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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 June 30, 2004. (Second quarter of
fiscal 2004)
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 (I.R.S. Employer I.D. No.)
of Incorporation or Organization)
4940-A CORPORATE DRIVE
HUNTSVILLE, AL 35805
(Address of Principal Executive Offices)
(256) 837-2620
(Issuer's Telephone Number, Including Area Code)
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 July 27, 2004, 7,984,904 shares of the issuer's common stock, par
value $.01 per share, were outstanding.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
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DIGITAL FUSION, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of June 30, 2004
(unaudited) and December 31, 2003.................................................. 1
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 2004 and 2003 (unaudited)...................... 2
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2004 and 2003 (unaudited)................................ 3
Notes to Condensed Consolidated Financial Statements............................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................................... 6
ITEM 3. CONTROLS AND PROCEDURES............................................................ 10
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.................................................................. 11
ITEM 2. CHANGES IN SECURITIES.............................................................. 11
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................................... 11
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................ 11
ITEM 5. OTHER INFORMATION.................................................................. 11
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................... 13
SIGNATURES.................................................................................. 14
SECTION 302 CERTIFICATION BY CHIEF EXECUTIVE OFFICER
SECTION 906 CERTIFICATION BY CHIEF EXECUTIVE OFFICER
EXHIBITS
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
DIGITAL FUSION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
ASSETS 2004 2003
----------- ------------
(UNAUDITED)
Current assets:
Cash and cash equivalents $ 444 $ 419
Accounts receivable (net of allowance for doubtful
accounts of $90 in 2004 and 2003) 1026 737
Other current assets 83 39
-------- --------
Total current assets 1,553 1,195
Property and equipment, net 20 29
Intangible assets, net 3,347 3,347
Other assets 13 13
-------- --------
Total assets $ 4,933 $ 4,584
======== ========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 834 $ 658
Current maturities of long-term debt 1,237 46
Deferred revenue 21 21
-------- --------
Total current liabilities 2,092 725
Interest payable - long term 62 39
Long-term debt, less current maturities 27 1,269
Pension obligation 295 295
-------- --------
Total liabilities 2,476 2,328
-------- --------
Stockholders' equity:
Common stock, $.01 par value, authorized 16,000,000 shares,
7,984,904 issued and outstanding 80 72
Additional paid in capital 40,434 39,919
Accumulated deficit (38,057) (37,735)
-------- --------
Total stockholders' equity 2,457 2,256
-------- --------
Total liabilities and stockholders' equity $ 4,933 $ 4,584
======== ========
See Accompanying Notes to Condensed Consolidated Financial Statements.
1
DIGITAL FUSION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- -------------------------
2004 2003 2004 2003
------- ------- ------- -------
Revenues:
Consulting $ 1,165 $ 1,576 $ 2,446 $ 3,188
Product 471 58 676 58
------- ------- ------- -------
Total revenue 1,636 1,634 3,122 3,246
------- ------- ------- -------
Cost of services and goods sold:
Consulting 959 1,151 1,902 2,485
Product 444 55 633 55
------- ------- ------- -------
Total cost of services and goods sold 1,403 1,206 2,535 2,540
------- ------- ------- -------
Gross profit 233 428 587 706
------- ------- ------- -------
Operating expenses:
Selling 93 72 190 181
General & Administrative 334 467 647 950
------- ------- ------- -------
Total operating expenses 427 539 837 1,131
------- ------- ------- -------
Operating income (loss) (194) (111) (250) (425)
Interest expense, net 39 53 73 105
------- ------- ------- -------
Income (loss) before income taxes (233) (164) (323) (530)
Income tax benefit -- -- -- --
------- ------- ------- -------
Net income (loss) $ (233) $ (164) $ (323) $ (530)
======= ======= ======= =======
Basic earnings (loss) per share $ (0.03) $ (0.02) $ (0.04) $ (0.07)
======= ======= ======= =======
Basic weighted average common shares outstanding 7,985 7,168 7,985 7,168
======= ======= ======= =======
Diluted earnings (loss) per share $ (0.03) $ (0.02) $ (0.04) $ (0.07)
======= ======= ======= =======
Diluted weighted average common shares outstanding 7,985 7,168 7,985 7,168
======= ======= ======= =======
See Accompanying Notes to Condensed Consolidated Financial Statements.
2
DIGITAL FUSION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
------ ------
Cash flows used in operating activities:
Net loss $(323) $(530)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 36 121
Changes in assets and liabilities (131) 70
----- -----
Net cash used in operating activities (418) (339)
----- -----
Cash flows used in investing activities:
Capital expenditures - property and equipment (4) (2)
Net cash used in investing activities (4) (2)
----- -----
Cash flows used in financing activities:
Repayments of notes payable: (6) (160)
Net proceeds from equity sale 453 256
----- -----
Net cash used in financing activities 447 96
----- -----
Net decrease in cash and cash equivalents 25 (245)
Cash and cash equivalents, beginning of periods 419 653
----- -----
Cash and cash equivalents, end of periods $ 444 $ 408
===== =====
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," or the "Company") 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, 2003 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 six months ended June 30,
2004 are not necessarily indicative of the results of operations and cash flows
expected for the year ended December 31, 2004.
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 $395,000 and $403,000 for the years ended 2003 and 2002 respectively
and cash flow deficiencies of $107,000 and $1,026,000 during 2003 and 2002
respectively. These items raise substantial doubt about the Company's ability to
continue as a going concern. However, because of the actions the Company has
taken to restructure and streamline the Company, the completion of its equity
sale, the payment in full of its outstanding debt to its primary lender, and the
establishment of a line of credit with a local bank, management believes it
currently has enough cash to meet its funding requirements over the next year.
The Company's current growth has been funded through internally generated funds,
the completion of its equity sale, and its line of credit. In order for the
Company to support substantial growth, it may need to obtain other externally
generated funds. There can be no assurance as to the availability of such
funding, and if available, whether the terms would be acceptable to the Company.
The Company accounts for stock-based compensation under the intrinsic value
method of accounting for stock-based compensation and, in the table below has
disclosed pro forma net income and earnings per share amounts using the fair
value based method prescribed by Statement of Financial Accounting Standards
("SFAS") No. 123 "Accounting for Stock Based Compensation". The Company has
implemented the disclosure provisions of SFAS No. 148, ACCOUNTING FOR
STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE. During the three-month
period ended June 30, 2004, 572,000 stock options were granted to employees.
4
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
------------- ------------ ------------ -----------
Net (loss), as reported $ (233,392) $ (164,000) $ (323,117) $ (530,000)
Total stock-based employee compensation
expense included in reported net income
applicable to common stockholder, net
of tax -- -- -- --
Total stock-based employee compensation
determined under fair value based
method, net of related tax effects $ (51,962) $ (79,000) $ (75,056) $ (158,000)
------------- ------------ ------------ -----------
Pro forma net (loss) (285,354) (243,000) (398,173) (688,000)
============= ============ ============ ===========
Earnings per share
Basic - as reported $ (0.03) $ (0.02) $ (0.04) $ (0.07)
============= ============ ============ ===========
Basic - pro forma $ (0.04) $ (0.03) $ (0.05) $ (0.10)
============= ============ ============ ===========
Diluted - as reported $ (0.03) $ (0.02) $ (0.04) $ (0.07)
============= ============ ============ ===========
Diluted - pro forma $ (0.04) $ (0.03) $ (0.05) $ (0.10)
============= ============ ============ ===========
The preceding pro forma results were calculated with the use of the
Black-Scholes option-pricing model. The following assumptions were used for the
periods ended June 30, 2004 and 2003, respectively.
2004 2003
----- -----
Risk-free interest rate 4.43% 3.52%
Dividend yield 0% 0%
Expected life - years 10 10
Volatility 59% 62%
2. LOSS PER SHARE DATA
Common stock equivalents in the three and six month periods ended June 30,
2004 and June 30, 2003, were anti-dilutive due to the net losses sustained by
the Company during these periods. Therefore, the diluted weighted average common
shares outstanding in these periods are the same as the basic weighted average
common shares outstanding.
5
3. INCOME TAXES
The Company has not recognized an income tax benefit for its operating
losses generated in the three and six-month periods ended June 30, 2004 and 2003
based on uncertainties concerning its ability to generate taxable income in
future periods. The tax benefit for the three and six-month periods ended June
30, 2004 and 2003 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. DEBT RESTRUCTURING
On January 15, 2004, the note to PowerCerv was paid by Digital Fusion's
President and CEO, Roy E. Crippen, III, tendering to PowerCerv $110,000 in cash
and 25,000 shares of PowerCerv preferred stock. In consideration therefor,
Digital Fusion issued a note to Mr. Crippen for approximately $137,000
(representing the amount of principal and interest on the PowerCerv note at the
time of its retirement). The note bears an interest rate of prime plus 6% and is
payable at $600 per month plus interest for the first twelve months, $4,400 per
month plus interest for the next eleven months, and a balloon payment of
approximately $81,000 plus interest on January 15, 2006. Subject to a
subordination agreement with Digital Fusion's primary lender, the note was
secured by a security interest in property owned or later acquired by the Debtor
(Digital Fusion) to secure the prompt payment and performance of all
liabilities, obligations, and indebtedness of the Debtor under the note.
On April 7, 2004, the Company restructured its outstanding note with its
primary lender to suspend monthly payments until February 2005. The note bore an
interest rate of 10% with monthly payments due on the first day of each month of
$50,000 plus interest commencing on February 1, 2005 until the maturity date of
January 1, 2006. In addition, the Company paid an amendment fee of $25,000 to
the note-holder that is being amortized to interest expense over the life of the
loan. In relation to the first note, the note-holder was given the right to
convert the principal portion of the note and/or interest due and payable into
fully paid and non-assessable shares of common stock of the Company at the fixed
conversion price of $0.922. In relation to the second note, the note-holder was
given the right to convert the principal and/or interest due and payable into
fully paid and non-assessable shares of common stock of the Company at the fixed
conversion price of $0.35.
On April 22, 2004 and on May 11, 2004, the Company's primary lender
exercised its right to convert principal and/or interest into fully paid and
non-assessable shares of common stock of Digital Fusion, Inc. at the fixed
conversion price of $0.35. With both the transactions, the primary lender
converted $35,000 of the principal, of which no interest is owed, to 100,000
shares of common stock. The conversion was deemed to constitute a conversion of
outstanding principal amount to be applied against subsequent amounts to be
paid. In addition, the lender issued a "rebate credit" for every dollar in
principal amount converted equal to the amount of time in years and fractions
thereof from the closing date, as defined in the Securities Purchase Agreement,
to the conversion date times four percent (4%) that was applied as a reduction
in the monthly amount due.
6
On May 11, 2004, Digital Fusion and Madison Run, LLC completed an equity
sale whereby Madison Run bought 608,108 shares of Digital Fusion common stock at
$0.74 per share, was issued a five year warrant to purchase 304,054 shares of
Digital Fusion common stock at $0.89 per share, and was issued a five year
warrant to purchase 212,839 shares of Digital Fusion common stock at $0.94 per
share. Digital Fusion President, Mr. Gary Ryan, is a member of the Madison Run
investment group and personally invested $100,000 in the offering.
5. SUBSEQUENT EVENTS
On July 1, 2004, Digital Fusion fully redeemed the approximately $560,000
secured convertible debt with its primary lender and entered into a secured
revolving line of credit with a local bank. The line of credit has an interest
rate of prime plus one percent, is secured by the Company's receivables and
certain guarantees, and is not to exceed $800,000.
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, the Company or its 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, readers are cautioned 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 the Company's control, include, but are not limited to, those set
forth in the Company's Form 10-KSB for 2003 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
Digital Fusion, Inc. is an information technology ("IT") consulting firm
that helps its customers maximize the use of modern technology to access
business information, enhance the performance of their human resources, and meet
various business needs. The Company's success is based on a total approach that
provides the people, processes, and technology needed to translate business
needs into sound IT strategies. Services are provided to business organizations
and public sector institutions primarily in the Eastern United States. The
Company is incorporated in Delaware with its main administrative office located
in Huntsville, Alabama and regional offices in Florida, New Jersey, and
Virginia.
7
Revenues are derived primarily from fees earned in connection with the
performance of services provided to customers. The Company typically invoices on
a time and materials basis. The majority of costs are associated with personnel.
Attracting and retaining billable employees is vital for the Company to move
forward. 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 because of
holidays and vacations. During the second quarter of 2003, the Company began
reselling the Intuit product Track-It!. All 2003 and 2004 Track-It! Product
sales were to governmental entities where margins are lower.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THE THREE AND SIX MONTHS
ENDED JUNE 30, 2003
REVENUES. Consulting revenues decreased by $411,000 to $1.2 million and
742,000 to $2.4 million for the three and six months ended June 30, 2004. Over
50% of the decrease in revenues was due to the reduction in sales to the
Company's largest consulting customer with the remainder due to projects being
completed without others available to replace them. Revenue from Digital
Fusion's largest professional services customer was responsible for 19% of its
revenue in 2004 as compared to 29% in 2003. The Company expects its revenues to
increase during the remainder of 2004 as compared to 2003 due to the expansion
of its federal services market and to certain identified new opportunities.
During the second quarter of 2003, the Company began reselling the Intuit
product Track-It! to governmental organizations. Revenues for the three and six
months ended June 30, 2004, were $471,000 and $676,000 respectively, as compared
to $58,000 for the three and six months ending June 30, 2003.
COST OF SERVICES AND GOODS SOLD. Cost of services consists primarily of
salaries and expenses of programming and technical personnel, expenses related
to applications sold to customers, and fees paid to outside consultants engaged
for customer projects. Cost of services decreased by $193,000 to $958,000 and
$583,000 to $1.9 million for the three and six months ended June 30, 2004. The
decrease is due to a reduction in head count in conjunction with the revenue
decrease from 2003 to 2004. The Company expects its cost of services in 2004 to
increase proportionally to its increase in revenues.
The cost of goods sold of $445,000 and $633,000 for the three and six
months ended June 30, 2004 is related to the reselling of the Intuit product
Track-It! that began in the second quarter of 2003.
GROSS PROFIT. Gross profit for services during the second quarter of 2004
is $206,000 or 18% of services revenues as compared to $425,000, or 27% of
services revenues for the second quarter of 2003. Gross profit for services for
the six-month period ended June 30, 2004 was $544,000 or 22% of services
revenues as compared to $703,000 or 22% of services revenues for the same period
in 2003. The decrease in services gross profit as a percent of services revenues
is due to decreased sales without a corresponding decrease in direct labor
costs.
8
The gross profit for product was $27,000 or 6% and 3,000 or 5% for the
quarter ending June 30, 2004 and 2003 respectively. Gross profit for product for
the six-month period ended June 30, 2004 and 2003 was $43,000 or 6% and 3,000 or
5% respectively. The consistent and low profit margin on product sales is
attributable to the low mark-up required on sales to governmental entities.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expenses consist primarily of salaries and expenses associated with
marketing, accounting, finance, sales, and administrative personnel, as well as
professional fees and other corporate costs associated with the administration
of the company. SG&A expenses decreased by $112,000, or 21%, for the three-month
period ended June 30, 2004 compared to the same period during 2003, and $294,000
or 26% for the six-month period ended June 30, 2004 compared to the same period
during 2003. The decrease in SG&A is due to the corporate headquarters move from
Tampa, Florida to Huntsville, Alabama, which resulted in the decrease of
corporate personnel and related salaries and benefits, and a decrease in
facilities, communications, and insurance expense. In addition, depreciation
expense decreased because of certain assets becoming fully depreciated. SG&A
costs are expected to increase during 2004 with the expansion of the Company's
federal services market and certain identified new opportunities that require
additional accountability.
INTEREST EXPENSE (INCOME), NET. Interest expense decreased from $53,000 in
the second quarter of 2003 to $39,000 for the second of 2004. The decrease was
due primarily to the reduction in debt to the Company's primary lender.
INCOME TAX BENEFIT. The Company has not recognized an income tax benefit
for its operating losses generated in the three and six-month periods ended June
30, 2004 and 2003 based on uncertainties concerning its ability to generate
taxable income in future periods. The tax benefit for the three and six-month
periods ended June 30, 2004 and 2003 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 $233,000 and $323,000
for the three and six-month periods ended June 30, 2004, respectively, compared
to a net loss of $164,000 and $530,000 for the three and six-month periods ended
June 30, 2003, respectively. Although revenues remained fairly constant during
the three and six-month period ended June 30, 2004 and 2003 and expenses in
general decreased, the mix of sales and cost of sales between services and
product caused the net loss to increase during the second quarter of 2004.
LIQUIDITY AND CAPITAL RESOURCES
The net cash used in operating activities was $418,000 in 2004 compared to
$339,000 during 2003 due to the Company's expenses exceeding its revenues.
Net cash used in investing activities was $4,000 during 2004, which was
used to invest in computer equipment for the Company's operations. The Company
does not expect to have significant equipment purchases during the remainder of
2004.
9
Net cash provided by financing activities was $447,000. During the first
quarter of 2004, the Company restructured its short-term debt to refinance its
note to PowerCerv with Mr. Roy E. Crippen, III, Digital Fusion's CEO, and to
suspend principal payments to its primary lender until February 2005.
On May 11, 2004, Digital Fusion and Madison Run, LLC completed an equity
sale whereby Madison Run bought 608,108 shares of Digital Fusion common stock at
$0.74 per share for a total of $450,000, was issued a five year warrant to
purchase 304,054 shares of Digital Fusion common stock at $0.89 per share, and
was issued a five year warrant to purchase 212,839 shares of Digital Fusion
common stock at $0.94 per share. Digital Fusion President, Mr. Gary Ryan, is a
member of the Madison Run investment group and personally invested $100,000 in
the offering.
Working capital at June 30, 2004 is negative $177,000. The net accounts
receivable balance outstanding at June 30, 2004 is $1.0 million. The Company has
funded its cash needs through consistent collections of accounts receivable and
current operations and through the convertible note issued by its primary lender
in July 2002 and restructured in April 2003 and 2004 and with the completion of
its equity sale to Madison Run, LLC.
On July 1, 2004, Digital Fusion fully redeemed the approximately $560,000
secured convertible debt with its primary lender and entered into a secured
revolving line of credit with a local bank. The line of credit has an interest
rate of prime plus one percent, is secured by the Company's receivables and
certain guarantees, and is not to exceed $800,000.
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. In addition, the federal services market is expected to increase with
the employment of Gary Ryan as the Company's president on May 5, 2004.
The Company believes that, because of these actions and the actions it has
taken to reorganize and streamline the Company, the completion of its equity
sale, the payment in full of its outstanding debt to its primary lender, and the
establishment of a line of credit with a local bank, it currently has enough
cash to meet its funding requirements over the next year. In order for the
Company to support substantial growth, it may need to obtain other externally
generated funds. There can be no assurance as to the availability of such
funding, and if available, whether the terms would be acceptable to the Company.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that have a significant impact on
the results reported in the financial statements. Some of the accounting
policies require management to make difficult and subjective judgments, often
because of the need to make estimates of matters that are inherently uncertain.
Digital Fusion's most critical accounting policies include accounts receivable
reserves and the valuation of goodwill. Actual results may differ from the
estimates under different assumptions or conditions. These policies are
discussed further, as well as the estimates and judgments involved:
10
ACCOUNTS RECEIVABLE RESERVE. The Company's accounts receivable is reduced
by $90,000 for an allowance for amounts that may become uncollectible in the
future. The estimated allowance for uncollectible amounts is based on a specific
analysis of accounts in the receivable portfolio and a general reserve based on
the aging of receivables and historical write-off experience. The Company's
management believes the allowance to be reasonable. The Company does not accrue
interest on past due accounts receivable.
VALUATION OF GOODWILL. Goodwill is reviewed annually for impairment or more
frequently if impairment indicators arise. This annual impairment test is
performed in the last quarter of each fiscal year. The goodwill impairment test
requires a comparison of the fair value of the Company to the amount of goodwill
recorded. If this comparison reflects impairment, then the loss would be
measured as the excess of recorded goodwill over its implied fair value.
Although the Company's management believes that the estimates and assumptions
used are reasonable, actual results could differ.
ITEM 3. CONTROLS AND PROCEDURES.
a. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Under the supervision
and with the participation of the Company's management, including the Company's
principal executive officer, the Company conducted an evaluation of the
effectiveness of the design and operations of its disclosure controls and
procedures, as such term is defined in Rules 13a-1(e) and 15(d)-15(e) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end
of the period covered by this report. Based on their evaluation, the principal
executive officer concluded that the disclosure controls and procedures were
effective such that the material information required to be included in the
Company's Securities and Exchange Commission ("SEC") reports is recorded,
processed, summarized, and reported within the time-periods specified in SEC
rules and forms relating to Digital Fusion, Inc., particularly during the period
when this report was being prepared.
b. CHANGES IN INTERNAL CONTROLS. There were no significant changes in the
Company's internal controls or to management's knowledge, in other factors that
could significantly affect the disclosure controls and procedures subsequent to
the Evaluation Date.
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.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The following matters were submitted to a vote of security holders during the
Company's annual meeting of shareholders held on July 28, 2004:
Votes Authority
Cast For Withheld
-------- ---------
1. Election of Directors:
Nicholas R. Loglisci, Jr. 5,643,485 367,621
Roy E. Crippen, III 5,645,585 365,521
O.G. Greene 5,640,385 370,721
Gary S. Ryan 5,645,725 365,381
Broker
For Against Abstentions Non-Votes
----- ------- ------------ ---------
2. Ratification of
Pender Newkirk & Company
as independent accountants 5,645,405 364,151 1,550 0
ITEM 5. OTHER INFORMATION.
EXECUTIVE AGREEMENTS
CRIPPEN EMPLOYMENT AGREEMENT. On May 5, 2004, The Company entered into a
subsequent agreement with Mr. Crippen for a period of two-years under which Mr.
Crippen continues to be employed to serve as our chief executive officer. Mr.
Crippen relinquished the title of president upon the commencement of Mr. Ryan's
employment with the Company to serve as our president. Under his employment
agreement, Mr. Crippen is eligible to receive an annual salary of $140,200 and a
monthly allowance of $125 to cover the cost of telephone expense. Under his
employment agreement, Mr. Crippen will be eligible for performance bonuses under
the executive compensation plan. Mr. Crippen is also eligible to participate in
our employee benefit plans, and receive three weeks vacation.
Under his employment agreement, Mr. Crippen is required to keep all
confidential information of DFI confidential, and for the period of his
employment, plus an additional one-year period following termination of his
employment, Mr. Crippen is not allowed to compete with DFI.
We are allowed to terminate Mr. Crippen's employment agreement at any time,
provided that, if his employment is terminated due to his death, disability, or
by us other than for cause (as defined in the agreement) he is entitled to six
months base salary and continuation of employee benefits for a period of six
months.
RYAN EMPLOYMENT AGREEMENT. On May 5, 2004, we entered into a two-year
employment agreement with Mr. Ryan under which Mr. Ryan is employed to serve our
president, which became May 5, 2004, respectively. Under his employment
agreement, Mr. Ryan is eligible to receive an annual salary of $130,000; a
monthly allowance of $125 to cover the cost of telephone expense; an option to
purchase a total of 450,000 shares of our common stock at an exercise price per
share of $0.81. A portion of the vesting shall be performance based. The vesting
will occur as follows: 1) 150,000 shares shall vest 100% immediately upon grant
of the option; 2) 150,000 shares shall vest 100% immediately upon the following
occurrence: If the Company's trailing four (4) quarters revenue is more than $15
million with minimum net income of $1 million OR if the Company's trailing four
(4) quarters' earnings is more than $1.5 million. Revenue and earnings shall be
based on GAAP; however, they shall be adjusted to eliminate extraordinary
one-time events such as expensing acquisition costs or revenue associated with
an acquisition; and 3) 150,000 shares shall vest 100% immediately upon the
following occurrence: If the Company's trailing four (4) quarters revenue is
more than $25 million with minimum net income of $1.75 million OR if the
Company's trailing four (4) quarters' earnings is more than $2.5 million.
Revenue and earnings shall be based on GAAP; however, they shall be adjusted to
eliminate extraordinary one-time events such as expensing acquisition costs or
revenue associated with an acquisition.
Under his employment agreement, Mr. Ryan will be eligible for performance
bonuses under the executive compensation plan. Mr. Ryan is also eligible to
participate in our employee benefit plans, and receive three weeks vacation.
Under his employment agreement, Mr. Ryan is required to keep all confidential
information of DFI confidential, and for the period of his employment, plus an
additional one-year period following termination of his employment, Mr. Ryan is
not allowed to compete with DFI.
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We are allowed to terminate Mr. Ryan's employment agreement at any time,
provided that, if his employment is terminated due to his death, disability, or
by us other than for cause (as defined in the agreement) he is entitled to six
months base salary and continuation of employee benefits for a period of six
months.
WILLIAMS EMPLOYMENT AGREEMENT. On May 4, 2004, we entered into a two-year
employment agreement with Mr. Williams under which Mr. Williams is employed to
serve as our vice president of federal services and operations. Under his
employment agreement, Mr. Williams is eligible to receive an annual salary of
$127,400 and a monthly allowance of $100 to cover the cost of telephone expense
Under his employment agreement, Mr. Williams will be eligible for
performance bonuses under the executive compensation plan. Mr. Williams is also
eligible to participate in our employee benefit plans, and receive three weeks
vacation. Under his employment agreement, Mr. Williams is required to keep all
confidential information of DFI confidential, and for the period of his
employment, plus an additional one-year period following termination of his
employment, Mr. Williams is not allowed to compete with DFI.
We are allowed to terminate Mr. Williams's employment agreement at any
time, provided that, if his employment is terminated due to his death,
disability, or by us other than for cause (as defined in the agreement) he is
entitled to six months base salary and continuation of employee benefits for a
period of six months.
Under the employment agreements, each is entitled to compensation if he is
employed by us at the time of a change in control and his or her employment is
terminated within one year after that change in control by us for a reason other
than for cause, death, legal incapacity of disability (as defined in the
employment agreement) or by the executive for good reason (as defined in the
employment agreement). In such event, he would receive a lump-sum payment equal
to one half the amount of his or her base salary then in effect plus any other
amounts accrued and unpaid as of the date of termination (i.e., earned bonuses,
car allowance, unreimbursed expenses, and any other amount due to him under
employee benefit or fringe benefit plans of the Company).
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS
The following is a list of Exhibits filed as a part of this Report.
EXHIBIT NO. DESCRIPTION
*10.1 Employment Agreement, dated as of May 5, 2004, by and between Digital
Fusion and Roy E. Crippen, III.
*10.2 Employment Agreement, dated as of May 5, 2004, by and between Digital
Fusion and Gary S. Ryan.
*10.3 Employment Agreement, dated as of May 4, 2004, by and between Digital
Fusion and Jeffrey L. Williams.
*10.4 Subscription Agreement, dated as of May 11, 2004, by and between
Digital Fusion and Madison Run LLC.
*10.5 Form of Warrant to Purchase Shares of Common Stock, dated as of May 11,
2004
**10.6 Loan Agreement, security agreements and guarantees, each dated June 20,
2004, among First Commercial Bank of Huntsville and the Company, for a
$800,000 revolving line of credit.
**31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
**32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. (This exhibit shall not be deemed "filed"
for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liability of that section.
Further, this exhibit shall not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933, as amended,
or the Securities Exchange Act of 1934, as amended.)
- ---------------
* Incorporated by reference.
** Filed herewith.
+ Management contract or compensatory plan or arrangement.
(B) REPORTS ON FORM 8-K.
1. Form 8-K filed March 16, 2004 pursuant to Item 12 (Results of
Operations and Financial Condition), announcing Registrant's financial
results for the fourth quarter and fiscal year ended December 31, 2003
and certain other information.
2. Report on Form 8-K filed April 30, 2004 pursuant to Item 5 (Other
Events and Regulation FD Disclosure), announcing the appointment by the
Board of Directors of Gary S. Ryan as a director and incoming President
and the letter of intent to make an equity investment in the Company by
Madison Run, LLC.
3. Form 8-K filed August 16, 2004 pursuant to Item 12 (Results of
Operations and Financial Condition), announcing the Registrant's
financial results for the second quarter ended June 30, 2004 and
certain other information.
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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: August 16, 2004
By: /s/ Roy E. Crippen, Iii
-----------------------------------------
Name: Roy E. Crippen, III
Title: Chief Executive Officer
(Principal Executive Officer)
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