UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the period ended September 30, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______.
Commission File Number 333-16031
FRONT PORCH DIGITAL INC.
----------------------------------------------------------
(Name of small business issuer as specified in its charter)
Nevada 86-0793960
--------------------------------- -------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
20000 Horizon Way,
Suite 120
Mt. Laurel, New Jersey 08054
----------------------------------------
(Address of principal executive offices)
(856) 439-9950
---------------------------
(Issuer's telephone number)
Check whether the issuer (1) 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 [ ]
As of October 31, 2002, 33,768,573 shares of the issuer's common stock, par
value $.001, were outstanding.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS -
FRONT PORCH DIGITAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2002
[UNAUDITED]
ASSETS
Current assets:
Cash and cash equivalents $ 622,876
Accounts receivable - trade & other 1,167,733
Other current assets 519,929
------------
Total current assets 2,310,538
Property and equipment, net 1,160,158
Software development costs, net 215,443
Software and intellectual property, net
of accumulated amortization of $460,500 1,870,170
Excess cost over fair value of net assets acquired, net
of accumulated amortization of $946,093 3,792,149
Other assets 109,699
------------
Total assets $ 9,458,157
============
Liabilities and stockholders' equity:
Current liabilities:
Current portion of note payable 160,000
Current portion of lease obligation 67,105
Notes payable (net of discount) 425,000
Accounts payable 1,614,867
Accrued expenses 1,607,020
Accrued expenses - employees 302,142
Accrued vacation 134,070
Deferred revenue 451,470
------------
Total current liabilities 4,761,674
============
Note payable, net of current portion 583,963
Other long-term liabilities 50,205
Stockholders' equity:
Preferred stock, nonvoting, $.001 par value, 5,000,000
shares authorized, none issued or outstanding
Common stock, $.001 par value 50,000,000 shares authorized
32,278,206 shares issued and outstanding 32,331
Additional paid in capital 23,538,683
Accumulated deficit (19,508,699)
------------
Total stockholders' equity 4,062,315
============
Total liabilities and stockholders' equity $ 9,458,157
============
SEE ACCOMPANYING NOTES
FRONT PORCH DIGITAL, INC.
Condensed Consolidated Statements of Operations
[Unaudited]
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
---------------------------------------------------------------------
Revenues:
Products $ 659,748 $ 2,700 $ 866,204 $ 51,660
Services 556,367 169,244 1,380,259 227,144
Services - affiliate -- -- -- 169,716
------------ ------------ ------------ ------------
Total revenue 1,216,115 171,944 2,246,463 448,520
Cost of revenue:
Products 220,019 2,100 300,228 25,098
Services 219,092 136,537 468,268 559,984
------------ ------------ ------------ ------------
439,111 138,637 768,496 585,082
------------ ------------ ------------ ------------
Gross margin (loss) 777,004 33,307 1,477,967 (136,562)
Selling, general and administrative 1,271,782 1,315,976 2,933,267 4,435,917
Research and development 212,176 92,082 430,953 502,146
Depreciation 278,569 146,266 584,761 429,351
Amortization 60,073 256,756 177,931 770,268
------------ ------------ ------------ ------------
1,822,600 1,811,080 4,126,912 6,137,682
------------ ------------ ------------ ------------
Loss from operations (1,045,596) (1,777,773) (2,648,945) (6,274,244)
Other income (expense):
Interest and other income 1,297 6,072 2,697 35,076
Interest expense (144,049) (4,500) (161,987) (13,500)
------------ ------------ ------------ ------------
(142,752) 1,572 (159,290) 21,576
------------ ------------ ------------ ------------
Net loss $ (1,188,348) $ (1,776,201) $ (2,808,235) $ (6,252,668)
============ ============ ============ ============
Weighted average number of common
shares outstanding - basic and diluted 29,886,714 25,313,200 27,565,231 24,820,070
Loss per common share - basic and diluted $ (0.04) $ (0.07) $ (0.10) $ (0.25)
============ ============ ============ ============
SEE ACCOMPANYING NOTES
FRONT PORCH DIGITAL, INC.
Statements of Cash Flows
(unaudited)
Nine Months Ended September 30,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(2,808,235) $(6,252,668)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 762,692 1,199,619
Amortization of debt discount 125,000 --
Non-cash issuance of common stock to employees and consultants 392,387 --
Stock option compensation cost 131,486 1,193,236
Cost in excess of fair market value of subsidiary -- --
Changes in operating assets and liabilities:
Decrease in accounts receivable - affiliate -- 222,410
Decrease (increase) in accounts receivable 68,912 (268,806)
Decrease (increase) in other current assets 471,868 (205,467)
(Decrease) increase in accounts payable (24,665) 307,506
Increase (decrease) in accrued expenses 303,226 (84,687)
(Decrease) increase in accrued expenses - employees (167,861) 300,000
(Decrease) increase in accrued vacation (12,132) 72,248
(Decrease) increase in deferred revenue (327,730) 576,229
Other changes in operating activities 86,257 (38,812)
----------- -----------
Net cash used in operating activities (998,795) (2,979,192)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (206,569) (303,259)
Cash acquired from ManagedStorage 859,706 --
Software development costs (59,917) (298,968)
Other investing activities (14,988) (28,881)
----------- -----------
Net cash used in investing activities 578,232 (631,108)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from note payable 600,000 --
Proceeds from issuance of common stock 50,000 1,521,788
----------- -----------
Net cash provided by financing activities 650,000 1,521,788
----------- -----------
Net increase (decrease) in cash and cash equivalents 229,437 (2,088,512)
Cash and cash equivalents, beginning of period 393,439 2,444,527
----------- -----------
Cash and cash equivalents, end of period 622,876 356,015
=========== ===========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Cash paid for interest $ 53,342 $ --
=========== ===========
Intellectual property acquired from ManagedStorage $ 721,126 $ --
=========== ===========
Other non-cash net assets aquired from ManagedStorage $ 537,122 $ --
=========== ===========
SEE ACCOMPANYING NOTES
Front Porch Digital, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Front Porch Digital Inc. and its subsidiaries (the "Company") are in the
emerging market of digital information asset management. The Company utilizes a
suite of proprietary products and services that enable the conversion of analog
and digital content, including text, images, audio, graphics, video and rich
media, into other digital formats or platforms. The Company's software-based
methodologies and intellectual property are incorporated throughout its service
offerings to allow content to be captured, converted, managed and distributed in
digital form efficiently and cost effectively.
The financial statements of the Company have been prepared on a going-concern
basis, which contemplates the realization of assets and liabilities in the
normal course of business. Accordingly, the financial statements do not include
any adjustments that might be necessary should the Company be unable to continue
in existence. For the nine months ended September 30, 2002, the Company incurred
net losses and negative cash flows from operating activities of $2.8 million and
$1.0 million, respectively. The Company has incurred losses since commencement
of operations in its current line of business and expects losses to continue
during the fourth quarter of 2002. Further, at September 30, 2002, the Company
has a working capital deficit of $2.5 million. These factors create significant
uncertainty about the Company's ability to continue as a going concern.
During 2001, the Company began marketing its suite of data and video solutions
to the marketplace and since September 2001, has been awarded new contracts
worth approximately $5 million. The Company has completed approximately $2.0
million of these contracts through September 30, 2002 and expects to complete
the remainder during 2002 and the first half of 2003. Management of the Company
recognizes that additional resources will be required to continue as a going
concern and has been seeking additional sources of capital. The Company has
implemented cash saving measures, including the deferral of payment of certain
expenses. Management believes that these actions will enable the Company to
obtain sufficient cash to continue as a going concern. However, there can be no
assurance that sufficient additional capital will be available on terms that are
acceptable to the Company.
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and pursuant to the rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements. Management of the Company believes the
disclosures are adequate to make the information presented not misleading. In
the opinion of management, all adjustments considered necessary for a fair
presentation have been included and such adjustments are of a normal and
recurring nature. For further information, refer to the financial statements and
footnotes included in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2001.
Operating results for the three and nine months ended September 30, 2002 are not
necessarily indicative of the operating results expected for the year ending
December 31, 2002.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Front Porch
Digital, Inc. and its wholly-owned subsidiary. All significant intercompany
transactions and balances have been eliminated in consolidation.
5
Front Porch Digital, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts and balances to
conform with the 2002 presentation.
2. INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
no longer permits the amortization of goodwill and indefinite-lived intangible
assets. Instead, these assets must be reviewed annually for impairment in
accordance with this statement. Accordingly, the Company has ceased amortization
of all goodwill as of January 1, 2002. During the nine months ended September
30,2002, the Company completed the initial impairment test as required under
SFAS No. 142 and determined that the fair value of its reporting units exceeded
their carrying values as of January 1,2002. The Company will perform an ongoing
annual impairment test, as required under SFAS No. 142, during the third quarter
of each year.
The Company's net loss and loss per share for the nine months ended September
30, 2001 adjusted to exclude goodwill amortization was $5.7 million and $.23,
respectively. Net loss and loss per share for the three months ended September
30, 2001 adjusted to exclude goodwill amortization was $1.6 million and $.06,
respectively.
3. ACQUISITION OF MANAGED STORAGE INTERNATIONAL FRANCE, INC
On July 31, 2002, the Company acquired all the outstanding shares of capital
stock of ManagedStorage International France, a French SOCIETE PAR ACTIONS
SIMPLIFEE("MSI France"), and certain assets of ManagedStorage International,
Inc., a Delaware corporation ("ManagedStorage"), pursuant to a Stock and Asset
Purchase Agreement dated as of July 31, 2002 (the "Purchase Agreement"), between
the Company and ManagedStorage. The consideration paid by the Company pursuant
to the Purchase Agreement consisted of (a) 5,000,000 shares of common stock, par
value $.001 per share, of the Company (the "Company Common Stock"); (ii) a
warrant for the purchase of up to 1,750,000 shares of Company Common Stock at a
price of $2.00 per share, exercisable immediately and expiring on July 31, 2012;
and (iii) a warrant for the purchase of up to 1,750,000 shares of Company Common
Stock at a price of $4.00 per share, exercisable immediately and expiring on
July 31, 2012. In addition, the Company agreed to issue and deliver up to
2,500,000 additional shares of Company Common Stock pursuant to the terms of an
earn-out as more fully described in Section 1.3(b) of the Purchase Agreement.
Pursuant to the terms of the Purchase Agreement, the Company acquired from
ManagedStorage (i) all of the issued and outstanding shares of capital stock of
MSI France and (ii) certain software and related intellectual property rights,
including DIVArchive, a software solution designed to assist media,
entertainment and medical companies in the preservation, management and
accessing of digital content consisting of large digital data files.
Pursuant to the Purchase Agreement, ManagedStorage entered into a Lock-Up
Agreement with the Company whereby, subject to certain exceptions,
ManagedStorage agreed not sell, assign, transfer, pledge or otherwise dispose of
any Company Common Stock owned or acquired by it or any interest therein prior
to July 31, 2003, except as expressly
6
Front Porch Digital, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
permitted by the Lock-Up Agreement. In connection with the transaction,
ManagedStorage was granted certain demand registration rights with respect to
the shares of Company Common Stock acquired by ManagedStorage pursuant to the
terms of the Purchase Agreement.
The acquisition has been accounted for as a purchase consistent with SFAS No.
141, "Business Combinations". Results of operations from the date of acquisition
for the acquired entity are included in the consolidated statement of operations
for the three months ended September 30, 2002. The total purchase price of the
acquisition at closing and recorded as of September 30, 2002 excluding any
earn-out was $2.1 million, which has been allocated as follows:
Purchase price allocation at September 30, 2002:
Net assets acquired $ 1,400,000
Intellectual property 700,000
-----------
Total purchase price $ 2,100,000
===========
This purchase price allocation does not include any contingent consideration as
a result of the earn-out provisions of the Purchase Agreement. As of November
14, 2002, management has determined that the realization of the full amount of
the contingent consideration under the earn-out provisions of the acquisition is
probable. The full amount of contingent consideration is $750,000, and this
amount will be recorded as goodwill during the fourth quarter of fiscal 2002 if
realized.
The following pro forma results of operations for the three months and nine
months ended September 30, 2002 and 2001 are presented to reflect the
acquisition as if it had occurred as of the beginning of the periods presented.
PRO FORMA RESULTS OF OPERATIONS:
[Pro forma]
[Unaudited]
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
------------------------------------------------------------
Revenues $ 1,433,011 763,544 $ 4,543,059 2,765,320
Loss from continuing operations 1,227,947 4,103,939 4,114,428 13,099,642
Net loss 1,382,172 4,122,967 4,365,991 13,384,766
Net loss per share $.04 $.14 $.14 $.45
4. NOTES PAYABLE
At September 30, 2002, notes payable consisted of:
Approximately $744,000 of an unsecured non-interest bearing note payable to an
employee. This note is payable based on a percentage of revenue of certain
operations of the Company, ranging between 2% and 3% per year, to be payable in
full no later than December 31, 2004. In the event the Company exits the media
conversion business prior to December 31, 2004, the remaining balance of this
note is payable on demand;
7
Front Porch Digital, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
$200,000 of unsecured notes payable that bear interest at 9% per annum and are
payable on demand;
$100,000 of an unsecured note payable that bears interest at 7% per annum and is
payable on demand; and
$500,000 aggregate principal amount of convertible secured notes to two
investors. The notes mature on March 27, 2003, bear interest at the rate of 7%
per annum, which is payable on a quarterly basis, and are secured by all assets
of the Company. The notes are convertible at any time at the option of the note
holders into a number of shares of common stock of the Company equal to 14% of
the outstanding shares of common stock, subject to certain anti-dilution
adjustments. The note holders were granted certain rights for the registration
of these shares under the Securities Act of 1933, as amended, which requires the
Company to register these shares on the earlier of April 2003, or upon the
filing of certain registration statements by the Company. The notes contain
restrictions that, among others, prohibit the Company from issuing new debt,
paying creditors in excess of specified amounts, or prepaying the notes without
the consent of the note holders. In the event the Company raises $2.5 million of
equity capital, the Company may deposit into an escrow account an amount equal
to the outstanding principal and interest on the notes, at which time all
restrictions and liens on the assets of the Company will be released. Upon the
sale or liquidation of substantially all of the assets of the Company, or a
business combination in which a majority of the issued and outstanding shares of
common stock of the Company is transferred, the note holders are entitled to
receive all outstanding principal and interest on the notes and a liquidation
preference equal to three times the amount of such outstanding principal and
interest.
In November 2000, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a consensus on Issue 00-27,
Application of EITF Issue 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios to
Certain Convertible Instruments," whereby it was concluded that an issuer should
calculate the intrinsic value of a conversion option using the effective
conversion price, based on the proceeds received allocated to the convertible
instrument instead of the specified conversion prices in the instrument.
Accordingly, the Company recorded a debt discount on the convertible secured
notes of $500,000 that will be amortized to interest expense over the term of
the debt. The Company recorded non-cash interest expense related to debt
discount of $125,000 during the three and nine months ended September 30, 2002.
5. SIGNIFICANT CUSTOMERS
For the nine months ended September 30, 2002, revenue from one customer exceeded
10% of total revenue, aggregated 41% of total revenue. At September 30, 2002,
this customer accounted for 6% of accounts receivable.
For the nine months ended September 30, 2001, revenue from three customers, each
exceeding 10% of total revenue, aggregated 72% of total revenue. The Company was
a subcontractor for its largest customer during the nine months ended September
30, 2001, which owned approximately 25% of the outstanding common stock of the
Company as of September 30, 2001.
6. PER SHARE DATA
The Company reports its loss per share in accordance with the SFAS No. 128,
"Accounting for Earnings Per Share". Basic loss per share is calculated using
the net loss divided by the weighted average common shares outstanding. Shares
from the assumed conversion of outstanding warrants and options are omitted from
the computations of diluted loss per share because the effect would be
antidilutive.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
GENERAL
When used in this discussion, the words "believes", "anticipates",
"expects" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those projected.
The Company's business and results of operations are affected by a wide
variety of factors that could materially and adversely affect the Company and
its actual results, including, but not limited to: (1) the availability of
additional funds to enable the Company to successfully pursue its business plan;
(2) the uncertainties related to the effectiveness of the Company's technologies
and the development of its products and services; (3) the Company's ability to
maintain, attract and integrate management personnel; (4) the ability of the
Company to complete the development of its proposed products in a timely manner;
(5) the Company's ability to effectively market and sell its products and
services to current and new customers; (6) the Company's ability to negotiate
and maintain suitable strategic partnerships and corporate relationships; (7)
the intensity of competition; and (8) general economic conditions. As a result
of these and other factors, the Company may experience material fluctuations in
future operating results on a quarterly or annual basis, which could materially
and adversely affect its business, financial condition, operating results and
stock price.
Any forward-looking statements herein speak only as of the date hereof.
The Company undertakes no obligation to publicly release the results of any
revisions to these forward-looking statements that may be made to reflect events
or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
OVERVIEW
Front Porch Digital Inc. is a leader in the conversion, preservation
and management of analog and digital content, including text, images, audio,
graphics, video and rich media. The Company has developed proprietary software
products and performs services that convert content into digital formats for
subsequent storage and on-demand delivery in the same or other formats or
digital platforms. This software, which is based on proprietary and
patent-pending technology, enables a new paradigm in the way broadcasters,
content owners, and medical, education and law enforcement personnel manage
their workflow - a shift from tape-oriented warehousing to a fully-digital,
instant access automated archive. With additional expertise in providing onsite,
offline data management services for tape and optical assets, the Company
believes it is uniquely positioned to enable clients to preserve, protect and
manage information assets.
The Company intends to use these proprietary technologies to accelerate
revenue growth and generate positive cash flows. Management has recently focused
on (i) completing the development of its products and service offerings that are
designed to facilitate the distribution of digital video content, (ii)
developing sales and marketing programs to build awareness of the Company's
product and service offerings and (iii) building an infrastructure that is
capable of effectively meeting anticipated demand for the Company's products and
services.
The Company is in the early stages of executing its business strategy
and anticipates beginning numerous new engagements during the next 12 months.
This expansion is contingent upon several factors, including the availability of
adequate cash resources, the price of its products and services relative to its
competitors, and general economic and business conditions, among other factors.
RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations are based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
9
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. These estimates are based on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001.
For the three months ended September 30, 2002, the Company reported a net loss
of $1.2 million, or ($.04) per share, compared to a net loss of $1.8 million, or
($.07) per share, for the three months ended September 30, 2001.
REVENUE. Total revenue for the three months ended September 30, 2002 of
$1.2 million has increased from total revenue of $172,000 for the three months
ended September 30, 2001. For the three months ended September 30, 2002,
$660,000, or 54% of total revenue, was attributable to sales of software and
related products. The remaining $556,000, or 46%, was attributable to data and
video conversion services. The significant increase in revenue was largely due
to new customer contracts generated during 2002 in the delivery of data
conversion services and the acquisition of MSI France, which generated $542,000
of the $660,000 in software and related services revenue. Substantially all of
the Company's revenue has been derived from customers in the United States and
through the acquisition of MSI France, Europe.
GROSS MARGIN. Total gross margin was $777,000, or 64% of total revenue,
for the three months ended September 30, 2002 compared to $33,000, or 19% of
total revenue, for the three months ended September 30, 2001. The increase in
total gross margin was principally due to increased throughput within the
Company's service delivery function. In September 2001, the Company reduced its
headcount within the service delivery group by 45% and took other actions to
reduce costs. For the three months ended September 30, 2002, sales of software
and related products resulted in gross margins of 67% and the provision of data
and video conversion services resulted in gross margins of 61%. For the three
months ended September 30, 2001, sales of software and related products resulted
in gross margins of 22% and the provision of data and video conversion services
resulted in negative gross margins of 19%. The Company plans to significantly
increase its revenue, and therefore expects expenses in this category to also
increase substantially.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended September 30, 2002 were $1.27
million, as compared to $1.3 million for the three months ended September 30,
2001. The slight reduction in expenses reflects additional costs associated with
supporting the increased revenue levels and an increase in costs for the MSI
France acquisition, offset by a decrease in expenses that were primarily related
to an overall reduction in employee headcount, including the elimination of
certain positions; the closing of the office in Boulder, Colorado; and the
relocation of the New Jersey office to a smaller facility. Selling, general and
administrative expenses for the three months ended September 30, 2002 consisted
primarily of $755,000 for salaries and related benefits for employees not
directly related to the production of revenue, $160,000 in professional and
consulting fees, $74,000 for travel, $118,000 of facilities costs, and $164,000
for general office expenses. Selling, general and administrative expenses for
the three months ended September 30, 2001 consisted primarily of $900,000 for
salaries and related benefits for employees not directly related to the
production of revenue, $150,000 in professional fees, $59,000 for travel,
$81,000 of facilities costs, and $110,000 for general office expenses. When the
Company secures additional funding, it plans to increase its sales and marketing
efforts and, to a lesser extent, continue to build its infrastructure and,
therefore, expects expenses in this category to increase significantly.
10
RESEARCH AND DEVELOPMENT. The Company maintains a software development
staff that designs and develops the Company's new products and services. The
Company believes that by performing most of its own software development, it can
more quickly and cost-effectively introduce new and innovative technologies and
services. In addition, the Company believes it will be better equipped to
incorporate customer preferences into its development plans. During the third
quarter of 2001, the Company focused its development efforts on the completion
of software tools and products that facilitate the conversion and migration of
data from legacy media to current technology, the conversion of analog content
to multiple digital formats, and the management and reformatting of digital
content on demand. In the third quarter of 2001, upon the completion of its
initial development efforts, the Company introduced its suite of video software
solutions. Development efforts during the first nine months of 2002 have been
focused on adding features and functionality to enhance the competitiveness of
these products. Research and development expenses for the three months ended
September 30, 2002 were $212,000 compared to $92,000 for the three months ended
September 30, 2001.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
was $339,000 for the three months ended September 30, 2002 compared to $403,000
for the three months ended September 30, 2001. Amortization expense primarily
consisted of amortization of the excess cost of the media services operations
over the fair value of the net assets acquired and other intangible assets. The
decrease in these expenses was primarily attributable to the issuance in July
2001 of SFAS No. 142, "Goodwill and Other Intangible Assets" by the Financial
Accounting Standards Board, which requires that all amortization of goodwill as
a charge to earnings ($197,000 for the three months ended September 30, 2001) be
eliminated. Depreciation expense consists of depreciation of furniture,
equipment, software and improvements.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001.
For the nine months ended September 30, 2002, the Company reported a net loss of
$2.8 million, or ($.10) per share, compared to a net loss of $6.3 million, or
($.25) per share, for the nine months ended September 30, 2001.
REVENUE. Total revenue for the nine months ended September 30, 2002 was
$2.2 million, an increase of 400% from total revenue of $449,000 for the nine
months ended September 30, 2001. Revenue from the sale of software and related
products for the nine months ended September 30, 2002 increased $815,000, or
1577%, over the year ago period due to the introduction of the Company's suite
of video software solutions late in the third quarter of 2001 and the
acquisition of MSI France in the third quarter of 2002, which acquisition
generated $542,000 of the $815,000 increase. Revenue generated from the
provision of data and video conversion services for the nine months ended
September 30, 2002 increased $983,000, or 248%, over the year ago period due to
delays experienced by customers in providing the data to be converted in the
prior period and substantial growth in the current period in the sale of data
conversion services. Substantially all of the Company's revenue has been derived
from customers in the United States and through the acquisition of MSI France,
Europe.
GROSS MARGIN. For the nine months ended September 30, 2002, revenue generated
from the provision of data and video conversion services resulted in gross
margins of $912,000, or 61% of service revenue, compared to a gross loss of
$163,000, or (41)%, for the nine months ended September 30, 2001. The gross loss
generated from the provision of data and video conversion services during the
nine months ended September 30, 2001 was below the Company's anticipated gross
margin and resulted from the excess capacity that existed within the Company's
service delivery function at that time.
For the nine months ended September 30, 2002, sales of software and related
products resulted in gross margins of $566,000, or 39% of product revenue,
compared to $27,000, or 51%, for the nine months ended September 30, 2001. This
increase was due to the introduction of the Company's suite of video software
solutions late in the third quarter of 2001.
The Company plans to increase substantially its sales of software and
related products and services, and therefore expects costs of revenue also to
increase substantially.
11
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the nine months ended September 30, 2002 were $2.9
million compared to $4.4 million for the nine months ended September 30, 2001.
The decrease in these expenses was primarily related to an overall reduction in
employee headcount, including the elimination of certain positions; the closing
of the office in Boulder, Colorado; and the relocation of the New Jersey office
to a smaller facility. Selling, general and administrative expenses for the nine
months ended September 30, 2002 consisted of $1,496,000 for salaries and related
benefits for employees not directly related to the production of revenue,
$698,000 in professional and consulting fees, $355,000 for general office
expenses, $237,000 of facilities costs, and $147,000 for travel. Selling,
general and administrative expenses for the nine months ended September 30, 2001
consisted of $3.1 million for salaries and related benefits for employees not
directly related to the production of revenue, $449,000 in professional fees,
$288,000 for travel, $249,000 of facilities costs and $355,000 for general
office expenses. Should the Company secure additional funding, it plans to
increase its sales and marketing efforts and, to a lesser extent, to continue to
build its infrastructure and, therefore, expects expenses in this category to
increase significantly.
RESEARCH AND DEVELOPMENT. As discussed above, the Company maintains a
software development staff that designs and develops the Company's new products
and services. Development efforts during the first nine months of 2002 have been
focused on adding features and functionality to enhance the competitiveness of
the Company's products. Research and development expenses decreased to $431,000
for the nine months ended September 30, 2002 from $502,000 for the nine months
ended September 30, 2001.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
was $763,000 for the nine months ended September 30, 2002 and $1.2 million for
the nine months ended September 30, 2001. The decrease in these expenses was
primarily attributable to the issuance in July 2001 of SFAS No. 142, "Goodwill
and Other Intangible Assets" by the Financial Accounting Standards Board, which
requires that all amortization of goodwill as a charge to earnings ($593,000 for
the nine months ended September 30, 2001) be eliminated. Depreciation expense
consisted of depreciation of furniture, equipment, software and improvements.
Amortization expense consisted of amortization of intangible assets, and for the
nine months ended September 30, 2001, amortization of the excess cost of the
media services operations over the fair value of the net assets acquired. During
the six months ended June 30, 2002, The Company completed the initial test as
required under SFAS No. 142 and determined that the fair value of its reporting
units exceeded their carrying value as of January 1, 2002. The Company will
perform an ongoing annual impairment test, as required under SFAS No. 142,
during the third quarter of each year.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, the Company had liquid assets (cash and cash
equivalents and accounts receivable) of $1.8 million and current assets of $2.3
million. These assets were primarily derived from financing activities and the
acquisition of MSI France. Long-term assets of $7.2 million consisted of the
excess of cost over fair value of the media services assets acquired during 2000
of $3.8 million, software and intellectual property of $2.1 million, property
and equipment of $1.2 million and other assets of $0.1 million.
Current liabilities of $4.8 million at September 30, 2002 consisted of
$1.6 million of accounts payable; $451,000 of deferred revenue, which consisted
of progress payments received on engagements currently in progress; $800,000 of
notes payable offset by the unamortized portion of debt discount in the amount
of $375,000, $1.6 million of accrued expenses; $302,000 of accrued expenses to
employees, of which $168,000 is payable to an employee upon the closing of an
offering that raises gross proceeds of at least $5 million; $160,000 for the
current portion of a note payable to an employee that was assumed upon the
acquisition of the media services operations, $134,000 of accrued vacation, and
$67,000 of current lease liability.
12
The Company's working capital deficit was $2.5 million as of September
30, 2002 for the reasons described above.
The Company used net cash of $1.0 million in operating activities
during the nine months ended September 30, 2002 and $3.0 million in operating
activities during the nine months ended September 30, 2001, primarily as a
result of the net losses incurred during the periods.
Excluding the $860,000 in cash acquired in the acquisition of MSI
France, the Company used net cash of $282,000 in investing activities during the
nine months ended September 30, 2002, of which $207,000 was used for capital
expenditures and $75,000 was used for the development of the Company's suite of
video software solutions and development efforts. During the nine months ended
September 30, 2001, the Company used $631,000 in investing activities, of which
$303,000 was used for capital expenditures and $328,000 was used for the
development of the Company's suite of video software solutions.
Financing activities provided net cash of $650,000 during the nine months ended
September 30, 2002. In March 2002, the Company issued 400,000 shares of
unregistered common stock to an individual investor in consideration of
aggregate proceeds of $50,000. In March and April 2002, the Company issued
$500,000 aggregate principal amount of convertible secured notes to two
investors. In July 2002, the Company borrowed $100,000 from one investor. During
the nine months ended September 30, 2001, net cash of $1.5 million was provided
by financing activities due to the sale of 863,000 shares of common stock and
warrants to purchase 863,000 shares of common stock.
The current level of cash flows from operating activities are not
sufficient to enable the Company to continue to operate and to execute its
business strategy. As a result, the Company is seeking additional capital. In
the interim, the Company is managing its investments in infrastructure based on
its cash position and the near term cash flow generated from operations. The
Company anticipates having sufficient cash to continue operations into the first
quarter of 2003. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The Company's actual financial results
may differ materially from the stated plan of operations. Factors which may
cause a change from the Company's plan of operations vary, but include, without
limitation, decisions of the Company's management and board of directors not to
pursue the stated plan of operations based on its reassessment of the plan, and
general economic conditions. If the Company is successful in raising additional
capital, the Company anticipates that its operating expenses will increase over
the next 12 months as it accelerates execution of its business strategy. There
can be no assurance that additional capital will be available on terms that are
acceptable to the Company. Additionally, there can be no assurance that the
Company's business will generate cash flows at or above current levels.
Accordingly, the Company may choose to defer capital expenditure plans and
extend vendor payments for additional cash flow flexibility.
It is expected that the Company's principal uses of cash will be to
provide working capital and to finance capital expenditures and for other
general corporate purposes, including financing its marketing strategy.
Depending upon the level of sales generated in the near term, the Company
expects capital expenditures to be approximately $500,000 during the next twelve
months. The amount of spending in each respective area is dependent upon the
total capital available to the Company.
ITEM 3. CONTROLS AND PROCEDURES
(a) Based upon an evaluation performed within 90 days of this Report,
our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO") have
each concluded that our disclosure controls and procedures are effective to
ensure that material information relating to our Company is made known to
management, including the CEO and CFO, particularly during the period when our
periodic reports are being prepared, and that our internal controls are
effective to provide reasonable assurances that our financial condition, results
of operations and cash flows are fairly presented in all material respects.
13
(b) The CEO and CFO each note that, since the date of his evaluation
until the date of this Report, there have been no significant changes in
internal controls or in other factors that could significantly affect internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS -
The Company is not subject to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
No changes in securities and use of proceeds.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
The following exhibits are filed herewith:
(a) Exhibits
None
(b) Current Reports on Form 8-K or 8-K/A
The Company filed a Current Report on Form 8-K dated July 31, 2002 announcing
the acquisition of all the outstanding shares of capital stock of ManagedStorage
International France and certain assets of ManagedStorage International, Inc.
The Company filed a Current Report on Form 8-K dated August 14, 2002 providing
certifications of its Chief Executive Officer and Chief Financial Officer with
respect to its Quarterly Report on Form 10-QSB for the period ended June 30,
2002 as required by 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
15
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
has caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Dated: November 14, 2002 FRONT PORCH DIGITAL INC.
By: /s/ Donald Maggi
---------------------------------
Donald Maggi
Chief Executive Officer (principal
executive officer)
By: /s/ Paul McKnight
---------------------------------
Paul McKnight
Chief Financial Officer (principal
financial and accounting officer)
16
Certification of Principal Executive Officer
Pursuant to 18 U.S.C. 1350
(SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002)
I, Donald Maggi, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Front Porch Digital
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
By: /s/ Donald Maggi
-------------------------
Name: Donald Maggi
Title: Executive Officer
November 14, 2002
17
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
Pursuant to 18 U.S.C. 1350
(SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002)
I, Paul McKnight, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Front Porch Digital
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
By: /s/ Paul McKnight
------------------------------
Name: Paul McKnight
Title: Chief Financial Officer
November 14, 2002
18