UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C.  20549


FORM
10-K





x ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)


OF THE
SECURITIES EXCHANGE ACT OF 1934


For the
fiscal year ended December 31, 2007





o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d)


OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]


For the
transition period from        
to





Commission
File Number:  000-26392





CICERO
INC.


(Exact
name of registrant as specified in its charter)





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





8000
      Regency Parkway, Suite 542, Cary, NC 27518(Address
      of principal executive offices, including Zip Code)(919)
      380-5000(Registrant’s telephone number,
      including area code)


_____________





Securities
      registered pursuant to Section 12(b) of the Act:
            NONESecurities
      registered pursuant to Section 12(g) of the Act:
            Common Stock, $.001
      par value


_____________





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the above Act. Yes o No x





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes x No o





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





Indicate
by check mark whether the registrant is a shell
company.  Yes o No x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act. (Check one):






Large
      accelerated filer o
            Accelerated
      filer o
            Non -
      accelerated filer x





Aggregate
market value of the outstanding shares of common stock held by non-affiliates of
the Registrant as of June 30, 2007 was approximately $5,765,578 based upon the
closing price quoted on the Over The Counter Bulletin Board.





There
were 43,805,508 shares of Common Stock outstanding as of March 11,
2008.





Documents
Incorporated by reference: None












CICERO
INC.


(Formerly
Level 8 Systems, Inc.)


Annual
Report on Form 10-K


For the
Fiscal YearEnded December 31, 2007





Item
              Number
            
            Page
              NumberPART
      I1.
            Business
            11A.
            Risk factors
            91B
            Unresolved Staff Comments
            142.
            Properties
            143.
            Legal Proceedings
            144.
            Submission of Matters to a Vote of Security
      Holders
            14PART
      II5.
            Market for Cicero Common Stock and Related Shareholder
      Matters
            156.
            Selected Financial Data
            167.
            Management's Discussion and Analysis of Financial Condition and
      Results of Operations
            177A.
            Quantitative and Qualitative Disclosures About Market
      Risk
            268.
            Financial Statements and Supplementary Data
            269.
            Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
            269A.
            Controls and Procedures
            269B.
            Other Information
            28PART
      III10.
            Directors and Executive Officers of Cicero
            2911.
            Executive Compensation
            3312.
            Security Ownership of Certain Beneficial Owners and
      Management
            3913.
            Certain Relationships and Related
    Transactions
            4114.
            Principal Accountant Fees and Services
            46PART
      IV15.
            Index Exhibits, Financial Statement Schedules, and Reports on
      Form 8-K
            47SIGNATURES
            53INDEX TO FINANCIAL STATEMENTS
            F-1


Table of Contents





PART
I





Item
1.          Business





Overview





Cicero Inc, formerly known as Level
8 Systems, Inc. (the “Company”)is aprovider of business
integration software, which enables organizations to integrate new and existing
information and processes at the desktop. Our business integration software
addresses the emerging need for companies’ information systems to deliver
enterprise-wide views of their business information processes.In addition to software
products, the Company also provides technical support, training and consulting
services as part of its commitment to providing its customers with
industry-leading integration solutions.  The Company’s consulting team
has in-depth experience in developing successful enterprise-class solutions as
well as valuable insight into the business information needs of customers in the
largest 500 corporations worldwide (the “Global 500”).





The
Company’s focus is on the desktop integration and business process automation
market with our Cicero® product.
Cicero® is a business application integration platform that enhances end-user
productivity, streamlines business operations and integrates systems and
applications that would not otherwise work together.  Cicero® software
offers a proven, innovative departure from traditional, costly and
labor-intensive enterprise application integration, which occurs at the server
level.  Cicero® provides non-invasive application integration at the
desktop level.  Desktop level integration provides the user with a
single environment with a consistent look and feel for diverse applications
across multiple operating environments, reduces enterprise integration
implementation cost and time, and supports a Service-Oriented Architecture
(“SOA”). Cicero®’s desktop level integration also enables clients to transform
applications, business processes and human expertise into a seamless, cost
effective business solution that provides a cohesive, task-oriented and
role-centric interface that works the way people think.





By using
Cicero® software, companies can decrease their customer management costs,
improve their customer service and more efficiently cross-sell the full range of
their products and services resulting in an overall increase in return on their
information technology investments.  In addition, Cicero® software
enables organizations to reduce the business risks inherent in replacement or
re-engineering of mission-critical applications and extend the productive life
and functional reach of their application portfolio.





Cicero®
software is engineered to integrate diverse business applications and shape them
to more effectively serve the people who use them.  Cicero® provides
an intuitive integration and development environment, which simplifies the
integration of complex multi-platform applications. Cicero® provides a unique
approach that allows companies to organize components of their existing
applications to better align them with tasks and operational
processes.  In addition, Cicero® can streamline end-user tasks by
providing a single, seamless user interface for simple access to multiple
systems or be configured to display one or more composite applications to
enhance productivity.  Cicero® software enables automatic information
sharing among line-of-business applications and tools. It is ideal for
deployment in contact centers where its highly productive, task-oriented user
interface promotes user efficiency.  Finally, Cicero® software, by
integrating diverse applications across multiple operating systems, is ideal for
the financial services, for which Cicero® was initially developed, insurance,
telecommunications, intelligence, security, law enforcement, governmental and
other industries requiring a cost-effective, proven application integration
solution.  Cicero® is also an integration solution for merger and
acquisition events where the sharing of data and combining of systems is
imperative.





Some of
the companies and other users that have implemented or are implementing our
Cicero® software product include Merrill Lynch Pierce Fenner & Smith
Incorporated, Nationwide Financial Services, IBM and N.E.W. Customer Service
Companies. We have also sold to intelligence, security, law enforcement and
other government users.





In
addition to our Cicero® product, our Ensuredmail email encryption products
address information and security compliance requirements from the individual to
the enterprise.  The Ensuredmail suite of products includes the
Enterprise Email Encryption Server, and Email Encryption Desktop for individual
use.  All of the Ensuredmail products use 3-DES or AES encryption
technology and are tested and federally certified FIPS
140-1.  Ensuredmail products are easy to install, use and administer.
They also use rules and other utilities that allow users to flag messages
including attachments for encryption.  Unlike other secure email
encryption software applications, Ensuredmail products do not require the
recipient to install software or use special secure keys to open and read
messages and attachments.  In conjunction with Cicero® software,
Ensuredmail email encryption technology has been used to secure information
shared in Cicero® integration projects.




1
 Table of Contents





Some of
the companies using Ensuredmail server products include the United Postal
Service, ITX, Physicians Plus, the U.S. Bureau of Alcohol, Tobacco, Firearms and
Explosives, UFCW, Select Benefit, Delta Dental, Truog-Ryding Company, and
hundreds of individual users with the Ensuredmail Email Desktop
product.  Ensuredmail customers use email encryption primarily to
secure outbound messages with confidential information for compliance (e.g.,
HIPAA) and security purposes.





Cicero
Inc. was incorporated in New York in 1988 as Level 8 Systems, Inc. and
re-incorporated in Delaware in 1999. Our principal executive offices are located
at 8000 Regency Parkway, Suite 542, Cary, NC 27518 and our telephone number is
(919) 380-5000. Our web site is www.ciceroinc.com.




Strategic
Realignment





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





Until
early 2001, we focused primarily on the development, sale and support of EAI
solutions through our Geneva product suite. After extensive strategic
consultation with outside advisors and an internal analysis of our products and
services, we recognized that a new market opportunity had
emerged.  This opportunity was represented by the increasing need to
integrate applications that are physically resident on different platforms, a
typical situation in larger companies.  In most cases, companies with
large customer bases utilize numerous different, or "disparate," applications
that were not designed to effectively communicate and pass
information.  In addition, traditional EAI is often times too costly
and time-consuming to implement.  It also requires a group of
programmers with the necessary skills and ongoing invasive changes to
application software code throughout the enterprise. With Cicero® software,
which non-invasively integrates the functionality of these disparate
applications at the desktop, we believe that we have found a unique solution to
this disparate application problem. We believe that our existing experience in
and understanding of the EAI marketplace coupled with the unique Cicero®
software solution, which approaches traditional EAI needs in a more effective
manner, position us to be a competitive provider of business integration
solutions to the financial services and other industries with large deployed
contact centers, as well as our other target markets.





We
originally licensed the Cicero® technology and related patents on a worldwide
basis from Merrill Lynch, Pierce, Fenner & Smith Incorporated in August of
2000 under a license agreement containing standard provisions and a two-year
exclusivity period. On January 3, 2002, the license agreement was amended to
extend our exclusive worldwide marketing, sales and development rights to
Cicero® in perpetuity (subject to Merrill Lynch's rights to terminate in the
event of bankruptcy or a change in control of the Company) and to grant
ownership rights in the Cicero® trademark. Merrill Lynch indemnifies us with
regard to the rights granted to us by them. Consideration for the original
Cicero® license we issued to Merrill Lynch consisted of 10,000 shares of our
common stock. In consideration for the amendment, we issued an additional 2,500
shares of common stock to MLBC, Inc., a Merrill Lynch affiliate and entered into
a royalty sharing agreement. Under the royalty sharing agreement, we pay a
royalty of 3% of the sales price for each sale of Cicero® or related maintenance
services. The royalties over the life of the agreement are not payable in excess
of $20 million. We have completely re-engineered the Cicero® software to provide
increased functionality and much more powerful integration
capabilities.





The
Company’s future revenues are entirely dependent on acceptance of Cicero® which
has had limited success in commercial markets to date. The Company has
experienced negative cash flows from operations for the past three years. As of
December 31, 2007, the Company had a working capital deficiency of approximately
$6,132,000.  Accordingly, there is substantial doubt that the Company
can continue as a going concern, as is expressed in the independent auditor’s
report accompanying our financial statements.  In order to address
these issues and to obtain adequate financing for the Company’s operations for
the next twelve months, the Company is actively promoting and expanding its
product line and continues to negotiate with significant customers who have
demonstrated interest in the Cicero® technology. The Company is experiencing
difficulty increasing sales revenue largely because of the inimitable nature of
the product as well as customer concerns about the Company’s financial
viability. Cicero® software is a new “category defining” product in that most
EAI projects are performed at the server level and Cicero®’s integration occurs
at the desktop level without the need to open and modify the underlying code for
those applications being integrated. Many companies are not aware of this new
technology or tend to look toward more traditional and accepted approaches. The
Company is attempting to solve the former problem by improving the market’s
knowledge and understanding of Cicero® through increased marketing and
leveraging its limited number of reference accounts while enhancing its list of
resellers and system integrators to assist in the sales and marketing process.
In addition, emerging competition in the marketplace has aided in the awareness
of this new technology.




2
 Table of Contents
  Additionally,
the Company is seeking additional equity capital or other strategic transactions
in the near term to provide additional liquidity.


Recent
Developments




In December 2007, the Company entered into an OEM agreement with Merrill Lynch,
Pierce Fenner and Smith. Under the terms of the agreement, the Company has
allowed Merrill to embed the Cicero framework in a product it is building for
resale in the financial services arena. Merrill has agreed to purchase licenses
for Cicero on an as needed basis with an initial license purchase of $500,000 in
December 2007. At the same time, the Company and Merrill agreed to an enterprise
wide three year support agreement with a total value of $3,000,000 to be
recognized over the next three years.





Plan
of Recapitalization





In
December 2006, the Company completed its Plan of Recapitalization which was
approved by shareholders at a Special Shareholder Meeting held on November 16,
2006. The Plan provided the Company’s Board of Directors with discretionary
authority to affect a reverse stock split ratio from 20:1 to 100:1 and on
November 20, 2006, the Board of Directors set that reverse stock ratio to be
100:1. In addition, the Company’s shareholders approved an amendment to change
the name of the Company from Level 8 Systems, Inc. to Cicero Inc., to increase
the authorized common stock of the Company from 85 million shares to 215 million
shares and to convert existing preferred shares into a new Series A-1 preferred
stock. Senior Reorganization Notes in the aggregate principal amount of
$2,309,000, were cancelled and converted into 3,438,473 shares of common
stock.  Senior Reorganization Notes were issued pursuant to a Note and
Warrant Offering in 2004 wherein warrant holders of the Company’s common stock
were offered a one-time conversion of their existing warrants at a conversion
price of $0.10 per share. Those warrant holders who elected to convert, tendered
their conversion price in cash and received a Note Payable in exchange. In
addition, holders of Senior Reorganization Notes were granted additional
warrants to acquire the Company’s common stock. The Company also converted
$3,915,000 of Convertible Bridge Notes into 30,508,448 shares of common stock.
The Plan of Recapitalization also included an exchange of existing preferred
shares into a new Series A-1 preferred shares for Cicero Inc. As part of that
exchange and part of the plan of recapitalization, $992,000 of Convertible
Promissory Notes were converted into 1,591 Series A-1 preferred shares and
$1,061,000 of Series D preferred stock recorded as mezzanine financing was
converted into 53 shares of Series A-1 preferred shares.





The
Company expects that increased revenues will reduce its operating losses in
future periods; however, there can be no assurance that management will be
successful in executing its strategy as anticipated or in a timely
manner.  If these strategies are unsuccessful, the Company may have to
pursue other means of financing that may not be on terms favorable to the
Company or its stockholders.  If the Company is unable to increase
cash flow or obtain financing, it may not be able to generate enough capital to
fund operations for the next twelve months.  At our current rate of
expenses and assuming revenues for the next twelve months at an annualized rate
of our revenue for the year ended 2007, we will be able to fund planned
operations with existing capital resources for a minimum of seven months and
experience negative cash flow of approximately $1,250,000 during the next twelve
months to maintain planned operations. The accompanying financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business.
The financial statements presented herein do not include any adjustments
relating to the recoverability of assets and classification of liabilities that
might be necessary should the Company be unable to continue as a going
concern.




Products





Desktop
Integration





Cicero®.
Cicero® software integrates disparate applications regardless of the platform,
enables rapid development of effective, simple-to-maintain composite
applications, accelerates time to value and deploys cost-effective,
"best-of-breed" business solutions by leveraging existing IT
investments.  Cicero® software helps the architect maintain consistent
integration project design and implementation by providing extensible,
standardized software methods for interacting with Windows applications, COM
objects, web pages, commercial software packages, legacy applications, and Java
applications among others. Cicero® software can integrate applications running
on the server or desktop, giving the architect complete flexibility in
determining where, when, and how application integration occurs. Cicero®
software can also be used to capture and aggregate data from many different
applications, apply business rules as needed, such as data transformation rules,
and share that data bi-directionally via a composite view. An event in one
application can cause processing in another unrelated application, even if these
were implemented using differing technologies, such as Windows and
Java.




3
 Table of Contents





The
patented Cicero® software technology, as exclusively licensed from Merrill
Lynch, consists of several components, including the following: The Resource
Manager, which manages the starting, stopping, and status of applications; the
Event Manager, a Component Object Model (COM)-based messaging service; the
Context Manager which administers the “publish and subscribe” protocols; and a
Graphical User Interface (GUI) manager which allows applications to be presented
to the user in one or more flexible formats selected by the user
organization.  In 2004, we released a version of the Cicero® product
which included our newly developed Cicero® Studio integration tool, to allow
applications to be integrated using point-and-click methods. Cicero® software
incorporates an Application Bus with code modules to handle the
inter-application connections. There are additional tools that provide ancillary
functions for the integrator including toolset to debug, view history and trace
logs.









Cicero® Studio provides a
nontraditional approach to application integration. By providing a high level of
object-oriented integration, Cicero® Studio eliminates the need for source code
modification. It includes high-level integration objects called genes (which
translate disparate application interface protocols to one common interface used
by Cicero® software), an event processor, a context manager and a
publish-subscribe information bus that enables applications to share data. It
also includes a set of integration wizards that greatly simplify the task of
application integration.





Cicero® Studio is a powerful
integration tool that eliminates most of the technical complexity associated
with application integration. Integrators avoid the high cost and complexity of
invasive code modifications and extend the scope of their integration
capabilities into new and legacy environments. Cicero® Studio provides an open
architecture that can be extended to incorporate new behaviors by adding genes
and communicating with COM objects. This enables Cicero® software to be extended
to accommodate new platforms and interface requirements as needed and provides a
rich paradigm for evolving integration behaviors over time. It also means that
Cicero® software can be implemented in both the desktop and n-tier server of a
service-oriented architecture.





Cicero® software runs on Vista,
Windows XP, and Windows 2000 to organize applications in a flexible graphical
configuration that keeps all the application functionality that the user needs
within easy reach. For instance, selecting the “memo” tab might cause a
Microsoft Word memo-template to be created within the Cicero® desktop. The
end-user need not even know that they are using Microsoft
Word.  Moreover, a customer-tracking database can be linked with a
customer relationship management software package.





Cicero®
technology provides non-intrusive integration of desktop and web applications,
portals, third-party business tools, and even legacy mainframe and client server
applications, so all co-exist and share their information
seamlessly.  Cicero®’s non-invasive technology means that clients
don’t risk modifying either fragile source code or sensitive application program
interfaces - and they can easily integrate off-the-shelf products and emerging
technologies.





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




4
 Table of Contents


Messaging





Ensuredmail.Our Ensuredmail products
provide encrypted email capabilities such as security, proof-of-delivery and
non-repudiation of origination. The recipient of an Ensuredmail message does not
need to be an Ensuredmail licensee or install software. When an Ensuredmail user
sends a message to another user, the recipient receives an email message with an
attached encrypted message.  The recipient opens the attached, which
starts their web browser, enters a password, and can read the message and
attachments.  If the recipient replies to the message, the message is
fully encrypted and sent back securely to the original sender. Organizations
typically use our server-based Ensuredmail products, whereas individuals can use
a person-to-person desktop variation.





Ensuredmail
is FIPS140-1 certified, and in use by agencies of the Federal Government, in
addition to private sector organizations.





Services





We
provide a full spectrum of technical support, training and consulting services
across all of our operating segments as part of our commitment to providing our
customers industry-leading business integration solutions.  Experts in
the field of systems integration with backgrounds in development, consulting,
and business process reengineering staff our services
organization.  In addition, our services professionals have
substantial industry specific backgrounds with extraordinary depth in our focus
marketplace of financial services.





Maintenance
and Support





We offer
customers varying levels of technical support tailored to their needs, including
periodic software upgrades, and telephone support.  Cicero® is
frequently used in mission-critical business situations, and our maintenance and
support services are accustomed to the critical demands that must be met to
deliver world-class service to our clients.  Many of the members of
our staff have expertise in mission critical environments and are ready to
deliver service commensurate with those unique client needs.





Training
Services





Our
training organization offers a full curriculum of courses and labs designed to
help customers become proficient in the use of our products and related
technology as well as enabling customers to take full advantage of our
field-tested best practices and methodologies.  Our training
organization seeks to enable client organizations to gain the proficiency needed
in our products for full client self-sufficiency but retains the flexibility to
tailor their curriculum to meet specific needs of our clients.





Consulting
Services





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




Customers
 
 Our
customers include both end-users to whom we sell our products and services
directly and distributors and other intermediaries who either resell our
products to end-users or incorporate our products into their own product
offerings. Typical end-users of our products and services are large businesses
with sophisticated technology requirements for contact centers, in the financial
services, insurance and telecommunications industries, and intelligence,
security, law enforcement and other governmental organizations.
  5
 Table of Contents
  Our
customers are using our solutions to rapidly deploy applications. Some examples
of customers' uses of our products include:
 
 · Business Process Outsourcers
- use our Cicero® solution in
contact centers to provide real time integration among existing back-office
systems, eliminate redundant data entry, shorten call times, provide real-time
data access and enhance customer service and service levels.
 
 · A financial institution -
uses our Cicero® solution to
provide real-time integration among market data, customer account information,
existing back-office systems and other legacy applications, eliminate redundant
data entry, provide real-time data access and processing, and enhance customer
service and service levels.
 
 · An insurance company - uses
our Cicero®
solution to integrate their customer information systems with over thirty
software applications including a CRM application.
 
 · A law enforcement
organization - uses our Cicero® solution to
streamline and automate support for arrests and investigations while merging
federal, state and local systems within a unified process.
 
 Other
customers are systems integrators, which use our Cicero® product to develop
integration solutions for their customers.


In 2007,
Merrill Lynch accounted for more then ten percent (10%) of our operating
revenues.  Merrill Lynch, N.E.W. Customer Service Companies, IBM, and
Pilar Services, Inc. each accounted for more than ten percent (10%) of our
operating revenues in 2006. In 2005, N.E.W. Customer Service Companies and
Innovative System Solutions Corporation accounted for more than ten percent
(10%) of our operating revenue.





Sales
and Marketing





Sales





An
important element of our sales strategy is to supplement our direct sales force
by expanding our relationships with third parties to increase market awareness
and acceptance of our business integration software solutions. As part of these
relationships, we continue to jointly sell and implement Cicero® software
solutions with strategic partners such as systems integrators and embed Cicero®
along with other products through reseller relationships.  We provide
training and other support necessary to systems integrators and Resellers to aid
in the promotion of our products.  To date we have entered into
strategic partnerships with the following resellers, for integrated business
solutions: BluePhoenix Solutions, ThinkCentric, Hewlett Packard and House of
Code.  In addition, we have entered into strategic partnerships with
TrySynergy Consulting, Innovative Solutions Group, Piercetech, Silent Systems,
Inc., ADPI LLC, and Pilar Services, Inc.  These organizations have
relationships with existing customers or have access to organizations requiring
top secret or classified access.  In addition, several of these
partners can bundle Cicero® with other software to provide a comprehensive
solution to customers.  We are not materially dependent on any of
these organizations. Generally, our agreements with such partners provide for
price discounts based on their sales volume, with no minimum required
volume.





Marketing





The
target market for our products and services are large companies operating
contact centers and in the financial services, insurance and telecommunications
industries, as well as users in the intelligence, security and law enforcement
communities and other governmental organizations. Increasing competitiveness and
consolidation is driving companies in such businesses to increase the efficiency
and quality of their customer contact centers. As a result, customer contact
centers are compelled by both economic necessity and internal mandates to find
ways to increase internal efficiency, increase customer satisfaction, increase
effective cross-selling, decrease staff turnover cost and leverage their
investment in current information technology.





Our
marketing staff has an in-depth understanding of the customer contact center
software marketplace and the needs of these customers, as well as experience in
all of the key marketing disciplines.  They also have knowledge of the
financial services industry and government organizations that have focused on
application integration solutions to address needs in mergers and acquisitions
and homeland security.





Core
marketing functions include product marketing, marketing communications and
strategic alliances.  We utilize focused marketing programs that are
intended to attract potential customers in our target vertical industries and to
promote our company and our brands. Our marketing programs are specifically
directed at our target markets, and include speaking engagements, public
relations campaigns, focused trade shows and web site marketing, while devoting
substantial resources to supporting the field sales team with high quality sales
tools and ancillary material.  As product acceptance grows and our
target markets increase, we will shift to broader marketing
programs.




6
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The
marketing department also produces ancillary material for presentation or
distribution to prospects, including demonstrations, presentation materials,
white papers, case studies, articles, brochures, and data sheets.





Research
and Product Development





In
connection with the narrowing of our strategic focus, we have experienced an
overall reduction in research and development costs. Since Cicero® is a new
product in a relatively untapped market, it is imperative to constantly enhance
the feature sets and functionality of the product.





We
incurred research and development expense of approximately $569,000, $533,000,
and $891,000 in 2007, 2006, and 2005, respectively. The increase in costs in
2007 as compared to 2006 reflects a charge for stock compensation expense of
approximately $103,000 offset by general decreases in overhead costs and
employee benefits. The decrease in costs in 2006 as compared to 2005 reflects
the reduction in the number of employees by two plus associated overheads in
2006.





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





Competition





The
markets in which we compete are highly competitive and subject to rapid change.
These markets are highly fragmented and served by numerous firms. We believe
that the competitive factors affecting the markets for our products and services
include:
 ·
                Product
      functionality and features;
 
 ·
                Availability
      and quality of support services;
 
 ·
                Ease
      of product implementation;
 
 ·
                Price;
 
 ·
                Product
      reputation; and
 
 ·
                Our
      financial stability.
 The
relative importance of each of these factors depends upon the specific customer
environment. Although we believe that our products and services can compete
favorably, we may not be able to increase our competitive position against
current and potential competitors. In addition, many companies choose to deploy
their own information technology personnel or utilize system integrators to
write new code or rewrite existing applications in an effort to develop
integration solutions. As a result, prospective customers may decide against
purchasing and implementing externally developed and produced solutions such as
ours.
 
 We
compete with companies that utilize varying approaches to modernize, web-enable
and integrate existing software applications:
 
 ·
              Portal
      software offers the ability to aggregate information at a single point,
      but not the ability to integrate transactions from a myriad of information
      systems on the desktop.  Plumtree is a representative company in
      the market.
 
 ·
              Middleware
      software provides integration of applications through messages and data
      exchange implemented typically in the middle tier of the application
      architecture.  This approach requires modification of the
      application source code and substantial infrastructure investments and
      operational expense.  Reuters, TIBCO and IBM MQSeries are
      competitors in the middleware
market.
  7
 Table of Contents
  ·
              CRM
      software offers application tools that allow developers to build product
      specific interfaces and custom applications.  This approach is
      not designed to be product neutral and is often dependent on deep
      integration with our technology.  Siebel is a representative
      product in the CRM software
category.
 
 ·
              Recently,
      there have been several companies that offer capabilities similar to our
      Cicero® software in that these companies advertise that they integrate
      applications without modifying the underlying code for those applications.
      OpenSpan is one company who advertises that they can non-invasively
      integrate at the point of contact or on the
  desktop.
 
 Other
competitors include Above All Software, Attachmate Corporation, Seagull Software
Ltd. and Oracle. Our Cicero® product competes directly with other contact center
solutions offered by Microsoft, Corizon and Jacada. We expect additional
competition from other established and emerging companies. Furthermore, our
competitors may combine with each other, or other companies may enter our
markets by acquiring or entering into strategic relationships with our
competitors. Many of our current and possible future competitors have greater
name recognition, a larger installed customer base and greater financial,
technical, marketing and other resources than we have.


Intellectual
Property





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





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





Employees





As of
December 31, 2007, we employed 19 employees, of which 16 are full time
employees.  Our employees are not represented by a union or a
collective bargaining agreement.





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





Available
Information





Our web
address is www.ciceroinc.com.  We make available free of charge
through our web site our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and all amendments to those reports as soon
as reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission.  Also, the public
may read and copy such material at the Security and Exchange Commission’s Public
Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.  The
public may obtain information on the operation of the Public Reference Room by
calling the Security and Exchange Commission at 1-800-SEC-0330.  The
Security and Exchange Commission also maintains an internet site that contains
reports, proxy and information statements, and other information at
www.sec.gov.





Forward
Looking and Cautionary Statements




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




8
 Table of Contents




Item
1A. Risk Factors





There is
substantial doubt as to whether we can continue as a going
concern.





Because
we incurred net operating losses of approximately $2.0 million for the year
ended December 31, 2007 in addition to losses from continuing operations of
approximately $6.7 million for the previous two fiscal years we experienced
negative cash flows from operations, had significant working capital
deficiencies at December 31, 2007, and because we are relying on acceptance of a
newly developed and marketed product, there is substantial doubt that we can
continue to operate as a going concern. While we have attracted some additional
capital to continue to fund operations, there can be no assurance that we can
obtain additional financing and if we do obtain financing that it will be on
terms that are favorable to us or our stockholders.





We have a history
of losses and expect that we will continue to experience losses at least through
the first quarter of 2008.





We
experienced operating losses and net losses for each of the years from 1998
through 2007. We incurred a net loss of $3.68 million in 2005, $3.0 million in
2006 and $2.0 million for 2007.  As of December 31, 2007, we had a
working capital deficit of $6.1 million and an accumulated deficit of $236
million. Our ability to generate positive cash flow is dependent upon sustaining
certain cost reductions and generating sufficient revenues.





Therefore,
due to these and other factors, we expect that we will continue to experience
net losses through the first quarter of 2008. We have not generated sufficient
revenues to pay for all of our operating costs or other expenses and have relied
on financing transactions over the last several fiscal years to pay our
operating costs and other expenses. We cannot predict with accuracy our future
results of operations and believe that any period-to-period comparisons of our
results of operations are not meaningful.  Furthermore, there can be
no assurance that if we are unable to generate sufficient revenue from
operations that we will be able to continue to access the capital markets to
fund our operations, or that if we are able to do so that it will be on
satisfactory terms.





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




9
 Table of Contents


We
develop new and unproven technology and products.





To date,
our products have not been widely accepted in the market place and therefore may
be considered unproven. The markets for our products are characterized by
rapidly changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles. Our future success will depend to a
substantial degree upon our ability to market and enhance our existing products
and to develop and introduce, on a timely and cost-effective basis, new products
and features that meet changing customer requirements and emerging and evolving
industry standards.





We
depend on an unproven strategy for ongoing revenue; going concern
qualification.





The
Company’s future revenues are entirely dependent on acceptance of Cicero® which
had limited success in commercial markets to date. The Company has experienced
negative cash flows from operations for the past three years. At December 31,
2007, the Company had a working capital deficiency of approximately
$6,132,000.  Accordingly, there is substantial doubt that the Company
can continue as a going concern, and the independent auditor’s report
accompanying our financial statements raises doubt about our ability to continue
as a going concern.  In order to address these issues and to obtain
adequate financing for the Company’s operations for the next twelve months, the
Company is actively promoting and expanding its product line and continues to
negotiate with significant customers who have demonstrated interest in the
Cicero® technology. The Company is experiencing difficulty increasing sales
revenue largely because of the inimitable nature of the product as well as
customer concerns about the Company’s financial viability. Cicero® software is a
new “category defining” product in that most EAI projects are performed at the
server level and Cicero®’s integration occurs at the desktop level without the
need to open and modify the underlying code for those applications being
integrated. Many companies are not aware of this new technology or tend to look
toward more traditional and accepted approaches although emerging competition
has increased the public awareness of this new form of technology. The Company
is attempting to solve the former problem by improving the market’s knowledge
and understanding of Cicero® through increased marketing and leveraging its
limited number of reference accounts while enhancing its list of resellers and
system integrators to assist in the sales and marketing process. Additionally,
the Company is seeking additional equity capital or other strategic transactions
in the near term to provide additional liquidity, however, there is no assurance
that the Company will be able to obtain any additional funding.





Our new
strategy is subject to the following specialized risks that may adversely affect
our long-term revenue and profitability prospects:


·
              Cicero®
      was originally developed internally by Merrill Lynch and has no track
      record of successful sales to organizations within the financial services
      industry and may not gain market
acceptance;
 ·
              We
      are approaching a different segment of the financial services industry,
      the customer contact center, compared to our sales and marketing efforts
      in the past and there can be no assurance that we can successfully sell
      and market into this industry; and
 ·
              We
      have had very limited success because the financial condition of the
      Company has caused concern for enterprise customers that would be
      dependent on Cicero® for their long-term
needs.
 Economic
conditions could adversely affect our revenue growth and cause us not to achieve
desired revenue.





Our
ability to generate revenue depends on the overall demand for desktop
integration software and services. Our business depends on overall economic
conditions, the economic and business conditions in our target markets and the
spending environment for information technology projects, and specifically for
desktop integration in those markets. A weakening of the economy in one or more
of our geographic regions, unanticipated major events and economic uncertainties
may make more challenging the spending environment for our software and
services, reduce capital spending on information technology projects by our
customers and prospective customers, result in longer sales cycles for our
software and services or cause customers or prospective customers to be more
cautious in undertaking larger transactions. Those situations may cause a
decrease in our revenue. A decrease in demand for our software and services
caused, in part, by an actual or anticipated weakening of the economy, may
result in a decrease in our revenue rates.





The
so-called “penny stock rule” could make it cumbersome for brokers and dealers to
trade in our common stock, making the market for our common stock less liquid
which could cause the price of our stock to decline.





The
Company ’s common stock is quoted on the Over-the-Counter Bulletin
Board.





Trading of our common
stock on the OTCBB may be subject to certain provisions of the Securities
Exchange Act of 1934, as amended, commonly referred to as the "penny stock"
rule. A penny stock is generally defined to be any
equity security that has a market price less than $5.00 per share, subject to
certain exceptions. If our stock is deemed to be a penny stock, trading in our
stock will be subject to additional sales practice requirements on broker-dealers.
These may require a broker-dealer to:




10
 Table of Contents


·
              make
      a special suitability determination for purchasers of our
      shares;
 
 ·
              receive
      the purchaser's written consent to the transaction prior to the purchase;
      and
 
 ·
              deliver
      to a prospective purchaser of our stock, prior to the first transaction, a
      risk disclosure document relating to the penny stock
    market.





Consequently,
penny stock rules may restrict the ability of broker-dealers to trade and/or
maintain a market in our common stock. Also, prospective investors may not want
to get involved with the additional administrative requirements, which may have
a material adverse effect on the trading of our shares.





Because we cannot
accurately predict the amount and timing of individual sales, our quarterly
operating results may vary significantly, which could adversely impact our stock
price.





Our
quarterly operating results have varied significantly in the past, and we expect
they will continue to do so in the future. We have derived, and expect to
continue to derive in the near term, a significant portion of our revenue from
relatively large customer contracts or arrangements. The timing of revenue
recognition from those contracts and arrangements has caused and may continue to
cause fluctuations in our operating results, particularly on a quarterly basis.
Our quarterly revenues and operating results typically depend upon the volume
and timing of customer contracts received during a given quarter and the
percentage of each contract, which we are able to recognize as revenue during
the quarter. Each of these factors is difficult to forecast. As is common in the
software industry, the largest portion of software license revenues are
typically recognized in the last month of each fiscal quarter and the third and
fourth quarters of each fiscal year. We believe these patterns are partly
attributable to budgeting and purchasing cycles of our customers and our sales
commission policies, which compensate sales personnel for meeting or exceeding
periodic quotas.





Furthermore,
individual Cicero® sales are large and each sale can or will account for a large
percentage of our revenue and a single sale may have a significant impact on the
results of a quarter. The sales of both our historical products and Cicero® can
be classified as generally large in size to a small discrete number of
customers. In addition, the substantial commitment of executive time and
financial resources that have historically been required in connection with a
customer’s decision to purchase Cicero® and our historical products increases
the risk of quarter-to-quarter fluctuations. Cicero® sales require a significant
commitment of time and financial resources because it is an enterprise product.
Typically, the purchase of our products involves a significant technical
evaluation by the customer and the delays frequently associated with customers’
internal procedures to approve large capital expenditures and to test, implement
and accept new technologies that affect key operations. This evaluation process
frequently results in a lengthy sales process of several months. It also
subjects the sales cycle for our products to a number of significant risks,
including our customers’ budgetary constraints and internal acceptance reviews.
The length of our sales cycle may vary substantially from customer to
customer.





Our
product revenue may fluctuate from quarter to quarter due to the completion or
commencement of significant assignments, the number of working days in a quarter
and the utilization rate of services personnel. As a result of these factors, we
believe that a period-to-period comparison of our historical results of
operations is not necessarily meaningful and should not be relied upon as
indications of future performance. In particular, our revenues in the third and
fourth quarters of our fiscal years may not be indicative of the revenues for
the first and second quarters. Moreover, if our quarterly results do not meet
the expectations of our securities analysts and investors, the trading price of
our common stock would likely decline.





Loss of key
personnel associated with Cicero®development
could adversely affect our business.





Loss of
key executive personnel or the software engineers we have hired with specialized
knowledge of the Cicero® technology could have a significant impact on our
execution of our new strategy given that they have specialized knowledge
developed over a long period of time with respect to the Cicero®
technology.  Furthermore, because of our restructuring and reduction
in the number of employees, we may find it difficult to recruit new employees in
the future.


11
 Table of Contents


Different
competitive approaches or internally developed solutions to the same business
problem could delay or prevent adoption of Cicero®.





Cicero®
is designed to address in a novel way the problems that large companies face
integrating the functionality of different software applications by integrating
these applications at the desktop. To effectively penetrate the market for
solutions to this disparate application problem, Cicero® will compete with
traditional Enterprise Application Integration, or EAI, solutions that attempt
to solve this business problem at the server or back-office level. Server level
EAI solutions are currently sold and marketed by companies such as NEON,
Mercator, Vitria, and BEA. There can be no assurance that our potential
customers will determine that Cicero®’s desktop integration methodology is
superior to traditional middleware EAI solutions provided by the competitors
described above in addressing this business problem. Moreover, the information
systems departments of our target customers, large financial institutions, are
large and may elect to attempt to internally develop an internal solution to
this business problem rather than to purchase the Cicero® product. Cicero®
itself was originally developed internally by Merrill Lynch to solve these
integration needs.





Accordingly,
we may not be able to provide products and services that compare favorably with
the products and services of our competitors or the internally developed
solutions of our customers. These competitive pressures could delay or prevent
adoption of Cicero® or require us to reduce the price of our products, either of
which could have a material adverse effect on our business, operating results
and financial condition.





Our
ability to compete may be subject to factors outside our control.





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





The
markets for our products are characterized by rapidly changing technologies,
evolving industry standards, frequent new product introductions and short
product life cycles.





Our
future success will depend to a substantial degree upon our ability to enhance
our existing products and to develop and introduce, on a timely and
cost-effective basis, new products and features that meet changing customer
requirements and emerging and evolving industry standards.





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





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





We
may face damage to the reputation of our software and a loss of revenue if our
software products fail to perform as intended or contain significant
defects.





Our
software products are complex, and significant defects may be found following
introduction of new software or enhancements to existing software or in product
implementations in varied information technology environments. Internal quality
assurance testing and customer testing may reveal product performance issues or
desirable feature enhancements that could lead us to reallocate product
development resources or postpone the release of new versions of our software.
The reallocation of resources or any postponement could cause delays in the
development and release of future enhancements to our currently available
software, require significant additional professional services work to address
operational issues, damage the reputation of our software in the marketplace and
result in potential loss of revenue. Although we attempt to resolve all errors
that we believe would be considered serious by our partners and customers, our
software is not error-free. Undetected errors or performance problems may be
discovered in the future, and known errors that we consider minor may be
considered serious by our partners and customers. This could result in lost
revenue, delays in customer deployment or legal claims and would be detrimental
to our reputation. If our software experiences performance problems or ceases to
demonstrate technology
leadership, we may have to increase our product development costs and divert our
product development resources to address the problems.




12
 Table of Contents


We may be unable
to enforce or defend our ownership and use of proprietary and licensed
technology.





We
originally licensed the Cicero® technology and related patents on a worldwide
basis from Merrill Lynch, Pierce, Fenner & Smith Incorporated in August of
2000 under a license agreement containing standard provisions and a two-year
exclusivity period. On January 3, 2002, the license agreement was amended to
extend our exclusive worldwide marketing, sales and development rights to
Cicero® in perpetuity (subject to Merrill Lynch's rights to terminate in the
event of bankruptcy or a change in control of the Company) and to grant
ownership rights in the Cicero® trademark. Merrill Lynch indemnifies us with
regard to the rights granted to us by them. Consideration for the original
Cicero® license consisted of 10,000 shares of our common stock. In exchange for
the amendment, we granted an additional 2,500 shares of common stock to MLBC,
Inc., a Merrill Lynch affiliate and entered into a royalty sharing agreement.
Under the royalty sharing agreement, we pay a royalty of 3% of the sales price
for each sale of Cicero® or related maintenance services. The royalties over the
life of the agreement are not payable in excess of $20 million. We have
completely re-engineered the Cicero® software to provide increased functionality
and much more powerful integration capabilities.





Our
success depends to a significant degree upon our proprietary and licensed
technology. We rely on a combination of patent, trademark, trade secret and
copyright law, contractual restrictions and passwords to protect our proprietary
technology. However, these measures provide only limited protection, and there
is no guarantee that our protection of our proprietary rights will be adequate.
Furthermore, the laws of some jurisdictions outside the United States do not
protect proprietary rights as fully as in the United States. In addition, our
competitors may independently develop similar technology; duplicate our products
or design around our patents or our other intellectual property rights. We may
not be able to detect or police the unauthorized use of our products or
technology, and litigation may be required in the future to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of our proprietary rights. Additionally, with respect to the
Cicero® line of products, there can be no assurance that Merrill Lynch will
protect its patents or that we will have the resources to successfully pursue
infringers. Any litigation to enforce our intellectual property rights would be
expensive and time-consuming, would divert management resources and may not be
adequate to protect our business.





We do not
believe that any of our products infringe the proprietary rights of third
parties. However, companies in the software industry have experienced
substantial litigation regarding intellectual property and third parties could
assert claims that we have infringed their intellectual property rights. In
addition, we may be required to indemnify our distribution partners and end-
users for similar claims made against them. Any claims against us would divert
management resources, and could require us to spend significant time and money
in litigation, pay damages, develop new intellectual property or acquire
licenses to intellectual property that is the subject of the infringement
claims. These licenses, if required, may not be available on acceptable terms.
As a result, intellectual property claims against us could have a material
adverse effect on our business, operating results and financial
condition.





Our
business may be adversely impacted if we do not provide professional services to
implement our solutions.





Customers
that license our software typically engage our professional services staff or
third-party consultants to assist with product implementation, training and
other professional consulting services. We believe that many of our software
sales depend, in part, on our ability to provide our customers with these
services and to attract and educate third-party consultants to provide similar
services. New professional services personnel and service providers require
training and education and take time and significant resources to reach full
productivity. Competition for qualified personnel and service providers is
intense within our industry. Our business may be harmed if we are unable to
provide professional services to our customers to effectively implement our
solutions of if we are unable to establish and maintain relationships with
third-party implementation providers.





Because
our software could interfere with the operations of customers, we may be subject
to potential product liability and warranty claims by these
customers.





Our
software enables customers’ software applications to
integrate   and is often used for mission critical functions or
applications. Errors, defects or other performance problems in our software or
failure to provide technical support could result in financial or other damages
to our customers. Customers could seek damages for losses from us. In addition,
the failure of our software and solutions to perform to customers’ expectations
could give rise to warranty claims.  The integration of our software
with our customer’s applications, increase the risk that a customer may bring a
lawsuit us. Even if our software is not at fault, a product liability claim
brought against us, even if not successful, could be time consuming and costly
to defend and could harm our reputation.




13
 Table of Contents




We
have not paid any dividends on our common stock and it is likely that no
dividends will be paid in the future.





We have
never declared or paid cash dividends on our common stock and we do not
anticipate paying any cash dividends on our common stock in the foreseeable
future.





Provisions
of our charter and Bylaws and Delaware law could deter takeover
attempts.





Section
203 of the Delaware General Corporation Law, which prohibits certain persons
from engaging in business combinations with the Company, may have anti-takeover
effects and may delay, defer or prevent a takeover attempt that a stockholder
may consider to be in the holder’s best interests. These provisions of Delaware
law also may adversely affect the market price of our common stock. Our
certificate of incorporation authorizes the issuance, without stockholder
approval, of preferred stock, with such designations, rights and preferences as
the board of directors may determine preferences as from time to time. Such
designations, rights and preferences established by the board may adversely
affect our stockholders. In the event of issuance, the preferred stock could be
used, under certain circumstances, as a means of discouraging, delaying or
preventing a change of control of the Company. Although we have no present
intention to issue any shares of preferred stock in addition to the currently
outstanding preferred stock, we may issue preferred stock in the
future.





Item
1B.      Unresolved Staff
Comments





Not
Applicable





Item
2.      Properties





Our
corporate headquarters and United States operations group and administrative
functions are based in offices of approximately 5,038 square feet in our Cary,
North Carolina office pursuant to a lease expiring in 2010.





Item
3.      Legal
Proceedings





Various
lawsuits and claims have been brought against us in the normal course of our
business. In October 2003, we were served with a summons and complaint in the
Superior Court of North Carolina regarding unpaid invoices for services rendered
by one of our subcontractors.  The amount in dispute was approximately
$200,000 and is recorded as part of our accounts payable. Subsequent to March
31, 2004, we settled this litigation.  Under the terms of the
settlement agreement, we agreed to pay a total of $189,000 plus interest over a
19-month period ending November 15, 2005. The Company is in the process of
negotiating a series of payments for the remaining liability of approximately
$80,000.





Under the
indemnification clause of the Company’s standard reseller agreements and
software license agreements, the Company agrees to defend the reseller/licensee
against third party claims asserting infringement by the Company’s products of
certain intellectual property rights, which may include patents, copyrights,
trademarks or trade secrets, and to pay any judgments entered on such claims
against the reseller/licensee.





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





None


14
 Table of Contents


PART
II





Item
5.      Market ForRegistrant's
Common Stock, Related Shareholder Matters and Issuer Purchases of Equity
Securities.




Our common is currently quoted on the Over-The-Counter Bulletin Board. In
January 2007 we formally changed our name to Cicero Inc. and now trade under the
ticker CICN.  The chart below sets forth the high and low stock prices
for the quarters of the fiscal years ended December 31, 2007 and 2006 as
retroactively adjusted for the 100:1 reverse stock split.





2007
            
            
            2006Quarter
            
            High
            
            
            Low
            
            
            High
            
            
            LowFirst
            
            
            $2.60
            
            
            
            $1.02
            
            
            
            $3.00
            
            
            
            $1.80Second
            
            
            $1.13
            
            
            
            $0.16
            
            
            
            $2.50
            
            
            
            $1.00Third
            
            
            $0.75
            
            
            
            $0.24
            
            
            
            $2.10
            
            
            
            $1.10Fourth
            
            
            $0.29
            
            
            
            $0.15
            
            
            
            $4.50
            
            
            
            $1.30




The
closing price of the common stock on December 31, 2007 was $0.25 per share, and
as of March 11, 2008, the closing price of the common stock was $0.15 per
share.





Dividends
and Record Stockholders





We have
never declared or paid any cash dividends on our common stock. We anticipate
that all of our earnings will be retained for the operation and expansion of our
business and do not anticipate paying any cash dividends on our common stock in
the foreseeable future   As of March 11, 2008 we had 224
registered stockholders of record.





Recent
Sales of Unregistered Securities





In
October 2007, the Company agreed to restructure the Note payable to Bank
Hapoalim and guaranty by BluePhoenix Solutions. Under a new agreement with
BluePhoenix, the Company made a principal reduction payment to Bank Hapoalim in
the amount of $300,000. Simultaneously, BluePhoenix paid $1,671,000 to Bank
Hapoalim, thereby discharging that indebtedness. The Company and BluePhoenix
entered into a new Note in the amount of $1,021,000, bearing interest at LIBOR
plus 1.0% and maturing on December 31, 2011. In addition, BluePhoenix acquired
2,546,149 shares of the Company’s common stock in exchange for $650,000 paid to
Bank Hapoalim to retire that indebtedness.





In August
2007, the Company issued 2,756,173 options of which 977,449 were vested
immediately.  The Company recognized $650,000 in stock-based
compensation expense in fiscal 2007.  The Company also recognized
$36,000 in stock-based compensation expense for the 549,360 restricted shares of
stock reserved for Mr. John Broderick, the Company’s CEO, in accordance with his
2007 employment agreement.





These
securities were issued pursuant to an exemption from registration under Rule 506
of Regulation D promulgated under Section UW of the Securities Act of 1933 as
amended.





The
Company has not repurchased any shares of its stock.




15
 Table of Contents


Equity
Compensation Plan Information





The
following table sets forth certain information as of December 31, 2007, about
shares of Common Stock outstanding and available for issuance under the
Company’s existing equity compensation plans: the 2007 Cicero Stock Option Plan,
the Level 8 Systems, Inc. 1997 Stock Option Incentive Plan, the 1995
Non-Qualified Option Plan and the Outside Director Stock Option
Plan.




Plan
      Category
            
            Number
      of Securities to
              be
      issued upon exercise of
              outstanding options
            
            
            Weighted-average
              exercise
      price of
              outstanding options
            
            
            Number
      of securities
              remaining
      available under
              equity
      compensation plans
              (excluding
      securities reflected
              in the first column)Equity
      compensation plans approved by stockholders
            
            
            28,265
            
            
            $
            76.09
            
            
            
            1,200Equity
      compensation plans not approved by stockholders
            
            
            2,500,760
            
            
            $
            0.51
            
            
            
            1,999,240Total
            
            
            2,529,025
            
            
            $
            1.35
            
            
            
            2,000,440




Item
6.      Selected Financial
Data.





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





See Item
7 for a discussion of the entities included in operations (in thousands).
Weighted average shares outstanding have been restated retroactively to reflect
the 100:1 reverse stock split.




Year Ended December 31,
              (in thousands, except per share
      data)2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2007SELECTED
      STATEMENT OF OPERATIONS DATARevenue
            
            $
            530
            
            
            $
            775
            
            
            $
            785
            
            
            $
            972
            
            
            $
            1,808Loss
      from continuing operations
            
            $
            (9,874
            )
            
            $
            (9,731
            )
            
            $
            (3,681
            )
            
            $
            (2,997
            )
            
            $
            (1,975
            )Loss
      from continuing operations per common share – basic and
      diluted
            
            $
            (54.00
            )
            
            $
            (27.05
            )
            
            $
            (8.27
            )
            
            $
            (0.25
            )
            
            $
            (0.05
            )Weighted
      average common and common equivalent shares outstanding– basic and
      diluted
            
            
            215
            
            
            
            360
            
            
            
            445
            
            
            
            35,182
            
            
            
            36,771





December 31,2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2007SELECTED
      BALANCE SHEET DATAWorking capital
      (deficiency)
            
            $
            (6,555
            )
            
            $
            (10,255
            )
            
            $
            (13,894
            )
            
            $
            (7,894
            )
            
            $
            (6,132
            )Total assets
            
            
            5,362
            
            
            
            530
            
            
            
            241
            
            
            
            597
            
            
            
            1,251Long-term debt, including current
      maturities
            
            
            2,756
            
            
            
            5,444
            
            
            
            7,931
            
            
            
            2,932
            
            
            
            2,558Senior convertible redeemable
      preferred stock
            
            
            3,355
            
            
            
            1,367
            
            
            
            1,061
            
            
            
            --
            
            
            
            --Stockholders'
      deficiency
            
            
            (6,103
            )
            
            
            (11,857
            )
            
            
            (15,076
            )
            
            
            (7,912
            )
            
            
            (7,433
            )


16
 Table of Contents




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





General
Information





Cicero
Inc. is a global provider of business integration software that enables
organizations to integrate new and existing information and processes at the
desktop with our Cicero® software product.  Business integration
software addresses the emerging need for a company's information systems to
deliver enterprise-wide views of the company's


business
information processes. The Company also provides email encryption products that
address information and security compliance from the individual to the
enterprise.




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





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








Business
Strategy




Based upon the current business environment in which the Company operates, the
economic characteristics of its operating segment and managements view of the
business, a revision in terms of aggregation of its segments was appropriate.
Therefore the segment discussion outlined below clarifies the adjusted segment
structure as determined by management under SFAS No. 131. All prior year amounts
have been restated to conform to the new reporting segment
structure.





Management
makes operating decisions and assesses performance of the Company’s operations
based on one reportable segment, the Software product segment.  Prior
to this change the Company had two separate segments: Desktop Integration and
Messaging. The Messaging business has always been an immaterial part of the
Company’s overall business and generally all its sales efforts are focused on
the Cicero product. As such, the Company has elected to combine the two products
into one reportable segment.




The Software product segment is comprised of the Cicero® product and the
Ensuredmail product.  Cicero® is a business integration software
product that maximizes end-user productivity, streamlines business operations
and integrates disparate systems and applications, while renovating or
rejuvenating older legacy systems by making them usable in the business
processes. Ensuredmail is an encrypted email technology that can reside on
either the server or the desktop.




17
 Table of Contents


Results
of Operations





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





Year
      Ended December 31,2007
            
            
            2006
            
            
            2005Revenue:Software
            
            
            27.7
            %
            
            
            21.4
            %
            
            
            51.9
            %Maintenance
            
            
            16.6
            %
            
            
            12.3
            %
            
            
            18.7
            %Services
            
            
            55.7
            %
            
            
            66.3
            %
            
            
            29.4
            %Total
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of revenue:Software
            
            
            1.0
            %
            
            
            0.9
            %
            
            
            2.0
            %Maintenance
            
            
            14.6
            %
            
            
            21.8
            %
            
            
            44.6
            %Services
            
            
            36.2
            %
            
            
            56.2
            %
            
            
            104.7
            %Total
            
            
            51.8
            %
            
            
            78.9
            %
            
            
            151.3
            %Gross
      margin (loss)
            
            
            48.2
            %
            
            
            21.1
            %
            
            
            (51.3
            )%Operating
      expenses:Sales
      and marketing
            
            
            43.5
            %
            
            
            35.6
            %
            
            
            79.9
            %Research
      and product development
            
            
            31.5
            %
            
            
            54.8
            %
            
            
            113.5
            %General
      and administrative
            
            
            75.0
            %
            
            
            124.1
            %
            
            
            144.8
            %(Gain)
      on disposal of assets
            
            
            0.0
            %
            
            
            (2.5
            )%
            
            
            0.0
            %Total
            
            
            150.0
            %
            
            
            212.0
            %
            
            
            338.2
            %Loss
      from operations
            
            
            (101.8
            )%
            
            
            (190.9
            )%
            
            
            (389.5
            )%Other  (expense),
      net
            
            
            (7.5
            )%
            
            
            (117.5
            )%
            
            
            (79.4
            )%Loss
      before taxes
            
            
            (109.3
            )%
            
            
            (308.4
            )%
            
            
            (468.9
            )%Income
      tax provision (benefit)
            
            
            0.0
            %
            
            
            0.0
            %
            
            
            0.0
            %Net
      loss
            
            
            (109.3
            )%
            
            
            (308.4
            )%
            
            
            (468.9
            )%





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





2007
            
            2006
            
            2005United
      States
            100%
            
            100
      %
            
            100
      %




18
 Table of Contents


The
table below presents information about reported segments for the years ended
December 31, 2007, 2006, and 2005 (in thousands):





For
      the year ended December 31,2007
            
            
            2006
            
            2005Total
      revenue
            
            $
            1,808
            
            
            $
            972
            
            
            $
            785Total
      cost of revenue
            
            
            937
            
            
            
            767
            
            
            
            1,188Gross
      margin (loss)
            
            
            871
            
            
            
            205
            
            
            
            (403
            )Total
      operating expenses
            
            
            2,711
            
            
            
            2,085
            
            
            
            2,655Segment
      loss
            
            $
            (1,840
            )
            
            $
            (1,880
            )
            
            $
            (3,058
            )





A
reconciliation of segment operating expenses to total operating expense follows
(in thousands):





2007
            
            
            2006
            
            
            2005Segment
      operating expenses
            
            $
            2,711
            
            
            $
            2,085
            
            
            $
            2,655(Gain)
      on disposal of assets
            
            
            --
            
            
            
            (24
            )
            
            
            --Total
      operating expenses
            
            $
            2,711
            
            
            $
            2,061
            
            
            $
            2,655





A
reconciliation of total segment profitability to net loss follows for the fiscal
years ended December 31 (in thousands):





2007
            
            
            2006
            
            
            2005Total
      segment profitability (loss)
            
            $
            (1,840
            )
            
            $
            (1,880
            )
            
            $
            (3,058
            )Gain
      on disposal of assets
            
            
            --
            
            
            
            24
            
            
            
            --Interest
      and other income/(expense), net
            
            
            (135
            )
            
            
            (1,141
            )
            
            
            (623
            )Net
      loss
            
            $
            (1,975
            )
            
            $
            (2,997
            )
            
            $
            (3,681
            )








Years
Ended December 31, 2007, 2006, and 2005





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





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





Total
revenues increased 86% from $972,000 in 2006 to $1,808,000 in 2007. Revenues
increased  24% from $785,000 in 2005 to $972,000 in
2006.   The increase in revenues in 2007 is primarily due to
increased labor billings from integration contracts with the Company’s
professional services staff (approximately $366,000) and software license
revenue generated under an OEM contract with Merrill Lynch in December 2007
($500,000). The increase in revenues in 2006 over 2005 reflects a change in the
mix of revenues, wherein license revenues decreased and professional service
revenues from consulting contracts increased. Gross profit margin (loss) was
48%, 21% and  (51%)  for 2007, 2006, and 2005,
respectively.  Under the terms of the OEM agreement with Merrill
Lynch, the Company will recognize two components of software revenue. The first
component will be runtime licenses, and once those licenses are deployed by
Merrill Lynch; the second component will be a monthly subscription fee for each
license deployed. The Company may or may not incur additional license revenues
under this OEM agreement.




Software Products. Software product revenue
increased from $208,000 in 2006 to $501,000 in 2007 or approximately 141%.
Software product revenue decreased approximately 49% in 2006 from those results
achieved in 2005. The increase in software revenues in 2007 is attributed the
Company entering into an OEM agreement with Merrill Lynch in December
2007.  In 2005, the Company was able to successfully deploy its
software to several smaller integration engagements.




19
 Table of Contents


The gross
margin (loss) on software products was 96% for each of the years ended December
31, 2007, 2006 and 2005.  Cost of software is composed primarily of
royalties to third parties, and to a lesser extent, production and distribution
costs. The Cicero® software technology and related patents was licensed by the
Company on a worldwide basis from Merrill Lynch in August of 2000 under a
license agreement containing standard provisions and a two-year exclusivity
period. On January 3, 2002, the license agreement was amended to extend the
Company’s exclusive worldwide marketing, sales and development rights to Cicero®
in perpetuity (subject to Merrill Lynch’s rights to terminate in the event of
bankruptcy or a change in control of the Company) and to grant ownership rights
in the Cicero® trademark. The Company is indemnified by Merrill Lynch with
regard to the rights granted to Cicero® by them. In consideration for the
original Cicero® license we issued to Merrill Lynch 10,000 shares of the
Company’s common stock. In consideration for the amendment, the Company issued
an additional 250,000 shares of common stock to MLBC, Inc., a Merrill Lynch
affiliate and entered into a royalty sharing agreement pursuant to which, the
Company pays a royalty of 3% of the sales price for each sale of Cicero®
software or related maintenance services. The royalties over the life of the
agreement are not payable in excess of $20,000,000.





The
Company expects to see significant increases in software sales coupled with
improving margins on software products as Cicero® gains acceptance in the
marketplace. The Company’s expectations are based on its review of the sales
cycle that has developed around the Cicero® product since being released by the
Company, its review of the pipeline of prospective customers and their
anticipated capital expenditure commitments and budgeting cycles, as well as the
status of in-process proof of concepts or beta sites with select
corporations.





Maintenance.Maintenance
revenues for the year ended December 31, 2007 increased by approximately 150% or
$180,000 from 2006. Maintenance revenues for the year ended December 31,
2006decreased by
approximately 18% or $27,000 from 2005. The increase in maintenance revenues for
2007 is primarily attributed to one significant new maintenance customer during
the year. The decline in maintenance revenues in 2006 reflects the non-renewal
of one maintenance contract for the Cicero® product.





Cost of
maintenance is comprised of personnel costs and related overhead and the cost of
third-party contracts for the maintenance and support of the Company’s software
products. The Company experienced a gross margin on maintenance products of 12%
for 2007. Gross margin (loss) on maintenance products for 2006 and 2005 were
(76%) and (138%), respectively.





Maintenance
revenues are expected to increase as a result of our expected increase in sales
of the Cicero® product. The cost of maintenance should increase
slightly.





Services.Services
revenue for the year ended December 31, 2007 increased by approximately 56% or
$363,000 over the same period in 2006. Services revenue for the year ended
December 31, 2006 increased by approximately 178% or $413,000 over the same
period in 2005.  The increase in service revenues in each of the past
two years are attributable to consulting engagements that were earned during the
past two years.





Cost of
services primarily includes personnel and travel costs related to the delivery
of services. Services gross margin (loss) was 35%, 15%, and  (256%)
for the years ended 2007, 2006, and 2005 respectively.





Services
revenues are expected to increase as the Cicero® product gains
acceptance.





Sales and
Marketing.Sales and marketing expenses primarily include
personnel costs for salespeople, marketing personnel, travel and related
overhead, as well as trade show participation and promotional expenses. Sales
and marketing expenses increased 127% or approximately $440,000 in 2007 and
decreased by 45% or approximately $281,000 in 2006. The increase in sales and
marketing expenses in 2007 is attributable to the establishment of a sales team
and several marketing campaigns as well as a charge for stock compensation
expense of approximately $97,000. In 2006, the Company had reduced its sales and
marketing workforce, decreased promotional activities
and  changed  the sales compensation structure.
Specifically, the Company changed the compensation structure to lower fixed
costs and increase variable success-based costs.





Sales and
marketing expenses are expected to increase as the Company adds additional
direct sales personnel and supports the sales function with collateral marketing
materials and marketing events.





20
 Table of Contents




Research and
Development.Research and development expenses primarily
include personnel costs for product authors, product developers and product
documentation and related overhead.  Research and development expense
increased by 7% or $36,000 in 2007 as compared to 2006 and decreased by 40% or
$358,000 in 2006 as compared to 2005. The increase in costs in 2007 as compared
to 2006 reflects a charge for stock compensation expense of approximately
$103,000 offset by general decreases in overhead costs and employee benefits.
The decrease in costs in 2006 as compared to 2005 reflects the reduction in the
number of employees by two plus associated overheads in 2006.





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





General and Administrative.General and administrative expenses consist of personnel costs for the
executive, legal, financial, human resources, investor relations and
administrative staff, related overhead, and all non-allocable corporate costs of
operating the Company. General and administrative expenses for the year ended
December 31, 2007 increased by 12% or $150,000 over the prior year. The increase
in general administrative costs reflects a charge for stock based compensation
of approximately $363,000, net of reductions in general overheads and salary
from its former Chief Information Officer who left the company in July 2007. In
fiscal 2006, general and administrative expenses increased by 6% or $69,000 as
compared to 2005. The increase in general administrative costs is primarily due
to costs associated with the Company’s recapitalization plan in
2006.





General
and administrative expenses are expected to slightly increase going forward as
the Company’s revenues increase.





Provision for Taxes.The
Company’s effective income tax rate for continuing operations differs from the
statutory rate primarily because an income tax benefit was not recorded for the
net loss incurred in 2007, 2006, or 2005. Because of the Company’s inconsistent
earnings history, the deferred tax assets have been fully offset by a valuation
allowance.





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








Liquidity and Capital
Resources





Operating
and Investing Activities





The
Company utilized $60,000 of cash for the year ended December 31,
2007





Operating
activities utilized approximately $1,384,000 in cash, which was primarily
comprised of the loss from operations of $1,975,000, offset by non-cash charges
for depreciation and amortization of approximately $10,000, and stock
compensation expense of $720,000 and a provision for doubtful accounts of
$50,000. In addition, the Company had an increase in accounts receivable of
$622,000, and prepaid expenses and other assets of $136,000. The Company
generated approximately $478,000 in cash through an increase in the amount owing
its creditors.





The
Company utilized approximately $17,000 in cash in the purchase of updating the
Company’s network equipment.





The
Company generated approximately $1,347,000 of cash during the year from
financing activities from increases in issuance of common stock in private
placement of $1,040,000 and from approximately $307,000 resulting from net
borrowings of notes payable.





The
Company generated $281,000 of cash for the year ended December 31,
2006





Operating
activities utilized approximately $2,224,000 in cash, which was primarily
comprised of the loss from operations of $2,997,000, offset by non-cash charges
for depreciation and amortization of approximately $12,000, and stock
compensation expense of $614,000 and a provision for doubtful accounts of
$60,000. In addition, the Company had an increase in accounts receivable of
$212,000, offset by a reduction of prepaid expenses and other assets of $31,000.
The Company generated approximately $311,000 in cash through an increase in the
amount owing its creditors.





The
Company utilized approximately $17,000 in cash in the purchase of updating the
Company’s network equipment.





21
 Table of Contents




The
Company generated approximately $2,528,000 of cash during the year from
financing activities from increases in Convertible Bridge notes of $2,148,000
and from approximately $380,000 resulting from the issuance of common
stock.




Financing
Activities





The
Company funded its cash needs during the year ended December 31, 2007 with cash
on hand from December 31, 2006, as well as through the use of proceeds from the
private sale of its common stock and from short term borrowings.





The
Company had a term loan in the principal amount of $1,971,000 from Bank Hapoalim
bearing interest at LIBOR plus 1.5%). In October 2007, the Company agreed to
restructure the Note payable to Bank Hapoalim and guaranty by BluePhoenix
Solutions (formerly Liraz Systems Ltd.). Under a new agreement with BluePhoenix,
the Company made a principal reduction payment to Bank Hapoalim in the amount of
$300,000. Simultaneously, BluePhoenix paid $1,671,000 to Bank Hapoalim, thereby
discharging that indebtedness. The Company and BluePhoenix entered into a new
Note in the amount of $1,021,000, bearing interest at LIBOR plus 1.0% and
maturing on December 31, 2011. In addition, BluePhoenix acquired 2,546,149
shares of the Company’s common stock in exchange for $650,000 paid to Bank
Hapoalim to retire that indebtedness.  Of the new note payable to
BluePhoenix, approximately $350,000 is due on January 31, 2009 and the balance
is due on December 31, 2011.  In November 2006, The Company and Liraz
Systems Ltd. agreed to extend its guaranty on the term loan with Bank Hapoalim,
and to extend the maturity date on the loan to October 31, 2007. Under the terms
of the agreement with Liraz, the Company agreed to issue 60,000 shares of its
common stock. Based upon fair market value at the time of issuance, the Company
recognized $240,000 as loan amortization costs in the Statement of Operations
for the year ended December 31, 2006. In addition, since the contingency
surrounding the warrants granted in the prior years’ debt extension was removed,
the Company also recognized $72,000 as the value of these warrants and as loan
amortization costs in the Statement of Operations for the year ended December
31, 2006. In November 2005, The Company and Liraz Systems Ltd. agreed to extend
its guaranty on the term loan with Bank Hapoalim, and to extend the maturity
date on the loan to November 15, 2006. Under the terms of the agreement with
Liraz, the Company agreed to issue 24,000 shares of its common stock and granted
a warrant to purchase an additional 36,000 shares of our common stock at an
exercise price of $0.20 per share. Based upon fair market value at the time of
issuance, the Company recognized $48,000 as loan amortization costs in the
Statement of Operations for the year ended December 31, 2005. Because the
warrants are contingently issuable upon an event outside the control of the
Company (the proposed Plan of Recapitalization), the Company did not recognize
any value to these warrants until the contingency is removed.





In
October 2007, the Company completed a private sale of shares of its common stock
to a group of investors, four of which are members of our Board of Directors.
Under the terms of that agreement, the Company sold 2,169,311 shares of its
common stock for $0.2457 per share for a total of $533,000. Participating in
this consortium were Mr. John L. (Launny) Steffens, the Company’s Chairman, and
Messrs. Bruce Miller, Don Peppers, and Bruce Percelay, members of the
Board.  Mr. Steffens converted the principal amount of his short term
notes with the Company of $250,000 for 1,017,501 shares of common
stock.  Mr. Miller invested $20,000 for 81,400 shares of common stock,
Mr. Peppers acquired 101,750 shares for a $25,000 investment and Mr. Bruce
Percelay acquired 40,700 shares for a $10,000 investment.





InFebruary 2007, the
Company completed a private sale of shares of its common stock to a group of
investors, three of which are members of our Board of Directors. Under the terms
of that agreement, the Company sold 3,723,007 shares of its common stock for
$0.1343 per share for a total of $500,000. Participating in this offering were
Mr. Mark Landis, who was the Company’s Chairman at that time and Mr. Bruce
Miller, who is a Board member. Mr. Landis acquired 74,460 shares for a $10,000
investment and Mr. Miller acquired 148,920 shares for a $20,000 investment. In
May 2007, Mr. John L. (Launny) Steffens was elected Chairman of the Board of
Directors.  Prior to his election, Mr. Steffens had participated in
the private purchase of shares acquiring 1,006,379 shares for an investment of
$135,157.





In
October 2007, the Company entered into a Long Term Promissory Note in the amount
of $300,000 with Mr. John L Steffens, our chairman. The Note bears interest at
3% per annum and matures on October 30, 2009. In order to bring the interest
rate on the Note in compliance with arm’s length regulations, the Company also
issued 188,285 warrants to purchase the Company’s common stock at $0.18 each.
The warrants were valued using the Black Scholes method and a fair value of
$34,230 was charged to stock compensation expense in the fourth quarter of 2007.
The warrants expire in 10 years. The Company used the proceeds from that loan to
pay down the debt to Bank Hapoalim as noted above.





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In 2004,
the Company announced a Note and Warrant Offering in which warrant holders of
the Company’s common stock were offered a one-time conversion of their existing
warrants at a conversion price of $0.10 per share as part of a recapitalization
plan. Under the terms of the Offer, which expired on December 31, 2004, warrant
holders who elected to convert, would tender their conversion price in cash and
receive a Note Payable in exchange.  As of December 31, 2004 the
Company had raised $1,615,000.  Upon approval of the plan of
recapitalization at a Shareholders meeting, these Notes would convert into
common shares of Cicero Inc. In addition, those warrant holders who elected to
convert the first $1 million of warrants would receive additional replacement
warrants at a ratio of 2:1 for each warrant converted, with a strike price of
$10.00 per share. In addition, upon approval of the plan of recapitalization,
each warrant holder would be entitled to additional warrants to purchase common
stock in Cicero Inc. In early 2005, the Company announced an extension to the
Note and Warrant offering and as of December 31, 2005, the Company has raised an
additional $944,000 for a total of approximately $2,559,000. Upon effectiveness
of the plan of recapitalization, $2,309,000 of the Note and Warrant holders
agreed to convert their notes into 3,438,473 shares of the Company’s common
stock.





From July
through December 2006, the Company issued several Convertible Bridge Notes with
a consortium of investors. The Company had raised a total of $3,915,000 of
Convertible Bridge Notes of which $746,000 was from various members of the
Company’s Board of Directors. Under the terms of these Notes, holders have
converted their Notes into 30,508,448 shares of Cicero Inc. common stock upon
effectiveness of the plan of recapitalization approved by stockholders on
November 16, 2006.





The
Company believes that the plan of recapitalization will have a positive impact
on the future operations of the Company and its ability to raise additional
capital that it will need to continue operations, however, there can be no
assurance that management will be successful in executing as anticipated or in a
timely enough manner.  If these strategies are unsuccessful, the
Company may have to pursue other means of financing that may not be on terms
favorable to the Company or its stockholders.  If the Company is
unable to increase cash flow or obtain financing, it may not be able to generate
enough capital to fund operations for the next twelve months.  We do
not believe that we currently have sufficient cash on hand to finance operations
for the next twelve months. At our current rates of expense and assuming
revenues for the next twelve months at the annualized rate of revenue for the
year ended 2007, we will be able to fund planned operations with existing
capital resources for a minimum of seven months and experience negative cash
flow of approximately $1.25 million during the next twelve months to maintain
planned operations. The accompanying financial statements have been prepared on
a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The financial
statements presented herein do not include any adjustments relating to the
recoverability of assets and classification of liabilities that might be
necessary should the Company be unable to continue as a going
concern.





In April
2005, the Company borrowed $30,000 from a director of the Company pursuant to a
convertible loan agreement. Under the term of this agreement, the loan bears
interest at 1% per month and is convertible upon the option of the director into
4,285 shares of our common stock at a conversion price of $7.00 per share which
was the fair market value of the Company’s stock at the time the loan was made.
As part of the Plan of Recapitalization, this debt together with all other
convertible promissory notes totaling $992,000 was converted into 1,591 shares
of preferred stock designated Series A-1.




The
Company incurred a net loss of approximately $1,975,000 for the year ended
December 31, 2007 in addition to net losses of approximately $6,678,000 for the
previous two fiscal years. The Company has experienced negative cash flows from
operations for the past three years. At December 31, 2007, the Company had a
working capital deficiency of approximately $6,132,000.  The Company’s
future revenues are entirely dependent on acceptance of Cicero®, which has had
limited success in commercial markets to date. Accordingly, there is substantial
doubt that the Company can continue as a going concern and the independent
auditor’s report accompanying our financial statements raises doubts about our
ability to continue as a going concern. In order to address these issues and to
obtain adequate financing for the Company’s operations for the next twelve
months, the Company is actively promoting and expanding its product line and
continues to negotiate with significant customers that have expressed interest
in the Cicero® technology. The Company is experiencing difficulty increasing
sales revenue largely because of the inimitable nature of the product as well as
customer concerns about the financial viability of the Company. Cicero® software
is a new “category defining” product in that most Enterprise Application
Integration (EAI) projects are performed at the server level and Cicero®’s
integration occurs at the desktop level without the need to open and modify the
underlying code for those applications being integrated. Many companies are not
aware of this new technology or tend to look toward more traditional and
accepted approaches. The Company is attempting to solve the former problem by
improving the market’s knowledge and understanding of Cicero® software through
increased marketing and leveraging our limited number of reference accounts,
while enhancing our list of resellers and systems integrators to assist in the
sales and marketing process.




23
 Table of Contents




The
emergence of competing technologies has also increased the awareness of this new
technology. Additionally, we must seek additional equity capital or other
strategic transactions in the near term to provide additional
liquidity.





Contractual
Obligations





Future
minimum payments for all contractual obligations for years subsequent to
December 31, 2007 are as follows (in thousands):





2008
            
            
            2009
            
            
            2010
            
            
            2011
            
            
            TotalShort
      and long-term debt, including interest payments
            
            $
            1,647
            
            
            $
            699
            
            
            $
            40
            
            
            $
            711
            
            
            $
            3,097Service
      purchase commitments
            
            
            175
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            175Operating
      leases
            
            
            103
            
            
            
            97
            
            
            
            101
            
            
            
            --
            
            
            
            301Capital
      leases
            
            
            2
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            2Total
            
            $
            1,927
            
            
            $
            796
            
            
            $
            141
            
            
            $
            711
            
            
            $
            3,575





Short and
long-term debt, including interest payments, includes an outstanding
indebtedness of approximately $1,021,000 term loan with BluePhoenix Solutions, a
long term promissory note of $300,000 with the Company’s Chairman, Mr. John L.
Steffens, and a $250,000 short-term note with SDS Merchant Fund.




Under the
employment agreement between the Company and Mr. Broderick effective January 1,
2008, the Company will pay Mr. Broderick a base salary of $175,000 and
performance bonuses in cash of up to $100,000 per annum based upon certain
revenue goals and operating metrics as determined by the Compensation Committee
of the Board of Directors of the Company. In addition, Mr. Broderick is eligible
for additional bonuses should the targeted pre tax income be exceeded by 150%.
Upon termination of Mr. Broderick's employment by the Company without cause, the
Company has agreed to provide Mr. Broderick with a lump sum payment of one year
of Mr. Broderick’s then current base salary and payment of all deferred salaries
and bonuses within thirty (30) days of termination. In addition, all then
outstanding but unvested stock options shall vest one hundred percent
(100%).





Off Balance Sheet
Arrangements





The
Company does not have any off balance sheet arrangements. We have no
subsidiaries or other unconsolidated limited purpose entities, and we have not
guaranteed or otherwise supported the obligations of any other
entity.




Significant Accounting
Policies and Estimates





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





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





We
consider the most significant accounting policies and estimates in our financial
statements to be those surrounding: (1) revenue recognition; (2) allowance for
doubtful trade accounts receivable; and (3) valuation of deferred tax
assets.  These accounting policies, the basis for any estimates and
potential impact to our Consolidated Financial Statements, should any of the
estimates change, are further described as follows:




24
 Table of Contents




Revenue
Recognition.Our revenues are derived principally from three
sources:  (i) license fees for the use of our software products; (ii)
fees for consulting services and training; and (iii) fees for maintenance and
technical support.  We generally recognize revenue from software
license fees when a license agreement has been signed by both parties, the fee
is fixed or determinable, collection of the fee is probable, delivery of our
products has occurredand no other significant obligations
remain.  For multiple-element arrangements, we apply the “residual
method”.  According to the residual method, revenue allocated to the
undelivered elements is allocated based on vendor specific objective evidence
(“VSOE”) of fair value of those elements.  VSOE is determined by
reference to the price the customer would be required to pay when the element is
sold separately.  Revenue applicable to the delivered elements is
deemed equal to the remainder of the contract price.  The revenue
recognition rules pertaining to software arrangements are complicated and
certain assumptions are made in determining whether the fee is fixed and
determinable and whether collectability is probable.  For instance, in
our license arrangements with resellers, estimates are made regarding the
reseller’s ability and intent to pay the license fee.  Our estimates
may prove incorrect if, for instance, subsequent sales by the reseller do not
materialize.  Should our actual experience with respect to collections
differ from our initial assessment, there could be adjustments to future
results.


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





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





Capitalization and Valuation of
Software Product Technology.  Our policy on capitalized
software costs determines the timing of our recognition of certain development
costs.  In addition, this policy determines whether the cost is
classified as development expense or cost of software
revenue.  Management is required to use professional judgment in
determining whether development costs meet the criteria for immediate expense or
capitalization.  Additionally, we review software product technology
assets for net realizable value at each balance sheet date.  Should we
experience reductions in revenues because our business or market conditions vary
from our current expectations, we may not be able to realize the carrying value
of these assets and will record a write down at that time. As of December 31,
2007 and 2006 the Company had $0 in capitalized software product
technology.





Valuation of Deferred Tax
Assets.  Income taxes are accounted for under the asset and
liability method.  Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry
forwards.  Deferred income tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled.  The effect on deferred income tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the
enactment date.  A valuation allowance is established to the extent
that it is more likely than not, that we will be unable to utilize deferred
income tax assets in the future.  At December 31, 2007, we had a
valuation allowance of $98,053,000 against $98,053,000 of gross deferred tax
assets.  We considered all of the available evidence to arrive at our
position on the net deferred tax asset; however, should circumstances change and
alter our judgment in this regard, it may have an impact on future operating
results.





At
December 31, 2007, the Company has net operating loss carryforwards of
approximately $230,847,000, which may be applied against future taxable income.
These carryforwards will expire at various times between 2008 and 2027. A
substantial portion of these carryforwards is restricted to future taxable
income of certain of the Company’s subsidiaries or limited by Internal Revenue
Code Section 382. Thus, the utilization of these carryforwards cannot be
assured.




Recent
Accounting Pronouncements:





In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – an amendment of FASB Statement
115”.  The statement permits entities to choose to measure many
financial instruments and certain other items at fair value.  The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
provisions.  Most of the provisions of this statement apply only to
entities that elect the fair value option; however, the amendment to FASB
Statement 115, “Accounting for Certain Investment in Debt and Equity Services,”
applies to all entities with available-for-sale and trading
securities.  The Company does not believe adoption of this statement
will have a material impact on the Company’s financial statements.





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 Table of Contents




In July
2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes –
An Interpretation of SFAS No. 109”.  FIN No. 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with SFAS No. 109, “Accounting for Income
Taxes.”  FIN No. 48 also prescribes a recognition threshold and
measurement attribute for financial statement recognition and measurement of a
tax position taken or expected to be taken in a tax return.  In
addition, FIN No. 48 provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.  The provisions of FIN No. 48 are to be applied to all tax
positions upon initial adoption of this standard.  Only tax positions
that meet the more-likely-than-not recognition threshold at the effective date
may be recognized or continue to be recognized as an adjustment to the opening
balance of accumulated deficit (or other appropriate components of equity) for
that fiscal year.  The provisions of FIN No. 48 are effective for
fiscal years beginning after December 15, 2006.  The adoption of this
new standard did not have a material impact on our financial position, results
of operations, or cash flows.





In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulleting (“SAB”) 108, to address diversity in practice in
quantifying financial statement misstatements.  SAB 108 requires that
the Company quantify misstatements based on their impact on each of its
financial statements and related disclosures.  SAB 108 is effective
for fiscal years ending after November 15, 2006.  The Company has
adopted SAB 108 effective as of December 31, 2006.  The adoption of
this bulletin did not have a material impact on our financial position, results
of operations, or cash flows.





In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements”.  SFAS No. 157 provides guidance for using fair value to
measure assets and liabilities.  It also responds to investors’
requests for expanded information about the extent to which companies measure
assets and liabilities at fair value, the information used to measure fair
value, and the effect of fair value measurements on earnings.  SFAS
No. 157 applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value, and does not expand the use of fair
value in any new circumstances.  SFAS No. 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007
and is required to be adopted by the Company in the first quarter of
2008.  The Company is currently evaluating the effect that the
adoption of SFAS No. 157 will have on our financial position, results of
operations, or cash flows.




Item
7A.      Quantitative and Qualitative Disclosures about Market Risk





As the
Company has disposed of or closed most of its European offices and operations,
the majority of revenues are generated from US sources. The Company expects that
trend to continue for the next year. As such, there is minimal foreign currency
risk at present.  Should the Company continue to develop a reseller
presence in Europe and Asia, that risk will be increased.




Item
8.      Financial Statements and Supplementary Data





The
information required by this item appears beginning on page F-1 of this
report.




Item
9.      Changes inandDisagreements with Accountants on Accounting and Financial
Disclosure





During
the two most recent fiscal years there were no changes in or disagreements with
the Company’s independent public accountants.




Item
9A.      Controls and Procedures




(a)
Evaluation of Disclosure Controls




26
 Table of Contents




Our Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of
our disclosure controls and procedures as of December 31, 2007. The term
“disclosure controls and procedures,” as defined in Rules 13a-15(e) and
15d-15(e) under the Securities and Exchange Act of 1934, means controls and
other procedures of a company that are designed to ensure that information
required to be disclosed by a company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized, and reported, within
the time periods specifiedin the SEC’s rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by a company in the
reports that it files and submits under the Exchange Act is accumulated and
communicated to the company’s management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding
required disclosure. Based on the evaluation of our disclosure controls and
procedures as of December 31, 2007, our Chief Executive Officer and Chief
Financial Officer concluded that, as of such date, our disclosure controls and
procedures were effective.





The Audit
Committee of the Board of Directors, which is composed solely of independent
directors, meets regularly with our independent registered public accounting
firm, Margolis & Company P.C., and representatives of management to review
accounting, financial reporting, internal control and audit matters, as well as
the nature and extent of the audit effort. The Audit Committee is responsible
for the engagement of the independent auditors. The independent auditors have
free access to the Audit Committee.




(b)
Management’s Responsibility for Financial Statements





Our
management is responsible for the integrity and objectivity of all information
presented in this report. The consolidated financial statements were prepared in
conformity with accounting principles generally accepted in the United States of
America and include amounts based on management’s best estimates and judgments.
Management believes the consolidated financial statements fairly reflect the
form and substance of transactions and that the financial statements fairly
represent the Company’s condensed consolidated financial position and results of
operations for the periods and as of the dates stated therein.




(c)
Management’s Assessment of Internal Control over Financial
Reporting





The
management of Cicero Inc. is responsible for establishing and maintaining
adequate internal control over financial reporting as defined by Rules 13a–15(f)
and 15(d)-15(f) under the Securities and Exchange Act of 1934.  This
system is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principals generally accepted in the
United States of America.





Our
internal control over financial reporting includes those policies and procedures
that: (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the Company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company’s assets that could have a
material effect on the financial statements.




Because
of its inherent limitations, a system of internal control over financial
reporting can only provide reasonable assurance and may not prevent or detect
misstatements.  Further, because of changes in conditions,
effectiveness of internal control over financial reporting may vary over
time.





Under the
direction of Chief Executive Officer and Chief Financial Officer, management
began an evaluation of the effectiveness of the system of internal control over
financial reporting based on the framework in Internal Control-Integrated
Framework, published by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  Management was not able to complete its
testing to determine that the identified controls were effective. Management is
aware that there is a lack of segregation of duties due to the small number of
employees dealing with general administrative and financial
matters.  Management has discussed the controls and procedures issues
with the Audit Committee.  However, at this time, with the
consideration of the Audit Committee,  management has decided that
taking into account the abilities of the employees now involved, the control
procedures in place and its awareness of the issues presented, the risks
associated with such lack of segregation are low and the potential benefits of
adding employees to clearly segregate duties do not justify the substantial
expenses associated with such increases.  Management will periodically
reevaluate this situation, and report to the Audit Committee and the registered
public accounting firm to the Company about this condition.  Based on
our overall controls, and taking into account the reporting and interaction by
our Audit Committee and Board of Directors, management determined that the
Company’s system of internal control over financial reporting was effective as
of December 31, 2007.




(d)
Report of Independent Registered Public Accounting Firm




27
 Table of Contents




This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management’s report
in this annual report.




Item
9B. Other Information





None


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 Table of Contents


PART
III





Item
10.  Directors and Executive Officers of the
Registrant





The following table sets forth certain information about our
directors and executive officers:


Name
            Age
            Position(s)John
      L Steffens
            66
            Director
      and ChairmanJohn
      Broderick
            58
            Director
      and Chief Executive Officer/Chief Financial OfficerAnthony
      C. Pizi
            48
            DirectorMark
      Landis
            66
            DirectorBruce
      W. Hasenyager
            66
            DirectorJay
      R. Kingley
            46
            DirectorCharles
      B. Porciello
            72
            DirectorBruce
      D. Miller
            57
            DirectorBruce
      A. Percelay
            52
            DirectorJohn
      W. Atherton
            65
            DirectorDon
      Peppers
            57
            Director





John
L. Steffens


Director
since May, 2007.





Mr.
Steffens was appointed to our Board of Directors on May 16, 2007 and is the
Founder and Managing Director of Spring Mountain Capital, L. P.  Prior
to establishing Spring Mountain Capital, Mr. Steffens spent 38 years at Merrill
Lynch & Co., where he held numerous senior management positions, including
President of Merrill Lynch Consumer Markets, which was later named the Private
Client Group, from July 1985 until April 1997, and both Vice Chairman of Merrill
Lynch & Co., Inc. (the parent company) and Chairman of its U.S. Private
Client Group from April 1997 until July 2001. Mr. Steffens was elected a member
of the Board of Directors of Merrill Lynch & Co., Inc. in April 1986 and
served on the board until July 2001. Mr. Steffens was Chairman of the Securities
Industry Association during 1994 and 1995, and is currently a Trustee of the
Committee for Economic Development. He is the National Chairman Emeritus of the
Alliance for Aging Research and serves on the Board of Aozora Bank in
Japan.  Mr. Steffens graduated from Dartmouth University in 1963
with a B.A. degree in Economics.  He also attended the Advanced
Management Program of the Harvard Business School in
1979.





John
P. Broderick


Director
since July 2005.





Mr.
Broderick is currently the Chief Executive Officer and Chief Financial Officer
of the Company and is also a director. Mr. Broderick has served as the Chief
Operating Officer of the Company since June 2002, as the Chief Financial Officer
of the Company since April 2001, and as Corporate Secretary since August 2001.
Prior to joining our Company, Mr. Broderick was Executive Vice President of
Swell Inc., a sports media e-commerce company where he oversaw the development
of all commerce operations and served as the organization's interim Chief
Financial Officer. Previously, Mr. Broderick served as Chief Financial Officer
and Senior Vice President of North American Operations for Programmer's
Paradise, a publicly held (NASDAQ: PROG) international software
marketer.  Mr. Broderick received his B.S. in accounting from
Villanova University.





Anthony
C. Pizi


Director
since August 2000.





Mr. Pizi
is presently the CIO of the Asset Management Platform Services Group of Deutsche
Bank AG. Mr. Pizi was the Company’s Chief Information Officer until August 2007
and served as Chief Executive Officer and Chief Technology Officer from February
2001 to July 2005. Mr. Pizi also served as Chairman of the Board of Directors
from December 1, 2000 until March 7, 2005 and from June 1, 2005 until July 22,
2005. Mr. Pizi has been a director since August 2000. Until December 2000, he
was First Vice President and Chief Technology Officer of Merrill Lynch’s Private
Client Technology Architecture and Service Quality Group.  Mr. Pizi’s
16 years with Merrill Lynch included assignments in Corporate MIS, Investment
Banking and Private Client. Mr. Pizi earned his B.S. in Engineering from West
Virginia University.





Mark
Landis


Director
since July 2005.





Mr. Mark Landis is the
Senior Managing Member of the Security Growth Fund, a newly established private
equity firm focused on the electronic security industry. Prior to joining the
Security Growth Fund and since 2003, Mr.
Landis was the Executive in Residence of The Jordan Company, a private equity
firm based in New York. Mr. Landis retired from being President of the North
American Security Division of Siemens Building Technologies, Inc. in July of
2003, having joined that company in 1988.  Mr. Landis earned his B.A.
from Cornell University and his Juris Doctorate from the University of
Pennsylvania.  Mr. Landis received his CPCU - Chartered Property and
Casualty Underwriter from the American Institute for Property and Liability
Underwriters.




29
 Table of Contents




Bruce
W. Hasenyager


Director
since October 2002.





Mr.
Hasenyager has been a director of the Company since October
2002.  Since November 2004, Mr. Hasenyager has served as Principal of
Bergen & Webster Executive Communications.  Prior to that, he
served as Director of Business and Technology Development at the Hart eCenter at
Southern Methodist University (SMU) and Chief Operating Officer of the Guildhall
at SMU. From April 1996 to April 2002, Mr. Hasenyager was a founder and served
as Senior Vice President of Technology and Operations and Chief Technology
Officer at MobilStar Network Corporation. Prior to April 1996, Mr. Hasenyager
held executive and senior management positions in information technology at
Chemical Bank, Merrill Lynch, Kidder Peabody, and Citibank.





Jay
R. Kingley


Director
since November 2002.





Mr.
Kingley has been a director of the Company since November 2002.  Mr.
Kingley is currently the Chief Executive Officer of Kingley Institute LLC, a
medical wellness company. Prior to that, Mr. Kingley has served as CEO of Warren
Partners, LLC, a software development and consultancy company. Mr. Kingley was
Managing Director of a business development function of Zurich Financial
Services Group from 1999-2001.  Prior to joining Zurich Financial
Services Group, Mr. Kingley was Vice President of Diamond Technology Partners,
Inc., a management-consulting firm.





Charles
B. Porciello


Director
since June 2005.





Mr.
Porciello has been a director since June 6, 2005.  Since 2003, Mr.
Porciello is the Chief Executive Officer of Pilar Services, Inc. From 2001 until
2003, he served as Chief Operating Officer of Enterprise Integration
Corporation, a minority-owned IT services company.  Prior to that Mr.
Porciello worked for various IT companies, developing and facilitating in their
growth.   Mr. Porciello retired from the U.S. Air Force in 1982
after serving his country for twenty five years. Mr. Porciello graduated from
the U.S. Military Academy with a B.S. in Engineering and received his Masters
Degree in Management from the University of Nebraska.





Bruce
D. Miller


Director
since July 2005.





Mr. Bruce
D. Miller has been a General Partner of Delphi Partners, Ltd. a privately-owned
investment partnership since 1989.  He is the treasurer and a director
of American Season Corporation.  Mr. Miller is a board member of Cape
Air/Nantucket Airlines, Inc.  Mr. Miller is a trustee of the Egan
Maritime Foundation and is involved in other non-profit
activities.  Mr. Miller received his B.S. in Finance from
Lehigh University and subsequently earned an M.B.A. from
Lehigh.





Bruce
A. Percelay


Director
since January 2006.





Mr.
Percelay has been a director since January 10, 2006.  Mr. Percelay is
the Founder and Chairman of the Mount Vernon Company, a real estate investment
company specializing in the acquisition and renovation of multi-family and
commercial properties in Greater Boston Communities. Since 2000, Mr. Percelay
has been President of the Board of Habitat for Humanity in Greater
Boston.  Mr. Percelay is currently Chairman of the Board of
Make-A-Wish Foundation of Greater Boston and Eastern
Massachusetts.  Since 2002, Mr. Percelay has been a Board Member of
the Nantucket Historic Association. Mr. Percelay received his B.S. from Boston
University School of Management, and a B.A. in Business and Economics from City
of London Polytechnic, Special Studies in Economics.




30
 Table of Contents


John
W. Atherton


Director
since May 2006.





Mr.
Atherton has been a director since May 12, 2006. Since 2005, Mr. Atherton has
been the Vice President and Chief Financial Officer of CityFed Financial, a
publicly held financial holding company, based in Nantucket, Massachusetts. He
served as Chairman of CityFed Financial from 1991 until 2005. Mr. Atherton
received his B.A. degree from Wesleyan University (Middletown, Connecticut) and
an M.B.A. with Distinction from Babson College (Wellesley,
Massachusetts).





Don
Peppers


Director
since June 2007.





Mr.
Peppers has been a director since June 20, 2007.  Mr. Peppers formed
Marketing 1:1, Inc. in January 1992 which became Peppers & Rogers Group, a
customer-centered management consulting firm with offices located in the United
States, Europe, Latin America and South Africa.  In August 2003,
Peppers & Rogers Group joined Carlson Marketing. From October 1990 to
January 1992, Mr. Peppers was the Chief Executive Officer of Perkins/Butler
Direct Marketing, a top-20 U.S.-direct-marketing agency.  Prior to
marketing and advertising, he worked as an economist in the oil business and as
the director of accounting for a regional airline. Mr. Peppers holds a
Bachelor's Degree in astronautical engineering from the U.S. Air Force Academy,
and a Master's Degree in public affairs from Princeton University's
Woodrow Wilson School.





Board
Meetings





The Board
met eight (8) times during the year ended December 31, 2007.  The
standing committees of the Board include the Compensation Committee, the Audit
Committee and the Nominating Committee. Stockholders are encouraged to
communicate with Board members via our investor relations department, and such
communications are either responded to immediately or referred to our chief
executive officer for a response. During fiscal 2007, each of the incumbent
directors, during his period of service, attended at least 75% of the total
number of meetings held by the Board.





Corporate
Governance Guidelines





Our Board
has long believed that good corporate governance is important to ensure that we
are managed for the long-term benefit of our stockholders. Our common stock is
currently quoted on the OTC Bulletin Board. The OTC Bulletin Board currently
does not have any corporate governance rules similar to the NASDAQ Stock Market,
Inc. or any other national securities exchange or national securities
association. However, our Board believes that the corporate governance rules of
NASDAQ represent good governance standards and, accordingly, during the past
year, our Board has continued to review our governance practices in light of the
Sarbanes-Oxley Act of 2002, the new rules and regulations of the Securities and
Exchange Commission and the new listing standards of NASDAQ and it has
implemented certain of the foregoing rules and listing standards during this
past fiscal year.





Director
Compensation





In 2007,
the Board of Directors approved the 2007 Cicero Employee Stock Option Plan which
permits the issuance of incentive and nonqualified stock options, stock
appreciation rights, performance shares, and restricted and unrestricted stock
to employees, officers, directors, consultants, and advisors. The aggregate
number of shares of common stock which may be issued under this Plan shall not
exceed 4,500,000 shares upon the exercise of awards and provide that the term of
each award be determined by the Board of Directors.In August 2007, outside
directors were each granted an option to purchase 5,000 shares of common stock
at a price equal to the fair market value on the date of grant. The value of
these awards was $2,609.  These options vest on the one year
anniversary of the date of grant provided that the director is still an active
member of the Board of Directors. In addition, each outside director who serves
on either the Audit Committee, the Compensation Committee or as the Chairman of
the Board, were each granted an additional option to purchase 3,000 shares of
common stock at a price equal to the fair value on the date of grant. The value
of these awards was $1,565.  These options also vest on the one year
anniversary of the date of grant and carry the same service
requirements.





In May 1999, stockholders
of the Company approved the Outside Director Stock Incentive Plan of the
Company. Under this plan, the outside directors may be granted an option to
purchase 120 shares of common stock at a price equal to the fair market value of
the common stock as of the grant date. In January 2002, the board of directors
approved an amendment to the Outside Director Stock Incentive Plan to provide an
increase in the number of options to be granted to outside directors to
240.  These options vest over a three-year period in equal increments
upon the
eligible director’s election to the Board, with the initial increment vesting on
the date of grant.  The Outside Director Stock Incentive Plan also
permits eligible directors to receive partial payment of director fees in common
stock in lieu of cash, subject to approval by the board of directors. In
addition, the plan permits the board of directors to grant discretionary awards
to eligible directors under the plan.  None of the Company’s directors
received additional monetary compensation for serving on the Board of Directors
of the Company in 2007.




31
 Table of Contents




In
October 2002, the Board of Directors approved an amendment to the stock
incentive plan for all non-management directors. Under the amendment, each
non-management director will receive 1,000 options to purchase common stock of
the Company at the fair market value of the common stock on the date of grant.
These shares will vest in three equal increments with the initial increment
vesting on the date of grant. The option grant contains an acceleration of
vesting provision should the Company incur a change in control. A change in
control is defined as a merger or consolidation of the Company with or into
another unaffiliated entity, or the merger of an unaffiliated entity into the
Company or another subsidiary thereof with the effect that immediately after
such transaction the stockholders of the Company immediately prior to the
transaction hold less than fifty percent (50%) of the total voting power of all
securities generally entitled to vote in the election of directors, managers or
trustees of the entity surviving such merger or consolidation.  Under
the amendment, there will be no additional compensation awarded for committee
participation.  The shares allocated to the Board of Directors were
issued out of the Level 8 Systems, Inc. 1997 Employee Stock Plan.





Audit
Committee





The Audit
Committee is composed of Mr. Bruce Miller, Mr. Bruce Hasenyager and Mr. John W.
Atherton. The responsibilities of the Audit Committee include the appointment
of, retention, replacement, compensation and overseeing the work of the
Company’s independent accountants and tax professionals. The Audit Committee
reviews with the independent accountants the results of the audit engagement,
approves professional services provided by the accountants including the scope
of non-audit services, if any, and reviews the adequacy of our internal
accounting controls. The Audit Committee met formally six times during our
fiscal year ended December 31, 2007. Each member attended every meeting while
they were appointed to the Audit Committee. The Board of Directors has
determined that the members of the Audit Committee are independent as defined in
Rule 4200(a)(15) of the National Association of Securities Dealers’ listing
standards. Mr. John W. Atherton was designated the “audit committee financial
expert” as defined in Item 401(h) of Regulation S-K.





Code
of Ethics and Conduct




Our Board
of Directors has adopted a code of ethics and a code of conduct that applies to
all of our directors, Chief Executive Officer, Chief Financial Officer, and
employees.  We will provide copies of our code of conduct and code of
ethics without charge upon request. To obtain a copy of the code of ethics or
code of conduct, please send your written request to Cicero Inc., Suite 542,
8000 Regency Pkwy, Cary, North Carolina 27518, Attn: Corporate
Secretary.  The code of ethics is also available on the Company’s
website at www.ciceroinc.com.





Section
16(a) Beneficial Ownership Reporting Compliance





Section
16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s
officers, directors and persons who own more than ten percent of the Company’s
Common Stock (collectively, “Reporting Persons”) to file reports of ownership
and changes in ownership with the SEC and Nasdaq.  Reporting Persons
are required by SEC regulations to furnish the Company with copies of all
Section 16(a) reports they file. Based solely on its review of the copies of
such reports received by it and written representations all Section 16(a)
reports were filed in a timely manner.




32
 Table of Contents
  Item
11. Executive Compensation.
 
 Compensation
Discussion and Analysis
 
 Compensation Committee Membership and
Organization
 
 The
Compensation Committee of the Board of Directors has responsibility for
establishing, implementing and monitoring adherence with the Company’s
compensation philosophy. It’s duties include:
 
 ·  Setting
      the total compensation of our Chief Executive Officer and evaluating his
      performance based on corporate goals and
  objectives;
  ·  Reviewing
      and approving the Chief executives Officer’s decisions relevant to the
      total compensation of the Company’s other executive
    officer;
  ·  Making
      recommendations to the Board of Directors with respect to equity-based
      plans in order to allow us to attract and retain qualified personnel;
      and
  ·  Reviewing
      director compensation levels and practices, and recommending, from time to
      time, changes in such compensation levels and practices of the Board of
      Directors.
  The
members of the Compensation Committee are Messrs. Kingley and Porciello. None of
the current members of the Compensation Committee has served as an executive
officer of the Company, and no executive officer of the Company has served as a
member of the Compensation Committee of any other entity of which Messrs.
Kingley and Porciello have served as executive officers. Mr. Porciello is the
Chief Executive Office of Pilar Services Inc., a reseller partner.  We
have recognized approximately $1,000 and $100,000 in revenues with Pilar
Services Inc. during 2007 and 2006, respectively.  There were no
interlocking relationships between us and other entities that might affect the
determination of the compensation of the directors and executive officers of the
Company. The Compensation Committee meets on an as necessary basis during the
year.
 
 General
Compensation Philosophy
 
 As a
technology company, we operate in an extremely competitive and rapidly changing
industry. We believe that the skill, talent, judgment and dedication of our
executive officers are critical factors affecting the long term value of our
company. The Compensation Committee’s philosophy and objectives in setting
compensation policies for executive officers are to align pay with performance,
while at the same time providing fair, reasonable and competitive compensation
that will allow us to retain and attract superior executive talent. The
Compensation Committee strongly believes that executive compensation should
align executives’ interests with those of shareholders by rewarding achievement
of specific annual, long-term and strategic goals by the Company, with an
ultimate objective of providing long-term stockholder value. The specific goals
that our current executive compensation program rewards are focused primarily on
revenue growth and profitability. To that end, the Compensation Committee
believes executive compensation packages provided by the Company to its
executive officers should include a mix of both cash and equity based
compensation that reward performance as measured against established goals. As a
result, the principal elements of our executive compensation are base salary,
non-equity incentive plan compensation, long-term equity incentives generally in
the form of stock options and/or restricted stock and post-termination severance
and acceleration of stock option vesting upon termination and/or a change in
control.
 
 Our goal
is to maintain an executive compensation program that will fairly compensate our
executives, attract and retain qualified executives who are able to contribute
to our long-term success, induce performance consistent with clearly defined
corporate goals and align our executives long-term interests with those of our
shareholders. The decision on the total compensation for our executive officers
is based primarily on an assessment of each individual’s performance and the
potential to enhance long-term stockholder value. Often, judgment is utilized in
lieu of total reliance upon rigid guidelines or formulas in determining the
amount and mix of compensation for each executive officer. Factors affecting
such judgment include performance compared to strategic goals established for
the individual and the Company at the beginning of the year, the nature and
scope of the executive’s responsibilities and effectiveness in leading
initiatives to achieve corporate goals.
  33
 Table of Contents
  Role
of Chief Executive Officer in Compensation Decisions
 
 The
Compensation Committee of our Board of Directors determines the base salary (and
any bonus and equity-based compensation) for each executive officer annually.
John Broderick, our Chief Executive Officer, confers with members of the
Compensation Committee, and makes recommendations, regarding the compensation of
all executive officers other than himself. He does not participate in the
Compensation Committee's deliberations regarding his own compensation. In
determining the compensation of our executive officers, the Compensation
Committee does not engage in any benchmarking of total compensation or any
material element of compensation.
 
 Components
of Executive Compensation
 
 The
compensation program for our Named Executive Officers consists of:
 
 ·  Base
      salary;
 ·  Non-equity
      incentive plan compensation;
 ·  Long-term
      incentive compensation; and
 ·  Other
      benefits
  Base
Salary
 
 The
Company provides our executive officers and other employees with base salary to
compensate them for services rendered during the fiscal year. The Compensation
Committee considered the scope and accountability associated with each executive
officer’s position and such factors as the performance and experience of each
executive officer, individual leadership and level of responsibility when
approving the base salary levels for fiscal year 2008.
 
 Non-Equity
Incentive Plan Compensation
 
 Non-equity
incentive plan compensation for our executive officers is designed to reward
performance against key corporate goals and for certain of our executives for
performance against individual business development goals. Our chief executive
officer incentive targets are designed to motivate management to exceed specific
goals related to profitability objectives. We believe that these metrics closely
correlate to stockholder value. Our other executive officer’s non-equity
incentive plan is based upon revenues generated through his individual business
development activities and subject to final approval by our chief executive
officer. We believe that these metrics also correlate to stockholder value and
individual performance. None of our executives have achieved a non-equity
incentive bonus in either of the past two years.
 
 Our Chief
Executive Officer, Mr. Broderick, is eligible for non-equity incentive plan
compensation with a target bonus of $100,000 for achieving targeted pre tax
income for fiscal 2008. In addition, Mr. Broderick is eligible for additional
bonuses should the targeted pre tax income be exceeded by 150%.
  Long-Term
Equity Incentive Awards
 
 The
Company presently has one equity-based compensation plan, entitled Cicero Inc.
2007 Employee Stock Option Plan, which will require stockholder approval. The
Plan provides for the grant of incentive and non-qualified stock options to
employees, and the grant of non-qualified options to consultants and to
directors and advisory board members. In addition, various other types of
stock-based awards, such a stock appreciation rights, may be granted under the
Plan. The Plan is administered by the Compensation Committee of our Board of
Directors, which determines the individuals eligible to receive options or other
awards under the Plan, the terms and conditions of those awards, the applicable
vesting schedule, the option price and term for any granted options, and all
other terms and conditions governing the option grants and other awards made
under the Plan. Under the 2007 Plan, 4,500,000 shares of our common stock were
reserved for issuance pursuant to options or restricted stock awards; at
December 31, 2007, 1,999,240 shares were available for future option grants and
awards. The Company’s previous equity-based compensation plan, entitled Level 8
Systems 1997 Employee Stock Option Plan, expired during fiscal 2007. There are
28,265 options outstanding under that plan.
 
 To date,
awards have been solely in the form of non-qualified stock options granted under
the Plans. The Compensation Committee grant these stock-based incentive awards
from time to time for the purpose of attracting and retaining key executives,
motivating them to attain the Company's long-range financial objectives, and
closely aligning their financial interests with long-term stockholder interests
and share value.
  34
 Table of Contents
 
 In August
2007, the Board of Directors approved a stock option grant to Mr. Broderick, our
CEO, for 549,360 shares of common stock at the fair market value on the date of
grant. The Company has also agreed to grant Mr. Pizi a stock option grant of
122,080 shares of the Company at the fair market value on the date of grant.
Vesting of Mr. Broderick’s grant will be over 2 years with one third being
vested immediately upon the date of grant and one third on each of the next two
anniversaries of the date of grant. Mr. Pizi’s grant was vested immediately
however, he failed to exercise his options within 90 days of his separation from
the Company and those shares were forfeited.
 
 Coincidental
with the grant of stock options to our named executives, the Company granted a
restricted stock award to Mr. Broderick. Mr. Broderick will receive a restricted
stock award equal to 1.35% of the fully diluted shares of the Company. The
restricted stock award will vest upon the termination or resignation of the
named executive or upon a change in control of the Company.
 
 The
grants to our named executives during fiscal 2007 reflect the absence of any
grants since 2004. Our focus as a Company and for our Chief Executive Officer
was to complete the Plan of Recapitalization that was approved by shareholders
in November 2006 and effective with our filing our Amended and Restated
Certificate with the State of Delaware in January 2007. The 2007 grant is
intended to satisfy three fiscal years of equity incentive awards and to bring
our named executive ownership in the Company up to competitive
levels.
 
 Grants to
other employees are typically made upon initial employment and then periodically
as the Compensation Committee so determines. During 2007, the Compensation
Committee approved grants totaling 2,084,733 shares to employees and directors
of the Company. These were the first grants made in the past two
years.  The Compensation Committee has empowered our Chief Executive
Officer to issue grants of up to 75,000 options to new employees at the fair
market value of the stock on the date of employment. Any proposed option grants
in excess of that amount require Compensation Committee approval. Our stock
options typically vest over two years with one third being immediately vested
upon the date of grant and one third vesting on each of the next two
anniversaries of the date of grant.
 
 We
account for equity compensation paid to all of our employees under the rules of
SFAS No. 123(R), which requires us to estimate and record compensation expense
over the service period of the award. All equity awards to our employees,
including executive officers, and to our directors have been granted and
reflected in our consolidated financial statements, based upon the applicable
accounting guidance, at fair market value on the date of grant. Generally, the
granting of a non-qualified stock option to our executive officers is not a
taxable event to those employees, provided, however, that the exercise of such
stock would result in taxable income to the optionee equal to the difference
between the fair market value of the stock on the exercise date and the exercise
price paid for such stock. Similarly, a restricted stock award subject to a
vesting requirement is also not taxable to our executive officers unless such
individual makes an election under section 83(b) of the Internal Revenue Code of
1986, as amended. In the absence of a section 83(b) election, the value of the
restricted stock award becomes taxable to the recipient as the restriction
lapses.
 
 Other
Benefits
 
 Our
executive officers participate in benefit programs that are substantially the
same as all other eligible employees of the Company.
 
 Compensation
Committee Report
 
 The
Compensation Committee has reviewed and discussed the Compensation Discussion
and Analysis required by Item 402(b) of Regulation S-K with management and,
based on such review and discussions, the Compensation Committee recommended to
the Board that the Compensation Discussion and Analysis be included in this
report.
 
 Submitted
by the Compensation Committee of the Board
 
 Jay Kingley
 Charles Porciello
 35
 Table of Contents
  The
following summary compensation table sets forth the compensation earned by all
persons serving as the Company’s executive officers during fiscal year
2007.
 
 Summary
Compensation Table
 Name
      and
                Principal
                Position
              
              Fiscal
                Year
              
              Salary
              
              
              Stock
                Awards
                (1)
              
              
              Option
                Awards
                (2)
              
              
              Non-
      Equity
                Incentive
                Plan
      Compensation(3)
              
              
              Nonqualified
      Deferred Compensation Earnings
      (4)
              
              
              All
      Other
                Compensation(5)
              
              
              TotalJohn
      P. Broderick
                Chief
      Executive OfficerChief /Financial Officer,Corporate
      Secretary
              
              2007
              
              $
              175,000
              
              
              $
              37,396
              
              
              $
              125,838
              
              
              
              --
              
              
              
              --
              
              
              $
              6,862
              
              
              $
              345,096Anthony
      C. Pizi
                Chief
      Information Officer  (6)
              
              2007
              
              $
              78,840
              
              
              
              --
              
              
              $
              63,543
              
              
              $
              15,289
              
              
              
              --
              
              
              $
              504
              
              
              $
              158,176
 
 (1)
              In
      August 2007, the Company issued Mr. Broderick a restricted stock award in
      the amount of 549,360 shares which will vest to him upon his resignation
      or termination or a change of control. The Company used the Black-Scholes
      method to value these shares and assumed a life of 10
    years.
 
 (2)
              The
      Company issued 549,360 options to Mr. Broderick in August 2007. The fair
      market on the date of grant was $0.51 each. The options vested one-third
      immediately and the balance on each of the next two anniversaries of the
      date of grant. The Company issued 122,080 options to Mr. Pizi in August
      2007. The fair market value on the date of grant was $0.51 each. Mr.
      Pizi’s options vested immediately however he failed to exercise these
      options within 90 days of separation from the Company and therefore they
      were cancelled on November 30,
2007.
 
 (3)
              Non-equity
      incentive plan compensation includes commission on revenue for named
      executive earned during fiscal year ended December 31,
    2007.
 
 (4)
              The
      Company had no nonqualified deferred compensation arrangements with named
      executive officers in the fiscal year ended December 31,
    2007.
  (5)
              Other
      compensation includes the Company’s portion of major medical insurance
      premiums and long term disability premiums for named executives during
      fiscal year ended December 31,
2007.
  (6)
              Mr.
      Pizi resigned as the Company’s Chief Information Officer effective July
      31, 2007.
  Grants
of Plan Based Awards
  The
Company awarded 549,360 stock options to the named executive during fiscal
2007.  The Company did not award any stock appreciation rights
(“SARs”) during fiscal 2007.
  36
 Table of Contents
  The
following table presents the number and values of exercisable options as of
December 31, 2007 by the named executive.
 
 Outstanding
Equity Awards at December 31, 2007
 Option
      Awards
              
              Stock
      AwardsName
              
              Number
      of Securities Underlying Unexercised Options # Exercisable (Vested)
              
              Number
      of Securities Underlying Unexercised Unearned Options# Unexercisable (Unvested)
              
              Option Exercise price ($)
              
              Option Expiration date
              
              Number of Shares of Stock That Have Not Vested
      (8)
              
              Market Value of Shares of Stock That Have Not
      VestedJohn
      P. Broderick
              
              500
      (1)
              
              --
              
              $
              400.00
              
              05/17/2011250
      (2)
              
              --
              
              $
              175.00
              
              09/25/2011909
      (3)
              
              --
              
              $
              174.00
              
              12/03/20111,000
      (4)
              
              --
              
              $
              39.00
              
              07/08/20124,950
      (5)
              
              --
              
              $
              26.00
              
              04/24/20135,000
      (6)
              
              --
              
              $
              31.00
              
              02/18/2014183,120
      (7)
              
              366,240
      (7)
              
              $
              0.51
              
              08/17/2017549,630
              
              $      
      126,415
 
 (1)
              These
      options were granted on May 17, 2001. This stock option vested and became
      exercisable in four equal installments with the first installment vesting
      on May 17, 2002.
  (2)
              These
      options were granted on September 25, 2001. This stock option vested and
      became exercisable in four equal annual installments with the first
      installment vesting on September 25,
2002.
  (3)
              These
      options were granted on December 3, 2001. This stock option vested and
      became exercisable in three equal annual installments with the first
      installment vesting on December 3,
2001.
  (4)
              These
      options were granted on July 8, 2002.  This stock option vested
      and became exercisable in three equal annual installments with the first
      installment vesting on July 8,
2002.
  (5)
              These
      options were granted on April 24, 2003. This stock option vested and
      became exercisable in three equal annual installments with the first
      installment vesting on April 24,
2003.
  (6)
              These
      options were granted on February 18, 2004. This stock option vested and
      became exercisable in three equal annual installments with the first
      installment vesting on February 18,
2004.
  (7)
              These
      options were granted on August 17, 2007. This stock option vests in three
      equal installments with the first installment vesting on August 17,
      2007.
  (8)
              These
      are restricted stock granted on August 17, 2007.  The shares
      will vest to him upon his resignation or termination or a change of
      control.
  Options
Exercised and Stock Vested
 
 The named
executive did not exercise any options during the year ended December 31, 2007.
All of Mr. Broderick’s outstanding options are fully vested except for those
identified in the table above.
  37
 Table of Contents
 
 Employment
Agreements, Termination of Employment and Change-In-Control
Arrangements
  Under the
employment agreement between the Company and Mr. Broderick effective January 1,
2008, we agreed to pay Mr. Broderick an annual base salary of $175,000 and
performance bonuses in cash of up to $300,000 per annum based upon certain
revenue goals and operating metrics, as determined by the Compensation
Committee,in its discretion.  Upon termination of Mr.
Broderick’s employment by the Company without cause, we agreed to pay Mr.
Broderick a lump sum payment of one year of Mr. Broderick’s then current base
salary within 30 days of termination and any unpaid deferred salaries and
bonuses. In the event there occurs a substantial change in Mr. Broderick’s job
duties, there is a decrease in or failure to provide the compensation or vested
benefits under the employment agreement or there is a change in control of the
Company, we agreed to pay Mr. Broderick a lump sum payment of one year of Mr.
Broderick’s then current base salary within thirty (30) days of termination. Mr.
Broderick will have thirty (30) days from the date written notice is given about
either a change in his duties or the announcement and closing of a transaction
resulting in a change in control of the Company to resign and execute his rights
under this agreement. If Mr. Broderick’s employment is terminated for any
reason, Mr. Broderick has agreed that, for one (1) year after such termination,
he will not directly or indirectly solicit or divert business from us or assist
any business in attempting to do so or solicit or hire any person who was our
employee during the term of his employment agreement or assist any business in
attempting to do so.
 
 Estimated
Payments and Benefits Upon Termination
 
 The
amount of compensation and benefits payable to named executive has been
estimated in the table below. Since all options held by the executive are
out-of-the-money, and fully vested, we have not estimated any value for option
acceleration. Deferred compensation reflects amounts voluntarily deferred from
salaries during fiscal 2004 and 2005 plus accrued but unpaid bonuses from
2003.
  CompensationBase
      Salary
                
                
                Non-equity
      Compensation Plan
                
                
                Restricted
      Shares Award
                
                
                Unvested
      Option Shares Accelerated
                
                
                Deferred
      Compensation
                
                
                Continua-tion
      of Medical Benefits
                
                
                Total
      Compensation and BenefitsJohn
      P. BroderickDeath
                
                $
                --
                
                
                $
                --
                
                
                $
                252,951
                
                
                $
                --
                
                
                $
                175,000
                
                
                $
                --
                
                
                $
                427,951Disability
                
                
                --
                
                
                
                --
                
                
                
                252,951
                
                
                
                --
                
                
                
                175,000
                
                
                
                --
                
                
                
                427,951Involuntary
      termination without cause
                
                
                175,000
                
                
                
                --
                
                
                
                252,951
                
                
                
                --
                
                
                
                175,000
                
                
                
                --
                
                
                
                602,951Change
      in Control
                
                
                175,000
                
                
                
                --
                
                
                
                252,951
                
                
                
                --
                
                
                
                175,000
                
                
                
                --
                
                
                
                602,951
  The
amounts shown in the table above do not include payments and benefits to the
extent they are provided on a non-discriminatory basis to salaried employees
generally upon termination, such as unreimbursed business expenses
payable.
  38
 Table of Contents
  Item
12.  Security Ownership of Certain Beneficial Owners
and Management.
 
 The
following table sets forth information as of December 31, 2007 with respect to
beneficial ownership of shares by (i) each person known to the Company to
be the beneficial owner of more than 5% of the outstanding common stock,
(ii) each of the Company’s directors, (iii) the executive officers of
the Company named in the Summary Compensation Table (the “Named Executives”) and
(iv) all current directors and executive officers of the Company as a
group. Unless otherwise indicated, the address for each person listed is c/o
Cicero Inc., 8000 Regency Parkway, Suite 542, Cary, North Carolina
27518.
 
 The named
person has furnished stock ownership information to the Company. Beneficial
ownership as reported in this section was determined in accordance with
Securities and Exchange Commission regulations and includes shares as to which a
person possesses sole or shared voting and/or investment power and shares that
may be acquired on or before December 31, 2007 upon the exercise of stock
options as well as exercise of warrants. The chart is based on 43,805,508 common
shares outstanding as of December 31, 2007.   Except as otherwise
stated in the footnotes below, the named persons have sole voting and investment
power with regard to the shares shown as beneficially owned by such
persons.
 
 Common
      StockName of Beneficial
      Owner
              
              No. of Shares
              
              
              Percent of ClassAhab
      International Ltd. (1)
              
              
              4,559,927
              (2)
              
              
              10.5
              %Ahab
      Partners LP (1)
              
              
              3,833,723
              (3)
              
              
              8.77
              %John
      L. Steffens (4)
              
              
              4,515,831
              (5)
              
              
              10.3
              %Mark
      and Carolyn P. Landis (6)
              
              
              5,104,863
              (7)
              
              
              11.6
              %BluePhoenix
      Solutions (8)
              
              
              2,546,149
              (9)
              
              
              5.81
              %Anthony
      C. Pizi
              
              
              1,397,634
              (10)
              
              
              3.2
              %Bruce
      Miller
              
              
              1,567,246
              (11)
              
              
              3.6
              %Bruce
      Percelay
              
              
              1,073,486
              (12)
              
              
              2.5
              %John
      P. Broderick
              
              
              748,337
              (13)
              
              
              1.7
              %John
      W.  Atherton
              
              
              148,884
              (14)
              
              
              *Bruce
      W. Hasenyager
              
              
              33,652
              (15)
              
              
              *Don
      Peppers
              
              
              101,750
              (16)
              
              
              *Charles
      Porciello
              
              
              80,286
              (17)
              
              
              *Jay
      R. Kingley
              
              
              1,000
              (18)
              
              
              *All
      current directors and executive officers as a group (11
      persons)
              
              
              14,027,780
              (19)
              
              
              32.0
              %
  *
              Represents
      less than one percent of the outstanding
shares.
 
 1.
              The
      address of Ahab International Ltd. and Ahab Partners LP is 299 Park Avenue
      New York, New York 10171.
 
 2.
              As
      of December 31, 2007, Ahab International Ltd. owns 4,587,415 shares of
      common stock and 13,347 shares issuable upon the exercise of
      warrants.  The exercise prices of the warrants are as follows:
      3,194 at $40.00 per share, and 9,318 at $10.00 per
  share.
 
 3.
              As
      of December 31, 2007, Ahab Partners LP. owns 3,833,723 shares of common
      stock and 6,738 shares issuable upon the exercise of
      warrants.  The exercise prices of the warrants are as follows:
      1,720 at $40.00 per share, and 5,018 at $10.00 per
  share.
 
 4.
              The
      address of John L. Steffens is 65 East 55th Street, New York, N.Y.
      10022.
 
 5.
              Includes
      4,293,470 shares of common stock, 14,832 shares of the Series A-1
      Convertible Preferred Stock and 207,529 shares issuable upon the exercise
      of warrants. The exercise prices of the warrants are as follows: 4,912 at
      $40.00 per share, 14,332 at $10.00 per share and 188,285 at $0.18 per
      share.
 
 6.
              The
      address of Mark and Carolyn P. Landis is 503 Lake Drive, Princeton, New
      Jersey 08540.
 
 7.
              Includes
      3,748,155 shares of common stock, 1,326,136 shares of the Series A-1
      Convertible Preferred Stock,  and 30,572 shares issuable upon
      the exercise of warrants. The exercise prices of the stock options and
      warrants are at $0.51 and $10.00 per share
      respectively.     Disclaims beneficial ownership
      of 35,572 shares because they are
anti-dilutive.
 
 8.
              The
      address of BluePhoenix Solutions is 8 Maskit Street, PO Box 2062, Herzlia,
      Israel 46120.
  39
 Table of Contents
  9.
              Includes
      2,546,149 shares of common stock
 
 10.
              Includes
      1,274,951 shares of common stock, 111.016 shares of the Series A-1
      Convertible Preferred Stock, and 11,667 shares of common stock issuable
      upon the exercise of warrants.  The exercise price of warrants
      is $10.00 per share of common
stock.
 
 11.
              Consists
      of 996,813 shares of common stock, 42.000 shares of the Series A-1
      Convertible Preferred Stock, and 15,652 shares of common stock issuable
      upon the exercise of warrants.  The exercise prices of the
      warrants are as follows:  2,457 at $40.00 per share, and 13,195
      at $10.00 per share.  Mr. Miller has sole or shared voting or
      dispositive power with respect to the securities held by Delphi Partners,
      Ltd., which holds 491,267 shares of common stock, 18.000 shares of the
      Series A-1 Convertible Preferred Stock, and 3,514 shares of common stock
      issuable upon the exercise of warrants at $10.00 per
  share.
 
 12.
              Consists
      of 1,073,486 shares of common
stock.
 
 13.
              Includes
      3,248 shares of common stock,  195,729 shares subject to stock
      options exercisable within sixty (60) days and 549,360 shares of
      restricted stock that is awarded upon resignation or termination and
      change of control.
 
 14.
              Includes
      148,784 shares of common stock, and 100 shares of common stock held in a
      self-directed IRA.
 
 15.
              Consists
      of 32,652 shares of common stock and 1,000 shares subject to stock options
      exercisable within sixty (60) days.  Disclaims beneficial
      ownership of 1,000 shares of common stock because they are
      anti-dilutive.
 
 16.
              Includes
      101,750 shares of common stock
 
 17.
              Consists
      of 80,286 shares of common stock.
 
 18.
              Consists
      of 1,000 shares subject to stock options exercisable within sixty (60)
      days.
 
 19.
              Includes
      shares issuable upon exercise of options and warrants exercisable within
      sixty (60) days as described in Notes 7-14 to our financial
      statements.
  40
 Table of Contents
  Item
13.     Certain Relationships and
Related Transactions.
 
 Sale
of Common Stock
 
 In
October 2007, the Company completed a private sale of shares of its common stock
to a group of investors, four of which are members of our Board of Directors.
Under the terms of that agreement, the Company sold 2,169,311 shares of its
common stock for $0.2457 per share for a total of $533,000. Participating in
this consortium were Mr. John L. (Launny) Steffens, the Company’s Chairman, and
Messrs. Bruce Miller, Don Peppers, and Bruce Percelay, members of the
Board.  Mr. Steffens converted the principal amount of his short term
notes with the Company of $250,000 for 1,017,501 shares of common
stock.  Mr. Miller invested $20,000 for 81,400 shares of common stock,
Mr. Peppers acquired 101,750 shares for a $25,000 investment and Mr. Bruce
Percelay acquired 40,700 shares for a $10,000 investment.
 
 InFebruary 2007, the
Company completed a private sale of shares of its common stock to a group of
investors, three of which are members of our Board of Directors. Under the terms
of that agreement, the Company sold 3,723,007 shares of its common stock for
$0.1343 per share for a total of $500,000. Participating in this offering were
Mr. Mark Landis, who was the Company’s Chairman at that time and Mr. Bruce
Miller, who is a Board member. Mr. Landis acquired 74,460 shares for a $10,000
investment and Mr. Miller acquired 148,920 shares for a $20,000 investment. In
May 2007, Mr. John L. (Launny) Steffens was elected Chairman of the Board of
Directors.  Prior to his election, Mr. Steffens had participated in
the private purchase of shares acquiring 1,006,379 shares for an investment of
$135,157.
 
 In March
2008, the Company was notified that a group of investors including two members
of the Board of Directors acquired a short term promissory note due SDS Merchant
Fund in the principal amount of $250,000. The note is unsecured and bears
interest at 10% per annum. Also in March, our Board of Directors approved a
resolution to convert this debt plus accrued interest into common stock of the
Company. The total principal and interest amounted to $361,827 and is being
converted into 1,417,264 shares of common stock. Mr. John Steffens, the
Company’s Chairman, will acquire 472,516 shares and Mr. Bruce Miller, also a
member of our Board of Directors, will acquire 472,374 shares.
 
 Loans
from Related Parties
 
 In
October 2007, the Company entered into a long-term promissory note with John L.
(Launny) Steffens, the Chairman on the Board of Directors, as part of the
restructuring of the Note payable to Bank Hapoalim.  The Note bears
interest of 3% and matures in October 2009. The Company also granted Mr.
Steffens 188,285 warrants to purchase common stock at $0.18 each. The Company
used the Black Scholes method to value the warrants and recorded a stock
compensation charge and additional paid-in capital in the amount of $34,230. At
December 31, 2007, the Company was indebted to Mr. Steffens in the amount of
$300,000.
 
 In
November 2007, the Company entered into a short term notepayable with John L.
(Launny) Steffens, the Chairman of the Board of Directors, for various working
capital needs. The Note bears interest at 6% per year and is unsecured. At
December 31, 2007, the Company was indebted to Mr. Steffens in the amount of
$40,000.
 
 During
2005, the Company entered into short term notespayable with Anthony
Pizi, the Company’s former Chief Information Officer, for various working
capital needs. The Notes bear interest at 1% per month and are unsecured. At
December 31, 2007, the Company was indebted to Mr. Pizi in the amount of
$9,000.
 
 Convertible Promissory
Notes.  Directors and executive officers made several loans to
us in exchange for convertible promissory notes. As part of the Plan of
Recapitalization which was approved by our shareholders, the Company offered to
adjust the conversion rates and terms on these notes. As a result of the Plan of
Recapitalization, these notes were automatically converted into shares of the
preferred stock designated as Series A-1 Preferred stock. Each share of Series
A-1 Preferred Stock is convertible into 1,000 shares of the Company’s common
stock. Because the conversion rates were adjusted, the Company calculated the
amount of the beneficial conversion resulting from the adjusted conversion rate
and recorded that amount as a deemed dividend and additional paid in capital.
See Note 2 to the Consolidated Financial Statements.
 
 In June,
2004, the Company entered into a convertible promissory note with Mr. Pizi in
the face amount of $100,000, bearing interest at 1% per month which was
converted into 14 shares of the Company’s Series A-1 Preferred Stock. In
addition, Mr. Pizi was granted 270,270 warrants to purchase the Company’s common
stock at $0.37 per share. As part of the Note and Warrant Offering, Mr. Pizi
elected to convert these warrants by loaning the Company the reduced exercise
price.
  41
 Table of Contents
  In
July 2004, the Company entered into a convertible promissory note with Mr. Pizi
in the face amount of $112,000, bearing interest at 1% per month which was
converted into 78.4 shares of the Company’s Series A-1 Preferred Stock upon
approval of the Plan of Recapitalization. In addition, at the time of the loan,
Mr. Pizi was granted warrants to purchase 560,000 shares of our common stock at
$0.20 per share.  As part of the Note and Warrant Offering, Mr. Pizi
elected to convert 289,376 of these warrants by loaning the Company the reduced
exercise price. Mr. Pizi elected not to exercise 270,624 warrants and after the
reverse stock ratio now total 2,706 warrants with an exercise price of $20 per
share. Also in July 2004, Mr. Pizi entered into a second convertible promissory
note in the face amount of $15,000 which was converted into 12.62 shares of the
Company’s Series A-1 Preferred Stock. In addition, at the time of the loan, Mr.
Pizi was granted warrants to purchase 90,118 shares of the Company’s common
stock at $0.17 per share. Mr. Pizi has not elected to exercise these warrants
and after the reverse stock ratio now total 901 warrants with an exercise price
of $17.
 
 In March
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Landis in the amount of $125,000. Under the terms of the note, the loan bore
interest at 1% per month, and was converted into 62.5 shares of Series A-1
Preferred stock. In addition, Mr. and Mrs. Landis were granted warrants to
purchase 446,429 shares of the Company’s common stock exercisable at $0.28 per
share. As part of the Note and Warrant Offering, Mr. and Mrs. Landis elected to
convert these warrants by loaning the Company the reduced exercise
price.
 
 In June
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Landis in the amount of $125,000. Under the terms of the note, the loan bore
interest at 1% per month and was converted into 113.64 shares of Series A-1
Preferred stock. In addition, Mr. and Mrs. Landis were granted warrants to
purchase 781,250 shares of the Company’s common stock exercisable at $0.16 per
share. As part of the Note and Warrant Offering, Mr. and Mrs. Landis elected to
convert these warrants by loaning the Company the reduced exercise
price.
 
 In
October 2004, the Company entered into a convertible promissory note with Mr.
and Mrs. Landis in the amount of $100,000. Under the terms of the agreement, the
loan bore interest at 1% per month and was converted into 400 shares of Series
A-1 Preferred stock. In addition, Mr. and Mrs. Landis were granted 2,000,000
warrants to purchase the Company’s common stock exercisable at $0.10 per share.
Mr. and Mrs. Landis elected not to exercise these warrants as part of the Note
and Warrant Offering and after the reverse stock split ratio these warrants
total 20,000 with an exercise price of $10.00.
 
 In
November 2004, the Company entered into a convertible promissory note with Mr.
and Mrs. Landis in the amount of $150,000. Under the terms of the agreement, the
loan bore interest at 1% per month and was converted into 18,750 shares of
common stock after the reverse stock split ratio. In addition, Mr. and Mrs.
Landis were granted 1,875,000 warrants to purchase the Company’s common stock
exercisable at $0.08 per share.  Mr. and Mrs. Landis elected not to
exercise these warrants as part of the Note and Warrant Offering and after the
reverse stock split ratio these warrants total 18,750 with an exercise price of
$8.00.
 
 In June
2004, the Company entered into a convertible promissory note with Fredric Mack,
a former director of the Company, in the amount of $125,000. Under the terms of
the note, the loan bore interest at 1% per month, and was converted into 54.69
shares of Series A-1 Preferred stock. In addition, Mr. Mack was granted warrants
to purchase 390,625 shares of the Company’s common stock exercisable at $0.32
per share.  As part of the Note and Warrant Offering, Mr. Mack elected
to convert these warrants by loaning the Company the reduced exercise
price.
 
 In April
2005, the Company entered into a convertible promissory note with Bruce Miller,
a director of the Company, in the amount of $30,000. Under the terms of the
note, the loan bore interest at 1% per month and was converted into 60 shares of
Series A-1 Preferred stock.
 
 In July
2004, the Company entered into a convertible promissory note with Nicholas
Hatalski, who until July 22, 2005 (during the period when the terms of the
recapitalization plan were being negotiated and at the time of approval of the
plan by our board of directors), was a director of the Company, in the amount of
$25,000. Under the terms of the note, the loan bore interest at 1% per month and
was converted into 10.94 shares of Series A-1 Preferred stock. In addition, Mr.
Hatalski was granted warrants to purchase 78,125 shares of the Company’s common
stock exercisable at $0.32 per share. Mr. Hatalski elected not to exercise these
warrants as part of the Note and Warrant Offering and after the reverse stock
split ratio these warrants total 781 with an exercise price of $32.
 
 All of
such warrants expire three years from date of grant.
 
 Senior ReorganizationNotes.  From March 2004 to April 2005, directors and executive
officers made the following loans to the Company evidenced by Senior
Reorganization Notes:  Mr. Pizi held $423,333 of Senior Reorganization
Notes, which were converted into warrants to purchase an additional 571,659
shares of Cicero common stock at a purchase price of $0.20 per
share.
  42
 Table of Contents
  Mr.
Landis held $327,860 of Senior Reorganization Notes, which were converted into
warrants to purchase an additional 442,345 shares of Cicero common stock at an
exercise price of $0.20 per share.
 
 Mr. Mack
held, together with his affiliates, $88,122 of Senior Reorganization Notes,
which were converted into warrants to purchase an additional 112,205 shares of
Cicero common stock at a purchase price of $0.20 per share.
 
 Mr.
Miller held, together with his affiliates, $77,706 of Senior Reorganization
Notes, which were converted into warrants to purchase an additional 114,597
shares of Cicero common stock at a purchase price of $0.20.
 
 Mr.
Atherton holds $20,000 of Senior Reorganization Notes which were converted into
warrants to purchase an additional 289,856 shares of Cicero common stock at a
purchase price of $0.20.
 
 Mr.
Broderick, Chief Executive Officer and Chief Financial Officer of the Company,
held $2,300 of Senior Reorganization Notes, which were converted into warrants
to purchase 3,222 shares of Cicero Inc. common stock at a purchase price of
$0.20 per share, and options to purchase 12,609 shares of common stock under the
Company’s stock option plan that will convert into options to purchase Cicero
common stock.
 
 Convertible Bridge
Notes.  From July 2005 to November 2006, directors and
executive officers made the following loans to us for Convertible Bridge
Notes:
 
 Mr. Pizi
held $85,000 of Convertible Bridge Notes which bear interest at 10% and matured
on September 15, 2005.  These notes automatically converted into
680,000 shares of Cicero common stock upon approval of the recapitalization plan
by stockholders.
 
 Mr.
Landis held $395,000 of Convertible Bridge Notes which bear interest at 10% and
matured on various dates in 2005 and 2006.  These notes automatically
converted into 3,160,000 shares of Cicero common stock upon approval of the
recapitalization plan by stockholders.
 
 Mr. Mack
held, together with his affiliates, $114,000 of Convertible Bridge Notes which
bear interest at 10% and matured on various dates in 2005 and
2006.  These notes automatically converted into 897,564 shares of
Cicero common stock upon approval of the recapitalization plan by
stockholders.
 
 Mr.
Miller held, together with his affiliates, $120,000 of Convertible Bridge Notes
which bear interest at 10% and matured on various dates in 2005 and
2006.  These notes automatically converted into 947,273 shares of
Cicero common stock upon approval of the recapitalization plan by
stockholders.
 
 Mr.
Hasenyager, a member of our Board of Directors, held $4,061 of Convertible
Bridge Notes which bear interest at 10% and matured on September 15, 2005. These
notes automatically converted into 32,485 shares of Cicero common stock upon
approval of the recapitalization plan by stockholders.
 
 Mr.
Percelay, a member of our Board of Directors, held $130,000 of Convertible
Bridge Notes which bear interest at 10% and matured on various dates in 2005 and
2006. These notes automatically converted into 1,027,273 shares of Cicero common
stock upon approval of the recapitalization plan by stockholders.
 
 Mr.
Atherton, a member of our Board of Directors, held $15,000 of convertible Bridge
Notes which bear interest at 10% and matured during 2006. These notes
automatically converted into 120,000 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
 
 Mr.
Porciello, a member of our Board of Directors, held $10,000 of Convertible
Bridge Notes which bear interest at 10% and matured during 2006. These notes
automatically converted into 80,000 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
 
 Transactions
with Merrill Lynch
 
 On
January 3, 2002, the Company entered into a Purchase Agreement with MLBC, Inc.,
an affiliate of Merrill Lynch. Pursuant to the Purchase Agreement, the Company
issued 2,500 shares of its common stock to MLBC and entered into a royalty
sharing agreement for sales of Cicero®.
Under the royalty sharing agreement, the Company is obligated to pay a royalty
of 3% of the sales price for each sale of Cicero®
or related maintenance services. The royalties are not payable in excess of $20
million. As consideration for the issuance of the shares and the royalty
payments, Merrill Lynch has entered into an amendment to the Cicero®
license agreement, which extends our exclusive worldwide marketing, sales, and
development rights to Cicero®
and granted us certain ownership rights in the Cicero®
trademark. Pursuant to the Purchase Agreement, the Company also entered into a
Registration Rights Agreement granting MLBC certain rights to have the shares of
common stock it received under the Purchase Agreement registered under the
Securities Act of 1933, as amended.
  43
 Table of Contents
  Preferred
Stock Exchange
 
 As part
of the Company’s plan of recapitalization presented to shareholders for
approval, the Company proposed to amend the conversion prices of the existing
Series A-3, B-3, C and D preferred shareholders and convert each of those shares
into Series A-1 Preferred stock.  The new conversion prices with
respect to the Series A-3, B-3 and D preferred stock were negotiated with the
holders of each series based upon such factors as the current conversion price
in relation to the market, the dollar amount represented by such series and,
waiver of anti-dilution, liquidation preferences, seniority and other senior
rights.  The conversion price for the Series C preferred stock was
determined in relation to the conversion price for the Series D preferred
stock.  The board of directors determined the new conversion price of
each series of Level 8 preferred stock after discussion and review of those
rights, ranks and privileges that were being waived by the present holders of
preferred stock.  Among those rights being waived are anti-dilution
protection, liquidation preferences and seniority.
 
 The
holders of the Series A-1 preferred stock shall have the rights and preferences
set forth in the Certificate of Designations filed with the Secretary of State
of the State of Delaware upon the approval of the
Recapitalization.  The rights and interests of the Series A-1
preferred stock of the Company will be substantially similar to the rights
interests of each of the series of Level 8 preferred stock other than for (i)
anti-dilution protections that have been permanently waived and (ii) certain
voting, redemption and other rights that holders of Series A-1 preferred stock
will not be entitled to.  All shares of Series A-1 preferred stock
will have a liquidation preference pari passu with all other
Series A-1 preferred stock.
 
 The
Series A-1 preferred stock is convertible at any time at the option of the
holder into an initial conversion ratio of 1,000 shares of Common Stock for each
share of Series A-1 preferred stock.  The initial conversion ratio
shall be adjusted in the event of any stock splits, stock dividends and other
recapitalizations.  The Series A-1 preferred stock is also convertible
on a automatic basis in the event that (i) the Company closes on an additional
$5,000,000 equity financing from strategic or institutional investors, or (ii)
the Company has four consecutive quarters of positive cash flow as reflected on
the Company’s financial statements prepared in accordance with generally
accepted accounting principals (“GAAP”) and filed with the
Commission.  The holders of Series A-1 preferred stock are entitled to
receive equivalent dividends on an as-converted basis whenever the Company
declares a dividend on its Common Stock, other than dividends payable in shares
of Common Stock.  The holders of the Series A-1 preferred stock are
entitled to a liquidation preference of $500 per share of Series A-1 preferred
stock upon the liquidation of the Company.  The Series A-1 preferred
stock is not redeemable.
 
 The
holders of Series A-1 preferred stock also possess the following voting
rights.  Each share of Series A-1 preferred stock shall represent that
number of votes equal to the number of shares of Common Stock issuable upon
conversion of a share of Series A-1 preferred stock.  The holders of
Series A-1 preferred stock and the holders of Common Stock shall vote together
as a class on all matters except: (i) regarding the election of the board
of directors of the Company (as set forth below); (ii) as required by law; or
(iii) regarding certain corporate actions to be taken by the Company (as
set forth below).
 
 The
approval of at least two-thirds of the holders of Series A-1 preferred stock
voting together as a class, shall be required in order for the Company to: (i)
merge or sell all or substantially all of its assets or to recapitalize or
reorganize; (ii) authorize the issuance of any equity security having any right,
preference or priority superior to or on parity with the Series A-1 preferred
stock; (iii) redeem, repurchase or acquire indirectly or directly any of its
equity securities, or to pay any dividends on the Company’s equity securities;
(iv) amend or repeal any provisions of its certificate of incorporation or
bylaws that would adversely affect the rights, preferences or privileges of the
Series A-1 preferred stock; (v) effectuate a significant change in the principal
business of the Company as conducted at the effective time of the
Recapitalization; (vi) make any loan or advance to any entity other than in the
ordinary course of business unless such entity is wholly owned by the Company;
(vii) make any loan or advance to any person, including any employees or
directors of the Company or any subsidiary, except in the ordinary course of
business or pursuant to an approved employee stock or option plan; and (viii)
guarantee, directly or indirectly any indebtedness or obligations, except for
trade accounts of any subsidiary arising in the ordinary course of
business.   In addition, the unanimous vote of the board of
directors is required for any liquidation, dissolution, recapitalization or
reorganization of the Company.   The voting rights of the holders
of Series A-1 preferred stock set forth in this paragraph shall be terminated
immediately upon the closing by the Company of at least an additional $5,000,000
equity financing from strategic or institutional investors.
  44
 Table of Contents
  In
addition to the voting rights described above, the holders of a majority of the
shares of Series A-1 preferred stock are entitled to appoint two observers to
the Company’s board of directors who shall be entitled to receive all
information received by members of the board of directors, and shall attend and
participate without a vote at all meetings of the Company’s board of directors
and any committees thereof.  At the option of a majority of the
holders of Series A-1 preferred stock, such holders may elect to temporarily or
permanently exchange their board observer rights for two seats on the Company’s
board of directors, each having all voting and other rights attendant to any
member of the Company’s board of directors.  As part of the
Recapitalization, the right of the holders of Series A-1 preferred stock to
elect a majority of the voting members of the Company’s board of directors shall
be terminated.
 
 As a
result of the reduced conversion prices and exchange of the Series A-3, B-3, C
and D preferred stock into Series A-1 preferred stock and using Black-Scholes,
we calculated a beneficial conversion in the exchange of the Series A-3, B-3, C
and D shares for Series A-1 preferred stock. The beneficial conversion of
$21,000 is treated as a deemed dividend in the Statement of Operations for the
year ended December 31, 2006.
 
 Borrowings
and Commitments from BluePhoenix Solutions
 
 BluePhoenix
Solutions guaranteed certain debt obligations of the Company. In October 2007,
the Company agreed to restructure the Note payable to Bank Hapoalim and guaranty
by BluePhoenix Solutions. Under a new agreement with BluePhoenix, the Company
made a principal reduction payment to Bank Hapoalim in the amount of $300,000.
Simultaneously, BluePhoenix paid $1,671,000 to Bank Hapoalim, thereby
discharging that indebtedness. The Company and BluePhoenix entered into a new
Note in the amount of $1,021,000, bearing interest at LIBOR plus 1.0% and
maturing on December 31, 2011. In addition, BluePhoenix acquired 2,546,149
shares of the Company’s common stock in exchange for $650,000 paid to Bank
Hapoalim to retire that indebtedness.  Of the new note payable to
BluePhoenix, approximately $350,000 is due on January 31, 2009 and the balance
is due on December 31, 2011.  In November 2006, the Company and
BluePhoenix (formerly Liraz Systems Ltd.) agreed to extend its guaranty on the
term loan and with Bank Hapoalim, to extend the maturity date on the loan until
October 31, 2007. Under the terms of the agreement with Liraz, the Company
agreed to issue 60,000 shares of its common stock. Based upon the fair market
value at the time of issuance, the Company recognized $240,000 as loan
amortization costs in the Statement of Operations for the year ended December
31, 2006. In November 2005, the Company and  Liraz Systems Ltd. agreed
to extend its guaranty on the term loan and with Bank Hapoalim, to extend the
maturity date on the loan to October 30, 2006. Under the terms of the agreement
with Liraz, the Company agreed to issue 24,000 shares of its common stock and
granted a warrant to purchase an additional 36,000 shares of our common stock at
an exercise price of $0.20 per share. Based upon fair market value at the time
of issuance, the Company recognized $48,000 as loan amortization costs in the
Statement of Operations for the year ended December 31, 2005.
 
 Transactions
with Board Members
 
 During
2006, under an existing reseller agreement, the Company recognized $100,000 of
software revenue with Pilar Services, Inc. Pilar Services is presently owned and
managed by Charles Porciello who is a member of our Board of Directors. As of
December 31, 2007, the receivable was still outstanding and the Company has
reserved for possible doubtful accounts.
 
 Director
Independence
 
 Our board
of directors currently consists of eleven members.  They are John L.
Steffens, John P. Broderick, Mark Landis, Anthony C. Pizi, Bruce Hasenyager, Jay
Kingley, Bruce D. Miller, Charles Porciello, Bruce Percelay, John W. Atherton,
and Don Peppers.  Mr. Steffens is the Company’s Chairman of the Board
and Mr. Broderick is the Chief Executive Officer and Chief Financial
Officer.  The Company’s stock is quoted on the Over The Counter
Bulletin Board, which does not have director independence requirements. Under
Item 407(a) of Regulation S-B, the Company has chosen to measure the
independence of its directors under the definition of independence used by the
American Stock Exchange, which can be found in the AMEX Company Guide,
§121(A)(2) (2007).  Under such definition, Messrs. Steffens,
Hasenyager, Kingley, Miller, Porciello, Percelay, Atherton and Peppers are
independent directors.
  45
 Table of Contents
  Item
14.     Principal Accountant Fees and
Services
 
 Independent
Registered Public Accounting Firm
 
 Margolis
& Company P.C. audited our financial statements for each of the years ended
December 31, 2007 and 2006.
 
 Audit
Fees
 
 Audit
fees include fees for the audit of the Company’s annual financial statements,
fees for the review of the Company’s interim financial statements, and fees for
services that are normally provided by the Independent Registered Public
Accounting Firm in connection with statutory and regulatory filings or
engagements. The aggregate fees billed by Margolis & Company P.C. for
professional services rendered to our company for the audit of the Company's
annual financial statements for fiscal years 2007 and 2006 (and reviews of
quarterly financial statements on form 10-Q), were $44,000 and $36,000
respectively.
 
 Audit-Related
Fees
 
 Audit-related
fees include fees for assurance and related services that are reasonably related
to the performance of the audit or review of the Company’s financial statements.
There were no audit-related fees paid to Margolis & Company P.C. for fiscal
years 2007 and 2006.
 
 Tax
Fees
 
 Tax fees
include fees for tax compliance, tax advice and tax planning. There were no fees
billed by Margolis & Company P.C. for these services in 2007 and
2006.
 
 Other
Fees
 
 All other
fees include fees for all services except those described above. There were no
other fees paid to Margolis & Company P.C. for fiscal year
2006.
  Determination
of Auditor Independence
 
 The Audit
Committee considered the provision of non-audit services by Margolis &
Company P.C. and determined that the provision of such services was consistent
with maintaining the independence of Margolis & Company P.C.
 
 Audit
Committee’s Pre-Approval Policies
 
 The Audit
Committee has adopted a policy that all audit, audit-related, tax and any other
non-audit service to be performed by the Company’s Independent Registered Public
Accounting Firm must be pre-approved by the Audit Committee. It is the Company’s
policy that all such services be pre-approved prior to commencement of the
engagement. The Audit Committee is also required to pre-approve the estimated
fees for such services, as well as any subsequent changes to the terms of the
engagement.
 46
 Table of Contents
 PART
IV
 
 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K.
 
 (A)           Financial
Statements
 
 The
following financial statements of the Company and the related reports of
Independent Registered Public Accounting Firms thereon are set forth immediately
following the Index of Financial Statements which appears on page F-1 of this
report:
 
 Independent
Registered Public Accounting Firm Report
 
 Consolidated
Balance Sheets as of December 31, 2007 and 2006
 
 Consolidated
Statements of Operations for the years ended December 31, 2007, 2006 and
2005
 
 Consolidated
Statements of Stockholders' Equity for the years ended December 31, 2007, 2006
and 2005
 
 Consolidated
Statements of Comprehensive Loss for the years ended December 31, 2007, 2006 and
2005
 
 Consolidated
Statements of Cash Flows for the years ended December 31, 2007, 2006 and
2005
 
 Notes to
Consolidated Financial Statements
 
 Financial
Statement Schedules
 
 All other
schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are not required under the related
instructions or are inapplicable and therefore have been omitted.
 
 Exhibits
 
 The
exhibits listed under Item 15(c) hereof are filed as part of this Annual Report
on Form 10-K.
 
 (B)
              Reports
      on Form 8-K
 
 On July
26, 2007, the Company filed a Form 8-K announcing the resignation of Mr. Anthony
Pizi, the Company’s Chief Information Officer.
 
 On June
20, 2007, the Company filed a Form 8-K reporting the election of Mr. Don Peppers
to the Board of Directors
 
 On May
16, 2007, the Company filed a Form 8-K reporting the election of  Mr.
John L Steffens as a member and Chairman of the Board of Directors
 
 On
November 21, 2006, the Company filed a Form 8-K reporting that shareholders
approved an amendment to the Certificate of Incorporation to provide the
Company’s Board of Directors with discretionary authority to effect a reverse
stock split ratio from 20:1 to 100:1 and that on November 20, 2006, the Board of
directors set that reverse stock ratio to be 100:1. In addition, the Company
also reported that shareholders approved an amendment to change the name of the
Company from Level 8 Systems, Inc. to Cicero Inc., to increase the authorized
common stock of the Company from 85 million shares to 215 million shares and to
convert existing preferred shares into a new Series A-1 preferred stock of
Cicero Inc The proposals at the Special Meeting of Stockholders of Level 8
comprised a proposed recapitalization of Level 8 which is also subject to the
receipt of amendments to outstanding convertible promissory notes, senior
reorganization notes and the convertible bridge notes.
 
 On May
15, 2006, the Company filed a Form 8-K reporting the election of Mr. John W.
Atherton to the Board of Directors.
 
 On March
9, 2006, the Company filed a Form 8-K reporting the resignation of Frederic Mack
as a member of the Board of Directors.
  47
 Table of Contents
  On
January 13, 2006, the Company filed a Form 8-K reporting the election of Mr.
Bruce Percelay to the Board of Directors.
  (C)           Exhibits
  Exhibit

                Number
              Description3.1
              Certificate of
      Incorporation of Level 8 Systems, Inc., a Delaware corporation, as amended
      and restated  December 29, 2006 (incorporated by reference to
      exhibit 3.1 to Level 8’s Form 8-K filed January
      17, 2007).
  
 3.2
              Certificate
      of Designation relating to Series A1 Convertible Redeemable Preferred
      Stock (incorporated by reference to exhibit 3.2 to Level 8’s Form 8-K
      filed January 17, 2007).
 
 3.3
              Certificate
      of Designation relating to Series A3 Convertible Redeemable Preferred
      Stock, as amended December 29, 2006 (incorporated by reference to exhibit
      3.3 to Level 8’s Level 8’s Form 8-K filed January 17,
    2007).
 
 3.4
              Certificate
      of Designation relating to Series B3 Convertible Redeemable Preferred as
      amended December 29, 2006 (incorporated by reference to exhibit 3.4 to
      Level 8’s Level 8’s Form 8-K filed January 17,
  2007).
 
 3.5
              Certificate
      of designation relating to Series C Convertible Redeemable Preferred Stock
      as amended December 29, 2006 (incorporated by reference to exhibit 3.5 to
      Level 8’s Level 8’s Form 8-K filed January 17,
  2007).
 
 3.6
              Certificate
      of designation relating to Series C Convertible Redeemable Preferred Stock
      as amended December 29, 2006 (incorporated by reference to exhibit 3.5 to
      Level 8’s Level 8’s Form 8-K filed January 17,
  2007).
 
 3.7
              Certificate
      of designation relating to Series D Convertible Redeemable Preferred Stock
      as amended December 29, 2006 (incorporated by reference to exhibit 3.5 to
      Level 8’s Level 8’s Form 8-K filed January 17,
  2007).
 
 3.8
              Certificate
      of Incorporation of Level 8 Systems, Inc., a Delaware corporation, as
      amended August 4, 2003 (incorporated by reference to exhibit 3.1 to Level
      8’s Form 10-K filed March 31,
2004).
 
 3.9
              Bylaws
      of Level 8 Systems, Inc., a Delaware corporation (incorporated by
      reference to exhibit 3.2 to Level 8’s Form 10-K filed April 2,
      2002).
 
 3.10
              Certificate
      of Designations, Preferences and Rights dated March 19, 2003 relating to
      Series D Convertible Redeemable Preferred Stock (incorporated by reference
      to exhibit 3.1 to Level 8's Form 8-K, filed March 31,
    2003).
 
 3.11
              Certificate
      of Designation relating to Series A3 Convertible Redeemable Preferred
      Stock (incorporated by reference to exhibit 3.1 to Level 8’s Form 10-Q
      filed November 15, 2002).
 
 3.12
              Certificate
      of Designation relating to Series B3 Convertible Redeemable Preferred
      Stock (incorporated by reference to exhibit 3.1 to Level 8’s Form 10-Q
      filed November 15, 2002).
 
 3.13
              Certificate
      of designation relating to Series C Convertible Redeemable Preferred Stock
      (incorporated by reference to exhibit 3.1 to Level 8’d Form 8-K filed
      August 27, 2002).
 
 4.1
              Registration
      Rights Agreement dated July 2006, by and among Level 8 Systems, Inc. and
      the Purchasers in the Senior  Placement listed on Schedule I
      thereto relating to the Security Purchasers Agreement  (filed
      herewith).
 
 4.2
              Registration
      Rights Agreement, dated January 2004, by and among Level 8 Systems, Inc.
      and the Purchasers in the January 2004 Private Placement listed on
      Schedule I thereto relating to the Security Purchasers
      Agreement  (incorporated by reference to exhibit 4.1 to Level
      8’s Form 10-K/A filed April
      21, 2004).
   48
 Table of Contents
  4.3
              Registration
      Rights Agreement dated as of March 19, 2003 by and among Level 8 Systems,
      Inc. and the Purchasers listed on Schedule I thereto relating to the
      Series D Convertible Redeemable Preferred Stock (incorporated by reference
      to exhibit 4.1 to Level 8’s Form 8-K, filed March 31,
    2003).
 
 4.4
              Registration
      Rights Agreement dated as of October 15, 2003 by and among Level 8
      Systems, Inc. and the Purchasers in the October Private Placement listed
      on schedule I thereto (incorporated by reference to exhibit 4.2 to Level
      8’s Form 10-K, filed March 31,
2004).
 
 4.5
              Registration
      Rights Agreement, dated as of January 16, 2002, by and among Level 8
      Systems, Inc. and the Purchasers in the January Private Placement listed
      on Schedule I thereto (incorporated by reference to exhibit 4.1 to Level
      8's Report on Form 8-K, filed January 25,
2002).
 
 4.6
              Registration
      Rights Agreement, dated as of January 3, 2002, between Level 8 Systems,
      Inc. and MLBC, Inc. (incorporated by reference to exhibit 4.1 to Level 8's
      Report on Form 8-K, filed January 11,
2002).
 
 4.7
              Registration
      Rights Agreement, dated as of August 29, 2002, entered into by and between
      Level 8 Systems, Inc. and the holders of Series A2/A3 Preferred Stock and
      Series B2/B3 Preferred Stock (incorporated by reference to exhibit 10.4 to
      Level 8’s Form 8-K filed August 30,
2002).
 
 4.7A
              First
      Amendment to Registration Rights Agreement, dated as of October 25, 2002,
      entered into by and between Level 8 Systems, Inc. and the holders of
      Series A2/A3 Preferred Stock and Series B2/B3 Preferred Stock
      (incorporated by reference to exhibit 10.4 to Level 8’s Form 10-Q filed
      November 15, 2002).
 
 4.8
              Registration
      Rights Agreement, dated as of June 13, 1995, between Level 8 Systems, Inc.
      and Liraz Systems Ltd. (incorporated by reference to exhibit 10.24 to
      Across Data Systems, Inc.'s (Level 8's predecessor) Registration Statement
      on Form S-1, filed May 12, 1995, File No.
  33-92230).
 
 4.8A
              First
      Amendment to Registration Rights Agreement, dated as of August 8, 2001, to
      the Registration Rights Agreement dated as of June 13, 1995, by and
      between Across Data Systems, Inc. (Level 8's predecessor) and Liraz
      Systems Ltd. (incorporated by reference to exhibit 4.1 to Level 8's Report
      on Form 8-K, filed August 14,
2001).
 
 4.9
              Registration
      Rights Agreement, dated as of August 14, 2002, entered into by and between
      Level 8 Systems, Inc. and the investors in Series C Preferred Stock
      (incorporated by reference to exhibit 4.1 to Level 8’s Form 8-K filed
      August 27, 2002).
 
 4.10
              Form
      of Registration Rights Agreement, dated January 2004, by and among Level 8
      Systems, Inc. and the Purchasers of Convertible Promissory Note
      (incorporated by reference to exhibit 4.2 to Level 8's Report on Form
      10-Q, filed May 12, 2004).
 
 4.13
              Form
      of Warrant issued to the Purchasers in the Series D Preferred Stock
      transaction dated as of March 19, 2003 (incorporated by reference to
      exhibit 4.2 to Level 8's Form 8-K, filed March 31,
  2003).
 
 4.13A
              Form
      of Warrant issued to the Purchasers in the Series D Preferred Stock
      transaction dated as of March 19, 2003 (incorporated by reference to
      exhibit 4.2 to Level 8's Form 8-K, filed March 31,
  2003).
 
 4.14
              Form
      of Stock Purchase Warrant issued to Purchasers in the October 2003 Private
      Placement (incorporated by reference to exhibit 4.9 to Level 8’s Form
      10-K, filed March31, 2004).
  4.16
              Form
      of Series A3 Stock Purchase Warrant (incorporated by reference to exhibit
      10.2 of Level 8’s Form 10-Q filed November 15,
  2002).
 
 4.17
              Form
      of Series B3 Stock Purchase Warrant (incorporated by reference to exhibit
      10.3 of Level 8’s Form 10-Q filed November 15,
  2002).
 
 4.18
              Form
      of Series C Stock Purchase Warrant (incorporated by reference to exhibit
      10.2 to Level 8’s Form 8-K filed August 27,
  2002)
 
 4.19
              Form
      of Long term Promissory Note Stock Purchase Warrant (filed
      herewith)
  49
 Table of Contents
  10.1
              Securities
      Purchase Agreement for Consortium IV (incorporated by reference to exhibit
      10.1 to Cicero Inc.’s Form 10-K/A filed July 11,
  2007).
 
 10.2
              Securities
      Purchase Agreement dated January 2004 by and among Level 8 Systems, Inc.
      and the Purchasers in the January 2004 Private Placement (incorporated by
      reference to exhibit 10.1 to Level 8’s Form 10-K/A filed April 21,
      2004).
 
 10.3
              Securities
      Purchase Agreement dated March 2004 by and among Level 8 Systems, Inc. and
      the Purchasers of Convertible Promissory Note (incorporated by reference
      to exhibit 10.2 to Level 8's Form 10-Q, filed May 12,
    2004).
 
 10.3
              Form
      of Convertible Promissory Note dated March 2004 by and among Level 8
      Systems, Inc. and the Purchasers of Convertible Promissory Note
      (incorporated by reference to exhibit 10.3 to Level 8's Form 10-Q, filed
      May 12, 2004).
 
 10.4
              Securities
      Purchase Agreement dated as of March 19, 2003 by and among Level 8
      Systems, Inc. and the Purchasers (incorporated by reference to exhibit
      10.1 to Level 8's Form 8-K, filed March 31,
  2003).
 
 10.5
              Securities
      Purchase Agreement dated as of October 15, 2003 by and among Level 8
      Systems, Inc. and the Purchasers in the October Private Placement
      (incorporated by reference to exhibit 10.2 to Level 8’s Form 10-K, filed
      March 31, 2004).
 
 10.6
              Securities
      Purchase Agreement, dated as of January 16, 2002, by and among Level 8
      Systems, Inc. and the Purchasers in the January Private Placement
      (incorporated by reference to exhibit 10.1 to Level 8's Report on Form
      8-K, filed January 25, 2002).
 
 10.7
              Purchase
      Agreement, dated as of January 3, 2002, between Level 8 Systems, Inc. and
      MLBC, Inc.  (incorporated by reference to exhibit 10.1 to Level
      8's Report on Form 8-K, filed January 11,
2002).
 
 10.7A
              Purchase
      Agreement, dated as of July 31, 2000, between Level 8 Systems, Inc. and
      Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated by
      reference to Exhibit 10.1 to Level 8's Report on Form 8-K, filed August
      11, 2000).
 
 10.8
              Securities
      Purchase Agreement, dated as of August 14, 2002, by and among Level 8
      Systems, Inc. and the purchasers of the Series C Preferred Stock
      (incorporated by reference to exhibit 10.1 to Level 8’s Form 8-K filed
      August 27, 2002).
 
 10.9
              Agreement
      by and among Level 8 Systems, Inc. and the holders of Series A1/A2/A3 and
      B1/B2/B3 Preferred Stock, dated as of August 14, 2002 (incorporated by
      reference to exhibit 10.3 to Level 8’s Form 8-K filed August 27,
      2002).
 
 10.10
              Exchange
      Agreement among Level 8 Systems, Inc., and the various stockholders
      identified and listed on Schedule I, dated as of August 29, 2002
      (incorporated by reference to exhibit 10.1 to Level 8’s Form 8-K filed
      August 30, 2002).
 
 10.11A
              First
      Amendment to Exchange Agreement, dated as of October 25, 2002, among Level
      8 Systems, Inc., and the various stockholders identified and listed on
      Schedule I to that certain Exchange Agreement, dated as of August 29, 2002
      (incorporated by reference to exhibit 10.1 to Level 8’s Form 10-Q filed
      November 15, 2002).
 
 10.11B
              Securities
      Purchase Agreement, dated as of June 29, 1999, among Level 8 Systems, Inc.
      and the investors named on the signature pages thereof for the purchase of
      Series A Preferred Stock (incorporated by reference to exhibit 10.1 to
      Level 8's Form 8-K filed July 23,
1999).
 
 10.11C
              Securities
      Purchase Agreement, dated as of July 20, 2000, among Level 8 Systems, Inc.
      and the investors named on the signature pages thereof for the purchase of
      Series B Preferred Stock (incorporated by reference to Exhibit 10.1 to
      Level 8's Report on Form 8-K filed July 31,
  2000).
 
 10.12
              Amended
      PCA Shell License Agreement, dated as of January 3, 2002, between Level 8
      Systems, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated
      (incorporated by reference to exhibit 10.2 to Level 8's Form 8-K, filed
      January 11, 2002).
  50
 Table of Contents
  10.12A
              PCA
      Shell License Agreement between Level 8 Systems, Inc. and Merrill Lynch,
      Pierce, Fenner & Smith Incorporated (incorporated by reference to
      exhibit 10.2 to Level 8’s Report on Form 8-K, filed September 11,
      2000).
 
 10.12A
              OEM
      License Agreement between Cicero Inc. and Merrill Lynch, Pierce, Fenner
      & Smith Incorporated (filed
herewith).
 
 10.12A
              Software
      Support and Maintenance Schedule between Cicero Inc. and Merrill Lynch,
      Pierce, Fenner & Smith Incorporated (filed
  herewith).
 
 10.15
              Employment
      Agreement between Anthony Pizi and the Company effective January 1, 2007
      (filed herewith).*
 
 10.16
              Employment
      Agreement between John P. Broderick and the Company effective January 1,
      2007 (filed herewith).*
 
 10.17
              Lease
      Agreement for Cary, N.C. offices, dated November 7, 2003, between Level 8
      Systems, Inc. and Regency Park Corporation (incorporated by reference to
      exhibit 10.17 to Level 8’s Form 10-K, filed March 31,
    2004).
 
 10.18
              Level
      8 Systems Inc. 1997 Stock Option Plan, as Amended and Restated
      (incorporated by reference to exhibit 10.2 to Level 8’s Registration
      Statement of Form S-1/A, filed September 22, 2000, File No.
      333-44588).*
 
 10.18A
              Fifth
      Amendment to Level 8 Systems Inc. 1997 Stock Option Plan (incorporated by
      reference to exhibit 10.9A to Level 8’s Form 10-K filed April 2,
      2002).*
 
 10.18B
              Seventh
      Amendment to Level 8 Systems Inc. 1997 Stock Option Plan (incorporated by
      reference to exhibit 10.14 B to Level 8’s Form 10-K, filed March 31,
      2004).*
 
 10.20
              Lease
      Agreement for Cary, N.C. offices, dated March 31, 1997, between Seer
      Technologies, Inc. and Regency Park Corporation (incorporated by reference
      to exhibit 10.47 to Seer Technologies, Inc.'s Quarterly Report on Form
      10-Q for the period ended March 31, 1997, File No.
    000-26194).
 
 10.20A
              Addendum
      #1 to the Lease Agreement for Cary, N.C. offices, dated July 6, 1998
      (incorporated by reference to exhibit 10.58 to Seer Technology Inc.'s
      Quarterly Report on Form 10-Q for the period ended June 30, 1998, File No.
      000-26194).
 
 10.20B
              Amendment
      to Lease Agreement for Cary, N.C. offices, dated January 21, 1999
      (incorporated by reference to exhibit 10.21A to Level 8's Annual Report on
      Form 10-K for the fiscal year ended December 31,
  1998).
 
 10.21
              Lease
      Agreement for Cary, N.C. offices, dated August 16,2007, between Cicero Inc. and Regency Park Corporation (filed
      herewith).
 
 10.22
              Cicero
      Inc. 2007 Employee Stock Option Plan (filed
  herewith).
 
 10.23
              Agreement
      and Promissory Note of Cicero Inc,, dated October 30, 2007 among Cicero
      Inc. and BluePhoenix Solutions Ltd. (filed
  herewith).
 
 10.24
              Promissory
      Note of Cicero Inc., dated October 29, 2007 among Cicero Inc. and John L.
      Steffens (filed herewith).
 
 10.25
              Securities
      Purchase Agreement, dated as of February 26, 2007, by and among Cicero
      Inc. and the Purchasers in the February Private Placement (filed
      herewith).
 
 10.26
              Securities
      Purchase Agreement, dated as of August 15, 2007, by and among Cicero Inc.
      and the Purchasers in the August Private Placement (filed
      herewith).
 
 14.1
              Code
      of Ethics (incorporated by reference to exhibit 14.1 to Level 8’s Form
      10-K/A, filed March
      31, 2004).
   51
 Table of Contents
  21.1
              List
      of subsidiaries of the Company (filed
herewith).
 
 22.1
              Consent
      of Margolis & Company P.C. (filed
herewith).
 
 31.1
              Certification
      of Chief Executive pursuant to Rule 13a-14(a) (filed
      herewith).
 
 31.2
              Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) (filed
      herewith).
 
 32.1
              Certification
      of John P. Broderick pursuant to 18 USC § 1350, as adopted pursuant to
      §906 of the Sarbanes-Oxley Act of 2002 (filed
  herewith).
 
 *        Management
contract or compensatory agreement.
  52
 Table of Contents
  
 SIGNATURES
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
 
 CICERO
      INC.By:
      /s/
      John P. BroderickJohn
      P. BroderickChief
      Executive OfficerDate:
      March 31, 2008
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated have signed this Report below.
 
 
 Signature
                
                /s/  John L. Steffens
              
              Title
                Chairman
      of the Board
              
              Date

                  
                  March
      31, 2008John
      L. Steffens
                
                /s/  John P.
      Broderick
              
              Chief Executive Officer/Chief Financial
      Officer
              
              March
      31, 2008John
      P. Broderick
                
                /s/  Mark
      Landis
              
              (Principal
      Executive Officer)
                Director
              
              March
      31, 2008Mark
      Landis
                
                /s/  Anthony C.
      Pizi
              
              Director
              
              March
      31, 2008Anthony
      C. Pizi
                
                /s/ Bruce
      Hasenyager
              
              Director
              
              March
      31, 2008Bruce
      Hasenyager
                
                /s/ Jay
Kingley
              
              Director
              
              March
      31, 2008Jay
      Kingley
                
                /s/ Bruce D.
      Miller
              
              Director
              
              March
      31, 2008Bruce
      D. Miller
                
                /s/ Charles
      Porciello
              
              Director
              
              March
      31, 2008Charles
      Porciello
                
                /s/ Bruce
      Percelay
              
              Director
              
              March
      31, 2008Bruce
      Percelay
                
                /s/ John W.
      Atherton
              
              Director
              
              March
      31, 2008John
      W. Atherton
                
                /s/ Don Peppers
              
              Director
              
              March
      31, 2008Don
      Peppers
  53
 Table of Contents
  INDEX TO FINANCIAL STATEMENTS
 
 Report
      of Independent Registered Public Accounting Firm
              F-2Financial
      Statements:Consolidated
      Balance Sheets
              F-3Consolidated
      Statements of Operations
              F-4Consolidated
      Statements of Stockholders' Equity (Deficit)
              F-5Consolidated
      Statements of Comprehensive Loss
              F-6Consolidated
      Statements of Cash Flows
              F-7Notes
      to Consolidated Financial Statements
              F-9
  F -
1
  REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 To the
Board of Directors and Stockholders of
 Cicero
Inc.
 Cary,
North Carolina
 
 We have
audited the accompanying consolidated balance sheet of Cicero Inc. and
subsidiaries (the "Company") as of December 31, 2007 and 2006, and the related
consolidated statements of operations, stockholders' equity (deficit),
comprehensive loss and cash flows for each of the years in the three-year period
ended December 31, 2007.  Cicero Inc’s management is responsible for
these financial statements. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Cicero Inc. and subsidiaries
as of December 31, 2007 and 2006, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
2007, in conformity with accounting principles generally accepted in the United
States of America.
 
 The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note 1
to the consolidated financial statements, the Company's recurring losses from
operations and working capital deficiency raise substantial doubt about its
ability to continue as a going concern.  Management's plans concerning
these matters are also described in Note 1.  The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
 
 
 /s/
Margolis & Company P.C.
 Certified
Public Accountants
 
 
 Bala
Cynwyd, PA
 March 10,
2008
 F -
2
  CICERO
INC.
 CONSOLIDATED
BALANCE SHEETS
 (in
thousands, except share and per share amounts)
  December
      31, 2007
              
              
              December
      31, 2006ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              250
              
              
              $
              310Assets
      of operations to be abandoned
              
              
              79
              
              
              
              80Trade
      accounts receivable, net
              
              
              692
              
              
              
              170Prepaid
      expenses and other current assets
              
              
              208
              
              
              
              22Total
      current assets
              
              
              1,229
              
              
              
              582Property
      and equipment, net
              
              
              22
              
              
              
              15Total
      assets
              
              $
              1,251
              
              
              $
              597LIABILITIES
      AND STOCKHOLDERS' DEFICITCurrent
      liabilities:Short-term
      debt (Note
      5)
              
              $
              1,235
              
              
              $
              2,899Accounts
      payable
              
              
              2,489
              
              
              
              2,360Accrued
      expenses:Salaries,
      wages, and related items
              
              
              1,002
              
              
              
              1,012Other
              
              
              2,072
              
              
              
              1,732Liabilities
      of operations to be abandoned
              
              
              455
              
              
              
              435Deferred
      revenue
              
              
              108
              
              
              
              38Total
      current liabilities
              
              
              7,361
              
              
              
              8,476Long-term
      debt (Note 6)
              
              
              1,323
              
              
              
              33Total
      liabilities
              
              
              8,684
              
              
              
              8,509Commitments
      and contingencies (Notes 14 and 15)Stockholders'
      deficit:Convertible
      preferred stock, $0.001 par value, 10,000,000 shares
      authorized
                Series
      A-1 – 1,603.6 shares issued and outstanding at December 31, 2007, $500 per
      share liquidation preference (aggregate liquidation value of $802) and
      1,763.5 shares issued and outstanding at December 31, 2006, $500 per share
      liquidation preference (aggregate liquidation value of
    $880)
              
              
              --
              
              
              
              --Common
      stock, $0.001 par value, 215,000,000 shares authorized at December 31,
      2007 and 2006, respectively; 43,805,508 and 35,182,406 issued and
      outstanding at December 31, 2007 and 2006, respectively (Note
      2)
              
              
              44
              
              
              
              35Additional
      paid-in-capital
              
              
              228,858
              
              
              
              226,407Accumulated
      deficit
              
              
              (236,320
              )
              
              
              (234,345
              )Accumulated
      other comprehensive loss
              
              
              (15
              )
              
              
              (9
              )Total
      stockholders' deficit
              
              
              (7,433
              )
              
              
              (7,912
              )Total
      liabilities and stockholders' deficit
              
              $
              1,251
              
              
              $
              597
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F -
3
  CICERO
INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
thousands, except per share amounts)
  Years
      Ended December 31,2007
              
              
              2006
              
              
              2005Revenue:Software
              
              $
              501
              
              
              $
              208
              
              
              $
              407Maintenance
              
              
              300
              
              
              
              120
              
              
              
              147Services
              
              
              1,007
              
              
              
              644
              
              
              
              231Total
      operating revenue
              
              
              1,808
              
              
              
              972
              
              
              
              785Cost
      of revenue:Software
              
              
              19
              
              
              
              9
              
              
              
              16Maintenance
              
              
              264
              
              
              
              212
              
              
              
              350Services
              
              
              654
              
              
              
              546
              
              
              
              822Total
      cost of revenue
              
              
              937
              
              
              
              767
              
              
              
              1,188Gross
      margin (loss)
              
              
              871
              
              
              
              205
              
              
              
              (403
              )Operating
      expenses:Sales
      and marketing
              
              
              786
              
              
              
              346
              
              
              
              627Research
      and product development
              
              
              569
              
              
              
              533
              
              
              
              891General
      and administrative
              
              
              1,356
              
              
              
              1,206
              
              
              
              1,137(Gain)
      on disposal of assets
              
              
              -
              
              
              
              (24
              )
              
              
              -Total
      operating expenses
              
              
              2,711
              
              
              
              2,061
              
              
              
              2,655Loss
      from operations
              
              
              (1,840
              )
              
              
              (1,856
              )
              
              
              (3,058
              )Other
      income (charges):Interest
      expense
              
              
              (257
              )
              
              
              (853
              )
              
              
              (593
              )Other
              
              
              122
              
              
              
              (288
              )
              
              
              (30
              )(135
              )
              
              
              (1,141
              )
              
              
              (623
              )Net
      loss
              
              $
              (1,975
              )
              
              $
              (2,997
              )
              
              $
              (3,681
              )Accretion
      of preferred stock and deemed dividends
              
              
              -
              
              
              
              5,633
              
              
              
              -Net
      loss applicable to common stockholders
              
              $
              (1,975
              )
              
              $
              (8,630
              )
              
              $
              (3,681
              )Loss
      per share:Net
      loss applicable to common stockholders - basic and diluted
              
              $
              (0.05
              )
              
              $
              (0.25
              )
              
              $
              (8.27
              )Weighted
      average common shares outstanding - basic and diluted
              
              
              36,771
              
              
              
              35,182
              
              
              
              445
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F -
4
  CICERO
INC.
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' DEFICIT
 (in
thousands)
  Common
      Stock
                    
                    
                    Preferred
      Stock
                    
                    
                    Additional
                      Paid-in
                    
                    
                    Accumulated
                    
                    
                    Accumulated
                      Other
                      ComprehensiveShares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    (Deficit)
                    
                    
                    Income
      (Loss)
                    
                    
                    TotalBalance
      at December 31, 2004
                    
                    
                    43,304
                    
                    
                    $
                    43
                    
                    
                    
                    33
                    
                    
                    
                    --
                    
                    
                    $
                    210,142
                    
                    
                    $
                    (222,034
                    )
                    
                    $
                    (8
                    )
                    
                    $
                    (11,857
                    )Conversion
      of preferred shares to common
                    
                    
                    395
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    --
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    --Shares
      issued as compensation
                    
                    
                    961
                    
                    
                    
                    2
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    101
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    103Shares
      issued for bank guarantee
                    
                    
                    2,400
                    
                    
                    
                    2
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    45
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    47Conversion
      of senior convertible redeemable preferred stock
                    
                    
                    957
                    
                    
                    
                    1
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    306
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    307Foreign
      currency translation adjustment
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5
                    
                    
                    
                    5Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    _
                    
                    
                    
                    (3,681
                    )
                    
                    
                    
                    
                    
                    
                    (3,681
                    )Balance
      at December 31, 2005
                    
                    
                    48,017
                    
                    
                    
                    48
                    
                    
                    
                    33
                    
                    
                    
                    --
                    
                    
                    
                    210,594
                    
                    
                    
                    (225,715
                    )
                    
                    
                    (3
                    )
                    
                    
                    (15,076
                    )Reversed
      stock split 100:1
                    
                    
                    (47,536
                    )
                    
                    
                    (48
                    )
                    
                    
                    (33
                    )
                    
                    
                    
                    
                    
                    
                    48
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    --Balance
      at December 31, 2005 as adjusted for stock split
                    
                    
                    481
                    
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    210,642
                    
                    
                    
                    (225,715
                    )
                    
                    
                    (3
                    )
                    
                    
                    (15,076
                    )Shares
      issued from conversion of senior reorganization debt
                    
                    
                    3,438
                    
                    
                    
                    3
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,705
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,708Shares
      issued from conversion of convertible bridge notes
                    
                    
                    30,508
                    
                    
                    
                    32
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,877
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,909Shares
      issued for bank guarantee
                    
                    
                    96
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    312
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    312Shares
      issued from short term debt conversion
                    
                    
                    224
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    190
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    190Shares
      issued from conversion of convertible promissory notes
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2
                    
                    
                    
                    
                    
                    
                    
                    992
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    992Conversion
      of senior convertible redeemable preferred stock
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,061
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,061Conversion
      of warrants
                    
                    
                    99
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,086
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,086Shares
      issued for interest conversion
                    
                    
                    211
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    629
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    629Shares
      issued as compensation
                    
                    
                    125
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    280
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    280Accretion
      of preferred stock
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    529
                    
                    
                    
                    (529
                    )
                    
                    
                    
                    
                    
                    
                    --Deemed
      dividend
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5,104
                    
                    
                    
                    (5,104
                    )
                    
                    
                    
                    
                    
                    
                    --Foreign
      currency translation adjustment
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (6
                    )
                    
                    
                    (6
                    )Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (2,997
                    )
                    
                    
                    
                    
                    
                    
                    (2,997
                    )Balance
      at December 31, 2006
                    
                    
                    35,182
                    
                    
                    
                    35
                    
                    
                    
                    2
                    
                    
                    
                    --
                    
                    
                    
                    226,407
                    
                    
                    
                    (234,345
                    )
                    
                    
                    (9
                    )
                    
                    
                    (7,912
                    )Shares
      issued for private placement
                    
                    
                    5,892
                    
                    
                    
                    6
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,034
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,040Shares
      issued for litigation settlement
                    
                    
                    25
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    50
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    50Conversion
      of preferred shares to common
                    
                    
                    160
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    --Options
      issued as compensation
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    650
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    650Restricted
      shares issued as compensation
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    36
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    36Warrant
      issued
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    34
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    34Shares
      issued with refinancing of debt
                    
                    
                    2,546
                    
                    
                    
                    3
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    647
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    650Foreign
      currency translation adjustment
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (6
                    )
                    
                    
                    (6
                    )Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (1,975
                    )
                    
                    
                    
                    
                    
                    
                    (1,975
                    )Balance
      at December 31, 2007
                    
                    
                    43,805
                    
                    
                    $
                    44
                    
                    
                    
                    2
                    
                    
                    
                    --
                    
                    
                    $
                    228,858
                    
                    
                    $
                    (236,320
                    )
                    
                    $
                    (15
                    )
                    
                    $
                    (7,433
                    )
  The
accompanying notes are an integral part of the consolidated financial
statements.
  F -
5
  CICERO
INC.
 CONSOLIDATED
STATEMENTS OF COMPREHENSIVE LOSS
 (in
thousands)
 
 Years
      Ended December 31,2007
              
              
              2006
              
              
              2005Net
      loss
              
              $
              (1,975
              )
              
              $
              (2,997
              )
              
              $
              (3,681
              )Other
      comprehensive income (loss), net of tax:Foreign
      currency translation adjustment
              
              
              (6
              )
              
              
              (6
              )
              
              
              5Comprehensive
      loss
              
              $
              (1,981
              )
              
              $
              (3,003
              )
              
              $
              (3,676
              )
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F -
6
  CICERO
INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (in
thousands)
  Years
      Ended December 31,2007
              
              
              2006
              
              
              2005Cash
      flows from operating activities:Net
      loss
              
              $
              (1,975
              )
              
              $
              (2,997
              )
              
              $
              (3,681
              )Adjustments
      to reconcile net loss to net cash (used in) operating
      activities:Depreciation
      and amortization
              
              
              10
              
              
              
              12
              
              
              
              11Stock
      compensation expense
              
              
              720
              
              
              
              614
              
              
              
              149Provision
      (credit) for doubtful accounts
              
              
              50
              
              
              
              60
              
              
              
              (12
              )Gain  on
      disposal of assets
              
              
              --
              
              
              
              24
              
              
              
              --Changes
      in assets and liabilities, net of assets acquired and liabilities
      assumed:Trade
      accounts receivable and related party receivables
              
              
              (622
              )
              
              
              (212
              )
              
              
              146Assets
      and liabilities of operations to be abandoned
              
              
              21
              
              
              
              (27
              )
              
              
              (29
              )Prepaid
      expenses and other assets
              
              
              (136
              )
              
              
              31
              
              
              
              55Accounts
      payable and accrued expenses
              
              
              478
              
              
              
              311
              
              
              
              804Deferred
      revenue
              
              
              70
              
              
              
              (40
              )
              
              
              (7
              )Net
      cash (used in) operating activities
              
              
              (1,384
              )
              
              
              (2,224
              )
              
              
              (2,564
              )Cash
      flows from investing activities:Purchases
      of property and equipment
              
              
              (17
              )
              
              
              (17
              )
              
              
              (6
              )Net
      cash (used in) investing activities
              
              
              (17
              )
              
              
              (17
              )
              
              
              (6
              )Cash
      flows from financing activities:Proceeds
      from issuance of common shares, net of issuance costs
              
              
              1,040
              
              
              
              380
              
              
              
              --Borrowings
      under credit facility, term loans and notes payable
              
              
              984
              
              
              
              2,148
              
              
              
              2,542Repayments
      of term loans, credit facility and notes payable
              
              
              (677
              )
              
              
              --
              
              
              
              (55
              )Net
      cash provided by  financing activities
              
              
              1,347
              
              
              
              2,528
              
              
              
              2,487Effect
      of exchange rate changes on cash
              
              
              (6
              )
              
              
              (6
              )
              
              
              5Net
      increase (decrease) in cash and cash equivalents
              
              
              (60
              )
              
              
              281
              
              
              
              (78
              )Cash
      and cash equivalents at beginning of year
              
              
              310
              
              
              
              29
              
              
              
              107Cash
      and cash equivalents at end of year
              
              $
              250
              
              
              $
              310
              
              
              $
              29SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATIONCash
      paid during the year for:Income
      taxes
              
              $
              5
              
              
              $
              20
              
              
              $
              1Interest
              
              $
              264
              
              
              $
              865
              
              
              $
              645
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F -
7
  CICERO
INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS - CONTINUED
 
 Non-Cash Investing and
Financing Activities
 
 2007
 
 During
2007, the Company issued 24,793 shares of common stock to Critical Mass Mail as
part of a litigation settlement valued at $50,000.
 
 In
October 2007, the Company issued 2,546,149 shares of common stock to BluePhoenix
(formerly Liraz Systems Ltd.) in exchange for $650,000 paid to Bank Hapoalim to
retire a portion of that indebtedness.
 
 2006
 
 During
2006, the Company issued 111,000 shares of common stock to vendors for
outstanding liabilities valued at $237,000.
 
 In
November 2006, the Company issued 60,000 shares of common stock to Liraz Systems
Ltd. as compensation for extension of a bank debt guaranty valued at
$240,000.
 
 In
December 2006, the Company issued 224,000 shares of common stock to Liraz
Systems Ltd. for its short term debt and interest of $191,000.
 
 In
December 2006, the Company issued 50,000 shares of common stock to Brown Simpson
Partners I, Ltd. as compensation for assisting in its
recapitalization.
 
 2005
 
 During
2005, the Company issued 9,613 shares of common stock to vendors for outstanding
liabilities valued at $103,000.
 
 In
November 2005, the Company issued 24,000 shares of common stock to a designated
subsidiary of Liraz Systems Ltd. as compensation for extension of a bank debt
guarantee valued at $48,000.
 
 During
2005, the Company issued 9,564 shares of Level 8 Systems common stock upon
conversion of 1,367 shares of Series D Convertible Redeemable Preferred
Stock.
 
 During
2005, 150 shares of Series C Convertible Redeemable Preferred Stock were
converted into 3,947 shares of Level 8 Systems common stock.
 F -
8
  CICERO
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE
      1.
              SUMMARY
      OF OPERATIONS, SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING
      PRONOUNCEMENTS
 
 Cicero
Inc., formerly Level 8 Systems, Inc. (''Cicero'' or the ''Company''), is a
provider of business integration software which enables organizations to
integrate new and existing information and processes at the
desktop.  Business integration software addresses the emerging need
for a company's information systems to deliver enterprise-wide views of the
company's business information processes.
 
 Going
Concern:
 
 The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business.  The Company has incurred an
operating loss of  approximately $1,975,000 for the year ended
December 31, 2007 and has experienced negative cash flows from operations for
each of the years ended December 31, 2007, 2006 and 2005.  At December
31, 2007, the Company had a working capital deficiency of approximately
$6,132,000. The Company’s future revenues are entirely dependent on acceptance
of a newly developed and marketed product, Cicero®, which has had limited
success in commercial markets to date. These factors among others raise
substantial doubt about the Company’s ability to continue as a going concern for
a reasonable period of time.
 
 The
financial statements presented herein do not include any adjustments relating to
the recoverability of assets and classification of liabilities that might be
necessary should the Company be unable to continue as a going
concern.  In order to address these issues and to obtain adequate
financing for the Company’s operations for the next twelve months, the Company
is actively promoting and expanding its Cicero®-related product line and
continues to negotiate with significant customers who have expressed interest in
the Cicero® software technology. The Company is experiencing difficulty
increasing sales revenue largely because of the inimitable nature of the product
as well as customer concerns about the financial viability of the Company.
Cicero® software is a new “category defining” product in that most Enterprise
Application Integration (EAI) projects are performed at the server level and
Cicero®’s integration occurs at the desktop without the need to open and modify
the underlying code for those applications being integrated. Many companies are
not aware of this new technology or tend to look toward more traditional and
accepted approaches. The Company is attempting to solve the former problem by
improving the market’s knowledge and understanding of Cicero® software through
increased marketing and leveraging its limited number of reference accounts
while enhancing its list of resellers and system integrators to assist in the
sales and marketing process. Additionally, the Company is seeking additional
equity capital or other strategic transactions in the near term to provide
additional liquidity.  Management expects that it will be able to
raise additional capital and to continue to fund operations and also expects
that increased revenues will reduce its operating losses in future periods,
however, there can be no assurance that management’s plan will be executed as
anticipated.
 
 
 Principles
of Consolidation:
 
 The
accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries. All of the Company's subsidiaries are wholly-owned
for the periods presented.
 
 All
significant inter-company accounts and transactions are eliminated in
consolidation.
  F -
9
  Use
of Estimates:
 
 The
preparation of financial statements in conformity with accounting principals
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period.  Actual amounts could differ from these
estimates.
 
 Financial
Instruments:
 
 The
carrying amount of the Company’s financial instruments, representing accounts
receivable, notes receivable, accounts payable and debt approximate their fair
value.
 
 Foreign
Currency Translation:
 
 The
assets and liabilities of foreign subsidiaries are translated to U.S. dollars at
the current exchange rate as of the balance sheet date. The resulting
translation adjustment is recorded in other comprehensive income as a component
of stockholders' equity. Statements of operations items are translated at
average rates of exchange during each reporting period.
 
 Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred.
 
 Cash
and Cash Equivalents:
 
 Cash and
cash equivalents include all cash balances and highly liquid investments with
maturity of three months or less from the date of purchase. For these
instruments, the carrying amount is considered to be a reasonable estimate of
fair value. The Company places substantially all cash and cash equivalents with
various financial institutions. At times, such cash and cash equivalents may be
in excess of FDIC insurance limits.
 
 Trade
Accounts Receivable:
 
 Trade
accounts receivable are stated in the amount management expects to collect from
outstanding balances.  Management provides for probable uncollectible
amounts through a charge to earnings and a credit to a valuation allowance based
on its assessment of the current status of individual
accounts.  Balances that are still outstanding after management has
used reasonable collection efforts are written off through a charge to the
valuation allowance and a credit to trade accounts
receivable.  Changes in the valuation allowance have not been material
to the financial statements.
 
 Property
and Equipment:
 
 Property
and equipment purchased in the normal course of business is stated at cost, and
property and equipment acquired in business combinations is stated at its fair
market value at the acquisition date.  All property and equipment is
depreciated using the straight-line method over estimated useful
lives.
 
 Expenditures
for repairs and maintenance are charged to expense as incurred. The cost and
related accumulated depreciation of property and equipment are removed from the
accounts upon retirement or other disposition and any resulting gain or loss is
reflected in the Consolidated Statements of Operations.
 
 Software
Development Costs:
 
 The
Company capitalizes certain software costs after technological feasibility of
the product has been established. Generally, an original estimated economic life
of three years is assigned to capitalized software costs, once the product is
available for general release to customers. Costs incurred prior to the
establishment of technological feasibility are charged to research and product
development expense.
  F -
10
  Capitalized
software costs are amortized over related sales on a product-by-product basis
using the straight-line method over the remaining estimated economic life of the
product.  (See Note 5.)
 
 The
establishment of technological feasibility and the ongoing assessment of
recoverability of capitalized software development costs require considerable
judgment by management with respect to certain external factors, including, but
not limited to, technological feasibility, anticipated future gross revenue,
estimated economic life and changes in software and hardware
technologies.
 
 Long-Lived
Assets:
 
 The
Company reviews the recoverability of long-lived intangible assets when
circumstances indicate that the carrying amount of assets may not be
recoverable. This evaluation is based on various analyses including undiscounted
cash flow projections. In the event undiscounted cash flow projections indicate
impairment, the Company would record an impairment based on the fair value of
the assets at the date of the impairment. The Company accounts for impairments
under the Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”.
 
 Revenue
Recognition:
 
 The
Company recognizes license revenue from end-users and third party resellers in
accordance with the American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, “Software Revenue Recognition”, as amended
by SOP 98-9, ''Modification of SOP 97-2, 'Software Revenue Recognition,' with
Respect to Certain Transactions''.  The Company reviews each contract
to identify elements included in the software arrangement.  SOP 97-2
and SOP 98-9 require that an entity recognize revenue for multiple element
arrangements by means of the ''residual method'' when (1) there is
vendor-specific objective evidence (''VSOE'') of the fair values of all of the
undelivered elements that are not accounted for by means of long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements, and (3) all revenue recognition criteria of SOP 97-2 (other
than the requirement for VSOE of the fair value of each delivered element) are
satisfied.  VSOE of the fair value of undelivered elements is
established on the price charged for that element when sold
separately.  Software customers are given no rights of return and a
short-term warranty that the products will comply with the written
documentation.  The Company has not experienced any product warranty
returns.
 
 Revenue
from recurring maintenance contracts is recognized ratably over the maintenance
contract period, which is typically twelve months. Maintenance revenue that is
not yet earned is included in deferred revenue.
 
 Revenue
from consulting and training services is recognized as services are performed.
Any unearned receipts from service contracts result in deferred
revenue.
 
 Cost
of Revenue:
 
 The
primary components of the Company's cost of revenue for its software products
are software amortization on internally developed and acquired technology,
royalties on certain products, and packaging and distribution costs. The primary
component of the Company's cost of revenue for maintenance and services is
compensation expense.
 
 Advertising
Expenses:
 
 The
Company expenses advertising costs as incurred.  Advertising expenses
were approximately $104,000, $88,000, and $16,000 for the years ended December
31, 2007, 2006 and 2005, respectively.
 
 Research
and Product Development:
 
 Research
and product development costs are expensed as incurred.
 
 Income
Taxes:
 
 The Company uses SFAS No.
109, ''Accounting for Income Taxes'', to account for income taxes. This
statement requires an asset and liability approach that recognizes deferred tax
assets and liabilities for the expected future tax consequences of events that
have been recognized in the Company's financial statements or tax returns. In
estimating future tax consequences, all
expected future events, other than enactments of changes in the tax law or
rates, are generally considered. A valuation allowance is recorded when it is
''more likely than not'' that recorded deferred tax assets will not be
realized.  (See Note 8.)
  F -
11
 
 Stock
Split:
 
 As
discussed in Note 2, the Company’s stockholders approved a 100 to 1 reverse
stock split in November 2006.  The Company retained the current par
value of $.001 per share for all common shares.  All references in the
financial statements and notes to the number of shares outstanding, per share
amounts, and stock option data of the Company’s common shares have been restated
to reflect the effect of the reverse stock split for the periods
presented.
  Loss
Per Share:
 
 Basic
loss per share is computed based upon the weighted average number of common
shares outstanding. Diluted loss per share is computed based upon the weighted
average number of common shares outstanding and any potentially dilutive
securities. During 2007, 2006, and 2005, potentially dilutive securities
included stock options, warrants to purchase common stock, and preferred
stock.
 
 The
following table sets forth the potential shares that are not included in the
diluted net loss per share calculation because to do so would be anti-dilutive
for the periods presented. The amounts have been restated in accordance with SAB
Topic 4 (c ) to reflect the adjustment to the Company’s capitalization as a
result of the 100:1 reverse stock split which was approved by the Company in
November 2006:
 
 2007
              
              
              2006
              
              
              2005Stock
      options
              
              
              2,529,025
              
              
              
              45,315
              
              
              
              59,009Warrants
              
              
              445,387
              
              
              
              323,623
              
              
              
              193,761Preferred
      stock
              
              
              1,603,618
              
              
              
              1,763,478
              
              
              
              85,0464,578,030
              
              
              
              2,132,416
              
              
              
              337,816
 
 In 2007,
2006 and 2005, no dividends were declared on preferred stock.
  Stock-Based
Compensation:
 
 During
2006, the Company adopted SFAS No. 123 (revised 2004) (SFAS No. 123R”),
“Share-Based Payment”, which addresses the accounting for stock-based payment
transactions in which an enterprise receives employee services in exchange for
(a) equity instruments of the enterprise or (b) liabilities that are based on
the fair value of the enterprise’s equity instruments or that may be settled by
the issuance of such equity instruments.  In January 2005, the SEC
issued SAB No. 107, which provides supplemental implementation guidance for SFAS
No. 123R.  SFAS No. 123R eliminates the ability to account for
stock-based compensation transactions using the intrinsic value method under
Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued
to Employees”, and instead generally requires that such transactions be
accounted for using a fair-value-based method.  The Company uses the
Black-Scholes option-pricing model to determine the fair-value of stock-based
awards under SFAS No. 123R, consistent with that used for pro forma disclosures
under SFAS No. 123, “Accounting for Stock-Based Compensation”.  The
Company has elected to use the modified prospective transition method as
permitted by SFAS No. 123R and, accordingly, prior periods have not been
restated to reflect the impact of SFAS No. 123R.  The modified
prospective transition method requires that stock-based compensation expense be
recorded for all new and unvested stock options that are ultimately expected to
vest as the requisite service is rendered beginning on the first day of the
Company’s year ended December 31, 2006.  Stock-based compensation
expense for awards granted prior to 2006 is based on the grant-date fair-value
as determined under the pro forma provisions of SFAS No. 123.  The
Company granted 2,756,173 options in August 2007 at an exercise price of $0.51
per share.  The Company recognized $650,000 of stock-based
compensation. The Company did not grant options during 2006.
 
 Prior to
the adoption of SFAS No. 123R, the Company measured compensation expense for its
employee stock-based compensation plans using the intrinsic value method
prescribed by APB Opinion No. 25.  The Company applied the disclosure
provisions of SFAS No. 123 as amended by SFAS No. 148, “Accounting for
Stock-Based Compensation – Transition and Disclosure”, as if the
fair-value-based method had been applied in measuring compensation
expense.  Under
  F -
12
  APB
Opinion No. 25, when the exercise price of the Company’s employee stock options
was equal to the market price of the underlying stock on the date of the grant,
no compensation expense was recognized.
 
 The
following table illustrates the effect on net loss and net loss per common share
as if the Company had applied the fair value recognition provisions of SFAS No.
123 to stock-based compensation during 2005 (in thousands):
 
 Years
      EndedDecember 31,2005Net
      loss applicable to common stockholders, as reported
              
              $
              (3,681
              )Less:  Total
      stock-based employee compensation expense underfair
      value based method for all awards, net of related tax effects
              
              
              (180
              )Pro
      forma loss applicable to common stockholders
              
              $
              (3,861
              )Loss
      per share:Basic
      and diluted, as reported
              
              $
              (8.27
              )Basic
      and diluted, pro forma
              
              $
              (8.68
              )
 
 The fair
value of the Company's stock-based awards to employees was estimated as of the
date of the grant using the Black-Scholes option-pricing model, using the
following weighted-average assumptions:
 
 2007
              
              
              2006
              
              
              2005Expected
      life (in years)
              
              10.0
      years
              
              
              3.6
      years
              
              
              6.0
      yearsExpected
      volatility
              
              
              166
              %
              
              
              140
              %
              
              
              149
              %Risk
      free interest rate
              
              
              5.25
              %
              
              
              4.93
              %
              
              
              4.48
              %Expected
      dividend yield
              
              
              0
              %
              
              
              0
              %
              
              
              0
              %
 
 Reclassifications:
 
 Certain
prior year amounts in the accompanying financial statements have been
reclassified to conform to the 2007 presentation. Such reclassifications had no
effect on previously reported net loss or stockholders’ deficit.
  Recent
Accounting Pronouncements:
 
 In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – an amendment of FASB Statement
115”.  The statement permits entities to choose to measure many
financial instruments and certain other items at fair value.  The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
provisions.  Most of the provisions of this statement apply only to
entities that elect the fair value option; however , the amendment to FASB
Statement 115, “Accounting for Certain Investment in Debt and Equity Services,”
applies to all entities with available-for-sale and trading
securities.  The Company does not believe adoption of this statement
will have a material impact on the Company’s financial statements.
 
 In July
2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes –
An Interpretation of SFAS No. 109”.  FIN No. 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with SFAS No. 109, “Accounting for Income
Taxes.”  FIN No. 48 also prescribes a recognition threshold and
measurement attribute for financial statement recognition and measurement of a
tax position taken or expected to be taken in a tax return.  In
addition, FIN No. 48 provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.  The provisions of FIN No. 48 are to be applied to all tax
positions upon initial adoption of this standard.  Only tax positions
that meet the more-likely-than-not recognition threshold at the effective date
may be recognized or continue to be recognized as an adjustment to the opening
balance of accumulated deficit (or other appropriate components of equity) for
that fiscal year.  The provisions of FIN No. 48 are effective for
fiscal years beginning after December 15, 2006.  The adoption of this
new standard did not have a material impact on our financial position, results
of operations, or cash flows.
  F -
13
  In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulleting (“SAB”) 108, to address diversity in practice in
quantifying financial statement misstatements.  SAB 108 requires that
the Company quantifymisstatements
based on their impact on each of its financial statements and related
disclosures.  SAB 108 is effective for fiscal years ending after
November 15, 2006.  The Company has adopted SAB 108 effective as of
December 31, 2006.  The adoption of this bulletin did not have a
material impact on our financial position, results of operations, or cash
flows.
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements”.  SFAS No. 157 provides guidance for using fair value to
measure assets and liabilities.  It also responds to investors’
requests for expanded information about the extent to which companies measure
assets and liabilities at fair value, the information used to measure fair
value, and the effect of fair value measurements on earnings.  SFAS
No. 157 applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value, and does not expand the use of fair
value in any new circumstances.  SFAS No. 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007
and is required to be adopted by the Company in the first quarter of
2008.  The Company is currently evaluating the effect that the
adoption of SFAS No. 157 will have on our financial position, results of
operations, or cash flows.
   NOTE
2.         RECAPITALIZATION
 
 In
November 2006, the Company’s stockholders approved an amendment to the
Certificate of Incorporation to provide the Company’s Board of Directors with
discretionary authority to effect a reverse stock split ratio from 20:1 to 100:1
and on November 20, 2006, the Board of Directors set that reverse stock ratio to
be 100:1. In addition, the Company’s stockholders approved an amendment to
change the name of the Company from Level 8 Systems, Inc. to Cicero Inc., to
increase the authorized common stock of the Company from 85 million shares to
215 million shares and to convert existing preferred shares into a new Series
A-1 preferred stock of Cicero Inc.  The proposals at the Special
Meeting of Stockholders of Level 8 comprised a proposed recapitalization of
Level 8 which was also subject to the receipt of amendments to outstanding
convertible promissory notes, senior reorganization notes and the convertible
bridge notes.
 
 As part
of the plan of recapitalization, Senior Reorganization Notes in the aggregate
principal amount of $2,559,000 to Senior Reorganization Noteholders who had
loaned funds to the Company in exchange for Senior Reorganization Notes and
Additional Warrants at a special one-time exercise price of $0.10 per share, (i)
will receive and have automatically exercised Additional Warrants exercisable
into shares of Common Stock, by applying the accrued interest on their Senior
Reorganization Notes and by cashless exercise to the extent of the balance of
the exercise price, (ii) if a holder of existing warrants who advanced the
exercise price of their warrants to the Company, will have their existing
warrants automatically exercised and (iii) those Senior Reorganization
Noteholders who loaned the Company the first $1,000,000 in respect of the
exercise price of their existing warrants will receive Early Adopter Warrants of
the Company at a ratio of 2:1 for shares issuable upon exercise of each existing
warrant exercised at the special exercise price of $10.00 per share. At the time
of issuance of the Senior Reorganization Notes, the trigger for conversion into
exercisable warrants was an anticipated recapitalization merger. Since the
recapitalization plan was amended, the Company solicited Senior Noteholders for
their consent to convert upon approval of the plan of recapitalization by
stockholders.  Approximately $2,309,000 of the Senior Reorganization
Noteholders have consented to the change in the “trigger” and have cancelled
their notes and converted into 3,438,473 shares of the Company’s common
stock.
 
 In
accordance with EITF 98-5, “Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”,
the Company has allocated the proceeds received from the Note and Warrant
Offering between the warrants exercised and the future warrants granted and has
employed the Black-Scholes valuation method to determine the fair value of the
warrants exercised and the additional warrants issued. The Senior Reorganization
Noteholders who have consented to convert their debt amounted to approximately
$2,309,000. Of that amount, approximately $979,000 represents the exercise price
of existing warrants that was loaned to the Company for which the warrant
holders will receive both additional warrants and early adopter warrants. Using
the Black-Scholes formula, the Company has determined that the fair value of the
warrants granted to this tranche was approximately $440,000. The difference
between the fair value of the additional warrants and the total invested in this
tranche, or $539,000, was treated as a beneficial conversion and fully
amortizable. The second tranche of investment that consisted of those warrant
holders who loaned the exercise price of their existing warrants,
and received additional warrants but no early adopter warrants, amounted to
approximately $107,000. Using Black-Scholes, the Company has determined that the
fair value of the warrants granted to this tranche was
approximately $32,000 and the beneficial conversion amount was $75,000. The
third tranche consisted of investors who had no existing warrants and will only
receive additional warrants upon consummation of the Recapitalization. The total
investment in this tranche was $1,223,000. Using Black-Scholes, the Company has
determined that the fair value of the warrants granted to this tranche was
approximately $570,000 and the beneficial conversion amount was $653,000. Since
this beneficial conversion feature was immediately convertible upon
issuance, the Company has fully amortized this beneficial conversion feature in
the Statement of Operations for the year ended December 31,
2006.
  F -
14
  Also as
part of the recapitalization plan, Convertible Bridge Notes in the principal
amount of $3,915,000 are automatically cancelled and converted into 30,508,448
shares of the Company’s common stock. Also in accordance with EITF 98-5, using
the Black-Scholes formula, the Company has calculated the fair value of the
common stock resulting from conversion of the Convertible Bridge Notes. Based
upon that calculation, the fair value of the stock received was $195,000. The
difference between the total of the Convertible Bridge Notes and the fair value
of the stock ($3,720,000) is treated as a beneficial conversion. Since this
beneficial conversion feature is immediately convertible upon issuance, the
Company has fully amortized this beneficial conversion feature in the Statement
of Operations for the year ended December 31, 2006.
 
 The
Company had issued $992,000 aggregate principal amount of Convertible Promissory
Notes.  As part of the recapitalization plan, these Noteholders were
offered reduced conversion prices to convert their notes into shares of the
Company’s new series A-1 preferred stock. All Noteholders have agreed to convert
their notes into shares of Series A-1 preferred stock. The Company has cancelled
these notes and issued 1,591 shares of its Series A-1 preferred stock. In
accordance with EITF 98-5 and specifically paragraph 8, the Company has utilized
the Black-Scholes formula to determine the fair value of the stock received. The
Company has calculated the fair value of the stock received to be $484,000
resulting in a beneficial conversion of $508,000. Since this beneficial
conversion is immediately recognizable by the holders, the Company has fully
amortized this conversion and recorded an accretion to preferred stock in the
Statement of Operations for the year ended December 31, 2006.
 
 Holders
of the Company’s Series A-3, B-3, C and D preferred stock were offered reduced
conversion rates on their existing preferred stock in exchange for shares in a
new Series A-1 preferred stock for Cicero Inc. as part of the recapitalization
plan. As a result of stockholder approval, the Company affected an exchange of
existing preferred shares into 172.15 Series A-1 preferred shares. In exchange
for the reduced conversion prices, holders of the series A-3, B-3 and D shares
forfeited their anti-dilution protection along with certain other rights, ranks
and privileges. The Company’s Series D preferred stock contained a redemption
feature which required that the Company account for same as a liability. The
Company’s Series A-1 preferred stock contains no redemption features and
accordingly, upon exchange, the fair value of these shares were converted to
equity. The Company employed the Black-Scholes formula to value the shares
exchanged and have determined that the reduced conversion prices and exchange
has created a beneficial conversion of $21,000. As the new Series A-1 preferred
shares are immediately convertible, the Company has recorded this beneficial
conversion as a deemed dividend in the Statement of Operations for the year
ended December 31, 2006.
 
 
 NOTE
3.        ACCOUNTS
RECEIVABLE
 
 Trade
accounts receivable was composed of the following at December 31 (in
thousands):
 
 2007
              
              
              2006Current
      trade accounts receivable
              
              $
              792
              
              
              $
              230Less:
      allowance for doubtful accounts
              
              
              100
              
              
              
              60$
              692
              
              
              $
              170
  The
(credit) provision for uncollectible amounts was $50,000, $60,000, and
($12,000), for the years ended December 31, 2007, 2006, and 2005,
respectively.  Write-offs (net of recoveries) of accounts receivable
were ($0) for the years ended December 31, 2007, 2006 and
2005.
  F -
15
  NOTE
4.         PROPERTY AND
EQUIPMENT
 
 Property
and equipment was composed of the following at December 31 (in
thousands):
 
 2007
              
              
              2006Computer
      equipment
              
              $
              263
              
              
              $
              252Furniture
      and fixtures
              
              
              8
              
              
              
              8Office
      equipment
              
              
              154
              
              
              
              149425
              
              
              
              409Less:
      accumulated depreciation and amortization
              
              
              (403
              )
              
              
              (394
              )$
              22
              
              
              $
              15
 
 Depreciation
and amortization expense of property and equipment was $10,000, $12,000, and
$11,000, for the years ended December 31, 2007, 2006, and 2005,
respectively.
 
 
 NOTE
5.         SHORT-TERM
DEBT
 
 Term
loan, notes payable, and notes payable to related party consist of the following
at December 31(in thousands):
 
 2007
              
              
              2006Term
      loan (a)
              
              $
              --
              
              
              $
              1,971Note
      payable related party (b)
              
              
              49
              
              
              
              9Notes
      payable (c)
              
              
              1,186
              
              
              
              919$
              1,235
              
              
              $
              2,899
  (a)
              The
      Company had a $1,971 term loan bearing interest at LIBOR plus
      1.5%.  Interest was payable quarterly.  There are no
      financial covenants and the term loan was guaranteed by Liraz Systems Ltd.
      (now known as BluePhoenix Solutions), the Company’s former principal
      stockholder.  The loan matured on October 31,
      2007.  In October 2007, the Company, in conjunction with Blue
      Phoenix Solutions, retired the term loan.  (See Note
      14.)
 
 (b)
              In
      November 2007, the Company entered into a short term note payable with
      John L. (Launny) Steffens, the Chairman of the Board of Directors, for
      various working capital needs. The Note bears interest at 6% per year and
      is unsecured. At December 31, 2007, the Company was indebted to Mr.
      Steffens in the amount of $40,000.
 
 From time
to time the Company entered into promissory notes with one of the Company’s
directors and the former Chief Information Officer, Anthony Pizi.  The
notes bear interest at 12% per annum. As of December 31, 2007 and 2006, the
Company was indebted to Anthony Pizi in the amount of $9,000.
 
 (c)
              The
      Company does not have a revolving credit facility and from time to time
      has issued a series of short term promissory notes with private lenders,
      which provide for short term borrowings, both secured by accounts
      receivable and unsecured.  In addition, the Company has settled
      certain litigation and agreed to issue a series of promissory notes to
      support its  obligations in the aggregate principal amount of
      $88,000. The notes bear interest between 10% and 36% per
      annum.
 F -
16
  NOTE
6.         LONG-TERM
DEBT
 
 Long-term
loan and notes payable to related party consist of the following at December
31(in thousands):
 
 2007
              
              
              2006Term
      loan (a)
              
              $
              1,021
              
              
              $
              --Note
      payable; related party (b)
              
              
              300
              
              
              
              --Other
      long-term debt
              
              
              2
              
              
              
              33$
              1,323
              
              
              $
              33
 
 
 (a)
              In
      October 2007, the Company, in conjunction with Blue Phoenix Solutions,
      retired the note payable to Bank Hapoalim and entered into a new note with
      Blue Phoenix Solutions in the principal amount of $1,021,000 with interest
      at Libor plus 1% (approximately 5.86% at December 31, 2007) maturing in
      December 2011. Interest is payable
quarterly.
 
 (b)
              In
      October 2007, the Company entered into a long-term note with John L.
      (Launny) Steffens, the Chairman on the Board of Directors, as part of the
      restructuring of the Note payable to Bank Hapoalim.  The Note
      bears interest of 3% and matures in October 2009.  At December
      31, 2007, the Company was indebted to Mr. Steffens in the amount of
      $300,000.
 
 Scheduled
maturities of the above debt  are as follows:
 
 Year2008
              
              $
              22009
              
              $
              3002011
              
              $
              1,021
 
 
 
 NOTE
7.         INCOME
TAXES
 
 A
reconciliation of expected income tax at the statutory federal rate with the
actual income tax provision is as follows for the years ended December 31 (in
thousands):
 
 2007
              
              
              2006
              
              
              2005Expected
      income tax benefit at statutory rate (34%)
              
              $
              (672
              )
              
              $
              (1,019
              )
              
              $
              (1,251
              )State
      taxes, net of federal tax benefit.
              
              
              (118
              )
              
              
              (180
              )
              
              
              (308
              )Effect
      of change in valuation allowance
              
              
              788
              
              
              
              1,073
              
              
              
              1,537Non-deductible
      expenses
              
              
              2
              
              
              
              126
              
              
              
              22Total
              
              $
              --
              
              
              $
              --
              
              
              $
              --
 F -
17
  Significant
components of the net deferred tax asset (liability) at December 31 were as
follows:
 
 2007
              
              
              2006Current
      assets:Allowance
      for doubtful accounts
              
              $
              44
              
              
              $
              24Accrued
      expenses, non-tax deductible
              
              
              222
              
              
              
              279Deferred
      revenue
              
              
              44
              
              
              
              15Noncurrent
      assets:Stock
      Compensation Expense
              
              
              287
              
              
              
              --Loss
      carryforwards
              
              
              92,337
              
              
              
              91,016Depreciation
      and amortization
              
              
              5,119
              
              
              
              5,93198,053
              
              
              
              97,265Less:
      valuation allowance
              
              
              (98,053
              )
              
              
              (97,265
              )$
              --
              
              
              $
              --
 
 At
December 31, 2007, the Company had net operating loss carryforwards of
approximately $230,847,000, which may be applied against future taxable income.
These carryforwards will expire at various times between 2008 and 2027. A
substantial portion of these carryforwards are restricted to future taxable
income of certain of the Company's subsidiaries or limited by Internal Revenue
Code Section 382. Thus, the utilization of these carryforwards cannot be
assured. Net operating loss carryforwards include tax deductions for the
disqualifying dispositions of incentive stock options. When the Company utilizes
the net operating loss related to these deductions, the tax benefit will be
reflected in additional paid-in capital and not as a reduction of tax expense.
The total amount of these deductions included in the net operating loss
carryforwards is $21,177,000.
 
 The
undistributed earnings of certain foreign subsidiaries are not subject to
additional foreign income taxes nor considered to be subject to U.S. income
taxes unless remitted as dividends. The Company intends to reinvest such
undistributed earnings indefinitely; accordingly, no provision has been made for
U.S. taxes on those earnings. The determination of the amount of the
unrecognized deferred tax liability related to the undistributed earnings is not
practicable.
 
 The
Company provided a full valuation allowance on the total amount of its deferred
tax assets at December 31, 2007 and 2006 since management does not believe
that it is more likely than not that these assets will be realized.
 
 
 NOTE
8.         STOCKHOLDERS’
EQUITY
 
 Common Stock:
 
 During
2007, the Company completed two common stock financing rounds wherein it raised
a total of $1,033,000 of capital from several new investors as well as certain
members of its Board of Directors. In February 2007, the Company sold 3,723,007
shares of its common stock for $0.1343 per share for a total of
$500,000.  In October 2007, the Company completed a private sale of
shares of its common stock to a group of investors, four of which are members of
our Board of Directors. Under the terms of that agreement, the Company sold
2,169,311 shares of its common stock for $0.2457 per share for a total of
$533,000.These
shares were issued in reliance upon the exemption from registration under Rule
506 of Regulation D and on the exemption from registration provided by Section
4(2) of the Securities Act of 1933 for transactions by an issuer not involving a
public offering.
 
 As part
of the recapitalization plan described in Note 2, the Company converted
outstanding convertible promissory notes, senior reorganization notes and
convertible bridge notes. Senior reorganization debt amounting to $2,309,000 was
cancelled and converted into 3,438,473 shares of the Company’s common stock. The
Company also converted $3,915,000 of Convertible Bridge Notes into 30,508,448
shares of Cicero common stock. These shares were issued in reliance upon the exemption
from registration under Rule 506 of Regulation D and on the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving a public offering.
 F -
18
  Stock Grants:
 
 In August
2007, the Company issued Mr. John P. Broderick, our Chief Executive Officer, a
restricted stock award in the amount of 549,360 shares which will vest to him
upon his resignation or termination.  The Company used the
Black-Scholes method to value these shares and assumed a life of 10
years.  The Company recorded compensation expense of approximately
$36,000 for fiscal 2007.
  Stock Options:
 
 In 2007,
the Board of Directors approved the 2007 Cicero Employee Stock Option Plan which
permits the issuance of incentive and nonqualified stock options, stock
appreciation rights, performance shares, and restricted and unrestricted stock
to employees, officers, directors, consultants, and advisors. The aggregate
number of shares of common stock which may be issued under this Plan shall not
exceed 4,500,000 shares upon the exercise of awards and provide that the term of
each award be determined by the Board of Directors.  The Company also
has a stock incentive plan for outside directors and the Company has set aside
1,200 shares of common stock for issuance under this plan. The Company's 1997
Employee Stock Option Plan expired during 2007.
 
 Under the
terms of the Plans, the exercise price of the incentive stock options may not be
less than the fair market value of the stock on the date of the award and the
options are exercisable for a period not to exceed ten years from date of grant.
Stock appreciation rights entitle the recipients to receive the excess of the
fair market value of the Company's stock on the exercise date, as determined by
the Board of Directors, over the fair market value on the date of grant.
Performance shares entitle recipients to acquire Company stock upon the
attainment of specific performance goals set by the Board of Directors.
Restricted stock entitles recipients to acquire Company stock subject to the
right of the Company to repurchase the shares in the event conditions specified
by the Board are not satisfied prior to the end of the restriction period. The
Board may also grant unrestricted stock to participants at a cost not less than
85% of fair market value on the date of sale. Options granted vest at varying
periods up to five years and expire in ten years.
 
 Activity
for stock options issued under these plans for the fiscal years ending December
31, 2007, 2006 and 2005 was as follows:
  Plan Activity
                
                
                Option PricePer Share
                
                
                Weighted Average
                  Exercise PriceBalance
      at December 31, 2004
                
                
                74,887
                
                
                
                12.00
      – 3,931.00
                
                
                
                111.00Granted
                
                
                2,529
                
                
                
                7.00
      – 12.00
                
                
                
                9.00Exercised
                
                
                (2,529
                )
                
                
                7.00
      – 12.00
                
                
                
                9.00Forfeited
                
                
                (15,877
                )
                
                
                22.00
      – 3,931.00
                
                
                
                75.00Balance
      at December 31, 2005
                
                
                59,010
                
                
                
                12.00
      – 3,931.00
                
                
                
                124.00Forfeited
                
                
                (13,695
                )
                
                
                22.00
      – 3,931.00
                
                
                
                137.14Balance
      at December 31, 2006
                
                
                45,315
                
                
                
                12.00
      – 3,931.00
                
                
                
                120.61Granted
                
                
                2,756,173
                
                
                
                0.51
                
                
                
                0.51Forfeited
                
                
                (270,413
                )
                
                
                0.51
      – 612.50
                
                
                
                12.21Expired
                
                
                (2,050
                )
                
                
                1,473.00
                
                
                
                1,473.00Balance
      at December 31, 2007
                
                
                2,529,025
                
                
                
                0.51
      – 3,931.00
                
                
                
                1.35
 
 
 There
were 2,756,173 options granted during 2007 and none during 2006. The weighted
average grant date fair value of options issued during the years ended December
31, 2007 and 2005 was equal to $0.51 and $9.00 per share, respectively. There
were no option grants issued below fair market value during 2007 and
2005.
 F -
19
  At
December 31, 2007, 2006, and 2005, options to purchase 888,634, 45,315, and
5,237 shares of common stock were exercisable, respectively, pursuant to the
plans at prices ranging from $0.51 to $3,931.25. The following table summarizes
information about stock options outstanding at December 31, 2007:
 
 EXERCISE PRICE
              
              
              NUMBER
                OUTSTANDING
              
              
              REMAINING
      CONTRACTUAL
                LIFE
      FOR OPTIONS
                OUTSTANDING
              
              
              NUMBER
                EXERCISABLE
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICE$0.51-0.51
              
              
              
              2,500,760
              
              
              
              9.6
              
              
              
              860,369
              
              
              $
              0.510.52-393.12
              
              
              
              26,680
              
              
              
              5.5
              
              
              
              26,680
              
              
              
              40.60393.13-786.25
              
              
              
              1,350
              
              
              
              3.2
              
              
              
              1,350
              
              
              
              532.20786.26-1,179.37
              
              
              
              165
              
              
              
              2.0
              
              
              
              165
              
              
              
              944.411,179.38-3,538.12
              
              
              
              40
              
              
              
              2.6
              
              
              
              40
              
              
              
              1,881.253,538.13-3,931.25
              
              
              
              30
              
              
              
              2.2
              
              
              
              30
              
              
              
              3,931.252,529,025
              
              
              
              9.6
              
              
              
              888,634
              
              
              $
              2.91
  Preferred Stock:
 
 As part
of the recapitalization plan approved by shareholders in November 2006, the
Company offered to exchange its existing Series A-3, B-3, C and D preferred
shares at reduced conversion rates in exchange for shares of a new Series A-1
preferred stock in Cicero Inc. This proposal also required approval by existing
preferred shareholders as a class. The new conversion prices with respect to the
Series A-3, B-3 and D preferred stock were negotiated with the holders of each
series based upon such factors as the current conversion price in relation to
the market, the dollar amount represented by such series and, waiver of
anti-dilution, liquidation preferences, seniority and other senior
rights.  The conversion price for the Series C preferred stock was
determined in relation to the conversion price for the Series D preferred
stock.  The Board of Directors determined the new conversion price of
each series of Level 8 preferred stock after discussion and review of those
rights, ranks and privileges that were being waived by the present holders of
preferred stock.  Among those rights being waived are anti-dilution
protection, liquidation preferences and seniority.
 
 The
holders of the Series A-1 preferred stock shall have the rights and preferences
set forth in the Certificate of Designations filed with the Secretary of State
of the State of Delaware upon the approval of the
Recapitalization.  The rights and interests of the Series A-1
preferred stock of the Company will be substantially similar to the rights
interests of each of the series of  the former Level 8 preferred stock
other than for (i) anti-dilution protections that have been permanently waived
and (ii) certain voting, redemption and other rights that holders of Series A-1
preferred stock will not be entitled to.  All shares of Series A-1
preferred stock will have a liquidation preference pari passu with all other
Series A-1 preferred stock.
 
 The
Series A-1 preferred stock is convertible at any time at the option of the
holder into an initial conversion ratio of 1,000 shares of Common Stock for each
share of Series A-1 preferred stock.  The initial conversion ratio
shall be adjusted in the event of any stock splits, stock dividends and other
recapitalizations.  The Series A-1 preferred stock is also convertible
on an automatic basis in the event that (i) the Company closes on an additional
$5,000,000 equity financing from strategic or institutional investors, or (ii)
the Company has four consecutive quarters of positive cash flow as reflected on
the Company’s financial statements prepared in accordance with generally
accepted accounting principals (“GAAP”) and filed with the
Commission.  The holders of Series A-1 preferred stock are entitled to
receive equivalent dividends on an as-converted basis whenever the Company
declares a dividend on its Common Stock, other than dividends payable in shares
of Common Stock.  The holders of the Series A-1 preferred stock are
entitled to a liquidation preference of $500 per share of Series A-1 preferred
stock upon the liquidation of the Company.  The Series A-1 preferred
stock is not redeemable.
 
 The
holders of Series A-1 preferred stock also possess the following voting
rights.  Each share of Series A-1 preferred stock shall represent that
number of votes equal to the number of shares of Common Stock issuable upon
conversion of a share of Series A-1 preferred stock.  The holders of
Series A-1 preferred stock and the holders of Common Stock shall vote together
as a class on all matters except: (i) regarding the election of the Board
of Directors of the Company (as set forth below); (ii) as required by law; or
(iii) regarding certain corporate actions to be taken by the Company (as
set forth below).
  F -
20
  The
approval of at least two-thirds of the holders of Series A-1 preferred stock
voting together as a class, shall be required in order for the Company to: (i)
merge or sell all or substantially all of its assets or to recapitalize or
reorganize; (ii) authorize the issuance of any equity security having any right,
preference or priority superior to or on parity with the Series A-1 preferred
stock; (iii) redeem, repurchase or acquire indirectly or directly any of its
equity securities, or to pay any dividends on the Company’s equity securities;
(iv) amend or repeal any provisions of its certificate of incorporation or
bylaws that would adversely affect the rights, preferences or privileges of the
Series A-1 preferred stock; (v) effectuate a significant change in the principal
business of the Company as conducted at the effective time of the
Recapitalization; (vi) make any loan or advance to any entity other than in the
ordinary course of business unless such entity is wholly owned by the Company;
(vii) make any loan or advance to any person, including any employees or
directors of the Company or any subsidiary, except in the ordinary course of
business or pursuant to an approved employee stock or option plan; and (viii)
guarantee, directly or indirectly any indebtedness or obligations, except for
trade accounts of any subsidiary arising in the ordinary course of
business.   In addition, the unanimous vote of the Board of
Directors is required for any liquidation, dissolution, recapitalization or
reorganization of the Company.   The voting rights of the holders
of Series A-1 preferred stock set forth in this paragraph shall be terminated
immediately upon the closing by the Company of at least an additional $5,000,000
equity financing from strategic or institutional investors.
 
 In
addition to the voting rights described above, the holders of a majority of the
shares of Series A-1 preferred stock are entitled to appoint two observers to
the Company’s Board of Directors who shall be entitled to receive all
information received by members of the Board of Directors, and shall attend and
participate without a vote at all meetings of the Company’s Board of Directors
and any committees thereof.  At the option of a majority of the
holders of Series A-1 preferred stock, such holders may elect to temporarily or
permanently exchange their board observer rights for two seats on the Company’s
Board of Directors, each having all voting and other rights attendant to any
member of the Company’s Board of Directors.  As part of the
Recapitalization, the right of the holders of Series A-1 preferred stock to
elect a majority of the voting members of the Company’s Board of Directors shall
be terminated.
 
 As a
result of the reduced conversion prices the Company exchanged all of the Series
A-3, B-3, C and D preferred stock into 172 shares of Series A-1 preferred stock
and using Black-Scholes, we calculated a beneficial conversion in the exchange
of the Series A-3, B-3, C and D shares for Series A-1 preferred stock. The
beneficial conversion of $21,000 is treated as a deemed dividend in the
Statement of Operations for the year ended December 31, 2006.
 
 As part
of the recapitalization plan, Noteholders of $992,000 of Convertible Promissory
Notes were offered reduced conversion prices to convert their notes into shares
of the Company’s new series A-1 preferred stock. All Noteholders have agreed to
convert their notes into shares of Series A-1 preferred stock. The Company has
cancelled these notes and issued 1,591 shares of its Series A-1 preferred stock.
In accordance with EITF 98-5 and specifically paragraph 8, the Company has
utilized the Black-Scholes formula to determine the fair value of the stock
received. The Company has calculated the fair value of the stock received to be
$484,000 resulting in a beneficial conversion of $508,000. Since this beneficial
conversion is immediately recognizable by the holders, the Company has fully
amortized this conversion and recorded an accretion to preferred stock in the
Statement of Operations for the year ended December 31, 2006.
 
 During
2005 and 2004, there were 456 shares of preferred stock converted into 13,511
shares of the Company's common stock and 4,686 shares of preferred stock
converted into 70,375 shares of the Company’s common stock,
respectively.  There were 1,571 shares of the Series A3 Preferred
Stock and 30,000 shares of Series B3 Preferred Stock, 991 shares of Series C
Preferred Stock, and 1,061 shares of  Series D Preferred Stock
outstanding at December 31, 2005.
  F -
21
  Stock
Warrants:
 
 The
Company values warrants based on the Black-Scholes pricing
model.  Warrants granted in 2007, 2006 and 2005 were valued using the
following assumptions:
 
 Expected
      Life in Years
              
              
              Expected
      Volatility
              
              
              Risk
      Free Interest Rate
              
              Expected
      Dividend
              
              Fair
      Value of Common StockPreferred
      Series D-1 Warrants
              
              
              5
              
              
              
              117
              %
              
              
              3
              %
              None
              
              $
              7.00Preferred
      Series D-2 Warrants
              
              
              5
              
              
              
              102
              %
              
              
              3
              %
              None
              
              $
              20.00Early
      Adopter Warrants
              
              
              4
              
              
              
              104
              %
              
              
              4
              %
              None
              
              $
              1.50Long
      Term Promissory Note Warrants
              
              
              10
              
              
              
              168
              %
              
              
              5.25
              %
              None
              
              $
              0.18
 
 Increase
in Capital Stock:
 
 In
November 2006, the stockholders approved a proposal to amend the Amended and
Restated Certificate of Incorporation to increase the aggregate number of shares
of Common Stock that the Company is authorized to issue from 85,000,000 to
215,000,000.
 
 
 NOTE
9.         EMPLOYEE BENEFIT
PLANS
 
 The
Company sponsors one defined contribution plan for its U.S. employees - the
Cicero Inc 401(K) Plan.  Under the terms of the Plan, the Company, at
its discretion, provides a 50% matching contribution up to 6% of an employee’s
salary.  Participants must be eligible company plan participants and
employed at December 31 of each calendar year to be eligible for employer
matching contributions. Matching contributions to the Plan included in the
Consolidated Statements of Operations totaled $0, $0 and $30,000, for the years
ended December 31, 2007, 2006, and 2005, respectively. On December 1, 2005,
the Company suspended further contributions to the defined contribution
plan.
 
 The
Company also had employee benefit plans for each of its foreign subsidiaries, as
mandated by each country's laws and regulations.  The Company’s
foreign subsidiaries are no longer active.
 
 
 NOTE
10.       SIGNIFICANT CUSTOMERS AND
CONCENTRATION OF CREDIT RISK
 
 In 2007,
one customer accounted for 87.2% of operating revenues and represented 100% of
accounts receivable at December 31, 2007.  In 2006, four customers
accounted for 50.0%, 18.7%, 13.3% and 10.0% of operating revenue. In 2005, two
customers accounted for 52.4% and 13.0% of operating revenues.
 
 
 NOTE
11.       FOREIGN CURRENCIES
 
 The
Company’s net foreign currency transaction losses/ (gains) were $15,000,
$14,000, and $(23,000), for the years ended 2007, 2006, and 2005,
respectively.
 
 
 NOTE
12.       SEGMENT INFORMATION AND GEOGRAPHIC
INFORMATION
 
 Based
upon the current business environment in which the Company operates, the
economic characteristics of its operating segments and management’s view of the
business, a revision in terms of aggregation of its segments was appropriate.
Therefore the segment discussion outlined below clarifies the adjusted segment
structure as determined by management under SFAS No. 131. All prior year amounts
have been restated to conform to the new reporting segment
structure.
  F -
22
  Management
makes operating decisions and assesses performance of the Company’s operations
based on one reportable segment, it’s the Software product
segment.  Prior to this change the Company had segregated into two
separate segments: Desktop Integration and Messaging. The Messaging business has
always been an immaterial part of the Company’s overall business and generally
all its sales efforts are focused on the Cicero product. As such, the Company
has elected to combine the two products into one reportable
segment.
 
 The
Software product segment is comprised of the Cicero® product and the Ensuredmail
product.  Cicero® is a business integration software product that
maximizes end-user productivity, streamlines business operations and integrates
disparate systems and applications, while renovating or rejuvenating older
legacy systems by making them usable in the business processes.Ensuredmail is an
encrypted email technology that can reside on either the server or the
desktop.
 
 The table
below presents information about reported segments for the year ended December
31, 2007, 2006 and 2005 (in thousands):
 
 For
      the year ended December 31,2007
                
                
                2006
                
                
                2005Total
      revenue
                
                $
                1,808
                
                
                $
                972
                
                
                $
                785Total
      cost of revenue
                
                
                937
                
                
                
                767
                
                
                
                1,188Gross
      margin (loss)
                
                
                871
                
                
                
                205
                
                
                
                (403
                )Total
      operating expenses
                
                
                2,711
                
                
                
                2,085
                
                
                
                2,655Segment
      loss
                
                $
                (1,840
                )
                
                $
                (1,880
                )
                
                $
                (3,058
                )
  A
reconciliation of segment operating expenses to total operating expense follows
(numbers are in thousands):
 
 2007
              
              
              2006
              
              
              2005Segment
      operating expenses
              
              $
              2,711
              
              
              $
              2,085
              
              
              $
              2,655(Gain)
      on disposal of assets
              
              
              --
              
              
              
              (24
              )
              
              
              --Total
      operating expenses
              
              $
              2,711
              
              
              $
              2,061
              
              
              $
              2,655
 
 A
reconciliation of total segment profitability to net loss for the fiscal years
ended December 31(in thousands):
 
 2007
              
              
              2006
              
              
              2005Total
      segment profitability (loss)
              
              $
              (1,840
              )
              
              $
              (1,880
              )
              
              $
              (3,058
              )Gain
      on disposal of assets
              
              
              --
              
              
              
              24
              
              
              
              --Interest
      and other income/(expense), net
              
              
              (135
              )
              
              
              (1,141
              )
              
              
              (623
              )Net
      loss
              
              $
              (1,975
              )
              
              $
              (2,997
              )
              
              $
              (3,681
              )
 
 The
following table presents a summary of revenue by geographic region for the years
ended December 31(in thousands):
 
 2007
              
              
              2006
              
              
              2005USA
              
              
              1,808
              
              
              
              972
              
              
              
              783Italy
              
              
              -
              
              
              
              -
              
              
              
              2$
              1,808
              
              
              $
              972
              
              
              $
              785
 
 Presentation
of revenue by region is based on the country in which the customer is domiciled.
As of December 31, 2007, 2006 and 2005, all of the long-lived assets of the
Company are located in the United States.
  F -
23
  NOTE
13.       RELATED PARTY
INFORMATION
 
 BluePhoenix
Solutions, formerly Liraz Systems Ltd., the Company’s former principal
stockholder, guaranteed certain debt obligations of the Company. In October
2007, the Company agreed to restructure the note payable to Bank Hapoalim and
guaranty by BluePhoenix Solutions. Under a new agreement with BluePhoenix, the
Company made a principal reduction payment to Bank Hapoalim in the amount of
$300,000. Simultaneously, BluePhoenix paid $1,671,000 to Bank Hapoalim, thereby
discharging that indebtedness. The Company and BluePhoenix entered into a new
Note in the amount of $1,021,000, bearing interest at LIBOR plus 1.0% and
maturing on December 31, 2011. In addition, BluePhoenix acquired 2,546,149
shares of the Company’s common stock in exchange for $650,000 paid to Bank
Hapoalim to retire that indebtedness.  Of the new note payable to
BluePhoenix, approximately $350,000 is due on January 31, 2009 and the balance
is due on December 31, 2011.  In November 2006, the Company and Liraz
agreed to extend the guaranty and with the approval of the lender, agreed to
extend the maturity of the debt obligation until October 31, 2007. The Company
issued 60,000 shares of common stock to Liraz in exchange for this debt
extension.
 
 In
October 2007, the Company entered into a long-term note with John L. (Launny)
Steffens, the Chairman on the Board of Directors, as part of the restructuring
of the Note payable to Bank Hapoalim.  The Note bears interest of 3%
and matures in October 2009.  At December 31, 2007, the Company was
indebted to Mr. Steffens in the amount of $300,000.
 
 In
November 2007, the Company entered into a short term notepayable with John L.
(Launny) Steffens, the Chairman of the Board of Directors, for various working
capital needs. The Note bears interest at 6% per year and is unsecured. At
December 31, 2007, the Company was indebted to Mr. Steffens in the amount of
$40,000.
 
 During
2006, under an existing reseller agreement, the Company recognized $100,000 of
software revenue with Pilar Services, Inc. Pilar Services is presently owned and
managed by Charles Porciello who is a member of our Board of Directors. As of
December 31, 2007, the receivable was still outstanding and the Company has
reserved 100% of the balance as doubtful.
 
 From time
to time during 2005 and 2004, the Company entered into short term notes payable
with Anthony Pizi, the Company’s former Chief Information Officer. The Notes
bear interest at 1% per month and are unsecured. At December 31, 2007, the
Company was indebted to Mr. Pizi in the amount of $9,000.
 
 Convertible Promissory Notes:
Directors and executive officers made the following loans to the Company for
convertible promissory notes:  In June 2004, the Company entered into
a convertible loan agreement with Mr. Pizi in the amount of $100,000. Under the
terms of the agreement, the loan bears interest at 1% per month and is
convertible upon the option of the Note holder into 270,270 shares of our common
stock and warrants to purchase 270,270 shares of our common stock exercisable at
$0.37. The warrants expire in three years from the date of grant. As part of the
recapitalization plan, the Company has offered to lower that conversion rate and
exchange the Note for 14 shares of Series A-1 preferred stock.In November 2006, the
Noteholder consented to the amended conversion rate and the Note has been
cancelled.
 
 In July
2004, the Company entered into a convertible promissory note with Mr. Pizi in
the face amount of $112,000.  Under the terms of the agreement, the
loan bears interest at 1% per month and is convertible upon the option of the
Note holder into 560,000 shares of our common stock and warrants to purchase
560,000 shares of our common stock at $0.20 per share. As part of the
recapitalization plan, the Company has offered to lower that conversion rate and
exchange the Note for 78.4 shares of Series A-1 preferred stock.In November 2006, the
Noteholder consented to the amended conversion rate and the Note has been
cancelled. Also in July 2004, Mr. Pizi entered into a second convertible
promissory note in the face amount of $15,000 which bears interest at 1% per
month and is convertible into 90,118 shares of our common stock and warrants to
purchase 90,118 shares of our common stock at $0.17 per share.  All
such warrants expire three years from the date of grant. As part of the
recapitalization plan, the Company has offered to lower that conversion rate and
exchange the note for 12.62 shares of Series A-1 preferred stock. In November 2006, the
Noteholder consented to the amended conversion rate and the Note has been
cancelled.
 
 In March
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Mark Landis in the amount of $125,000.  Mr. Landis is a director and
the Company’s former Chairman of the Board and Mr. and Mrs. Landis are
parents-in-law to Mr. Pizi, the Company’s former Chief Information Officer.Under
the terms of the agreement, the loan bears interest at 1% per month and is
convertible upon the option of the note holder into 446,429 shares of our common
stock and warrants to purchase 446,429 shares of our common stock exercisable at
$0.28. The warrants expire in three years from the date of grant. As part of the
recapitalization plan, the Company has offered to lower that conversion rate and
exchange the note for 62.5 shares of Series A-1 preferred stock.In
November 2006, the Noteholder consented to the amended conversion rate and the
Note has been cancelled.
  F -
24
  In June
2004, the Company entered into a convertible promissory note with Mr. and Mrs.
Landis in the amount of $125,000. Under the terms of the note, the loan bears
interest at 1% per month and is convertible into 781,250 shares of the Company’s
common stock and warrants to purchase 781,250 shares of Level 8 common stock
exercisable at $0.16 per share. The warrants expire in three years from the date
of grant. As part of the recapitalization plan, the Company has offered to lower
that conversion rate and exchange the note for 113.64 shares of Series A-1
preferred stock. In November 2006, the Noteholder consented to the amended
conversion rate and the Note has been cancelled.
 
 In
October 2004, the Company entered into a convertible promissory note with Mr.
and Mrs. Landis in the amount of $100,000. Under the terms of the agreement, the
loan bears interest at 1% per month and is convertible into 1,000,000 shares of
our common stock and warrants to purchase 2,000,000 shares of the Company’s
common stock exercisable at $0.10 per share. The warrants expire in three
years.  As part of the recapitalization plan, the Company has offered
to lower that conversion rate and exchange the note for 400 shares of Series A-1
preferred stock.In November 2006,
the Noteholder consented to the amended conversion rate and the Note has been
cancelled.
 
 In
November 2004, the Company entered into a convertible promissory note with Mr.
and Mrs. Landis, in the amount of $150,000. Under the terms of the agreement,
the loan bears interest at 1% per month and is convertible into 1,875,000 shares
of our common stock and warrants to purchase 1,875,000 shares of the Company’s
common stock exercisable at $0.08 per share. All such warrants expire three
years from the date of grant. As part of the recapitalization plan, the Company
has offered to lower that conversion rate and exchange the note for 750 shares
of Series A-1 preferred stock.  In November 2006, the Noteholder
consented to the amended conversion rate and the Note has been
cancelled.
 
 In June
2004, the Company entered into a convertible promissory note with Fredric Mack,
a former director of the Company, in the amount of $125,000. Under the terms of
the note, the loan bears interest at 1% per month, and is convertible into
390,625 shares of the Company’s common stock and warrants to purchase 390,625
shares of the Company’s common stock exercisable at $0.32 per
share.  As part of the recapitalization plan, the Company has offered
to lower that conversion rate and exchange the note for 54.69 shares of Series
A-1 preferred stock.   In November 2006, the Noteholder consented
to the amended conversion rate and the Note has been cancelled.
 
 In April
2005, the Company entered into a convertible promissory note with Bruce Miller,
a director of the Company, in the amount of $30,000. Under the terms of the
note, the loan bears interest at 1% per month and is convertible into 428,571
shares of the Company’s common stock. As part of the recapitalization plan, the
Company has offered to lower that conversion rate and exchange the note for 60
shares of Series A-1 preferred stock.In November 2006, the
Noteholder consented to the amended conversion rate and the Note has been
cancelled.
 
 In July
2004, the Company entered into a convertible promissory note with Nicholas
Hatalski, who until July 22, 2005 (during the period when the terms of the
recapitalization merger were being negotiated and at the time of approval of the
recapitalization merger by our board of directors), was a director of the
Company, in the amount of $25,000. Under the terms of the note, the loan bears
interest at 1% per month and is convertible into 78,125 shares of the Company’s
common stock and warrants to purchase 78,125 shares of the Company’s common
stock exercisable at $0.32 per share. As part of the recapitalization plan, the
Company has offered to lower that conversion rate and exchange the note for
10.94 shares of Series A-1 preferred stock.In November 2006, the
Noteholder consented to the amended conversion rate and the Note has been
cancelled.
 
 All of
such warrants expire three years from date of grant.
 
 Senior ReorganizationNotes.  From March 2004 to April 2005, directors and executive
officers made the following loans to us for Senior Reorganization
Notes:  Mr. Pizi held $423,333 of Senior Reorganization Notes, which
were converted into warrants to purchase an additional 5,716 shares of Cicero
common stock at a purchase price of $0.20 per share.
 
 Mr.
Landis held $327,860 of Senior Reorganization Notes, which were converted into
warrants to purchase an additional 4,423 shares of Cicero common stock at an
exercise price of $0.20 per share.
 
 Mr. Mack
held, together with his affiliates, $88,122 of Senior Reorganization Notes,
which were converted into warrants to purchase an additional 1,122 shares of
Cicero common stock at a purchase price of $0.20 per share.
  F -
25
  Mr.
Miller held, together with his affiliates, $77,706 of Senior Reorganization
Notes, which were converted into warrants to purchase an additional 1,145 shares
of Cicero common stock at a purchase price of $0.20.
 
 Mr.
Atherton held, together with his affiliates, $20,000 of Senior Reorganization
Notes which were converted into warrants to purchase an additional 2,898 shares
of Cicero common stock at a purchase price of $0.20.
 
 Mr.
Broderick, Chief Executive Officer and Chief Financial Officer of the Company,
held $2,300 of Senior Reorganization Notes, which were converted into warrants
to purchase 3,222 shares of the Cicero Inc. common stock at a purchase price of
$0.20 per share, and options to purchase 12,609 shares of common stock under the
Company’s stock option plan that will convert into options to purchase Cicero
common stock.
 
 Such
warrants are only issuable upon approval of the recapitalization merger, and
were automatically exercised in connection with the consummation of the
recapitalization plan.
 
 Convertible Bridge
Notes.  From July 2005 to December 2006, directors and
executive officers made the following loans to the Company for Convertible
Bridge Notes:
 
 Mr. Pizi
held $85,000 of Convertible Bridge Notes which bore interest at 10% and matured
on September 15, 2005.  These notes automatically converted into
680,000 shares of Cicero common stock upon approval of the recapitalization plan
by stockholders.
 
 Mr.
Landis held $395,000 of Convertible Bridge Notes which bore interest at 10% and
matured on various dates in 2005 and 2006.  These notes automatically
converted into 3,160,000 shares of Cicero common stock upon approval of the
recapitalization plan by stockholders.
 
 Mr. Mack
held, together with his affiliates, $114,000 of Convertible Bridge Notes which
bear interest at 10% and matured on various dates in 2005 and
2006.  These notes automatically converted into 897,564 shares of
Cicero common stock upon approval of the recapitalization plan by
stockholders.
 
 Mr.
Miller held, together with his affiliates, $120,000 of Convertible Bridge Notes
which bear interest at 10% and matured on various dates in 2005 and
2006.  These notes automatically converted into 947,273 shares of
Cicero common stock upon approval of the recapitalization plan by
stockholders.
 
 Mr. Bruce
Hasenyager, a member of our Board of Directors, held $4,061 of Convertible
Bridge Notes which bear interest at 10% and matured on September 15, 2005. These
notes automatically converted into 32,485 shares of Cicero common stock upon
approval of the recapitalization plan by stockholders.
 
 Mr. Bruce
Percelay, a member of our Board of Directors, held $130,000 of Convertible
Bridge Notes which bear interest at 10% and matured on various dates in 2005 and
2006. These notes automatically converted into 1,027,273 shares of Cicero common
stock upon approval of the recapitalization plan by stockholders.
 
 Mr. John
W. Atherton, a member of our Board of Directors, held $15,000 of convertible
Bridge Notes which bear interest at 10% and matured during 2006. These notes
automatically converted into 120,000 shares of Cicero common stock upon approval
of the recapitalization plan by stockholders.
 
 Mr.
Charles Porciello, a member of our Board of Directors, held $10,000 of
Convertible Bridge Notes which bear interest at 10% and matured during 2006.
These notes automatically converted into 80,000 shares of Cicero common stock
upon approval of the recapitalization plan by stockholders.
  F -
26
  NOTE
14.       LEASE COMMITMENTS
 
 The
Company leases certain facilities and equipment under various operating
leases.  Future minimum lease commitments on operating leases that
have initial or remaining non-cancelable lease terms in excess of one year as of
December 31, 2007 consisted of only one lease as follows (in
thousands):
  Lease
                Commitments2008
              
              $
              1032009
              
              
              972010
              
              
              101$
              301
 
 Rent
expense for the years ended December 31, 2007, 2006, and 2005 was $74,000,
$60,000, and $122,000, respectively.  As of December 31, 2007,
2006, and 2005, the Company had no sublease arrangements.
 
 
 NOTE
15.       CONTINGENCIES
 
 Various
lawsuits and claims have been brought against us in the normal course of our
business.
 
 In
October 2003, we were served with a summons and complaint in Superior Court of
North Carolina regarding unpaid invoices for services rendered by one of our
subcontractors.  The amount in dispute was approximately $200,000 and
is included in accounts payable. Subsequent to March 31, 2004, we settled this
litigation.  Under the terms of the settlement agreement, we agreed to
pay a total of $189,000 plus interest over a 19-month period ending November 15,
2005. The Company is in the process of negotiating a series of payments for the
remaining liability of approximately $80,000.
 
 Under the
indemnification clause of the Company’s standard reseller agreements and
software license agreements, the Company agrees to defend the reseller/licensee
against third party claims asserting infringement by the Company’s products of
certain intellectual property rights, which may include patents, copyrights,
trademarks or trade secrets, and to pay any judgments entered on such claims
against the reseller/licensee.
 
 
 NOTE
16.       SELECTED QUARTERLY FINANCIAL DATA
(UNAUDITED)
 
 First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    Quarter(In
      thousands, except per share data)2007:Net
      revenues
                  
                  $
                  232
                  
                  
                  $
                  316
                  
                  
                  $
                  387
                  
                  
                  $
                  873Gross
      margin
                  
                  
                  65
                  
                  
                  
                  160
                  
                  
                  
                  82
                  
                  
                  
                  564Net
      income/(loss)
                  
                  
                  (529
                  )
                  
                  
                  (452
                  )
                  
                  
                  (966
                  )
                  
                  
                  (29
                  )Net
      loss/share –basic and diluted attributedto
      common stockholders
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.02
                  )
                  
                  
                  --
 2006:Net
      revenues
                  
                  $
                  281
                  
                  
                  $
                  320
                  
                  
                  $
                  248
                  
                  
                  $
                  123Gross
      margin/(loss)
                  
                  
                  75
                  
                  
                  
                  114
                  
                  
                  
                  60
                  
                  
                  
                  (44
                  )Net
      loss
                  
                  
                  (576
                  )
                  
                  
                  (515
                  )
                  
                  
                  (647
                  )
                  
                  
                  (1,259
                  )Net
      loss/share –basic and diluted attributed to common
      stockholders
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.22
                  )
  F -
27
  NOTE
17.       SUBSEQUENT EVENTS
 
 In March
2008, the Company was notified that a group of investors including two members
of the Board of Directors acquired a short term promissory note due SDS Merchant
Fund in the principal amount of $250,000. The note is unsecured and bears
interest at 10% per annum. Also in March, our Board of Directors approved a
resolution to convert this debt plus accrued interest into common stock of the
Company. The total principal and interest amounted to $361,827 and is being
converted into 1,417,264 shares of common stock. Mr. John Steffens, the
Company’s Chairman, will acquire 472,516 shares and Mr. Bruce Miller, also a
member of our Board of Directors, will acquire 472,374 shares.
 
 In March
2008, the Company amended the terms of its Note Payable with BluePhoenix
Solutions. Under the terms of the original Note, the Company was to make a
principal reduction payment in the amount of $350,000 on January 30, 2009. The
Company and BluePhoenix agreed to accelerate that principal payment to March and
April 2008 in return for a conversion of $50,000 into 195,848 shares of the
Company’s common stock. In March, the Company paid $200,000 plus accrued
interest and in April, the Company will pay $100,000 plus accrued
interest.
   F -
28