U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________ to __________
Commission file number 1-11568
DYNTEK, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 95-4228470
-------- ----------
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
18881 Von Karman Avenue, #250
Irvine, CA 92612
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (949) 955-0078
Indicate by check whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filings requirements for the past 90 days. Yes X No
--- ---
Indicate by check whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
The number of shares outstanding of the issuer's Class A Common Stock,
$.0001 par value, as of May 13, 2004 was 51,789,168.
DYNTEK, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION Page
Number
------
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - March 31, 2004 (unaudited)
and June 30, 2003 3
Condensed Consolidated Statements of Operations and Comprehensive
Loss (unaudited) - For the Three Months and Nine Months Ended
March 31, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows (unaudited) - For
the Nine Months Ended March 31, 2004 and 2003 5-6
Notes to Condensed Consolidated Financial Statements (unaudited) 7-17
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18-22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 23-24
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities 24
Item 5. Other Information 24-25
Item 6. Exhibits and Reports on Form 8-K 25-26
SIGNATURE 27
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PART 1 - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, June 30,
2004 2003
----------- --------
(unaudited)
ASSETS
------
CURRENT ASSETS:
Cash - Restricted 1,048 920
Accounts receivable, net of allowance for doubtful accounts of $139 and 8,990 9,370
$463
Inventories 396 351
Prepaid expenses and other assets 587 151
Other receivables 141 122
------- -------
TOTAL CURRENT ASSETS 11,162 10,914
RESTRICTED CASH - over one year 210 317
INVESTMENTS - Marketable Securities 198 282
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $3,166 and $2,904 546 624
GOODWILL 28,469 31,214
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $755 and $594 322 483
ACQUIRED CUSTOMER LIST, net of accumulated amortization of $6,579 and $4,955 6,099 7,602
PURCHASED SOFTWARE, net of accumulated amortization of $628 and $498 62 192
NOTES RECEIVABLE, long term, including receivable from officer of $100, net of
allowance for doubtful accounts of $200 564 1,204
DEPOSITS AND OTHER ASSETS 1,442 295
------- -------
$49,074 $53,127
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $6,614 $11,714
Line of credit 2,443 708
Accrued expenses 1,797 2,271
Deferred revenue 1,452 981
Notes payable-accrued interest 33 625
Current liabilities of discontinued operations 4,421 5,888
------- -------
TOTAL CURRENT LIABILITIES 16,760 22,187
DEFERRED REVENUE - long term 210 317
LONG TERM NOTE PAYABLE 3,500 5,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized;
959,692and 1,490,437 shares issued and outstanding as of March 31, 2004
and June 30,
2003, respectively 1 1
Class A Common stock, $.0001 par value, 70,000,000 shares
authorized;49,711,654 shares and 38,382,705 shares issued and outstanding
as of March 31, 2004 and June 30, 2003 respectively 4 4
Class B Common stock, $.0001 par value, 20,000,000 shares authorized -- --
Additional paid-in capital 92,988 81,918
Accumulated other comprehensive loss (149) (244)
Accumulated deficit (64,240) (56,056)
------- -------
TOTAL STOCKHOLDERS' EQUITY 28,604 25,623
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $49,074 $53,127
======= ========
See notes to condensed consolidated financial statements.
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DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME / LOSS
(Unaudited)
(in thousands, except per share data)
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------- ------------ ------------
REVENUES:
Product Revenues $ 4,673 $ 5,051 $ 13,735 $ 16,176
Service Revenues 7,423 6,961 21,087 21,824
------------ ------------ ------------ ------------
Total revenues 12,096 12,012 34,822 38,000
------------ ------------ ------------ ------------
COST OF REVENUES:
Cost of products 3,846 4,135 11,893 13,496
Cost of services 5,767 5,370 16,809 17,189
------------ ------------ ------------ ------------
Total cost of revenues 9,613 9,505 28,702 30,685
------------ ------------ ------------ ------------
GROSS PROFIT 2,483 2,507 6,120 7,315
------------ ------------ ------------ ------------
------------
OPERATING EXPENSES:
Selling expenses 1,494 1,802 5,134 5,348
General and administrative expenses 985 496 3,098 2,366
Depreciation and amortization 791 689 2,132 2,101
Goodwill Impairment -- -- 3,000 --
------------ ------------ ------------ ------------
Total operating expenses 3,270 2,987 13,364 9,815
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (787) (480) (7,244) (2,500)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of marketable securities -- -- (107) --
Interest expense (199) (316) (700) (905)
Interest income 2 48 95 64
Reversal of state audit assessment and other -- 1,948 -- 1,948
Equity interest in loss of investee -- (10) -- (72)
------------ ------------ ------------ ------------
Total other income (expense) (197) 1,670 (712) 1,035
INCOME / (LOSS) FROM CONTINUING OPERATIONS $ (984) $ 1,190 $ (7,956) $ (1,465)
DISCONTINUED OPERATIONS
Gain (loss) on disposal of discontinued operations -- 2,791 -- 2,791
Loss on discontinued operations (23) (3,133) (228) (2,871)
------------ ------------ ------------ ------------
LOSS FROM DISCONTINUED OPERATIONS (23) (342) (228) (80)
NET INCOME / (LOSS) $ (1,007) $ 848 $ (8,184) $ (1,545)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE: Basic
Continuing Operations (.02) .03 (.17) (.03)
Discontinued Operations (.00) (01) (.01) (.01)
------------ ------------ ------------ ------------
$ (.02) $ .02 $ (.18) $ (.04)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE: Diluted
Continuing Operations (.02) .02 (.17) (.03)
Discontinued Operations (.00) (01) (.01) (.01)
------------ ------------ ------------ ------------
$ (.02) $ .01 $ (.18) $ (.04)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION-
Basic 48,215,944 35,504,391 46,453,466 36,537,342
============ ============ ============ ============
Diluted 48,215,944 46,556,536 46,453,466 36,537,342
============ ============ ============ ============
NET INCOME / (LOSS) $ (1,007) $ 848 $ (8,184) $ (1,545)
COMPREHENSIVE LOSS, NET OF TAX
Change in unrealized gain (loss) on available-
for-sale-securities 1 (21) 95 (68)
------------ ------------ ------------ ------------
COMPREHENSIVE INCOME / (LOSS) $ (1,006) $ 827 $ (8,089) $ (1,613)
============ ============ ============ ============
See notes to condensed consolidated financial statements
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DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Nine months ended
March 31,
--------------------
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss - Continuing Operations $ (7,956) (1,465)
-------- --------
Adjustments to reconcile net loss, excluding discontinued operations, to
net cash provided by (used in) operating activities:
Depreciation and amortization 1,971 1,940
Amortization of capitalized software costs 161 161
Equity interest in investee -- 72
Loss on sale of marketable securities 107 --
Interest on note payable 33 428
Settlement of future royalties, net -- (425)
Impairment of goodwill 3,000 --
State audit assessment -- (1,861)
Changes in operating assets and liabilities:
Accounts receivable (37) 5,840
Inventories (45) 751
Prepaid expenses and other current assets (366) 238
Deposits and other assets (51) 63
Accounts payable (5,108) (2,558)
Deferred revenue 471 (2,904)
Restricted cash (110) 218
Accrued expenses (875) (1,068)
-------- --------
Total adjustments (849) 895
-------- --------
NET CASH (USED IN) CONTINUING OPERATIONS (8,805) (570)
-------- --------
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS (1,695) (1,130)
-------- --------
NET CASH (USED IN) PROVIDED BY OPERATIONS (10,500) (1,700)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Notes receivable (47) 188
Cash proceeds from the sale to First Transit -- 6,450
Cash proceeds from sale of marketable securities 71 --
Capital expenditures (134) (22)
-------- --------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (110) 6,616
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds (repayments) under bank line of credit 1,735 (5,587)
Notes payable 3,500 (25)
Net cash proceeds from the issuance of common stock 5,375 696
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 10,610 (4,916)
-------- --------
NET INCREASE (DECREASE) IN CASH -- --
CASH AT BEGINNING OF YEAR -- --
-------- --------
CASH AT END OF PERIOD $ -- $ --
======== ========
See notes to condensed consolidated financial statements
-5-
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands, except share data)
Nine Months
Ended March 31,
---------------
2004 2003
------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 490 $ 291
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND
INVESTING ACTIVITIES:
Forgiveness by shareholders of note payable
and accrued interest $5,625 $ --
Buyback of common stock in conjunction with
note payable $ -- $5,000
Exchange of note receivable for 300,000 shares
of common stock $ -- $ 430
See notes to condensed consolidated financial statements
-6-
DYNTEK, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(UNAUDITED)
1. Basis of Presentation and Management's Liquidity Plans
The accompanying unaudited condensed consolidated financial statements of
DynTek, Inc. and Subsidiaries ("DynTek", "the Company", or "we") have been
prepared in accordance with accounting principles generally accepted in the
United State of America, for interim financial statements and with the
instructions to Form 10-Q and Article 10 of Regulations S-X. Accordingly, they
do not include all of the information and disclosures required for annual
financial statements. These condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and related
footnotes for the year ended June 30, 2003 included in the Form 10-K for the
year then ended.
The accompanying condensed consolidated financial statements reflect all
adjustments, which, in the opinion of management consist of normal recurring
items, are necessary for a fair presentation in conformity with accounting
principles generally accepted in the United States of America. These adjustments
include certain reclassifications to reflect the disposal of certain
non-emergency transportation services which was a component of our business
outsourcing segment. Preparing condensed consolidated financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses. The results of operations
for any interim period are not necessarily indicative of the results attainable
for a full fiscal year.
As of March 31, 2004, the Company had a working capital deficiency of
approximately $5.6 million. During January 2004, the Company received proceeds
from a convertible debt placement of $3.5 million. In May 2004 the convertible
debt was increased by $2.5 million to $6 million. In April 2004, stock purchase
warrants were exercised and proceeds were received for $1 million. Additionally,
in May the Company entered into a series of agreements for a private placement
of the Company's common stock for aggregate sales proceeds of $6.3 million.
The Company during fiscal 2004 is reviewing further reductions of overhead
expenses as well as pursing new business opportunities and expansion of services
offered to customers. The Company believes that its present cash on hand as well
as the additional debt and equity financing provides adequate funding through
March 31, 2005. However, there can be no assurances that the Company will have
sufficient funds to implement its current plan. In such an event, the Company
could be forced to significantly alter its plan and reduce its operating
expenses or would consider divesting of certain contracts or other assets that
may not be critical to the future success of the Company.
2. Accounting Policies
The accounting policies followed by the Company are set forth in Note 1 to the
Company's consolidated financial statements as filed in its Form 10-K for the
year ended June 30, 2003.
During the current fiscal year the Company adopted, the Statement of Financial
Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
addresses certain financial instruments that, under previous guidance, could be
accounted for as equity, but now must be classified as liabilities in statements
of financial position. These financial instruments include: (1) mandatorily
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redeemable financial instruments, (2) obligations to repurchase the issuer's
equity shares by transferring assets, and (3) obligations to issue a variable
number of shares. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003.
During the current fiscal year, the Company adopted, the FASB issued SFAS No.
149, "Amendment of Statement 133 on Derivative instruments and Hedging
Activities." This Statement amends and clarifies SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities." This statement clarifies the
accounting guidance on (1) derivative instruments (including certain derivative
instruments embedded in other contracts) and (2) hedging activities that fall
within the scope of the SFAS No.133. SFAS No.149 also amends certain other
existing pronouncements, which will result in more consistent reporting of
contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. SFAS No. 149 is effective (1) for
contracts entered into or modified after December 31, 2003, with certain
exceptions, and (2) for hedging relationships designated after December 31,
2003. The guidance is to be applied prospectively.
There was no effect on the condensed consolidated financial statements from the
adoption of these pronouncements.
3. Marketable Securities
Marketable securities have been classified as available for sale securities at
March 31, 2004 and, accordingly, the unrealized loss resulting from valuing such
securities at market value is reflected as a component of stockholders' equity.
At March 31, 2004, the unrealized loss on such securities was $149,000.
4. Note Receivable
On October 3, 2003, the Company received 1,000 shares of Non-Voting Convertible
Preferred Stock from Private Label Cosmetic, Inc. ("PLC") in exchange for their
surrender to PLC of a note receivable in the amount of $1,104,000 which is
included in other assets. The shares of preferred stock are convertible at the
Company's option into 306 shares of common stock of PLC. Such shares have been
placed in escrow in connection with the Stock Pledge Agreement and shall remain
there for such conversion. Commencing the quarter ended March 31, 2005, these
shares of preferred stock become entitled to receive a dividend of $10,000 per
quarter, payable at the end of the quarter.
5. Goodwill and Other Intangibles
The Company evaluates the recoverability of its goodwill and other intangibles
in accordance with the Statement of Financial Accounting Standards Board
("SFAS") No. 142, Goodwill and Other Intangible Assets. As of December 31, 2003,
goodwill associated with certain child support enforcement outsource services
contracts was evaluated for impairment. Due to a re-focus of business strategy,
the Company determined that the projected revenues from contract renewals in the
future will be lower and as a result, the Company determined in accordance with
the provisions of SFAS No. 142 that there had been impairment of goodwill
requiring an adjustment of $3,000,000 to reduce the carrying value of goodwill
which was recorded as of December 31, 2003. The Company's evaluation at March
31, 2004 did not indicate any impairment. The Company will be conducting its
annual test of existing goodwill at June 30, 2004.
-8-
6. Credit Facility
On June 30, 2003, the Company entered into a 12 month credit facility agreement
with annual automatic renewals (the "Textron Factoring Facility") with an agency
of Textron Financial Corporation ("Textron"). The Textron Factoring Facility
provides a full notification factoring facility for up to $7 million of working
capital collateralized by accounts receivable, inventory, general intangibles
and other assets. Eligible accounts receivable expected to be collected within
90 days are purchased with recourse, with a holdback amount of 15%. Interest is
charged on the outstanding balance at Prime rate plus 2.5% (6.5% at March 31,
2004). Additionally, a 0.25% discount fee is charged at the time of purchase. As
of March 31, 2004, $2,443,000 was outstanding under the agreement.
7. Commitments, Contingencies, and Other Agreements
COMMONWEALTH OF VIRGINIA
Effective December 15, 2002, the Company entered into a mutual Settlement
Agreement to cancel a contract to provide non-emergency transportation brokerage
services in certain regions of the Commonwealth of Virginia. The terms of the
Settlement Agreement provided that the Company make payments to transportation
provider vendors according to an agreed-upon schedule, which expired in June
2003. This was extended under an interim letter of understanding. In connection
with initially entering into the contract, a performance bond was posted by a
third party guarantor to guarantee payment to the transportation provider
vendors up to the bond amount of $2.4 million. A number of such vendors caused
the bond to be called, requiring the bond amount to be deposited in an escrow
account and initiating a process of disbursing the $2.4 million to vendors with
valid claims. The bonding company filed an interpleader action on July 22, 2003.
In a separate transaction, the Company has entered into a limited release of
indemnification to reimburse the guarantor for funding the bond. As a result,
the Company's liability to such vendors will in effect be extinguished to the
extent of the funds disbursed. The amount of $2.4 million deposited in escrow
for the payment to the Company's vendors has not yet been recorded as an offset
to the Company's accounts payable. When the individual claims are determined for
each vendor, in accordance with court procedures, the interplead funds shall be
disbursed and the payable shall be reduced accordingly. Should valid claims
remain outstanding after the disbursement of the interpleader funds, certain
vendors may continue to pursue their claims after the interpleader proceedings
are concluded, however, such claims may not exceed the amounts determined by the
courts to be due. The courts are currently in the process of assembling the
amounts of the claims due. The Company believes a substantial amount of these
claims are without merit based on billings for services that were not provided
under the agreements or on billings which were outside the terms of the
subcontracts, or which may already have been settled with claimants. Since
August 2003, the Company has made payments in the aggregate amount of
approximately $100,000 per month to various providers. As of March 31, 2004, the
Company paid $956,000 to providers.
A number of the vendors that provided transportation services in the
Commonwealth of Virginia have initiated separate legal demands for payment. Some
of the demands, either in whole or in part, have been disputed by the Company as
being without merit or have been settled. As of March 31, 2004, actions for
collection are pending in 12 separate proceedings. Ali Medical, et.al, a joint
case of 27 providers for approximately $1,042,000 is the largest of the claims.
The Ali Medical joint case was consolidated with the above-referenced
interpleader action for all purposes. The Ali Medical claimants are considered
cross-claimants in the interpleader action. In addition to the Ali Medical
claimants, additional providers in the interpleader action have filed
cross-claims against the Company. The proceedings have been stayed by an order
of the court overseeing the interpleader action.
-9-
Provisions in the Company's condensed consolidated financial statements for the
estimated settlement amounts for these and other potential similar claims are
considered adequate; however, the Company is unable to predict the outcome of
these claims.
OTHER AGREEMENTS
On April 7, 2003 Westcon, Inc. filed a breach of contract complaint in the
Supreme Court of New York State, County of Westchester. The complaint arose from
the Company's failure to make payments within the terms of the reseller
agreement. The Company does not dispute the amount due of $413,000 and has
negotiated payment terms. As of March 31, 2004 $388,000 remained outstanding
such amount is included in the Company's accounts payable.
On July 7, 2003, a Settlement Agreement was reached in a matter brought by
Computer Associates International, Inc. against the City of Boston, in United
States District Court, District of Massachusetts (Case Number 01-10566-EFH), in
which the Company was named as a third-party defendant. Under the Agreement, the
parties mutually released each other from any further claims on this matter.
Effective October 8, 2003, the Company and James Linesch, its Chief Financial
Officer, entered into an Amendment to Employment Agreement, with respect to his
Employment Agreement dated August 14, 2000 as previously amended on August 15,
2001. Under the revised terms, the Company reduced Mr. Linesch's salary from an
annual rate of $200,000 to $150,000 effective November 1, 2003. On November 1,
2004, his salary shall be further reduced to an annual rate of $100,000 for one
year, and the Employment Agreement shall terminate on October 31, 2005 without
further obligation by the Company.
On October 16, 2003, the board of directors approved an increase in the base
salary of Steven J. Ross, its Chief Executive Officer, from $400,000 to $440,000
effective October 1, 2003.
On November 4, 2003, New England Life Insurance Company filed a breach of
contract complaint in Orange County Superior Court of California. The complaint
arose from the cancellation of a contract for health insurance benefits and non
payment of remaining fees. The claim is for $534,000, a part which the company
disputes, and such amount is included in accrued expenses. The Company is
currently negotiating settlement terms.
As of March 1, 2004, the Company entered a series of agreements with Young
Williams, P.C. Under the Services Agreement, Young Williams, P.C. will manage
certain contracts of the Company pursuant to which it provides child support
services. The Company will pay Young Williams a fee of 12% of revenues under the
contracts, and the Company will remain responsible for the operating expenses
related to the contracts managed by Young Williams, P.C., for the current term
and option year extensions of each contract. In the event of a contract renewal
past the current terms and option years, Young Williams will have the right to
bid the contracts. If Young Williams is awarded a new contract, it will pay the
Company 4% of revenues under the contract during the awarded term through
February, 2010.
The Company also (i) sold licenses of its ProductivIT software to be used in
connection with the performance of the child support enforcement management
services, for $900,000, and (ii) will provide maintenance and support of the
licensed technology, in each case to Child Support Technology, a subsidiary of
Young Williams P.C. As of May 14, 2004, the Company has received payment
$350,000. The remaining balance due will be paid during the next nine months as
per the terms of the agreement.
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8. Other Settlements
On October 11, 2002, Merisel Americas, Inc. ("Merisel") filed a breach of
contract complaint in Superior Court of California, Southwest District. The
complaint arose from the Company's failure to make payments within the terms of
the reseller agreement. In July 2003, the Company entered into an agreement with
Merisel to repay the liability and accrued interest and expenses, with an
obligation to make payments over the next 12 months in an aggregate amount of
$567,000 which is included in accounts payable. As of March 31, 2004 $167,000 of
this amount remained outstanding.
9. First Transit Agreement
On March 1, 2003, the Company entered into an Asset Purchase Agreement (the
"First Transit Agreement") with First Transit, Inc. ("First Transit"), pursuant
to which it sold to First Transit certain specific assets relating to its
discontinued transportation management business originally acquired in December
2002. The assets sold consisted of interests in three contracts to provide
non-emergency transportation related services and related assets used in
connection with the performance of such contracts, as well as the assumption of
all vendor and services sub-contract agreements relating to the acquired
contracts. The purchase price consisted of cash payments of $6,450,000 and an
obligation for First Transit to pay up to $1,750,000 in the event that First
Transit is able to obtain extension of the Company's former Illinois Department
of Public Aid transportation services contract for a period of up to three years
beyond May 31, 2004 under certain specified conditions.
10. Stock Based Compensation
During the year ended June 30, 2003, the Company adopted SFAS No. 148,
"Accounting for Stock-based Compensation-Transition and Disclosure." This
statement amended Statement No. 123, "Accounting for Stock-based Compensation."
As permitted under Statement No. 123, the Company continues to apply the
Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued
to Employees." As required under Statement No. 148, the following table presents
pro- forma net loss and basic and diluted loss per share as if the fair
value-based method had been applied to all awards.
Three Months Ended Nine Months Ended
------------------ ------------------
Periods Ended March 31, 2004 2003 2004 2003
- ----------------------- ------- ---- ------- -------
Net Loss $(1,007) $848 $(8,184) $(1,545)
Stock-based employee compensation
cost, net of tax effect, under fair
value accounting 33 69 297 207
------- ---- ------- -------
Pro-forma net loss under Fair Value $(1,040) $779 $(8,481) $(1,752)
Method
======= ==== ======= =======
Income / (Loss) per share:
Basic $ (.02) $.02 $ (.17) $ (.04)
======= ==== ======= =======
Diluted $ (.02) $.01 $ (.17) $ (.04)
======= ==== ======= =======
Pro-forma income (loss) share: Basic $ (.02) $.02 $ (.18) $ (.05)
======= ==== ======= =======
Pro-forma income (loss) share:
Diluted $ (.02) $.01 $ (.18) $ (.05)
======= ==== ======= =======
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The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option valuation model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. Because the Company's stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value estimate of
its stock options. In calculating the fair values of the stock options, the
following assumptions were used:
Fiscal year Fiscal year
2004 grants 2003 grants
----------- -----------
Dividend yield -- --
Weighted average expected life: 3 years 3.6 years
Weighted average risk-free interest rate 1.79% 2.5%
Expected volatility 77% 136%
11. Stockholders' Equity
On August 14, 2001, the Company's preferred stock became convertible into the
Company's Class A common stock, at a rate of 2.5 common shares for each
preferred share tendered. As of March 31, 2004, 1,230,108 of such shares were
converted into 3,075,270 shares of Class A common stock, with a remainder of
959,692 shares not yet converted.
On July 3, 2003, an investor group cancelled a note payable by the Company of $5
million plus accrued interest of $625,000 which was recorded as an increase to
additional paid-in-capital. The note was acquired by the group in connection
with their private purchase of 10,336,663 shares of the Company's Common Stock
from DynCorp, Inc. The investor group also cancelled a warrant to acquire
7,500,000 shares of Company Common Stock that they acquired in the same
transaction.
In July 2003, the Company sold 4,198,000 shares of its Common Stock at $0.50 per
share, for aggregate proceeds, net of costs, of approximately $1.8 million.
On October 9, 2003, the Company issued 50,000 shares of its Common Stock as
payment of an outstanding payable for services rendered.
On October 16, 2003, the Company issued 108,434 shares of its Common Stock
valued at $90,000 in connection with the April 1, 2003 Asset Purchase Agreement
with Entellus Technology Group.
On December 9, 2003, the Company sold 3,333,333 shares of Common Stock at a
price equal to $0.66 per share for an aggregate gross purchase price of
$2,200,000. The investors also received two warrants for each share of common
stock. The first warrant entitles the investor to purchase up to 20% of the
Common Stock issued at an exercise price equal to $1.00 per share (the "20%
Investor Warrants") and the second warrant entitles the investor to purchase up
to 30% of the Common Stock issued at an exercise price equal to $0.75 per share
(the "30% Investor Warrants"). Both the 20% Investor Warrants and the 30%
Investor Warrants are exercisable immediately at closing and have a five-year
term. In addition, the placement agent received, placement agent fee (including
expense reimbursement) of $189,050 and placement agent warrants equal to 10% of
the aggregate shares of Common Stock issued on the closing date (and issuable
under 20% Investor Warrants and 30% Investor Warrants) at an exercise
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price of $0.91 per share. On January 15, 2004, the exercise price of the 20%
Investor Warrants was reduced to $0.75 in exchange for the investors allowing
additional shares to be registered, pursuant to an amendment to the investor's
Registration Rights Agreement.
As a result of a delay in filing a required registration statement with respect
to the distribution of Company Common Stock by certain investors, the Company
has agreed to issue warrants to such investors. When issued such warrants will
give the investors the right to acquire, in the aggregate, up to 2,848,235
shares of common stock at $0.75 per share, all of which underlying shares of
common stock are subject to registration rights.
On January 29, 2004, the Company sold an additional $300,000 of Common Stock,
and warrants, all on the same terms as offered to the investors in the December
2003 private placement, as amended by the January 15, 2004 Registration Right
Agreement Amendment and Allonges. The placement agent for this $300,000 offering
received $24,000 in cash and warrants, exercisable at $.091 per share, to
acquire 68,182 shares of Common Stock.
On January 30, 2004, DynTek closed issued a $3,500,000 principal secured
convertible three-year term note to an institutional investor, Laurus Funds. The
note bears interest at the greater of the Prime Rate plus 1%, or 4%, with
interest only payments commencing in March 2004 and level payments of principal
commencing August 1, 2004. The note is convertible to DynTek common stock at the
option of the investor. Monthly payments of principal and accrued interest under
the note may be made by DynTek delivering common stock shares instead, if the
shares are fully registered and the price is above $1.04. Subject to the same
restrictions on stock payments of monthly accrued interest and principal, the
entire principal and accrued interest of the note may be prepaid by DynTek in
common stock, subject to certain fees for the conversion. As part of the
transaction, the investor also received a five-year warrant to purchase 425,000
shares of DynTek common stock, exercisable at prices between $1.12 and $1.57 per
share. DynTek paid a closing fee equal to $122,500 and paid $29,500 as
reimbursement for the investor's legal and due diligence expenses. Additionally,
the Company paid an investment advisory fee of $280,000 (8% of offering
proceeds), payable $210,000 in cash and $70,000 in DynTek common stock (77,778
shares at a value of $0.90 per share), and issued additional warrants to Duncan
Capital to acquire 388,889 shares of DynTek common stock at $0.99 per share. The
Company subsequently amended this note into a further note payable, aggregating
$6,000,000 principal (See footnote 17. Subsequent Events).
On March 17, 2004, the Company sold 1,780,000 shares of common stock at $0.68
per share, for an aggregate purchase price of $1,210,400. The investors received
warrants for 356,000 shares of common stock at $0.90 per share for five years.
Placement fees and expenses for the offering were $96,832 and a warrant to
purchase 356,000 shares at $.90 per share for five years.
12. Earnings per Share
Basic earnings per share is computed on the basis of the weighted average number
of common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options using the "treasury stock method". Common
stock equivalents consisting of options, warrants, and convertible preferred
stock totaling 69,915,192 were not included in the calculation of diluted
earnings per share as the results would be anti-dilutive.
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Total outstanding stock, options, convertible preferred stock and warrants as of
March 31, 2004 are as follows:
--------------------------------------------------
Shares
Outstanding
Common stock 49,711,654
Options and warrants 13,915,420
Convertible debt 3,888,888
Convertible preferred stock 2,399,230
----------------
69,915,192
================
13. Business Acquisitions
Pursuant to an agreement, dated March 31, 2004, the Company agreed to acquire
the shares of Alex Woda and Associates, Inc., a Toronto, Canada based
information risk management consulting firm, for $200,000 to be paid in the
Company's common stock and $130,000 in cash for total consideration of $330,000.
14. Discontinued Operations
During 2003, the Company disposed of its non-emergency transportation business.
As of March 31, 2004, the total remaining liabilities of discontinued operations
were $4,421,000. A significant portion of such payables are owed to third party
vendors and are subject to an interpleader action (see note 7 Commitments,
Contingencies and Other Agreements - COMMONWEALTH OF VIRGINIA).
15. Business Segments
DynTek's operations are organized along its product lines and include two
segments - Information Technology Services and Business Process Outsource
Services segments. The Information Technology Services segment provides a range
of specialized IT infrastructure services: system architectural design, legacy
systems integration, network engineering, applications development, network
security services, help desk support and operational support, primarily to state
and local government entities. In conjunction with these service offerings, it
also sells hardware and software to its customers. Operations are distributed
primarily among nine states (including the principal executive office),
California, Florida, Louisiana, Massachusetts, Michigan, Texas, New Mexico,
Virginia and New York, with employees situated in locations that are convenient
to client sites.
The Business Process Outsourcing segment contracts outsourced program operations
for state government agencies in several areas, including the privatization of
child support enforcement services. Our business process outsourcing customers
have included various governmental departments in the states of Virginia, North
Carolina, Kansas and Nebraska. The Company maintains employee locations in these
states as well. Typically these contracts are for multi-year periods of
performance, with options to renew for additional periods. Such contracts are
generally awarded through competitive procurements. Payment is based on either
fixed-price, fixed-unit- price based on contractual allocations, revenue
sharing, or a combination of the above.
Our reportable segments are business units that offer different services and
contract types and are managed separately due to the expertise and different
managed key factors in each area.
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Since the separate Outsourcing business segment was acquired as a unit,
management has retained separate reporting and review criteria for that unit.
The following table provides actual selected financial data for our business
segments (in thousands): Reportable Business Segments:
Business Information
Process Technology
Outsourcing Services Total
----------- -------- -----
Three months ended March 31, 2004
- ---------------------------------
Sales to external customers $ 2,145 $ 9,951 $ 12,096
Depreciation and amortization expense 123 668 791
Operating income (loss) 234 (1,021) (787)
Net interest expense (income) -- 197 197
Total assets 22,509 26,565 49,074
Capital expenditures -- 18 18
Three months ended March 31, 2003
- ---------------------------------
Sales to external customers $ 2,499 $ 9,513 $ 12,012
Depreciation and amortization expense 119 570 689
Operating income (loss) 576 (1,056) (480)
Net interest expense (income) 56 212 268
Total assets 37,345 26,119 63,464
Capital expenditures -- 16 16
Nine Months Ended March 31, 2004
- --------------------------------
Sales to external customers $ 7,159 $ 27,663 $ 34,822
Depreciation and amortization expense 345 1,787 2,132
Operating income (loss) (2,903) (4,341) (7,244)
Net interest expense (income) -- 605 605
Total assets 22,509 26,565 49,074
Capital expenditures 78 56 134
Nine Months Ended March 31, 2003
- --------------------------------
Sales to external customers $ 7,854 $ 30,146 $ 38,000
Depreciation and amortization expense 363 1,738 2,101
Operating income (loss) (123) (2,377) (2,500)
Net interest expense (income) 433 408 841
Total assets 37,345 26,119 63,464
Capital expenditures 5 17 22
16. Related-Party Transactions
In March 2001, the Company purchased 25% of the equity in LaborSoft Corporation
("LaborSoft"), a company providing labor relations software to labor unions and
commercial customers to supplement other market segment services. As a result of
its investment, the Company assigned one of its directors to become the chairman
of the board of directors of LaborSoft. The Company has a service agreement to
provide infrastructure services to LaborSoft, on a cost plus fee-for-service
basis. The Company accounts for its investment under the equity method of
accounting, and has therefore recognized its pro-rata portion of the losses
incurred by this affiliate, since March 2001, in the amount of $392,000. Such
losses have reduced the carrying value of the LaborSoft investment, which is
recorded in deposits and other assets, to $64,000 at March 31, 2004.
On September 30, 2003, the Company received additional security collateral for
its receivable from LaborSoft by obtaining a Promissory Note and Security
Agreement for the amount of $636,000 owed by LaborSoft for the value of
previously delivered services for which the
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Company has not been compensated. Under the Promissory Note, LaborSoft shall pay
interest on the amount, at the prime rate (4.0% as of March 31, 2004), with the
principal amount due on September 21, 2006. Under the Security Agreement
LaborSoft granted the Company a security interest in the assets of LaborSoft
including receivables, equipment, software, and other intellectual property,
inventory and other intangible assets of LaborSoft. The Company maintains a
reserve against this Promissory Note of $200,000. An additional amount due of
$27,760 is also due for services provided by the Company.
17. Subsequent Events
On April 5, 2004 the Company issued a short term promissory note to an affiliate
of Duncan Capital for working capital of $337,000, at 6% per annum. The term of
the note was 45 days. On May 5, 2004, the Company paid the principal and
interest of $338,828.
On April 27, 2004, the "Company entered into a series of agreements for a
private placement of shares of the Company's common stock, for an aggregate
gross purchase price of $6,347,480 at a price equal to $1.15 per share. Upon
closing, the Company issued (i) 5,519,550 shares of Common Stock to the
Purchasers, (ii) Series A common stock purchase warrants to purchase 1,655,865
shares of Common Stock (or up to 30% of the Common Stock issued to the
Purchasers) at an exercise price equal to $1.75 per share (the "Series A
Warrants") and (iii) Series B common stock purchase warrants to purchase
1,103,910 shares of Common Stock (or up to 20% of the Common Stock issued to the
Purchasers) at an exercise price equal to $1.50 per share (the "Series B
Warrants"). In addition, the placement agent received a placement agent fee of
$507,799 and Placement Agent Warrants equal to 10% of the aggregate shares of
Common Stock issued on the closing date (and issuable under Series A Warrants
and Series B Warrants) at an exercise price of $1.35 per share. The Series A
Warrants and the Placement Agent Warrants are exercisable for a term of five
years beginning six months following the closing date and are subject to
anti-dilution protection. The Series B Warrants are exercisable for a period of
180 days following the effective date of a registration statement on Form S-3 to
be filed by the Company promptly after the closing. An additional fee of $60,000
was paid for professional services rendered in connection with the closing.
On May 4, 2004, the Company issued an Accommodation Letter to the investors in
the April 27, 2004 Securities Purchase Agreement. The investors were provided
the opportunity to participate in an additional offering by which each will
receive from the Company (i) a number of shares (the "Additional Shares") of
Company common stock, which, when added to the number of Shares purchased by the
Investor in the Offering, will reduce the price per share paid for the aggregate
number of the Shares and the Additional Shares purchased by each Investor
respectively to $1.05 per share of Common Stock; (ii) an amendment to the
Investor's Series A Warrants acquired in the Offering, reducing the exercise
price from $1.75 per share to $1.50 per share and increasing the number of
shares of Common Stock for which it can be exercised by 30% of the number of
Additional Shares purchased by each Investor respectively; and (iii) an
amendment to the Investor's Series B Warrants acquired in the Offering, reducing
the exercise price from $1.50 per share to $1.25 per share, and increasing the
number of shares of Common Stock for which it can be exercised by 20% of the
number of Additional Shares purchased by each Investor respectively. The
placement agent also received additional warrants based on10% of the on the
Additional Shares and warrants issued under the Accommodation.
On May 3, 2004, the Company closed the private placement of a $2,500,000
principal secured convertible three-year term convertible debt financing
("Tranche B") with the Laurus Funds, by amending and restating its original
$3,500,000 principal secured convertible term note made to Laurus Funds and
creating a $6,000,000 amended and restated Note (the "Note"). This Note bears
interest at the Prime Rate (which under no circumstances will be considered to
fall below 4%) plus 1% (currently 5%), with interest payable monthly on a
current basis with respect to
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Tranche B commencing in June 2004 and level payments of principal with respect
to Tranche B commencing November 1, 2004. The Note is convertible to Company
common stock at the option of Laurus Funds. The Company's monthly payments of
principal and accrued interest under the Note with respect to Tranche B may be
made by delivering common stock shares instead, if at the time such stock
payment is delivered (i) there exists an effective registration statement
covering the distribution of such shares by the investor and (ii) the market
price for such shares is greater than 115% of $1.15 per share, the price fixed
for conversion to common stock of amounts outstanding with respect to Tranche B
under the Note. Subject to the same restrictions on stock payments of monthly
accrued interest and principal, the entire principal and accrued interest of the
Note may be prepaid in common stock. Any amounts of Note principal paid in cash,
including prepayments of the entire note principal, shall be subject to a 2%
premium payment (which is increased to a 4% premium payment in the event that an
effective registration statement covering the conversion shares is not in
place). As part of the transaction, Laurus Funds also received a five-year
warrant to purchase 625,000 shares of DynTek common stock, exercisable at $1.25
per share.
18. Recent Accounting Pronouncements
The following pronouncements have been issued by the Financial Accounting
Standards Board ("FASB").
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have a
sufficient equity at risk for the entity to finance its activities without
additional financial support from other parties. FIN 46 is effective for all new
variable interest entities created or acquired after January 31, 2003. However,
in December 2003, FASB deferred the latest date by which all public entities,
which meet the definition of small business issuer under SEC Regulation S-B
("Public SBs"), must apply FIN 46 to the first interim or annual reporting
period ended after March 15, 2004. The adoption of this pronouncement did not
have a material effect on the Company's financial statements.
-17-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
When used in the Form 10-Q and in future filings by the Company with the
Securities and Exchange Commission, the words or phrases "will likely result"
and "the Company expects," "will continue," "is anticipated," "estimated,"
"project," or "outlook" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, each of which
speaks only as of the date made. Such statements are subject to certain risks
and uncertainties that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. Such risks and
uncertainties include, among others, success in reaching target markets for
services and products in a highly competitive market and the ability to attract
future customers, the size and timing of additional significant orders and their
fulfillment, the success of the Company's business emphasis, the ability to
finance and sustain operations, including the ability either to maintain and
extend the Textron Factoring Facility and/or the Laurus Funds Note when either
becomes due, respectively, or to replace it with alternative financing, the
ability to raise equity capital in the future, either or both, despite
historical losses from operations, the ability to fulfill the Company's
obligations to third parties, and ability to defend successfully certain ongoing
litigation over contract performance, the size and timing of additional
significant orders and their fulfillment, the ability to turn contract backlog
into revenue and net income, the continuing desire of state and local
governments to outsource to private contractors and the ability of the Company
to obtain extensions of the remaining profitable DMR contracts at their
maturity, the performance of governmental services, the ability to develop and
upgrade our technology, and the continuation of general economic and business
conditions that are conducive to governmental outsourcing of service performance
and the acquisition of other services and products. The Company has no
obligation to publicly release the results of any revisions, which may be made
to any forward-looking statements to reflect anticipated or unanticipated events
or circumstances occurring after the date of such statements.
RESULTS OF CONTINUING OPERATIONS
The three months ended March 31, 2004 (the "2004 Three Month Period") as
compared to the three months ended March 31, 2003 (the "2003 Three Month
Period").
Revenues for the 2004 Three Month Period increased to $12,096,000 from
$12,012,000 for the 2003 Three Month Period. The revenue mix of product and
services was 39% and 61%, respectively, for the 2004 Three Month Period, as
compared to 42% and 58%, respectively, for the 2003 Three Month Period. The
decrease in revenues were in part off set by $450,000 from the sales of its
ProductivIT licenses during the 2004 Three Month Period.
Cost of revenues for the 2004 Three Month Period increased to $9,613,000 from
$9,505,000 for the 2003 Three Month Period, due primarily to the increase in
revenue. The overall gross margin percentage of 21% remained unchanged.
Selling, general and administrative expenses for the 2004 Three Month Period
increased to $2,479,000 from $2,298,000 for the 2003 Three Month Period. The
increase is due primarily from an expansion in sales personnel in new geographic
regions and lines of business. As a
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percentage of total revenues, such costs increased to 21% during the 2004 Three
Month Period, from 19% in the prior 2003 Three Month Period.
Depreciation and amortization expense for the 2004 Three Month Period increased
to $791,000 from $689,000 for the 2003 Three Month Period. The increase during
the 2004 Three Month Period is a result of additional amortization from the
increase in capitalized customer contracts associated with small acquisitions.
Interest expense for the 2004 Three Month Period was $199,000, as compared to
$316,000 during the 2003 Three Month Period. The decrease of $117,000 was
primarily due to a long term note payable in the 2003 Three Month Period which
did not exist in the comparable 2004 period. Also, interest from the credit
facility borrowings decreased $46,600 during the 2004 Three Month Period due to
reduced fees on the new Textron Factoring Facility entered into on June 30,
2003. During the 2003 Three Month Period the Company wrote off a liability to
the State of California for $1,821,000 which is reflected in other income.
Net loss from continuing operations was $984,000 for the 2004 Three Month
Period, as compared to net income of $1,190,000 for the 2003 Three Month Period.
The one-time reversal of a liability, mentioned above, is the primary cause of
this change from period to period.
The Nine Months Ended March 31, 2004 (the "2004 Nine Month Period") as compared
to the Nine Months Ended March 31, 2003 (the "2003 Nine Month Period").
Revenues for the 2004 Nine Month Period decreased to approximately $34,822,000
from approximately $38,000,000 for the 2003 Nine Month Period. This decrease
was associated with decreased orders from customers, resulting primarily from
reduced or delayed information technology spending budgets during the period.
However, revenue of $350,000 from the sale of its ProductivIT licenses to Child
Support Technologies, Inc. a subsidiary of Young Williams occurred during the
2004 Three Month Period.
The revenue mix from product sales and services was 39% and 61%, respectively,
for the 2004 Nine Month Period, as compared to 43% and 57%, respectively, for
the 2003 Nine Month Period.
Cost of revenues for the 2004 Nine Month Period decreased to approximately
$28,702,000 from approximately $30,685,000 for the 2003 Nine Month Period. The
overall gross margin percentage was 18% for the 2004 Nine Month Period and 19%
for the 2003 Nine Month Period. This decrease in margin primarily resulted from
lower margins on software license sales .
Selling, general and administrative expenses for the 2004 Nine Month Period
increased to approximately $8,232,000 from approximately $7,714,000 for the 2003
Nine Month Period. The increase is due primarily from an expansion in sales
personnel in new geographic regions and lines of business.
The Company recorded impairment of goodwill of $3,000,000 during the 2004 Nine
Month Period. Such adjustment reduced the carrying value of goodwill for the
outsourced management business. Due to a re-focus of business strategy, the
Company has determined that the projected revenues from contract renewals in the
future may be lower than in prior projections, as used for impairment analysis.
Depreciation and amortization expense for the 2004 Nine Month Period increased
to approximately $2,132,000 from approximately $2,101,000 for the 2003 Nine
Month Period. Interest income for the 2004 Nine Month Period increased to
approximately $95,000 from approximately $64,000 for the 2003 Nine Month Period.
This increase is due to the interest
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earned on the interest-bearing investment in Private Label Cosmetics during the
2003 Nine Month Period. Interest expense for the 2004 Nine Month Period was
approximately $700,000, as compared to $905,000 during the 2003 Nine Month
Period. Interest of $437,500 was attributed to a long term note payable in the
2003 Three Month Period which did not exist in the comparable 2004 period.
During the Nine Months Ended March 31, 2004, marketable securities were sold,
for net proceeds of $71,000 and a recognized loss of $107,000, of which $81,000
was previously provided as a valuation reserve as unrealized loss on securities.
The Company had recognized its pro-rata portion of the losses incurred by an
affiliate, in the amount of $62,000 during the 2003 Nine Month Period compared.
During the 2003 Nine Month Period the Company wrote off a liability to the State
of California, resulting in the Company recording other income of $1,862,000.
The increase in net loss to $8,184,000 for the 2004 Nine Month Period, as
compared to a loss of $1,545,000 for the 2003 Nine Month Period, is principally
attributed to a one-time reversal of a liability during the 2003 Nine Month
Period and the $3,000,000 expense for impairment of goodwill as mentioned above.
RESULTS OF DISCONTINUED OPERATIONS
Net loss from discontinued operations was $23,000 for the 2004 Three Month
Period as compared to a net loss of $342,000 for the 2003 Three Month Period.
Net loss was approximately $228,000 for the 2004 Nine Month Period compared to
a net loss of $80,000 for the 2003 Nine Month Period. This ongoing loss is
attributed to the continued legal, facility and administrative costs of the
discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2004, the Company had a working capital deficiency of
approximately $5,598,000. This deficiency has been eliminated in April and May
2004, with additional equity investments of over $7 million and funds from
additional long-term debt of $2,500,000. Furthermore, the Company anticipates a
substantial reduction in its accounts payable from a disbursement of proceeds
from a third party's performance bond to certain former vendors.
In April 2004, the Company sold shares of common stock for $6,347,480.
Additionally, warrants were exercised to purchase shares of the Company's common
stock for $1,040,721. In May 2004, the Company borrowed $2,500,000 in exchange
for an amendment to its outstanding convertible three-year term with an
institutional investor such three year term note aggregate principal now totals
$6,000,000.
As a result of being released from its obligations of indemnification under a
bond in an amount of $2.4 million, the Company's liability to former vendor
providers whose service payments are covered by the bond will be reduced by
approximately $2.4 million, upon disbursement of the bond proceeds to such
vendors, see Part II, Item I Legal Proceedings. Such anticipated reduction is
the result of the Company obtained a limited release of indemnification from
DynCorp of its obligation to pay to a bonding company, and limited release of
the Company's obligation to reimburse DynCorp for its obligation to fund,
respectively, an amount of approximately $2.4 million under a performance bond
related to the Company's discontinued transportation services business. Such
liability to the vendors is currently reflected in current liabilities from
discontinued operations, and will be eliminated from current liabilities from
discontinued operations as and to the extent that the bond proceeds are used to
satisfy those obligations to such vendors.
-20-
As provided in the asset sale to First Transit, in March 2003, First Transit has
an obligation to pay up to $1,750,000 in the event that they are able to obtain
an extension of the Company's former Illinois Department of Public Aid
transportation services contract for a period of up to three years beyond May
31, 2004 under certain specified conditions.
In June 2003, the Company entered into a 12 month renewable Textron Credit
Facility with an agency of Textron. The Textron Credit Facility provides a full
notification factoring facility for up to $7 million of working capital.
Eligible accounts receivable expected to be collected within 90 days from
invoice date are purchased with recourse, with a holdback amount of 15%.
Interest is charged on the outstanding balance at the Prime rate plus 2.5% (6.5%
at March 31, 2004). Additionally, a 0.25% discount fee is charged at the time of
purchase. As of March 31, 2004, $2,443,000 was outstanding under the Textron
Credit Facility. The Company is currently seeking alternative sources of
financing to replace the Textron facility in June 2004 with improved terms.
The Company may expand the scope of its product offerings by pursuing
acquisition candidates with complementary technologies, services or products.
Should the Company commence such acquisitions, it anticipates that it would
finance the transactions with a combination of its working capital and the
issuance of additional equity securities. The Company would attempt to secure
additional funding, including equity financing where appropriate, for
acquisitions. There can be no assurance, however, that the Company will be
successful in identifying appropriate acquisition candidates or that, if
appropriate candidates are identified, that the Company will be successful in
obtaining the necessary financing to complete the acquisitions.
The Company anticipates continued improvement in its cash flows during fiscal
2004 by implementing reductions of administrative overhead expenses as well as
aggressively pursuing new customer relationships and expanding the services
offered to existing customers. The Company believes that its present cash on
hand as well as the recently obtained additional debt and the recently obtained
equity financing will provide adequate funding through March 31, 2005.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's financial statements and accompanying notes are prepared in
accordance with accounting principles generally accepted in the United States.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. Critical accounting policies for us include
revenue recognition, impairment of investment securities, impairment of
goodwill, accounting for contingencies and accounting for discontinued
operations.
Basis of Presentation. During the fiscal year ended June 30, 2003, the Company
adopted a plan to sell our transportation brokerage operations. The operations
are accounted for as a discontinued operation, and, accordingly, amounts in the
consolidated financial statements and related notes for all periods presented
reflect discontinued operation accounting.
Revenue Recognition. The Company's policy follows the guidance from SEC Staff
Accounting Bulletin ("SAB") 101 "Revenue Recognition in Financial Statements".
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. The Company recognizes revenues when persuasive
evidence of an arrangement exists, the product has been shipped or the services
have been provided to the client, the sales price is fixed or determinable, and
collectibility is reasonably assured.
-21-
Generally, information technology processing revenues are recognized as services
are provided to the client. Revenues from annual maintenance contracts services
provided by the Company are deferred and recognized ratably over the maintenance
period. Revenues from hardware sales are recognized upon delivery to the client
and when uncertainties regarding customer acceptance have expired. Revenues for
business process outsourcing services are recognized as services are rendered,
normally invoiced on a monthly basis. Revenues on unit-price contracts are
recognized at the contractual selling prices of work completed and accepted by
the client. Revenues on time and material contracts are recognized at the
contractual rates as the labor hours and direct expenses are incurred.
Collectibility of Receivables. A considerable amount of judgment is required to
assess the ultimate realization of receivables, including assessing the
probability of collection and the current credit worthiness of our clients.
Probability of collection is based upon the assessment of the client's financial
condition through the review of its current financial statements or credit
reports.
SFAS 142, Goodwill and Other Intangible Assets, The Company evaluates the
recoverability of its goodwill and other intangibles in accordance with the
Statement of Financial Accounting Standards Board ("SFAS") No. 142, Goodwill and
Other Intangible Assets. As of March 31, 2004, goodwill associated with certain
child support enforcement outsource services contracts was evaluated for
impairment. Due to a re-focus of business strategy, the Company has determined
that the projected revenues from contract renewals in the future will be lower
and as a result, the Company has determined in accordance with the provisions of
SFAS No. 142, that there has been impairment of goodwill requiring an adjustment
of $3,000,000 to reduce the carrying value of goodwill. The Company will be
conducting its annual test of existing goodwill at June 30, 2004. The results of
this annual testing of goodwill will determine if further adjustments to reduce
the carrying value are required.
RECENT ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have a
sufficient equity at risk for the entity to finance its activities without
additional financial support from other parties. FIN 46 is effective for all new
variable interest entities created or acquired after January 31, 2003. However,
in December 2003, FASB deferred the latest date by which all public entities,
which meet the definition of small business issuer under SEC Regulation S-B
("Public SBs"), must apply FIN 46 to the first interim or annual reporting
period ended after March 15, 2004. The adoption of this pronouncement did not
have a material effect on the Company's financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Textron Factoring Facility exposes the Company to the risk of earnings or
cash flow loss due to changes in market interest rates. The Textron Credit
Facility requires interest to be paid at 2.5% over the prime rate. The Laurus
Funds convertible secured term note ($6,000,000 on May 3, 2004), exposes the
Company to similar risks, and requires interest to be paid at 1% over the prime
rate. The table below provides information on the Textron Credit Facility and
the Laurus Funds note as of March 31, 2004.
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- --------------------------- --------------------- ------------------------------
Weighted Average
- --------------------------- --------------------- ------------------------------
Principal Balance Interest Rate
- --------------------------- --------------------- ------------------------------
Factoring credit facility $2,443,000 6.5%
- --------------------------- --------------------- ------------------------------
Secured Convertible Note $3,500,000 5.0%
- --------------------------- --------------------- ------------------------------
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of
the Company's management, including its Chief Executive Officer, or CEO and
Chief Financial Officer, or CFO, of the effectiveness of the Company's
disclosure controls and procedures as of March 31, 2004. Based on that
evaluation, the Company's management, including its CEO and CFO, have concluded
that the Company's disclosure controls and procedures are effective to ensure
that the information required to be disclosed in the Company filings or which it
submits under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. There have been no changes in the Company's
internal controls over financial reporting or in other factors identified in
this evaluation that occurred during the Nine Months Ended March 31, 2004 that
have materially affected, or are reasonably materially likely to affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
COMMONWEALTH OF VIRGINIA
Effective December 15, 2002, the Company entered into a mutual Settlement
Agreement to cancel a contract to provide non-emergency transportation brokerage
services in certain regions of the Commonwealth of Virginia. The terms of the
Settlement Agreement provided that the Company make payments to transportation
provider vendors according to an agreed-upon schedule, which extended through
June 2003. This was extended under an interim letter understanding. In
connection with initially entering the contract, a performance bond was posted
by a third party to guarantee payment to the transportation provider vendors up
to the bond amount of $2.4 million. A number of such vendors caused the bond to
be called, requiring the bond amount to be deposited in an escrow account and
initiating a process of disbursing the $2.4 million to vendors with valid
claims. The bonding company filed an interpleader action on July 22, 2003. In a
separate transaction, the Company has entered into a limited release of
indemnification to reimburse the guarantor for funding the bond. As a result,
the Company's liability to such vendors will in effect have been extinguished to
the extent of the funds disbursed. The amount of $2.4 million deposited in
escrow for the payment to the Company's vendors has not yet been recorded as an
offset to the Company's accounts payable. When the individual claims are
determined for each vendor, in accordance with court procedures, the interplead
funds shall be disbursed and the payable shall be reduced accordingly. Should
valid claims remain outstanding after the disbursement of the interplead funds,
certain vendors may continue to pursue their claims after the interpleader
proceedings are concluded, however, such claims may not exceed the amounts
determined by the courts to be due. The courts are currently in the process of
assembling the amounts of the claims of due from these vendors; however, initial
indications are that the aggregate of the interpleader claims filed will not
exceed the combined total of the bond amount and the Company payables currently
recorded as due to such vendors. The Company believes a substantial amount of
these claims are without merit based on billings for services that were not
provided under the agreements or on billings which were outside the terms of the
subcontracts, or as a result of certain claims having already been settled with
claimants. Since August 2003, the Company has made payments in the aggregate
amount of approximately $100,000 per month to various providers.
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A number of the vendors that provided transportation services in the
Commonwealth of Virginia have initiated separate legal demands for payment. Some
of the demands, either in whole or in part, have been disputed by the Company as
being without merit or have been settled. As of March 31, 2004, actions for
collection are pending in 12 separate proceedings. Ali Medical,et.al, a joint
case of 27 providers for approximately $1,042,000 is the largest of the claims.
The Ali Medical joint case was consolidated with the above-referenced
interpleader action for all purposes. The Ali Medical claimants are considered
cross-claimants in the interpleader action. In addition to the Ali Medical
claimants, additional defendants in the interpleader action have filed
cross-claims. The remaining eleven proceedings have been stayed by an order of
the court overseeing the interpleader action. In both the outside lawsuits and
the cross-claims all or a portion of the amounts claimed have been disputed.
Provisions in the Company's condensed consolidated financial statements for the
estimated settlement amounts for these and other potential similar claims are
considered adequate; however, the Company is unable to predict the outcome of
these claims.
On November 4, 2003, New England Financial filed a breach of contract complaint
in Orange County Superior Court of California. The complaint arose from the
cancellation of a contract for health insurance benefits and non payment of
remaining fees. The claim is for $534,000 of which the company partially
disputes and is currently negotiating settlement terms.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On January 29, 2004, the Company sold $300,000 of Common Stock and warrants to
accredited investors in an offering exempt from the registration requirements of
the Securities Act of 1933 and Regulation D promulgated thereunder, all on the
same terms as offered to the investors in the Company's December 2003 private
placement, as amended by the January 15, 2004 Registration Right Agreement
Amendment and Allonges. As a result, the Company issued to such investors an
aggregate of 454,545 shares of its common stock and five-year warrants to
acquire 227,272 shares of common stock exercisable at $.75 per share. The
placement agent for this $300,000 offering received $24,000 in cash and
warrants, exercisable at $.091 per share, to acquire 68,182 shares of Common
Stock.
ITEM 5. OTHER INFORMATION
Following receipt of commitments to purchase shares of its common stock and
warrants under the terms of a Securities Purchase Agreement, dated April 27,
2004, by and between the Company and certain accredited investors (the
"Purchasers"), for an aggregate gross purchase price of $6,347,480 (the
"Offering"), which reflected a price equal to $1.15 per share (5,519,550
shares), and which agreement also provided for the issuance of (i) Series A
common stock purchase warrants to purchase 1,655,865 shares of Common Stock (or
up to 30% of the Common Stock issued to the Purchasers) at an exercise price
equal to $1.75 per share (the "Series A Warrants") and (ii) Series B common
stock purchase warrants to purchase 1,103,910 shares of Common Stock (or up to
20% of the Common Stock issued to the Purchasers) at an exercise price equal to
$1.50 per share (the "Series B Warrants"), a significant decrease in the market
price of the common stock occurred. As a result of such decrease, by letter
agreement dated as of May 4, 2004, the Company determined that it would be fair
to the investors in the Offering, as well as in its best interest, to
accommodate the Purchasers (x) by issuing additional shares of its common stock
in a private placement exempt from registration under Section 4(2) of the
Securities Act of 1933 and Regulation D promulgated thereunder, and (y) by
amending the Series A and Series B Warrants for nominal additional
consideration, as follows:
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(1) The Company issued to each Purchaser a number of shares of its common stock
(the "Additional Shares") which, when added to the number of shares
purchased in the Offering , reduced the price per share paid for the
Offering shares and such Additional Shares to $1.05 per share;
(2) Each Purchaser's Series A Warrants were amended by reducing the exercise
price from $1.75 per share to $1.50 per share, and increasing the number of
shares underlying such warrant by 30% of the number of Additional Shares
received by the Purchaser, respectively ("Additional Series A Shares"); and
(3) Each Purchaser's Series B Warrants were amended by reducing the exercise
price from $1.50 per share to $1.25 per share, and increasing the number of
shares underlying such warrant by 20% of the number of Additional Shares
received by the Purchaser, respectively ("Additional Series B Shares").
All of the registration rights and other rights granted to Purchaser under the
terms of the documents executed in connection with the Offering were extended to
the Additional Shares and to the Additional Series A and Additional Series B
Shares. In total, approximately 560,000 Additional Shares were issued as a
result of this accommodation.
As part of the accommodation, Duncan Capital LLC, the placement agent for the
Offering, received additional five-year Placement Agent Warrants giving it the
right to acquire a number of shares of the Common Stock equal to 10% of the
aggregate of the Additional Shares and the Additional Series A and Series B
Shares at $1.16 per share.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Services Agreement, dated March 1, 2004, by and between
Dyntek, Inc., DynTek Services, Inc. and Young, Williams, P.C
10.2 First Amendment to Services Agreement, dated April 27, 2004,
by and between Dyntek, Inc., DynTek Services, Inc. and Young,
Williams, P.C
10.3 ProductivIT Sale Agreement, dated March 1, 2004, by and
between DynTek Services, Inc. and Child Support Technologies
Inc.
10.4 ProductivIT Maintenance, Support and Portal Agreement, dated
March 1, 2004 by and between DynTek Services, Inc. and Child
Support Technologies Inc.
31.1 Rule 13a-14(a) / 15d-14(a), Certification of Steven J. Ross.
31.2 Rule 13a-14(a) / 15d-14(a), Certification of James Linesch.
32.1 Section 1350 Certification of Steven J. Ross.
32.2 Section 1350 Certification of James Linesch.
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(b) Reports on Form 8-K
The following reports on Form 8-K were filed by the Company during the quarter
ended March 31, 2004:
(1.) On February 3, 2004, the Company filed a Current Report on Form 8-K in
connection with the private placement of a $3,500,000 principal secured
convertible three-year term note with the Laurus Master Fund, Ltd.
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DYNTEK, INC.
By: /s/ James Linesch
--------------------
James Linesch
Chief Financial Officer
Date: May 14, 2004
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