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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 September
30, 2004. (Third 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 November 9, 2004, 9,636,704 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 September 30, 2004
(unaudited) and December 31, 2003.................................................. 1
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2004 and 2003 (unaudited)................ 2
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 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 ............................................................. 7
ITEM 3. CONTROLS AND PROCEDURES............................................................. 12
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................................... 12
ITEM 2. CHANGES IN SECURITIES.............................................................. 12
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................................... 12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................ 12
ITEM 5. OTHER INFORMATION.................................................................. 12
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................... 14
SIGNATURES.................................................................................. 15
SECTION 302 CERTIFICATION BY CHIEF EXECUTIVE OFFICER
SECTION 906 CERTIFICATION BY CHIEF EXECUTIVE OFFICER
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
DIGITAL FUSION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30,
2004 DECEMBER 31,
ASSETS UNAUDITED 2003
-------- -------
Current assets:
Cash and cash equivalents $ 58 $ 419
Accounts receivable (net of allowance for doubtful
accounts of $90 in 2004 and 2003) 1,208 737
Other current assets 20 39
-------- --------
Total current assets 1,286 1,195
Property and equipment, net 185 29
Intangible assets, net 3,347 3,347
Other assets 13 13
-------- --------
Total assets $ 4,831 $ 4,584
======== ========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,544 $ 658
Current maturities of long-term debt 801 46
Deferred revenue 21 21
-------- --------
Total current liabilities 2,366 725
Interest payable - long term -- 39
Long-term debt, less current maturities 40 1,269
Pension obligation 295 295
-------- --------
Total liabilities 2,701 2,328
-------- --------
Stockholders' equity:
Common stock, $.01 par value, authorized 16,000,000 shares,
7,985,404 and 7,167,671 issued and outstanding
for 2004 and 2003 respectively 80 72
Additional paid in capital 40,434 39,919
Accumulated deficit (38,384) (37,735)
-------- --------
Total stockholders' equity 2,130 2,256
-------- --------
Total liabilities and stockholders' equity $ 4,831 $ 4,584
======== ========
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, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three months ended Nine months ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
------- ------ ------- ------
Revenues:
Consulting $ 1,153 $1,484 $ 3,598 $ 4,672
Product 891 174 1,567 232
------- ------ ------- -------
Total revenue 2,044 1,658 5,165 4,904
------- ------ ------- -------
Cost of services and goods sold:
Consulting 996 1,092 2,897 3,577
Product 845 165 1,478 220
------- ------ ------- -------
Total cost of services and goods sold 1,841 1,257 4,375 3,797
------- ------ ------- -------
Gross profit 203 401 790 1,107
------- ------ ------- -------
Operating expenses:
Selling 98 70 288 250
General & Administrative 374 316 1,021 1,266
------- ------ ------- -------
Total operating expenses 472 386 1,309 1,516
------- ------ ------- -------
Operating income (loss) (269) 15 (519) (409)
Interest expense, net 58 49 131 154
------- ------ ------- -------
(Loss) before income taxes (327) (34 (650) (563)
Income tax benefit -- -- -- --
------- ------ ------- -------
Net (loss) $ (327) $ (34) $ (650) $ (563)
======= ====== ======= =======
Basic (loss) per share $ (0.04) $(0.00) $ (0.09) $ (0.08)
======= ====== ======= =======
Basic weighted average common shares outstanding 7,985 7,168 7,599 7,168
======= ====== ======= =======
Diluted (loss) per share $ (0.04) $(0.00) $ (0.09) $ (0.08)
======= ====== ======= =======
Diluted weighted average common shares outstanding 7,985 7,168 7,599 7,168
======= ====== ======= =======
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, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
----- -----
Cash flows used in operating activities:
Net loss $(650) $(563)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 72 153
Changes in assets and liabilities 371 60
----- ----
Net cash used in operating activities (207) (350)
----- ----
Cash flows used in investing activities:
Capital expenditures - property and equipment (71) (4)
----- ----
Net cash used in investing activities (71) (4)
----- ----
Cash flows used in financing activities:
Repayments of notes payable (536) (270)
Net proceeds from equity sale 453 256
----- ----
Net cash used in financing activities (83) (14)
----- ----
Net decrease in cash and cash equivalents (361) (368)
Cash and cash equivalents, beginning of periods 419 653
----- ----
Cash and cash equivalents, end of periods $ 58 $ 285
===== ====
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. ("Digital Fusion", "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 nine-month
period ended September 30, 2004 are not necessarily indicative of the
results of operations and cash flows expected for the year ending
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 $650,000 for the nine months ended
September 30, 2004, and $395,000 and $403,000 for the years ended 2003
and 2002 respectively and cash flow deficiencies of $207,000 for the
nine months ended September 30, 2004, and $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 numerous actions the Company has taken
to restructure and streamline the Company, adding an Engineering
Services Division which includes the acquisition of a high technology
engineering firm, completing two equity sales, paying in full its
outstanding debt to its former primary lender, and establishing a line
of credit with a local bank, management believes it 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 two equity sales, and its line of credit. Future growth
will be supported with revenue from continuing operations, the
Company's new Engineering Services division and the acquisition of a
high technology engineering firm.
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
September 30, 2004, 547,000 stock options were granted to employees.
4
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---------- ---------- ---------- ------------
Net (loss), as reported $(327,000) $ (34,000) $ (650,000) $ (563,000)
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 $ (61,000) $ (78,000) $ (136,000) $ (158,000)
---------- ---------- ----------- ------------
Pro forma net (loss) (388,000) (112,000) (786,000) (799,000)
========== ========== =========== ============
Earnings per share
Basic - as reported $ (0.04) $ (0.00) $ (0.09) $ (0.08)
========== ========== =========== ===========
Basic - pro forma $ (0.05) (0.02) (0.10) (0.11)
========== ========== =========== ============
Diluted - as reported $ (0.04) $ (0.00) $ (0.09) $ (0.08)
=========== ========== =========== ============
Diluted - pro forma $ (0.05) $ (0.02) $ (0.10) $ (0.11)
=========== ========== =========== ============
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 September 30, 2004 and 2003, respectively.
2004 2003
------- -------
Risk-free interest rate 4.35% 3.52%
Dividend yield 0% 0%
Expected life - years 10 10
Volatility 57% 62%
5
2. LOSS PER SHARE DATA
Common stock equivalents in the three and nine month periods
ended September 30, 2004 and September 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.
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, 2004 and 2003 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, 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 therefore, 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
is 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 will be 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.
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.
5. SUBSEQUENT EVENTS
On October 21, 2004, the Company completed its second $1.65
million equity sale with Madison Run, LLC. The financing will allow the
Company to retire certain debt, provide working capital to grow its
federal engineering services business, and provide capital to make
potential acquisitions. The financing agreement will allow Madison Run
to purchase 1.6 million shares of Digital Fusion common stock at $1.00
per share as well as the issuance of 50,000 five-year warrants to
purchase Digital Fusion common stock at $1.25 per share.
On October 28, 2004, Digital Fusion, Inc. (the "Company")
entered into a Stock Purchase Agreement (the "Agreement") with Michael
W. Wicks ("Wicks") pursuant to which Wicks agreed to sell all of his
outstanding capital stock of Summit Research Corporation ("Summit").
Under the terms of the Agreement, the Company will pay to
Wicks (a) $1,600,000 in cash at the closing of the transaction (the
"Closing"), (b) 575,000 shares of the Company's common stock as of the
Closing, (c) on the sixth month anniversary of the Closing, $600,000
cash plus an additional amount equal to the excess of Summit's tangible
net worth as of the Closing in excess of $900,000 (the "Second
Payment"). The tangible net worth of Summit as of the Closing shall be
determined by Summit's independent certified public accountants
(subject to review by the Company's independent certified public
accountants), and (d) convertible promissory note (the "Note") in the
cumulative amount of $2,700,000. To the extent that Summit's tangible
net worth as of the Closing is less than $900,000, the Note shall be
reduced by that same amount.
The principal portion of the Note may be converted at any
time by Wicks into a number of shares determined by dividing the
converted principal amount of the Note by the Conversion Price of $2.25
per share. In the event the entire Note is converted, Wicks will
receive a total of 1,200,000 shares of the Company's common stock. No
interest shall accrue on the Note during any calendar month in which
the Company's common stock is publicly traded and the average closing
price of the Company's common stock is greater than $2.80 per share.
The Closing, subject to normal closing conditions, is
scheduled for January 3, 2005.
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.
7
OVERVIEW
Digital Fusion is an information technology and engineering
services company that helps its customers make the most of technology
to meet their business needs. The Company's IT Services division
provides solutions to both government and commercial customers, focused
in the following areas: Business process Automation, Application
Development and Data Management, Application Security, Web Portals and
Digital Dashboards, System Integration and IT Support. Digital Fusion's
Engineering Services division supports a variety of customers with
state-of-the art solutions that include Computational Aerodynamics/CFD,
Optical Systems Design, Development and Test, Thermo/structural
Dynamics, Models and Simulations, and Ground/Flight Planning,
Execution, and Data Analysis. Based in Huntsville, Alabama, Digital
Fusion also has offices in Washington D.C., Orlando, and New Jersey.
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.
On September 13, 2004, Digital Fusion employed Mr. Edward G.
Rawlinson as its Vice President of Engineering Services reporting to
the Company's president and COO, Mr. Gary Ryan. Mr. Rawlinson has over
30 year experience in the ballistic missile defense industry
specializing in the analysis, development and test of missile systems.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003
REVENUES. Consulting revenues decreased by $331,000 to $1.2
million and $1.1 million to $3.6 million for the three and nine months
ended September 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 that were completed without others
available to replace them. Revenue from Digital Fusion's largest
professional services customer was responsible for 15.4% of its revenue
in 2004 as compared to 26.5% 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 the addition of its
Engineering Services Division, which will specialize in the analysis,
development, and test of missile systems.
8
During the second quarter of 2003, the Company began reselling
the Intuit product Track-It! to governmental organizations. Revenues
for the three and nine months ended September 30, 2004, increased to
$891,000 and $1.6 million respectively, as compared to $174,000 and
$232,000 for the three and nine months ending September 30, 2003.
Digital Fusion is the sole source through which Intuit can sell to
governmental entities. As the relationship between DFI and Intuit has
solidified, Intuit developed its own federal team that concentrates on
government agencies exclusively.
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 $96,000 to $996,000 and $680,000 to $2.9 million
for the three and nine months ended September 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 to
increase proportionally to its increase in revenues.
Cost of goods sold increased by $680,000 to $845,000 and $1.3
million to $1.5 million for the three and nine months ended September
30, 2004. The increase is due to the increased sales of the Intuit
product Track-It! that began in the second quarter of 2003.
GROSS PROFIT. Gross profit for services during the third
quarter of 2004 is $157,000 or 13.6% of services revenues as compared
to $392,000, or 26.4% of services revenues for the third quarter of
2003. Gross profit for services for the nine-month period ended
September 30, 2004 was $701,000 or 19.5% of services revenues as
compared to $1.1 million or 23.4% 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.
Gross profit for product was $46,000 or 5.2% and $9,000 or
5.2% for the quarter ending September 30, 2004 and 2003 respectively.
Gross profit for product for the nine-month period ended September 30,
2004 and 2003 was $89,000 or 5.7% and $12,000 or 5.2% 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 related to the administration of the company. SG&A
expenses increased $86,000, or 22.3%, for the three-month period ended
September 30, 2004 compared to the same period during 2003, and
decreased $207,000 or 13.7% for the nine-month period ended September
30, 2004 compared to the same period during 2003. The increase in SG&A
for the three-month period ended September 30, 2004 compared to the
same period during 2003 is primarily due to the $88,000 write-down of
certain liabilities in the third quarter 2003. The decrease in SG&A for
the nine-month period ended September 30, 2004 compared to the same
period during 2003 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 $132,000 because certain
assets became fully depreciated. SG&A costs are expected to increase
during 2004 with the expansion of the Company's federal services market
and the addition of its Engineering Services Division.
9
INTEREST EXPENSE, NET. Interest expense increased from $48,000
in the third quarter of 2003 to $59,000 for the third quarter of 2004.
The increase was due to certain deferred financing costs of $29,000
that were fully amortized offset by the interest savings associated
with the pay-off of the Company's debt to its former primary lender.
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, 2004 and 2003 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, 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 LOSS. The Company incurred a net loss of $327,000 and
$650,000 for the three and nine-month periods ended September 30, 2004,
respectively, compared to a net loss of $34,000 and $563,000 for the
three and nine-month periods ended September 30, 2003, respectively.
In addition to the total revenue decrease, the mix of sales between
services and product caused the net loss to increase during the third
quarter of 2004.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $207,000 in 2004
compared to $350,000 during 2003 due to the Company's expenses
exceeding its revenues.
Net cash used in investing activities was $71,000 during
2004, which was used to invest in computer equipment for the Company's
operations and office furniture for the Company's new Engineering
Services Division. The Company does not expect to have significant
equipment purchases during the remainder of 2004.
Net cash used in financing activities was $29,000. 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, 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.
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.
10
Working capital at September 30, 2004 is negative $1.1million.
The net accounts receivable balance outstanding at September 30, 2004
is $1.2 million. The Company has funded its cash needs through
consistent collections of accounts receivable, through the convertible
note issued by its former primary lender in July 2002, restructured in
April 2003 and 2004, and paid in full July 1, 2004, through the
completion of its two equity sales to Madison Run, LLC, and with
obtaining a line of credit with a local bank secured by the Company's
receivables and certain guarantees, at an interest rate of prime plus
one percent, not to exceed $800,000.
Management is currently building relationships where Digital
Fusion 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
the Company's services readily available to federal agencies.
During the third quarter 2004, Digital Fusion began selling
the SPI Dynamics Information Assurance product line WebInspect. Digital
Fusion is a Value Added Reseller (VAR) for SPI Dynamics. WebInspect
audits web based applications and determines security vulnerabilities.
Digital Fusion markets these products along with remediation services
to commercial and government customers.
The federal services market is expected to increase with the
employment of Gary Ryan as the Company's president on May 5, 2004, the
addition of the Company's Engineering Services Division and the
acquisition of Summit Research Corporation.
The Company has taken numerous actions to restructure and
streamline the Company, adding an Engineering Services Division, which
includes the acquisition of a high technology engineering firm,
completing two equity sales, paying in full its outstanding debt to its
former primary lender, and establishing a line of credit with a local
bank. Because of these actions, management believes it 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 two equity sales, and its line of credit. Future growth
will be supported with revenue from continuing operations, the
Company's new Engineering Services division and the acquisition of
Summit, a high technology engineering firm.
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:
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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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
An Annual Meeting of Stockholders of the Company was held on
July 28, 2004. At the meeting, holders of 6,011,106 shares of common
stock were present in person or by proxy, which constituted a quorum
thereof. The stockholders voted on three proposals at the Meeting, all
of which were approved. The vote of the stockholders is set forth
below:
1. Election of Directors to serve until the next Annual Meeting of
Stockholders and until their respective successors have been elected and
qualified.
Against or Broker
For withheld Non-vote
----------------- ------------- --------------
Nicholas R. Loglisci, Jr. 5,643,485 367,621 0
Roy E. Crippen, III 5,645,585 365,521 0
O.G. Greene 5,640,385 370,721 0
Gary S. Ryan 5,645,725 365,381 0
2. Ratify the appointment of Pender Newkirk & Company as the independent
auditors for the Company for the fiscal year ending December 31, 2004.
Broker
For Against Abstain Non-vote
----------------- ------------- ------------ ---------------
5,645,405 364,151 1,550 0
ITEM 5. OTHER INFORMATION.
None.
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 an $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.
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(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 first quarter ended March 31, 2004 and the completion
of the equity investment by Madison Run, LLC.
2. Form 8-K filed July 22, 2004 pursuant to Item 5 (Other Events and
Regulation FD Disclosure), announcing the redemption of its convertible
debt owed to a New York based institutional private equity fund and the
entering of a secured revolving line of credit with First Commercial
Bank in Huntsville, Alabama, an affiliate of Synovus Financial Corp.
3. Form 8-K filed August 13, 2004 pursuant to Item 12 (Results of
Operations and Financial Condition), announcing Registrant's financial
results for the second quarter ended June 30, 2004 and certain other
information.
4. Form 8-K filed September 30, 2004 pursuant to Item 8.01 (Other Events)
announcing the equity financing commitment from Madison Run, LLC and
hiring of Edward Rawlinson as VP of Engineering Services.
5. Form 8-K filed October 21, 2004 pursuant to Item 8.01 (Other Events)
announcing the completion of a $1.65 million equity financing
transaction with Madison Run, LLC.
6. Form 8-K filed October 28, 2004 pursuant to Item 1.01 (Entry Into a
Material Definitive Agreement) and Item 9.01 (Financial Statements and
Exhibits) announcing Digital Fusion, Inc. entering into a Stock
Purchase Agreement (the "Agreement") with Michael W. Wicks ("Wicks")
pursuant to which Wicks agreed to sell all of his outstanding capital
stock of Summit Research Corporation ("Summit").
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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: November 15, 2004
By: /s/ ROY E. CRIPPEN, III
---------------------------------------
Name: Roy E. Crippen, III
Title: Chief Executive Officer
Principal Executive Officer)
15