-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KztL+DKsalDnUzhUwJfx+lQu5/3I08dHFcd8/IkKFJXAovdRF3QLrAdRwmLEAomA O0rdDhKB5ww7PunwxU2mqg== 0001157523-04-010789.txt : 20041115 0001157523-04-010789.hdr.sgml : 20041115 20041115163039 ACCESSION NUMBER: 0001157523-04-010789 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041115 DATE AS OF CHANGE: 20041115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL FUSION INC/NJ/ CENTRAL INDEX KEY: 0001057257 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 133817344 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-24073 FILM NUMBER: 041145697 BUSINESS ADDRESS: STREET 1: 4940-A CORPORATE DRIVE CITY: HUNTSVILLE STATE: AL ZIP: 35805 BUSINESS PHONE: 2568372620 MAIL ADDRESS: STREET 1: 4940-A CORPORATE DRIVE CITY: HUNTSVILLE STATE: AL ZIP: 35805 FORMER COMPANY: FORMER CONFORMED NAME: IBS INTERACTIVE INC DATE OF NAME CHANGE: 19980306 10QSB 1 a4765145.txt DIGITAL FUSION ================================================================================ 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| ================================================================================ 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: 11 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. 12 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. 13 (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"). 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: November 15, 2004 By: /s/ ROY E. CRIPPEN, III --------------------------------------- Name: Roy E. Crippen, III Title: Chief Executive Officer Principal Executive Officer) 15 EX-31.1 2 a4765145ex311.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Roy E. Crippen, III certify that: 1. I have reviewed this quarterly report on Form 10-QSB of Digital Fusion, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as the end of the period covered by this report based on such evaluation; and c) disclosed in this any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons fulfilling the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 15, 2004 By: /s/ Roy E. Crippen, III ------------------------------ Roy E. Crippen, III Chief Executive Officer EX-32.1 3 a4765145ex321.txt CERTFICATION EXHIBIT 32.1 WRITTEN STATEMENT OF THE CHIEF EXECUTIVE OFFICER Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 Solely for the purposes of complying with 18 U.S.C. ss.1350, I, the undersigned President and Chief Executive Officer of Digital Fusion, Inc. (the "Company"), hereby certify, based on my knowledge, that the Quarterly Report on Form 10-QSB of the Company for the quarter ended September 30, 2004 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: November 15, 2004 By: /s/ Roy E. Crippen, III ------------------------ Roy E. Crippen, III -----END PRIVACY-ENHANCED MESSAGE-----