As filed with the Securities and Exchange Commission on September 11, 1998


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

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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


                                   FORM 10-K/A

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

                   For the fiscal year ended December 31, 1997
                                       or

[ ]  TRANSITION  REPORT  PURSUANT  TO SECTION  14 OR 15(d) OF THE  SECURITIES
     EXCHANGE ACT OF 1934

                       For the transition period from to

                           Commission File No. 0-26392

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

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

               New York                                11-2920559
      (State or Other Jurisdiction of              (I.R.S. Employer
       Incorporation or organization)             Identification No.)

         1250 Broadway, 35th Floor
             New York, New York                           10001
     (Address of principal executive offices)          (Zip Code)

                                 (212) 244-1234

              (Registrant's telephone number, including area code)

        Securities registered pursuant to Section 12(b) of the Act: None
   Securities registered pursuant to Section 12(g) of the Act: Common Stock,
                                 $.01 par value

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


     Indicate by check mark 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 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. [ ]

     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 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 ___.

     The   aggregate   market   value  of  the  voting   Common  Stock  held  by
non-affiliates  of the registrant was $37,560,987 based on the price of the last
reported sale on the  over-the-counter  National Market System on March 18, 1998
reported by NASDAQ.

     As of March 18, 1998, there were 7,049,192 shares of Common Stock, $.01 par
value, outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

     The  responses  to items 10,  11, 12,  and 13 herein  are  incorporated  by
reference to certain information in the Company's Definitive Proxy Statement for
its Annual Meeting of Shareholders to be held May 11, 1998.




<PAGE>

Item 6.    Selected Financial Data
           -----------------------

     The  selected  financial  data  presented  below has been  derived from the
Company's  Consolidated  Financial  Statements.  This  data  should  be  read in
conjunction with  "Management's  Discussion and Analysis of Financial  Condition
and Operations" and the Consolidated Financial Statements.

     For 1997, the following data includes ASU,  ProfitKey,  Level 8 and Level 8
Technologies.  For 1996, the following data includes ASU, ProfitKey, Level 8 and
Level 8 Technologies  for the full year and Bizware  Computer  Systems  (Canada)
Inc.  ("Bizware") until its sale in September 1996. For 1995, the following data
includes  ASU,  ProfitKey,  Level 8 and  Bizware  for the full  year and Level 8
Technologies  since its  acquisition  on April 1, 1995.  For 1994, the following
data  includes  ASU,  ProfitKey  since its  acquisition  on  October 3, 1994 and
Bizware since its acquisition on October 28, 1994. Periods prior to 1994 include
only the operations of ASU. ProfitKey and Bizware are included with discontinued
operations.

                      SELECTED STATEMENT OF OPERATIONS DATA

<TABLE>
<CAPTION>


                                                                     Year Ended December 31,
                                                                     -----------------------
<S>                                           <C>                <C>               <C>                 <C>             <C> 
                                              1993               1994              1995                1996            1997
                                              ----               ----              ----                ----            ----
Revenue  from continuing operations         $1,312,935      $ 1,660,453       $3,011,851         $7,271,602      $14,679,988
Revenue from discontinued operations                          1,936,149        7,127,173          5,803,736        5,545,292
Net income (loss)
  Continuing operations                        (32,712)          25,893         (429,257)          (845,285)       1,036,107
  Discontinued operations                                       537,697        1,047,306         (1,524,112)          52,856

Net income (loss) per common and
common equivalent share -  basic
  Continuing operations                          ( .01)             .01            ( .10)             ( .14)             .15
  Discontinued operations                                           .14              .24              ( .25)             .01

Net income (loss) per common and
common equivalent share -  diluted
  Continuing operations                          ( .01)             .01            ( .10)             ( .14)             .13
  Discontinued operations                                           .14              .24              ( .25)             .01

Weighted average common and common
   equivalent shares outstanding - basic     3,839,166        3,839,166        4,314,106          6,076,103        6,992,398
Weighted average common and common
   equivalent shares outstanding  - diluted  3,839,166        3,839,166        4,403,004          6,076,103        7,561,084



                           SELECTED BALANCE SHEET DATA


                                                                                        At December 31,
                                               1993             1994(1)          1995(1)           1996              1997
                                               ----             ----             ----              ----              ----
Working capital (deficiency)               $   290,991     $ (1,679,294)     $ 4,103,621       $ 11,007,583      $15,825,883
Total assets                                   438,340        5,848,838       15,059,108         20,787,075       23,482,687
Long-term debt, net of current maturities        6,771           19,053           43,975             23,297           15,518
Loans from related companies, net of
   current maturities                          418,900        2,015,165          453,847            330,706          201,751

Shareholders' equity (deficit)                 (85,407)         489,729       11,498,535         18,300,153       20,371,623

(1) As originally reported, not adjusted for discontinued operations.

</TABLE>


                                        2

<PAGE>



Item 8.   Financial Statements and Supplementary Data
          -------------------------------------------

                         REPORT OF INDEPENDENT CERTIFIED
                               PUBLIC ACCOUNTANTS



Board of Directors
    Level 8 Systems, Inc. and Subsidiaries


We have  audited the  consolidated  balance  sheet of Level 8 Systems,  Inc. and
Subsidiaries as of December 31, 1997, and the related consolidated statements of
operations,  shareholders'  equity and cash flows for the year 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 audit.

We conducted our audit in accordance with generally accepted auditing standards.
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 audit provides a reasonable basis for our opinion.

In our opinion,  the 1997 financial statements referred to above present fairly,
in all  material  respects,  the  consolidated  financial  position  of  Level 8
Systems,  Inc. and  Subsidiaries  as of December 31, 1997, and the  consolidated
results of their operations and their  consolidated cash flows for the year then
ended, in conformity with generally accepted accounting principles.

We have also audited Schedule II for the year ended December 31, 1997, listed in
the Index at Item  14(b)2.  In our  opinion,  this  schedule  for the year ended
December 31, 1997 presents  fairly,  in all material  respects,  the information
required to be set forth therein.




/s/ GRANT THORNTON LLP


New York, New York
February 23, 1998  (except for Note N, as to which the date is February 27, 1998
    and Note H, as to which the date is April 6, 1998)




                                        3

<PAGE>

                          INDEPENDENT AUDITOR'S REPORT




Shareholders and Board of Directors
Level 8 Systems, Inc.



We have audited the accompanying  consolidated balance sheet of LEVEL 8 SYSTEMS,
INC. AND  SUBSIDIARIES  as of December 31,  1996,  and the related  consolidated
statements of operations,  changes in shareholders'  equity,  and cash flows for
each of the two years in the period ended December 31, 1996.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the consolidated  financial position of LEVEL 8 SYSTEMS,
INC. AND SUBSIDIARIES as of December 31, 1996, and the  consolidated  results of
their  operations  and their  cash flows for each of the two years in the period
ended  December 31, 1996,  in  conformity  with  generally  accepted  accounting
principles.




/s/ LURIE, BESIKOF, LAPIDUS & CO., LLP

Minneapolis, Minnesota
January 31, 1997, except for Note H, as to which the date is April 6, 1998


<PAGE>

<TABLE>
<CAPTION>


                     Level 8 Systems, Inc. and Subsidiaries
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1997 and 1996


<S>                                                                     <C>                        <C> 
                               ASSETS                                   1997                       1996
                                                                        ----                       ----
CURRENT ASSETS
    Cash and cash equivalents                                     $  7,062,275                $  3,318,252
    Marketable securities                                                    -                   6,524,758
    Accounts receivable, less allowance for doubtful
        accounts of $433,900 and $197,400, respectively              6,455,041                   2,410,755
    Income taxes receivable                                            405,525                     591,004
    Inventory                                                          336,310                           -
    Prepaid expenses and other assets                                  421,235                     169,533
    Net assets of discontinued operation                             3,577,292                       -
                                                                   -----------                ------------
        Total current assets                                        18,257,678                  13,014,302

PROPERTY AND EQUIPMENT                                                 973,747                     685,876

OTHER ASSETS
    Excess of cost over net assets of businesses
        acquired, net                                                1,793,375                   2,215,347
    Software development costs, net                                  2,167,980                   1,149,532
    Deposits and deferred costs                                        289,907                      47,200
    Net assets of discontinued operations                                    -                   3,674,818
                                                                                                 ---------
                                                                     4,251,262                   7,086,897
                                                                                                 ---------
                                                                   $23,482,687                 $20,787,075
                                                                    ==========                  ==========


                       LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
    Current maturities of loan from related company              $     128,000               $     122,000
    Current maturities of long-term debt                                 7,170                       8,593
    Accounts payable                                                 1,935,792                     862,586
    Accrued expenses                                                   224,246                     328,931
    Net liabilities of discontinued operations                               -                     535,009
    Customer deposits                                                   29,687                           -
    Deferred revenue                                                    12,500                           -
    Deferred income taxes                                               94,400                     149,600
                                                                   -----------

        Total current liabilities                                    2,431,795                   2,006,719
                                                                     ---------                   ---------

OTHER LIABILITIES
    Loan from related company, net of current maturities               201,751                     330,706
    Long-term debt, net of current maturities                           15,518                      23,297
    Deferred income taxes                                              462,000                     126,200
                                                                       -------                     -------

                                                                       679,269                     480,203
                                                                       -------                     -------

COMMITMENTS                                                                  -                           -

SHAREHOLDERS EQUITY
    Preferred stock, $.01 par value (authorized -
        1,000,000 shares; no shares issued and outstanding)                  -                           -
    Common stock, $.01 par value (authorized -
        15,000,000 shares; issued and outstanding -
        7,044,634 and 6,954,366, respectively)                          70,446                      69,543
    Additional paid-in capital                                      20,603,498                  19,506,914
    Accumulated deficit                                               (184,212)                 (1,273,175)
    Unearned compensation                                             (118,109)                     (3,129)
                                                                 -------------             ---------------
                                                                    20,371,623                  18,300,153
                                                                    ----------                  ----------

                                                                   $23,482,687                 $20,787,075
                                                                    ==========                  ==========

The accompanying notes are an integral part of these statements.

</TABLE>

                                        4

<PAGE>



                     Level 8 Systems, Inc. and Subsidiaries
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                            Years ended December 31,


<TABLE>
<CAPTION>

<S>                                                                       <C>                     <C>                       <C> 
                                                                          1997                    1996                      1995
                                                                          ----                    ----                      ----
REVENUE
    Consulting and service                                           $10,170,622           $  5,521,050                $  2,951,880
    Software                                                           4,354,112              1,485,017                           -
    Other                                                                155,254                265,535                      59,971
                                                                   -------------           ------------              --------------
                                                                      14,679,988              7,271,602                   3,011,851
                                                                   -------------            -----------              --------------
COST OF REVENUE
    Consulting and service                                             4,995,133              3,055,840                   2,098,132
    Software                                                           2,638,479              1,421,669                           -
    Other                                                                 39,966                 38,885                      53,755
                                                                   -------------          -------------              --------------
                                                                       7,673,578              4,516,394                   2,151,887
                                                                   -------------            -----------              --------------
GROSS MARGIN                                                           7,006,410              2,755,208                     859,964
                                                                   -------------            -----------              --------------
OPERATING EXPENSES
    Selling, general and administrative                                5,435,346              3,497,527                   1,171,348
    Amortization of goodwill                                             432,422                421,971                     320,827
                                                                   -------------           ------------              --------------
                                                                       5,867,768              3,919,498                   1,492,175
                                                                                           ------------
OPERATING INCOME (LOSS) BEFORE GAIN
   (LOSS) ON SALE OF BUSINESSES                                        1,138,642            (1,164,290)                   (632,211)
    Gain on sale of business                                              60,278                       -                       -
                                                                   -------------           ------------
OPERATING INCOME (LOSS)                                                1,198,920            (1,164,290)                   (632,211)
                                                                   -------------           ------------              --------------
OTHER INCOME (EXPENSE)
    Interest income                                                      409,792                170,031                     121,729
    Interest expense                                                    (19,905)               (25,126)                    (14,575)
                                                                   -------------            ------------             --------------
                                                                         389,887                144,905                     107,154
                                                                                           ------------              --------------
INCOME (LOSS) BEFORE INCOME TAXES                                      1,588,807            (1,019,385)                   (525,057)
INCOME TAX EXPENSE (BENEFIT)                                             552,700              (174,100)                    (95,800)
                                                                                             ---------               --------------
INCOME (LOSS) OF CONTINUING
    OPERATIONS                                                         1,036,107              (845,285)                   (429,257)
                                                                   -------------              ---------

DISCONTINUED OPERATIONS
    Income (loss) on discontinued operations, net
       of income tax expense of  $138,200, $26,400
       and $374,500                                                       52,856               (40,051)                   1,047,306
    Loss on the sale of discontinued operation, net
       of income tax expense of $0                                          -               (1,484,061)                        -
                                                                   -------------           ------------
                                                                          52,856            (1,524,112)                   1,047,306
                                                                   -------------
NET INCOME (LOSS)                                                   $  1,088,963         $  (2,369,397)               $     618,049
                                                                     ===========          ============                 ============

NET INCOME (LOSS) PER COMMON SHARE-
   BASIC
      Continuing Operations                                       $.15                   $(.14)                    $(.10)
      Discontinued Operations                                      .01                    (.25)                      .24
                                                                  ----                    -----                     ----
Total                                                             $.16                   $(.39)                     $.14
                                                                  ====                   ======                     ====         
NET INCOME (LOSS) PER COMMON SHARE-
     DILUTED
      Continuing Operations                                       $.13                   $(.14)                    $(.10)
      Discontinued Operations                                      .01                    (.25)                      .24
                                                                  ----                    ----                      ----            
Total                                                             $.14                   $(.39)                     $.14
                                                                  ====                    -----                     ====

The accompanying notes are an integral part of these statements.

</TABLE>

                                        5

<PAGE>



                     Level 8 Systems, Inc. and Subsidiaries
                      CONSOLIDATED STATEMENTS OF CHANGES IN
                               SHAREHOLDERS' EQUITY
                 Years ended December 31, 1997, 1996 and 1995

<TABLE>
<CAPTION>

<S>                               <C>           <C>             <C>            <C>           <C>           <C>             <C>
                                                                                                        Foreign           
                                                             Additional    Retained                     currency
                                      Common stock            paid-in      earnings     Unearned      translation
                                   Shares       Amount        capital      (deficit)   compensation   adjustments         Total
                                   ------       ------        -------      ---------   ------------   -----------         -----
Balance at December 31, 1994     3,009,119    $16,710     $       --      $ 478,173     $     --        $ (5,154)   $   489,729
Recapitalization                        --     10,179        (10,179)            --           --              --             --
Common stock issued:
    Prior to initial public
       offering                    394,315      3,943        521,057             --           --              --        525,000
    Level 8 Technologies
       acquisition                 525,159      5,252      1,570,225             --           --              --      1,575,477
    Conversion of loan from            
       related company to equity   471,264      4,713      2,045,287             --           --              --      2,050,000
    Initial public offering      1,430,000     14,300      5,913,063             --           --              --      5,927,363
    Conversion of minority
       common shares of
       ProfitKey                    91,344        913        273,119             --           --              --        274,032
    Stock options                    1,209         12            988             --           --              --          1,000
    Other                           19,801      3,400             --             --           --              --          3,400
Common stock repurchased           (19,801)      (198)        (3,202)            --           --              --         (3,400)
Net income                              --         --             --        618,049           --              --        618,049
Unearned compensation related           --
    to issuance of stock options                   --         68,285             --      (68,285)             --             --
Adjustment of unearned
   compensation                         --         --         (7,341)            --       34,962              --         27,621
Foreign currency translation                                                         
   adjustment                           --         --             --             --           --          10,264         10,264
                                ----------     ------     ----------      ---------    ---------          ------      --------- 
Balance at December 31, 1995     5,922,410     59,224     10,371,302      1,096,222      (33,323)          5,110     11,498,535
Common stock issued:
    Candle Corporation             246,800      2,468      2,607,274             --           --              --      2,609,742
    Public offering                705,000      7,050      6,470,147             --           --              --      6,477,197
    Stock options                   80,156        801         58,191             --           --              --         58,992
Net loss                                --         --             --     (2,369,397)          --              --     (2,369,397)
Adjustment of unearned
   compensation                         --         --             --             --       30,194              --         30,194
Foreign currency translation            --                        --
   adjustment                           --                        --                          --          (5,110)        (5,110)
                                ----------     ------     ----------     ----------      -------         -------   ------------ 
Balance at December 31, 1996     6,954,366     69,543     19,506,914     (1,273,175)      (3,129)             --     18,300,153

Stock options and warrants (net     90,268        903        506,549             --           --              --        507,452
   of 29,546 shares surrendered)                     
Additional public offering costs        --         --       (137,365)            --           --              --       (137,365)
Net income                              --         --             --      1,088,963           --              --      1,088,963
Unearned compensation related
    to issuance of nonemployee
    stock options                       --         --        263,400             --     (263,400)             --             --
Adjustment of unearned
   compensation                         --         --             --             --      148,420              --        148,420
Tax benefit from stock plans            --         --        464,000             --           --              --        464,000
                                ----------     ------     ----------     ----------    ---------      ----------
Balance at December 31, 1997     7,044,634    $70,446    $20,603,498     $ (184,212)   $(118,109)  $          --    $20,371,623
                                 =========     ======     ==========    ===========     ========    ============     ==========


The accompanying notes are an integral part of these statements.

</TABLE>

                                        6

<PAGE>



                     Level 8 Systems, Inc. and Subsidiaries
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                            Years ended December 31,

<TABLE>
<CAPTION>

<S>                                                                                 <C>                  <C>                <C> 
                                                                                    1997                 1996               1995
                                                                                    ----                 ----               ----

Cash flows from operating activities
    Net income (loss)                                                          $ 1,088,963          $ (2,369,397)     $    618,049
    Adjustments to reconcile net income (loss) to net cash
        provided by (used in) operating activities
           (Income) loss from discontinued operations                              (52,856)               40,051        (1,047,306)
           Depreciation                                                            228,394                35,979            22,842
           Amortization                                                            559,372               421,971           320,827
           (Gain) loss on sale of businesses                                       (60,278)            1,484,061                --
           Deferred income taxes                                                   280,600                89,700           (19,800)
           Nonemployee stock options expense                                       120,291                    --                --
           Accrued interest income                                                      --                    --           (45,190)
           Changes in operating assets and liabilities, exclusive
               of those arising from business acquisitions and sales
                Accounts receivable                                             (4,044,286)           (1,804,053)         (456,126)
                Income taxes                                                       675,473              (518,071)          (88,635)
                Inventory                                                         (336,310)                4,000            (4,000)
                Prepaid expenses and other assets                                 (251,702)              (83,221)          (58,718)
                Deposits and deferred costs                                       (242,707)              (18,088)          (21,527)
                Accounts payable                                                 1,073,206               710,698            80,875
                Accrued expenses                                                  (104,685)              219,107            88,189
                Customer deposits                                                   29,687                    --                --
                Deferred revenue                                                    12,500                    --                --
               Change in net assets of discontinued operations                     507,485               726,247         1,575,121
                                                                               -----------           -----------         ---------

         Net cash provided by (used in) operating activities                      (516,853)           (1,061,016)          964,601
                                                                               -----------           -----------       ----------- 

Cash flows from investing activities
    Purchase of marketable securities                                           (1,998,128)            (6,524,758)      (1,999,772)
    Redemption of marketable securities                                          8,522,886              2,044,962               --
    Purchases of property and equipment                                           (516,265)              (412,485)        (301,109)
    Software development costs                                                  (1,155,848)            (1,182,010)        (203,484)
    Employee advances (repayments)                                                      --              (101,824)           (9,033)
    Proceeds from sale of businesses                                                65,000                156,667               --
    Cost of acquisitions                                                                --                     --       (2,151,302)
    Cash acquired in acquisitions                                                       --                     --            5,669
    Change in net assets of discontinued operations                               (887,998)            (1,191,863)      (1,149,336)
                                                                               -----------            -----------    -------------

         Net cash provided by (used in) investing activities                     4,029,647            (7,211,311)       (5,808,367)
                                                                               -----------            -----------       -----------

</TABLE>


                                        7

<PAGE>



                     Level 8 Systems, Inc. and Subsidiaries
                CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
                            Years ended December 31,
<TABLE>
<CAPTION>


<S>                                                                                 <C>                   <C>              <C> 
                                                                                    1997                  1996             1995
                                                                                    ----                  ----             ----
Cash flows from financing activities
    Proceeds from issuance of common stock                                              --           $10,469,800       $ 8,393,400
    Cost of issuance of common stock                                           $  (137,365)           (1,382,861)       (1,937,637)
    Proceeds from exercise of stock options                                        507,452                58,992             1,000
    Repurchase of common stock                                                          --                    --            (3,400)
    Payments on loans from related companies                                      (122,918)             (118,141)         (907,325)
    Loans from related companies                                                        --                    --         1,513,007
    Payments on long-term debt                                                      (9,239)               (9,613)          (18,008)
    Proceeds from long-term debt                                                        --                    --            52,740
    Change in net assets of discontinued operations                                 (6,701)              (38,619)          (44,687)
                                                                                ----------            ----------         ---------  

         Net cash provided by financing activities                                 231,229             8,979,558         7,049,090
                                                                                ----------            ----------        ----------

         NET INCREASE IN CASH AND
             CASH EQUIVALENTS                                                    3,744,023               707,231         2,205,324

Cash and cash equivalents at beginning of year                                   3,318,252             2,611,021           405,697
                                                                                ----------           -----------       -----------

Cash and cash equivalents at end of year                                       $ 7,062,275          $  3,318,252       $ 2,611,021
                                                                                ==========           ===========        ==========

Supplemental disclosures of cash flow information Cash paid during the year for:
       Interest                                                                 $   19,905        $       25,121        $   14,575
       Income taxes                                                                 10,610                92,297           315,712

Supplemental disclosures of noncash financing and
    investing activities
       Acquisitions of Level 8 Technologies (Note B)
           Cost of net assets acquired                                                  --                    --         3,575,477
           Additional direct costs                                                      --                    --           151,302
           Common stock issued                                                          --                    --        (1,575,477)
                                                                                ----------           -----------       -----------

         Cash cost of acquisition                                                       --                    --         2,151,302

       Financed the sale of a subsidiary                                                --                73,333                --
       Converted loans from related companies into
           471,264 shares of common stock                                               --                    --         2,050,000
       Computer equipment acquired through capital lease                            60,318                    --                --
       Deferred unearned compensation related to
           issuance of nonemployee stock options                                    25,000                    --                --





The accompanying notes are an integral part of these statements.

</TABLE>


                                        8

<PAGE>



                     Level 8 Systems, Inc. and Subsidiaries
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        December 31, 1997, 1996 and 1995



NOTE A - DESCRIPTION OF THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING
                  POLICIES

      1.   The Company

           Level 8  Systems,  Inc.  (Level 8)  develops  and  sells  proprietary
           vertical   application   software   packages  and  provides  software
           consulting and support services to customers located primarily in the
           United  States  and  Canada.  Level 8  Technologies,  Inc.  (Level  8
           Technologies),    a   wholly-owned    subsidiary,    specializes   in
           transactional messaging middleware and distributed object technology.
           Level 8 Technologies  provides  consulting  services to the financial
           services  industry and to computer  hardware and software  providers,
           and has begun to package portions of its distributed objects for sale
           to the financial services  industry.  Level 8 Technologies also sells
           third-party   software  through   licensing   agreements.   ProfitKey
           International,  Inc. (ProfitKey), a wholly-owned subsidiary, provided
           computer consulting services and sold turnkey manufacturing  resource
           planning (MRP II) and scheduling  software  packages to manufacturing
           companies.  ProfitKey  was sold in  1998.  Bizware  Computer  Systems
           (Canada) Inc. (Bizware), a wholly-owned  subsidiary until its sale on
           September  9,  1996,  sold  software   packages  that  provided  cost
           information used by the petroleum and retail industries to manage and
           control individual retail outlets and groups of outlets.
           ProfitKey and Bizware are reported as discontinued operations.

           Liraz   Systems  Ltd.   and  its   wholly-owned   subsidiaries   own
           approximately 52% of Level 8's common stock at December 31, 1997.

           All disclosures  relate to continuing  operations  unless  otherwise
           stipulated.

      2.   Principles of Consolidation

           The consolidated  financial  statements include the accounts of Level
           8, its U.S. subsidiaries, ProfitKey and Level 8 Technologies, and its
           Canadian   subsidiary,   Bizware   (through   September   9,   1996),
           collectively  referred to as the Company.  All intercompany  accounts
           and transactions are eliminated in consolidation.

      3.   Use of Estimates

           The preparation of financial  statements in conformity with generally
           accepted accounting  principles requires management to make estimates
           and assumptions  that affect the reported  amounts and disclosures in
           these financial  statements and  accompanying  notes.  Actual results
           could differ from those estimates.  Significant  management estimates
           relate to the capitalization and amortization of software development
           costs,  amortization periods for intangible assets, the allowance for
           doubtful  accounts,  and the  valuation  allowance  for  deferred tax
           assets.

      4.   Foreign Currency Translation

           Revenue  and  expenses  of Bizware  were  translated  at the  average
           exchange rates prevailing during the years.

      5.   Fair Value of Financial Instruments

           The carrying  amounts of financial  instruments  consisting of cash,
           marketable  securities,  receivables,  long-term  debt, and accounts
           payable  approximate  their fair values.  It is not  practicable  to
           determine the fair value of the loan from the related company due to
           the related party nature of the transaction.


                                        9

<PAGE>



           

      6.   Revenue Recognition

           The  Company  recognizes  revenue  from  the sale of a  software  and
           hardware  system  at the  time  of the  installation  of the  system,
           provided no  significant  obligations  remain and  collection  of the
           resulting receivable is deemed probable. Revenue from add-on hardware
           sales is  recognized  when the  hardware is shipped to the  customer.
           Revenue related to service  contracts is recognized  ratably over the
           terms of the contracts.  Any unearned receipts from service contracts
           result in  deferred  revenue.  Consulting  and  specialized  software
           development revenue is recognized as services are rendered.

      7.   Cash Equivalents and Marketable Securities

           The Company  considers all highly liquid  investments  purchased with
           original  maturities of three months or less to be cash  equivalents.
           Investments  with  original  maturities in excess of three months are
           classified as marketable securities based on the maturity date.

           Marketable  securities  at  December  31,  1996,  consisting  of U.S.
           Government  agency bonds,  are considered to be "available for sale,"
           and are reported at cost which approximates fair market value.

           The  Company  maintains  cash and cash  equivalents  in bank  deposit
           accounts which, at times,  may exceed federally  insured limits.  The
           Company has not  experienced any losses in such accounts and does not
           believe it is exposed to any significant credit risk on cash and cash
           equivalents.

      8.   Inventory

           Inventory  is valued at the lower of cost  (first-in,  first-out)  or
           market and  consists of  purchased  computers,  software  and related
           equipment.

      9.   Property and Equipment

           Property  and   equipment   are  stated  at  cost  less   accumulated
           depreciation.   Depreciation   is  provided   using   primarily   the
           straight-line  method over the estimated  useful lives of the assets,
           primarily five to seven years.

   10.     Excess of Cost Over Net Assets Acquired

           The  excess of the  purchase  price and  related  costs over the fair
           value  of  the  net  assets  of  businesses  acquired  (goodwill)  is
           amortized on a straight-line basis. The goodwill related to the Level
           8  Technologies  acquisition  is amortized  over seven years and that
           related to the Bizware  acquisition was over ten years. The remaining
           Bizware  goodwill was written off when Bizware was sold.  The Company
           periodically  assesses the  recoverability of goodwill by determining
           whether the  amortization  of the balance over its remaining life can
           be recovered through  undiscounted future operating cash flows of the
           acquired  operations.   Accumulated   amortization  of  goodwill  was
           $1,160,423 and $738,450 at December 31, 1997 and 1996, respectively.

   11.     Software Development Costs

           The Company capitalizes  qualifying software  development costs after
           having established  technological feasibility and ends capitalization
           when the product is available  for release to  customers,  consistent
           with Statement of Financial  Accounting  Standards (SFAS) No. 86. The
           Company amortizes such costs over a three-year period or the expected
           useful life of the product,  whichever is shorter.  Development costs
           which are principally  attributable to enhancements and modifications
           of existing products,  and which are expected to provide little or no
           future revenue, are charged to current period operations. Accumulated


                                       10

<PAGE>



           amortization  was  $121,248 at December  31,  1997.  Amortization  of
           in-process  software  development  costs totaling  $1,742,063 has not
           begun as of December 31, 1997.

   12.     Accounting for Stock-Based Compensation

           The  Company  accounts for employee  stock options  under  Accounting
           Principles  Board  Opinion  (APB) No. 25  and  provides the pro forma
           disclosures required by SFAS No. 123.

   13.     Net Income (Loss) Per Common Share

           In February 1997,  the Financial  Accounting  Standards  Board issued
           Statement of Financial  Accounting  Standards  No. 128,  Earnings per
           Share (SFAS 128).  SFAS 128 specifies the  compilation,  presentation
           and disclosure  requirements for earnings per share for entities with
           publicly   held  common  stock  or  potential   common   stock.   The
           requirements  of this  statement are effective for interim and annual
           periods ending after December 15, 1997. All prior years were restated
           in accordance with SFAS 128.

           Net income  (loss) per common  share-basic  is determined by dividing
           the net income  (loss) by the  weighted  average  number of shares of
           common stock outstanding.  Net income (loss) per common share-diluted
           is  determined  by  dividing  the net income  (loss) by the  weighted
           number of shares  outstanding and dilutive common  equivalent  shares
           from stock options and warrants.

   14.     Research and Development Costs

           Research and development  costs are expensed when incurred.  Research
           and development  expenses were approximately  $1,057,468 and $530,541
           for the years ended December 31, 1997 and 1996, respectively.

   15.     Advertising Expenses

           The Company expenses  advertising costs as incurred.  Sales brochures
           and materials are carried as prepaid expenses until they are consumed
           or determined to be obsolete. Advertising expenses were approximately
           $357,843,  $154,434,  and $45,366 for the years  ended  December  31,
           1997, 1996 and 1995, respectively.

   16.     Reclassifications

           Certain  reclassifications  were made to the 1996 and 1995  financial
           statements  to  conform  with  the  1997   presentation,   and  other
           reclassifications  were  made  for all  years to  separately  present
           discontinued operations.

   17.     Recent Accounting Pronouncement

           In  June  1997,  the  Financial  Accounting  Standards  Board  issued
           Statement  of  Financial  Accounting  Standards  No.  130,  Reporting
           Comprehensive Income ("SFAS 130"). SFAS 130 establishes standards for
           reporting and display of comprehensive income and its components in a
           full set of general purpose financial statements. The requirements of
           this  statement will be effective for both interim and annual periods
           beginning  after December 15, 1997.  Management  does not believe the
           implementation  of  SFAS  130  will  have a  material  effect  on the
           financial statements.

           The FASB has issued SFAS No. 131,  "Disclosures  About Segments of an
           Enterprise and Related  Information"  ("SFAS No. 131").  SFAS No. 131
           changes how  operating  segments  are  reported  in annual  financial
           statements and requires the reporting of selected  information  about
           operating   segments   in  interim   financial   reports   issued  to
           shareholders.  SFAS No. 131 is effective for periods  beginning after
           December 15, 1997, and  comparative  information for earlier years is
           to be restated. SFAS No. 131 need not be applied to interim financial
           statements in the initial year of its application.  The Company is in
           the process


                                       11

<PAGE>



           of evaluating the disclosure  requirements.  The adoption of SFAS No.
           131 will have no  impact on the  Company's  consolidated  results  of
           operations, financial position or cash flows.

           In  October  1997,  the  American   Institute  of  Certified   Public
           Accountants  has issued  Statement  of  Position  97-2 ("SOP  97-2"),
           Software  Revenue  Recognition,  which is effective for  transactions
           entered  into in fiscal  years  beginning  after  December  15, 1997.
           Retroactive  application of the provisions of this SOP is prohibited.
           The  SOP  97-2  provides  guidance  on  applying  generally  accepted
           accounting    principles   in   recognizing   revenue   on   software
           transactions.   This  SOP  supersedes  SOP  91-1,   Software  Revenue
           Recognition.  The effect of adopting  this new  standard has not been
           determined.

   18.     Deferred Costs

           The Company  has  deferred  costs of $178,374  relating to a proposed
           acquisition  (Note N) and of $51,471  relating  to a proposed  common
           stock offering.  The deferred  acquisition  costs will be recorded as
           part of the  purchase  price of the  acquisition,  while the offering
           costs will be a reduction of the offering  proceeds.  There can be no
           assurance   that  either   transaction   will  be   consummated.   If
           unsuccessful, the costs will be charged to operations.


NOTE B - ACQUISITION

      Effective April 1, 1995, the Company purchased all of the stock of Level 8
      Technologies,  Inc.  (Level 8  Technologies)  for cash of  $2,000,000  and
      525,159  shares of common  stock valued at  $1,575,477  ($3.00 per share).
      Employees and  shareholders of Level 8 Technologies  also received options
      to  purchase  an  aggregate  of  39,164  shares  at $1.37 per share and an
      aggregate of 116,707 shares at $5.00 per share,  respectively.  Additional
      direct costs of the acquisition totaled $132,032. Level 8 Technologies was
      incorporated   and  commenced   operations  on  February  24,  1994.   The
      acquisition  was accounted for as a purchase  and,  accordingly,  the 1995
      consolidated  statements  of  operations  and of cash  flows  include  the
      transactions of Level 8 Technologies since the date of acquisition.

      The cost was allocated as follows:


Cash                                                    $       5,669
Accounts receivable                                         1,826,602
Property and equipment                                         53,626
Excess of cost over net assets acquired                     2,828,391
Accounts payable and accrued expenses                        (586,811)
Other liabilities, primarily deferred income taxes           (552,000)
                                                          -----------

Cost of net assets acquired                                $3,575,477





                                       12

<PAGE>



NOTE C - PROPERTY AND EQUIPMENT

      Property and equipment consist of the following:

                                        1997                            1996
                                        ----                            ----

Computer equipment                  $  956,894                     $   501,307
Furniture                              239,776                         208,528
Office equipment                       173,658                         144,242
Leasehold improvements                  50,909                          50,909
                                   -----------                     -----------

                                     1,421,237                         904,986

Less accumulated depreciation          447,490                         219,110
                                    ----------                     -----------
                                    $  937,747                     $   685,876
                                     =========                      ==========


NOTE D - ACCRUED EXPENSES

      Accrued expenses consist of the following:


                                          1997                       1996
                                          ----                       ----

 Accrued compensation                   $  81,837                 $   54,290
 Accrued professional fees                 16,928                     78,686
 Accrued cost on sale of subsidiary       125,481                    143,000
 Other accrued expenses                        -                      52,955
                                          -------                   --------

                                        $ 224,246                 $  328,931
                                          =======                    =======


NOTE E - LONG-TERM DEBT

      Long-term  debt  consists of three  equipment  obligations  with  interest
      between 11.8% and 18.4%. Future maturities of long-term debt for the years
      ending December 31 are as follows:  1998 - $7,170;  1999 - $9,075;  2000 -
      $6,443.


NOTE F - TRANSACTIONS WITH RELATED COMPANIES

      The Company has a note payable to Liraz Systems, Ltd. (Liraz) due in equal
      quarterly  installments  of $34,822,  including  interest at 4%.  Interest
      expense on the loan for the years ended December 31, 1997,  1996, and 1995
      was $16,540, $21,132, and $12,319, respectively.

      Future maturities of the loan are as follows:


                   Year                          Amount
                   1998                        $128,000
                   1999                         133,177
                   2000                          68,574
                                                -------       
                                               $329,751

      The Company sold a software license to Liraz for $160,000 in 1997.


                                       13

<PAGE>



      The  Company  and Liraz had an  agreement  for the  joint  development  of
      certain software for a Microsoft contract. Liraz and the Company will each
      pay 50% of the total project  development costs. In exchange for providing
      50% of the project  development  costs,  Liraz was to receive royalties of
      30% of  the  first  $2,000,000  in  contract  revenue,  20%  of  the  next
      $1,000,000, and 8% thereafter.

      On February 16, 1998,  the Company and Liraz  entered into an amendment to
      the original custom computer programming  agreement,  whereby the original
      royalty  payment  provisions were repealed.  Under the new agreement,  the
      Company will pay Liraz royalties of 3% of Program revenues  generated from
      January 1, 1998 until December 31, 2000.

      In addition, the Company will pay $1,300,000 to Liraz,  reflecting Liraz's
      expenses  incurred in  developing  the Program.  This amount is payable in
      three installments as follows:


           February 16, 1998       $500,000
           February 16, 1999        400,000              + 8% interest
           February 16, 2000        400,000              + 8% interest
                                   --------
                                 $1,300,000

      In  addition,  the  Company  and  Liraz  were  awarded  an  Israel  - U.S.
      Binational  Industrial Research and Development  Foundation ("BIRD") grant
      totaling  $432,000.  The  BIRD  grant  will  reimburse  up to  50%  of the
      development  costs of the above project.  Once the products are sold, BIRD
      will be paid a royalty of 2.5% of  related  sales in the first year and 5%
      in subsequent  years until BIRD  recovers  110% to 150%  (depending on the
      elapsed time) of its payments.  The Company estimates its 50% share of the
      revised  total  project   development   costs  to  be  $1,200,000   before
      reimbursement of its BIRD funds of $216,000.  The Company  capitalizes the
      software  development  costs  associated  with the project and reduces the
      capitalized  costs by any grant funds  received from BIRD. At December 31,
      1997,  the  Company  had  capitalized   approximately   $1,130,640   after
      reimbursement of BIRD funds totaling approximately $216,000.

      At December 31, 1997, the Company had accounts  receivable of $160,000 and
      accounts payable of $14,276 from and to Liraz, respectively.


NOTE G - COMMON STOCK, UNEARNED COMPENSATION, STOCK OPTIONS, AND WARRANTS

      1.   Preferred Stock

           On May 31,  1995,  the Board of Directors  and on June 16, 1995,  the
           shareholders  authorized the Company to issue up to 1,000,000  shares
           of  preferred  stock,  $.01  par  value.  No  shares  are  issued  or
           outstanding.

      2.   Common Stock

           On March 10, 1995, the Board of Directors and  shareholders  voted to
           change the no par value common  stock to $.01 par value,  to increase
           the authorized common stock from 200 shares to 8,000,000 shares,  and
           to declare a stock  split  resulting  in the  issuance of 200,000 for
           each share  outstanding  at the time.  On May 12, 1995,  the Board of
           Directors   authorized  a   1.45593157   to  1  common  stock  split.
           Accordingly,  all share  information  was  retroactively  adjusted to
           reflect the  recapitalization  and stock splits. On May 31, 1995, the
           Board of Directors and on June 16, 1995, the shareholders approved an
           increase  in the  authorized  shares of common  stock from  8,000,000
           shares to 15,000,000 shares.

           On April 3,  1995,  minority  common  shares  of  ProfitKey  totaling
           1,254,725  were  converted into 91,344 common shares of Level 8 at an
           exchange  rate of 13.74  shares of  ProfitKey  stock for one share of
           Level 8 stock.  The effect of the conversion  increased net assets on
           discontinued  operations  by  $238,854,  common  stock  by  $913  and
           additional paid-in capital by $273,119, and reduced minority interest
           by $35,178.


                                       14

<PAGE>




           On July 27,  1995,  the  Company  completed  its public  offering  of
           1,430,000  shares  (including  30,000  shares  sold  pursuant  to the
           underwriter's  exercise of its  over-allotment  option) at a price of
           $5.50 per  share.  The  proceeds  from the  initial  public  offering
           totaled $7,865,000 before costs of $1,937,637.

           On July 26, 1996,  the Company sold 246,800 shares of common stock to
           Candle  Corporation  at  $11.00  per  share  before  costs of sale of
           $105,058.

           On December  17,  1996,  the Company  completed a public  offering of
           705,000  shares   (including  45,000  shares  sold  pursuant  to  the
           underwriter's  exercise of its  over-allotment  option) at a price of
           $11.00  per  share  before  1996 and 1997  costs  of  $1,277,803  and
           $137,365, respectively.

      3.   Unearned Compensation

           Unearned  compensation  relates to stock options  issued to employees
           and nonemployees and represents for employees the difference  between
           the fair market value of the stock at the grant date and the price to
           be paid by the individual and for  nonemployees the fair market value
           of the options granted. Compensation is recognized as an expense over
           the service period and totaled $123,420, $30,194, and $27,621 for the
           years ended December 31, 1997, 1996, and 1995, respectively.

      4.   Stock Options

           The Company has 1997 and 1995 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  1,500,000  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.

           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  five  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.




                                       15

<PAGE>



           Stock option  activity during the years ended December 31, 1997, 1996
           and 1995, was as follows:

<TABLE>
<CAPTION>


<S>                                             <C>                         <C>                                <C> 
                                                1997                        1996                               1995
                                     ----------------------        --------------------------        ------------------------

                                                   Weighted-                        Weighted-                       Weighted-
                                                    average                           average                          average
                                                    exercise                        exercise                          exercise
                                      Options         price          Options           price           Options           price

Outstanding, beginning of year        783,155       $  7.31          489,678           $4.23                -                -

Granted                               444,500          8.14          496,620            9.74          432,459            $4.70
ProfitKey options converted                 -             -                -               -           72,742              .69
Exercised                             (91,646)         7.01          (80,156)            .73           (1,209)             .69
Forfeited                             (45,705)        11.38         (122,987)           9.10          (14,314)             .90
                                    ---------                       --------                         -------- 

Outstanding, end of year            1,090,304       $  7.51          783,155           $7.31          489,678            $4.23
                                    =========        ======          =======            ====          =======             ====


<S>                                              <C>                                    <C>                            <C> 
                                                 1997                                   1996                           1995
                                    -------------------------       ----------------------------      ------------------------
                                                    Weighted-                        Weighted-                       Weighted-
                                                     average                          average                          average
                                      Options         fair           Options           fair           Options           fair
                                      granted        value           granted           value          granted           value

Weighted average grant
   date fair value
     Option price less than
        stock price                         -             -          187,420           $6.36          275,300            $3.88
     Option price equals
        stock price                   444,500         $9.35          309,200            7.15          229,901             1.80
                                      -------       -------          -------                          -------                     

                                      444,500         $9.35          496,620           $6.85          505,201            $2.93
                                      =======                        =======                          =======


           Options  outstanding  and exercisable as of December 31, 1997, are as follows:


                                                  Options outstanding                                 Options exercisable
                                                  -------------------                                 -------------------         

                                                          Weighted-                                                     Weighted-
                                                           average             Remaining                                 average
Range of exercise                                         exercise            contractual                                exercise
prices                                Options               price              life-years           Options               price
-----------------                     -------               -----              ----------           -------               -----

$  .69 to $ 1.37                       41,374                 $1.24                 7.0              26,426               $1.26
$ 5.00 to $ 5.75                      291,220                  5.36                 7.4             239,346                5.30
$ 8.29 to $12.23                      566,176                  8.90                 9.2             210,364                8.96
$14.73 to $16.03                      191,534                  8.00                 9.8              63,844                8.00
                                    ---------                                                      --------

$    .69 to $16.03                  1,090,304                 $8.31                 8.7             539,980               $7.39
                                    =========                                                       =======

</TABLE>

If the Company  recognized  compensation  expense based on the fair value at the
grant dates for options under the Plan, consistent with the method prescribed by
Statement of Financial Accounting Standards No.


                                       16

<PAGE>



123, net income (loss) and per share  disclosures  would change to the pro forma
amounts below:

<TABLE>
<CAPTION>

<S>                                                 <C>                              <C>                         <C> 
                                                    1997                             1996                        1995
                                              --------------------           -----------------------      ---------------

Net income (loss)
    As reported                                 $1,088,963                       $(2,369,397)                  $618,049
                                                 ---------

    Pro Forma                                     $820,789                       $(3,524,984)                  $107,698
                                                  --------

Net income (loss) per common
share
    As reported
         Basic                                        $.16                           $(.39)                         $.14
                                                      ----
        Diluted                                       $.14                           $(.39)                         $.14
                                                      ----

    Pro forma
        Basic                                        $(.12)                          $(.58)                         $.02
                                                     ------
        Diluted                                      $(.11)                          $(.58)                         $.02
                                                     ------

</TABLE>

The fair value of stock  options used to compute pro forma net income (loss) and
per share  disclosures  is the  estimated  present value at grant date using the
Black-Scholes   Option-Pricing   model  with  the   following   weighted-average
assumptions:

<TABLE>
<CAPTION>

<S>                                                 <C>                       <C>                       <C> 
                                                    1997                      1996                      1995
                                                    ----                      ----                      ----

           Risk-free interest rate                  6.05%                     6.44%                     6.32%
           Expected life                            5 years                   5 years                   5 years
           Expected volatility                      77%                       75%                       68%
           Expected dividend rate                   0%                        0%                        0%

</TABLE>


      5.   Stock Warrants

           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.

           Prior to 1996,  the Company  issued 6,188  warrants,  exercisable  at
           $6.87 per share and with a grant  date fair  value of $.53 per share,
           which were forfeited on March 31, 1997.

           Warrants totaling 18,168 were exercised at an exercise price of $7.43
           during the year ended December 31, 1997.  There were 231,832 warrants
           outstanding   and   exercisable   at  December  31,   1997,   with  a
           weighted-average  exercise  price and grant date fair value of $10.95
           and $5.81, respectively.

           The weighted  average  assumptions  used to price the grant date fair
           value of warrants are as follows:


                                December 1996                     Initial
                                offering                          offering

Risk-free interest rate         6.50%                             5.88%
Expected life                   4 years                           4 years
Expected volatility             76%                               68%
Expected dividend rate          0%                                0%



                                       17

<PAGE>



NOTE H - SALE OF BUSINESSES

      Effective  December  31,  1997,  the Company sold the business and related
      assets of the ASU Consulting division for $65,000,  resulting in a gain of
      $60,278 for the year ended December 31, 1997.

      On September 9, 1996, the Company sold Bizware for $230,000,  resulting in
      a loss on the sale of $1,484,061. The disposition of Bizware was accounted
      for as a discontinued operation.  The sales price consisted of $120,000 in
      cash and  $110,000 due in six equal  monthly  installments  through  March
      1997.  In  connection  with the sale,  the Company  wrote off  goodwill of
      $999,126,  software development costs of $501,665,  property and equipment
      of $78,877,  and other costs were accrued or expended in  connection  with
      the sale totaling $134,933.

           On April 6,  1998,  the  Company  sold  substantially  all assets and
           operations of its wholly owned subsidiary, ProfitKey. The disposition
           of ProfitKey  was  accounted  for as a  discontinued  operation.  The
           Company  received  $463,615 at the closing and a $2,000,000 note from
           the buyer.

           Revenue from discontinued operations is as follows:

                   1997                           $5,542,292
                   1996                            5,803,736
                   1995                            7,127,173

           The components of net assets (liabilities) of discontinued operations
           is as follows

<TABLE>
<CAPTION>

<S>                                                                          <C>                       <C> 
                                                                             1997                      1996
                                                                             ----                      ----

Cash                                                                       $184,417                  $212,850
Accounts receivable                                                         699,947                   566,505
Inventory                                                                   123,856                   143,874
Prepaid expenses                                                            126,029                    91,649
Property and equipment                                                      343,175                         -
Service contracts acquired, net                                           1,689,932                         -
Software development costs, net                                           1,885,354                         -
Deposits and deferred costs                                                   4,067                         -
Deferred income taxes                                                       633,000                   480,800
Accounts payable and accrued expenses                                     (518,331)                 (477,725)
Customer deposits and deferred revenue                                  (1,540,538)               (1,552,962)
Current and long-term debt                                                 (53,616)                         -
                                                                           --------                  --------

Current net assets (liabilities) of discontinued   
    operations                                                           $3,577,292                $(535,009)
                                                                         ==========                ==========

Property and equipment, net                                      $                -                $  272,234
Service contracts acquired, net                                                   -                 1,834,469
Software development costs, net                                                   -                 1,543,582
Deposits and deferred cost, net                                                   -                     3,833
Deferred income taxes                                                             -                    20,700
                                                                    ---------------
Noncurrent net assets of discontinued operations                 $                -                $3,674,818
                                                                   ================                ==========


</TABLE>



                                       18

<PAGE>



NOTE I - INCOME TAXES

      Income tax expense (benefit) consists of the following:

<TABLE>
<CAPTION>

<S>                                     <C>                    <C>                          <C> 
                                        1997                   1996                         1995
                                        ----                   ----                         ----

Current
    Federal                            $238,900           $  (246,800)                   $ 12,000
    State                                42,200               (43,500)                      5,500
                                         ------

                                        281,100              (290,300)                     17,500
                                        -------

Deferred
    Federal                             230,800                 98,800                   (96,300)
    State                                40,800                 17,400                   (17,000)
                                         ------

                                        271,600                116,200                  (113,300)
                                        -------

                                       $552,700             $(174,100)                 $ (95,800)
                                        =======              ========                   =========
</TABLE>




Income taxes  receivable  increased  by the  $464,000  tax benefit  derived from
nonqualified  stock  option   transactions,   which  was  credited  directly  to
additional paid-in capital.  The benefit is the tax effected  difference between
the  market  value of the stock  issued at the time of  exercise  and the option
price.

Income tax expense (benefit) reconciled to the statutory federal income tax rate
is as follows:

<TABLE>
<CAPTION>

<S>                                                                     <C>                   <C>                      <C> 
                                                                        1997                  1996                     1995
                                                                        ----                  ----                     ----
Tax at statutory Federal rate - 34%:
  Continuing Operations                                                $540,200          $(346,600)                  $(178,500)
  Loss on sale of discontinued operation                                      -           (468,500)
  Discontinued Operations                                                65,000            (40,700)                    488,600

State taxes, net of Federal tax benefit                                  97,400                 300                     17,900
Effect of foreign tax rates and credits                                       -               7,500                   (126,100)
Change in deferred tax asset
    valuation allowance                                               (303,600)             381,000                   (129,000)
Rate differences                                                              -              14,900                     38,800
Nondeductible goodwill amortization                                     197,300             181,500                    159,100
Nondeductible expenses                                                   34,200              14,200                      7,600
Nondeductible loss on sale of foreign subsidiary                              -             106,100                          -
Other                                                                    60,400               2,600                        300
                                                                      ---------

                                                                       $690,900          $(147,700)                  $ 278,700
                                                                       ========

Allocated as follows:
  Continuing operations                                                $552,700          $(174,100)                   $(95,800)
  Sale of discontinued operation                                              -                   -                          -
  Discontinued operations                                               138,200              26,400                    374,500



                                       19

<PAGE>



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

<S>                                                             <C>                                     <C> 
                                                                1997                                    1996
                                                ------------------------------------       ----------------------------


                                                      Current         Long-term             Current         Long-term

Deferred tax assets
    Allowance for uncollectible
       accounts receivable                           $ 174,400                -            $ 80,000                  -
    Accrued expenses not currently
       deductible for tax purposes                      11,700                -              15,200                  -
    Deferred revenue                                     8,300                -            (30,000)                  -
    Loss carryforwards                                  35,400        $ 399,300              35,200          $ 715,800
    Unearned compensation                                  -             72,400                -                22,000
                                                  ------------
                                                       229,800          471,700             100,400            737,800
                                                      --------
Deferred tax liabilities
    Depreciation and amortization                            -         (930,500)                   -          (476,500)
    Change from cash to accrual
       basis                                            (3,200)          (3,200)             (6,400)            (6,500)
                                                    ----------         --------          ----------         ----------
                                                        (3,200)        (933,700)             (6,400)          (483,000)
                                                    ----------         --------          ----------           --------
Deferred tax asset valuation
  allowance                                           (321,000)               -            (243,600)          (381,000)
                                                      --------
Net deferred tax (liability)                         $ (94,400)       $(462,000)         $ (149,600)         $(126,200)
                                                     =========         ========           ==========          ========

</TABLE>

At December 31, 1997, the Company has an approximate  capital loss  carryforward
of $250,000 from the Bizware sale, which expires in 2011.

At December 31, 1997,  the Company also has an  approximate  net operating  loss
carryforward of $835,000 from the acquisition of ProfitKey, which may be applied
against future  taxable  income.  Under Internal  Revenue Code Section 382, as a
result of the change in controlling interest of ProfitKey, the Company's ability
to  utilize  the  acquired  net  operating  loss   carryforward  is  limited  to
approximately  $88,000 each year. The carryforward is cumulative if not utilized
each year and expires primarily in 2008.





                                       20

<PAGE>



NOTE J - NET INCOME (LOSS) PER SHARE

   Net income (loss) per share is computed as follows:

<TABLE>
<CAPTION>

                                                                                     Year ended December 31,
                                                                                     -----------------------

<S>                                                   <C>                       <C>                       <C> 
                                                      1997                      1996                      1995
                                                      ----                      ----                      ----
Net income(loss)(numerator)
    Continuing operations                         $ 1,036,107              $(845,285)             $   (429,257)
    Discontinued operations                            52,856             (1,524,112)                1,047,306
                                                       ------

                                                   $1,088,963            $(2,369,397)                 $618,049
                                                   ==========
Net income (loss) per common share-
  basic
    Weighted average shares outstanding
       (denominator)                                6,992,398              6,076,103                 4,314,106
                                                    =========

    Per share amount
          Continuing operations                          $.15                  $(.14)                    $(.10)
          Discontinued operations                         .01                   (.25)                      .24
                                                          ---
    Total                                                $.16                  $(.39)                     $.14
                                                         ====
Net income (loss) per common share -
    assuming dilution
       Weighted average shares outstanding -
             basic                                  6,992,398              6,076,103                 4,314,106
       Options and warrants                           568,686                      -                    88,898
                                                 ------------
     Total (denominator)                            7,561,084              6,076,103                 4,403,004
                                                    =========

    Per share amount
          Continuing operations                          $.13                  $(.14)                    $(.10)
          Discontinued operations                         .01                   (.25)                      .24
                                                          ---
    Total                                                $.14                  $(.39)                     $.14
                                                          ===                   ====                       ===

</TABLE>

Options and warrants to purchase shares of common stock were outstanding and not
included in the  computation of per share amounts  assuming  dilution due to the
following:


<TABLE>
<CAPTION>

                                                                             Year ended December 31,

<S>                                                                   <C>              <C>               <C> 
                                                                      1997             1996              1995
                                                                      ----             ----              ----

Antidulutive shares due to loss                                          -        1,039,343                  -
Exercise prices were greater than the
    average market price of the common shares                       66,742                -                  -

</TABLE>

NOTE K - COMMITMENTS

      1.   Operating Leases

           The  Company  has  facilities  operating  lease  agreements  expiring
           through November 2000. The leases provide for base monthly rents plus
           an adjustment based on the increase in operating expenses or lessor's
           property  taxes over the base  amounts,  as  defined  in the  leases.
           Certain of these leases  contain  renewal  options.  Rent expense was
           approximately  $378,000,  $279,000 and $147,000 for 1997,  1996,  and
           1995, respectively.


                                       21

<PAGE>



           Approximate future minimum lease payments are as follows:


                         Year                      Amount

                         1998                    $293,000
                         1999                     212,000
                         2000                     128,000
                                                  -------
                                                 $633,000

      2.   Employment Agreements

           The  Company has  employment  agreements  with three  officers of the
           Company for salaries  totaling  $310,000  annually  through May 1998,
           plus performance bonuses.


NOTE L - EMPLOYEE BENEFIT PLAN

      The Company has a 401(k)  retirement  plan for  qualified  employees.  The
      Company has not made any contributions to the plan.


NOTE M - FOREIGN OPERATIONS AND SIGNIFICANT CUSTOMERS

      There were no foreign  operations in 1997. Foreign operations for 1996 and
      1995 consisted of the discontinued  Bizware subsidiary sales which were to
      customers  located in North America.  Revenue and operating  income (loss)
      relating to foreign operations were $363,200 and ($350,000), respectively,
      for the year  ended  December  31,  1996,  and  $1,405,900  and  $581,900,
      respectively,  for  the  year  ended  December  31,  1995.  There  were no
      identifiable  assets at  December  31, 1996 and  $706,600 of  identifiable
      assets at December 31, 1995.

      In 1997 one  customer  accounted  for  approximately  $2.1  million of the
      Company's  revenue  which  represents  approximately  10% of  the  Company
      revenue for the year.  In 1996 one customer  accounted  for  approximately
      $1.3 million of the Company's revenue which represented  approximately 10%
      of the Company's revenue for the year. No customer accounted for more than
      10% of the Company's revenue in 1995.


NOTE N - SUBSEQUENT EVENTS

      Pending Acquisition

      On  February  27,  1998,  the  Company  has signed a  contract  to acquire
      Momentum  Software  Corporation   ("Momentum")  in  a  stock  transaction.
      Momentum is a privately held independent  software vendor. Under the terms
      of the agreement, Momentum shareholders will receive 544,866 common shares
      of Level 8 stock  and  warrants  for  200,000  shares  as well as  certain
      contingent  consideration  based  on the  value  of  Level 8  stock.  This
      transaction  will  be  recorded  as a  purchase  for  financial  reporting
      purposes.


NOTE O - FOURTH QUARTER ADJUSTMENTS

      During the fourth quarter of 1997, the Company increased its allowance for
      doubtful  accounts  by  $275,000  and  recorded  compensation  expense  of
      approximately $120,000 for options issued to a consultant.




                                       22

<PAGE>



NOTE P - EVENTS SUBSEQUENT TO THE REPORT OF INDEPENDENT CERTIFIED PUBLIC
ACCOUNTANTS  (UNAUDITED)

      As  disclosed  in Note H, the Company  sold its  wholly-owned  subsidiary,
      ProfitKey.  The  purchase  price is subject to  adjustment  to reflect any
      working  capital  from a  specified  amount.  The buyer has  notified  the
      Company that it believed there was a variance of  $1,466,444,  which would
      require  a  reduction  in the  purchase  price  of that  amount.  Based on
      information  available  to the Company at this time,  Management  believes
      that an  adjustment,  if any,  is not  determinable  and should not have a
      material  adverse effect on the Company.  In connection  with the sale, in
      1998,  the  Company  recorded a loss from the  discontinued  operation  of
      approximately $1.3 million before a tax benefit of $270,000.






                                                                  23

<PAGE>



Item 14. (a)2.  Financial Statement Schedule

SCHEDULE II

                     LEVEL 8 SYSTEMS, INC. AND SUBSIDIARIES

                        VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>


<S>                <C>                             <C>                            <C>                    <C>               <C>
                 Column A                        Column B                      Column C               Column D          Column E
                 --------                        --------                      --------               --------          --------
                                                                              Additions
                                                                --------------------------------------
                                              Balance at       Charged to                                                Balance at
                                              Beginning         Costs and       Charged to Other       Deductions-         End of
                Description                   of Period         Expenses        Accounts-Describe      Describe(1)         Period
                                           ----------------  ---------------  --------------------- ----------------- --------------



Year ended December 31, 1995 
Deducted from asset accounts:
     Allowance for doubtful accounts       $        -          $      50,823  $          -          ($      29,823)$        21,000
                                           ================  ===============  ===================== ================= ============

Year ended December 31, 1996 
Deducted from asset accounts:
     Allowance for doubtful accounts        $        21,000     $    179,000  $          -           ($        2,600)   $  197,400
                                           ================  ===============  ===================== ================= ============

Year ended December 31, 1997 
Deducted from asset accounts:
     Allowance for doubtful accounts         $      197,400        $ 335,300  $           -           ($      98,800)   $  433,900
                                           ================  ===============  ======================================= ============


(1) Uncollectible accounts written off, net of recoveries.

</TABLE>


                                       24

<PAGE>


Item 14. (c)  Exhibits

      23.1           Consent of Grant Thornton LLP
      23.2           Consent of Lurie, Besikof, Lapidus & Co., LLP






                                   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/ Arie Kilman
                                                    ----------------------------
                                                    Arie Kilman
                                                    Chief Executive Officer and
                                                    Chairman of the Board

Dated:  September 11, 1998




                                       25
<PAGE>