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 June 30, 2003
[ ] 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 [ ] No [X]
As of August 11, 2003, 41,615,648 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.
CONSOLIDATED BALANCE SHEET
(Unaudited)
ASSETS June 30, 2003
Current assets:
Cash and cash equivalents $ 604,431
Accounts receivable - trade & other, net of allowance of $175,000:
Non-affiliates 1,609,809
Affiliates 324,740
Deferred costs 44,530
Other current assets 435,098
------------
Total current assets 3,018,608
Restricted cash 89,308
Property and equipment, net 862,034
Software development costs, net 326,655
Software and intellectual property, net
of accumulated amortization of $808,065 1,028,732
Excess cost over fair value of net assets acquired, net
of accumulated amortization of $949,778 1,182,289
Other assets 64,042
------------
Total assets $ 6,571,668
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of note payable $ 303,333
Current portion of other long term liability 100,000
Current lease liability 2,589
Accounts payable 808,181
Accrued expenses 1,119,629
Accrued expenses - employees 705,239
Deferred revenue 367,487
------------
Total current liabilities 3,406,458
Note payable, net of current portion 715,392
Other long-term liabilities, net of current portion 422,318
Other long-term liabilities 50,931
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
41,615,652 shares issued and outstanding 41,615
Additional paid in capital 25,367,405
Accumulated other comprehensive income 33,623
Common stock to be issued --
Accumulated deficit (23,466,074)
------------
Total stockholders' equity 1,976,569
------------
Total liabilities and stockholders' equity $ 6,571,668
============
SEE ACCOMPANYING NOTES.
2
FRONT PORCH DIGITAL, INC.
Consolidated Statements of Operations
(Unaudited)
Three months ended June 30, Six months ended June 30,
---------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------------------
Revenues:
Products $ 228,486 $ 95,256 $ 930,272 $ 206,456
Services 1,456,511 684,907 1,926,684 823,893
Services - affiliate 386,498 -- 1,435,480 --
----------- ----------- ----------- -----------
Total revenue 2,071,495 780,163 4,292,436 1,030,349
Cost of revenue:
Products 44,877 35,475 100,634 80,210
Services 495,475 277,883 886,238 249,176
----------- ----------- ----------- -----------
540,352 313,358 986,872 329,386
----------- ----------- ----------- -----------
Gross margin 1,531,143 466,805 3,305,564 700,963
Selling, general and administrative 1,112,727 805,562 2,164,402 1,661,484
Research and development 10,290 115,928 43,163 218,777
Depreciation 207,702 153,096 402,776 306,192
Amortization 146,052 58,929 295,544 117,858
----------- ----------- ----------- -----------
1,476,771 1,133,515 2,905,885 2,304,311
Operating income (loss) 54,372 (666,710) 399,679 (1,603,348)
Other income (expense):
Interest income 412 504 797 1,400
Interest expense (208,857) (13,438) (362,392) (17,938)
Other expense (1,346) -- (80) --
Transaction loss (2,536) -- (3,237) --
Loss on impairment of goodwill and intellectual property (3,335,848) -- (3,335,848) --
----------- ----------- ----------- -----------
Total other expense (3,548,175) (12,934) (3,700,760) (16,538)
Loss from continuing operations (3,493,803) (679,644) (3,301,081) (1,619,886)
Loss on operations of discontinued operation (313,844) -- (750,846) --
Gain on sale of discontinued operation 586,955 -- 586,955 --
----------- ----------- ----------- -----------
Net loss $(3,220,692) $ (679,644) $(3,464,972) $(1,619,886)
=========== =========== =========== ===========
Weighted average shares outstanding - basic and diluted 39,370,754 26,807,923 35,869,795 26,386,128
Earnings per share - basic and diluted:
Loss from continuing operations $ (0.09) $ (0.03) $ (0.09) $ (0.06)
Net income $ (0.08) $ (0.03) $ (0.10) $ (0.06)
SEE ACCOMPANYING NOTES.
3
FRONT PORCH DIGITAL, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
2003 2002
--------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(3,464,972) $(1,619,886)
Loss from discontinued operations 750,846 --
Gain on sale of discontinued operations (586,955) --
----------- -----------
Loss from continuing operations (3,301,081) (1,619,886)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation & amortization 698,319 424,050
Non-cash interest expense 310,691 --
Impairment of goodwill and intellectual property related to Media Services business 3,335,848 --
Non-cash issuance of common stock to employees and consultants -- 357,556
Stock option compensation cost 9,259 68,987
Bad Debt Expense 50,000 --
Gain on sale of fixed assets (9,951) --
Changes in operating assets and liabilities:
Increase in accounts receivable - affiliate (2,414) --
Increase in accounts receivable (494,465) (97,346)
Decrease in deferred costs 43,997 --
Decrease (increase) in other current assets 159,535 (13,337)
Decrease in other assets 33,548 --
(Decrease) increase in accounts payable (836,725) 52,823
Decrease in accrued expenses (64,778) (19,362)
Increase (decrease) in accrued expenses - employees 95,470 (75,682)
Decrease in deferred revenue (959,488) (159,085)
Other changes in operating activities -- 165,877
----------- -----------
Net cash used in operating activities by continuing operations (932,235) (915,405)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (86,507) (50,406)
Cash received from sale of discontinued operations 800,000 --
Software development costs (151,275) (43,634)
Proceeds from sale of fixed assets 39,534 --
----------- -----------
Net cash provided by (used in) investing activities from continuing operations 601,752 (94,040)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable 645,000 600,000
Repayment of note payable and capital leases (68,780) --
Proceeds from issuance of common stock -- 50,000
----------- -----------
Net cash provided by financing activities from continuing operations 576,220 650,000
----------- -----------
Net cash used by discontinued operation (316,384) --
Effect of exchange rate fluctuations on cash and cash equivalents (35,082) --
----------- -----------
Net decrease in cash and cash equivalents (105,729) (359,445)
Cash and cash equivalents, beginning of period 799,468 393,439
----------- -----------
Cash and cash equivalents, end of period $ 693,739 $ 33,994
=========== ===========
SEE ACCOMPANYING NOTES.
4
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Front Porch Digital Inc. (the "Company") enables the conversion, preservation
and management of analog and digital content, including text, images, audio,
graphics, video and rich media. The Company develops 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. The software, which is based on proprietary and
patent-pending technology, enables a new paradigm in the way broadcasters,
content owners and education and law enforcement personnel manage their workflow
- - a shift from tape-oriented warehousing to a fully-digital, instant access
automated archive.
The Company's customers are located in the United States, Europe and Asia.
The consolidated 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 consolidated
financial statements do not include any adjustments that might be necessary
should the Company be unable to continue in existence. The Company has incurred
losses since commencement of operations in its current line of business.
Although the Company's operating results have continued to improve in the first
six months of 2003, and the Company has improved its overall financial position
and liquidity during that period, there can be no assurance that the Company
will not continue to sustain operating losses.
In May 2003, the Company sold its DIVArchive Medical operations to Eastman Kodak
Company ("Kodak") and has accounted for the gain on the sale and the operations
of the business as discontinued operations. As a result, the operating results
of the DIVArchive Medical component are excluded from operating income and loss
from continuing operations and are reported as a separate line item as a
component of net income for the three and six months ended June 30, 2003.
For the six months ended June 30, 2003, the Company generated a net loss of $3.5
million. Excluding the charge of $3.3 million for the impairment of goodwill and
intellectual property related to the Company's media services business and net
losses from discontinued operations of $164,000, net income for the six months
ended June 30, 2003 was $35,000 (as compared to a loss of $1.6 million in the
prior year period). Included in net income for the period was a non-recurring
gain on the sale of discontinued operations of $587,000 related to the sale of
the DIVArchive Medical business to Kodak. For the six months ended June 30,
2003, the Company generated negative cash flow from continuing operations of
$0.9 million and had an ending cash balance at June 30, 2003 of $0.7 million
(including restricted cash).
For the three months ended June 30, 2003, the Company generated a net loss of
$3.2 million. Excluding the charge of $3.3 million for the impairment of
goodwill and intellectual property related to the media services business and
the net gain from discontinued operations of $273,000, the Company generated a
net loss for the three months ended June 30, 2003 of $158,000 (as compared to a
loss of $0.7 million in the prior year period). Included in the net loss for the
period is a non-recurring gain on the sale of discontinued operations of
$587,000 related to the sale of the DIVArchive Medical business and a loss on
operations of discontinued operations of $314,000. The Company generated
negative cash flow from continuing operations for the three months ended June
30, 2003 of $0.5 million. In addition, at June 30, 2003, the Company had a cash
balance of $0.7 million, but a working capital deficit of $.4 million (which
deficit amounted to $1.9
5
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
million at March 31, 2003). These factors create significant uncertainty about
the Company's ability to continue as a going concern.
During the second quarter of 2003, management continued implementing a
restructuring of the operations of the Company that included reorganizing the
personnel of the Company, reducing headcount, reducing non-essential operating
costs and refocusing the Company's business strategy, products and services. As
of August 2003, this restructuring was largely complete, and management believes
the Company's operating cost levels are adequate and appropriate to support its
operations and working capital needs. The Company is now focusing on the
expansion of its DIVArchive Broadcast operations in the United States and is
continuing to hire personnel for those operations. As a result, operating costs
are expected to increase. In April 2003, the Company secured additional capital
through the sale of convertible notes, restructured certain liabilities and sold
the DIVArchive Medical operations to Kodak for $850,000 in cash and the transfer
of certain liabilities and operations. Management believes these actions enabled
the Company to obtain sufficient cash to continue as a going concern. However,
there can be no assurance that the additional capital and improved liquidity
will be adequate to enable the Company to continue as a going concern.
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, 2002. Operating results for the three and six months ended
June 30, 2003 are not necessarily indicative of the operating results expected
for the year ending December 31, 2003.
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.
REVENUE RECOGNITION
The Company recognizes revenue when persuasive evidence of an arrangement
exists, delivery and acceptance has occurred, the fee is fixed or determinable,
and collection is reasonably assured.
The Company licenses software under license agreements and provides professional
services, including training, installation, consulting and maintenance. License
fee revenues are recognized when a license agreement has been signed, the
software product has been shipped, the fees are fixed and determinable,
collection is considered probable and no significant vendor obligations remain.
The Company allocates revenue to each component of the contract based on
objective evidence of its fair value, as established by management. Because
licensing of the software generally is not dependent on the professional
services portions of the contract, the software revenue is recognized upon
delivery.
6
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
Fees for maintenance agreements are recognized ratably over the term of the
agreement. Maintenance is generally billed in advance resulting in deferred
revenues.
The Company provides software-related professional services. Services are
generally provided on a time and materials basis and revenue is recognized as
the services are provided.
Revenue under service contracts is recognized when services have been performed
and accepted, or on the proportional-performance method of accounting, depending
on the nature of the project. The extent of progress toward completion under the
proportional-performance method of accounting is measured by using the number of
sites and/or units under the contract that have been completed and the progress
towards completion of batches in progress at period end.
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its employee stock options because the alternative fair value
accounting provided for under Financial Accounting Standards Board Statement of
Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock Based
Compensation," requires the use of option valuation models that were not
developed for use in valuing employee stock options. The effect of applying SFAS
No. 123's fair value method to the Company's stock-based awards results in pro
forma net loss and loss per share that is not materially different from the
amounts reported. Pro forma results of operations may not be representative of
the effects on reported or pro forma results of operations for future years. For
the three months ended June 30, 2003 and 2002, $0 and $62,000, respectively of
compensation cost was recorded. For the six months ended June 30, 2003 and 2002,
$10,000 and $131,000 respectively of compensation cost was recorded.
The Company accounts for equity instruments issued to non-employees in exchange
for goods or services using the fair value method and records expense based on
the values determined.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions affecting the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts and balances to
conform with the 2003 presentation.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to
7
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company has not adopted SFAS
No. 148 in its accounting for stock-based compensation. However, the Company has
updated its disclosure to conform to the pronouncement.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. This interpretation addresses consolidation by
business enterprises of variable interest entities. The interpretation is not
expected to have a material effect on the Company's consolidated financial
statements.
3. NOTES PAYABLE
At June 30, 2003, notes payable consisted of:
$133,333 of an unsecured note payable that bears interest at 9% per annum. In
September 2002, the Company recapitalized the outstanding balance and accrued
interest of an existing unsecured note payable. The new principal amount of
$246,500 included the original principal balance of $200,000 plus accrued
interest of $46,500. The note was payable in an initial payment of $45,000, and
equal monthly installments of $25,000 through June 1, 2003, with a final payment
of $8,647 on July 1, 2003. At December 31, 2002, the remaining principal balance
on this note was $150,000. Effective April 30, 2003, the Company restructured
the $150,000 remaining principal balance on the note payable and accrued
interest which was due in full on June 30, 2003 into a new note that is payable
over 12 months and matures on May 1, 2004. The note is payable in equal monthly
installments which began on May 1, 2003 and carries an annual interest rate of
9% per annum. Accrued interest is payable at maturity. In connection with this
agreement, the Company issued to the noteholder warrants to purchase up to
100,000 shares of common stock at a price per share of $0.10. The fair value of
these warrants amounted to $10,000 and was recorded as a discount to the note
and is being amortized to interest expense over the note term of one year.
$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. The Company has estimated that $170,000 will be payable on this note in
the next 12 months; and
$990,000 aggregate principal amount of unsecured convertible notes that were
issued in April 2003. The notes contain a beneficial conversion feature as the
notes include certain anti-dilution protection and rights, and are convertible
into Company Common Stock at a price significantly below the then current market
price. The Company allocated $990,000 of the value received to this beneficial
conversion feature, which has been recorded as a debt discount and is being
amortized to interest expense over the term of the debt. The Company recorded
non-cash interest expense related to debt discount of $141,000 during the three
months ended June 30, 2003. Proceeds from the issuance of these notes were the
following: $645,000 cash proceeds received by the Company; retirement of
$250,000 principal balance of the former secured convertible notes that matured
on March 31, 2003 (the remaining $250,000 principal and accrued interest was
converted into Company Common Stock in accordance with the terms of the
convertible secured note); and the conversion of $95,000 in current liabilities.
The
8
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
convertible notes bear interest at the rate of 8% per annum and mature on
September 30, 2004. Principal and accrued interest are payable at maturity. The
convertible notes are convertible at any time at the option of the note holders
into shares of Company Common Stock at a conversion price of $.042 per share,
subject to certain anti-dilution adjustments. The convertible notes may be
prepaid by the Company at any time without penalty. In the event of a prepayment
by the Company, or upon payment of principal and interest at maturity, the
Company will be required to issue to the holders of such notes five-year common
stock purchase warrants pursuant to which the holders of the warrants will have
the right to purchase a number of shares of Company Common Stock equal to 5,500
shares for each $1,000 of principal balance repaid, at a purchase price of $0.10
per share, subject to certain anti-dilution adjustments. The purchase agreement
relating to the convertible notes contains restrictions that, among others,
prohibit the Company from issuing new debt, making capital expenditures in
excess of specified amounts, paying dividends on the common stock or granting
security interests in assets without the consent of note holders owning a
majority in principal amount of the outstanding notes.
In April 2003, the holders of $500,000 aggregate principal amount of convertible
secured notes converted the remaining $250,000 of the outstanding principal
($250,000 of principal was converted into the unsecured convertible notes
described above) and 100% of the accrued interest into 6,785,715 shares of
Company Common Stock pursuant to the conversion terms of the convertible secured
notes. In connection with this conversion, the Company recorded $39,000 in
non-cash interest expense related to the value of the induced conversion of the
debt.
4. SALE OF DIVARCHIVE MEDICAL OPERATIONS
On April 23, 2003, the Company sold to Kodak the Company's intellectual property
rights relating to the DIVArchive product applications for the medical imaging
and information management market. In connection with such sale, Kodak paid the
Company $800,000, will pay the Company a final payment of $50,000 upon
completion of the transition process and has offered employment to substantially
all of the Company's personnel associated with the transferred assets and
assumed certain software support obligations to the Company's existing
DIVArchive customers in the medical industry. The Company recorded a $587,000
gain on the sale in the three months ended June 30, 2003.
The DIVArchive Medical component is accounted for as a discontinued operation in
the accompanying financial statements in accordance with Statement of Financial
Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." The results of operations and cash flows of the
DIVArchive Medical operations have been removed from the Company's results of
continuing operations for all periods presented. For the three and six months
ended June 30, 2003, the loss from operations for the DIVArchive Medical
component was $314,000 and $751,000, respectively. All related disclosures have
also been adjusted to reflect the discontinued operation. Summarized selected
financial information from discontinued operations for the three and six months
ended June 30, 2003 (excluding the net gain) is as follows:
9
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
RESULTS OF OPERATIONS - DIVARCHIVE MEDICAL OPERATIONS:
June 30, 2003
-----------------------------------------------
Three Months Ended Six Months Ended
----------------------- ---------------------
Revenues $ 32,000 $ 239,000
Gross margin 4,000 47,000
Loss from DIVArchive Medical operations
(318,000) (798,000)
--------- ---------
$(314,000) $(751,000)
========= =========
Summarized components of the gain on the sale of the DIVArchive Medical
component were as follows:
Cash received and liabilities transferred $ 800,000
Receivable from Kodak 50,000
Liabilities transferred 138,000
Intellectual property and goodwill sold (401,000)
---------
Gain on sale of DIVArchive Medical component $ 587,000
=========
In April 2003, as a result of the sale of the DIVArchive Medical component, the
Company performed an impairment analysis of the remaining DIVArchive goodwill
and intellectual property that was not sold in the transaction and determined
that no impairment of the assets was warranted.
5. LOSS ON IMPAIRMENT OF GOODWILL AND INTELLECTUAL PROPERTY - MEDIA SERVICES
SEGMENT
At June 30, 2003, as a result of changes in the business environment, the
Company recorded a loss of $3.3 million on the impairment of goodwill and
intellectual property related to the media services segment to reflect the fair
value of the business based upon a valuation analysis using discontinued future
cash flows. This amount was excluded from operating income, but was included in
loss from continuing operations in the statement of operations for the three and
six months ended June 30, 2003. Included in the loss is:
Impairment of intellectual property $ 362,000
Impairment of goodwill 2,974,000
----------
Total impairment recorded $3,336,000
==========
6. CONCENTRATION OF CREDIT RISK
The Company sells its products and services throughout the United States, Europe
and Asia. The Company performs periodic credit evaluations of its customers'
financial condition and generally does not require collateral. Credit losses
have been within management's expectations. For the six months ended June 30,
2003, revenues from two customers, each exceeding 10% of total revenue,
aggregated 32% and 20%, respectively. At June 30, 2003, accounts receivable from
the largest customer was $325,000, or 17% of total trade receivables. This
customer is also a stockholder of the Company. In addition, accounts receivable
from two other customers aggregated 26% and 20% of accounts receivable at June
30, 2003. For the six months ended June 30, 2002, revenues from two customers,
each exceeding 10% of total revenue, aggregated 54% and 15%, respectively. The
Company was a subcontractor for this customer/stockholder during 2002 and 2003,
which beneficially owned approximately 13.5% of the Company's outstanding common
stock as of August 11, 2003.
10
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
7. PER SHARE DATA
The Company reports its earnings (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.
For the three and six months ended June 30, 2003 and 2002, shares from the
assumed conversion of outstanding convertible notes, warrants and options are
omitted from the computations of diluted earnings per share because the effect
would be anti-dilutive.
8. SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," establishes standards for reporting information about operating
segments and related disclosures about products and services, geographic areas
and major customers. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.
The Company's operations are segregated into two lines of business: media
conversion services and software and related services. The Company operates
these lines of business across the geographic areas of the United States,
Europe, Canada and Asia-Pacific. Offices and facilities are located in Mount
Laurel, New Jersey, Houston, Texas and Toulouse, France. The Company's lines of
business are not completely integrated into all locations and therefore the
Company does not currently offer all solutions in all markets in which it is
present. Current efforts are underway to integrate products and services across
all markets served.
The media conversion business segment offers a comprehensive, integrated suite
of enterprise data media solutions ("EDMS") that can help customers ensure
information preservation, reduce cost and improve productivity without
compromising the security and integrity of their stored information. The
Company's EDMS group has performed professional services for over 600 customers
worldwide in industries that include banking and finance, power utility,
petroleum, pharmaceutical and government. All services offered by the EDMS group
are performed offline utilizing the Company's proprietary software and
stand-alone hardware devices, at either the customer site or one of the
Company's secure delivery facilities. These services can be performed for any
applicable optical and/or tape media type and format. Components of the
currently available offerings include tape copy and conversion, tape volume
management, tape data assurance, and archive generation and conversion.
The software and related services business segment offers an integrated suite of
digital media solutions that facilitate the capture, management and distribution
of digital content. Components of these offerings include a desktop encoding
system, automated video indexing and a real-time format transcoder. In addition,
the Company offers a distributed storage and archive management solution for the
entertainment industry that simplifies the process of preserving, managing and
accessing digital content.
Revenues, margins and operating expenses of the Company's lines of business are
evaluated by management. The Company does not measure assets by lines of
business as assets are generally not distinctive to a particular line of
business and they are not fundamental in assessing segment performance. Capital
expenditures are managed by segment, but only for purposes of budgeting and cash
flow management. General overhead expenses are included completely in the
software and services business segment as the media conversion segment has been
and continues to be an easily definable, separate,
11
Front Porch Digital, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
stand-alone business - no allocations of such costs are made as allocated
indirect costs are not considered in the management of the business segments.
All direct and indirect costs associated with a segment are reported within that
segment. Summarized operations of each of the Company's operating segments in
the aggregate for the three and six months ended June 30, 2003 and 2002, are as
follows:
MEDIA CONVERSION SOFTWARE AND SERVICES
Three Months Ended June 30, Three Months Ended June 30,
2003 2002 2003 2002
Revenues $1,680,854 $ 691,885 $390,641 $ 88,278
Gross margin 1,314,905 389,113 216,238 77,692
Gross margin % 78% 56% 55% 88%
Operating income (loss) 1,177,338 199,583 (1,122,967) (866,293)
MEDIA CONVERSION SOFTWARE AND SERVICES
Six Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
Revenues $3,056,058 $ 815,421 $1,236,378 $ 214,928
Gross margin 2,453,424 514,121 852,140 186,842
Gross margin % 80% 63% 69% 87%
Operating income (loss) 2,121,229 (54,252) (1,721,549) (1,549,096)
At June 30, 2003, the Company recorded a loss of $3.3 million on the impairment
of goodwill and intellectual property related to the media services segment to
reflect the decrease in the fair value of the goodwill. The impairment charge
was excluded from operating income (loss) above, but was included in loss from
continuing operations in the statement of operations for the three and six
months ended June 30, 2003.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
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 and continued enhancement of its 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
The Company enables the conversion, preservation and management of
analog and digital content, including text, images, audio, graphics, video and
rich media. The Company develops 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. The
software, which is based on proprietary and patent-pending technology, enables a
new paradigm in the way broadcasters, content owners and 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's customers are located in the United States, Europe and
Asia.
The Company is in the early stages of executing its business strategy
and anticipates generating significant revenues from the sale of its data
conversion and software products 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.
In the fourth quarter of 2002, the Company initiated a restructuring
plan in an effort to position itself to raise the necessary working capital to
capitalize on its product and service portfolio, which has been gaining
widespread acceptance in the marketplace. The restructuring plan included:
o Implementing cost reductions and cost control measures to limit new
spending, including reducing headcount in the United States and
Europe, reducing salaries and benefits costs, reducing consulting
fees, controlling and reducing travel
13
and entertainment costs, reducing facility size and costs and reducing
overall general operating costs.
o Securing additional resources in executive management and operations
to develop and implement the restructuring plan.
o Reducing short-term liabilities by renegotiating with its key vendors
and other short-term creditors to settle outstanding obligations for
reduced amounts or extending payment terms, in some cases beyond one
year.
o Implementing aggressive cash flow management, including accelerating
significant cash receipts from customers in advance of due dates and
deferring vendor payables to minimize the actual cash outflows of the
business.
o Re-aligning existing personnel and operations to better match the
costs of the business with the business focus and expected results of
operations.
o Improving operational management, effectiveness and efficiency to
enable the Company to deliver on its existing customer contracts in a
timely and predictable manner.
During the three months ended June 30, 2003, the following significant events
occurred:
o On April 23, 2003, the Company sold to Eastman Kodak Company ("Kodak")
the Company's intellectual property rights relating to the DIVArchive
product applications for the medical imaging and information
management market. In connection with such sale, Kodak paid the
Company $800,000, will pay the Company a final payment of $50,000 upon
completion of the transition process and has offered employment to
substantially all of the Company's personnel associated with the
transferred assets and assumed certain software support obligations to
the Company's existing DIVArchive customers in the medical industry.
The Company recorded a $587,000 gain on the sale in the three months
ended June 30, 2003. The operations of the DIVArchive Medical
component was accounted for as discontinued operations in the
accompanying financial statements. The results of operations and cash
flows for the DIVArchive Medical operations have been excluded from
the Company's results of continuing operations for all periods
presented. For the three and six months ended June 30, 2003, the loss
from operations for the DIVArchive Medical component was $314,000 and
$751,000, respectively.
o In April 2003, the Company issued $990,000 aggregate principal amount
of unsecured convertible notes. Payment for these notes included the
following: $645,000 cash proceeds received by the Company; $250,000
principal balance of the former secured convertible notes which
matured on March 31, 2003; and the conversion of $95,000 in current
liabilities. The convertible notes bear interest at the rate of 8% per
annum and mature on September 30, 2004. Principal and accrued interest
are payable at maturity. The convertible notes are convertible at any
time at the option of the note holders into shares of common stock of
the Company at a conversion price of $.042 per share, subject to
certain anti-dilution adjustments. The convertible notes may be
prepaid by the Company at any time without penalty. In the event of a
prepayment by the Company, or upon payment of principal and interest
at maturity, the Company will be required to issue to the holders of
such notes five-year common stock purchase warrants pursuant to which
the holders of the warrants will have the right to purchase a number
of shares of common stock of the Company equal to 5,500 shares for
each $1,000 of principal balance repaid, at a purchase price of $0.10
per share, subject to certain anti-dilution adjustments. The purchase
agreement relating to the convertible notes contains restrictions
that, among others, prohibit the Company from issuing new debt, making
capital expenditures in excess of specified amounts, paying dividends
on the common stock or granting security interests in assets without
the consent of note holders owning a majority in principal amount of
the outstanding notes.
14
o In April 2003, the holders of the $500,000 aggregate principal amount
of convertible secured notes converted the remaining $250,000 of the
outstanding principal ($250,000 of principal was converted into the
unsecured convertible notes described above) and 100% of the accrued
interest into 6,785,715 shares of common stock of the Company pursuant
to the conversion terms of the convertible secured notes. In
connection with this conversion, the Company recorded $39,000 in
non-cash interest expense related to the value of the induced
conversion of the debt.
o During the three months ended June 30, 2003, the Company successfully
restructured the following: (i) $530,000 of current liabilities to a
single vendor to be payable over a five-year period, with interest at
the rate of 5% per annum. Principal payments under the agreement are
fixed for the first year at $100,000 per year. Remaining payments are
subject to certain acceleration clauses based upon working capital
levels and capital raised. In connection with this agreement, the
Company will issue to the vendor warrants to purchase up to 500,000
shares of common stock at a price per share of $0.10 and (ii) a
$150,000 note payable and accrued interest which was due in full on
June 30, 2003 into a new note that is payable over 12 months and
matures on May 1, 2004. The note is payable in equal monthly
installments beginning May 1, 2003 and carries an annual interest rate
of 9% per annum. Accrued interest is payable at maturity. In
connection with this agreement, the Company issued to the noteholder
warrants to purchase up to 100,000 shares of common stock at a price
per share of $0.10. The fair value of these warrants amounted to
$10,000 and was recorded as a discount to the note and is being
amortized to interest expense over the note term of one year.
o At June 30, 2003, the Company recorded a non-recurring charge of $3.3
million for the impairment of goodwill and intellectual property
related to the media services business segment.
The items described above demonstrate the Company's efforts to refocus its
business on the broadcast space and specifically in the sale of the DIVArchive
and transcoder products. The sale of the DIVArchive Medical business in the
second quarter of 2003 and the loss on the impairment of the goodwill and
intellectual property of the media services business segment are indicative of
these efforts. The impairment of goodwill and intellectual property recorded in
the media services business segment brought the intangible asset balances to a
level that management believes properly reflects the fair value of the business
segment. The sale of the DIVArchive Medical business component generated a gain
for the Company and significantly reduced the operating costs in France to a
more appropriate level relative to broadcast revenues.
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
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.
RESULTS OF CONTINUING OPERATIONS - Three Months Ended June 30, 2003 Compared to
the Three Months Ended June 30, 2002
REVENUE. Total revenue for the three months ended June 30, 2003
increased $1.3 million to $2.1 million, compared to total revenue of $780,000
for the three months ended June 30, 2002. This increase in revenue was
attributable to significantly higher revenue generated from the media conversion
business segment ($1.7 million in segment revenue for the three months ended
June 30, 2003 as compared to $0.7 million for the prior year period) and
additional revenue generated in the software and related
15
services business segment from DIVArchive broadcast sales, totaling $0.3 million
for the three months ended June 30, 2003 (the DIVArchive revenues excluded
DIVArchive Medical revenue of $32,000 for the three months ended June 30, 2003
that has been accounted for as a discontinued operation). Revenue generated in
the software and related services business segment in the United States remained
relatively unchanged for the three months ended June 30, 2003. Service revenues
totaled $1,900,000, or 89% of total revenues, for the three months ended June
30, 2003 as compared to $685,000, or 88% of total revenues, for the three months
ended June 30, 2002. For the three months ended June 30, 2003, $200,000, or 11%
of total revenue, was attributable to product revenues as compared to $95,000,
or 12% of total revenue, for the three months ended June 30, 2002.
GROSS MARGIN. Total gross margin was $1.5 million, or 74% of total
revenue, for the three months ended June 30, 2003 compared to $467,000, or 60%
of total revenue, for the three months ended June 30, 2002. This increase was
attributable to the increased revenues discussed above and the timely delivery
of services to customers. In addition, revenues scaled to a level whereby the
direct costs of operations were supported, unlike in the prior year period
during which revenue was marginally able to cover cost of sales. For the three
months ended June 30, 2003, sales of software and related products resulted in
gross margins of 55% and the provision of data and media conversion services
resulted in gross margins of 78%. For the three months ended June 30, 2002,
sales of software and related products resulted in gross margins of 88% and the
provision of data and media conversion services resulted in gross margins of
56%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended June 30, 2003 were $1.1
million, as compared to $0.8 million for the three months ended June 30, 2002.
Selling, general and administrative expenses for the three months ended June 30,
2003 consisted primarily of $502,000 for salaries and related benefits for
employees not directly related to the production of revenue, $270,000 in
professional and consulting fees, $91,000 for travel, $101,000 of facilities
costs, $50,000 for bad debt expense, and $97,000 for general office expenses.
Selling, general and administrative expenses for the three months ended June 30,
2002 consisted primarily of $308,000 for salaries and related benefits for
employees not directly related to the production of revenue, $220,000 in
professional fees, $37,000 for travel, $60,000 of facilities costs, and $180,000
for general office expenses.
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. The Company
continues to devote more resources to the development of its solutions that
convert analog content to multiple digital formats, manage and reformat digital
content on demand and archiving technologies and software tools and products
that facilitate the conversion and migration of data from legacy media to
current technology. Research and development expenses for the three months ended
June 30, 2003 were $10,000 compared to $116,000 for the three months ended June
30, 2002. The decrease in expense in 2003 is directly related to the increase in
projects which will provide future benefit to the company and have passed the
point of technological feasibility. As a result, significantly more of the
Company's costs of its research and development efforts are being capitalized as
software development costs and amortized to expense over a three-year period.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
was $354,000 for the three months ended June 30, 2003 compared to $212,000 for
the three months ended June 30, 2002. Amortization expense primarily consisted
of amortization of intangible assets. Depreciation expense consists of
depreciation of furniture, equipment, software and improvements. The increase in
depreciation and amortization expenses was the result of the inclusion of such
expenses for MSI France, which was acquired in August 2002.
16
OPERATING INCOME. For the three months ended June 30, 2003, operating
income totaled $54,000 as compared to an operating loss of $.7 million for the
three months ended June 30, 2003. The increase in operating income was primarily
due to the increased revenues from the media conversion business segment and
sales related to the Company's DIVArchive broadcast solutions.
LOSS ON IMPAIRMENT OF GOODWILL. The Company performs an ongoing annual
impairment test, as required under SFAS No. 142, "Goodwill and Other Intangible
Assets" by the Financial Accounting Standards Board, on the first day of the
fourth quarter of each year or as conditions warrant. As such, during the three
months ended June 30, 2003:
o as a result of changes in the media conversion business, the Company
performed an impairment analysis of the recorded goodwill for that
business segment, and, as a result, recorded a loss on the impairment
of goodwill of $2.8 million at June 30, 2003.
o in April 2003, as a result of the sale of the DIVArchive Medical
component, the Company performed an impairment analysis of the
remaining DIVArchive goodwill and intellectual property and determined
that no impairment of the assets was warranted.
LOSS ON IMPAIRMENT OF INTELLECTUAL PROPERTY. As a result of changes in
the media conversion business and in conjunction with the SFAS No. 142 analysis,
the Company recorded an impairment change of $362,000 on intellectual property
consistent with SFAS No. 144.
INTEREST EXPENSE. Interest expense was $209,000 for the three months
ended June 30, 2003 compared to $13,000 for the three months ended June 30,
2002. Interest expense for the three months ended June 30, 2003 included
non-cash interest charges aggregating $185,000, including a non-cash interest
charge of $141,000 related to the amortization of debt discount on the Company's
unsecured convertible notes, $39,000 of non-cash interest expense related to the
induced conversion of debt and non-cash interest expense of $5,000 related to
amortization of non-cash financing costs.
LOSS FROM CONTINUING OPERATIONS. For the three months ended June 30,
2003, the Company reported a loss from continuing operations of $3.5 million
compared to a loss from continuing operations of $0.7 million for the three
months ended June 30, 2002. Included in the loss for the three months ended June
30, 2003 was a loss on the impairment of goodwill and intellectual property of
$3.3 million.
LOSS FROM DISCONTINUED OPERATIONS. For the three months ended June 30,
2003, the Company reported a $314,000 loss from discontinued operations of its
DIVArchive Medical component.
GAIN ON SALE OF DIVARCHIVE MEDICAL BUSINESS. For the three months ended
June 30, 2003, the Company reported a gain on the sale of its DIVArchive Medical
component of $587,000.
NET LOSS. For the three months ended June 30, 2003, the Company
reported a net loss of $3.2 million, or ($.08) per share, compared to a net loss
of $.7 million, or ($.03) per share, for the three months ended June 30, 2002.
Included in the loss for the three months ended June 30, 2003 was a loss on the
impairment of goodwill and intellectual property of $3.3 million, a loss from
discontinued operations of $314,000 and a gain on the sale of discontinued
operations of $587,000.
RESULTS OF CONTINUING OPERATIONS - Six Months Ended June 30, 2003 Compared to
the Six Months Ended June 30, 2002
REVENUE. Total revenue for the six months ended June 30, 2003 increased
$3.3 million to $4.3 million, compared to total revenue of $1.0 million for the
six months ended June 30, 2002. This increase in revenue was attributable to
significantly higher revenue generated from the media conversion business
segment ($3.1 million in segment revenue for the six months ended June 30, 2003
as compared to $0.8 million for the prior year period) and additional revenue
generated in the software and related services business segment from DIVArchive
broadcast sales, totaling $0.7 million for the six months ended June 30, 2003
(the DIVArchive revenues excluded DIVArchive
17
Medical revenue of $240,000 for the six months ended June 30, 2003, which has
been accounted for as a discontinued operation). Revenue generated in the
software and related services business segment in the United States increased
approximately $0.3 million for the six months ended June 30, 2003. Service
revenues totaled $3.4 million, or 78% of total revenues, for the six months
ended June 30, 2003 as compared to $.8 million or 80% of total revenues, for the
six months ended June 30, 2002. For the six months ended June 30, 2003, $0.9
million, or 22% of total revenue, was attributable to sales of software and
related products as compared to $.2 million, or 20% of total revenue, for the
six months ended June 30, 2002.
GROSS MARGIN. Total gross margin was $3.3 million, or 77% of total
revenue, for the six months ended June 30, 2003 compared to $.7 million, or 68%
of total revenue, for the six months ended June 30, 2002. This increase was
attributable to the increased revenues discussed above and the timely delivery
of services to customers. In addition, revenues scaled to a level whereby the
direct costs of operations were supported, unlike in the prior year period
during which revenue was marginally able to cover cost of sales. For the six
months ended June 30, 2003, sales of software and related products resulted in
gross margins of 69% and the provision of data and media conversion services
resulted in gross margins of 80%. For the six months ended June 30, 2002, sales
of software and related products resulted in gross margins of 87% and the
provision of data and media conversion services resulted in gross margins of
63%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the six months ended June 30, 2003 were $2.2
million, as compared to $1.7 million for the six months ended June 30, 2002.
Selling, general and administrative expenses for the six months ended June 30,
2003 consisted primarily of $986,000 for salaries and related benefits for
employees not directly related to the production of revenue, $493,000 in
professional and consulting fees, $157,000 for travel, $188,000 of facilities
costs, $50,000 for bad debt expense, and $291,000 for general office expenses.
Selling, general and administrative expenses for the six months ended June 30,
2002 consisted primarily of $741,000 for salaries and related benefits for
employees not directly related to the production of revenue, $537,000 in
professional fees, $73,000 for travel, $118,000 of facilities costs, and
$191,000 for general office expenses.
RESEARCH AND DEVELOPMENT. As discussed above, the Company maintains a
software development staff that designs and develops the Company's new products
and services. Research and development expenses for the six months ended June
30, 2003 were $43,000 compared to $219,000 for the six months ended June 30,
2002. The decrease in expense in 2003 is directly related to the increase in
projects which will provide future benefit to the company and have passed the
point of technological feasibility. As a result, significantly more of the
Company's costs of its research and development efforts are being capitalized as
software development costs and amortized to expense over a three-year period.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
was $698,000 for the six months ended June 30, 2003 compared to $424,000 for the
six months ended June 30, 2002. Amortization expense primarily consisted of
amortization of intangible assets. Depreciation expense consists of depreciation
of furniture, equipment, software and improvements. The increase in depreciation
and amortization expenses resulted from the inclusion in the current period of
such expenses for MSI France, which was acquired in August 2002.
OPERATING INCOME. For the six months ended June 30, 2003, operating
income totaled $0.4 million as compared to an operating loss of $1.6 million for
the six months ended June 30, 2003. The increase in operating income was
primarily due to the increased revenues from the media conversion business
segment and sales from the Company's DIVArchive broadcast solutions.
INTEREST EXPENSE. Interest expense was $362,000 for the six months
ended June 30, 2003 compared to $18,000 for the six months ended June 30, 2002.
Interest expense for the six months ended June 30, 2003 included non-cash
interest charges aggregating $324,000, including a non-cash interest charge of
$266,000 related to the
18
amortization of debt discount on the Company's convertible note instruments,
$39,000 of non-cash interest expense related to the induced conversion of debt
and non-cash interest expense of $19,000 related to amortization of non-cash
financing costs.
LOSS FROM CONTINUING OPERATIONS. For the six months ended June 30,
2003, the Company reported a loss from continuing operations of $3.3 million as
compared to a loss from operations of $1.6 million for the six months ended June
30, 2002. Included in the loss for the three months ended June 30, 2003 was a
loss on the impairment of goodwill and intellectual property of $3.3 million, as
discussed above.
NET LOSS. For the six months ended June 30, 2003, the Company reported
a net loss of $3.5 million, or ($.10) per share, compared to a net loss of $1.6
million, or ($.06) per share, for the six months ended June 30, 2002. Included
in the loss for the three months ended June 30, 2003 was a loss on the
impairment of goodwill and intellectual property of $3.3 million, a loss from
discontinued operations of $751,000 and a gain on the sale of discontinued
operations of $587,000.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS. The Company conducts
business in various countries outside the United States in which the functional
currency of the country is not the U.S. dollar. As a result, the Company has
foreign currency exchange translation exposure as the results of these foreign
operations are translated into U.S. dollars in its consolidated financial
statements. The effect of changes in value of the U.S. dollar compared to other
currencies, primarily the euro, has been to increase reported revenues and
operating profit when the U.S. dollar weakens and reduce these amounts when the
dollar strengthens. While the Company looks for opportunities to reduce its
exposure to foreign currency fluctuations against the U.S. dollar, at this point
the Company has not had adequate financial resources to pursue hedging
opportunities generally. At June 30, 2003, the Company reported a translation
loss of $33,623 as a component of Comprehensive Loss. The Company is also
subject to foreign exchange transaction exposure when its subsidiaries transact
business in a currency other than its own functional currency. These
transactions are infrequent and have not had a significant effect on the
consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
On April 15, 2003, the Company issued $990,000 aggregate principal
amount of unsecured convertible notes. Proceeds to the Company from the issuance
of these notes included the following: $645,000 cash proceeds received by the
Company; the retirement of $250,000 principal balance of the former secured
convertible notes that matured on March 31, 2003 (the remaining $250,000
principal and accrued interest was converted into common stock in accordance
with the terms of the convertible secured note); and the conversion of $95,000
in current liabilities. The convertible notes bear interest at the rate of 8%
per annum and mature on September 30, 2004. Principal and accrued interest are
payable at maturity. The convertible notes are convertible at any time at the
option of the note holders into shares of common stock of the Company at a
conversion price of $.042 per share, subject to certain anti-dilution
adjustments. The convertible notes may be prepaid by the Company at any time
without penalty. In the event of a prepayment by the Company, or upon payment of
principal and interest at maturity, the Company will be required to issue to the
holders of such notes five-year common stock purchase warrants pursuant to which
the holders of the warrants will have the right to purchase a number of shares
of common stock of the Company equal to 5,500 shares for each $1,000 of
principal balance repaid, at a purchase price of $0.10 per share, subject to
certain anti-dilution adjustments. The purchase agreement relating to the
convertible notes contains restrictions that, among others, prohibit the Company
from issuing new debt, making capital expenditures in excess of specified
amounts, paying dividends on the common stock or granting security interests in
assets without the consent of note holders owning a majority in principal amount
of the outstanding notes.
In April 2003, the holders of the $500,000 aggregate principal amount
of convertible secured notes converted the remaining $250,000 of the outstanding
principal ($250,000 of principal was converted into the unsecured convertible
notes described above) and 100% of the accrued interest into 6,785,715 shares of
common
19
stock of the Company pursuant to the conversion terms of the convertible secured
notes. In connection with this conversion, the Company recorded $39,000 in
non-cash interest expense related to the value of the induced conversion of the
debt.
During the three months ended June 30, 2003, the Company successfully
restructured the following: (i) $530,000 of current liabilities to a single
vendor to be payable over a five-year period, with interest at the rate of 5%
per annum. Principal payments under the agreement are fixed for the first year
at $100,000 per year. Remaining payments are subject to certain acceleration
clauses based upon working capital levels and capital raised. In connection with
this agreement, the Company will issue warrants to purchase up to 500,000 shares
of common stock at a price per share of $0.10 to the vendor and (ii) a $150,000
note payable and accrued interest which was due in full on June 30, 2003 into a
new note that is payable over 12 months and matures on May 1, 2004. The note is
payable in equal monthly installments beginning May 1, 2003 and carries an
annual interest rate of 9% per annum. Accrued interest is payable at maturity.
In connection with this agreement, the Company issued to the noteholder warrants
to purchase up to 100,000 shares of common stock at a price per share of $0.10.
The fair value of these warrants amounted to $10,000 and was recorded as a
discount to the note and is being amortized to interest expense over the note
term of one year.
On April 23, 2003, the Company sold to Eastman Kodak Company the
Company's intellectual property rights relating to the DIVArchive product
applications for the medical imaging and information management market. In
connection with such sale, Kodak paid the Company $800,000, will pay the Company
a final payment of $50,000 upon completion of the transition process and has
offered employment to substantially all of the Company's personnel associated
with the transferred assets and assumed certain software support obligations to
the Company's existing DIVArchive customers in the medical industry.
As a result of the issuance of the convertible notes in April 2003, at
June 30, 2003, on a diluted basis in accordance with generally accepted account
principles, the Company had authorized the issuance of a number of shares of
common stock that exceeded its authorized 50 million common shares. The Company
expects to remedy this through a shareholder vote prior to year end.
As of June 30, 2003, the Company had liquid assets (unrestricted cash
and cash equivalents and accounts receivable) of $2.5 million and current assets
of $3.0 million. Current liabilities of $3.4 million at June 30, 2003 consisted
of $0.8 million of accounts payable; $1.1 million of accrued expenses; $705,000
of accrued expenses to employees; $367,000 of deferred revenue, which consisted
of progress payments received on engagements currently in progress; $403,000 of
current portion of notes payable and $3,000 of current lease liability. The
Company's working capital deficit was $0.4 million as of June 30 2003 for the
reasons described above.
The Company used net cash of $0.9 million in operating activities
during the six months ended June 30, 2003 and used net cash of $0.9 million in
operating activities during the six months ended June 30, 2002, primarily as a
result of the net loss incurred during the 2002 period. In 2003, cash used in
operating activities was primarily driven by the loss for the period, adjusted
for a $3.3 million non-cash charge on the impairment of goodwill and
intellectual property, and offset by significant payments of liabilities not
related to the ongoing operating expenses, significant decrease in deferred
revenues largely due to the recognition of revenues in 2003 which were deferred
at December 31, 2002, and an increase in accounts receivable due to a slight
slowdown in collections on certain contracts due to them reaching completion and
reconciling. The Company expects to fully collect the balance of accounts
receivable at June 30, 2003.
The Company used net cash of $316,000 in discontinued operations during
the six months ended June 30, 2003.
20
During the six months ended June 30, 2003, the Company provided
$602,000 from investing activities, of which $87,000 was used for capital
expenditures and $151,000 was used for the development of the Company's suite of
video software solutions, offset by proceeds of $800,000 from the sale of the
DIVArchive Medical operations and proceeds of $40,000 from the sale of fixed
assets. During the six months ended June 30, 2002, the Company used $94,000 in
investing activities, of which $50,000 was used for capital expenditures and
$44,000 was used for the development of the Company's suite of video software
solutions.
The Company provided $576,000 from financing activities during the six
months ended June 30, 2003, which consisted of $645,000 in proceeds from the
issuance in April 2003 of notes payable, offset by principal repayments made on
notes payable and capital leases of $69,000. During the six months ended June
30, 2002, financing activities provided $650,000, which consisted of $600,000 of
borrowings on notes payable and $50,000 of proceeds from the issuance of 400,000
shares of unregistered common stock to an individual investor.
The Company expects capital expenditures to be approximately $0.5
million during the next twelve months. 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
sales and marketing strategy. The amount of spending in each respective area is
dependent upon the total capital available to the Company.
The Company expects that anticipated cash flow from operations combined
with its cash and cash equivalents at August 14, 2003 will be sufficient to
operate for at least the next 12 months. However, continued operating losses and
the early stage of the Company's business, as well as potential changes in the
business and competitive environment, continue to present a significant risk to
the Company's long-term success. 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. 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.
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.
(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.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
On or about March 21, 2003, Giancarlo Gaggero, a former employee of the Company,
and Data Strategies International, Inc., a company owned and controlled by Mr.
Gaggero, filed a suit against the Company in the District Court of Harris
County, Texas alleging breach by the Company of an asset purchase and related
agreements between Data Strategies and the Company and breach by the Company of
an employment agreement between Mr. Gaggero and the Company. Mr. Gaggero's
employment with the Company was terminated on March 5, 2003. The plaintiffs seek
monetary damages of approximately $253,000 plus interest and costs and a
declaration that they are excused from performance under the agreements from and
after January 2001. The Company responded to the complaint on April 17, 2003 and
requested that the case be moved from state court to federal court jurisdiction.
The Company believes certain of the claims are without merit, with respect to
which the Company intends to defend the action vigorously, and is considering
certain counterclaims against the plaintiffs in addition to the action taken by
the Company described below. An outcome in this litigation that is adverse to
the Company, costs associated with defending the lawsuit and the diversion of
management's time and resources to defend the lawsuit could seriously harm the
Company's business and its financial condition. On July 30, 2003, the Company
filed suit in the District Court of Denton County, Texas against Mr. Gaggero and
one of his associates seeking damages relating to claims of defamation and
business disparagement, tortious interference with business relations, breach of
fiduciary duty and breach of contract.
In addition to the proceeding described above, the Company is involved in
certain other disputes that arise in the ordinary course of business. The
Company believes that no current dispute will have a material adverse effect on
its financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
In April 2003, the Company issued $645,000 aggregate principal amount of 8%
unsecured convertible promissory notes (the "8% Notes") to a group of investors
primarily consisting of existing shareholders and management. See Note 3 in the
Notes to Consolidated Financial Statements and Item 2. Management's Discussion
and Analysis or Plan of Operations for further information.
In April 2003, $250,000 aggregate principal amount of outstanding convertible
notes and all accrued interest were converted into 6,785,715 shares of common
stock and the remaining $250,000 principal amount of the outstanding convertible
notes was exchanged for 8% Notes. See Note 3 in the Notes to Consolidated
Financial Statements and Item 2. Management's Discussion and Analysis or Plan of
Operations for further information.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
The following exhibits are filed herewith:
(a) Exhibits
10.1 Employment Agreement dated as of June 1, 2003 between
the Company and Michael Knaisch.
10.2 Employment Agreement dated as of June 1, 2003 between
the Company and Matthew Richman.
31.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
22
31.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Current Reports on Form 8-K or 8-K/A
None
23
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: August 19, 2003 FRONT PORCH DIGITAL INC.
By: /s/ MICHAEL KNAISCH
-----------------------------
Michael Knaisch
Chief Executive Officer
(principal executive officer)
By: /s/ MATTHEW RICHMAN
-----------------------------
Matthew Richman
Chief Financial Officer and Treasurer
(principal financial and accounting officer)
Certification of Principal Executive Officer
Pursuant to 18 U.S.C. 1350
(SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002)
I, Michael Knaisch, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Front Porch Digital
Inc.;
2. Based on my knowledge, this 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
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
By: /s/ MICHAEL KNAISCH
----------------------
Name: Michael Knaisch
Title: Chief Executive Officer
August 19, 2003
Certification of Principal Financial Officer
Pursuant to 18 U.S.C. 1350
(SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002)
I, Matthew Richman, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Front Porch Digital
Inc.;
2. Based on my knowledge, this 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
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
By: /s/ MATTHEW RICHMAN
----------------------
Name: Matthew Richman
Title: Chief Financial Officer
August 19, 2003