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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 March 31, 2005.
(First quarter of fiscal 2005)
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)
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 April 20, 2005, 10,804,214 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
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PART I. FINANCIAL INFORMATION Page No.
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Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2005 (unaudited) and
December 31, 2004.................................................................. 1
Condensed Consolidated Statements of Operations for the three months ended March
31, 2005 and 2004 (unaudited)...................................................... 2
Condensed Consolidated Statements of Cash Flows for the three months ended March
31, 2005 and 2004 (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.................................................................. 14
Item 2. Changes in Securities.............................................................. 14
Item 3. Defaults Upon Senior Securities.................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders................................ 14
Item 5. Other Information.................................................................. 14
Item 6. Exhibits........................................................................... 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)
March 31, December 31,
2005 2004
(Unaudited)
--------------- ----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1 $ 252
Accounts receivable and unbilled revenues (net of
Allowance for doubtful accounts of $54 for 2005 and
2004) 4,719 1,050
Prepaid expenses and other current assets 39 27
--------------- ----------------
Total current assets 4,759 1,329
Property and equipment, net of accumulated depreciation
of $999 for 2005 and $952 for 2004 507 417
Prepaid acquisition costs and acquisition deposit - 285
Intangible assets, net 7,869 3,347
Other assets 22 13
--------------- ----------------
Total assets $ 13,157 $ 5,391
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ 1,316 $ 647
Accounts payable 1,082 609
Deferred revenue 118 21
Accrued compensation and related expenses 536 97
Other current liabilities 275 266
--------------- ----------------
Total current liabilities 3,327 1,640
Long-term debt, less current maturities 4,365 81
Pension obligation 302 302
--------------- ----------------
Total liabilities 7,994 2,023
--------------- ----------------
Stockholders' Equity:
Preferred Stock - $.01 par value; authorized
1,000 shares, no shares issued and outstanding - -
Common Stock - $.01 par value; authorized
16,000 shares; 10,801 and 9,721 shares issued
and outstanding at March 31, 2005 and December 31,
2004, respectively 108 97
Additional paid in capital 43,741 42,050
Accumulated deficit (38,686) (38,779)
--------------- ----------------
Total stockholders' equity 5,163 3,368
--------------- ----------------
Total liabilities and stockholders' equity $ 13,157 $ 5,391
=============== ================
See Accompanying Notes to Condensed Consolidated Financial Statements.
1
DIGITAL FUSION, INC.
Condensed Consolidated Statements of Operations
For the three months ended March 31, 2005 and 2004
(Unaudited)
(In thousands, except per share data)
2005 2004
-------------------- ------------------
Revenues:
Services and fees $ 3,495 $ 1,268
Reimbursed costs 509 13
Product 437 205
-------------------- ------------------
Total revenue 4,441 1,486
-------------------- ------------------
Cost of services and goods sold:
Services and fees 2,663 930
Reimbursed costs 476 13
Product 422 189
-------------------- ------------------
Total cost of services and goods sold 3,561 1,132
-------------------- ------------------
Gross profit 880 354
Selling General & Administrative 638 410
-------------------- ------------------
Operating income (loss) 242 (56)
-------------------- ------------------
Other expenses:
Interest expense, net 47 34
Amortization of discount on debt and intrinsic value of
convertible debt 102 -
-------------------- ------------------
Total other expenses 149 34
-------------------- ------------------
Net income (loss) before income taxes 93 (90)
Income tax benefit - -
-------------------- ------------------
Net income (loss) $ 93 $ ( 90)
==================== ==================
Basic earnings (loss) per share $ 0.01 $ (0.01)
==================== ==================
Basic weighted average common stock shares outstanding 10,446 7,168
==================== ==================
Diluted earnings (loss) per share $ 0.01 $ (0.01)
==================== ==================
Diluted weighted average common stock shares outstanding 12,758 7,168
==================== ==================
See Accompanying Notes to Condensed Consolidated Financial Statements.
2
DIGITAL FUSION, INC.
Condensed Consolidated Statements of Cash Flows
For the three months ended March 31, 2005 and 2004
(Unaudited)
(In thousands)
2005 2004
----------------- --------------
Cash flows provided by (used in) operating activities:
Net Income (loss) $ 93 $ (90)
Adjustments to reconcile net loss to net cash used in
operating activities, net of effect of acquisition:
Depreciation and amortization 38 8
Amortization of beneficial interest 70 -
Amortization of discount on debt 32 -
Non-cash restructuring - 9
Changes in assets and liabilities (1,499) (186)
----------------- --------------
Net cash used in operating activities (1,266) (259)
----------------- --------------
Cash flows used in investing activities:
Capital expenditures - property and equipment (71) (3)
Acquisition of Summit (1,125) -
----------------- --------------
Net cash used in investing activities (1,196) (3)
----------------- --------------
Cash flows provided by (used in) financing activities:
Proceeds from exercise of options and warrants 455 -
Repayments of notes payable (166) (1)
Net proceeds from line of credit 1,922 -
----------------- --------------
Net cash provided by (used in) financing activities 2,211 (1)
----------------- --------------
Net decrease in cash and cash equivalents (251) (263)
Cash and cash equivalents, beginning of periods 252 419
----------------- --------------
Cash and cash equivalents, end of periods $ 1 $ 156
================= ==============
See Accompanying Notes to Condensed Consolidated Financial Statements.
3
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Unaudited)
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, 2004 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) necessary for a fair
presentation of the information shown herein have been included.
The results of operations and cash flows for the three-month period ended
March 31, 2005 are not necessarily indicative of the results of operations and
cash flows expected for the year ending December 31, 2005.
The Company accounts for stock-based compensation issued to employees under
the intrinsic value based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Under the intrinsic value based method,
compensation cost is measured on the date of grant as the excess of the quoted
market price of the underlying stock over the exercise price. Such compensation
amounts are amortized over the vesting periods of the options. During the
three-month period ended March 31, 2005, 749,000 stock options were granted to
employees.
The following table illustrates the effect on net loss and loss per share
as if the fair value based method of accounting had been applied to stock-based
employee compensation, as required by SFAS No. 123, "Accounting for Stock-Based
Compensation" and SFAS 148 "Accounting for Stock-Based Compensation - transition
and disclosure", an amendment of SFAS No. 123 for the three months ended March
31, 2005 and 2004 (in thousands, except per share data):
4
Three Months Ended
March 31,
---------------------------------
2005 2004
--------------- -------------
Net income (loss), as reported $ 93 $ (90)
Deduct: Fair value of stock-based employee
compensation costs (32) (23)
-------------- --------------
Pro forma net income (loss) $ 61 $ (113)
============== ==============
Basic net income (loss) per share :
As reported $ 0.01 $ (0.01)
=============== =============
Pro forma $ 0.01 $ (0.02)
=============== =============
Diluted net income (loss) per share:
As reported $ 0.01 $ (0.01)
=============== =============
Pro forma $ 0.00 $ (0.02)
=============== =============
2. Loss Per Share Data
Common stock equivalents in the three-month period ended March 31, 2004,
were anti-dilutive due to the net losses sustained by the Company during this
period. Therefore, the diluted weighted average common stock shares outstanding
in this period are the same as the basic weighted average common stock shares
outstanding.
3. Income Taxes
The income tax expense for the Company's income from operations generated
during the first quarter of 2005 was offset by a reduction in the valuation
allowance established against deferred tax assets arising from prior periods.
For the three-month period ended March 31, 2004, the Company did not recognize
an income tax benefit for its operating losses generated in that period based on
uncertainties concerning its ability to generate taxable income in future
periods. The tax benefit for the three-month period ended March 31, 2004 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
During March 2005, the Company made payments of approximately $188,000 that
was comprised of $157,000 of principal and the remaining amount was accrued
interest on certain notes outstanding. During April 2005, the Company paid
another note holder $216,996 that was comprised of $183,946 of principal and the
remaining amount was accrued interest on his note.
At March 31, 2005, the Company had two notes outstanding to the Chief
Executive Officer and on April 29, 2005, the Company refinanced these two notes
by executing a $374,304 convertible note. The convertible note bears an annual
interest rate of prime and interest is payable monthly. The CEO can convert the
note into the Company's common stock at a conversion price of $2.43 per share.
The note matures on April 29, 2007. At April 29, 2005, approximately $49,000 of
interest is owed to the CEO related to the two notes refinanced and this accrued
interest will be payable during May 2005.
5
On March 10, 2005, Digital Fusion amended its secured revolving line of
credit agreement with a local bank. The Amendment (i) extended the maturity date
to April 10, 2006, (ii) stated the rate of interest at prime, payable monthly
and (iii) secured the line of credit by the Company's receivables and certain
guarantees. The line of credit is not to exceed the lower of 80% of eligible
accounts receivable or $2.5 million.
See Note 6 below for a discussion of the debt acquired during the first
quarter of 2005 from the acquisition of Summit Research Corporation.
5. Commitments
On February 25, 2005, the Company amended the Chief Executive Officer's
employment agreement to increase his annual salary to $175,000 per year and the
employment agreement expires on February 25, 2007.
On February 25, 2005, the Company amended the Chief Operating
Officer/President's employment agreement to increase his annual salary to
$175,000 per year and the employment agreement expires on February 25, 2007.
6 Summit Acquisition
On January 3, 2005, the Company closed on its acquisition of Summit
Research Corporation ("Summit"). To purchase all of the outstanding capital
stock of Summit, the Company (a) paid $1.6 million in cash (b) issued 575,000
shares of its common stock (c) entered into a six-month note for $898,692 (6%
annual interest) and (d) executed a convertible promissory note for $2.7
million. The note holder may convert the principal portion of the convertible
note into the Company's common stock at a conversion price of $2.25 per share.
In the event the entire convertible note is converted, the note holder will
receive a total of 1.2 million shares of the Company's common stock. The annual
interest rate is 5%; however, no interest shall accrue for the first six months
and during any calendar month in which the average closing price of the publicly
traded Company's common stock is greater than $2.80 per share. The Company
recorded imputed interest of $131,000. The estimates used to determine the
imputed interest will be reviewed each quarter and adjusted as needed. The
imputed interest amount of $131,000 will be amortized to interest expense during
2005. The Company also estimated the intrinsic value of the embedded beneficial
conversion options of the $2.7 million note at $671,000. The $671,000 will be
amortized to interest expense over the life of the note.
In conjunction with this acquisition, on January 3, 2005, the Company
entered into employment agreements with two individuals with Summit. The annual
salaries for these two individuals total $310,000 per year for two years or when
the convertible note is paid off whichever is later.
The Company included the results of Summit in its financial statements
beginning January 1, 2005. The following table summarizes the estimated fair
values of the assets acquired and liabilities assumed at the date of
acquisition. The Company is in the process of evaluating the intangibles
purchased, thus the purchase price allocation has not been finalized and is
subject to change.
6
(in thousands)
Accounts receivable $ 2,354
Fixed assets 57
Other assets 313
Goodwill and other intangibles 4,522
---------------------
Total assets acquired 7,246
---------------------
Notes payable (300)
Accounts payable and accrued liabilities (1,225)
---------------------
Total liabilities assumed (1,525)
---------------------
Total purchase price $ 5,721
=====================
7. Unaudited Pro Forma Financial information for Acquisition
The following unaudited pro forma financial information presents the
combined results of operations of the Company as if the Summit acquisition had
occurred on January 1, 2004. The unaudited pro forma financial information is
not intended to represent or be indicative of the consolidated results of
operations of the Company that would have been reported had the acquisition been
completed as of the dates presented, and should not be taken as representative
of the future consolidated results of operations of the Company. Summarized
unaudited pro forma results were as follows for the three months ended March 31,
2004:
(in thousands)
Revenues $ 3,390
Net income $ 40
Basic earnings per share $ 0.01
Weighted average common stock shares outstanding 7,743
8. Other Equity Transactions
Effective March 17, 2005, Madison Run, LLC exercised warrants to purchase
354,054 shares of the Company's common stock. The Company received $333,108 from
the exercise of these warrants.
During the first quarter of 2005, employees exercised options to purchase
150,000 shares of the Company's common stock. The company received $122,600 from
the exercise of these options.
9. Reclassifications
The Company has reclassed certain amounts for the three months ending 2004
to conform to the 2005 presentation on its Condensed Consolidated Statements of
Operation.
7
10. Subsequent Events
See note 4 above for a discussion of the convertible note payable issued to
the Chief Executive Officer on April 29, 2005 for refinancing of two notes
outstanding at March 31, 2005.
During April 2005, the Company paid a note holder $216,996 that was
comprised of $183,946 of principal and the remaining amount was accrued interest
to pay off his note in full.
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 2004 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 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 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 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 an office in New Jersey and
satellite offices in Florida and Washington DC.
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. Currently, the majority of the Track-It! product sales
are to governmental entities where margins are lower.
8
With the addition of engineering services during the third quarter of 2004
and the acquisition of Summit on January 3, 2005, Digital Fusion greatly
expanded its services offerings and past performance with governmental customers
and federal prime contracts. Engineering services include the design,
development and integration of advanced sensing systems as well as aerodynamic
analysis and thermal-structural analysis. The engineering services provided by
the Summit acquisition include modeling & simulation, hardware-in-the-loop
testing, mechanical design & prototype fabrication, information technology and
information management systems, program analysis, and associated technology
transfer into production automation processes. These new services give the
Company the ability to capitalize on the increased spending by the governmental
sector due to increased military and homeland security spending.
With the addition of engineering services and the acquisition of Summit,
the Company believes it has taken the necessary steps to attain positive cash
flow from continuing operations during 2005. The Company will continue to focus
on consistent collections of accounts receivable and continued improvements in
its operational performance. Company management believes that, as a result of
these actions and assuming it can grow its client base in the private and
federal sectors, it currently has sufficient cash to meet its funding
requirements over the next year, although the Company has experienced negative
cash flows from operations and incurred large net losses in the past.
Results of Operations
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THE THREE MONTHS ENDED MARCH
31, 2004
REVENUES. Services and fees revenues increased by approximately $2.2
million to $3.5 million for the three months ended March 31, 2005 and reimbursed
costs revenue increased by approximately $496,000 to $509,000 for the same
period. The combined increase from consulting revenue and reimbursed costs
revenue was $2.7 million for the three months ending March 31, 2005 compared to
the same period in the prior year. The Summit acquisition accounted for $2.2
million of increased revenue and the newly formed engineering services accounted
for $750,000 of revenues during the first quarter of 2005. This was offset by
the reduction of revenue from the Company's IT services of approximately
$300,000 that was the result of the IT Support and Integration service being
phased out during 2004. During the first quarter of 2005, the Company's largest
customer contributed 31% of its revenue with two other customers contributing
13% and 10% of revenue each. The Company expects its services and fees and
reimbursed costs revenues to increase during the remainder of 2005 as compared
to 2004 due to the addition of engineering services and the Summit acquisition.
Revenues for the Company's products for the three months ended March 31,
2005, increased to $437,000 as compared to $205,000 for the three months ended
March 31, 2004. During the third quarter of 2004, Digital Fusion began selling
the SPI Dynamics Information Assurance product line WebInspect, which was
$101,000 of the increase. The remaining increase is due to Digital Fusion being
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 governmental agencies exclusively.
9
COST OF SERVICES AND GOODS SOLD. Cost of services includes labor, or the
salaries and wages of our employees, plus fringe benefit; and other direct
costs. Cost of services increased by $1,733,000 to $2,663,000 for the three
months ended March 31, 2005. The increase is due to the increase in revenues as
a result of the Summit acquisition and the addition of engineering services.
Reimbursed costs consist primarily of third-party materials, such as
hardware and software that we purchase for customer solutions resold to
customers and also include the costs of subcontracted labor and travel related
expenses that are reimbursed. The increase in the reimbursed costs from $13,000
for the three months ended March 31, 2004 to $476,000 for the three months ended
March 31, 2005 is primarily due to the materials that are resold to the Summit
customers. Summit was acquired on January 3, 2005; therefore, there were no cost
of materials during 2004.
Product cost of goods sold increased by $233,000 to $422,000 for the three
months ended March 31, 2005. The increase is due to the increased sales of the
Intuit product Track-It! and the newly introduced SPI Dynamics Information
Assurance product line WebInspect.
GROSS PROFIT. Gross profit for services during the first quarter of 2005 is
$832,000 or 24% of services revenues as compared to $338,000, or 27% of services
revenues for the first quarter of 2004. The decrease in services gross profit as
a percent of services revenues is primarily due to an increase in benefit costs
incurred beginning January 1, 2005, which resulted in increased costs of
$200,000 for the three months ending March 31, 2005.
Gross profit for the reimbursed costs during the first quarter of 2005 is
$33,000 or 6% of reimbursed costs revenue as compared to $-0- for the first
quarter of 2004. The reimbursed costs will have a low margin as this is
reimbursement for costs incurred with a small mark-up for handling costs, if
any.
Gross profit for product was $15,000 or 3.4% and $16,000 or 7.8% for the
quarter ending March 31, 2005 and 2004 respectively. The consistent and low
profit margin on product sales is attributable to the low mark-up permitted 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 $228,000 for the three-month period ended March
31, 2005 compared to the same period during 2004. The increase in SG&A for the
first quarter of 2005 compared to the same period during 2004 is primarily due
to the addition of engineering services and the acquisition of Summit. SG&A as a
percent of revenue was 14% and 28% for the three months ending March 31, 2005
and 2004, respectively. The Company expects its SG&A will continue to decrease
as a percent of revenue for the remainder of 2005; however, the Company expects
its SG&A actual dollars to continue to increase for the remainder of 2005
compared to the same periods in 2004 due to the addition of engineering services
and the acquisition of Summit.
10
INTEREST EXPENSE, NET. Interest expense increased from $34,000 in the first
quarter of 2004 to $47,000 for the first quarter of 2005. The increase is due to
the additional debt issued to the former Summit shareholder for the acquisition
of Summit.
AMORTIZATION OF DISCOUNT ON DEBT AND INTRINSIC VALUE OF CONVERTIBLE DEBT.
The $32,000 amortization of debt discount and $70,000 from the intrinsic value
of the convertible debt are related to the convertible debt issued to the former
Summit shareholder. The Company expects these expenses to continue throughout
2005. There were no such expenses during 2004.
INCOME TAX BENEFIT. The income tax expense for the Company's income from
operations generated during the first quarter of 2005 was offset by a reduction
in the valuation allowance established against deferred tax assets arising from
prior periods. The Company has not recognized an income tax benefit for its
operating losses generated in the three-month period ended March 31, 2004 based
on uncertainties concerning its ability to generate taxable income in future
periods. The tax benefit for the three-month period ended March 31, 2004 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 recorded net income of $93,000 for the
three-month period ended March 31, 2005, compared to a net loss of $90,000 for
the three-month period ended March 31, 2004. The increase in net income for the
first quarter of 2005 compared to the same period during 2004 is primarily the
result of the addition of engineering services and the Summit acquisition.
Liquidity and Capital Resources
Net cash used in operating activities was $1.3 million during the first
quarter of 2005. Net of unbilled revenue, the Company had an increase in
accounts receivable of $1.3 million as a result of the acquisition of Summit and
the addition of engineering services. The Company expects its accounts
receivable will continue to grow during 2005 as its revenues grow. The Company
will attempt to collect its accounts receivable as quickly as possible to
minimize this increase in accounts receivable. The largest cost of sales is for
personnel costs and this cost must be paid timely and cannot be delayed; thus as
the Company's revenues grow this will cause a use of cash in the interim period
until the revenue can be collected. The Company is able to borrow on its line of
credit up to 80% of its eligible accounts receivable to a maximum borrowing of
$2.5 million. This borrowing capability helps the Company's cash flow until the
accounts receivable are collected.
During the first quarter of 2005, the Company invested $71,000 in computer
equipment for the Company's operations. The Company does not expect to have
significant equipment purchases during the remainder of 2005.
On January 3, 2005, the Company closed on its acquisition of Summit. Under
the terms of the Summit acquisition agreement, the Company (a) paid $1.6 million
in cash (of which $500,000 was in escrow at December 31, 2004) (b) issued
575,000 shares of the Company's common stock, (c) executed a $898,692 six-month
note and (d) executed a $2.7 million convertible promissory note. The
convertible note requires a $600,000 principal payment on December 31, 2005.
11
The principal portion of the convertible note may be converted at any time
by the note holder into the Company's common stock at a conversion price of
$2.25 per share. In the event the entire convertible note is converted, the
Company would issue 1.2 million shares of the Company's common stock. No
interest will accrue for the first six months and during any calendar month in
which the average closing price of the Company's common stock is greater than
$2.80 per share.
Net cash provided by financing activities for the first quarter of 2005 was
$2.2 million. The Company received $455,000 of proceeds from the exercise of
warrants and options and $1.9 million from its line of credit. This was offset
by the payment of $166,000 to certain note holders during the first quarter of
2005. During April 2005, the Company also paid principal and interest of
$217,000 on another note. Also on April 29, 2005, the Company executed a
$374,304 convertible note payable to its CEO to refinance two notes it had
outstanding to the CEO at March 31, 2005. The Company owes the CEO $49,000 of
interest related to the two notes that were refinanced and this accrued interest
will be payable during May 2005. The interest on the convertible debt is payable
monthly with the principal due on April 29, 2007. The CEO can convert the note
into the Company's common stock at a conversion price of $2.43 per share.
Working capital at March 31, 2005 is $1.4 million. The net accounts
receivable balance outstanding at March 31, 2005 is $4.7 million. During 2005,
the Company has funded its cash needs through consistent collections of accounts
receivable, through the exercise of warrants and options and by borrowing on its
line of credit, which is secured by the Company's receivables and certain
guarantees, at an interest rate of prime.
Management is currently building relationships in which Digital Fusion
would be the service provider. 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.
Federal services revenues are expected to increase with the employment of
Gary Ryan as the Company's president during mid-2004, the addition of the
Company's engineering services during late 2004 and the acquisition of Summit
Research Corporation during January of this year.
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.
Digital Fusion's ability to grow substantially may be dependent upon
obtaining cash flow from its operations and other external sources.
The Company has taken numerous actions to restructure and streamline its
operations. Most recently, the Company added engineering services during late
2004 and acquired Summit during early 2005. The Company has also obtained a line
of credit secured with its receivables and certain guarantees. 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 exercise of warrants and options and its line of
credit. Future growth will be supported with revenue from continuing operations,
which includes the Company's new engineering services and the acquisition of
Summit, a high technology engineering firm. If the Company fails to meet its
goals, seeks to expand its operations at a level above its current cash flow
from operations, or does not collect its accounts receivable in a timely manner,
it may require an infusion of working capital the availability and terms of
which cannot be predicted.
12
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 below, as are the estimates and judgments involved:
Accounts Receivable Reserve. The Company's accounts receivable are reduced
by $54,000 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. We maintain disclosure
controls and procedures designed to ensure that material information
related to us is recorded, processed, summarized and reported in accordance
with SEC rules and forms. Our management, with the supervision of the
Chairman and Chief Executive officer, Roy E. Crippen, III, has evaluated
the effectiveness of our disclosure controls and procedures as of the end
of the period covered by this report. Based upon that evaluation, Mr.
Crippen has concluded that our disclosure controls and procedures are
effective in causing material information to be recorded, processed,
summarized and reported so as to ensure the quality and timeliness of our
public disclosures in compliance with SEC rules and forms.
b. Changes in internal controls. There was no change in our internal control
over financial reporting that occurred during our most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect our internal control over financial reporting.
13
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.
Issuance of Unregistered Securities-
- ------------------------------------
On January 3, 2005, the Company acquired all of the common stock shares of
Summit in exchange for consideration paid totaling $5,721,000, which included
issuing 575,000 shares of the Company's common which shares were valued at
$575,000. These shares were issued to a sophisticated investor. The company
relied on Section 4(2) of the Securities Act of 1933 as the basis for an
exemption from registration for this issuance.
On March 28, 2005, the Company issued 354,054 shares of its common stock
for exercises of warrants. The Company received proceeds of $270,608 for 304,054
shares of common stock at an exercise price of $0.89 per share and $62,500 for
50,000 shares of common stock at an exercise price of $1.25 per share. These
shares were issued to a sophisticated investor. The company relied on Section
4(2) of the Securities Act of 1933 and Regulation D thereunder as the basis for
an exemption from registration for this issuance.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
(a) Exhibits
The following is a list of Exhibits filed as a part of this Report.
Exhibit No. Description
- ----------- -----------
* 10.1 Convertible Promissory Note dated April 29, 2005 for $374,303.52
between Roy E Crippen, III (CEO) and the Company is incorporated
herein by reference to Exhibit 10.1 to the Form 8-K filed May 5,
2005.
* 10.2 Registration Rights Agreement dated April 29, 2005 between Roy E.
Crippen, III (CEO) and the Company in incorporated herein by
reference to Exhibit 10.2 to the Form 8-K filed May 5, 2005.
**10.3 Consultant agreement dated March 30, 2005 between Frank Libutti
and the Company to provide business development.
**10.4 Employment Agreement dated April 7, 2005 between Digital Fusion
and Christopher Brunhoeber +
**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.
14
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: May 12, 2005
By: /s/ Roy E. Crippen, III
-----------------------------------
Name: Roy E. Crippen, III
Title: Chief Executive Officer
(Principal Executive Officer)
15