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 December 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|
As of February 14, 2005, the number of shares outstanding of the
registrant's Common Stock, $.0001 par value, was 60,437,621.
DYNTEK, INC. AND SUBSIDIARIES
INDEX
Page
PART I - FINANCIAL INFORMATION Number
------
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - as of December 31, 2004
(unaudited) and June 30, 2004 3
Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) (unaudited) - For the Three and Six Months Ended
December 31, 2004 and December 31, 2003 4
Condensed Consolidated Statements of Cash Flows (unaudited) -
For the Six Months Ended December 31, 2004 and December 31, 2003 5 - 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7 - 19
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20 - 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
Item 4. Controls and Procedures 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 6. Exhibits 31
SIGNATURE 32
-2-
PART 1 - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, June 30,
ASSETS 2004 2004
------------ ---------
(unaudited)
CURRENT ASSETS:
Cash 315 2,810
Cash - Restricted 324 479
Accounts receivable, net of allowance for doubtful accounts of $240 15,924 12,045
Inventories 2,050 1,399
Prepaid expenses and other assets 353 54
Other receivables 8 88
--------- ---------
TOTAL CURRENT ASSETS 18,974 16,875
RESTRICTED CASH - over one year 95 91
INVESTMENTS - Marketable Securities 43 78
INVESTMENTS - Preferred Stock 1,104 1,104
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $3,105 and $3,035 1,117 519
GOODWILL 19,316 19,869
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $734 and $652 81 163
ACQUIRED CUSTOMER LIST, net of accumulated amortization of $8,502 and $7,136 6,017 5,542
PURCHASED SOFTWARE, net of accumulated amortization of $690 and $671 -- 19
DEFERRED FINANCING COSTS, net of accumulated amortization of $247 and $77 1,231 655
NOTES RECEIVABLE, long term, including receivable from officer of $100 678 548
DEPOSITS AND OTHER ASSETS 216 186
--------- ---------
TOTAL ASSETS $ 48,872 $ 45,649
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,877 $ 5,897
Line of credit 6,160 2,454
Acquisition costs 950 --
Accrued expenses 1,440 1,468
Deferred revenue 723 559
Notes payable - accrued interest 79
Notes payable current portion 846 1,812
Liabilities of discontinued operations 966 4,181
--------- ---------
TOTAL CURRENT LIABILITIES 19,961 16,450
DEFERRED REVENUE - long term 95 91
LONG TERM NOTE PAYABLE 9,812 3,505
--------- ---------
TOTAL LIABILITIES 29,868 20,046
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized; 604,597
and 683,317 shares issued and outstanding as of December 31, 2004 and June
30, 2004, respectively 1 1
Common stock, $.0001 par value, 150,000,000 shares authorized; 58,989,235
and 58,430,597 shares issued and outstanding as of December 31, 2004 and
June 30, 2004 respectively 5 5
Additional paid-in capital 101,218 100,822
Accumulated other comprehensive loss (207) (170)
Accumulated deficit (82,012) (75,055)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 19,004 25,603
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 48,872 $ 45,649
========= =========
The accompanying notes are an integral part of these
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 Six Months Ended
December 31, December 31,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
REVENUES:
Product Revenues $ 10,731 $ 3,470 $ 19,145 $ 9,063
Service Revenues 9,271 6,331 15,640 13,664
------------ ------------ ------------ ------------
Total revenues 20,002 9,801 34,785 22,727
------------ ------------ ------------ ------------
COST OF REVENUES:
Cost of products 8,641 3,086 15,601 8,047
Cost of services 7,210 5,362 12,351 11,042
------------ ------------ ------------ ------------
Total cost of revenues 15,851 8,448 27,952 19,089
------------ ------------ ------------ ------------
GROSS PROFIT 4,151 1,353 6,833 3,638
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling expenses 2,548 1,817 4,374 3,639
General and administrative expenses 1,398 1,259 2,766 2,113
Non cash expense for warrants 43 -- 43 --
Depreciation and amortization 781 668 1,542 1,341
Goodwill Impairment 6,026 3,000 6,026 3,000
------------ ------------ ------------ ------------
Total operating expenses 10,796 6,744 14,751 10,093
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (6,645) (5,391) (7,918) (6,455)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of marketable securities -- -- -- (107)
Interest expense (402) (147) (675) (502)
Other expense -- -- (50)
Interest income 2 88 11 93
------------ ------------ ------------ ------------
Total other income (expense) (400) (59) (714) (516)
LOSS FROM CONTINUING OPERATIONS $ (7,045) $ (5,450) $ (8,632) $ (6,971)
DISCONTINUED OPERATIONS
Gain (loss) on disposal of discontinued operations 41 (30) 1,676 (205)
------------ ------------ ------------ ------------
NET LOSS $ (7,004) $ (5,480) $ (6,956) $ (7,176)
============ ============ ============ ============
NET LOSS PER SHARE: Basic and Diluted
Continuing Operations (.12) (.12) (.15) (.16)
Discontinued Operations -- -- .03 (.01)
------------ ------------ ------------ ------------
$ (.12) $ (.12) $ (.12) $ (.17)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION -
Basic and Diluted 58,710,066 44,102,624 58,570,482 43,345,273
============ ============ ============ ============
NET LOSS $ (7,004) $ (5,480) $ (6,956) $ (7,176)
COMPREHENSIVE LOSS, NET OF TAX
Change in unrealized gain (loss) on available-for-sale-
securities (25) 22 (37) 96
------------ ------------ ------------ ------------
COMPREHENSIVE LOSS $ (7,029) $ (5,458) $ (6,993) $ (7,080)
============ ============ ============ ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-4-
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
------------------------
Six Months Ended
December 31,
------------------------
2004 2003
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss - Continuing operations $(8,632) (6,971)
------- -------
Adjustments to reconcile net loss, excluding discontinued operations, to
net cash used in operating activities:
Depreciation and amortization 1,455 1,245
Amortization of debt discount (34) --
Amortization of deferred financing costs 158 --
Amortization of capitalized software costs 82 108
Amortization of warrants issued for services 43
Loss (gain) on marketable securities -- 107
Impairment of goodwill 6,026 3,000
Changes in operating assets and liabilities:
Accounts receivable (781) 2,345
Inventory (524) (162)
Prepaid expenses (108) 55
Deposits and other assets 108 22
Accounts payable 704 (2,792)
Deferred revenue 16 (57)
Accrued expenses (972) (694)
Restricted cash 155 (21)
------- -------
Total adjustments 6,334 3,156
------- -------
NET CASH USED IN CONTINUING OPERATIONS (2,304) (3,815)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES OF DISCONTINUED OPERATIONS (1,539) (1,301)
------- -------
NET CASH USED IN OPERATING ACTIVITIES (3,843) (5,116)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Other notes receivable (130) --
Cash proceeds from the sale of marketable securities -- 71
Cash paid for acquisitions (6,036)
Cash received from Redrock acquisition 405 --
Cash received from ITI acquisition 106
Capital expenditures (203) (116)
------- -------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (5,858) (45)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from debt financing 4,775 --
Net proceeds under line of credit 2,431 1,179
Issuance of Common Stock, net of expenses -- 3,982
------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES 7,206 5,161
------- -------
NET DECREASE IN CASH (2,495) --
CASH AT BEGINNING OF PERIOD 2,810 --
------- -------
CASH AT END OF PERIOD 315 $ --
======= =======
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-5-
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands, except share data)
Six Months Ended
December 31,
--------------------------
2004 2003
------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 360 $ 355
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:
Forgiveness by shareholders of note and accrued interest $ -- $ 5,625
Debt discount issued in connection with convertible debt (34) --
Issuance of stock in connection with convertible debt 40 --
Acquisition of Red Rock Communications in 2004:
Cash paid to shareholders 2,750 --
Gross cash acquired 405 --
Contingent consideration 750 --
Acquisition of Integration Technologies Inc. in 2004:
Cash paid to shareholders 2,500 --
Gross cash acquired 105 --
Acquisition of AMR in 2004:
Cash paid to shareholders 786 --
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-6-
DYNTEK, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 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.
During the second quarter of fiscal year 2005, the Company completed its
acquisition of Integration Technologies, Inc. ("ITI"). See "Note 14, Business
Acquisitions." The condensed consolidated financial statements include ITI's
results of operations of from October 2004.
As of December 31, 2004, the Company had a working capital deficiency of
approximately $987,000 which includes $950,000 of acquisition indebtedness
incurred in business combinations that were consummated on September 29, 2004
and October 14, 2004 (Note 14). As described in Note 18, the Company received
$7,700,000 in connection with the sales of its common stock. The proceeds of
this offering will be used for general working capital purposes.
The Company believes that its cash on hand and cash it expects to generate
from operations will sustain the business at least through December 31, 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. If the Company is not successful in its efforts
to either raise or generate sufficient liquidity, it could be forced to
significantly alter its business plan, which could include making further
reductions in overhead costs, and/or divesting itself of certain contracts or
other assets.
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.
In January 2003, Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
This interpretation of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," provides
-7-
guidance for identifying a controlling interest in a variable interest entity
("VIE") established by means other than voting interest. FIN 46 also required
consolidation of a VIE by an enterprise that holds such controlling interest. In
December 2003, the FASB completed its deliberations regarding the proposed
modifications to FIN No., 46 and issued Interpretation Number 46R,
"Consolidation of Variable Interest Entities - an Interpretation of ARB 51"
("FIN No. 46 R"). The decisions reached included a deferral of the effective
date and provisions for additional scope exceptions for certain types of
variable interests. Application of FIN No. 46R is required in financial
statements of public entities that have interests in VIEs or potential VIEs
commonly referred to as special-purpose entities for periods ending after
December 15, 2003. Application by public small business issuers' entities is
required in all interim and annual financial statements for periods ending after
December 15, 2004.
The adoption of this pronouncement is not expected to have material effect
on the Company's financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment". This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its
related implementation guidance. SFAS 123R addresses all forms of share based
payment ("SBP") awards including shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation rights. Under SFAS
123R, SBP awards result in a cost that will be measured at fair value on the
awards' grant date, based on the estimated number of awards that are expected to
vest that will result in a charge to operations. This statement is effective for
public entities that do not file as small business issuers--as of the beginning
of the first interim or annual reporting period that begins after June 15, 2005.
The Company is currently in the process of evaluating the effect that the
adoption of this pronouncement may have on its financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") no. 153 "Exchanges of Nonmonetary Assets". This Statement
amends Opinion 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception for exchanges
of nonmonetary assets that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. The provisions of
this Statement, which is to be applied prospectively, are effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. Earlier application is permitted for nonmonetary asset exchanges occurring
in fiscal periods beginning after December 16, 2004.
The adoption of this pronouncement is not expected to have material effect
on the Company's financial statements.
EITF Issue 04-8, "The Effect of Contingently Convertible Instruments on
Diluted Earnings per Share." The EITF reached a consensus that contingently
convertible instruments, such as contingently convertible debt, contingently
convertible preferred stock, and other such securities should be included in
diluted earnings per share (if dilutive) regardless of whether the market price
trigger has been met. The consensus became effective for reporting periods
ending after December 15, 2004.
The adoption of this pronouncement does not currently have an effect on
the Company's financial statements because the inclusion of common stock
equilivants in earning per share are anti-dilutive.
-8-
3. Marketable Securities
Marketable securities are classified as available for sale in accordance
with Statement of Financial Accounting Standard ("SFAS") No. 115 "Accounting for
Marketable Securities.". Accordingly, the unrealized loss resulting from valuing
such securities at their current market values is presented as a component of
stockholders' equity. At December 31, 2004, the unrealized loss on such
securities amounted to $207,000
4. Investment in 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 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 17), 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, (5.25% as of December 31, 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 of this note in
fiscal year 2003. The Company received an additional promissory note in the
amount of $130,000 on December 31, 2004 as additional security for trade
receivables due from LaborSoft. The Note bears interest at the prime rate and
matures on December 31, 2007.
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 December 31,
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 December 31, 2004, the Company recorded a
$6,026,000 goodwill impairment charge including $4,227,000 relating to a
specific service contract that the Company was notified will not be renewed. The
Company acquired such contract as part of a group of contracts in its merger
with Dyncorp in 2001. In addition, the Company recorded a $1,799,000 impairment
charge associated with certain contracts for which the renewal options were
unlikely.
-9-
7. Credit Facility
On June 30, 2003, the Company entered into a twelve month credit facility
agreement with annual automatic renewals with an agency of Textron Financial
Corporation ("Textron"). Textron provides the Company with a full notification
factoring facility for up to $7,000,000 of working capital collateralized by
accounts receivable, inventory, general intangibles and other assets. Under the
terms of such credit facility, Textron finances, with recourse, up to 85% of the
Company's eligible accounts receivable, as defined, Advances under this facility
bear interest at the prime rate plus 2% (7.25% at December 31, 2004). In
addition, the Company pays a 0.15% discount fee on all advances. Effective July
1, 2004 the Textron agreement was amended and extended for an additional period
of twenty four months. As of December 31, 2004, $6,160,000 was outstanding under
this credit facility.
8. Senior Subordinated Convertible Notes
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, which are
immediately exercisable, expire on September 30, 2009. In addition, the Company
issued to Purchasers who had 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, which are immediately exercisable, 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 and
61,538 shares of common stock. The Placement Warrants may be exercised
immediately and will expire on September 30, 2009. In addition, the Company
incurred additional legal and transfer fees of $45,000.
The Company registered 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,that was filed with the
Securities and Exchange Commission on November 17, 2004.
9. Amended and Restated Secured Convertible Notes
On November 15, 2004, the Company issued an Amended and Restated Secured
Convertible Term Note (the "Amended Note") to the Laurus Master Fund, Ltd.
("Laurus Funds"). The Amended Note replaces previous the previous notes
outstanding in the aggregate principal amount of $6,000,000 that were
convertible into common stock at $1.15 per share.
The Amended Note provides for a $1,000,000 increase in the remaining
principal balance of the previous notes and to restructure the new aggregate
principal of $6,649,999 after taking into account principal payment made to
date, under the Amended Note to defer all payments until December 1, 2005. In
exchange, the Company reduced the conversion price under the Amended Note from
$1.15 per share to $0.65 per share. The Amended Note is convertible to Company
common stock at the option of Laurus Funds.
-10-
The Amended Note provides for Interest payable at the prime plus 1% per
annum, but not less than 4% per annum. The Company, at its option, may repay the
principal and interest in shares of its common stock shares, if at the time such
stock 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 $0.65 per share, the price fixed for
conversion to common stock of amounts outstanding under the Amended Note. Any
amounts of Amended Note principal paid in cash, prior to maturity, shall be
subject to a 2% premium payment.
As part of the transaction, Laurus Funds also received a five-year amended
and restated warrant to purchase 1,046,150 shares of DynTek common stock,
exercisable at $0.65 per share (the "Amended Warrant"). The Amended Warrant
replaces the warrant previously issued to Laurus Funds in connection with the
convertible note financing which provided for the purchase of 625,000 shares at
an exercise price of $1.25 per share. Substantially all assets of the Company
have been pledged as security for this obligation.
10. 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"). Pursuant 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. At the time the Company entered into
the Transportation Contract, DynCorp, Inc. ("Dyncorp") posted a $2,400,000 bond
(the "Bond") to guarantee its financial performance under the contract in favor
of Virginia. Dyncorp also indemnified the Company for any potential losses
(obligations) in excess of $2,400,000 (the "Bonded Amount"). Certain claims of
the Transportation Vendors caused the Bond to be called, initiating a process of
disbursing the Bonded Amount to Transportation Vendors with verifiable claims.
The bonding company filed an interpleader action (the "Interpleader Matter") to
distribute the Bonded Amount on July 22, 2003. In addition to making claims
against the Bond in the Interpleader Matter, many of the Transportation Vendors
initiated separate claims for payment against the Company both as part of and
separate from the Interpleader Matter. The Company provided DynCorp with a
limited release of its indemnity for aggregate claims in excess of the Bonded
Amount. Accordingly, the Company assumed the liability for valid claims in
excess of the Bonded Amount.
The Company entered into settlement agreements with a number of the
Transportation Vendors and, on December 1, 2004, the Court entered an Order
granting the Company's Motion to Approve Settlements and to Authorize
Disbursement of Interpleader Funds (the "Order"). Pursuant to the Order, the
Bonded Amount was transferred to the Transportation Vendors by DynTek in
accordance with the terms of various settlement agreements.
All claims in the Interpleader Matter against the Bond and/or against the
Company, except for six, have been settled and paid in full as of December 31,
2004. The Transportation Vendors holding these settled and paid claims have been
dismissed from the Interpleader Matter and pending state court lawsuits, if any,
have also been dismissed. Of the six remaining unpaid claims, five are settled
and will be paid in full by June 1, 2005. These remaining Transportation Vendors
will be dismissed from the Interpleader Matter as their settlements are paid.
The Company is still negotiatiating and is proceeding with litigation with the
remaining Transportation Vendor with which it has not entered into a settlement
agreement. A portion of the Bonded Amount is being held in escrow for this
Transportation Vendor, if necessary.
-11-
The Company records provisions for the estimated amount of any settlement
or judgment in excess of amount covered by the portion of the Bonded Amount that
is held in escrow. The Company believes that its provisions are adequate but, is
unable to predict the outcome of the remaining unsettled claim.
OTHER AGREEMENTS
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 of $300,000 per year, and an annual performance bonus
pursuant to a plan to be established by the Company's Compensation Committee.
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.
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 is entitled to receive an annual incentive
bonus pursuant to a bonus plan to be established by the Company's Compensation
Committee. The bonus will be based upon the achievement of criteria as set forth
in the Company's bonus plan. Mr. Webber received a grant of options to purchase
660,000 shares of the Company's common stock, and may receive 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 to be established by the
Company's Compensation Committee. The bonus will be based upon the achievement
of criteria as set forth in the Company's bonus plan. Under the agreement, Mr.
Ross will receive a grant of options to purchase 1,320,000 shares of the
Company's common stock, and may receive 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.
On October 15, 2004, the Company entered into a one year agreement with DC
Asset Management, LLC for the negotiation, evaluation and structure of merger,
acquisition and other transactions. As consideration the Company issued a
five-year warrant to purchase up to 1,150,000 shares of Common Stock at an
exercise price of $.50. The exercise price was subsequently increased to $.52.
11. Stock Based Compensation
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
-12-
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 Six Months Ended
---------------------- ----------------------
Periods Ended December 31, 2004 2003 2004 2003
- -------------------------- ------ ------ ------ ------
Net Loss $7,004 $5,480 $6,956 $7,176
Stock-based employee compensation
cost, net of tax effect, under fair
value accounting 35 9 70 18
------ ------ ------ ------
Pro-forma net income (loss) under
Fair Value Method $7,039 $5,489 $7,026 $7,194
====== ====== ====== ======
Income / (Loss) per share:
Basic $ .12 $ .12 $ .15 $ .17
====== ====== ====== ======
Diluted $ -- $ -- $ $ --
====== ====== ====== ======
Pro-forma income (loss) share: Basic $ -- $ -- $ -- $ --
====== ====== ====== ======
Pro-forma income (loss) share:
Diluted $ .12 $ .12 $ .15 $ .17
====== ====== ====== ======
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 3.12% 2.5%
Expected volatility 35% 136%
12. 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 December 31, 2004, 1,585,203 of such shares have
been converted into 3,963,008 shares of Common stock, with a remainder of
604,597 shares not yet converted.
On October 7, 2004, the Company issued 300,000 shares of its Common Stock
to be held in escrow for AMR Networks. The shares are included in the total
outstanding shares as of December 31, 2004. However, the shares do not have any
voting rights are not eligible for dividend while held in escrow. The issuance
relates to the purchase of certain assets and contracts from AMR Networks. The
shares are held in escrow and may be earned and
-13-
distributed over a three year period of 100,000 shares annually upon annual
fiscal year achievement of $ 500,000 of gross profit.
On October 15, 2004, the Company issued a warrant to purchase 1,150,000
shares of Common Stock at an exercise price of $.50 to DC Asset Management, LLC
as retainer for negotiation, evaluation and structure of merger, acquisition and
other transactions. The exercise price was subsequently increased to $.52 per
share.
In connection with the Note Agreement dated October 15, 2004, see Note 8,
the Company issued warrants to purchase 3,414,442 shares of the Company's Common
Stock at an exercise price of $.7475. The warrants will expire on September 30,
2009. Additionally, warrants to purchase up to 554,540 shares of the Company's
Common stock at an exercise price of $1.25 per share, which will expire on June
10, 2005 were issued. 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 which will expire on September 30, 2009.
On November 15, 2004, the Company issued an amended five year warrant to
purchase 1,046,150 shares of Common Stock, exercisable at $.65 per share in
relation to the Amended and Restated Secured Convertible Note, described in Note
9.
On November 15, 2004, the Company issued 61,538 shares of Common Stock to
Duncan Capital as a placement agent in connection with the Amended and Restated
Secured Convertible Note, described in Note 9.
13. 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, convertible debt, and
convertible preferred stock totaling 45,640,598 and 17,610,990 were excluded in
the diluted weighted average calculation for the three months ended December 31,
2004 and December 31, 2003 respectively. As the effect would be anti-dilutive.
Total outstanding stock, options, convertible preferred stock, convertible debt
and warrants are as follows:
------------------------------------------------------------
As of December 31,
2004 2003
Common stock 58,989,235 46,720,235
Options and warrants 26,859,990 14,532,662
Convertible debt 17,269,115 --
Convertible preferred stock 1,511,493 3,078,328
-------------------------
104,629,833 64,331,225
=========================
14. Business Acquisitions
Red Rock Communications
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
-14-
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.
An employee of Redrock Communications Solutions, Inc., a Nevada
corporation "Redrock"), is claiming that he owns up to one-third (1/3) of the
outstanding shares of Common Stock of Redrock at the time of the Company's
acquisition of the outstanding shares of Redrock pursuant to a Stock Purchase
Agreement dated September 29, 2004, by and among the Company and the two (2)
holders of record (the "Sellers") of the outstanding shares of Redrock (the
"Redrock Agreement"). The Redrock employee thereby is claiming that he is
entitled to receive one-third (1/3) of the consideration paid by the Company for
the acquisition of all then-outstanding shares of Redrock. The Redrock Agreement
provides an indemnification for the benefit of the Company by the Sellers of any
breach or inaccuracy of any of the representations and warranties made by the
Sellers and the Company in the Redrock Agreement, which include representations
with respect to Redrock's capital structure, its securities then-outstanding and
the Sellers' ownership of the shares of Redrock stock. No complaint has been
filed, and the parties in the dispute have discussed the possibility of
mediation as a means to resolve the dispute.
As a result of this dispute, the Company is withholding a portion of the
deferred cash payment in the amount of $250,000 ("Deferred Payment"), which
payment is past due, that is payable to the Sellers pursuant to the Redrock
Agreement as part of the consideration for the purchase of the Redrock shares to
offset any indemnification claims that the Company may have against the Sellers
once the dispute is resolved. The Company will release the Deferred Payment that
is withheld upon execution by the Redrock employee of a letter of affirmation
and waiver of any claims he might have against the Company.
A summary of the business assets acquired (in thousands) is as follows:
Consideration paid:
Stock to be issued $ 500
Cash 3,000
Liabilities assumed 2,095
------
Total consideration $5,595
------
Assets acquired:
Cash 405
Accounts receivable, net 1,221
Inventory 115
Prepaid expenses, deposits and other assets 8
Property and equipment 136
Customer list 755
Goodwill 2,955
------
Fair value of assets acquired $5,595
------
Integration Technologies Inc.
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").
-15-
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 the 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.
A summary of the business assets acquired (in thousands) is as follows:
Consideration paid:
Cash 2,500
Liabilities assumed 2,542
------
Total consideration $5,042
------
Assets acquired:
Cash 105
Accounts receivable, net 1,952
Inventory 12
Prepaid expenses, deposits and other assets 101
Property and equipment 329
Customer list 1,200
Goodwill 1,343
------
Fair value of assets acquired $5,042
------
The following unaudited pro-forma information reflects the results of
continuting operations of the Company as though the acquisitions had been
consummated as of July 1, 2003 (in thousands).
- -------------------------------------------------------------
Six Month ended December 31,
- -------------------------------------------------------------
2004 2003
- -------------------------------------------------------------
Revenue $38,884 $32,838
- -------------------------------------------------------------
Net Loss (6,523) (8,754)
- -------------------------------------------------------------
Net Loss per share .11 .12
- -------------------------------------------------------------
15. Discontinued Operations
During 2003, the Company disposed of its non-emergency transportation
business.
-16-
As of December 31, 2004, the total remaining liabilities of discontinued
operations amounted to $966,000. A significant portion of such payables are owed
to the Transportation Vendors involved in the Inter-Pleader Matter described in
Note 10.
16. 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 and mid-market commercial entities. In conjunction
with these service offerings, it also sells hardware and software to its
customers. Operations are distributed primarily among seven states 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):
-17-
Business Information
Process Technology
Outsourcing Services Total
-------- -------- --------
Three months ended December 31, 2004
Sales to external customers $ 2,201 $ 17,801 $ 20,002
Depreciation and amortization expense 116 655 781
Goodwill impairment 5,837 189 6,026
Operating loss (5,763) (1,283) (7,046)
Net interest expense -- 400 400
Total assets 9,985 38,887 48,872
Capital expenditures 27 104 167
Three months ended December 31, 2003
Sales to external customers $ 2,302 $ 7,499 $ 9,801
Depreciation and amortization expense 111 557 668
Goodwill impairment 3,000 -- 3,000
Operating loss (3,001) (2,390) (5,391)
Net interest expense -- 59 59
Total assets 22,299 24,169 46,468
Capital expenditures -- 35 35
Six months ended December 31, 2004
Sales to external customers $ 4,877 $ 29,908 $ 34,785
Depreciation and amortization expense 233 1,309 1,542
Goodwill impairment 5,837 189 6,026
Operating loss (5,684) (2,948) (8,632)
Net interest expense -- 664 664
Total assets 9,985 38,887 48,872
Capital expenditures 27 176 203
Six months ended December 31, 2003
Sales to external customers $ 5,014 $ 17,713 $ 22,727
Depreciation and amortization expense 222 1,119 1,341
Goodwill impairment 3,000 -- 3,000
Operating loss (3,137) (3,319) (6,456)
Net interest expense -- 409 409
Total assets 22,299 24,169 46,468
Capital expenditures 78 38 116
17. 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.
18. Subsequent Events
On February 10, 2005, the Company entered into a Securities Purchase
Agreement with certain institutional and accredited investors (the "Investors")
for the sale of $7,700,000 of Common Stock of the Company at a price of $0.52
per share. In connection with such
-18-
purchase, the Investors received warrants (the "Warrants") to purchase up to
3,700,000 shares of our Common Stock. The Warrants have an exercise price of
$0.66 per share, and are exercisable for a period beginning six months from
issuance and ending five years thereafter. The Company has agreed to file a
registration statement underlying the common stock and shares issuable upon
exercise of the Warrants within a period of 30 days of the closing of this
transaction.
-19-
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;
-20-
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 ability to trade on the NASD bulletin board; 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 (in
thousands):
-21-
Revenues
For the Three Months ended For the Six Months ended
---------------------------------------------------------------------------------------------------
December 31, December 31,
---------------------------------------------------------------------------------------------------
Percentage Percentage
2004 2003 change Amount 2004 2003 change Amount
---------------------------------------------------------------------------------------------------
Product(1) $ 5,874 $3,470 69% $ 2,404 $ 12,271 9,063 35% $ 3,208
Service(1) 5,480 6,331 (13%) (851) 11,061 13,664 (19%) (2,603)
-------- ------ --- -------- -------- ------- --- --------
Total (1) 11,354 9,801 16% 1,553 23,332 22,727 3% 605
Product(2) 2,983 n/a 100% 2,983 5,000 n/a 100% 5,000
Service(2) 2,270 n/a 100% 2,270 3,058 n/a 100% 3,058
-------- ------ --- -------- -------- ------- --- --------
Total(2) 5,253 n/a 100% 5,253 8,058 n/a 100% 8,058
Product(3) 1,874 n/a 100% 1,874 1,874 n/a 100% 1,874
Service(3) 1,521 n/a 100% 1,521 1,521 n/a 100% 1,521
-------- ------ --- -------- -------- ------- --- --------
Total(3) 3,395 n/a 100% 3,395 3,395 n/a 100% 3,395
Totals $ 20,002 $9,801 104% $ 10,201 $ 34,785 $22,727 53% $ 12,058
======== ====== === ======== ======== ======= === ========
(1) Revenues from Redrock and Integration Technologies are excluded for
comparative purposes.
(2) Represents revenues generated from Redrock following the acquisition on
August 1, 2004.
(3) Represents revenues generated from Integration Technologies following the
acquisition on October 1, 2004.
Three Months ended December 31, 2004 and 2003
Revenue for the three months ended December 31, 2004 amounted to approximately
$20,002,000 as compared with revenue of approximately $9,801,000 for the
comparable 2003 period. The increase in revenue is attributable to an increase
in product revenue of approximately $7,261,000 and an increase in service
revenue of approximately $2,940,000. The increase in revenue is primarily
attributable to an increase of $8,648,000 in revenues from Redrock and ITI
during the quarter, and an increase of $1,553,000 in revenues, or 16%, from the
prior DynTek business over the same period in the prior fiscal year.
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 54% of our total revenues and 40% of
our total accounts receivable during the quarter.
Although no one customer accounted for 10% or more of our revenues, 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.
Six Months ended December 31, 2004 and 2003
-22-
Revenues for the six month period ended December 31, 2004 amounted to
approximately $34,785,000, as compared to revenues of approximately $22,727,000
during the same six-month period for the prior fiscal year. This increase
resulted primarily from $8,058,000 in additional revenues from the Redrock
acquisition, which was effective in August 2004, and $3,395,000 in revenues from
the ITI acquisition, which closed in October 2004.
Gross Profit
Three Months ended December 31, 2004 and 2003
Gross profit from product sales increased to 19% in the three months ended
December 31, 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 increased to 22% in the three months ended December
31, 2004 from 15% in the comparable 2003 period. The increase in gross profit
margin from services was primarily related to the higher service margins from
acquisitions and sale of higher end service solutions.
Six Months ended December 31, 2004 and 2003
Gross profit during the six months ended December 31, 2004 increased to 20% from
16% in the comparable six month period in the prior year. Gross profit from
product sales increased from 11% to 19%, and gross profit from service revenue
increased from 19% to 21%. These increases were primarily due to the sale of
higher margin products in our solutions and higher margins in product sales and
services from acquisitions completed during the six months ended December 31,
2004.
We continue to face competitive market pressures which may 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, voice over-IP and access infrastructure. There can be no assurance,
however, that we will be able to continue to improve profit margins and compete
effectively and profitably in all areas, given the intense competition currently
existing in the IT Service industry.
Selling, General and Administrative
The following table sets forth for the periods presented information derived
from our unaudited condensed consolidated statement of operations (in
thousands):
-23-
For the Three Months ended For the Six Months ended
December 31, December 31,
Percentage of Percentage of
Dollars Revenues Dollars Revenues
2004 2003 2004 2003 2004 2003 2004 2003
---------------------------------------------------------------------------------------------
Selling(4) $ 1,533 $1,817 8% 19% $ 3,102 3,639 9% 16%
General &
Administrative(4) 1,219 1,259 6% 12% 2,525 2,113 7% 9%
Depreciation &
Amortization(4) 710 668 4% 6% 1,404 1,341 4% 6%
Goodwill impairment 6,026 3,000 30% 31% 6,026 3,000 17% 13%
Other(4) 443 59 3% 1% 746 516 3% 2%
------- ------ --- --- ------- ------- --- ---
Total $ 9,931 $6,803 51% 69% $13,803 10,609 40% 46%
Selling(5) 446 n/a 2% n/a 703 n/a 2 n/a
General &
Administrative(5) 21 n/a * n/a 82 n/a * n/a
Depreciation &
Amortization(5) 38 n/a * n/a 105 n/a * n/a
Other(5) -- n/a -- n/a 11 n/a * n/a
------- ------ --- --- ------- ------- --- ---
Total $ 505 n/a 2% n/a $ 901 n/a 2% n/a
Selling(6) 569 n/a 3% n/a 569 n/a 2% n/a
General &
Administrative(6) 159 n/a 1% n/a 159 n/a * n/a
Depreciation &
Amortization(6) 33 n/a 1% n/a 33 n/a * n/a
Other(6) -- n/a -- n/a -- n/a * n/a
------- ------ --- --- ------- ------- --- ---
Total $ 761 n/a 4% n/a $ 761 n/a 2% n/a
Totals $11,197 $6,803 57% 69% $15,465 $10,609 45% 46%
======= ====== === === ======= ======= === ===
(4) Expenses from Redrock and Integration Technologies are excluded for
comparative purposes
(5) Represents expenses generated by Redrock following its acquisition on
August 1, 2004
(6) Represents expenses generated by Integration Technologies following its
acquisition on October 1, 2004
* less than 1%
Three Months ending December 31, 2004 and 2003
Selling, general and administrative expenses increased to approximately
$3,946,000 in the three months ended December 31, 2004 from approximately
$3,076,000 in the comparable 2003 period. The increase in expenses was primarily
due to increased selling costs on a higher revenue base, and an increase in
general and administrative expenses incurred in connection with acquisitions
completed during the quarter ended December 31, 2004. Expressed as a percentage
of net revenues, selling, general and administrative expenses decreased to 20%
as compared to 32% in the comparable 2003 period. The decrease was primarily
related to selling costs on a higher revenue base during the quarter ended
December 31, 2004.
Six Months ending December 31, 2004 and 2003
Selling, general and administrative expenses increased to approximately
$7,140,000 in the six months ended December 31, 2004 from approximately
$5,752,000 in the comparable 2003 period. The increase in expenses was primarily
due to increased selling costs on a higher revenue base, and an increase in
general and administrative expenses incurred in connection with acquisitions
completed during the December 31, 2004 period. Expressed as a percentage of net
revenues, selling, general and administrative expenses were 21% as compared to
26% in
-24-
the comparable 2003 period. The decrease was primarily related to additional
selling costs on a higher revenue base during the six month period ending
December 31, 2004.
Net Income
Three Months ending December 31, 2004 and 2003
Our net loss for the three months ended December 31, 2004 is $7,005,000 compared
to a net loss of $5,480,000 for the quarter ended December 31, 2003. The net
loss in the December 31, 2004 includes several non-cash items, including a
goodwill impairment of $6,026,000, a non-cash expense for warrants of $43,000
and depreciation and amortization of $781,000. Excluding these non-cash items,
the Company had positive EBITDA of $204,000. The increase in the net loss for
the period ended December 31, 2004 is primarily due to the goodwill impairment
that the Company recorded in the amount of $6,026,000, compared to the goodwill
impairment charge of $3,000,000 for the same period in 2003, partially offset by
increases in our gross profit margins during the quarter ended December 31,
2004.
The Company defines EBITDA as net income (loss) before interest, taxes,
depreciation and amortization, goodwill impairment charges, and non-cash expense
for securities. Other companies may calculate EBITDA differently. EBITDA is a
non-GAAP measure of profitability and is a widely accepted financial indicator
of a company's ability to service debt, and produce positive cash flow. EBITDA
should not be considered in isolation, or as an alternative to net income (loss)
or to cash flows from operating activities as determined in accordance with
generally accepted accounting procedures. The Company believes that EBITDA can
be a useful tool for investors and others to ascertain the financial health of
the business, especially in situations where a company has significant non-cash
operating expenses. EBITDA is widely used in the IT services industry to analyze
company performance and potential acquisitions, and management of the Company
also uses EBITDA as a measure of performance for our regional sales units.
Six Months ending December 31, 2004 and 2003
Our net loss for the six months ended December 31, 2004 is $6,956,000 compared
to a net loss of $7,177,000 for the six months ended December 31, 2003. The net
loss in the six month period ended December 31, 2004 includes a goodwill
impairment of $6,026,000, compared to a goodwill impairment of $3,000,000 for
the comparable six-month period in the prior year. The increased goodwill
expense is partially offset by improvements in gross profit from $3,638,000 for
the six months ended December 31, 2003 to $6,833,000 for the six month period
ended December 31, 2004. The Company also had a gain on disposal of discontinued
operations of $1,676,000 during the six month period ended December 31, 2004.
Discontinued Operations
Net gain from discontinued operations was $41,000 for the three months ended
December 31, 2004 compared to a net loss of $30,000 for the three months ended
December 31, 2003. The gain was attributable to settled claims associated with
the Virginia non-emergency 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:
-25-
(Dollars in thousands)
As of As of
December 31, 2004 June 30, 2004
----------------- -------------
Cash and cash equivalents $ 639 $ 3,289
Working capital $ (987) $ 425
Working capital without giving effect to
acquisition liability $ (37) $ 425
Current ratio 0.95:1 1.03:1
Current ratio without giving effect to
acquisition liability 0.99:1 1.03:1
Notes payable (current portion) $ 846 $ 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 six months ended December 31, 2004, we used cash of approximately
$2,304,000 in operating activities and $1,539,000 in discontinued operations.
As described in Note 13 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 13 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 $987,000 as of December 31, 2004. As a
result of the foregoing, our cash decreased by $2,495,000.
On February 10, 2005, the Company entered into a Securities Purchase Agreement
with certain institutional and accredited investors (the "Investors") for the
sale of $7,700,000 of Common Stock, (the "Common Shares") of the Company at a
price of $0.52 per share. In connection with such purchase, the Investors
received warrants (the "Warrants") twenty five percent of the Common Shares. The
Warrants have an exercise price of $0.66 per share, and cannot be exercised for
a period of six months from issuance. The Company has agreed to file a
registration statement underlying the common stock and shares issuable upon
exercise of the Warrants within a period of 30 days of the closing of this
transaction.
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 Textron facility provides us with a full notification
factoring facility for up to $7,000,000 of
-26-
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% (7.25% at
December 31, 2004). Additionally, a 0.15% discount fee is charged at the time of
purchase. As of December 31, 2004, the outstanding balance under such credit
facility amounted to $6,160,000.
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 may attempt to secure additional funding, including
equity or debt 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 3-5 than 5
Total year 1-3 years years years
Contractual Obligations
Long-Term Debt Obligations 11,087 1,263 9,824 -- --
Operating Lease Obligations 2,551 1,078 902 571 --
------- ------ ------- ---- ----
Total $13,638 $2,341 $10,726 $571 --
======= ====== ======= ==== ====
Recent Accounting Pronouncements
In January 2003, Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
This interpretation of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," provides guidance for identifying a controlling interest
in a variable interest entity ("VIE") established by means other than voting
interest. FIN 46 also required consolidation of a VIE by an enterprise that
holds such controlling interest. In December 2003, the FASB completed its
deliberations regarding the proposed modifications to FIN No., 46 and issued
Interpretation Number 46R, "Consolidation of Variable Interest Entities - an
Interpretation of ARB 51" ("FIN No. 46 R"). The decisions reached included a
deferral of the effective date and provisions for additional scope exceptions
for certain types of variable interests. Application of FIN No. 46R is required
in financial statements of public entities that have interests in VIEs or
potential VIEs commonly referred to as special-purpose entities for periods
ending after December 15, 2003. Application by public small business issuers'
entities is required in all interim and annual financial statements for periods
ending after December 15, 2004.
The adoption of this pronouncement is not expected to have material effect
on the Company's financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment". This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its
related implementation guidance.
-27-
SFAS 123R addresses all forms of share based payment ("SBP") awards including
shares issued under employee stock purchase plans, stock options, restricted
stock and stock appreciation rights. Under SFAS 123R, SBP awards result in a
cost that will be measured at fair value on the awards' grant date, based on the
estimated number of awards that are expected to vest that will result in a
charge to operations. This statement is effective for public entities that file
as small business issuers--as of the beginning of the first interim or annual
reporting period that begins after December 15, 2005.
The Company is currently in the process of evaluating the effect that the
adoption of this pronouncement may have on its financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") no. 153 "Exchanges of Nonmonetary Assets". This Statement
amends Opinion 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception for exchanges
of nonmonetary assets that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. The provisions of
this Statement which is to be applied prospectively, are effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. Earlier application is permitted for nonmonetary asset exchanges occurring
in fiscal periods beginning after December 16, 2004. The provisions of this
Statement should be applied prospectively.
The adoption of this pronouncement is not expected to have material effect
on the Company's financial statements.
EITF Issue 04-8, "The Effect of Contingently Convertible Instruments on
Diluted Earnings per Share." The EITF reached a consensus that contingently
convertible instruments, such as contingently convertible debt, contingently
convertible preferred stock, and other such securities should be included in
diluted earnings per share (if dilutive) regardless of whether the market price
trigger has been met. The consensus is effective for reporting periods ending
after December 15, 2004.
The adoption of this pronouncement is not expected to have material effect
on the Company's financial statements.
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
-28-
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.
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 December 31, 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 ($6,649,999 on January 31, 2005), 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 December 31, 2004.
Weighted Average
Principal Balance Interest Rate
----------------- ----------------
Factoring credit facility $ 6,160,000 6.5%
Secured Convertible Notes $ 4,438,775 9.0%
Secured Convertible Laurus Note $ 6,649,000 5.5%
-29-
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 December 31, 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
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 December 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 (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. At the time the Company entered into
the Transportation Contract, DynCorp, Inc. ("Dyncorp") posted a $2,400,000 bond
(the "Bond") to guarantee its financial performance under the contract in favor
of Virginia. Dyncorp also indemnified the Company for any potential losses
(obligations) in excess of $2,400,000 (the "Bonded Amount"). Certain claims of
the Transportation Vendors caused the Bond to be called, initiating a process of
disbursing the Bonded Amount to Transportation Vendors with verifiable claims.
The bonding company filed an interpleader action (the "Interpleader Matter") to
distribute the Bonded Amount on July 22, 2003. In addition to making claims
against the Bond in the Interpleader Matter, many of the Transportation Vendors
initiated separate claims for payment against the Company both as part of and
separate from the Interpleader Matter. The Company provided DynCorp with a
limited release of its indemnity for aggregate claims in excess of the Bonded
Amount. Accordingly, the Company assumed the liability for valid claims in
excess of the Bonded Amount.
The Company entered into settlement agreements with a number of the
Transportation Vendors and, on December 1, 2004, the Court entered an Order
granting the Company's Motion to Approve Settlements and to Authorize
Disbursement of Interpleader Funds (the "Order"). Pursuant to the Order, the
Bonded Amount was transferred to the Transportation Vendors by DynTek pursuant
to the terms of various settlement agreements. All claims in the Interpleader
Matter against the Bond and/or against the Company, except for six, have been
settled and paid in full as of December 31, 2004. The Transportation Vendors
holding these settled and paid claims have been dismissed from the Interpleader
Matter and pending state court lawsuits, if any, have also been dismissed. Of
the six unpaid claims, five are settled and will be paid in full by June 1,
2005. These remaining Transportation Vendors will be dismissed from the
Interpleader Matter as their settlements are paid.
The Company is still in negotiations and is proceeding with litigation
with the one remaining Transportation Vendor that has not entered into a
settlement agreement with the Company. A portion of the Bonded Amount is being
held in escrow for this Transportation Vendor, if necessary. The Company records
provisions for the estimated amount of any settlement or judgment in excess of
amount covered by the portion of the Bonded Amount being
-30-
held in escrow. The Company believes its provisions are adequate but is unable
to predict the outcome of the remaining unsettled claim.
ITEM 6. EXHIBITS
(a) Exhibits.
10.10 Service Agreement between DynTek Inc. and DC Asset Management
dated September 1, 2004
10.11 Form of warrant issued by DynTek Inc. to DC Asset Management
pursuant to the Service Agreement dated September 1, 2004
10.12 Agreement and Plan of Merger by and amount DynTek Inc. ITI
Acquisition Corp., Integration Technologies, Inc.,the Shareholders
of Integration Technologies, Inc. and Casper Zublin, Jr. as the
Shareholder Representative dated as of October 14, 2004
10.13 Amended and Restated Convertible Note dated November 15, 2004
10.14 Form of warrant issued by DynTek Inc. issued to Laurus
pursuant to the Amended and Restated Convertible Note dated November
15, 2004
10.15 Registration rights agreement pursuant to the Amended and
Restated Convertible Note dated November 15, 2004
10.16 Form of stock option agreement pursuant to the 2001 DynTek
Stock Option Plan
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.
-31-
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: February 14, 2005
-32-