**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

** **

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**FORM 10-Q**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

** **

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001**

** **

**OR**

 
| **o** |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------|-----------------------------------------------------------------------------------------------|

** **

 

**FOR THE QUARTERLY PERIOD ENDED _______________**

 

**Commission File Number 0-25171**

** **

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**LIFEF/X, INC.**

(ExactName of registrant as Specified in its Charter)

 

| **NEVADA**                                                  |   | **84-1385529**                        |
|-------------------------------------------------------------|--------|---------------------------------------|
| (State  of Incorporation)                                   |   | (I.R.S.  Employer Identification No.) |
|                                                        |   |                                  |
| **153 NEEDHAM STREET, BUILDING ONE, NEWTON, MASSACHUSETTS** |   | **02464**                             |
| (Address  of Principal Executive Offices)                   |   | (Zip  Code)                           |
|                                                        |   |                                  |
| **(617) 964-4200**                                          |
| (Registrant's  Telephone Number)                            |

 

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Check whether theregistrant (1) filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the past 12 months (or for suchshorter 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   ý   No  o

 

As of November 9, 2001,there were 33,615,724 shares of common stock of Lifef/x, Inc. outstanding.

 

 

**LIFEF/X, INC.**

**FORM 10-Q**

**FOR THE QUARTER ENDED SEPTEMBER 30, 2001**

**TABLE OF CONTENTS**

** **

** **
| Part I - Financial  Information |
|---------------------------------|
|                            |
| Item 1.                         | Consolidated Financial  Statements |
|                            |   |
| Item  2.                        | Management's  Discussion and Analysis or Plan of Operation |
|                            |   |
| Part II - Other  Information    |
|                            |
| Item 1.                         | Legal Proceedings |
|                            |   |
| Item  4.                        | Submission  of Matters to a Vote of Security Holders |
|                            |   |
| Item 5.                         | Other Information |
|                            |   |
| Item 6.                         | Exhibits and  Reports on Form 8-K |
|                            |   |
|                            | Signatures |

 

**LIFEF/X,INC. AND SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                |   | **September  30,** |       | **December  31,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------|------------|
| Assets                                                                                                                                              |   | **2001**           |       | **2000**          |       |
|                                                                                                                                                |   | **(Unaudited)**    | ** ** |              | ** ** |
| Current  assets:                                                                                                                                    |   |               |       |              |       |
| Cash  and cash equivalents                                                                                                                          |   | $                  | 1,255,485  |              | $          | 5,150,629 |   |
| Interest  receivable                                                                                                                                |   | 9,032              |       | 17,265            |       |
| Other  receivables                                                                                                                                  |   | 34,583             |       | 4,836             |       |
| Prepaid  expenses                                                                                                                                   |   | 98,410             |       | 84,953            |       |
| Total  current assets                                                                                                                               |   | 1,397,510          |       | 5,257,683         |       |
| Property,  plant and equipment (net)                                                                                                                |   | 1,780,431          |       | 2,282,839         |       |
| Investments                                                                                                                                         |   | 217,500            |       | 217,500           |       |
| Deposits                                                                                                                                            |   | 3,910              |       | 28,910            |       |
|                                                                                                                                                |   | $                  | 3,399,351  |              | $          | 7,786,932 |   |
|                                                                                                                                                |   |               |       |              |       |
| Liabilities  and Shareholders' Equity                                                                                                               |   |               |       |              |       |
|                                                                                                                                                |   |               |       |              |       |
| Current  liabilities:                                                                                                                               |   |               |       |              |       |
| Accounts  payable and accrued expenses                                                                                                              |   | $                  | 1,460,507  |              | $          | 1,408,033 |   |
| Current  portion of capital lease obligation                                                                                                        |   | 55,637             |       | 89,232            |       |
| Deferred  Income                                                                                                                                    |   | 223,599            |       | -                 |       |
| Total  current liabilities                                                                                                                          |   | 1,739,743          |       | 1,497,265         |       |
|                                                                                                                                                |   |               |       |              |       |
| Capital  lease obligation, net of current portion                                                                                                   |   | 22,214             |       | 57,822            |       |
| Other  long-term liabilities                                                                                                                        |   | 100,723            |       | 192,597           |       |
|                                                                                                                                                |   | 1,862,680          |       | 1,747,684         |       |
| Shareholders'  equity:                                                                                                                              |   |               |       |              |       |
| Common  stock, $.001 par value.  Authorized  100,000,000 shares: issued and outstanding 33,615,724 shares (2001) and  19,207,401 shares (2000) |   | 33,615             |       | 19,207            |       |
| Additional  paid-in capital                                                                                                                         |   | 74,225,886         |       | 59,271,858        |       |
| Deferred  compensation related to stock options                                                                                                     |   | (1,369,662         | )          | (2,530,682        | )          |
| Accumulated  deficit                                                                                                                                |   | (71,353,168        | )          | (50,721,135       | )          |
| Total  shareholders' equity                                                                                                                         |   | 1,536,671          |       | 6,039,248         |       |
|                                                                                                                                                |   | $                  | 3,399,351  |              | $          | 7,786,932 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

**LIFEF/X,INC. AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
|                                                     |   | **Three  months ended September 30,** |       | **Nine  months ended September 30,** |       |
|----------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                     |   | **2001**                              |       | **2000**                             |       | **2001** |   | **2000** |   |
|                                                     |   | **(Unaudited)**                       | ** ** | **(Unaudited)**                      |       |
| Revenue                                                  |   | $                                     | 36,001     |                                 | -          |   | $ | 49,826 |   | - |   |
| Cost  of revenue                                         |   | 7,774                                 |       | -                                    |       | 7,774 |   | - |   |
| Gross  profit                                            |   | 28,227                                |       | -                                    |       | 42,052 |   | - |   |
|                                                     |   |                                  |       |                                 |       |   |   |   |   |
| Operating  costs and expenses:                           |   |                                  |       |                                 |       |   |   |   |   |
| General  and administrative                              |   | 1,903,529                             |       | 2,250,668                            |       | 5,767,681 |   | 5,077,770 |   |
| Research  and development                                |   | 1,838,185                             |       | 1,426,324                            |       | 14,989,337 |   | 3,246,924 |   |
| Total  operating costs and expenses                      |   | 3,741,714                             |       | 3,676,992                            |       | 20,757,018 |   | 8,324,694 |   |
| Loss  from operations                                    |   | (3,713,487                            | )          | (3,676,992                           | )          | (20,714,966 | ) | (8,324,694 | ) |
|                                                     |   |                                  |       |                                 |       |   |   |   |   |
| Non  operating (income) expense:                         |   |                                  |       |                                 |       |   |   |   |   |
| Interest  expense                                        |   | 14,431                                |       | 10,461                               |       | 40,213 |   | 35,127 |   |
| Other  income                                            |   | -                                     |       | -                                    |       | - |   | (3,250 | ) |
| Interest  income                                         |   | (23,290                               | )          | (177,784                             | )          | (127,446 | ) | (598,470 | ) |
| Loss  before income tax expense                          |   | (3,704,628                            | )          | (3,509,669                           | )          | (20,627,733 | ) | (7,758,101 | ) |
|                                                     |   |                                  |       |                                 |       |   |   |   |   |
| Income  tax expense                                      |   | -                                     |       | 1,011                                |       | 4,300 |   | 5,567 |   |
| Net  loss                                                |   | $                                     | (3,704,628 | )                                    | (3,510,680 | ) | (20,632,033 | ) | (7,763,668 | ) |
| Net  loss per common share on a basic and diluted basis: |   | $                                     | (0.11      | )                                    | (0.18      | ) | (0.68 | ) | (0.41 | ) |
| Weighted  average common shares outstanding              |   | 33,539,637                            |       | 19,206,881                           |       | 30,313,864 |   | 19,125,495 |   |
|                                                          |        |                                       |            |                                      |            |  |  |  |  |  |  |

 

Seeaccompanying notes to consolidated financial statements.

 

**LIFEF/X,INC. AND SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                                         |   | **Three  months ended September 30,** |       | **Nine  months ended September 30,** |       |
|----------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                         |   | **2001**                              |       | **2000**                             |       | **2001** |   | **2000** |   |
|                                                                                         |   | **(Unaudited )**                      | ** ** | **(Unaudited)**                      | ** ** |
| Cash  flows from operating activities:                                                       |   |                                  |       |                                 |       |   |   |   |   |
| Net  loss                                                                                    |   | $                                     | (3,704,628 | )                                    | $          | (3,510,680 | ) | $ | (20,632,033 | ) | $ | (7,763,668 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities:   |   |                                  |       |                                 |       |   |   |   |   |
| Depreciation  expense                                                                        |   | 217,846                               |       | 108,126                              |       | 637,753 |   | 167,351 |   |
| Noncash  professional services expense - stock and warrants                                  |   | -                                     |       | -                                    |       | 9,850,025 |   | - |   |
| Noncash  compensation expense - stock options                                                |   | 458,712                               |       | 682,869                              |       | 1,279,430 |   | 1,268,607 |   |
| Noncash  rent expense – stock warrants                                                  |   | -                                     |       | -                                    |       | - |   | 40,000 |   |
| Changes  in operating assets and liabilities:                                                |   |                                  |       |                                 |       |   |   |   |   |
| Other  receivables, prepaid expenses and other assets                                        |   | (58,305                               | )          | (73,172                              | )          | (9,971 | ) | (283,458 | ) |
| Accounts  payable, accrued expenses and other long-term liabilities                          |   | 371,912                               |       | 9,945                                |       | 184,198 |   | 338,693 |   |
| Net  cash (used in) operating activities                                                     |   | (2,714,463                            | )          | (2,782,912                           | )          | (8,690,598 | ) | (6,232,475 | ) |
|                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Cash  flows from investing activities:                                                       |   |                                  |       |                                 |       |   |   |   |   |
| Purchases  of property, plant and equipment                                                  |   | (4,372                                | )          | (809,493                             | )          | (135,344 | ) | (1,776,724 | ) |
| Net  cash (used in) investing activities                                                     |   | (4,372                                | )          | (809,493                             | )          | (135,344 | ) | (1,776,724 | ) |
|                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Cash  flows from financing activities:                                                       |   |                                  |       |                                 |       |   |   |   |   |
| Proceeds  from exercise of stock warrants                                                    |   | 1,250,000                             |       | -                                    |       | 5,000,001 |   | - |   |
| Payment  on capital lease obligations                                                        |   | (22,788                               | )          | -                                    |       | (69,203 | ) | - |   |
| Proceeds  from sale of stock through private placement related to common stock  subscribed   |   | -                                     |       | -                                    |       | - |   | 579,000 |   |
| Restricted  cash from stock subscriptions                                                    |   | -                                     |       | -                                    |       | - |   | 9,051,000 |   |
| Proceeds  from exercise of stock options                                                     |   | -                                     |       | 8,748                                |       | - |   | 195,797 |   |
| Net  cash provided by (used in) financing activities - discontinued operation                |   | -                                     |       | -                                    |       | - |   | (720,644 | ) |
| Net  cash provided by financing activities                                                   |   | 1,227,212                             |       | 8,748                                |       | 4,930,798 |   | 9,105,153 |   |
| Net  increase (decrease)in cash and cash equivalents                                         |   | (1,491,623                            | )          | (3,583,657                           | )          | (3,895,144 | ) | 1,095,954 |   |
| Cash  and cash equivalents at beginning of period                                            |   | 2,747,108                             |       | 12,457,651                           |       | 5,150,629 |   | 7,778,040 |   |
| Cash  and cash equivalents at end of period                                                  |   | $                                     | 1,255,485  |                                 | $          | 8,873,994 |   | $ | 1,255,485 |   | 8,873,994 |   |
|                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Supplemental  disclosures of cash flow information:                                          |   |                                  |       |                                 |       |   |   |   |   |
| Cash  paid during the period for:                                                            |   |                                  |       |                                 |       |   |   |   |   |
| Interest                                                                                     |   | $                                     | 14,431     |                                 | $          | 10,461 |   | $ | 40,213 |   | 212,067 |   |
| Income  taxes                                                                                |   | -                                     |       | 1,011                                |       | 4,300 |   | 5,567 |   |
|                                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Supplemental  disclosure of noncash financing activities:                                    |   |                                  |       |                                 |       |   |   |   |   |
| Transfer  of assets and liabilities of discontinued operation to PTM Productions, Inc.,  net |   | $                                     | -          |                                 | $          | - |   | - |   | 3,704,867 |   |
|                                                                                              |        |                                       |            |                                      |            |  |  |  |  |  |  |  |  |

 

Seeaccompanying notes to consolidated financial statements.

 

**LIFEF/X,INC. AND SUBSIDIARY**

**Notes to Consolidated Financial Statements**

**For the three months and nine months ended September 30, 2001and 2000**

**(Unaudited)**

 

Basis of Presentation

 

Theinformation furnished is unaudited but reflects all adjustments which are, inthe opinion of management, necessary for a fair statement of results for theinterim periods.  Results for interimperiods are not necessarily indicative of results to be expected for the entireyear.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beencondensed or omitted.  Reference shouldbe made to the Notes to the Consolidated Financial Statements in the AnnualReport on Form 10-K for the year ended December 31, 2000 filed by Lifef/x, Inc.for a further discussion of accounting policies and other significant matters.

 

(1)           Summary of Significant AccountingPolicies

 

(a)           Organization and Description ofBusiness

 

Lifef/x,Inc. (the “Company” or “LifeF/X”) and its wholly-owned subsidiary, LifeF/XNetworks, Inc., have been engaged in the following operations: (1) thedevelopment of LifeF/X technology, a mathematically based technology capable ofcreating photo-realistic computer animation of biological entities, includinghumans animated in real time, and (2) the non-LifeF/X operations, whichprovides film title, credits, special effects, digital effects and relatedservices to the motion picture and television industry.

 

TheCompany has continued to incur losses since it discontinued certain operations.It has funded its losses through an $18 million equity round of financingreceived in early 2000. Safeguard Scientifics, Inc. (Safeguard), LifeF/Xlargest shareholder, committed to fund an additional $5 million, all of whichhas been received through the period ending September 30, 2001.

 

Dueto a general contraction of corporate investment in technology innovation and adecrease in overall demand for our software products, revenues for the threemonths ended September 30, 2001, and projected for the three months endedDecember 31, 2001, were and will be lower than originally forecast bymanagement. In response to the decrease in demand, the Company recentlyre-evaluated its revenue model and modified its current business plan. Underthe revised model, the Company will move from licensing its technology toselling a software kit with a pricing structure more in line with the currenteconomic climate. However, this modified business model remains unproven andthere can be no assurances that it will be successful. The Company has alsoinstituted various cost reduction measures, but believes that existing cash andcash equivalents will only be sufficient to support operations through November2001. The Company is actively pursuing additional financing sources, but therecan be no assurances that additional financing will be available, or ifavailable, on terms satisfactory to the Company.

 

(b)           Earnings (Loss) per Share

 

Basicearnings (loss) per share is computed by dividing net income (loss) available tocommon shareholders by the weighted average number of common shares outstandingduring the period in accordance with SFAS No. 128, "Earnings PerShare."  Diluted earnings (loss)per share reflects the potential dilution that could occur if securities orother contracts to issue common stock were exercised or converted into commonstock or resulted in the issuance of common stock that then shared in theearnings of the entity. Diluted earnings (loss) per share is computed similarlyto fully diluted earnings (loss) per share pursuant to APB Opinion No. 15.

 

Therewere 9,148,475 and 7,416,397 common stock options outstanding at September 30,2001 and 2000, respectively, and 18,282,985 and 27,975,365 warrants to purchaseshares of common stock at September 30, 2001 and 2000, respectively, which werenot included in the computation of diluted loss per share because the impactwould have been antidilutive.

 

(2)           Stockholders Equity

 

InFebruary 2001, the Company granted Eastman Kodak Company a warrant to purchaseup to the lesser of 1,650,000 shares or 4.9% of the Company’s outstandingstock. The warrant, which expired unexercised on September 30, 2001, had anexercise price of $3.75 per share until July 17, 2001, and $4.50 per sharethereafter.

 

InJune 2001, the Company granted stock options for 243,000 shares to itsemployees in lieu of cash compensation for merit salary increases. The optionsare exercisable at $.01 per share and vest in four equal installments over oneyear. For financial reporting purposes, the Company recorded deferred stockcompensation of $143,000, representing the difference between the exerciseprice and the fair value of the Company's common stock on the grant date. Thisamount is being amortized by a charge to operations ratably over the vestingperiod.

 

(3)           Commitments

 

AucklandUniservices Limited

 

Welicense a portion of the LifeF/X technology from Auckland UniServices Limited(UniServices) under a licensing agreement. Under the UniServices licensingagreement, we have been granted an exclusive, worldwide, perpetual license touse UniServices' continuum modeling technology in all communicationsapplications. The license required quarterly license fees and developmentpayments to be made to the licensor. These payments totaled approximately $0and $112,500 for the three months ended September 30, 2001 and 2000,respectively, and $12,500 and $337,500 for the nine months ended September 30,2001 and 2000.

 

InJanuary 2001, the Company amended its agreements with UniServices. Theagreements were amended in part to compensate UniServices for servicespreviously rendered under a fundamental business relationship with the Companywhich commenced in 1997 and to grant the Company an exclusive license to expandinto further markets including professional medical, scientific andengineering. UniServices and the Company began negotiations in January 2000. Inaddition, UniServices will provide certain development services for theCompany.

 

Inconsideration of the agreements, the Company issued 2,250,000 shares of commonstock to UniServices. In addition, the Company granted UniServices warrants topurchase 750,000 shares of common stock as follows: 225,000 shares with a $20exercise price and with a five-year expiration; 225,000 shares with a $20 exerciseprice and a four-year expiration; 225,000 shares with a $20 exercise price anda three-year expiration; and 75,000 shares with a $12 exercise price and athree-year expiration. For financial reporting purposes, the Company hasrecognized $9,000,000 of expense related to the issuance of the stock based onits fair value and $808,275 in expense related to the warrants. Upon issuance,the Company estimated the fair value of the warrants using a Black-Scholesoption pricing model using an 80% volatility factor and an interest rate of6.2%.

 

Inconsideration of the development agreement, the Company will pay UniServices abase payment of $200,000 each year for three years. In addition, specificprojects will be billed on a time and materials basis.

 

LegalProceedings

 

OnOctober, 24, 2001, Havas Advertising North America, Inc. d/b/a Circle.com(“Circle”) filed suit against the Company seeking damages and prejudgmentrelief in the amount of $750,000 for alleged breach of a contract and relatedequitable claims for certain web site development services provided to theCompany.  The Company disputes Circle’sclaims and intends to file counterclaims for damages as a result of Circle’sfailure to perform.  The Companybelieves the counterclaim damages will offset amounts accrued on this matter,which to date total $292,500.  Thismatter is currently in the preliminary stages and the parties are awaiting aresponse from the court as to Circle’s request for preliminary relief.  The Company believes that it has satisfactorydefenses to Circle’s claim and will vigorously pursue its counterclaims.  Although the Company believes that it willbe successful in this matter, there can be no assurance that it will prevail;but in the event it does not prevail, in light of the Company’s currentfinancial position, the litigation could have a material adverse effect on theoperations of the Company.

 

(4)           Exercise of Warrants

 

InJanuary 2001, Safeguard committed to fund the Company an additional $5 million.The funds were made available through Safeguard's exercise of 10,199,119warrants at $.01 price per share and 1,959,204 warrants at $2.50 per share.Safeguard exercised all 10,199,119 of its $.01 warrants and 959,204 of its$2.50 warrants in February 2001, providing $2.5 million of cash to the Company.Safeguard exercised 500,000 of its $2.50 warrants in May 2001, providing $1.25million of cash to the Company and completed the commitment by exercising theremaining 500,000 of its $2.50 warrants in July 2001.

 

 

Thefollowing discussion should be read with the consolidated financial statementsand the related notes included herein. Certain statements that are not relatedto historical results, including statements regarding LifeF/X's businessstrategy and objectives, future financial position, expectations about pendinglitigation and estimated cost savings, are forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933, as amended (the“Securities Act”) and Section 21E of the Securities Exchange Act of 1934, asamended (the "Exchange Act"), and involve risks and uncertainties.Although management believes that the assumptions on which theseforward-looking statements are based are reasonable, there can be no assurancethat such assumptions will prove to be accurate and actual results could differmaterially from those discussed in the forward-looking statements. Factors thatcould cause or contribute to such differences include regulatory policies,competition from other similar businesses, and market and general economicfactors. All forward-looking statements contained in this Form 10-Q arequalified in their entirety by this statement.

 

 

Item 2.  Management’s Discussion and Analysis or Planof Operation

 

Thefollowing discussion should be read with the consolidated financial statementsand the related notes included herein. Certain statements that are not related to historical results, includingstatements regarding LifeF/X’s business strategy and objectives, futurefinancial position, expectations about pending litigation and estimated costsavings, are forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended (the “Securities Act”) and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”), andinvolve risks and uncertainties. Although management believes that the assumptions on which theseforward-looking statements are based are reasonable, there can be no assurancethat such assumptions will prove to be accurate and actual results could differmaterially from those discussed in the forward-looking statements.  Factors that could cause or contribute tosuch differences include regulatory policies, competition from other similarbusinesses, and market and general economic factors.  All forward-looking statements contained in this Form 10-Q arequalified in their entirety by this statement.

 

Results of Operations

 

Quarter Ended September30, 2001 Compared to Quarter Ended September 30, 2000

 

                Revenue - Revenue for the quarter ended September 30,2001 was $36,000.  Revenue resulted fromcontracts for the production of LifeF/X Stand-in virtual people, from licensingLifeF/X software, and from maintenance and support services.  Revenue was recognized from both theproduction of Stand-in virtual people under limited license agreements fordemonstrations and market testing, and from the sale of Stand-in virtual peopleunder licensing agreements.  Revenuerelated to the production of limited-use Stand-in virtual people is recognizedupon delivery.  Revenue related to thesale of Stand-in virtual people, together with the related licensing revenueand support fees, is recognized over the life of the related licensingagreement or support agreement in accordance with generally accepted accountingprinciples including the guidance in SFAS No. 48, SOP 97-2/98-9, SOP 98-1 andStaff Accounting Bulletin 101.  LifeF/Xdid not have revenue in the quarter ended September 30, 2000.  All of our products were in the research anddevelopment or planning stages and there were no sales from the LifeF/Xtechnology in 2000.

 

General andadministrative expenses - General and administrative expenses were $1,904,000for the quarter ended September 30, 2001 compared to $2,251,000 for the quarterended September 30, 2000, a decrease of $347,000, or 15.4%.  This decrease

is primarily due to thefollowing items:

 

(1)In September 2000, LifeF/X recorded deferred stock compensation of $1,950,000on stock options issued to key employees. This amount is amortized ratably asthe options vest. The related expense recorded in the quarter ended September30, 2001 was $130,000 compared to $390,000 for the quarter ended September 30,2000, a decrease of $260,000. In addition, in June 2001 the Company grantedstock options to its employees in lieu of cash compensation for merit salaryincreases and recorded deferred compensation of $143,000. This amount isamortized ratably as the options vest. The related expense recorded in thequarter ended September 30, 2001 was $36,000.

 

(2)Administrative wages, taxes and benefits were $461,000 for the quarter endedSeptember 30, 2001 compared to $346,000 for the quarter ended September 30,2000, an increase of $115,000, or 33.2%. This is a result of the increasednumber of employees in the quarter ended September 30, 2001 as compared to thequarter ended September 30, 2000.

 

(3)Professional services were $365,000 for the quarter ended September 30, 2001compared to $465,000 for the quarter ended September 30, 2000, a decrease of$100,000 or 21.5%. This resulted primarily from a decrease in legal fees of$142,000, a decrease in investor and public relations costs of $69,000 offsetby an increase in professional services of $137,000 for the comparable period.The decrease in legal fees related to the expenses incurred for theregistration of LifeF/X common stock and other filings in 2000. The increase inprofessional services expenses for the quarter ended September 30, 2001resulted primarily from activity related to efforts to raise additional capitaland repositioning the sales model.

 

(4)Rent expense was $87,000 for the quarter ended September 30, 2001 compared to$86,000 for the quarter ended September 30, 2000, a increase of $1,000, or1.2%.

 

(5)Depreciation expense increased by $110,000 or 101.5% for the quarter endedSeptember 30, 2001 over the comparable period last year as a result of theaddition of computer equipment, software, leasehold improvements and otherequipment.

 

(6)In the quarter ended September 30, 2000, LifeF/X paid liquidated damages toinvestors in its private placement relating to the schedule of its common stockregistration. Damages began on May 13, 2000 and accrued daily through August 8,2000. The related expense recorded in the quarter ended September 30, 2000 andincluded in general and administrative expenses was $201,000.

 

(7)In September 2001, LifeF/X expensed $42,000 related to its effort to raisecapital through a private placement offering. Although the Company continuesits efforts to raise capital, the February 2001 private placement offering hasstopped and accordingly the deferred charges associated with it have beenexpensed. Expenses were primarily related to printing services.

 

(8)Other general and administrative expenses were $272,000 for the quarter endedSeptember 30, 2001 compared to $362,000 for the quarter ended September 30,2000, a decrease of $90,000 or 24.9%. This is primarily due to a decrease infiling and other fees of $75,000, temporary help of $14,000, offset by anincrease in insurance of $24,000.

 

 

Researchand development expenses -   Researchand development expenses were $1,838,000 for the quarter ended September 30,2001 compared to $1,426,000 for the quarter ended September 30, 2000, anincrease of $412,000, or 28.9%. Research and development consists of costsrelated to LifeF/X development activities. This increase is primarily due tothe following items:

 

Salariesand wages, related personnel benefits and outside contractors expenses includedin research and development were $1,156,000 for the quarter ended September 30,2001 compared to $1,073,000 for the quarter ended September 30, 2000, anincrease of $83,000, or 7.7%.  Thisreflects an increase in full-time research and development personnel over thecomparable period last year offset by a reduction in contractors fees.

 

LifeF/Xhas an exclusive, world-wide, perpetual license and support agreement fromUniServices for the use of certain continuum modeling technology in commercialapplications. Recurring license fees paid under the agreement included inresearch and development costs were $0 for the quarter ended September 30, 2001and $112,500 for the quarter ended September 30, 2000.

 

InJanuary 2001, the Company amended its agreements with UniServices. Theagreements were amended in part to compensate UniServices for servicespreviously rendered under a fundamental business relationship with the Companywhich commenced in 1997 and to grant the Company an exclusive license to expandinto further markets including professional medical, scientific andengineering. UniServices and the Company began negotiations in January 2000. Inaddition, UniServices will provide certain development services for theCompany.

 

TheCompany paid $58,000 for the quarter ended September 30, 2001, under the termsof the UniServices development agreement.

 

Professionalfees were $374,000 for the quarter ended September 30, 2001. There were noprofessional fees for the quarter ended September 30, 2000. These fees wereprimarily for services provided to enhance LifeFX voice processing technologyand facial recognition processes.

 

Otherexpenses were $250,000 for the quarter ended September 30, 2001, compared to$241,000 for the quarter ended September 30, 2000, an increase of $9,000, or3.7%. This is primarily due to an increase in service fees of $176,000, relatedto third party web hosting services offset by a decrease in recruitment of$81,000, equipment rentals of $55,000 and supplies of $24,000.

 

InterestIncome - Interest income for the quarter ended September 30, 2001 was $23,000as compared to $178,000 for the quarter ended September 30, 2000, a decrease of$155,000 or 87.1%. This reflects the decrease in cash and lower interest rates.Cash is invested in highly liquid short-term investments.

 

Nine Months EndedSeptember 30, 2001 Compared to Nine Months Ended September 30, 2000

 

                Revenue - Revenue for the nine months ended September30, 2001 was $50,000.  Revenue resultedfrom contracts for the production of LifeF/X Stand-in virtual people, from licensingLifeF/X software, and from maintenance and support services.  Revenue was recognized from both theproduction of Stand-in virtual people under limited license agreements fordemonstrations and market testing, and from the sale of Stand-in virtual peopleunder the licensing agreements.  Revenuerelated to the production of limited-use Stand-in virtual people is recognizedupon delivery.  Revenue related to thesale of Stand-in virtual people, together with the related licensing revenueand support fees, is recognized over the life of the related licensingagreement or support agreement in accordance with generally accepted accountingprinciples including the guidance in SFAS No. 48, SOP 97-2/98-9, SOP 98-1 andStaff Accounting Bulletin 101.  LifeF/Xdid not have revenue in the nine months ended September 30, 2000.  All of our products were in the research anddevelopment or planning stages and there were no sales from the LifeF/Xtechnology in 2000.

 

Generaland administrative expenses - General and administrative expenses were$5,768,000 for the nine months ended September 30, 2001 compared to $5,078,000for the nine months ended September 30, 2000, an increase of $690,000 or13.6%.  This increase is primarily dueto the following items:

 

(1)In September 2000, LifeF/X recorded deferred stock compensation of $1,950,000on stock options issued to key employees. This amount is amortized ratably asthe options vest. In addition, in June 2001 the company granted stock optionsto its employees in lieu of cash compensation for merit salary increases andrecorded deferred compensation of $143,000. This amount is amortized ratably asthe options vest. The related expense recorded for the nine months endedSeptember 30, 2001 was $36,000.

 

(2)Administrative wages, taxes and benefits were $1,498,000 for the nine monthsended September 30, 2001 compared to $885,000 for the nine months endedSeptember 30, 2000, an increase of $613,000 or 69.3%. This is a result of theincreased number of full time executive, sales, financial and otheradministrative personnel employed in the nine months ended September 30, 2001as compared to the nine months ended September 30, 2000.

 

(3)Professional services were $1,006,000 for the nine months ended September 30,2001 compared to $1,213,000 for the nine months ended September 30, 2000, adecrease of $207,000 or 17.1%. This resulted primarily from a decrease in legalfees of $367,000 and audit fees of $85,000 offset by an increase in investorand public relations costs of $94,000 and professional fees of $121,000 for thecomparable period. The decrease in legal and audit fees was attributed toexpenses incurred in 2000 for the registration of LifeF/X common stock andother filings, general corporate matters relating to corporate organization,and development of administrative infrastructure. The increase in investor andpublic relations expenses for the nine months ended September 30, 2001 over thecomparable period resulted from increased stock and investor activity andongoing public relations matters. The increase in professional servicesexpenses for the nine months ended September 30, 2001 resulted primarily fromactivity related to efforts to raise additional capital and repositioning thesales model.

 

(4)Rent expense was $260,000 for the nine months ended September 30, 2001 comparedto $270,000 for the nine months ended September 30, 2000, a decrease of$10,000, or 3.7%. The decrease resulted from the issuance of 25,000 stockwarrants to a related party for consideration of rent in the nine months endedSeptember 30, 2000. The fair value of the warrants of $40,000 was reflected asrent expense. This was offset by increased office rent.

 

(5)Depreciation expense increased by $471,000 for the nine months ended September30, 2001 over the comparable period last year as a result of the addition ofcomputer equipment, software, leasehold improvements and other equipment.

 

(6)In the nine months ended September 30, 2000, LifeF/X paid liquidated damages toinvestors in its private placement relating to the schedule of its common stockregistration. Damages began on May 13, 2000 and accrued daily through August 8,2000. The related expense recorded in the nine months ended September 30, 2000and included in general and administrative expenses was $347,000.

 

(7)In the nine months ended September 2001, LifeF/X expensed $317,000 related toits effort to raise capital through a private placement offering. Although theCompany continues its efforts to raise capital, the February 2001 private placementoffering has stopped and accordingly the deferred charges associated with ithave been expensed. Expenses were primarily related to legal, audit andprinting services.

 

(8)Other general and administrative expenses were $744,000 for the nine monthsended September 30, 2001 compared to $927,000 for the nine months endedSeptember 30, 2000, a decrease of $183,000, or 19.7%. This is primarily due toa decrease in recruitment expense of $56,000, temporary help of $44,000 andfiling and other fees of $198,000, offset by increases in insurance of $74,000,utilities of $10,000, travel of $14,000 and marketing of $13,000.

 

 

Researchand development expenses -   Researchand development expenses were $14,989,000 for the nine months ended September30, 2001 compared to $3,247,000 for the nine months ended September 30, 2000,an increase of $11,742,000. Of the$15.0 million for the nine months ended September 30, 2001, $9.81 millionrelated to the non-cash expense for the issuance of stock and warrants to UniServices.The increase is primarily due to the following items:

 

Salariesand wages, related personnel benefits and outside contractors expenses includedin research and development were $3,498,000 for the nine months ended September30, 2001 compared to $2,419,000 for the nine months ended September 30, 2000,an increase of $1,079,000 or 44.6%. This reflects an increase in full-time research and developmentpersonnel over the comparable period last year offset by a decrease in incontractors fees.

 

LifeF/Xhas an exclusive, world-wide, perpetual license and support agreement fromUniServices for the use of certain continuum modeling technology in commercialapplications. Recurring license fees paid under the agreement included inresearch and development costs were $12,500 for the nine months ended September30, 2001 and $337,500 for the nine months ended September 30, 2000.

 

InJanuary 2001, the Company amended its agreements with UniServices. Theagreements were amended in part to compensate UniServices for servicespreviously rendered under a fundamental business relationship with the Companywhich commenced in 1997 and to grant the Company an exclusive license to expandinto further markets including professional medical, scientific andengineering. UniServices and the Company began negotiations in January 2000. Inaddition, UniServices will provide certain development services for theCompany.

 

In consideration of the amended agreements, theCompany issued 2,250,000 shares of common stock to UniServices. In addition,the Company granted UniServices warrants to purchase 750,000 shares of commonstock as follows: 225,000 shares with a $20 exercise price and with a five-yearexpiration; 225,000 shares with a $20 exercise price and a four-yearexpiration; 225,000 with a $20 exercise price and a three-year expiration; and75,000 shares with a $12 exercise price and a three-year expiration. TheCompany has recognized $9,000,000 of expense related to the issuance of thestock based on its fair value and $808,275 in expense related to the warrants.Upon issuance, the Company estimated the fair value of the warrants using aBlack-Scholes option pricing model. 

 

TheCompany paid $133,000 for the nine months ended September 30, 2001, under theterms of the UniServices development agreement.

 

Professionalfees were $602,000 for the nine months ended September 30, 2001. There were noprofessional fees for the nine months ended September 30, 2000. These fees wereprimarily for services provided to enhance LifeF/X voice processing technologyand facial recognition processes.

 

Otherexpenses were $940,000 for the nine months ended September 30, 2001, comparedto $490,000 for the nine months ended September 30, 2000, an increase of$450,000 or 91.8%. This is primarily due to an increase in service fees of$624,000, related to third party web hosting services and recruitment of$20,000, offset by a decrease in equipment rentals of $105,000 and supplies of$45,000.

 

InterestIncome - Interest income for the nine months ended September 30, 2001 was$127,000 as compared to $598,000 for the nine months ended September 30, 2000,a decrease of $471,000 or 78.8%. This reflects the decrease in cash and lowerinterest rates. Cash is invested in highly liquid short-term investments.

 

Liquidity and CapitalResources

 

OnMarch 20, 2000, LifeF/X sold its non-LifeF/X assets, which consisted of filmtitle and special effects services, to PTM Productions, Inc., an entity ownedby shareholders of its predecessor corporation. The sale included a transfer ofall liabilities associated with the discontinued operation, including all debt.As a result, LifeF/X is presently debt-free, other than accounts payable,accrued expenses and capital lease obligations. In addition, Safeguard hasindemnified LifeF/X against all liabilities associated with the discontinuedoperation. See note 3 to the consolidated financial statements included on Form10-K for the year ended December 31, 2000. Historically, the Company’s revenueshave been solely related to its discontinued operation.

 

Dueto a general contraction of corporate investment in technology innovation and adecrease in overall demand for our software products, revenues for the threemonths ended September 30, 2001, and projected for the three months ended December31, 2001, were and will be lower than originally forecast by management. Inresponse to the decrease in demand, the Company recently re-evaluated itsrevenue model and modified its current business plan. Under the revised model,the Company will move from licensing its technology to selling a software kitwith a pricing structure more in line with the current economic climate.However, this modified business model remains unproven and there can be noassurances that it will be successful. The Company has also instituted variouscost reduction measures, but believes that existing cash and cash equivalentswill only be sufficient to support operations through November 2001. TheCompany is actively pursuing additional financing sources, but there can be noassurances that additional financing will be available, or if available, onterms satisfactory to the Company.

 

Netcash used in operating activities was $8,691,000 for nine months endedSeptember 30, 2001. This use was primarily due to the net loss for the periodand a increase of $184,000 in accounts payable and accrued expenses, partiallyoffset by a non-cash expense of $9,808,000 relating to the issuance of stockand warrants to UniServices and non-cash expenses of $1,279,000 relating tostock options and $42,000 related to the issuance of stock warrants. Net cashused in operating activities for the comparable period of the prior year was$6,232,000. This was primarily due to the $7,764,000 net loss for the periodand a increase in prepaid expenses and other assets of $283,000 partiallyoffset by a non-cash expense of $1,269,000 relating to stock options, $40,000relating to stock warrants and a $339,000 increase in accounts payable andaccrued liabilities.

 

Netcash used in investing activities was $135,000 for the nine months endedSeptember 30, 2001, as compared to net cash used in investing activities of$1,777,000 for the nine months ended September 30, 2000, a decrease of$1,642,000 or 92.4%. Investing activities represent purchases of computerequipment, furniture and fixtures and miscellaneous equipment.

 

Netcash provided by financing activities for the nine months ended September 30,2001 was $4,931,000. This primarily represents the receipt of $5,000,000 ofproceeds received from the exercise of stock warrants by Safeguard. Net cashprovided by financing activities for the comparable period of the prior yearwas $9,105,000. This primarily represents the receipt of proceeds of $9,051,000from the sale of stock through a private placement that were held in escrow atDecember 31, 1999.

 

Quantitative andQualitative Disclosures about Market Risk

 

Todate, we have not utilized derivative financial instruments or derivativecommodity instruments.  We do not expectto employ these or other strategies to hedge market risk in the foreseeablefuture.  We invest our cash in moneymarket accounts and short-term marketable securities.  We believe the market risks associated with these financialinstruments are immaterial.

 

Inflation

 

Wedo not believe that inflation has had any material effect on our business overthe past two years.

 

**PART II- OTHER INFORMATION**

 

Item 1.  Legal Proceedings

** **

On October, 24, 2001,Havas Advertising North America, Inc. d/b/a Circle.com (“Circle”) filed suitagainst the Company seeking damages and prejudgment relief in the amount of$750,000 for alleged breach of a contract and related equitable claims forcertain web site development services provided to the Company.  The Company disputes Circle’s claims andintends to file counterclaims for damages as a result of Circle’s failure toperform.  The Company believes thecounterclaim damages will offset amounts accrued on this matter, which to datetotal $292,500.  This matter iscurrently in the preliminary stages and the parties are awaiting a responsefrom the court as to Circle’s request for preliminary relief.  The Company believes that it hassatisfactory defenses to Circle’s claim and will vigorously pursue itscounterclaims.  Although the Companybelieves that it will be successful in this matter, there can be no assurancethat it will prevail; but in the event it does not prevail, in light of theCompany’s current financial position, the litigation could have a materialadverse effect on the operations of the Company.

 

Item 4.  Submission of Matters to a Vote of SecurityHolders

 

Nomatters were submitted to a vote of security holders through the solicitationof proxies or otherwise, during the quarter ended September 30, 2001.

 

Item 5.  Other Information

 

The Company received aNasdaq Staff Determination on November 8, 2001 indicating that the Company hasfailed to comply with the minimum net tangible assets requirement for continuedlisting set forth in Marketplace Rule 4450, and that its securities are,therefore delisted from the Nasdaq National Market effective November 15, 2001.It is expected that the Company's securities will be traded on the OTC BulletinBoard.

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a).          Exhibits

 

None.

 

(b).          Reports on Form 8-K

 

Noreports on Form 8-K were filed during the quarter ended September 30, 2001.

 

**SIGNATURES**

 

In accordance withsection 13 or 15(d) of the Exchange Act, the registrant has caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|   | LIFEF/X, INC.                  |
|--------|--------------------------------|
|   |                           |
|   | /s/  Lucille S. Salhany   |
|   | Lucille S. Salhany             |
|   | Co-President and Chief         |
|   | Executive Officer              |
|   | (Principal Executive  Officer) |
|   | November 15, 2001              |

 
|   | /s/  Richard A. Guttendorf, Jr.   |
|--------|----------------------------------------|
|   | Richard A. Guttendorf,  Jr.            |
|   | Chief Financial  Officer and Secretary |
|   | (Principal Accounting  Officer)        |
|   | November 15, 2001                      |