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 September 30, 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 Common Stock, $.0001 par
value, as of November 12, 2004 was 59,690,298. .
DYNTEK, INC. AND SUBSIDIARIES
INDEX
Page
PART I - FINANCIAL INFORMATION Number
------
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - as of September 30, 2004
(unaudited) and June 30, 2004 3
Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) (unaudited) - For the Three Months Ended
September 30, 2004 and September 30, 2003 4
Condensed Consolidated Statements of Cash Flows (unaudited)
- For the Three Months Ended September 30, 2004 and
September 30, 2003 5-6
Notes to Condensed Consolidated Financial Statements (unaudited) 7-16
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 21-22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURE 24
-2-
PART 1 - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30, June 30,
ASSETS 2004 2004
------------- --------
(unaudited)
CURRENT ASSETS:
Cash 1,073 2,810
Cash - Restricted 321 479
Accounts receivable, net of allowance for doubtful
accounts of $240 12,552 12,045
Inventories 1,877 1,399
Prepaid expenses and other assets 208 54
Other receivables 5 88
-------- ---------
TOTAL CURRENT ASSETS 16,036 16,875
RESTRICTED CASH - over one year 137 91
INVESTMENTS - Marketable Securities 67 78
INVESTMENTS - Preferred Stock 1,104 1,104
PROPERTY AND EQUIPMENT, net of accumulated depreciation of
$3,069 and $3,035 656 519
GOODWILL 22,264 19,869
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization
of $693 and $809 122 163
ACQUIRED CUSTOMER LIST, net of accumulated amortization
of $7,809 and $7,136 6,762 5,542
PURCHASED SOFTWARE, net of accumulated amortization
of $690 and $671 -- 19
DEFERRED FINANCING COSTS, net of accumulated amortization
of $153 and $77 579 655
NOTES RECEIVABLE, long term, including receivable from
officer of $100 548 548
DEPOSITS AND OTHER ASSETS 151 186
-------- ---------
$ 48,426 $ 45,649
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 6,122 $ 5,897
Line of credit 2,457 2,454
Acquisition costs 4,286 --
Accrued expenses 2,001 1,468
Deferred revenue 410 559
Notes payable - accrued interest 145 79
Notes payable current portion 2,160 1,812
Current liabilities of discontinued operations 2,036 4,181
-------- ---------
TOTAL CURRENT LIABILITIES 19,617 16,450
DEFERRED REVENUE - long term 137 91
LONG TERM NOTE PAYABLE 3,043 3,505
-------- ---------
TOTAL LIABILITIES 22,797 20,046
-------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized; 683,317
shares issued and outstanding as of September 30, 2004 and June 30, 2004,
respectively 1 1
Common stock, $.0001 par value, 70,000,000 shares authorized; 58,430,597
shares issued and outstanding as of September 30, 2004 and June 30, 2004
respectively 5 5
Additional paid-in capital 100,815 100,822
Accumulated other comprehensive loss (184) (170)
Accumulated deficit (75,008) (75,055)
-------- ---------
TOTAL STOCKHOLDERS' EQUITY 25,629 25,603
-------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 48,426 $ 45,649
======== =========
See notes to condensed consolidated financial statements.
-3-
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(in thousands, except per share data)
Three Months Ended
September 30,
2004 2003
------------ ------------
REVENUES:
Product Revenues $ 8,413 $ 5,593
Service Revenues 6,370 7,332
------------ ------------
Total revenues 14,783 12,925
------------ ------------
COST OF REVENUES:
Cost of products 6,961 4,961
Cost of services 5,141 5,680
------------ ------------
Total cost of revenues 12,102 10,641
------------ ------------
GROSS PROFIT 2,681 2,284
------------ ------------
OPERATING EXPENSES:
Selling expenses 1,825 1,822
General and administrative expenses 1,370 848
Depreciation and amortization 760 679
------------ ------------
Total operating expenses 3,955 3,349
------------ ------------
LOSS FROM OPERATIONS (1,274) (1,065)
------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of marketable
securities -- (107)
Interest expense (273) (355)
Interest income 9 5
Other expense (50) --
------------ ------------
Total other income (expense) (314) (457)
NET LOSS FROM CONTINUING OPERATIONS $ (1,588) $ (1,522)
DISCONTINUED OPERATIONS
Gain on disposal of discontinued
operations -- --
Income (Loss) on discontinued
operations 1,635 (175)
------------ ------------
INCOME (LOSS) FROM DISCONTINUED
OPERATIONS 1,635 (175)
------------ ------------
NET INCOME (LOSS) $ 47 $ (1,697)
============ ============
NET LOSS PER SHARE: Basic and Diluted:
Continuing Operations (.03) (.04)
Discontinued Operations .03 --
------------ ------------
$ -- $ (.04)
============ ============
WEIGHTED AVERAGE NUMBER OF SHARES
USED IN COMPUTATION
Basic and Diluted 58,430,597 40,522,222
NET INCOME (LOSS) $ 47 $ (1,697)
COMPREHENSIVE INCOME (LOSS), NET OF TAX
Change in unrealized gain (loss) on
available-for-sale- securities (14) 74
------------ ------------
COMPREHENSIVE INCOME (LOSS) $ 33 $ (1,623)
============ ============
See notes to condensed consolidated financial statements
-4-
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
---------------------
Three Months Ended
September 30,
---------------------
2004 2003
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss - Continuing operations $(1,588) (1,522)
------- -------
Adjustments to reconcile net loss, excluding discontinued operations, to
net cash
used in operating activities:
Depreciation and amortization 720 625
Amortization of debt discount 41 --
Amortization of deferred financing costs 76 --
Amortization of capitalized software costs 41 54
Loss (gain) on marketable securities -- 107
Changes in operating assets and liabilities:
Accounts receivable 714 2,126
Inventory (223) (141)
Prepaid expenses (70) 33
Deposits and other assets 35 32
Accounts payable (1,044) (2,962)
Deferred revenue (103) (98)
Accrued expenses (221) (950)
Note Payable-accrued interest 27 --
Restricted cash 112 195
------- -------
Total adjustments 105 (979)
------- -------
NET CASH USED IN CONTINUING OPERATIONS (1,483) (2,501)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES OF DISCONTINUED OPERATIONS (510) (744)
------- -------
NET CASH USED IN OPERATING ACTIVITIES (1,993) (3,245)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Other notes receivable -- 71
Cash received from Redrock acquisition 405 --
Capital expenditures (36) (81)
------- -------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 369 (10)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds (repayments) from debt financing (116) --
Net proceeds (repayments) under line of credit 3 1,420
Issuance of Common Stock, net of expenses -- 1,835
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (113) 3,255
------- -------
NET INCREASE (DECREASE) IN CASH (1,737) --
CASH AT BEGINNING OF YEAR 2,810 --
------- -------
CASH AT END OF YEAR $ 1,073 $ --
======= =======
See notes to condensed consolidated financial statements
-5-
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands, except share data)
Three Months Ended
September 30,
------------------------
2004 2003
------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 208 $ 355
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:
Forgiveness by shareholders of note and accrued interest -- 5,625
See notes to condensed consolidated financial statements
-6-
DYNTEK, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(UNAUDITED)
1. Basis of Presentation and Management's Liquidity Plans
The accompanying unaudited condensed consolidated financial statements of
DynTek, Inc. and its subsidiaries ("DynTek", "Company", or "we") have been
prepared in accordance with accounting principles generally accepted in the
United State of America, for interim financial statements and pursuant to the
instructions to Form 10-Q and Article 10 of Regulation 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, 2004 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, that 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 were a component of the Company's
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 September 30, 2004, the Company had a working capital deficiency of
approximately $3,581,000, which includes $4,286,000 of acquisition indebtedness
incurred in a business combination that was consummated on September 30, 2004
(Note 12). In October 2004, the Company entered into a Convertible Note Purchase
Agreement for an aggregate principal amount of $4,438,775. The proceeds of this
offering were used to acquire other businesses, expand the Company's product and
service offerings and for general working capital purposes.
The Company believes that its cash on hand, cash it expects to generate
from operations and proceeds it expects to receive in future financing
transactions will sustain the business through September 30, 2005. The Company
believes that its cost cutting initiatives and additional revenue it expects to
generate from acquired businesses will enable it to steadily improve its
financial condition in 2005 However, there can be no assurance that the Company
will have sufficient funds to implement its business plan or that the
implementation of such plan will generate sufficient cash flow. In such event,
the Company could be forced to significantly alter its plan, which could include
making further cost reductions in overhead and/or divesting certain contracts or
other assets that may not be critical to its future success.
2. Accounting Policies
The Company's significant accounting policies are included in Note 1 to
the Company's consolidated financial statements that were filed in its Form 10-K
for the year ended June 30, 2004.
3. Marketable Securities
Marketable securities have been classified as available for sale
securities at September 30, 2004. Accordingly, the unrealized loss resulting
from valuing such securities at market value is reflected as a component of
stockholders' equity. At September 30, 2004, the unrealized loss on such
securities amounted to $184,000.
-7-
4. Investment Preferred Stock
At June 30, 2003, the Company held a $1,104,000 note receivable due from
Private Label Cosmetics, Inc., ("PLC") payable in 48 monthly installments with
interest at 7. 5% per annum. The note was secured by 342 shares of PLC common
stock. On September 23, 2003, the Company agreed to convert the note into 1,000
shares of PLC preferred stock which it currently holds as an investment. Such
preferred shares are convertible, at the Company's option, into 306 shares of
PLC Common Stock. The preferred shares also include a liquidation provision in
the event that PLC is sold. Dividends are payable at $10,000 per quarter
beginning March 31, 2005.
5. Notes Receivable
On September 30, 2003, the Company received additional security collateral
for its accounts receivable due from LaborSoft Corporation ("LaborSoft"), a 25%
equity investee of the Company (Note 15), by obtaining a Promissory Note and
Security Agreement in the amount of $636,000 that LaborSoft owes the Company,
for previously delivered services. The Promissory Note, which bears interest at
the prime rate, (4.5% as of September 30, 2004), matures on September 21, 2006.
LaborSoft granted the Company a security interest in its assets which includes
receivables, equipment, software, and other intellectual property, inventory and
intangible assets. The Company established a $200,000 reserve against the
carrying value Promissory Note in fiscal year 2003. The Company also has $82,000
of trade receivables due from LaborSoft for current services, which are included
in accounts receivable in the September 30, 2004 balance sheet.
On January 2, 2001, the Company advanced $170,000 to Steven Ross, its
Chief Executive Officer, which was evidenced by a promissory note bearing
interest at 8% per annum. On December 10, 2001, the Company extended the term of
the note to the end of Mr. Ross' period of employment. On December 10, 2001, the
Company forgave $70,000 of such note as a bonus to Mr. Ross. At September 30,
2004, $100,000 remained outstanding under the note receivable.
6. Goodwill and Other Intangibles
The Company evaluates the recoverability of its goodwill and other
intangible assets in accordance with the Statement of Financial Accounting
Standards Board ("SFAS") No. 142, "Goodwill and Other Intangible Assets," on an
annual basis and at interim periods when events occur or circumstances change
that would more likely than not reduce the fair value of a reporting unit below
its carrying amount. During the quarter ended September 30, 2004, there were no
events or circumstances that reduced the carrying value.
7. Credit Facility
On June 30, 2003, the Company entered into a twelve (12) month credit
facility agreement with annual automatic renewals with an agency of Textron
Financial Corporation ("Textron"). Textron provides a full notification
factoring facility for up to $7,000,000 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 the prime rate plus 2% (6.5% at September 30, 2004). Additionally, a
0.25% discount fee is charged at the time of purchase. Effective July 1, 2004
the Textron agreement was amended and extended for an additional period of (24)
twenty four months. As of September 30, 2004, $2,457,000 was outstanding under
this credit facility.
-8-
8. Commitments, Contingencies, and Other Agreements
COMMONWEALTH OF VIRGINIA
Effective December 15, 2002, the Company entered into a mutual Settlement
Agreement (the "Settlement Agreement") to cancel a contract (the "Transportation
Contract") in which it provided non-emergency transportation brokerage services
through third party providers (the "Transportation Vendors") to the Commonwealth
of Virginia ("Virginia"). Under the terms of the Settlement Agreement, the
Company agreed to make certain payments due to the Transportation Vendors under
an agreed-upon schedule through June 2003.
DynCorp, Inc ("Dyncorp") posted a $2,400,000 bond (the "Bond") to
guarantee its financial performance under the contract in favor of Virginia at
the time of its origination. In 2003, certain of the Transportation Vendors made
claims that caused the bond to be called. On July 22, 2003, the bonding company
filed an inter-pleader action (the "Inter-Pleader Matter") to distribute the
$2,400,000 (the "Bonded Amount").
During the quarter ended September 30, 2004, the Company substantially
completed the process of verifying claims by the Transportation Vendors, which
had been consolidated under the Inter-Pleader Matter The Company expects total
claims under the settlement to amount to $4,200,000. Approximately $1,600,000 of
such claims were reviewed, negotiated and settled in accordance with procedures
established by the Virginia state court during the current quarter relating to
liabilities that originated prior to September 30, 2004. The Company therefore
recorded this extinguishment as part of discontinued operations. In accordance
with SFAS 140 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities".
Transportation Vendors that have valid claims under the settlement will be
paid on or about December 15, 2004. The Company is responsible to pay any claims
in excess of the Bond coverage. The Company believes that the excess amount will
may be as much as $1,800,000 for which such amount has been included in
liabilities of discontinued operations in the Company's balance sheet.
OTHER AGREEMENTS
On September 29, 2004, the Company entered into a Stock Purchase Agreement
with Redrock Communications Solutions, Inc. as described in note 12 of the
condensed consolidated financial statements.
9. Stock Based Compensation
-9-
During the year ended June 30, 2003, the Company adopted Statement of
Financial Accounting Standard ("SFAS") No. 148, "Accounting for Stock-based
Compensation-Transition and Disclosure." This statement amended SFAS No. 123,
"Accounting for Stock-based Compensation." As permitted under SFAS No. 123, the
Company applies the intrinsic value method of accounting for its stock based
compensation in accordance with Accounting Principles Board Opinion (APB) No.
25, "Accounting for Stock Issued to Employees." As required under SFAS No. 148,
the following table presents pro-forma net income (loss) and basic and diluted
income (loss) per share as if the fair value-based method had been applied to
all awards.
Three Months Ended
September 30,
-------------------
Periods Ended September 30, 2004 2003
--------------------------- ------- ---------
Net Income (Loss) $ 47 $ (1,697)
Stock-based employee compensation
cost, net of tax effect, under fair
value accounting (22) (83)
------- ---------
Pro-forma net income (loss) under
Fair Value Method $ 25 $ (1,780)
======= =========
Income / (Loss) per share:
Basic $ -- $ (.04)
======= =========
Diluted $ -- $ (.04)
=========
Pro-forma income (loss) share: Basic $ -- $ (.04)
======= =========
Pro-forma income (loss) share:
Diluted $ -- $ (.04)
======= =========
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
2005 grants 2004 grants
----------- -----------
Dividend yield -- --
Weighted average expected life: 2.2 years 3.6 years
Weighted average risk-free interest rate 1.79% 2.5%
Expected volatility 77% 136%
10. 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 September 30, 2004, 1,506,483 of such shares
have been converted into 3,766,208 shares of Common stock, with a remainder of
683,317 shares not yet converted.
-10-
On October 5, 2004, an additional 66,300 shares of the preferred stock
were converted into 165,760 shares of common stock.
11. 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 26,551,721 were included in the diluted weighted average
calculation for the three months ended September 30, 2004. For the three months
ended September 30, 2003, common stock equivalents totaling 12,938,719 were
excluded from the weighted average share calculation as their inclusion would be
anti-dilutive..
Total outstanding stock, options, convertible preferred stock, convertible debt
and warrants are as follows:
-----------------------------------------------------
As of September 30,
2004 2003
Common stock 58,430,897 42,661,739
Options and warrants 19,030,626 9,293,661
Convertible debt 5,812,802 --
Convertible preferred stock 1,708,293 3,645,058
-----------------------
84,982,618 55,600,458
=======================
12. Business Acquisitions
On September 29, 2004, the Company entered into a Stock Purchase Agreement
(the "Agreement") Effective August 1, 2004 to acquire all of the outstanding
Common Stock of Redrock Communications Solutions, Inc., ("Redrock") for purchase
consideration consisting of (i) an initial aggregate cash payment of $2,500,000;
(ii) a deferred aggregate cash payment of $500,000 payable 60 days after the
closing date; (iii) an earn-out cash payment up to a maximum amount of
$1,500,000, based upon Redrock's EBITDA for the period of July 1, 2004 through
June 30, 2005 and (iv) $500,000 of the Company's common stock, subject to
adjustment based on the final determination of Redrock's working capital,
divided by $.63, the average closing price of the Company's common stock for the
10 trading preceding the closing date.
A summary of the business assets acquired (in thousands) is as follows:
Consideration paid:
Stock to be issued $ 500
Cash 3,000
Liabilities assumed 2,020
------
Total consideration $5,520
------
Assets acquired:
Cash 405
Accounts receivable, net 1,221
Inventory 255
Prepaid expenses, deposits and other assets 8
Property and equipment 136
Customer list 1,200
Goodwill 2,295
------
Fair value of assets acquired $5,520
------
-11-
The following unaudited pro-forma information reflects the results of operations
of the Company as though the acquisition had been consummated as of July 1,
2003.
- --------------------------------------------------------------------------------
(000's) Three Months Three Months
ended 9/30/04 ended 9/30/03
- --------------------------------------------------------------------------------
Revenue $15,534 $15,492
- --------------------------------------------------------------------------------
Net Income (Loss) (186) (1,404)
- --------------------------------------------------------------------------------
Net Income (Loss) per share (.00) (.03)
- --------------------------------------------------------------------------------
13. Discontinued Operations
During 2003, the Company disposed of its non-emergency transportation
business. As of September 30, 2004, the total remaining liabilities of
discontinued operations amounted to $2,036,000. A significant portion of such
payables are owed to the Transportation Vendors involved in the Inter-Pleader
Matter described in Note 8.
14. Business Segments
DynTek's operations are organized along its product lines and include two
segments; - Information Technology Services and Business Process Outsource
Services. 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 seven states (including the principal executive office),
California, Florida, Massachusetts, Michigan, Nevada, 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 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. Since the separate Business Processing
Outsourcing 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):
-12-
Business Information
Process Technology
Outsourcing Services Total
----------- -------- -----
Three months ended September 30, 2004
- -------------------------------------
Sales to external customers $ 2,676 $ 12,107 $ 14,783
Depreciation and amortization expense 117 643 760
Operating income (loss) 80 (1,354) (1,274)
Net interest expense (income) -- 264 264
Total assets 14,614 33,812 48,426
Capital expenditures -- 36 36
Three months ended September 30, 2003
- -------------------------------------
Sales to external customers $ 1,873 $ 11,052 $ 12,925
Depreciation and amortization expense 111 568 679
Operating income (loss) 57 (1,579) (1,522)
Net interest expense (income) -- (350) (350)
Total assets 25,892 24,288 50,180
Capital expenditures -- 81 81
15. Related-Party Transactions
In March 2001, the Company purchased 25% of the equity in LaborSoft, a
company that provides labor relations management software to labor unions and
commercial customers, to supplement its other market segment services. In
connection with such investment, the Company appointed one of its directors to
become chairman of Laborsoft's board of directors. The Company also provides
infrastructure services to LaborSoft, under a cost plus fee-for-service
agreement.
The Company accounts for its investment in Laborsoft under the equity method of
accounting. Accordingly, the Company's records its pro-rata share of Laborsoft's
income (loss) as an increase (decrease) in the carrying value of its investment.
The Company's pro-rata share of Laborsoft's losses since March 2001 amount to
approximately $456,000. Such losses have eliminated the carrying value of the
LaborSoft investment.
16. Subsequent Events
On October 15, 2004 the Company entered into a 9% Senior Subordinated
Convertible Note Purchase Agreement (the "Note Agreement") with certain
investors (the "Purchasers") in which it issued an aggregate of $4,438,775 in
principal amount of the Company's Senior Subordinated Convertible Notes (the
"Senior Notes"), bearing 9% interest per annum with a maturity of three years..
The Senior Notes are convertible into shares of the Company's common stock at a
conversion price of $.65 per share, subject to certain adjustments.
As part of the issuance of the Notes, the Company also issued to the
Purchasers warrants to purchase 3,414,442 shares of the common stock at an
exercise price of $.7475 per share (the "Warrants"). The Warrants may be
exercised immediately and will expire on September 30, 2009. In addition, the
Company issued to the Purchasers who have not previously participated in any
financing of the Company warrants to purchase up to 554,540 shares of the Common
stock at an initial exercise price of $1.25 per share (the "Additional
Warrants"). The Additional Warrants may be exercised immediately and will expire
on June 10, 2005.
Pursuant to the Note Agreement, the Company issued to Duncan Capital LLC,
the placement agent in connection with the transaction, warrants to purchase up
to 692,308 shares of the Company's Common Stock at an initial exercise price of
$0.7475 per share (the "Placement Warrants") and paid a cash fee of $360,000.
The Placement Warrants may be exercised immediately and will expire on September
30, 2009.
-13-
In connection with the issuance of the Notes and the warrants, the Company
entered into a Registration Rights Agreement with the Purchasers obligating the
Company to register for resale the shares of the Common Stock issuable upon the
conversion of the Notes and the exercise of the associated warrants discussed
above on a registration statement on Form S-3 to be filed with the Securities
and Exchange Commission within thirty (30) days after the closing date.
On October 14, 2004, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement"), by and among the Company, ITI Acquisition
Corp., a California corporation and wholly owned Subsidiary of the Company
("Merger Sub"), Integration Technologies, Inc., a California corporation
("ITI"), the shareholders of ITI (the "Shareholders") and Casper Zublin, Jr., in
his capacity as the shareholder representative (the "Representative").
On October 18, 2004, the Merger Sub was merged into ITI with ITI becoming
a wholly-owned subsidiary of the Company (the "Merger"). The consideration paid
or payable to the Shareholders in connection with the Merger is comprised of:
(i) an initial cash payment of $2,500,000; (ii) an earn-out cash payment up to a
maximum amount of $1.5 million, based upon ITI's EBITDA for the period between
July 1, 2004 through June 30, 2005 to be paid on or before July 30, 2005; (iii)
a earn-out cash payment up to a maximum amount of $1.5 million, based upon ITI's
revenue for the period between July 1, 2004 through June 30, 2005 to be paid on
or before July 30, 2005; and (iv) an aggregate number of whole shares of Company
common stock of based on the average closing sale price per share (the "Share
Price") of such common stock as reported on the Nasdaq SmallCap Market (the
"Nasdaq") for the 30 trading days prior to June 28, 2005, determined as follows:
(a) 2,140,000 shares if the Share Price is greater than $1.00 but less than
$1.50; (b) that number of shares equal to $2,140,000 divided by the Share Price
if the Share Price is less than $1.00, provided that the maximum number of
shares issuable pursuant to this clause (b) shall be no more than 4,280,000
shares; or (c) that number of shares equal to $3,210,000 divided by the Share
Price if the Share Price is greater than $1.50 (the "Stock Consideration"). At
the option of the Representative, up to fifty percent (50%) of the Stock
Consideration may be paid in cash instead of Company Common Stock. In no event
will the Company be required to issue shares of Company Common Stock if such
issuance would require stockholder approval under applicable Nasdaq Marketplace
Rules. In the event the number of shares issuable as Stock Consideration is so
limited, the Company will pay the difference to the Shareholders in cash.
Effective October 15, 2004, the Company entered into an Employment
Agreement, ("Zublin Agreement") with Casper Zublin, Jr. to serve as the
Company's Chief Operating Officer. Under the Zublin Agreement, Mr. Zublin will
receive a base salary at the annualized rate of $300,000, and he is entitled to
receive an annual bonus pursuant to a bonus plan established by the Company's
Compensation Committee. The bonus shall be based upon the achievement of
criteria as set forth in the Company's bonus plan. Mr. Zublin received a grant
of options to purchase 350,000 shares of the Company's common stock, subject to
certain vesting provisions. The Zublin Agreement also provides Mr. Zublin with
severance benefits in the event of his termination for certain reasons. The
Zublin Agreement provides additional benefits for Mr. Zublin in the event of a
change in control of the Company and Mr. Zublin's employment is terminated,
subject to certain conditions. In connection with his employment, Mr. Zublin
also entered into an Indemnification Agreement with the Company, as well as an
Incentive Stock Option Agreement.
On November 12, 2004, the Company entered into an Employment Agreement
(the "Webber Agreement") with Robert I. Webber to serve as the Company's Chief
Financial Officer and as a director of the Company. Under the Webber Agreement,
which is effective as of August 1, 2004, Mr. Webber receives a base salary at an
annualized rate of $300,000, and he is entitled to receive an annual incentive
bonus pursuant to a bonus plan established by the Company's Compensation
Committee. The bonus shall be based upon the achievement of criteria as set
forth in the Company's bonus plan. Mr. Webber received a grant of options to
-14-
purchase 660,000 shares of the Company's common stock, and a grant of 50,000
shares of restricted stock, subject to certain Company performance and vesting
provisions. The Webber Agreement also includes severance and change in control
benefits, in the event of Mr. Webber's termination for certain reasons.
On November 12, 2004, the Company entered into an Employment Agreement
(the "Ross Agreement") with Steven J. Ross to serve as the Company's President
and Chief Executive Officer and as a director of the Company. Under the Ross
Agreement, which is effective as of July 1, 2004, Mr. Ross receives a base
salary at an annualized rate of $440,000, and he is entitled to receive an
annual incentive bonus pursuant to a bonus plan established by the Company's
Compensation Committee. The bonus shall be based upon the achievement of
criteria as set forth in the Company's bonus plan. Mr. Ross received a grant of
options to purchase 1,320,000 shares of the Company's common stock, and a grant
of 200,000 shares of restricted stock, subject to certain Company performance
and vesting provisions. The Ross Agreement also includes severance and change in
control benefits, in the event of Mr. Ross' termination for certain reasons.
-15-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
The following discussion and analysis of our results of operations and financial
position should be read in conjunction with our audited consolidated financial
statements and related notes included in our Annual Report on Form 10-K for the
year ended June 30, 2004 and the unaudited consolidated financial statements and
related notes included in this Quarterly Report on Form 10-Q.
Forward-Looking Statements
Statements contained in this Quarterly Report on Form 10-Q and in future filings
with the Securities and Exchange Commission include "forward-looking statements"
within the meaning of such term in Section 27A of the Securities Act of 1933,
Section 21E of the Securities Exchange Act of 1934, and 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. Forward-looking statements involve known and
unknown risks, uncertainties and other factors which could cause actual
financial or operating results, performance or achievements expressed or implied
by such forward-looking statements not to occur or be realized. Such statements
are subject to certain risks and uncertainties that could cause actual results
to differ materially from historical results and those presently anticipated or
projected. See a discussion of such risks and factors in the "Factors That May
Affect Future Results" section of our Annual Report on Form 10-K for the fiscal
year ended June 30, 2004 as filed with the Securities and Exchange Commission.
Forward-looking statements made in this Form 10-Q generally are based on our
best estimates of future results, performances or achievements, predicated upon
current conditions and the most recent results of the companies involved and
their respective industries. Forward-looking statements may be identified by the
use of forward-looking terminology such as "may," "will," "could," "should,"
"project," "expect," "believe," "estimate," "anticipate," "intend," "continue,"
"potential," "endeavor," "opportunity" or similar terms, variations of those
terms or the negative of those terms or other variations of those terms or
comparable words or expressions. Potential risks and uncertainties include,
among other things, such factors as:
o Our ability to reach target markets for services and products and our
ability to retain current and attract future customers;
o Our ability to successfully integrate acquired companies into our
operations, and our ability to acquire additional companies, if any;
o Our ability to turn contract backlog into revenue and net income, the size
and timing of additional orders and their fulfillment, as well as market
acceptance, revenues and profitability of our current and future products
and services;
o Our ability to finance and sustain operations, including the ability to
fund, maintain, replace and/or extend the Textron credit facility, which
is discussed in Note 7, and/or the Laurus Funds Note, when either becomes
due, respectively, or to replace such instruments with alternative
financing;
o Our ability to raise equity capital or debt in the future, despite
historical losses from operations;
o Our ability to successfully defend or settle the remaining claims in the
Virginia litigation;
o The continuing desire of state and local governments to outsource to
private contractors, and our ability to service such contracts;
o General economic conditions in the United States and elsewhere, as well as
the economic conditions affecting the industries in which we operate, our
customers and suppliers;
-16-
o The competitive environment in the regions in which we compete, and the
cost-effectiveness of our products and services;
o Political and regulatory matters that affect the industries in which we
operate;
o Our continued listing on the Nasdaq SmallCap Market; and
o Other risks detailed in our filings with the Securities and Exchange
Commission.
The Company has no obligation to publicly release the results of any revisions
to any forward-looking statements to reflect anticipated or unanticipated events
or circumstances occurring after the date of such statements.
Business Overview
We provide information technology ("IT") security, converged network, internet
protocol ("IP") telephony, access infrastructure, and technology management
solutions. We serve as a source of products and services to state and local
government and mid-market commercial enterprises. We provide total solutions to
our clients by delivering systems design, installation, consulting, maintenance
and integration of network computing products and applications.
Through recent acquisitions of Redrock Communications Solutions, Inc. and
Integration Technologies, Inc., we have increased our presence in Southern
California, and have bolstered our multi-disciplinary practice areas in
security, access infrastructure, wide area networks ("WAN") and local area
networks ("LAN"), IP telephony or voice-over IP ("VOIP"), and application
infrastructure. We are focusing on growing our higher margin service offerings,
while maintaining expense controls and improving our balance sheet. We intend to
continue to seek acquisitions and organic growth that will build threshold share
and critical density in our target markets of leading IT spending states.
Moreover, we intend to capitalize on business practices of acquired entities
that we believe will enhance competitive advantage and ensure delivery of high
quality IT services to our customers and build stronger relationships with our
vendors.
We presently realize revenue from client engagements that entail the delivery of
end-to-end solutions, and the sales of products to our customers. Services are
primarily provided to the client at hourly rates that are established for each
of our employees or third-party contractors based upon their skill level,
experience and the type of work performed. We also provide project management
and consulting work which are billed either by an agreed upon fixed fee or
hourly rates, or a combination of both. We generally endeavor to expand our
sales of higher margin solution and project management services. The majority of
our services are provided under purchase orders or bid contracts with government
entities.
Costs of services and related products consist primarily of salaries, cost of
outsourced labor and products to complete the projects. Selling, general and
administrative expenses consist primarily of salaries and benefits of personnel
responsible for administrative, finance, operative, sales and marketing
activities and all other corporate overhead expenses. Corporate overhead
expenses include rent, telephone and internet charges, insurance premiums,
accounting and legal fees, depreciation and amortization expenses.
Results of Operations
Continuing Operations
The following table sets forth for the periods presented information derived
from our unaudited condensed consolidated statement of operations:
Revenues
-17-
Three months ended September 30th,
Percentage
2004 2003 change Amount
---------------------------------------------------
Product(1) $ 6,396 $ 5,593 14% $ 803
Service(1) 5,587 7,332 (23%) (1,745)
------- ------- --- -------
Total (1) 11,983 12,925 (7%) (942)
Product(2) 2,017 n/a 100% 2,017
Service(2) 783 n/a 100% 783
------- ------- --- -------
Total(2) 2,800 n/a 100% 2,800
Totals $14,783 $12,925 14% $ 1,858
======= ======= === =======
(1) Revenues from Redrock are excluded for comparative purposes.
(2) Represents revenues generated from Redrock following the acquisition
on August 1, 2004.
Revenue for the three months ended September 30, 2004 amounted to approximately
$14,800,000 as compared with revenue of approximately $12,900,000 for the
comparable 2003 period. The increase in revenue is attributable to an increase
in product revenue of approximately $2,900,000 offset by a decrease in service
revenue of approximately $1,000,000. The increase in product revenue primarily
was due to an increase in customer demand, and an increase mix in product
revenue from the business of Redrock Communications, the acquisition of which
closed during the quarter. The decrease in service revenue was primarily caused
by reduced revenue from New York outsourced service contracts.
Our customers are primarily state and local government entities, primarily
located in New York, Michigan, Massachusetts, and Florida, as well as mid-sized
corporations in diversified industries located in Southern California.
Twenty-five of our customers accounted for 51% of our total revenues and 36% of
our total accounts receivable.
The loss of major customers could be expected to have a material adverse effect
on our financial condition during the short term and until we are able to
generate replacement business, and there can be no assurance of obtaining such
business.
Gross Profit
Gross profit from product sales increased to 17% in the three months ended
September 30, 2004 from 11% in the comparable 2003 period, primarily due to the
sale of higher margin products in our solutions, pass thru sales in the
education business and higher product margins from the acquisitions. The gross
profit from service revenue decreased to 19% in the three months ended September
30, 2004 from 22% in the comparable 2003 period. The decrease in gross profit
margin from services was primarily related to the lower margin renewals from the
Business Process Outsource service contracts.
We continue to face competitive market pressures which will impact the gross
profit on our product revenue and service related revenue, including price and
gross profit margin pressures. We intend to meet the challenges of aggressive
price reductions and discount pricing by certain product suppliers by focusing
our offerings around relatively higher margin practice areas, including security
solutions and access infrastructure. We believe that market pressures may
present us with an opportunity to expand our business in certain regions where
we can provide a more complete offering of IT services in a fragmented market.
There can be no assurance,
-18-
however, that we will be able to compete effectively and profitably in all
areas, given the intense competition currently existing in the IT Service
industry.
Selling, General and Administrative
Three months ended September 30th
Percentage of
Dollars Revenues
2004 2003 2004 2003
-----------------------------------------------
Selling(3) $1,568 $1,822 13% 14%
General &
Administrative(3) 1,307 848 11% 7%
Depreciation &
Amortization(3) 693 679 6% 5%
Other(3) 303 457 3% 4%
------ ------ --- ---
Total $3,871 $3,806 33% 30%
Selling(4) 257 n/a 9% n/a
General &
Administrative(4) 61 n/a 2% n/a
Depreciation &
Amortization(4) 67 n/a 2% n/a
Other(4) 11 n/a -- n/a
------ ------ --- ---
Total $ 396 n/a 13% n/a
Totals $4,267 $3,806 29% 30%
====== ====== === ===
(3) Expenses from Redrock are excluded for comparative purposes
(4) Represents expenses generated by Redrock following its acquisition
on August 1, 2004
Selling, general and administrative expenses increased to approximately
$3,200,000 in the three months ended September 30, 2004 from approximately
$2,700,000 in the comparable 2003 period. Expressed as a percentage of net
revenues, selling, general and administrative expenses were 21% as compared to
20% in the comparable 2003 period. The increase was primarily related to
additional selling costs on a higher revenue base and transaction costs incurred
during the quarter ended September 30, 2004.
Net Income
Net income was $47,000 in the three months ended September 30, 2004 as compared
to a net loss of $1,697,000 in the comparable 2003 period. The income increase
was due to a gain on disposal of discontinued operations of $1,635,000 and the
factors described above.
Discontinued Operations
Net gain from discontinued operations was $1,635,000 for the three months ended
September 30, 2004 compared to a net loss of $175,000 for the three months ended
September 30, 2003. The gain was attributable to settled claims associated with
the Virginia non-emergency
-19-
transportation services contract as described in Note 8 of the condensed
consolidated financial statements.
Liquidity and Capital Resources
We measure our liquidity in a number of ways, as summarized in the following
table:
(Dollars in thousands)
As of As of
September 30, 2004 June 30, 2004
------------------ -------------
Cash and cash equivalents $ 1,394 $ 3,289
Working capital $ (3,581) $ 425
Working capital without giving
effect to acquisition liability $ 705 $ N.A.
Current ratio 0.82:1 1.03:1
Current ratio without giving effect
to acquisition liability 1.04:1 1.03:1
Notes payable (current portion) $ 2,160 $ 1,812
Cash and cash equivalents generally consist of cash and money market funds. We
consider all highly liquid investments purchased with maturities of three months
or less to be cash equivalents. Such investments are stated at cost, which
approximates fair value, and are considered cash equivalents for purposes of
reporting cash flows.
During the three months ended September 30, 2004, we used cash of approximately
$1,483,000 in operating activities and $510,000 in discontinued operations.
As described in Note 12 to the Condensed Consolidated Financial Statements, in
October 2004, we paid to the former shareholders of Redrock Communications as
part of the purchase price for our acquisition of Redrock Communications an
initial cash payment of $2,500,000. In addition, we are obligated to pay a
deferred cash payment of $500,000 sixty (60) days after the closing date of the
transaction as well as an earn-out cash payment up to a maximum amount of
$1,500,000, based upon Redrock Communications' EBITDA for the period between
July 1, 2004 through June 30, 2005.
As described in Note 17 to the Condensed Consolidated Financial Statements, as
part of the purchase price in our acquisition of Integration Technologies, Inc.,
we paid an initial cash payment of $2,500,000. In addition, we are obligated to
pay an earn-out cash payment up to a maximum amount of $1,500,000, based upon
ITI's EBITDA for the period between July 1, 2004 through June 30, 2005 and an
additional earn-out payment up to a maximum amount of $1,500,000, based upon
ITI's revenue for the period between July 1, 2004 through June 30, 2005.
We had a working capital deficiency of $3,581,000 as of September 30, 2004 a
decrease of $4,006,000 from June 30, 2004. As a result of the foregoing, our
cash decreased by $1,737,000.
On July 31, 2004, our credit facility agreement with an agency of Textron
Financial Corporation ("Textron") was amended and extended for 24 months through
June 30, 2006. The amended
-20-
Textron facility provides us with a full notification factoring facility for up
to $7,000,000 of working capital. Eligible accounts receivable expected to be
collected within 90 days are purchased with recourse, less a holdback amount of
15%. Interest is charged on the outstanding balance at the Prime rate plus 2.0%
(6. 5% at September 30, 2004). Additionally, a 0.15% discount fee is charged at
the time of purchase. As of September 30, 2004, the outstanding balance under
such credit facility amounted to $2,457,000.
We may expand the scope of our product and services offerings by pursuing
acquisition candidates with complementary technologies, services or products.
Should we commence such acquisitions, we believe that we would finance the
transactions with a combination of our working capital and the issuance of
additional securities. We would attempt to secure additional funding, including
equity financing where appropriate, for acquisitions. There can be no assurance,
however, that we will be successful in identifying appropriate acquisition
candidates or that, if appropriate candidates are identified, that we will be
successful in obtaining the necessary financing to complete the acquisitions
In the event of any additional financing, any equity financing would likely
result in dilution to our existing stockholders and any debt financing may
include restrictive covenants. Should we require additional working capital, we
would consider divesting certain of our contracts or other assets that may not
be critical to the business.
Contractual Obligations
Payments due by period
(in thousands)
Less More
than 1 than 5
Total year 1-3 years 3-5 years years
Contractual Obligations
Long-Term Debt Obligations 5,350 2,307 3,043 -- --
Operating Lease Obligations 1,707 898 529 280 --
------ ------ ------ ---- ----
Total $7,366 $2,673 $4,413 $280 --
====== ====== ====== ==== ====
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 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, requires that goodwill be tested
for impairment at the reporting unit level (operating segment or one level below
an operating segment) on an annual basis (June 30th for DynTek) and between
annual tests in certain circumstances. Application of the goodwill impairment
test requires judgment, including the identification of reporting units,
assigning assets and liabilities to reporting units, assigning goodwill to
reporting units, and determining the fair value of each reporting unit.
Significant judgments required to estimate the fair value of reporting units
include estimating future cash flows, determining appropriate discount rates and
other assumptions. Changes in these estimates and assumptions could materially
affect the determination of fair value and/or goodwill impairment for each
reporting unit.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk associated with adverse changes in financial and commodity market
prices and rates could impact our financial position, operating results or cash
flows. We are exposed to market risk due to changes in interest rates such as
the prime rate and LIBOR. This exposure is directly related to our normal
operating and funding activities. Historically, and as of September 30, 2004, we
have not used derivative instruments or engaged in hedging activities.
The Textron credit 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 2.0% over the prime rate. The Laurus Funds
convertible secured term note ($5,650,000 on November 5, 2004), exposes the
Company to similar risks, and it 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 September 30, 2004.
- --------------------------------------------------------------------------------
Weighted Average
Principal Balance Interest Rate
----------------- ----------------
Factoring credit facility $ 2,457,000 6.5%
- --------------------------------------------------------------------------------
Secured Convertible Note $ 5,767,000 5.5%
- --------------------------------------------------------------------------------
ITEM 4. CONTROLS AND PROCEDURES
An evaluation as of the end of the period covered by this quarterly report
was performed under the supervision and with the participation of the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
for the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of September 30, 2004. Based on that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer, have concluded
that the Company's disclosure controls and procedures are effective to ensure
-22-
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 three months ended September 30, 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 issue certain payments due to
transportation provider vendors according to an agreed-upon schedule, which
extended through June 2003. In connection with initially entering the contract,
a bond was posted by DynCorp, Inc. for the Company's payment to the
transportation providers. A number of such providers caused the bond to be
called, initiating a process of disbursing approximately $2,400,000 (the "Bonded
Amount") of payments to providers with verified claims due. The Company has
arranged for a limited release of indemnification by DynCorp, Inc. of the
Company's obligation to pay to the bonding company and to reimburse the third
party for its obligation to fund, respectively, in an amount not to exceed the
Bonded Amount to the extent that the Company otherwise would have an obligation
to fund or reimburse such parties with respect to the bond. The bonding company
filed an inter-pleader action to distribute the penal sum of the bond on July
22, 2003. As a result of the Company being released from its obligations with
respect to indemnification under and reimbursement with respect to the bond in
an amount up to the Bonded Amount, its liability to such providers has in effect
been reduced by the Bonded Amount. When the individual claims are determined for
each provider, in accordance with court procedures, the inter-plead funds shall
be disbursed. Should valid claims remain outstanding after the disbursement of
the interplead funds, certain providers may continue to pursue their claims
after the inter-pleader proceedings are concluded. While the inter-pleader is in
process, the Company has offered to make payments to providers with valid claims
of approximately $100,000 per month, commencing in September 2003, until
whatever shortfall amount as the Company determines to exist in excess of the
Bonded Amount is paid.
A number of the vendors that provided transportation services in the
Commonwealth of Virginia initiated separate legal demands for payment either
prior to or after the filing of the inter-pleader action. 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 August 2004, all state and federal litigation
initiated by such vendors have been stayed by order of the United States
District Court for the Eastern District of Virginia and such claims have been
substantially consolidated with above-referenced inter-pleader action. The
Company believes that all claims against the Company will be fully resolved as
..part of the final distribution of the Bonded Amount in the inter-pleader
action. Provisions in the 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.
-23-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 9% Senior Subordinated Convertible Note Purchase Agreement by
and Among DynTek, Inc. and the purchasers named therein, dated
October 15, 2004.
10.2 Form of Warrant issued by DynTek, Inc. to each purchaser
pursuant to the 9% Senior Subordinated Convertible Note Purchase
Agreement dated October 15, 2004.
10.3 Form of Warrant issued by DynTek, Inc. to each purchaser who
had not previously participated in any of DynTek's financings
pursuant to the 9% Senior Subordinated Convertible Note Purchase
Agreement dated October 15, 2004.
10.4 Form of Warrant issued by DynTek, Inc. to the placement agent
pursuant to the 9% Senior Subordinated Convertible Note Purchase
Agreement dated October 15, 2004.
10.5 Form of Note issued by DynTek, Inc. to each purchaser pursuant
to the 9% Senior Subordinated Convertible Note Purchase Agreement
dated October 15, 2004.
10.6 Registration Rights Agreement by and among DynTek, Inc. and the
purchasers named therein, dated October 15, 2004.
10.7 Employment Agreement with Casper Zublin, Jr., dated October 15,
2004.
10.8 Employment Agreement with Robert Webber, dated November 12,
2004
10.9 Employment Agreement with Steven Ross, dated November 12, 2004
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes- Oxley Act of 2002.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed by the Company during the quarter
ended September 30, 2004:
(1) On July 1, 2004, we filed a Current Report on Form 8-K
regarding the July 1, 2004 press release announcing the
resignation of James Linesch and the hiring of the Company's
new Chief Financial Officer Robert Webber.
-24-
(2) On September 29, 2004, we filed a Current Report on Form 8-K
for the September 28, 2004 press release announcing the
results of operations for the fiscal year and fourth quarter
ended June 30, 2004.
-25-
SIGNATURE
Pursuant to the requirements 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/ Robert I. Webber
--------------------------------
Robert I. Webber
Chief Financial Officer,
Chief Accounting Officer,
Executive Vice President and
Secretary
Date: November 15, 2004