK Chief Financial April 1, 2002
- ----------------------------- Officer (Principal
John P. Broderick Financial and Accounting
Officer)

/S/ FRANK ARTALE Director April 1, 2002
- -----------------------------
Frank Artale

/S/ JOHN BARBANO Director April 1, 2002
- -----------------------------
John Barbano

/S/ MICHEL BERTY Director Apri 1, 2002
- -----------------------------
Michel Berty

/S/ RICHARD DALY Director April 1, 2002
- -----------------------------
Richard Daly

/S/ THEODORE FINE Director April 1, 2002
- -----------------------------
Theodore Fine

/S/ BYRON VIELEHR Director April 1, 2002
- -----------------------------
Byron Vielehr

INDEX TO FINANCIAL STATEMENTS

-----------------

Contents

Reports of Independent Accountants........................ F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets............................... F-4
Consolidated Statements of Operations..................... F-5
Consolidated Statements of Changes in Stockholders' Equity F-6
Consolidated Statements of Comprehensive Loss............. F-7
Consolidated Statements of Cash Flows..................... F-8
Notes to Consolidated Financial Statements................ F-11

F-1

INDEPENDENT AUDITORS' REPORT

-----------------

To the Board of Directors and Stockholders of
Level 8 Systems, Inc.
Cary, North Carolina

We have audited the accompanying consolidated balance sheets of Level 8
Systems, Inc. and subsidiaries (the "Company") as of December 31, 2001 and
2000, and the related consolidated statements of operations, stockholders'
equity, and cash flows and comprehensive loss for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2001 and
2000, and the results of its operations and its cash flows for the two years
then ended in conformity with accounting principles generally accepted in the
United States of America.

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 1 to the consolidated financial statements, the Company's recurring losses
from operations and working capital deficiency raise substantial doubt about
its ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.

/s/ DELOITTE & TOUCHE LLP

Raleigh, North Carolina
March 25, 2002

F-2

REPORT OF INDEPENDENT ACCOUNTANTS

-----------------

To the Board of Directors and Stockholders of Level 8 Systems, Inc.

In our opinion, the accompanying consolidated statements of operations, of
changes in stockholders' equity and of cash flows for the year ended December
31, 1999 present fairly, in all material respects, the results of operations
and cash flows of Level 8 Systems, Inc. (the "Company") and its subsidiaries
for the year ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audit. We
conducted our audit of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

McLean, Virginia
February 18, 2000

F-3

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)

December 31, December 31,
2001 2000
------------ ------------

ASSETS
Cash and cash equivalents..................................................................... $ 698 $ 23,856
Available-for-sale securities................................................................. 155 588
Trade accounts receivable, net................................................................ 2,297 21,066
Receivable from related party................................................................. 1,045
Notes receivable.............................................................................. 1,977 1,700
Note receivable from related party............................................................ 1,082 104
Assets held for sale.......................................................................... -- 2,236
Prepaid expenses and other current assets..................................................... 2,044 5,987
--------- --------
Total current assets................................................................... 9,298 55,537
Property and equipment, net................................................................... 1,249 3,309
Intangible assets, net........................................................................ -- 65,422
Software product technology, net.............................................................. 24,406 41,743
Note receivable............................................................................... 500 1,000
Note receivable from related party............................................................ -- 396
Investment in Access International............................................................ -- 1,600
Other assets.................................................................................. 291 949
--------- --------
Total assets........................................................................... $ 35,744 $169,956
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Short term debt............................................................................... $ 245 $ 2,133
Accounts payable.............................................................................. 2,768 2,210
Accrued expenses:.............................................................................
Salaries, wages, and related items........................................................ 1,070 4,175
Restructuring............................................................................. 853 210
Merger-related............................................................................ 104 311
Other..................................................................................... 5,760 9,093
Due to related party.......................................................................... 56 59
Deferred revenue.............................................................................. 3,410 9,035
--------- --------
Total current liabilities.............................................................. 14,266 27,226
Long-term debt, net of current maturities..................................................... 4,600 25,000
Warrant liability............................................................................. 2,985 --
Commitments and contingencies (Notes 20 and 21)...............................................
Stockholders' equity..........................................................................
Convertible redeemable preferred stock, $0.001 par value, 10,000,000 shares authorized.
Series A--21,000 shares issued at December 31, 2000 with 11,570 shares
outstanding at December 31, 2000; 0 shares outstanding as of December 31, 2001........ -- --
Series A1--11,570 shares issued and outstanding at December 31, 2001, $1,000 per
share liquidation preference (aggregate liquidation value of $11,570)................. -- --
Series B--30,000 shares issued at December 31, 2000; 0 shares outstanding as of
December 31, 2001..................................................................... -- --
Series B1--30,000 shares issued and outstanding at December 31, 2001, $1,000 per
share liquidation preference (aggregate liquidation value of $30,000)................. -- --
Common stock, $0.001 par value, 40,000,000 authorized; 16,155,559 and 15,785,975
issued and outstanding at December 31, 2001 and 2000, respectively....................... 16 16
Additional paid-in-capital................................................................ 196,043 196,944
Accumulated other comprehensive loss...................................................... (778) (3,903)
Accumulated deficit....................................................................... (181,388) (75,327)
--------- --------
Total stockholders' equity.......................................................... 13,893 117,730
--------- --------
Total liabilities and stockholders' equity............................................. $ 35,744 $169,956
========= ========

The accompanying notes are an integral part of the consolidated financial
statements.

F-4

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share amounts)

For the Years Ended December 31,
2001 2000 1999
--------- -------- --------

Revenue:
Software............................................................ $ 2,367 $ 45,998 $ 16,030
Maintenance......................................................... 11,328 15,967 14,981
Services............................................................ 8,964 20,626 21,909
--------- -------- --------
Total operating revenue....................................... 22,659 82,591 52,920
Cost of revenue:
Software............................................................ 16,652 9,844 4,245
Maintenance......................................................... 3,705 5,716 5,391
Services............................................................ 7,840 18,619 19,270
--------- -------- --------
Total cost of revenue......................................... 28,197 34,179 28,906
Gross margin......................................................... (5,538) 48,412 24,014
Operating expenses:
Sales and marketing................................................. 13,485 35,177 12,009
Research and product development.................................... 7,946 8,861 6,796
General and administrative.......................................... 12,446 12,682 6,822
In-process research and development................................. -- 1,800 2,944
Amortization of intangible assets................................... 10,212 14,191 6,959
Impairment of intangible assets..................................... 43,853 -- --
(Gain)/loss on disposal of assets................................... (6,346) 379 --
Restructuring, net.................................................. 8,650 -- 383
--------- -------- --------
Total operating expenses...................................... 90,246 73,090 35,913
--------- -------- --------
Loss from operations................................................. (95,784) (24,678) (11,899)
Other income (expense):
Interest income..................................................... 820 976 579
Interest expense.................................................... (4,346) (3,337) (2,742)
Other-than-temporary decline in fair value of marketable securities. (3,845) -- --
Change in fair value of warrant liability........................... (885) -- --
Other expense....................................................... (594) (265) (695)
--------- -------- --------
Loss before provision for income taxes............................... (104,634) (27,304) (14,757)
Income tax provision................................................. 501 1,063 720
--------- -------- --------
Net loss............................................................. $(105,135) $(28,367) $(15,477)
========= ======== ========
Preferred dividends.................................................. 926 1,036 422
Cumulative effect of accounting change (See Note 1).................. -- 4,785 --
--------- -------- --------
Net loss applicable to common stockholders........................... $(106,061) $(34,188) $(15,899)
========= ======== ========
Loss before cumulative effect of accounting change--basic and diluted $ (6.65) $ (2.10) $ (1.78)
Cumulative effect of accounting change--basic and diluted............ -- (0.34) --
--------- -------- --------
Net loss applicable to common stockholders--basic and diluted........ $ (6.65) $ (2.44) $ (1.78)
========= ======== ========
Weighted average common shares outstanding--basic and diluted........ 15,958 14,019 8,918
========= ======== ========

The accompanying notes are an integral part of the consolidated financial
statements.

F-5

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)

Common Stock Preferred Stock
------------ ---------------
Accumulated
Additional Other
Paid-in Accumulated Comprehensive
Shares Amount Shares Amount Capital (Deficit) Income Total
------ ------ ------ ------ ---------- ----------- ------------- ---------

Balance at December 31, 1998....... 8,708 $ 87 -- $ 0 $ 34,045 $ (25,240) $ -- $ 8,892
Reclass par value to $0.001........ (79) (79)
Shares issued for Template......... 1,531 2 41,586 41,588
Shares issued for private
placement......................... 21 19,149 19,149
Shares issued for loan guarantee... 60 1,207 1,207
Conversion of preferred shares..... 206 (2) 0 0
Conversion of warrants............. 1,263 1 12,637 12,638
Exercises of stock options......... 561 1 4,883 4,884
Preferred stock dividend........... (422) (422)
Cumulative translation
adjustment........................ (159) (159)
Net loss........................... (15,477) (15,477)
------ ---- -- ------ -------- --------- ------- ---------
Balance at December 31, 1999....... 12,329 $ 12 19 0 113,507 (41,139) (159) 72,221
Shares issued for StarQuest........ 492 1 10,082 10,083
Shares issued for StarQuest debt... 243 0 2,175 2,175
Shares issued for private
placement......................... 30 29,532 29,532
Shares issued for loan guarantee... 110 0 2,805 2,805
Shared issued for Cicero
Technology purchase............... 1,000 1 22,464 22,465
Shares issued for Momentum
debt conversion................... 55 0 1,904 1,904
Conversion of preferred shares..... 738 1 (7) -- -- 1
Conversion of warrants............. 296 0 2,529 2,529
Warrants issued for bank loan...... 775 775
Exercises of stock options......... 523 1 6,386 6,387
Preferred stock dividend........... (1,036) (1,036)
Cumulative effect of accounting
change............................ 4,785 (4,785) --
Foreign currency translation
adjustment........................ (332) (332)
Unrealized losses on marketable
securities........................ (3,412) (3,412)
Net loss........................... (28,367) (28,367)
------ ---- -- ------ -------- --------- ------- ---------
Balance at December 31, 2000....... 15,786 $ 16 42 $ 0 $196,944 $ (75,327) $(3,903) $ 117,730
Shares issued as compensation...... 369 0 1,199 1,199
Preferred stock dividend........... (926) (926)
Reclassification of warrant
liability......................... (2,100) (2,100)
Foreign currency translation
adjustment........................ (287) (287)
Reclassification of unrealized loss
included in income--other than
temporary decline................. 3,765 3,765
Unrealized losses on marketable
securities........................ (353) (353)
Net loss........................... _____ (105,135) (105,135)
------ ---- -- ------ -------- --------- ------- ---------
Balance at December 31, 2001....... 16,155 $ 16 42 $ 0 $196,043 $(181,388) $ (778) $ 13,893
====== ==== == ====== ======== ========= ======= =========

The accompanying notes are an integral part of the financial statements.

F-6

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)

For the Years Ended December 31,
-------------------------------
2001 2000 1999
--------- -------- --------

Net loss........................................................... $(105,135) $(28,367) $(15,477)
Other comprehensive income, net of tax.
Foreign currency translation adjustment........................... (287) (332) (159)
Unrealized loss on available-for-sale securities.................. (353) (3,412) --
Reclassification of unrealized loss included in income--other than
temporary decline............................................... 3,765 -- --
--------- -------- --------
Comprehensive loss................................................. $(102,010) $(32,111) $(15,636)
========= ======== ========

The accompanying notes are an integral part of the financial statements.

F-7

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)

For the Years Ended December 31,
-------------------------------
2001 2000 1999
--------- -------- --------

Cash flows from operating activities:
Net loss............................................................................. $(105,135) $(28,367) $(15,477)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization....................................................... 27,758 26,078 11,633
Change in fair value of warrant liability........................................... 885 -- --
Stock compensation expense.......................................................... 1,199 -- --
Unrealized loss on marketable securities--other than temporary decline.............. 3,845 -- --
Purchased in-process research and development....................................... -- 1,800 2,944
Impairment of intangible assets and software product technology..................... 46,923 -- --
Provision for doubtful accounts..................................................... 3,812 572 757
(Gain)/loss on disposal of assets................................................... (6,346) 379 --
Other............................................................................... -- 42 172
Changes in assets and liabilities, net of assets acquired and liabilities assumed:
Trade accounts receivable and related party receivables............................ 10,454 (2,339) 1
Due from Liraz..................................................................... (3) -- 271
Prepaid expenses and other assets.................................................. 834 1,854 (557)
Accounts payable and accrued expenses.............................................. (5,284) (1,223) (4,275)
Merger-related and restructuring................................................... 952 (3,526) (4,545)
Deferred revenue................................................................... 657 (1,236) (3,811)
--------- -------- --------
Net cash used in operating activities............................................ (19,449) (5,966) (12,887)
Cash flows from investing activities:
Purchases of property and equipment.................................................. (198) (1,972) (353)
Cash payments secured through notes receivable....................................... (77) (1,252) --
Repayment of note receivable......................................................... 675 500 --
Purchase of available for sale securities............................................ -- (4,000) --
Investment in Access International................................................... -- (350) --
Cash received from sale of property.................................................. 2,236 -- --
Cash received from sale of line of business assets................................... 19,900 -- --
Payments for businesses acquired..................................................... -- (2,674) (25,340)
Cash received from acquisitions, net................................................. -- 1,839 160
Additions to software product technology............................................. (2,310) (726) (1,427)
--------- -------- --------
Net cash provided by (used in) investing activities.............................. 20,226 (8,635) (26,960)
Cash flows from financing activities:
Proceeds from issuance of common shares, net of issuance costs....................... -- 8,915 17,272
Proceeds from issuance of preferred shares, net of issuance costs.................... -- 29,532 19,215
Dividends paid for preferred shares.................................................. (1,345) (789) (250)
Proceeds from bridge financing....................................................... 1,600 -- --
Issuance costs of common shares...................................................... -- (187) --
Payments on loans to related party................................................... -- (4,519) (8,628)
Payments under capital lease obligations and other liabilities....................... (133) (87) (47)
Net borrowings on line of credit..................................................... 245 5,175 6,717
Borrowings under credit facility, term loans and notes payable....................... -- 15,000 10,000
Repayments of term loans, credit facility and notes payable.......................... (24,000) (20,945) (4,000)
--------- -------- --------
Net cash (used in) provided by financing activities.............................. (23,633) 32,095 40,279
Effect of exchange rate changes on cash................................................ (302) (147) (1)
Net (decrease) increase in cash and cash equivalents................................... (23,158) 17,347 431
Cash and cash equivalents:
Beginning of period.................................................................. 23,856 6,509 6,078
--------- -------- --------
End of period........................................................................ $ 698 $ 23,856 $ 6,509
========= ======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes........................................................................ $ 280 $ 497 $ 949
Interest............................................................................ $ 1,339 $ 2,104 $ 1,604

The accompanying notes are an integral part of the consolidated financial
statements.

F-8

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(amounts in thousands, except share data)

Noncash Investing and Financing Activities

2001

During 2001, the Company issued 369,591 shares of common stock to employees and
consultants for retention bonuses, severance and consulting. The shares were
valued at $1,199. See Note 13.

In September and October 2001, the Company received $400 and $1,000 in notes
receivable related to the sale of assets related to the Message Queuing/XIPC
and AppBuilder assets, respectively. See Note 3.

During 2001, the Company recorded a $3,845 realized loss on marketable
securities related to an other-than-temporary decline in fair value. See Note 5.

During 2001, the Company performed consulting services valued at $750 in
exchange for common shares of a strategic partner. See Note 7.

In September 2001, the Company retired a note receivable from related party
totaling $495 in exchange for the forfeiture by the director and officer of
certain retirement benefits. See Note 8.

2000

During 2000, the Company issued 110,000 shares of common stock to a related
party in order to obtain a guarantee for an additional $5 million in borrowings
from a commercial lender and an extension of the guarantee for the amended term
loan. The amended guarantee was valued at $2,805. See Note 11.

During 2000, the Company obtained a credit facility from a commercial lender.
In connection with this facility, the Company provided warrants to the lender
to purchase approximately 173,000 shares of common stock that were valued at
$775. See Note 13.

During 2000, the Company acquired StarQuest Software, Inc. ("StarQuest") for
$850 in cash and approximately $10,138 in stock and warrants. A reconciliation
of the cost of the acquisition to the net cash paid for the acquisition is as
follows:

Fair value of:
Assets received............... $ 18,372
Liabilities assumed........... (7,228)
Additional direct costs....... (70)
Stock and warrants issued..... (10,138)
--------
Cash paid..................... (936)
Cash acquired................. 15
--------
Net cash paid for acquisition. $ (921)
========

Total acquisition costs for StarQuest was $650, of which $70 were paid in 2000
and the remaining costs paid in 2001.

F-9

LEVEL 8 SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(amounts in thousands, except share data)

Immediately subsequent to the acquisition, the Company retired $2,175 of
StarQuest's debt obligations by issuing the debtholders approximately 243,000
shares of the Company's common stock. See Note 2.

During 2000, the Company purchased 500,000 shares of common stock and warrants
to purchase an additional 500,000 shares of common stock of a publicly traded
company. The investment was originally recorded at $4,000 and has been revalued
to $588, fair value as of December 31, 2000. These shares of common stock are
classified as available-for-sale securities. See Note 5.

During 2000, the Company acquired the rights to a comprehensive integrated
desktop computer environment from Merrill Lynch in exchange for 1,000,000
shares of the Company's common stock. The total consideration including fair
value of common stock and transaction expenses was $22,523. See Note 9.

During 2000, the Company assigned collection on certain accounts receivable
totaling $408 to a strategic partner in exchange for a note receivable from the
partner. See Note 8.

During 2000, the Company performed consulting services valued at $1,250 in
exchange for common shares of a strategic partner. See Note 7.

During 2000, the Company converted $1,904 of the Momentum notes to
approximately 55,000 shares of the Company's common stock. During August, 2000
the Company paid off the remaining balances due under these notes. See Note 13.

1999

During 1999, the Company acquired all of the common stock of Template Software,
Inc. (''Template'') for approximately $63,972. In connection with the
acquisition, the Company purchased 5,394,959 shares of Template common stock
for $21,579 in cash and 1,531,089 shares of Level 8 common stock. Additionally,
Level 8 also issued stock options exercisable for 1,124,023 shares of the
Company's common stock in exchange for all of the outstanding Template stock
options. See Note 2.

A reconciliation of the cost of the acquisition to the net cash paid for the
acquisition is as follows:

Fair value of:
Assets received.................... $ 73,160
Liabilities assumed................ (7,712)
Additional direct costs............ (1,129)
Stock and stock options issued..... (41,526)
--------
Cash paid.......................... (22,793)
Cash acquired...................... 160
--------
Net cash paid for acquisition...... $(22,633)
========

During 1999, the Company obtained a guarantee from a related party in order to
secure a $10 million term loan to partially finance the Template acquisition.
The guarantee was received in exchange for 60,000 shares of the Company's
common stock and was valued at $1,209. See Note 11.

F-10

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share and per share data)

NOTE 1. SUMMARY OF OPERATIONS, SIGNIFICANT ACCOUNTING POLICIES, AND RECENT
ACCOUNTING PRONOUNCEMENTS

Level 8 Systems, Inc. ("Level 8" or the "Company") is a global provider of
business integration software that 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.

Liraz Systems, Ltd. ("Liraz") and its wholly-owned subsidiaries own
approximately 24% of Level 8's outstanding common stock at December 31, 2001
and hold preferred stock convertible into an additional 1,200,000 shares of
common stock.

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 a loss
of $105 million and has experienced negative cash flows from operations for the
year ended December 31, 2001. At December 31, 2001, the Company had a working
capital deficiency of approximately $5.0 million. The Company's future revenues
are largely dependent on acceptance of a newly developed and marketed
product--Cicero. These factors among others may indicate the Company will be
unable 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 Level 8 be unable to continue as a going concern. To
address these issues, the Company is actively promoting and expanding its
product line and has entered into preliminary sales negotiations with several
significant new customers. Additionally, in January 2002 the Company has
successfully completed a private financing round wherein they raised
approximately $3.5 million of new funds from several investors. Management is
pursuing non-strategic asset sales with third parties and has retained an
investment banker to assist in that process. Management expects that it will be
successful in the sale of non-strategic assets, 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. See Notes 2 and 3 regarding the acquisitions and
sales of subsidiaries. All of the Company's subsidiaries are wholly-owned for
the periods presented, except for Seer Technologies, Inc. (''Seer''). The
Company acquired a 69% interest in Seer on December 31, 1998 and the remaining
31% interest on April 30, 1999.

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.

F-11

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 a 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 in both the United States and
several foreign countries. At times, such cash and cash equivalents in the
United States may be in excess of FDIC insurance limits.

Available-for-Sale Securities

The Company has made an equity investment in a publicly traded company which
has been classified as available for sale securities. This investment is
recorded on the balance sheet at fair market value and unrealized gains and
losses are recorded in other comprehensive income. The Company has recorded a
realized loss of $3,845 relating to an other than temporary decline in the
market value of the shares in the accompanying consolidated statement of
operations. See Note 5.

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 the estimated useful lives of
the related assets as follows:

Leasehold improvements The lesser of the lease term or
estimated useful life

Furniture and fixtures 3 to 5 years
Office equipment...... 3 to 5 years
Computer equipment.... 3 to 5 years

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 Statement of Operations.

Asset Held For Sale

The Company acquired a building in conjunction with its acquisition of Template
in Windsor, England. As the Company determined this asset was not needed for
its ongoing operations it was placed for sale during 2000. The asset was valued
at the lower of cost or fair market value less costs of disposal as of December
31, 2000. The building was sold in February of 2001. See Note 3.

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 to five years is assigned to capitalized software costs, once the
product is available for general release to customers. Costs incurred prior to
the establishment of technological feasibility are charged to research and
development expense.

F-12

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Additionally, the Company has recorded software development costs for its
purchases of developed technology through acquisitions. See Notes 2 and 9.

Capitalized software costs are amortized over related sales on a
product-by-product basis at the greater of the amount computed using (a) the
ratio of current gross revenues for a product to the total of current and
anticipated future gross revenues or (b) the straight-line method over the
remaining estimated economic life of the product. See Note 9.

The establishment of technological feasibility and the ongoing assessment of
recoverability of capitalized software development costs requires 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. See
Note 9.

Intangible Assets

Intangible assets consist of both identifiable and unidentifiable assets
(goodwill) and are amortized on a straight-line basis over periods from three
to seven years. On a periodic basis and whenever changes in events or
circumstances indicate that the asset may not be recoverable, the Company
assesses the recoverability of intangible assets by determining whether the
amortization of the balance over its remaining life can be recovered through
undiscounted future operating cash flows of the related operations. If an
impairment exists, the amount of such impairment is calculated based on the
difference between the carrying amount of the asset and estimated fair value of
the asset, which is determined based upon anticipated cash flows discounted at
a rate commensurate with the risk involved. In April 2001, management
reevaluated and modified its approach to managing the business and opted to
conduct business and assess the performance of operations under a
line-of-business approach. As a result, the Company changed its accounting
policy to assess the recoverability of intangible assets in accordance with the
Company's lines of business. Prior to 2001, the Company assessed the
recoverability of intangible assets on enterprise level using the projected
cash flows of the Company. See Note 10.

Long-Lived Assets

The Company assesses whether its identifiable assets are impaired as required
by SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, based on an evaluation of undiscounted
projected cash flows through the remaining amortization period. If impairment
exists, the amount of such impairment is calculated based on the estimated fair
value of the asset determined based upon anticipated cash flows discounted at a
rate commensurate with the risk involved.

Revenue Recognition

The Company recognizes license revenue from end-users and third party resellers
in accordance with Statement of Position 97-2, "Software Revenue Recognition"
("SOP 97-2"), as amended by Statement of Position 98-9, "Modification of SOP
97-2, 'Software Revenue Recognition,' with Respect to Certain Transactions"
("SOP 98-9"). 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. Any unearned
receipts from service contracts result in deferred revenue.

F-13

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 $1,198, $3,494, and $108, for the years ended December 31, 2001,
2000, and 1999, respectively.

Research and Product Development

Research and product development costs are expensed as incurred.

Income Taxes

The Company uses Statement of Financial Accounting Standards ("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 12.

Loss Per Share

Basic (loss) per share is computed based upon the weighted average number of
common shares outstanding. Diluted earnings (loss) per share is computed based
upon the weighted average number of common shares outstanding and any
potentially dilutive securities. During 2001, 2000 and 1999, 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 in ('000's):

2001 2000 1999
------ ----- -----

Stock options.................................... 4,366 3,876 3,800
Warrants......................................... 2,569 2,662 1,522
Convertible preferred stock...................... 3,782 2,354 1,895
------ ----- -----
10,717 8,892 7,217
====== ===== =====

In 2001, 2000 and 1999, dividends on preferred stock were included in the loss
per share calculation. The dividends totaled $926, $1,036 and $422 in 2001,
2000, and 1999, respectively.

Accounting Change

In November 2000, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF 00-27 "Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios",

F-14

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

which establishes accounting and reporting standards for the determination of
beneficial conversion features in convertible securities. The EITF reached a
consensus that an issuer should first allocate the proceeds received in a
financing transaction that includes preferred stock convertible into common
stock to the preferred stock and any other detachable warrants on a relative
fair value basis. The Company has applied the provisions of EITF 00-27, which
resulted in a beneficial conversion feature of the Company's Series A and
Series B preferred stock of $4,785. As required by EITF 00-27 the beneficial
conversion feature was reflected as a cumulative effect of a change in
accounting which resulted in an increase in additional paid in capital and
accumulated deficit of $4,785 or $.34 per common share, in the fourth quarter
of 2000.

Stock-Based Compensation

The Company has adopted the disclosure provisions of SFAS 123 and has applied
Accounting Principles Board Opinion No. 25 and related Interpretations in
accounting for its stock-based compensation plans. See Note 13.

Warrants

The Company has issued warrants to Series A1 and Series B1 preferred
stockholders which contain provisions that allow the warrant holders to force a
cash redemption for events outside the control of the Company. The fair value
of the warrants are accounted for as a liability and are remeasured at each
balance sheet date.

Reclassifications

Certain prior year amounts in the accompanying financial statements have been
reclassified to conform to the 2001 presentation. Such reclassifications had no
effect on previously reported net income or stockholders' equity.

Recent Accounting Pronouncements

In June 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" ("SFAS 141") which supersedes Accounting
Principles Board (APB) Opinion No. 16, Business Combinations. SFAS 141
eliminates the pooling-of-interests method of accounting for business
combinations for all transactions initiated after June 30, 2001 and modifies
the application of the purchase accounting method. The provisions of SFAS 141
will be effective for transactions account for using the purchase method that
are completed after June 30, 2001. Management does not expect this Statement
will have an impact on the consolidated financial statements.

In June 2001, the FASB also issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Intangible Assets" ("SFAS 142") which supersedes APB
Opinion No. 17, Intangible Assets. SFAS 142 eliminates the current requirement
to amortize goodwill and indefinite-lived intangible assets, addresses the
amortization of intangible assets with a defined life and addresses the
impairment testing for goodwill and intangible assets and the identification of
reporting units for purposes of assessing potential future impairment of
goodwill. SFAS 142 also requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. SFAS 142 will
apply to goodwill and intangible assets arising from transactions completed
before and after the statement's effective date. SFAS 142 is effective for
fiscal years beginning after December 15, 2001. As the Company has no goodwill
remaining on its balance sheet at December 31, 2001, management does not
believe that the provisions of this statement will have a material impact on
the consolidated financial statements. Goodwill and intangible assets
amortization was $10,212 for the twelve months ended December 31, 2001.

F-15

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In June of 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 applies to
the accounting and reporting obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
Statement applies to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, and
development and (or) the normal operation of a long-lived asset, except for
certain obligations of lessees. Adoption of this Statement is required for
fiscal years beginning after June 15, 2002. The Company does not believe that
adoption of this standard will have an impact on its results of operations and
financial position.

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets," which supercedes Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" and certain provisions of APB Opinion No.
30, "Reporting Results of Operations--Reporting the Effects of Disposal of a
Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS 144 requires that long-lived assets to be
disposed of by sale, including discontinued operations, be measured at the
lower of carrying amount or fair value less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS 144 also broadens the
reporting requirements of discontinued operations to include all components of
an entity that have operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the
rest of the entity. The provisions of SFAS 144 are effective for fiscal years
beginning after December 15, 2001. Management is evaluating the effect of this
statement on the Company's results of operations and financial position.

In January 2002, Emerging Issues Task Force Topic No. D-103, Income Statement
Characterization of Reimbursements Received for "Out-of-Pocket" Expenses
Incurred, was issued, and considered whether reimbursements received for
"out-of-pocket" expenses incurred would be characterized in the income
statement as revenue or as a reduction of expenses incurred. The FASB staff
believes that the reimbursements received should be characterized as revenue.
Reimbursement for "out-of-pocket" expenses in 2001 and 2000 totaled $539 and
$1,119, respectively, and will be classified as revenue in future periods.

NOTE 2. ACQUISITIONS AND PRO FORMA FINANCIAL STATEMENTS

Acquisition of StarQuest

On November 28, 2000, the Company acquired StarQuest Software, Inc.
("StarQuest"). Under the terms of the agreement, Level 8 paid $850 in cash and
issued 492,000 shares of common stock, net of 8,000 shares forfeited at the
direction of the employees acquired in the transaction, valued at $17.2752 and
250,000 warrants valued at $6.00 per share. The total purchase price of the
acquisition was $11,638, including $650 of acquisition costs and has been
accounted for by the purchase method of accounting. The operations of StarQuest
are included in the Company's consolidated results of operations from the date
of acquisition.

The purchase price was allocated to the assets acquired and liabilities assumed
based on the Company's estimates of fair value at the acquisition date. The
fair value assigned to intangible assets acquired was based on a valuation
prepared by an independent third-party appraisal company of the purchased
in-process research and development, developed technology, and assembled
workforce of StarQuest. The purchase price exceeded the amounts allocated to
tangible and identifiable intangible assets acquired less liabilities assumed
by approximately $8,006. This excess of the purchase price over the fair values
of assets acquired less liabilities assumed was allocated to goodwill. The
warrants were valued at issuance utilizing the Black Scholes option pricing
model using the following assumptions: expected life of 3 years, volatility of
121%, exercise price of $30.00 and a risk-free interest rate of 6%.

F-16

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The purchase price of the acquisition was allocated as follows:

Cash......................................... $ 15

Accounts receivable.......................... 54
Prepaid expenses and other current assets.... 52
Property and equipment....................... 45
Capitalized software and developed technology 6,600
In-process research and development.......... 1,800
Goodwill and assembled workforce............. 9,806
Accounts payable and accrued liabilities..... (1,789)
Debt......................................... (4,475)
Deferred revenue............................. (470)
-------
Cost of net assets acquired.................. $11,638
=======

Approximately $1,800 of the purchase price represents purchased in-process
research and development that had not yet reached technological feasibility and
had no alternative future use. Accordingly, this amount was immediately
expensed in the Consolidated Statement of Operations upon consummation of the
acquisition. The value assigned to in-process research and development, based
on a valuation prepared by an independent third-party appraisal company, was
determined by identifying research projects in areas for which technological
feasibility had not been established. The efforts considered included projects
related to StarQuest's StarSQL product ($1,200), projects related to
StarQuest's CTRC product ($400), and projects related to StarQuest's StarTran
product ($200). The value of the in-process projects was adjusted to reflect
the relative value and contributions of the required research and development.
In doing so, consideration was given to the stage of completion, the difficulty
of completing the remaining development costs already incurred, and the
projected cost to complete the projects. The discount rate included a factor
that takes into account the uncertainty surrounding successful development of
the purchased in-process research and development.

In conjunction with the acquisition, the Company retired $2,175 of StarQuest's
debt obligations by issuing the debtholders approximately 243,000 shares of the
Company's common stock.

Acquisition of Template

On December 27, 1999, the Company acquired Template Software, Inc.
(''Template''). Under the terms of the agreement, Level 8 purchased 5,394,959
shares of Template common stock for $21,579 in cash and 1,531,089 shares of
Level 8 common stock. Additionally, Level 8 also issued stock options
exercisable for 1,124,023 shares of the Company's common stock to assume all of
the outstanding Template stock options. The total purchase price of the
acquisition was $63,972 and has been accounted for by the purchase method of
accounting. The operations of Template are included in the Company's
consolidated results of operations from the date of acquisition. The fair value
assigned to the common stock was determined based on the 2-day period before
and after the announcement of the transaction and the fair value assigned to
the options issued was based on a valuation prepared by an independent
third-party appraisal company using the Black Scholes Pricing Model.

F-17

LEVEL 8 SYSTEMS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

$44,371. This excess of the purchase price over the fair value of assets
acquired less liabilities assumed was allocated to goodwill.

Prior to completing the acquisition, the Company had determined not to continue
with certain non-strategic operations of Template in Germany and Austria. These
operations were primarily reselling third party software and providing related
consulting services. At the time of merger, the Company had entered into an
agreement in principle to sell the assets of the German operations, which
consist principally of its consulting workforce and certain lease agreements.
The Austrian operations were closed down in 2000. Accordingly, the Company has
recorded the estimated fair value of these operations at the acquisition date
based on its estimate of the net future cash flows from the transactions and
associated operations through the wind up period. The fair value of the German
and Austrian operating liability was estimated as $25 at the acquisition date.

The purchase price of the acquisition was allocated as follows:

Cash......................................... $ 160

Accounts receivable.......................... 6,123
Prepaid expenses and other current assets.... 597
Property and equipment....................... 4,183
Capitalized software and developed technology 12,200
In-process research and development.......... 2,200
Goodwill and assembled workforce............. 47,291
Other assets................................. 431
Assets held for resale....................... (25)
Accounts payable............................. (668)
Accrued expenses and other liabilities....... (6,445)
Deferred revenue............................. (439)
Deferred tax liability....................... (1,476)
Long-term debt............................... (160)
-------
Cost of net assets acquired.................. $63,972
=======

Approximately $2,200 of the purchase price represents purchased in-process
research and development that had not yet reached technological feasibility and
had no alternative future use. Accordingly, this amount was immediately
expensed in the Consolidated Statement of Operations upon consummation of the
acquisition. The value assigned to in-process research and development, based
on a valuation prepared by an independent third-party appraisal company, was
determined by identifying research projects in areas for which technological
feasibility had not been established. The efforts considered included projects
related to Template's Enterprise Integration Template ("EIT") product ($1,298),
and projects related to new versions of Template's Business Process Template
("BPT") product ($902). The value of the in-process projects was adjusted to
reflect the relative value and contributions of the required research and
development. In doing so, consideration was given to the stage of completion,
the difficulty of completing the remaining development costs already incurred,
and the projected cost to complete the projects. The discount rate included a
factor that takes into account the uncertainty surrounding successful
development of the purchased in-process research and development.

Acquisition of Seer Technologies, Inc.

On December 31, 1998, the Company, as the first step in its acquisition of the
entire equity interest in Seer, acquired beneficial ownership of approximately
69% of the outstanding voting stock of Seer, which was held by Welsh, Carson,
Anderson and Stowe VI L.P. ("WCAS") and certain other parties affiliated or
associated with

F-18

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

WCAS ("WCAS Parties") in exchange for 1,000,000 shares of the Company common
stock and warrants to purchase an additional 250,000 shares of the Company
common stock at an exercise price of $12.00 per share ("Step 1"). On April 15,
1999, the Company acquired the remaining minority interest in Seer, for $0.35
in cash per share of the outstanding common stock of Seer ("Step 2"). As a
result of Step 2 of the acquisition, Seer became a wholly-owned subsidiary of
the Company. The total cost of the acquisition was $7,754 for Step 1 and $1,697
for Step 2 and has been accounted for by the purchase method of accounting. The
net book value of Seer's liabilities exceeded its assets on the acquisition
dates; therefore, no minority interest in Seer was recorded.

The purchase price was allocated to the assets acquired and liabilities assumed
based on the Company's estimates of fair value at the acquisition date. The
fair value assigned to intangible assets acquired was based on valuations
prepared by an independent third-party appraisal company of the purchased
in-process research and development, developed technology, installed customer
base, assembled workforce, and trademarks of Seer at the completion of Step 1.
The purchase price exceeded the amounts allocated to tangible and identifiable
intangible assets acquired less liabilities assumed by approximately $18,684 in
Step 1. For Step 2, the fair value assigned to intangible assets acquired was
based on a valuation of the purchased in-process research and development,
developed technology, installed customer base, and assembled workforce of Seer.
The Step 2 purchase price was less than the amounts allocated to the tangible
and intangible assets acquired by approximately $1,307. This difference between
the purchase price and the fair values of assets acquired less liabilities
assumed was allocated to goodwill.

The cost of the acquisition was allocated as follows:

Step 1 Step 2 Total
-------- ------- --------

Cash...................................................... $ 479 $ -- $ 479
Accounts receivable....................................... 14,505 -- 14,505
Prepaid expenses and other current assets................. 1,418 -- 1,418
Property and equipment.................................... 1,614 -- 1,614
Capitalized software and developed technology............. 3,659 3,410 7,069
In-process research and development....................... 4,692 744 5,436
Goodwill, assembled workforce, customer base and trademark 28,344 (1,307) 27,037
Other assets.............................................. 370 -- 370
Accounts payable.......................................... (1,949) -- (1,949)
Accrued expenses and other liabilities.................... (13,228) (1,150) (14,378)
Deferred revenue.......................................... (7,875) -- (7,875)
Notes payable, due on demand.............................. (12,275) -- (12,275)
Long-term debt............................................ (12,000) -- (12,000)
-------- ------- --------
Cost of net assets acquired............................... $ 7,754 $ 1,697 $ 9,451
======== ======= ========

Approximately $4,692 for Step 1 and $744 for Step 2, of the purchase price
represents purchased in-process research and development that had not yet
reached technological feasibility and had no alternative future use.
Accordingly, this amount was immediately expensed in the Consolidated Statement
of Operations upon consummation of the acquisition. The value assigned to
in-process research and development, based on a valuation prepared by an
independent third-party appraisal company, was determined by identifying
research projects in areas for which technological feasibility had not been
established. For Step 1, this included Java based projects ($3,105) and
application warehousing projects ($1,587). For Step 2, the amount was related
to Java

F-19

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

based projects only, as there was no change in the status of the application
warehouse projects. The value of the in-process projects was adjusted to
reflect the relative value and contributions of the required research and
development. In doing so, consideration was given to the stage of completion,
the complexity of the work completed to date, the difficulty of completing the
remaining development costs already incurred, and the projected cost to
complete the projects. The discount rate included a factor that takes into
account the uncertainty surrounding successful development of the purchased
in-process research and development.

In connection with the Company's purchase of Seer's capital stock from the WCAS
Parties, WCAS contributed approximately $17 million to Seer and the Company
provided a $12 million subordinated loan to Seer to pay down Seer's bank debt.
The funds used by the Company to make the subordinated loan to Seer were
borrowed from Liraz Systems Ltd. ("Liraz"), a principal stockholder of the
Company. See Note 11.

The following unaudited pro forma results of continuing operations assume the
acquisition of StarQuest, as described above, occurred as of January 1, 2000
after giving effect to certain adjustments, including amortization of the
excess of cost over underlying net assets.

2000
--------

Net sales.......................................................... $ 85,113
Net loss from continuing operations before income taxes............ (33,572)
Net loss........................................................... (34,640)
Loss applicable to common stockholders............................. (40,461)
Loss per share applicable to common stockholders--basic and diluted $ (2.79)
Weighted average shares outstanding--basic and diluted............. 14,519

The pro forma financial information does not purport to be indicative of the
results of operations which would have actually resulted had the transactions
taken place at the beginning of the periods presented or of future results of
operations.

NOTE 3. DISPOSITIONS

Sale of AppBuilder Assets

On October 1, 2001, the Company sold its AppBuilder software business to
BluePhoenix Solutions, a wholly owned subsidiary of Liraz Systems Ltd. Under
the terms of the agreement, the Company sold the rights, title and interest in
the AppBuilder product and certain receivables, deferred revenue, maintenance
contracts, fixed assets and certain liabilities. The AppBuilder product
accounted for approximately 59% of total revenues for the year and
approximately 79% of total revenues within the messaging and application
engineering segment. The Company received total proceeds of $20,350, $19,000 in
cash, a note receivable for $1,000 due February 2002 and a cash payment for the
net assets which is subject to final audit and settlement by March 31, 2002.
The carrying value of net assets sold was approximately $15,450, resulting gain
of approximately $4.9 million has been recorded in the gain on disposal of
asset. The Company subsequently liquidated $22,000 of its short-term debt using
the proceeds received and cash on hand. In March 2002, the $1,000 note was
repaid with cash of $825 and settlement of other liabilities. At December 31,
2001, the $1,000 note was recorded as note receivable from related party and
$863 was recorded as receivable related party representing amounts due to the
Company from BluePhoenix Solutions for the net asset amount noted above and the
reimbursement for certain general and administrative functions performed by the
Company.

Sale of Message Queuing and XIPC Assets

Also during the quarter ended September 30, 2001, the Company sold two of its
messaging products--Geneva Message Queuing and Geneva XIPC to Envoy
Technologies, Inc. Under the terms of the agreement, Envoy acquired all rights,
title and interest to the products along with all customer and maintenance
contracts.

F-20

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company retained all accounts receivable, received $50 in cash and a note
receivable for $400. The resulting gain of $342 has been recorded in the gain
on disposal of assets. As of February 28, 2002, the note has been paid in full.

Sale of Government Operations

In connection with the acquisition of Template, the Company acquired certain
classified government contracts and employees who performed services for such.
As of May 1, 2000 the Company disposed of its government contracts and
employees and certain other related assets and obligations by selling them to a
new company formed by certain of the Company's employees. The Company received
a note for $1,000 to be paid in five annual payments beginning May 1, 2001 and
4.9% of the outstanding shares of the purchasing company. Due to the
uncertainty of collection on the note and valuation of the new company, Level 8
fully reserved the value of the note and valued the investment at $0. During
the first quarter of 2001, the Company renegotiated the note to $850, collected
this amount and gave up the 4.9% ownership interest of the acquiring company.
The gain was included in the gain/loss on disposal of assets.

Asset Held for Sale

The Company owned a building in Windsor, England from the acquisition of
Template Software, Inc. The Company determined that this facility was not
needed for ongoing operations and was placed for sale. During the first quarter
of 2001, the Company sold the building, fixtures, and certain equipment for
approximately $2,236. No gain or loss was recognized.

NOTE 4. ACCOUNTS RECEIVABLE

Trade accounts receivable consists of the following at December 31:

2001 2000
------ -------

Current trade accounts receivable.... $2,480 $22,801
Less: allowance for doubtful accounts (183) (1,735)
------ -------
$2,297 $21,066
====== =======

Approximately $200 and $358 of current trade receivables were unbilled at
December 31, 2001 and 2000, respectively. There were no receivables with
payment terms in excess of one year recorded during the fiscal year ended
December 31, 2001.

During 2000 and 1999, the Company acquired certain trade receivables, net of
allowances for doubtful accounts, in conjunction with its acquisitions of
StarQuest, Template, and Seer. See Note 2.

The provision for uncollectible amounts was $3,812, $572, and $757, for the
years ended December 31, 2001, 2000, and 1999, respectively. Write-offs of
accounts receivable were $5,364, $35, and $3,044, for the years ended December
31, 2001, 2000, and 1999, respectively. Included in the write-offs for 2001 is
approximately $3,800 from one customer who filed for Chapter 11 Protection
under the U.S. Bankruptcy laws.

NOTE 5. AVAILABLE-FOR-SALE SECURITIES

On September 29, 2000, the Company purchased 500,000 shares of the common stock
and 500,000 warrants to purchase the common stock of a publicly traded
e-business service provider for total consideration of $4,000 in cash. The
500,000 shares of common stock represent approximately a seven percent interest
in the e-business

F-21

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

service provider for total consideration of $4,000 in cash. The 500,000 shares
of common stock represent approximately a seven percent interest in the
e-business service provider. The 500,000 warrants to purchase common stock have
an exercise price of $13.00 per share. At the time of purchase, the fair value
of the common stock was recorded using the quoted market price of $6.50 per
share and the fair value of the warrants were recorded using the Black Scholes
Option Pricing Model at $1.50 per warrant. The shares of common stock are
classified as available-for-sale securities. At December 31, 2001, the market
value of the common stock was $.29 per share and the fair value of the warrants
determined by using the Black Scholes pricing model was $0.02 per share. The
realized loss of $3,845 on the available for sale securities has been recorded
in the accompanying consolidated statement of operations for 2001, as the
Company deemed it to be an other-than-temporary decline in fair value. The
common stock was sold subsequent to December 31, 2001.

NOTE 6. PROPERTY AND EQUIPMENT

Property and equipment consists of the following at December 31:

2001 2000
------- -------

Computer equipment............................. $ 2,852 $ 5,205
Furniture and fixtures......................... 651 1,035
Office equipment............................... 1,335 1,656
Leasehold improvements......................... 542 972
Land and buildings............................. -- --
------- -------
Subtotal.................................. 5,380 8,868
Less: accumulated depreciation and amortization (4,131) (5,559)
------- -------
Total..................................... $ 1,249 $ 3,309
======= =======

Depreciation and amortization expense was $1,308, $1,941, and $1,373, for the
years ended December 31, 2001, 2000, and 1999, respectively.

NOTE 7. INVESTMENT IN ACCESS INTERNATIONAL

During 2001 and 2000, the Company accepted the common stock of one of its
customers, Access International, in exchange for consulting services totaling
$750 and $1,250, respectively. The fair value of the stock was determined based
on the estimated fair value of the stock, which approximated the fair value of
the services. The Company also made a cash investment of $350 in July of 2000.
On October 1, 2001, the Company sold its interest in Access International to
BluePhoenix Solutions as part of the sale of the AppBuilder assets. See Note 3.

NOTE 8. NOTES RECEIVABLE AND NOTE RECEIVABLE FROM RELATED PARTY

As discussed in Note 3--Dispositions, in conjunction with the sale of the
AppBuilder software business to BluePhoenix Solutions, the Company received a
note receivable from the purchaser in the amount of $1,000. The note is due on
February 28, 2002 and bears interest at 2.36% per annum. In March 2002 the note
was settled for $825 in cash and $175 in the settlement of other liabilities.

In conjunction with the sale of Geneva Message Queuing and Geneva XIPC
products, the Company received a note receivable from the purchaser in the
amount of $400. As of December 31, 2001, approximately $275 was outstanding
under the note. In February 2002 the note was paid.

F-22

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In February 2001, the Company loaned $75 to a director and officer of the
Company under a secured note, which bears interest at a rate of 6.5% per annum.
The note was payable in full in February 2002. In March 2002, the officer and
director returned to the Company 15,000 shares of stock and will repay the
remaining $50 over the remainder of 2002.

In the fourth quarter of 2000, the Company loaned $495 to a director and
officer of the Company under an unsecured note, which bears an interest rate of
6.5%. The note is payable over a period of five years in equal annual
installments. In the third quarter of 2001, the Company retired the note in
exchange for the forfeiture by the director and officer of certain retirement
benefits.

In conjunction with the sale of Profit Key on April 6, 1998, the Company
received a note receivable from the purchaser for $2,000. The remaining
payments at December 31, 2001, on the note total $1,000 and are due in two
equal annual installments on March 31. The note bears interest at 9% per annum.

During 2000, the Company loaned $1,165 to a strategic partner in the form of
$757 in cash and $408 by assignment of accounts receivable. The note bears
interest at prime plus 2% and was to be repaid in installments during 2001. The
note is guaranteed by the CEO of the strategic partner and secured by stock in
the Company. The payer was in default under the repayment schedule and was
subsequently acquired by another concern who assumed the payment obligation. In
March 2002 the note was repaid.

NOTE 9. SOFTWARE PRODUCT TECHNOLOGY

During the third quarter of 2000, the Company acquired license rights to
Cicero, a comprehensive integrated desktop computer environment from Merrill
Lynch in exchange for 1,000,000 shares of its common stock valued at $22,750.
Subsequent to December 31, 2001, the Company issued 250,000 shares to MLBC,
Inc., an affiliate of Merrill Lynch valued at $620 in order to amend the
license. See Note 24.

During the fourth quarter of 2000, the Company acquired $6,600 in developed
technology through its acquisition of StarQuest. During fiscal year 1999, the
Company acquired $3,410 and $12,200 in developed technology through its
acquisitions of Seer and Template, respectively.

For the fiscal years ended December 31, 2001, 2000, and 1999, the Company
capitalized $2,310, $576, and $1,427, respectively, of costs related to
developing software for sale.

During the fiscal years ended December 31, 2001, 2000, and 1999, the Company
recognized $13,342, $8,629, and $3,301, respectively, of expense related to the
amortization of these costs, which is recorded as cost of software in the
consolidated statements of operations. During the third quarter of fiscal year
2001, the Company reduced the carrying value by $3,070 of the capitalized
software cost recorded as part of the StarQuest acquisition to its fair value
based upon an evaluation of its net realizable value. Accumulated amortization
of capitalized software costs is $17,175, and $12,536 at December 31, 2001 and
2000, respectively.

NOTE 10. IDENTIFIABLE AND UNIDENTIFIABLE INTANGIBLE ASSETS

Identifiable and unidentifiable intangible assets primarily include goodwill,
existing customer base, assembled workforce and trademarks recorded in
connection with the Company's previous acquisitions. Goodwill and intangible
assets from these acquisitions are being amortized using the straight-line
method over periods

F-23

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

ranging from three to seven years. At December 31, 2001 and 2000, identifiable
and unidentifiable intangible assets consist of the following:

2001 2000
---- --------

Goodwill--Level 8 Technologies......... $-- $ 2,954
Goodwill--Momentum..................... -- 4,014
Goodwill--Seer Technologies............ -- 12,545
Goodwill--Template Software............ -- 44,232
Goodwill--StarQuest Software........... -- 8,006
Assembled workforce--Seer Technologies. -- 5,673
Assembled workforce--Template Software. -- 2,920
Assembled workforce--StarQuest Software -- 1,800
Customer base--Seer Technologies....... -- 6,900
Trademark--Seer Technologies........... -- 621
--- --------
Subtotal........................ -- 89,665
Less accumulated amortization.......... -- (24,243)
--- --------
Total........................... $ 0 $ 65,422
=== ========

Amortization expense was $10,212, $14,191, and $6,959 for the fiscal years
ended December 31, 2001, 2000, and 1999, respectively.

Sale of Seer Technologies Assets (AppBuilder)

As described in Note 3, Sale of AppBuilder Assets, the Company sold the
intangible assets acquired from Seer Technologies to BluePhoenix Solutions (a
wholly-owned subsidiary of Liraz), which resulted in a net reduction of $11,052.

Asset Impairments

During the quarter ended March 31, 2001, management reevaluated and modified
its approach to managing the business and decided to conduct business and
assess the efficiency of operations under a line-of-business approach,
representing a change in accounting principle inseparable from the effect of
the change in accounting estimate. As such, the Company performed an assessment
of the recoverability of its long-lived assets under a line-of-business
approach. The results of its analysis of undiscounted cash flows indicated that
an impairment had occurred with regard to the Systems Integration segment (i.e.
intangible assets acquired from Template). The Company estimated the fair
market value of the related assets through a discounted future cash flow
valuation technique. The results of its analysis indicated that the carrying
values of these assets exceeded their fair market values. The Company has
reduced the carrying value of these intangible assets by approximately $21,824
as of March 31, 2001, which approximates a net income affect of $1.37 per share.

During the quarter ended September 30, 2001, the Company was notified by one of
its resellers that they would no longer engage in re-sales of the Company's
CTRC products acquired from StarQuest. This reseller accounted for
substantially all of the product sales and as a result, the Company performed
an assessment of the recoverability of the Messaging Application Engineering
Segment. The results of the Company's analysis of undiscounted cash flows
indicated that an impairment had occurred. The Company estimated the fair
market value of the related assets through a discounted future cash flow
valuation technique. The results of this analysis indicated that the carrying
value of these intangible assets exceeded their fair market values. The Company
has reduced the carrying value of these intangible assets by approximately
$10,999 as of September 30, 2001, of which $3,070 was recorded as software
amortization costs. See Note 9.

F-24

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

At December 31, 2001, the Company determined that the results of operations and
continuing market decline necessitated the reassessment of the recoverability
of its long-lived assets included in the Systems Integration segment. The
results of its analysis of undiscounted cash flows indicated that an impairment
had occurred. The Company estimated the fair market value of the related assets
through discounted future cash flow valuation. The results of its analysis
indicated the carrying values of these assets exceeded their fair market
values. The Company has reduced the carrying value of these intangible assets
by approximately $14,100 as of December 31, 2001.

Purchase Price Allocation Adjustments

During fiscal year 2000, the Company reassessed its estimates of certain asset
valuations, merger costs and assumed liabilities related to the Template
acquisition, which resulted in a net reduction of approximately $139 to
goodwill related to pre-acquisition litigation contingencies and adjustments to
accruals and reserves on the books related to the estimated values of those
assumed liabilities at the acquisition date. In the fourth quarter of 1999, the
Company revised its estimates of certain Seer merger costs and assumed
liabilities, which resulted in an approximate $1,300 reduction in goodwill
related to pre-acquisition litigation contingencies and acquisition costs.

NOTE 11. LONG-TERM DEBT AND CREDIT FACILITIES

Notes payable, long-term debt, and notes payable to a related party consist of
the following at December 31:

2001 2000
------ -------

Credit facility (a)............. $ 0 $10,000
Bridge financing ( b)........... 1,600
Term loan (c)................... 3,000 15,000
Note payable-related parties (d) 245 --
Note payable (e)................ -- 2,000
Capital leases (f).............. -- 30
Other notes payable............. -- 103
------ -------
4,845 27,133
Less current maturities......... (245) (2,133)
------ -------
$4,600 $25,000
====== =======

- --------
(a) On October 1, 2001, as part of the closing conditions of the sale of the
AppBuilder product line, the Company liquidated its entire indebtedness
under this credit facility. At that time the facility was terminated.
(b) In December 2001, the Company entered into a stock purchase agreement to
sell common stock. As part of the agreement, the Company received a $1,600
advance from investors. The amount was converted to common stock upon the
closing of the transaction in January 2001.
(c) The Company has a term loan with a commercial bank for $3,000 due November
15, 2003. This loan bears interest at LIBOR plus 1% (approximately 3.13% at
December 31, 2001), which is payable quarterly. There are no financial
covenants. This loan is guaranteed by Liraz, Level 8's principal
shareholder.

The Company borrowed $10,000 in 1999 and an additional $5,000 in 2000. In
exchange for the initial and amended guarantees of the debt by Liraz, the
Company issued Liraz a total of 60,000 and 110,000 shares of the Company's
common stock in 1999 and 2000, respectively. Based upon the fair market
value of the stock issued, using the quoted market value of the Company's
stock per the Nasdaq for the 5-day period prior to

F-25

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

the agreement, the Company has recorded total deferred costs of $4,013
related to the guaranty. These costs are being amortized in the consolidated
statement of operations as a component of interest expense over the term of
the guaranty. During 2001, the loan was amended to extend the due date to
January 30, 2002 and later as part of the closing conditions on the sale of
the AppBuilder product to BluePhoenix Solutions, the maturity was extended
to November 15, 2003. As of December 31, 2001 and 2000, there were $388 and
$2,702 of unamortized costs classified as prepaid and other current assets
in the consolidated balance sheet, respectively.

Subsequent to December 31, 2001, and as part of an agreement with Liraz as
guarantor of the debt, the Company utilized approximately 10% of the
proceeds from its stock sale agreement and further reduced the principal to
$2,650.

(d) In December 2001, the Company has entered into an agreement with two of the
executive officers of the Company, which provides for borrowings from them
up to $250 and is secured by accounts and notes receivable.
(e) As part of its acquisition of StarQuest, as described in Note 2, the
Company assumed a $2,000 note payable with one of its strategic partners.
The note is due on February 11, 2001 and bears interest at 6.8%, which is
payable quarterly. On February 21, 2001, the note was paid in full.
(f) The Company is obligated under various capital leases for certain computer
and office equipment providing for aggregate payment, excluding interest,
of $30 during 2001.

Principal amounts of notes payable and long-term debt maturing over the next
two years ending December 31 are as follows:

Notes Payable
And
Long-Term Debt
--------------

2002................................... $ 245
2003................................... 3,000
------
Total............................... $3,245
======

This table above excludes the $1,600 advance from investors as the amount was
converted to stock in January 2002.

NOTE 12. INCOME TAXES

Income tax expense consists of the following as of December 31:

2001 2000 1999
----- ------ -----

Federal--current....................... $ -- $ -- $ --
State and local--current............... -- -- --
----- ------ -----
-- -- --
Foreign taxes and withholdings......... 501 1,063 720
----- ------ -----
Current taxes.......................... 501 1,063 720
Federal--deferred...................... -- -- --
State and local--deferred.............. -- -- --
----- ------ -----
Deferred taxes......................... -- -- --
Total income tax provision.......... $ 501 $1,063 $ 720
===== ====== =====

F-26

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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:

2001 2000 1999
-------- ------- -------

Expected income tax benefit at statutory rate (34%)..... $(35,540) $(9,283) $(5,017)
State taxes, net of federal tax benefit................. (5,158) (1,148) (335)
Effect of foreign operations including withholding taxes 801 538 503
Effect of change in valuation allowance................. 38,136 7,719 4,497
Amortization and write-off of non-deductible goodwill... 1,906 2,676 521
In-process research and development--StarQuest.......... -- 30 --
In-process research and development--Template........... -- -- 748
Non-deductible expenses................................. 1,076 531 17
Other................................................... (720) -- (214)
-------- ------- -------
Total................................................ $ 501 $ 1,063 $ 720
======== ======= =======

Significant components of the net deferred tax asset (liability) are as follows:

2001 2000
-------- --------

Current assets:
Allowance for doubtful accounts..... $ -- $ 693
Accrued expenses non-tax deductible. 197 200
Deferred revenue.................... 637 267
Noncurrent assets:.....................
Loss carryforwards.................. 68,024 28,053
Depreciation and amortization....... (534) 975
-------- --------
68,324 30,188
-------- --------
Noncurrent liabilities:
Depreciation and amortization....... -- --
-------- --------
-- --
-------- --------
Valuation allowance.................... (68,324) (30,188)
-------- --------
$ -- $ --
======== ========

At December 31, 2001, the Company has net operating loss carryforwards of
approximately $170,060, which may be applied against future taxable income.
These carryforwards will expire at various times between 2005 and 2022. A
substantial portion of these carryforwards is restricted to future taxable
income of certain of the Company's subsidiaries or limited by Internal Revenue
Code Section 382. Thus, the utilization of these carryforwards cannot be
assured. Approximately $6,978 of the valuation allowance relates to deferred
tax assets for which any subsequently recognized tax benefits will be allocated
directly to reduce noncurrent intangible assets purchased from Momentum and
StarQuest and the remaining amounts would go to reduce tax expense.
Additionally, 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 $21,200.

During 1999, the Company acquired the stock of Template. This acquisition was
accounted for using the purchase method of accounting. The purchase price of
the acquired company was in excess of the carryover tax

F-27

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

basis of the assets acquired, resulting in the recognition of a deferred tax
liability of $1,476. Since the acquired company and the Company may elect to
file a consolidated return on an ongoing basis, the future taxable difference
may be offset by the Company's future deductible differences, primarily its net
operating loss carryforwards. Therefore, the Company's valuation allowance
against its deferred tax asset and its investment in the acquired subsidiary
was reduced by $1,476.

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 Company provided a full valuation allowance on the total amount of its
deferred tax assets at December 31, 2001 and 2000 since management does not
believe that it is more likely than not that these assets will be realized.

NOTE 13. STOCKHOLDERS' EQUITY

Stock Grants

During 2001, the Company issued 369,591 shares of common stock to employees and
consultants for retention bonuses, severance, and consulting. The grants
represented compensation for services previously performed and were valued and
recorded based on the fair market value of the stock on the date of grant which
totaled $1,199.

Stock Options

The Company maintains two stock option plans, the 1995 and 1997 Stock Incentive
Plans, which permit the issuance of incentive and nonstatutory stock options,
stock appreciation rights, performance shares, and restricted and unrestricted
stock to employees, officers, directors, consultants, and advisors. The Plans
reserve a combined total of 7,400,000 shares of common stock for issuance upon
the exercise of awards and provide that the term of each award be determined by
the Board of Directors. The Company also has a stock incentive plan for outside
directors and the Company has set aside 120,000 shares of common stock for
issuance under this plan.

Under the terms of the Plans, the exercise price of the incentive stock options
may not be less than the fair market value of the stock on the date of the
award and the options are exercisable for a period not to exceed ten years from
date of grant. Stock appreciation rights entitle the recipients to receive the
excess of the fair market value of the Company's stock on the exercise date, as
determined by the Board of Directors, over the fair market value on the date of
grant. Performance shares entitle recipients to acquire Company stock upon the
attainment of specific performance goals set by the Board of Directors.
Restricted stock entitles recipients to acquire Company stock subject to the
right of the Company to repurchase the shares in the event conditions specified
by the Board are not satisfied prior to the end of the restriction period. The
Board may also grant unrestricted stock to participants at a cost not less than
85% of fair market value on the date of sale. Options granted vest at varying
periods up to five years and expire in ten years.

In December 1999, as part of its acquisition of Template the Company assumed
the three Stock Option Plans of Template; the 1992 Incentive Stock Option Plan,
the 1992 Non-Statutory Stock Option Plan and the 1996 Equity Incentive Plan. No
further grants may be made under these plans. The options granted under these
plans have been converted to options for the Company's common stock.

F-28

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Activity for stock options issued under these plans for the fiscal years ending
December 31, 2001, 2000, and 1999 is as follows:

Option Weighted
Plan Price Per Average
Activity Share Exercise Price
---------- ---------- --------------

Balance at December 31, 1998 1,912,094 0.69-16.62 8.85
Granted.................. 1,797,210 8.38-30.25 14.15
Assumed Template options. 1,124,023 3.39-39.29 17.22
Exercised................ (523,225) 0.69-16.62 9.26
Forfeited................ (510,210) 7.88-11.76 9.00
----------
Balance at December 31, 1999 3,799,892 1.37-39.29 13.65
Granted.................. 2,082,337 7.06-39.31 24.84
Exercised................ (629,554) 4.87-39.31 10.42
Forfeited................ (1,395,158) 1.37-39.29 26.56
----------
Balance at December 31, 2000 3,857,517 1.37-39.31 15.83
Granted.................. 3,037,581 1.74-6.13 3.60
Forfeited................ (2,528,945) 1.37-39.31 16.38
----------
Balance at December 31, 2001 4,366,153 1.37-39.31 6.92
==========

The weighted average grant date fair value of options issued during the years
ended December 31, 2001, 2000, and 1999 was equal to $2.59, $17.60 and $9.77
per share, respectively. The fair value of options granted during the fiscal
years ended December 31, 2001, 2000 and 1999 was equal to $7,882, $36,641, and
$17,550 respectively. There were no option grants issued below fair market
value during 2001, 2000 or 1999. Exercises reported in the Consolidated
Statements of Stockholder's Equity in 1999 and 2000 are reported net of
repurchases of 103,000 and 106,000 respectively.

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:

2001 2000 1999
------- ------- -------

Expected life (in years)............... 5 years 5 years 5 years
Expected volatility.................... 90% 85% 82%
Risk free interest rate................ 4.50% 6.09% 5.44%
Expected dividend yield................ 0% 0% 0%

For disclosure purposes, the adjusted estimated fair value of the Company's
stock-based awards to employees is amortized over the vesting period. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates as calculated in
accordance with SFAS 123, the Company's net loss and loss per share for the
fiscal years December 31, 2001, 2000 and 1999 would have been increased to the
pro forma amounts indicated below. The Company's adjusted information follows
(in thousands, except for per share information):

2001 2000 1999
--------- -------- --------

Net loss, as reported.......................................... $(105,135) $(28,367) $(15,477)
Net loss applicable to common stockholders..................... (106,061) (34,188) (15,899)
Net loss applicable to common stockholders, as adjusted........ (108,796) (42,356) (22,960)
Net loss per share applicable to common stockholders, as
reported--basic and diluted.................................. (6.65) (2.44) (1.78)
Pro forma net loss per share applicable to common stockholders,
as adjusted--basic and diluted............................... (6.82) (3.02) (2.57)

F-29

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

At December 31, 2001, 2000 and 1999, options to purchase approximately
1,313,826, 1,667,179, and 1,850,087 shares of common stock were exercisable,
respectively, pursuant to the plans at prices ranging from $1.37 to $39.29. The
following table summarizes information about stock options outstanding at
December 31, 2001:

Remaining
Contractual
Number Life for Options Number
Exercise Price Outstanding Outstanding Exercisable
-------------- ----------- ---------------- -----------

$1.37-- 2.00 1,613,385 9.9 3,684
4.04-- 5.81 841,377 7.8 198,079
6.13-- 9.00 1,042,445 7.2 403,650
9.50--14.00 516,356 3.4 479,022
14.73--20.00 119,157 5.0 97,877
22.10--31.62 60,833 6.6 52,008
34.38--39.31 172,600 7.2 79,506
--------- ---------
4,366,153 1,313,826
========= =========

Preferred Stock

On October 16, 2001, the Company completed an exchange of 11,570 shares of
Series A 4% Convertible Redeemable Preferred Stock ("Series A Preferred Stock")
and 30,000 shares of Series B 4% Convertible Redeemable Preferred Stock
("Series B Preferred Stock") for 11,570 shares of Series A1 Convertible
Preferred Stock ("Series A1 Preferred Stock") and 30,000 shares of Series B1
Convertible Preferred Stock ("Series B1 Preferred Stock"), respectively. Series
A1 Preferred Stock and Series B1 Preferred Stock are convertible into an
aggregate of 1,388,456 and 2,394,063 shares of the Company's common stock at
$8.33 and $12.531 per share, respectively. Additionally, the 753,640 Series A
Preferred Stock and 1,047,382 Series B Preferred Stock warrants to issue common
stock at $10 and $25.0625, respectively, were adjusted to an exercise price of
$1.77. The exchange was made in consideration of the temporary release of the
anti-dilution privileges of the Series A Preferred Stockholders and Series B
Preferred Stockholders. The fair value of the exchange, as determined by an
independent third-party valuation firm, was not accretive to the stockholder
thus no dividend was recorded. The exchange of the Series A Preferred Stock for
Series A1 Preferred Stock and Series B Preferred Stock for Series B1 Preferred
Stock was made in a private transaction exempt from the registration
requirements of the federal securities laws.

Holders of the Series A1 Preferred Stock and Series B1 Preferred Stock will
have one vote per share of Series A1 Preferred Stock and Series B1 Preferred
Stock, voting together with the common stock and not as a separate class except
on certain matters adversely affecting the rights of holders of the Series A1
Preferred Stock and Series B1 Preferred Stock, respectively. The Series A1
Preferred Stock and Series B1 Preferred Stock may be redeemed at the option of
Level 8 at a redemption price equal to the original purchase price at any time
if the closing price of Level 8's common stock over 20 consecutive trading days
is greater than $16.00 and $25.0625 per share, respectively. The conversion
prices of the Series A1 Preferred Stock and Series B1 Preferred are subject to
certain anti-dilution provisions, including adjustments in the event of certain
sales of common stock at a price of less than $8.33 and $12.531 per share,
respectively; provided, that the Company may issue up to 3,000,000 shares
without triggering the anti-dilution provisions. In the event the Company
breaches its obligations to issue common stock upon conversion, or the
Company's common stock is delisted, dividends will be payable on the Series A1
Preferred Stock and Series B1 Preferred Stock at a rate of 14% per annum
(partially payable in shares of common stock at the option of the Company
during the first 60 days of such dividend rate).

F-30

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company is required to make certain payments in the event it is unable to
meet its obligations in connection with the Series A1 Preferred Stock, Series
B1 Preferred Stock and warrants, such as registration under the Securities Act
or issuance of shares of common stock upon conversion or exercise. The
aggregate amount of all such payments, together with dividends on the Series A1
Preferred Stock and Series B1 Preferred Stock, is limited to 19% of the
liquidation value of the respective series of preferred stock. One of the
investors in the Series A1 Preferred Stock was Advanced Systems Europe B.V.,
which is a subsidiary of Liraz, Level 8's principal stockholder.

During 2000 and 1999, there were 7,375 and 2,005 shares of preferred stock
converted into 737,500 and 206,000 shares of the Company's common stock,
respectively. There were 11,570 shares of the Series A1 Preferred Stock and
30,000 shares of Series B1 Preferred Stock outstanding at December 31, 2001.

Stock Warrants

The Company values warrants based on the Black Scholes pricing model. Warrants
granted in 2001 and 2000 were valued using the following assumptions:

December 2000 Preferred Preferred
Commercial StarQuest Series A1 Series B1
Lender Warrants Warrants Warrants Warrants
--------------- --------- --------- ---------

Expected life (in years).. 4 3 4 4
Expected volatility....... 87% 121% 107.5% 107.5%
Risk free interest rate... 5% 6% 4% 4%
Expected dividend......... None None None None
Fair value of common stock $6.19 $17.28 $1.89 $1.89

In connection with the exchange of Series A Preferred Stock for Series A1
Preferred Stock, the Company exchanged the investors warrants to purchase
753,640 shares of common stock at an exercise price of $10 per share for
warrants to purchase 753,640 shares of common stock at an exercise price of
$1.77 per share. In connection with the exchange of Series B Preferred Stock
for Series B1 Preferred Stock, the Company also exchanged the investors
warrants to purchase 1,047,382 shares of common stock at an exercise price of
$1.77 per share. The fair value of the preferred stock and warrant exchange, as
determined by an independent third party valuation firm, was not accretive to
the stockholder thus no dividend was recorded. See "Preferred Stock". The
Company may cause the redemption of the Series A1 Preferred Stock warrants and
the Series B1 Preferred Stock warrants for $.0001 at any time if the closing
price of the Company's common stock over 20 consecutive trading days is greater
than $5.00 and $7.50 per share, respectively. The holders may cause the
warrants to be redeemed for cash at the difference between the exercise price
and the fair market value immediately preceding a redemption event as defined
in the warrant. As such, the fair value of the warrants at issuance of $2,100
has been classified as a warrant liability in accordance with EITF 00-19
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in a Company's Own Stock". As of December 31, 2001, no warrants have
been exercised and the fair value of the liability is $2,985.

F-31

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

During December 2000, the Company issued a commercial lender rights to purchase
up to 172,751 shares of the Company's common stock at an exercise price of
$4.3415 in connection with a new credit facility. See Note 11. The warrants
were valued at $775 or $4.49 per share and are exercisable until December 28,
2004. As of December 31, 2001, no warrants have been exercised.

In connection with the acquisition of StarQuest, the Company issued warrants to
purchase 250,000 shares of the Company's common stock. The warrants will have
an exercise price of $30 per share. See Note 2. The warrants were valued at
$1,500 or $6.00 per share and are exercisable until November 28, 2003. As of
December 31, 2001, no warrants have been exercised.

In connection with the acquisition of Momentum during 1998, the Company issued
warrants to purchase 200,000 shares of the Company's common stock. The warrants
have an exercise price of $13.108 per share and expire on March 26, 2003. The
warrants were valued at $654 or $3.27 per share. See Note 2. During 2000,
104,597 warrants were exercised, net of 31,248 warrants forfeited in lieu of
purchase price, leaving 95,403 of these warrants outstanding at December 31,
2001.

In connection with the acquisition of Seer during 1998, the Company issued
warrants to purchase 250,000 shares of the Company's common stock. The warrants
have an exercise price of $12 per share and expire on December 31, 2002. The
warrants were valued at $280 or $1.12 per share. See Note 2. As of December 31,
2001, no warrants have been exercised.

In connection with the initial and secondary public offerings, the Company
issued 140,000 and 110,000 warrants, respectively, to the underwriter. The
warrants are exercisable for four years, commencing one year from the effective
dates of the public offerings at exercise prices of $7.43 and $14.85 per share,
respectively, and have grant date fair values of $3.82 and $6.85 per share,
respectively. Warrants totaling 0, 136,466 and 3,000 were exercised at an
exercise price of $7.43 during the years ended December 31, 2001, 2000 and
1999, respectively. As of December 31, 2001, there were no warrants outstanding
as the warrants have all expired.

Reincorporation and Common Stock

Effective June 23, 1999, the Company completed its re-incorporation under
Delaware law. As a result of the re-incorporation of the Company under Delaware
law, the rights of stockholders of the Company are now governed by the
Certificate of Incorporation and Bylaws of Level 8 Systems, Inc., a Delaware
corporation, and the General Corporation Law of the State of Delaware. In
conjunction with the re-incorporation, the Company changed the par value of its
common stock from $.01 to $.001.

NOTE 14. EMPLOYEE BENEFIT PLANS

As of January 1, 2001 the Company sponsored one defined contribution plan for
its U.S. employees--the Level 8 Systems 401(k). On December 31, 2000 the
Company amended the Level 8 Systems 401(k) plan to provide a 50% matching
contribution up to 6% of an employee's salary. Participants must be eligible
Level 8 plan participants and employed at December 31 of each calendar year to
be eligible for employer matching contributions. Matching contributions to the
Level 8 Plan included in the Consolidated Statement of Operations totaled $7
and $363 for fiscal years 2001 and 2000, respectively.

The Company also has employee benefit plans for each of its foreign
subsidiaries, as mandated by each country's laws and regulations. There was
$260 and $470 in expense recognized under this plan for the years ended
December 31, 2001, and 2000, respectively.

F-32

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company also has an Employee Stock Purchase Plan (U.S.) for its U.S.
employees and the International Stock Purchase Plan, currently available to its
UK employees, (collectively, the ''Stock Purchase Plans''). The Stock Purchase
Plans allow employees to purchase shares of the Company's common stock for 85%
of fair market value. The Stock Purchase Plans are authorized to grant rights
to purchase an aggregate maximum of 250,000 shares of common stock. The Company
is responsible for the administrative costs of the plans. Expenses related to
these plans totaled $95 and $123 during the years ended December 31, 2001 and
2000, respectively.

NOTE 15. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK

For fiscal year 2001, no customer accounted for more than 10% of operating
revenue. Two customers accounted for 11.4% and 11.2% of operating revenues for
fiscal year 2000. No customers accounted for more than 10% of operating revenue
in fiscal year 1999.

As of December 31, 2000 and 2001, the Company had significant balances
outstanding from individual customers due to the nature of its operations. It
is the policy of the Company to closely monitor all accounts receivable and to
record a provision for uncollectible accounts as they become estimable.
Generally, no collateral is required.

NOTE 16. FOREIGN CURRENCIES

As of December 31, 2001, the Company had $321 and $898 US dollar equivalent
cash and trade receivable balances, respectively, denominated in foreign
currencies. At December 31, 2000, the Company had approximately $1,566 and
$5,759 U.S. dollar equivalent cash and trade receivable balances, respectively,
denominated in foreign currencies.

The more significant trade accounts receivable denominated in foreign
currencies as a percentage of total trade accounts receivable were as follows:

2001 2000
---- ----

Euro................................... 32.2% --
Pound Sterling......................... -- 9.2%
Deutsche Mark.......................... -- 1.75%
Italian Lira........................... -- 2.69%

NOTE 17. SEGMENT INFORMATION AND GEOGRAPHIC INFORMATION

During the first quarter of 2001, management reassessed how the Company would
be managed and how resources would be allocated. Management now makes operating
decisions and assesses performance of the Company's operations based on the
following reportable segments: (1) Desktop Integration Products, (2) System
Integration Products, and (3) Messaging and Application Engineering Products.
Prior to 2001, the Company's reportable segmants were: (1) Software, (2)
Maintenance, (3) Services and, (4) Research and development. The historical
segments have not been restated as it is impractical to do so.

The principal product in the Desktop Integration segment is Cicero. Cicero is a
business integration software product that maximizes end-user productivity,
streamlines business operations and integrates disparate systems and
applications.

The products that make up Systems Integration are as follows: Geneva Enterprise
Integrator and Geneva Business Process Automator. Geneva Enterprise Integrator
is an integration tool that provides unified, real-time views of enterprise
business information for eBusiness applications. Geneva Business Process
Automator is a

F-33

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

product designed to work with Geneva Enterprise Integrator for automating the
many business processes that an organization uses to run its operations and
enables the automation of information workflows spanning front and back office
systems.

The products that comprise the Messaging and Application Engineering segment
are Geneva Integration Broker, Geneva Message Queuing, Geneva XIPC and Geneva
AppBuilder.

During the quarter ended September 30, 2001, the Company sold two of its
messaging products, Geneva Message Queuing and Geneva XIPC. Also, on October 1,
2001 the Company sold its AppBuilder software business. See Note 3. The CTRC
products, a component of the Messaging and Application Engineering segment was
not sold.

Segment data includes a charge allocating all corporate-headquarters costs to
each of its operating segments based on each segment's proportionate share of
expenses. The Company evaluates the performance of its segments and allocates
resources to them based on earnings (loss) before interest and other
income/(expense), taxes, in-process research and development, restructuring and
amortization of goodwill (EBITA).

While EBITA should not be construed as a substitute for operating income or a
better indicator of liquidity than cash flows from operating activities, which
are determined in accordance with accounting principles generally accepted in
the United States of America, it is included herein to provide additional
information with respect to our ability to meet our future debt service,
capital expenditure and working capital requirements. EBITA is not necessarily
a measure of our ability to fund our cash needs.

The non-GAAP measures presented may not be comparable to similarly titled
measures reported by other companies.

The table below presents information about reported segments for the twelve
months ended December 31, 2001:

F-34

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

A reconciliation of segment operating expenses to total operating expense for
fiscal year 2001:

2001
-------

The table below presents information about previously reported segments for the
fiscal years ended December 31:

2001 2000 1999
---------------- ---------------- ---------------
Total Total Total Total Total Total
Revenue EBITA Revenue EBITA Revenue EBITA
------- -------- ------- -------- ------- -------

Software................ $ 2,367 $(35,120) $45,998 $ (6,338) $16,030 $(2,549)
Maintenance............. 11,328 5,987 15,967 9,312 14,981 8,819
Services................ 8,964 (2,336) 20,626 (958) 21,909 (116)
Research and development -- (7,946) -- (10,324) -- (7,767)
------- -------- ------- -------- ------- -------
Total................ $22,659 $(39,415) $82,591 $ (8,308) $52,920 $(1,613)
======= ======== ======= ======== ======= =======

A reconciliation of total segment EBITA to loss before provision for income
taxes for the fiscal years ended December 31:

2001 2000 1999
--------- -------- --------

Total EBITA............................. $ (39,415) $ (8,308) $ (1,613)
Amortization of intangible assets....... (10,212) (14,191) (6,959)
Impairment of intangible assets......... (43,853) -- --
(Gain)/loss on disposal of assets....... 6,346 (379) --
In-process research and development..... -- (1,800) (2,944)
Restructuring........................... (8,650) -- (383)
Interest and other income/(expense), net (8,850) (2,626) (2,858)
--------- -------- --------
Total loss before income taxes....... $(104,634) $(27,304) $(14,757)
========= ======== ========

The following table presents a summary of long-lived assets by segment as of
December 31, 2001:

2001
-------

Desktop Integration.................... $13,323
Systems Integration.................... 9,963
Messaging/Application Engineering...... 2,369
-------
Total assets........................ $25,655
=======

F-35

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The following table presents a summary of revenue by geographic region for the
fiscal years ended December 31:

December 31,
-----------------------
2001 2000 1999
------- ------- -------

Australia.............................. $ 141 $ 976 $ 2,429
Denmark................................ 2,428 4,097 4,861
France................................. 492 2,371 6
Germany................................ 776 1,584 3,553
Israel................................. 909 6,778 1,987
Italy.................................. 1,263 2,259 3,370
Norway................................. 579 2,069 2,128
Switzerland............................ 1,229 1,742 2,782
United Kingdom......................... 4,268 9,841 5,055
USA.................................... 7,088 44,573 18,134
Other.................................. 3,486 6,301 8,615
------- ------- -------
Total revenue....................... $22,659 $82,591 $52,920
======= ======= =======

Presentation of revenue by region is based on the country in which the customer
is domiciled. Only countries with greater than 3% of total revenue are
disclosed individually.

The following table represents a summary of long-lived assets by geographic
region as of December 31:

2001 2000
------- --------

United States.......................... $25,553 $109,878
United Kingdom......................... -- 411
France................................. 54 113
Other.................................. 48 72
------- --------
Total assets........................ $25,655 $110,474
======= ========

The Company's foreign operations are reimbursed by the Company for their costs
plus an appropriate mark-up for profit. Intercompany profits and losses are
eliminated in consolidation.

NOTE 18. RELATED PARTY INFORMATION

The Company paid royalties to Liraz of $48 and $15 for the years ended December
31, 2000 and 1999 for products which were developed under a joint development
agreement. The agreement expired on December 31, 2000.

The Company sold software licenses to Liraz for $0, $280, and $0 in 2001, 2000,
and 1999, respectively, for resale to unrelated third parties.

Liraz also pays the salaries and expenses of certain company employees and is
reimbursed by the Company. Salaries and expenses paid by Liraz amounted to $67,
$259, and $372, during 2001, 2000, and 1999, respectively.

At December 31, 2001 and 2000, the Company had accounts payable of $56 and $59
to Liraz, respectively. At December 31, 2001 and 2000, the Company had accounts
receivable of $1,293 and $306 from Liraz and its affiliates, respectively.

The Company exchanged Series A and Series B Preferred stock and warrants for
Series A1 and Series B1 preferred stock and warrants. See Note 13.

In October 2001, the Company sold its AppBuilder assets to Blue Pheonix for $19
million cash, a note receivable of $1,000 and a payment for net assets of $350.
See Note 3.

F-36

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In June 1999, a subsidiary of Liraz purchased convertible preferred stock and
warrants from the Company for $10,000 on the same terms as the other investors
in the $21,000 offering. In December 1999, Liraz exercised its warrants for
1,000 shares of common stock for an aggregate exercise price of $10,000.

Liraz guarantees certain debt obligations of the Company through November 15,
2003. The Company issued common stock to Liraz in exchange for the guaranty.
See Note 11.

In the third quarter of 2000, the Company had software sales of $6,000 to a
customer that currently holds approximately six percent (6%) of our outstanding
shares of common stock and has an employee as a member of our Board of
Directors.

The Company has entered into an agreement with two of the executive officers of
the Company, which provides for borrowings up to $250 and is secured by
accounts and notes receivable. See Note 11.

NOTE 19. RESTRUCTURING CHARGES

In the first quarter of 2001, the Company began an operational restructuring to
reduce its operating costs and streamline its organizational structure. This
operational restructuring involves the reduction of employee staff throughout
the Company in all geographical regions in sales, marketing, services and
development and administrative functions. The Company recorded restructuring
charges of $6,650 during the quarter March 31, 2001 and an additional $2,000
during the quarter ending June 30, 2001.

The restructuring plan included the termination of 191 employees, all of whom
had been notified by June 30, 2001 and terminated by December 31, 2001. The
plan included a reduction of 83 personnel in the European operations and 108
personnel in the U.S. Operations. Employee termination costs comprised of
severance-related payments for all employees terminated in connection with the
operational restructuring. Termination benefits do not include any amounts for
employment-related services prior to termination.

Premises obligations primarily relate to the continuation of lease obligations,
brokers commissions and leasehold improvements for approximately 60,000 square
feet of facilities no longer deemed necessary and costs to exit short-term
leases for various sales offices. Amounts expenses relating to lease
obligations represent estimates of undiscounted future cash outflows, offset by
anticipated third-party sub-lease payments. Marketing obligations related to
contracts and services relating to the prior focus of the Company and are no
longer expected to be utilized.

Other miscellaneous restructuring costs include professional fees, royalty
commitments, recruiting fees, excess equipment and other miscellaneous expenses
directly attributable to the restructuring.

F-37

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The following table sets forth a summary by category of accrued expenses and
cash paid as of December 31, 2001:

Cash
Expense Non-Cash Paid Accrued
------- -------- ------- -------

Employee termination................... $5,319 $(1,045) $(4,231) $ 43
Excess office facilities............... 2,110 (156) (1,307) 647
Marketing obligations.................. 288 -- (235) 53
Royalty commitments.................... 725 (360) (365) --
Other miscellaneous restructuring costs 208 -- (98) 110
------ ------- ------- ----
Total............................... $8,650 $(1,561) $(6,236) $853
====== ======= ======= ====

The Company believes the accrued restructuring cost of $853 at December 31,
2001 represents its remaining cash obligations for the restructuring changes
included above.

NOTE 20. FUNDED RESEARCH AND DEVELOPMENT

In July 2001, the Company and a significant customer entered into a multi-year
agreement to fund the development of the next generation of Level 8's Geneva
Enterprise Integrator and Geneva Business Process Automator software. The terms
of the agreement provide $6.5 million in funding for research and development
over 18 months in exchange for future fully paid and discounted licensing
arrangement. The Company and its significant customer will eliminate the
proprietary code in existence and migrate the GEI and GBPA software to the Java
2 Enterprise Edition (J2EE) environment in order to provide customers with a
flexible, common development environment. Payments are refundable upon
cancellation of the contract excluding amounts for work performed prior to
cancellation. Recognition of the payments has been deferred until the services
have been performed and refund provisions have expired. As of December 31,
2001, the Company has received $2,833 in funding payments and had a $944
receivable and $1,592 in deferred revenue under the arrangement. The Company
had capitalized $2,310 in software product technology costs associated with the
arrangement and subsequently offset those costs with $2,074 which had been
earned under the agreement. At December 31, 2001, $236 remained in software
product technology which will be offset by future amounts recognized under the
agreement.

F-38

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 21. LEASE COMMITMENTS

The Company leases certain facilities and equipment under various operating
leases. Some of these facilities have been subleased. 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, 2001 are as follows:

Lease Lease
Commitments Sublease Commitments
Total Income Net
----------- -------- -----------

2002................................... $3,305 $(1,198) $2,107
2003................................... 2,780 (974) 1,806
2004................................... 2,022 (436) 1,586
2005................................... 1,821 (290) 1,531
2006................................... 1,537 (274) 1,263
------
$8,293
======

Rent expense for the fiscal years ended December 31, 2001, 2000, and 1999 was
$1,835, $3,255, and $2,940, respectively. Sublease income was $221, $171, and
$0 for the fiscal years ended December 31, 2001, 2000 and 1999, respectively.

NOTE 22. CONTINGENCIES

During the year ended December 31, 2001, the Company was named as a defendant
in several actions that ranged from improper dismissal claims to claims for
breach of contract. All such claims were settled by December 31, 2001 and
totaled $950. Management is not aware of any additional claims that would have
a material effect on the financial position or results of operations of the
Company.

NOTE 23. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
(In thousands, except per share data)

2001:
Net revenues.................................................. $ 7,938 $ 7,172 $ 5,889 $ 1,660
Gross profit.................................................. (37) 722 (997) (5,226)
Net loss...................................................... (48,911) (12,508) (24,958) (18,759)
Net loss applicable to common stockholders.................... (49,330) (12,820) (25,273) (18,759)
Net loss per share -- basic and diluted....................... $ (3.12) $ (0.81) $ (1.55) $ (1.18)
2000:
Net revenues.................................................. $ 19,662 $ 21,081 $ 22,318 $ 19,528
Gross profit.................................................. 9,534 13,347 15,238 10,293
Net loss...................................................... (8,028) (5,527) (4,499) (10,312)
Net loss applicable to common stockholders.................... (8,176) (5,644) (4,851) (15,517)
Net loss per share -- basic and diluted....................... $ (0.64) $ (0.41) $ (0.34) $ (0.71)
Net loss per share applicable to common stockholders -- basic
and diluted................................................. $ (0.64) $ (0.41) $ (0.34) $ (1.03)

During the fourth quarter of 2001, the Company reassessed the recoverability of
the remaining intangible assets relating to the Template Software acquisition
and determined that an impairment of $14.2 million was required. See Note 10.

During the fourth quarter of 2000, the Company recorded significant
nonrecurring adjustments totaling $1,800. The fourth quarter adjustments
related primarily to the acquisition of StarQuest. See Note 2.

F-39

LEVEL 8 SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 24. SUBSEQUENT EVENTS

In January 2002, the Company amended its August 2000 license agreement with
Merrill Lynch. Under the terms of the previous agreement, the Company had a
perpetual license to commercialize and sell the Cicero technology, however, the
Company's exclusivity under that contract expired in August 2002. The amendment
provides for the extension of the exclusive, perpetual license to develop and
sell the Cicero application integration software and to obtain ownership of the
Cicero registered trademark. In exchange, Merrill Lynch affiliate, MLBC, Inc.,
will receive 250,000 shares of the Company's common stock. Merrill Lynch now
beneficially owns approximately 1.2 million shares of the Company's common
stock. In addition, Merrill Lynch and the Company entered into a revenue
sharing agreement that provides for royalties to Merril Lynch on future Cicero
software sales. Under the agreement, royalties are capped at $20 million.

Subsequent to December 31, 2001, the Company entered into a Securities Purchase
Agreement with several investors wherein the Company agreed to sell up to three
million shares of its common stock and warrants. The common stock was valued at
$1.50 per share and warrants to purchase additional shares were offered at
$2.75 per share. At December 31, 2001, the Company had received bridge
financing of $1.6 million which was convertible to common stock subject to
closing conditions. This amount has been reflected in the accompanying balance
sheet as long-term debt. This offering closed on January 16, 2002. The Company
sold 2,381,952 shares of common stock for a total of approximately $3.5 million
and granted 476,396 warrants to purchase the Company's common stock at a price
of $2.75 per share. The warrants expire in three years from the date of grant
and have a call feature that forces exercise if the Company's common stock
exceeds $5.50 per share.

F-40

EXHIBITS

Exhibit
Number Description
- ------ -----------

3.2 Bylaws of Level 8 Systems, Inc., a Delaware corporation (filed herewith).

3.3 Certificate of Designation relating to Series A1 Convertible Redeemable Preferred Stock
(incorporated by reference to exhibit 3.1 to Level 8's Report on Form 8-K, filed October 17, 2001).

3.4 Certificate of Designation relating to Series B1 Convertible Redeemable Preferred Stock
(incorporated by reference to exhibit 3.2 to Level 8's Report on Form 8-K, filed October 17, 2001).

E-1

Exhibit
Number Description
- ------ -----------
4.5 Registration Rights Agreement, dated June 13, 1995, between Level 8 Systems, Inc. and Liraz
Systems Ltd. (incorporated by reference to exhibit 10.24 to Across Data Systems, Inc.'s (Level 8's
predecessor) Registration Statement on Form S-1, filed May 12, 1995, File No. 33-92230).

4.8 Form of Stock Purchase Warrant issued to the Purchasers in the January Private Placement
(incorporated by reference to exhibit 10.2 to Level 8's Report on Form 8-K, filed January 25, 2002).

4.9 Form of Stock Purchase Warrant issued to the investors in Series A1 Preferred Stock (incorporated
by reference to exhibit 10.2 to Level 8's Report on Form 8-K, filed October 17, 2001).

4.10 Form of Stock Purchase Warrant issued to the investors in Series B1 Preferred Stock (incorporated
by reference to exhibit 10.3 to Level 8's Report on Form 8-K, filed October 17, 2001).

10.1 Securities Purchase Agreement dated as of January 16, 2002 by and among Level 8 Systems, Inc. and
the Purchasers in the January Private Placement (incorporated by reference to exhibit 10.1 to
Level 8's Report on Form 8-K, filed January 25, 2002).

10.2 Purchase Agreement dated as of January 3, 2002 between Level 8 Systems, Inc. and MLBC, Inc.
(incorporated by reference to exhibit 10.1 to Level 8's Report on Form 8-K, filed January 11, 2002).

10.3B. Securities Purchase Agreement dated July 20, 2000 among Level 8 Systems, Inc. and the investors
named on the signature pages thereof for the purchase of Series B Preferred Stock (incorporated by
reference to Exhibit 10.1 to Level 8's Report on Form 8-K filed July 31, 2000).

E-2

Exhibit
Number Description
- ------ -----------
10.4 Amended PCA Shell License Agreement dated as of January 3, 2002 between Level 8 Systems, Inc.
and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (incorporated by reference to exhibit 10.2
to Level 8's Form 8-K, filed January 11, 2002).

10.5 Promissory Note of Level 8 Systems, Inc. dated September 28, 2001 among Level 8 Systems, Inc.
and Bank Hapoalim (filed herewith).

10.7 License Agreement, dated as of December 17, 1998, between BULL and Template Software, Inc.
(incorporated by reference to exhibit 10.31 to Template Software, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 1998).

10.8 Agreement, dated June 13, 1995, between the Company and Liraz (incorporated by reference to
exhibit 10.23 to Across Data Systems, Inc.'s (Level 8's predecessor) Registration Statement on
Form S-1, filed May 12, 1995, File No. 33-- 92230).

10.10 Employment Agreement between Anthony Pizi and the Company effective January 1, 2002 (filed
herewith).*

10.11 Employment Agreement between John P. Broderick and the Company effective January 1, 2002
(filed herewith).*

10.12 Employment Agreement between Paul Rampel and the Company effective January 1, 2002 (filed
herewith).*

10.14A Fifth Amendment to Level 8 Systems Inc. 1997 Stock Option Plan (filed herewith).*

E-3

Exhibit
Number Description
- ------ -----------

21.1 List of subsidiaries of the Company (filed herewith).

23.1 Consent of Deloitte & Touche LLP (filed herewith).

23.2 Consent of PricewaterhouseCoopers LLP (filed herewith).

- --------
* Management contract or compensatory agreement.

E-4