U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended September 30, 2002
(Third quarter of fiscal 2002)
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the
transition period from_____________ to __________________
Commission File No. 0-24073
DIGITAL FUSION, INC.
(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 13-3817344
(State or Other Jurisdiction of (I.R.S. Employer I.D. No.)
Incorporation or Organization)
400 North Ashley Drive
Suite 2600
Tampa, FL 33602
(Address of Principal Executive Offices)
(813) 221-0024
(Issuer's Telephone Number, Including Area Code)
- -------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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, 7,164,436 shares of the issuer's common stock, par
value $.01 per share, were outstanding.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
DIGITAL FUSION, INC.
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2002 (unaudited) and
December 31, 2001.................................................................. 1
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2002 and 2001 (unaudited)............................................ 2
Condensed Consolidated Statements of Cash Flows for the nine months ended September
30, 2002 and 2001 (unaudited)...................................................... 3
Notes to Condensed Consolidated Financial Statements............................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
8
Item 3. Controls and Procedures............................................................. 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 13
Item 2. Changes in Securities............................................................... 13
Item 3. Defaults Upon Senior Securities..................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders................................. 13
Item 5. Other Information................................................................... 13
Item 6. Exhibits and Reports on Form 8-K.................................................... 14
SIGNATURES.................................................................................. 14
Certification by Chief Executive Officer.................................................... 15
Certification by Chief Financial Officer.................................................... 16
Exhibits.................................................................................... 17
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
DIGITAL FUSION, INC.
Condensed Consolidated Balance Sheets
(in thousands)
September 30,
2002 December 31,
ASSETS unaudited 2001
----------------- ----------------
Current assets:
Cash and cash equivalents $ 696 $ 1,350
Accounts receivable (net of allowance for doubtful
accounts of $340 in 2002 and 2001) 1,313 1,963
Other current assets 135 20
----------------- ----------------
Total current assets 2,144 3,333
Property and equipment, net 272 495
Intangible assets, net 4,547 4,547
Other assets 77 74
----------------- ----------------
Total assets $ 7,040 $ 8,449
================= ================
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,200 $ 1,681
Accrued liabilities on sale of discontinued operations 15 437
Accrued severance and restructuring expenses 119 883
Current maturities of long-term debt 762 233
Deferred revenue 26 132
----------------- ----------------
Total current liabilities 2,122 3,366
Accrued liabilities on sale of discontinued operations - long term - 1,103
Accrued severance and restructuring expenses - long term - 187
Interest payable - long term 73 -
Long-term debt, less current maturities 666 709
Pension obligation 124 124
Acquisition liabilities 71 71
----------------- ----------------
Total liabilities 3,056 5,560
----------------- ----------------
Stockholders' equity:
Common stock, $.01 par value, authorized 16,000,000 shares,
7,163,936 shares issued and outstanding 72 72
Additional paid in capital 39,833 39,754
Accumulated deficit (35,921) (36,937)
----------------- ----------------
Total stockholders' equity 3,984 2,889
----------------- ----------------
Total liabilities and stockholders' equity $ 7,040 $ 8,449
================= ================
See Accompanying Notes to Condensed Consolidated Financial Statements.
1
DIGITAL FUSION, INC.
Condensed Consolidated Statements of Operations
For the three and nine months ended September 30, 2002 and 2001
(unaudited, in thousands, except per share amounts)
Three months ended September 30, Nine months ended September 30,
---------------------------------- ---------------------------------
2002 2001 2002 2001
------------------ --------------- ---------------- ----------------
Revenues $ 2,131 $ 3,383 $ 7,497 $ 14,016
Cost of services 1,696 2,561 5,771 10,823
------------------ --------------- ---------------- ----------------
Gross profit 435 822 1,726 3,193
------------------ --------------- ---------------- ----------------
Operating expenses:
Selling, general and administrative 724 1,036 2,438 4,440
Amortization of intangible assets - 870 - 2,906
Severance and restructuring - - (182) 518
Gain on forgiveness of debt (46) (95) (1,585) (95)
------------------ --------------- ---------------- ----------------
Total operating expenses 678 1,811 671 7,769
------------------ --------------- ---------------- ----------------
Operating income (loss) (243) (989) 1,055 (4,576)
Interest expense (income), net 18 23 39 56
Loss on disposal of assets, net - 12 - 223
------------------ --------------- ---------------- ----------------
Income (loss) before income taxes (261) (1,024) 1,016 (4,855)
Income tax benefit - - - -
------------------ --------------- ---------------- ----------------
Net income (loss) $ (261)$ (1,024) $ 1,016 $ (4,855)
================== =============== ================ ================
Basic earnings (loss) per share $ (0.04)$ (0.14) $ 0.14 $ (0.70)
================== =============== ================ ================
Basic weighted average common shares outstanding 7,164 7,137 7,164 6,910
================== =============== ================ ================
Diluted earnings (loss) per share $ (0.04)$ (0.14) $ 0.13 $ (0.70)
================== =============== ================ ================
Diluted weighted average common shares outstanding 7,164 7,137 7,693 6,910
================== =============== ================ ================
See Accompanying Notes to Condensed Consolidated Financial Statements.
2
DIGITAL FUSION, INC.
Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 2002 and 2001
(unaudited, in thousands)
2002 2001
---------------- -----------------
Cash flows used in operating activities
Net income (loss) $ 1,016 $ (4,855)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 246 3,420
Gain on forgiveness of debt (1,585) (95)
Non-cash restructuring (136) 459
Loss on disposal of assets, net - 223
Changes in assets and liabilities (632) (89)
---------------- -----------------
Net cash used in operating activities (1,091) (937)
Cash flows used in investing activities:
Capital expenditures - property and equipment (23) (27)
Proceeds from assets sold - 550
---------------- -----------------
Net cash provided by (used in) investing activities (23) 523
Cash flows provided by (used in) financing activities:
Repayments of notes payable (257) (204)
Net proceeds from note issued 717 -
---------------- -----------------
Net cash used in financing activities 460 (204)
---------------- -----------------
Net decrease in cash and cash equivalents (654) (618)
Cash and cash equivalents, beginning of periods 1,350 1,557
---------------- -----------------
Cash and cash equivalents, end of periods $ 696 $ 939
================ =================
See Accompanying Notes to Condensed Consolidated Financial Statements.
3
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated interim financial statements of Digital Fusion,
Inc. ("DFI," the "Company," "we," or "us") have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission with respect to Form 10-QSB. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures made herein are adequate to make the information contained
herein not misleading. These condensed consolidated interim financial statements
should be read in conjunction with the Company's audited financial statements
for the year ended December 31, 2001 and the notes thereto included in the
Company's Annual Report on Form 10-KSB. In the Company's opinion, all
adjustments (consisting only of normal recurring adjustments and reclasses)
necessary for a fair presentation of the information shown herein have been
included.
The results of operations and cash flows for the three and nine months
ended September 30, 2002 are not necessarily indicative of the results of
operations and cash flows expected for the year ending December 31, 2002.
The accompanying financial statements have been prepared on the assumption
that the Company will continue as a going concern. The Company has incurred
losses of $11,412,000 and $18,062,000 for the years ended 2001 and 2000,
respectively and cash flow deficiencies from operations of $513,000 and
$6,837,000 in 2001 and 2000, respectively. During the nine months ended
September 30, 2002, the Company had net income of $1,016,000 (net loss of
$569,000 excluding gain on forgiveness of debt) and cash flow deficiencies from
operations of $1,091,000. These factors raise substantial doubt about the
ability of the Company to continue as a going concern. The financial statements
do not include any adjustments that may result from the outcome of this
uncertainty. The ability of the Company to continue as a going concern is
dependent upon obtaining cash flow from external sources, increasing revenue and
decreasing costs.
Management is currently building relationships where DFI would be the
service provider in the relationship. During October 2002, DFI was awarded its
five-year information technology schedule by the U.S. General Services
Administration (GSA), which makes DFI's services readily available to federal
agencies. Management continues to review its cost structure and continues to
reduce costs. The Company's current operations have been funded through
internally generated funds. On July 26, 2002, the Company completed an $800,000
secured convertible debt financing. In order for the Company to support growth,
the Company may need to fund this growth through additional externally generated
funds. The Company continues to review its options, which include additional
debt, equity raise or a combination of both. However, there can be no assurance
that the Company's efforts to increase revenues and reduce expenses will result
in operating profits or positive cash flows from operations and there can be no
assurance as to the availability or terms upon which such financing and capital
might be available or if at all.
4
2. Loss Per Share Data
Common stock equivalents in the three-month period ended September 30, 2002
and the three- and nine- month periods ended September 30, 2001, were
anti-dilutive due to the net losses sustained by the Company during these
periods, thus the diluted weighted average common shares outstanding in these
periods are the same as the basic weighted average common shares outstanding.
3. Income Taxes
The Company has not recognized an income tax benefit for its operating
losses generated in the three- and nine-month periods ended September 30, 2002
and 2001 based on uncertainties concerning its ability to generate taxable
income in future periods. The tax benefit for the three- and nine-month periods
ended September 30, 2002 and 2001 is offset by a valuation allowance established
against deferred tax assets arising from operating losses and other temporary
differences, the realization of which could not be considered more likely than
not. In future periods, tax benefits and related deferred tax assets will be
recognized when management considers realization of such amounts to be more
likely than not.
4. Related Party Transaction
The Company entered into a consulting services agreement with PowerCerv
Technologies, Inc. (PowerCerv) where the Company provides consulting services to
PowerCerv at $100 per hour for 275 hours. DFI recorded deferred revenue of
$27,500 during the first quarter of 2002 related to this agreement. The $27,500
was paid to PowerCerv by reducing the note payable owed to PowerCerv. As of
September 30, 2002, there was no deferred revenue balance remaining.
5. Goodwill
On January 1, 2002, the Company adopted the Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets.
SFAS 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets. SFAS 142 requires, among other things, that companies
no longer amortize goodwill, but instead test goodwill for impairment at least
annually. The Company tested goodwill for impairment as of February 2002
determining that no impairment loss was necessary. The Company will continue to
test goodwill for impairment at least annually. Goodwill was $4.5 million as of
September 30, 2002, and was unchanged for the three and nine months then ended.
The Company recorded amortization of $870,000 and $2,906,000 for the three and
nine months ended September 30, 2001, respectively. In accordance with SFAS 142,
the Company discontinued amortization of goodwill as of January 1, 2002. The
impact of the adoption of SFAS No. 142 for the three- and nine-month periods
ended September 30, 2002 and 2001 are summarized as follows:
5
Three months ended Nine months ended
September 30, September 30,
------------------------- ---------------------
2002 2001 2002 2001
------------ ------------ ---------- ----------
Reported net income (loss) $ (261) $ (1,024) $ 1,016 $ (4,855)
Add back: Goodwill amortization - 870 - 2,906
------------ ------------ ---------- ----------
Adjusted net income (loss) (261) (154) 1,016 (1,949)
============ ============ ========== ==========
Basic earnings (loss) per share
Reported earnings (loss) per share $ (0.04) $ (0.14) $ 0.14 $ (0.70)
Goodwill amortization - 0.12 - 0.42
------------ ------------ ---------- ----------
Adjusted earnings (loss) per share $ (0.04) $ (0.02) $ 0.14 $ (0.28)
============ ============ ========== ==========
Basic weighted average common shares
outstanding 7,164 7,137 7,164 6,910
============ ============ ========== ==========
Diluted earnings (loss) per share
Reported earnings (loss) per share $ (0.04) $ (0.14) $ 0.13 $ (0.70)
Goodwill amortization - 0.12 - 0.42
------------ ------------ ---------- ----------
Adjusted earnings (loss) per share $ (0.04) $ (0.02) $ 0.13 $ (0.28)
============ ============ ========== ==========
Diluted weighted average common shares
outstanding 7,164 7,137 7,693 6,910
============ ============ ========== ==========
6. Recently Issued Accounting Pronouncements
On January 1, 2002, the Company adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses the financial
accounting and reporting for the impairment of long-lived assets, excluding
goodwill and intangible assets, to be held and used or disposed of. The adoption
of SFAS 144 did not have an impact on the Company's financial position or
results of operations.
On April 1, 2002, the Company adopted SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 rescinded the following pronouncements: SFAS 4, Reporting
Gains and Losses from Extinguishment of Debt; SFAS 64, Extinguishments of Debt
Made to Satisfy Sinking-Fund Requirements; and SFAS 44, Accounting for
Intangible Assets of Motor Carriers. In addition, SFAS 145 amends SFAS 13,
Accounting for Leases and makes technical corrections and amendments to various
existing pronouncements. The adoption of SFAS 145 resulted in the Company
classifying the gain on forgiveness of debt as part of income from operations on
the Company's Condensed Consolidated Statements of Operations.
7. Forgiveness of Debt and Severance and Restructuring
During the three and nine months ended September 30, 2002, the Company
reached settlement agreements on some debts associated with offices that were
closed, business units that were sold and services not used, which resulted in
forgiveness of debt of $46,000 and $1,585,000, respectively. After the
settlements of these debts, the Company reduced its Severance and Restructuring
liability by $182,000 for the nine-month period ended September 30, 2002, based
upon its current estimates of its remaining liabilities associated with its 2001
restructurings.
6
The adoption of SFAS 145 resulted in the Company classifying the gain on
forgiveness of debt as income from operations instead of an extraordinary gain
on the Company's Condensed Consolidated Statements of Operations. Prior periods
have been reclassified to conform to the adoption of SFAS 145. This
reclassification had no effect on net income for any period.
8. Reclass of Income Statement Accounts
To conform to the presentation in 2002, revenues and cost of goods sold
were increased for the three- and nine-month periods ended September 30, 2001 in
the consolidated income statement to include travel and entertainment expenses
billed to customers. This reclassification had no effect on net income for any
period.
9. Secured convertible note
On July 26, 2002, the Company closed on an $800,000, 10% convertible note
collateralized by the Company's accounts receivable. After ninety days, the
Company pays principal and interest on a monthly basis. This note matures on
January 25, 2004. At the noteholder's election, this note can be converted into
DFI common stock at $0.922 a share after the DFI common stock price is at or
above $1.15 a share for ten consecutive days. Additionally, a five-year warrant
to purchase 75,000 shares of DFI common stock at $1.15 per share was issued and
resulted in additional equity of $12,000 being recorded for the fair market
value of these warrants. The Company paid a management fee of $40,000 to the
noteholder, which will be amortized to interest expense over the 18-month life
of the note.
10. Subsequent event
On October 28, 2002, the Company was notified by The Nasdaq Stock Market,
Inc. that its common stock has failed to maintain a minimum bid price of $1.00
over the last 30 consecutive trading days as required by The Nasdaq SmallCap
Market listing requirements. The letter states that the Company will have
180-days or until April 28, 2003 to regain compliance by maintaining a minimum
closing bid price of $1.00 per share for 10 consecutive trading days. Following
this initial 180 calendar day grace period, if the Company can demonstrate net
income of at least $750,000 in either its latest fiscal year or in two of its
last three fiscal years, stockholders' equity of $5 million or a market
capitalization of at least $50 million, the Company will be given an additional
180-day grace period or until October 25, 2003 to regain compliance.
On November 12, 2002, the Company renegotiated the terms of notes due to
certain former digital fusion, inc. (Florida based company) shareholders
totaling $$440,000. The interest rate increased from 6% to 8%. The maturity date
was extended from March 1, 2003 to March 1, 2005. The accrued interest was
converted into principal in the amended notes. These renegotiated notes and
related interest are classified as long-term liabilities on the September 30,
2002 balance sheet.
7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This Quarterly Report on Form 10-QSB contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). In addition, from time to time, we or our representatives have made or
may make other forward-looking statements orally or in writing. Such statements
may include, without being limited to, statements concerning anticipated
financial performance, future revenues or earnings, business prospects,
projected ventures, new products, anticipated market performance and similar
matters. The words "plan," "budget, "intend," "anticipate," "project,"
"estimate," "expect," "may," "might," "believe," "potential," "could," "should,"
"would" and similar statements are intended to be among the statements that are
forward-looking statements. The Private Securities Litigation Reform Act of 1995
provides a safe harbor for forward-looking statements. In order to comply with
the terms of the safe harbor, we caution our readers that, because such
statements reflect the reality of risk and uncertainty that is inherent in doing
business, actual results may differ materially from those expressed or implied
by such forward-looking statements. These risks and uncertainties, many of which
are beyond our control, include, but are not limited to, those set forth in the
Company's Form 10-KSB for 2001 in the Management's Discussion and Analysis of
Financial Condition and Results of Operations under the heading "Certain Factors
Which May Affect the Company's Future Performance" which are incorporated herein
by reference. Readers are cautioned not to place undue reliance on these
forward-looking statements, which are made as of the date of this report. Except
as otherwise required to be disclosed in periodic reports required to be filed
by companies registered under the Exchange Act by the rules of the SEC, the
Company has no duty and undertakes no obligation to update such statements.
Overview
DFI is an information technology ("IT") consulting company helping our
customers use technology to access business information and enhance the
performance of their human resources and meet their business needs. We provide a
broad range of services in business process and application strategy and
development, including Enterprise Application Solutions, IT Consulting and IT
Support and integration. We are a Delaware corporation and our main
administrative office is located in Tampa, Florida, along with regional offices
in Alabama, Florida, New Jersey, New York and Virginia. We provide our services
to businesses, organizations and public sector institutions primarily in the
Eastern United States.
Our revenues are derived principally from fees earned in connection with
the performance of services provided to customers. We typically bill on a time
and materials basis. The majority of our costs are associated with personnel.
Attracting and retaining billable personnel will be important for our Company
going forward. Our quarterly operating results are affected by the number of
billable days in the quarter, holiday seasons and vacations. Demand for the
Company's services has historically been lower during the fourth quarter as a
result of holidays and vacations.
Our success is based on a total approach, providing the people, processes,
and technology needed to translate business needs into sound IT strategies. This
total approach is driven by the vision and diverse skills of our people,
talented professionals who view projects from a wider perspective. They
understand that no successful project is developed in isolation. We transform
technology into complete solutions through our integrated multi-disciplinary
services, including Information Technology Consulting, Business Application
Development and IT Support and Integration.
8
On January 1, 2002, the Company adopted the Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets.
SFAS 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets. SFAS 142 requires, among other things, that companies
no longer amortize goodwill, but instead test goodwill for impairment at least
annually. The Company tested goodwill for impairment as of February 2002
determining that no impairment loss was necessary. The Company will continue to
test goodwill for impairment at least annually. Goodwill was $4.5 million as of
September 30, 2002. The Company recorded amortization of $870,000 and $2,906,000
for the three and nine months ended September 30, 2001, respectively. In
accordance with SFAS 142, the Company discontinued amortization as of January 1,
2002.
On January 1, 2002, the Company adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses the financial
accounting and reporting for the impairment of long-lived assets, excluding
goodwill and intangible assets, to be held and used or disposed of. The adoption
of SFAS 144 did not have an impact on our financial position or results of
operations.
On April 1, 2002, the Company adopted SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 rescinded the following pronouncements: SFAS 4, Reporting
Gains and Losses from Extinguishment of Debt; SFAS 64, Extinguishments of Debt
Made to Satisfy Sinking-Fund Requirements; and SFAS 44, Accounting for
Intangible Assets of Motor Carriers. In addition, SFAS 145 amends SFAS 13,
Accounting for Leases and makes technical corrections and amendments to various
existing pronouncements. The adoption of SFAS 145 resulted in the Company
classifying the gain on forgiveness of debt as part of income from operations on
the Company's Condensed Consolidated Statements of Operations.
There are no new litigation issues.
Results of Operations
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE THREE AND
NINE MONTHS ENDED SEPTEMBER 30, 2001
REVENUES. Revenues decreased by $1,252,000 to $2,131,000 for the three
months ended September 30, 2002 and decreased $6,519,000 to $7,497,000 for the
nine months ended September 30, 2002. The decrease in revenues during the three
and nine months ended 2002 compared to the same period in the prior year was
primarily due to the business divisions and offices that were shut down or sold
during our 2001 restructuring. Approximately $900,000 and $2,200,000 of the
decrease in revenue during the three and nine months ended September 30, 2002,
respectively, was due to the softening of the IT consulting market over the last
year. Revenue from our largest professional services customer was responsible
for 24% of our revenue in 2002 as compared to 25% in 2001. We expect our
revenues to continue to be lower during the remainder of 2002 as compared to
2001 due to the business divisions and offices that were shut down or sold
during 2001.
9
COST OF SERVICES. Cost of services consists primarily of salaries and
expenses of engineering, programming and technical personnel, expenses relating
to cost of equipment and applications sold to customers and fees paid to outside
consultants engaged for customer projects. Cost of services decreased by
$865,000 for the three months ended September 30, 2002 compared to the prior
year and $5,052,000 for the nine months ended September 30, 2002 compared to the
prior year. As our revenues decreased due to the business units and offices that
were shut down or sold during 2001 and the softening of the IT consulting market
over the last year, we reduced our services headcount, which reduced our cost of
services. We expect our cost of services to continue to be lower during the
remainder of 2002 as compared to 2001 due to the reduced services headcount from
business units and offices that were shut down or sold and lower than expected
revenue due to the softening of the IT consulting market over the last year.
GROSS PROFIT. Our gross profit for the third quarter during 2002 was
$435,000, or 20% of revenues as compared to $822,000, or 24% of revenues for the
third quarter of 2001. This decrease in gross profit as a percent of revenues is
due to the lower utilization rate of the billable consultants for 2002 compared
to the same period in 2001.
The gross profit for the nine-month period ended September 30, 2002 was
$1,726,000, or 23% of revenues and $3,193,000, or 23% of revenues for the
nine-month period ended September 30, 2001. The Company's gross profit in actual
dollars decreased $1,467,000 due to the decrease in revenue discussed above.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
(SG&A) expenses consist primarily of salaries and expenses associated with
marketing literature, advertising, direct mailings, and accounting, finance,
sales and administrative personnel, as well as professional fees and other costs
associated with being a public company and the administration of DFI. Selling,
general and administrative expenses decreased by $312,000, or 30%, for the
three-month period ended September 30, 2002 compared to the same period during
2001. SG&A decreased $2,002,000 or 45% for the nine-month period ended September
30, 2002 compared to the same period during 2001. The decrease in SG&A is
primarily due to the administrative headquarters move from New Jersey to Florida
during January 2001 and the reduction of costs related to the business units
that were sold and offices closed during 2001 and the April 2001 restructuring.
We expect our selling, general and administrative costs to be lower during the
remainder of 2002 as compared to 2001.
AMORTIZATION OF INTANGIBLE ASSETS. We implemented SFAS 142 on January 1,
2002 and in accordance with SFAS 142, we discontinued amortization of goodwill
as of January 1, 2002. The amortization recorded for the three- and nine- month
periods ended September 30, 2001 was $870,000 and $2,906,000, respectively. In
accordance with SFAS 142, there will be no amortization of goodwill during the
remainder of 2002.
SEVERANCE AND RESTRUCTURING. We reduced our Severance and Restructuring
liability by $182,000 for the nine-month period ending September 30, 2002 based
upon our current estimates of our remaining liabilities associated with our 2001
restructurings.
During April 2001, the Company took additional cost reduction and
restructuring steps to become profitable. We closed our Detroit facility and
reduced our sales and general and administrative management headcount by 21
employees. As a result, we recognized a severance and restructuring expense of
$518,000 in April 2001. This is comprised of $456,000 relating to the closing of
the office, and $62,000 relating to severance, benefits and entitlements.
10
GAIN ON FORGIVENESS OF DEBT. During the three and nine months ended
September 30, 2002, the Company reached settlement agreements on some debts
associated with offices that were closed, business units that were sold and
services not used, which resulted in forgiveness of debt of $46,000 and
$1,585,000, respectively. For the three and nine months ended September 30,
2001, the Company recognized $95,000 of forgiveness of debt related to
settlement agreements.
INTEREST EXPENSE (INCOME), NET. Interest expense in 2002 and 2001 consists
of interest payments and accruals on indebtedness in connection with the
acquisition of digital fusion, inc (a Florida corporation). On July 26, 2002,
the Company completed an $800,000 secured convertible debt financing which will
increase its 2002 interest expense over prior 2002 quarters. Net interest
expense was $18,000 and $23,000 for the three months ended September 30, 2002
and 2001, respectively and $39,000 and $56,000 for the nine months ended
September 30, 2002 and 2001, respectively.
LOSS ON DISPOSAL OF ASSETS, NET. During April 2001, the Company sold its
web hosting and non-dial-up internet access business to Veraciti, Inc. for
$200,000 cash and $60,000 worth of services to complete certain customer
projects. In addition, Veraciti assumed certain lease obligations of the Company
related to the web hosting and non-dial-up internet access business and
subleased 4,000 square feet of the Cedar Knolls office space. The Company
recorded a $211,000 loss related to this sale. Veraciti is owned by Frank
Altieri, a former member of the DFI Board of Directors.
During July 2001, the Company sold its network services and installation
business unit to Spectrum Solutions, Inc. ("Spectrum") for $350,000 and Spectrum
assumed certain lease obligations of the Company related to this network
services and installation business unit. In July 2001, the Company recorded a
$12,000 loss related to this sale.
INCOME TAX BENEFIT. The Company has not recognized an income tax benefit
for its operating losses generated in the three- and nine-month periods ended
September 30, 2002 and 2001 based on uncertainties concerning its ability to
generate taxable income in future periods. The tax benefit for the three- and
nine-month periods ended September 30, 2002 and 2001 is offset by a valuation
allowance established against deferred tax assets arising from operating losses
and other temporary differences, the realization of which could not be
considered more likely than not. In future periods, tax benefits and related
deferred tax assets will be recognized when management considers realization of
such amounts to be more likely than not.
NET INCOME (LOSS). The Company incurred a net loss of $261,000 and
$1,024,000 for the three and nine months ended September 30, 2002, respectively.
The Company adopted FASB 142 effective January 1, 2002, which requires the
Company to discontinue amortizing its goodwill. Thus, no goodwill amortization
was recorded during 2002. The Company recorded goodwill amortization of $870,000
for the three months ended September 30, 2001. The net loss for this same period
excluding this goodwill amortization would have been $154,000.
The Company recorded net income of $1,016,000 (net loss of $569,000
excluding gain on forgiveness of debt) and net loss of $4,855,000 for the nine
months ended September 30, 2002 and 2001, respectively. As discussed above, no
goodwill amortization was recorded during 2002. The Company recorded goodwill
amortization of $2,906,000 for the nine months ended September 30, 2001. The net
loss for this same period excluding this goodwill amortization would have been
$1,949,000. The reduction of the net loss from the nine months ended September
30, 2001 compared to the same period in 2002 is due to the factors discussed
above.
11
Liquidity and Capital Resources
The net cash used in operating activities was $1,091,000 in 2002. During
the nine months ended September 30, 2002 DFI paid approximately $720,000 related
to restructuring liabilities and accrued liabilities on sale of discontinued
operations.
Net cash used in investing activities was $23,000 during 2002 and was used
to invest in equipment for the Company's operations. The Company does not expect
to have significant equipment purchases during the remainder of 2002.
Financing activities provided cash and cash equivalents of $460,000 in
2002. In July 2002, DFI completed an $800,000 secured convertible debt
financing, which resulted in net cash received of $717,000 after fees and
financing costs which was reduced by principal payments made on the note payable
owed to PowerCerv of $257,000. DFI paid the December 31, 2002 and March 31, 2003
debt service payments early on the PowerCerv note during the third quarter to
receive a $31,000 discount. The next payment owed on the PowerCerv note is due
June 2003.
Our working capital at September 30, 2002 is $22,000. Our net accounts
receivable balance outstanding at September 30, 2002 is $1,313,000. Our cash and
cash equivalents is $696,000. Currently the Company is funding its cash needs
through consistent collections of accounts receivable and current operations. On
July 26, 2002, the Company completed an $800,000 secured convertible debt
financing, which resulted in net proceeds of $717,000 after certain fees and
costs were deducted.
The accompanying financial statements have been prepared on the assumption
that the Company will continue as a going concern. The Company has incurred
losses of $11,412,000 and $18,062,000 for the years ended 2001 and 2000,
respectively and cash flow deficiencies from operations of $513,000 and
$6,837,000 in 2001 and 2000, respectively. During the nine months ended
September 30, 2002, the Company had net income of $1,016,000 (net loss of
$569,000 excluding gain on forgiveness of debt) and cash flow deficiencies from
operations of $1,091,000. These factors raise substantial doubt about the
ability of the Company to continue as a going concern. The financial statements
do not include any adjustments that may result from the outcome of this
uncertainty. The ability of the Company to continue as a going concern is
dependent upon obtaining cash flow from external sources, increasing revenue and
decreasing costs.
Management is currently building relationships where DFI would be the
service provider in the relationship. During October 2002, DFI was awarded its
five-year information technology schedule by the U.S. General Services
Administration (GSA), which makes DFI's services readily available to federal
agencies. Management continues to review its cost structure and continues to
reduce costs. The Company's current operations have been funded mainly through
internally generated funds. On July 26, 2002, the Company completed an $800,000
secured convertible debt financing which will be used for working capital. The
Company continues to review its options, which includes additional debt, equity
raise or a combination of both. However, there can be no assurance that the
Company's efforts to increase revenue and reduce expenses will result in
operating profits or positive cash flows from operations and there can be no
assurance as to the availability or terms upon which such financing and capital
might be available or if at all.
12
Item 3. Controls & Procedures
Within the 90 days prior to this report, the Company carried out an
evaluation, under the supervision of our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as defined in the Securities
Exchange Act Rule 15d-14(c). Based upon this evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective in timely enabling the Company to record,
process, summarize and report information required to be included in the
Company's periodic SEC filings. There have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
No legal proceedings against the Company are required to be
disclosed under this Item pursuant to the requirements of Form
10-QSB.
Item 2. Changes in Securities.
On July 26, 2002, in connection with a Securities Purchase -
Agreement that the Company entered into with Laurus Master Fund,
Ltd., a Cayman Islands company, the Company issued a Convertible
Note and Warrant to Laurus Master Fund, Ltd. pursuant to an
exemption from the registration requirements of the Securities
Act of 1933, as amended, provided under its section 4(2). The
Warrant entitles Laurus Master Fund, Ltd. to purchase up to
75,000 shares of the Company's common stock, $.01 par value per
share. The Warrant may be exercised, in whole or in part, at a
price of $1.15 per share until its expiration on July 26, 2007.
The Convertible Note is in the original principal amount of
$800,000 and bears interest at the simple annual rate of 6%. An
additional fee payable on the Convertible Note accrues at the
simple annual interest rate of 4%. The Convertible Note is
convertible into shares of the Company's common stock at the
fixed conversion price of $.922 per share provided that the
average closing price of the common stock for the 10 trading days
prior to conversion is equal to or greater than $1.15. The
proceeds from this transaction are being used for working
capital.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
13
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
*10.1 Securities Purchase Agreement, dated as of July 26, 2002,
between the Company and Laurus Master Fund, Ltd. (filed as
Exhibit 10.30 to our Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2002)
*10.2 Convertible Note, dated as of July 26, 2002, between the
Company and Laurus Master Fund, Ltd. (filed as Exhibit 10.31
to our Quarterly Report on Form 10-QSB for the quarter ended
June 30, 2002)
99.1 Written Statement of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Written Statement of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
On October 30, 2002, the Company filed a Form 8-K regarding
the notification from The Nasdaq Stock Market that its Common
Stock had failed to maintain a minimum closing bid price of
$1.00 per share over the last 30 consecutive trading days.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DIGITAL FUSION, INC.
Date: November 14, 2002
By: /s/ Roy E. Crippen, III
-----------------------------------------
Name: Roy E. Crippen, III
Title: Chief Executive Officer and President
(Principal Executive Officer)
Date: November 14, 2002
By: /s/ Karen L. Surplus
-----------------------------------------
Name: Karen L. Surplus
Title: Chief Financial Officer
(Principal Financial and Accounting Officer)
*Incorporated by reference
14
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Roy E. Crippen, III certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Digital Fusion,
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 officer 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 officer 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 officer 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.
Date: November 14, 2002 By: /s/ Roy E. Crippen, III
------------------------------
Roy E. Crippen, III
Chief Executive Officer and President
15
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Karen L. Surplus certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Digital Fusion,
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 officer 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 officer 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 officer 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.
Date: November 14, 2002 By: /s/ Karen L. Surplus
------------------------------
Karen L. Surplus
Chief Financial Officer
16