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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 31, 2005
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 Ave., Suite 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 May 11, 2005, the number of shares outstanding of the registrant's
Common Stock, $.0001 par value, was 75,426,765.
DYNTEK, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION Page
Number
------
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - as of March 31, 2005 3
(unaudited) and June 30, 2004
Condensed Consolidated Statements of Operations and Comprehensive 4
Income (Loss) (unaudited) - For the Three and Nine Months
Ended March 31, 2005 and March 31, 2004
Condensed Consolidated Statements of Cash Flows (unaudited) 5 - 6
- For the Nine Months Ended March 31, 2005 and
March 31, 2004
Notes to Condensed Consolidated Financial Statements (unaudited) 7 - 22
Item 2. Management's Discussion and Analysis of Financial 23-33
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
Item 4. Controls and Procedures 33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 6. Exhibits 35
SIGNATURE 36
PART 1 - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS March 31, 2005 June 30, 2004
------ -------------- -------------
CURRENT ASSETS: (unaudited)
Cash $ 828 $ 2,810
Cash - Restricted 417 479
Accounts receivable, net of allowance for doubtful accounts of $260
and $240 at June 30, 2004 15,711 12,045
Inventories 977 1,255
Prepaid expenses and other assets 120 54
Other receivables 23 88
--------- ---------
TOTAL CURRENT ASSETS 18,076 16,731
--------------------
RESTRICTED CASH - over one year 86 91
INVESTMENTS - Marketable Securities 51 78
INVESTMENTS - Preferred Stock 500 1,104
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $3,157 and $3,035 1,629 663
GOODWILL 23,101 19,869
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $734 and $652 81 163
ACQUIRED CUSTOMER LIST, net of accumulated amortization of $9,183 and $7,136 5,336 5,542
PURCHASED SOFTWARE, net of accumulated amortization of $690 and $671 -- 19
DEFERRED FINANCING COSTS, net of accumulated amortization of $357 and $77 1,124 655
NOTES RECEIVABLE, long term, including receivable from officer of $100 300 548
DEPOSITS AND OTHER ASSETS 534 186
--------- ---------
TOTAL ASSETS $ 50,818 $ 45,649
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 6,714 $ 5,897
Line of credit 3,651 2,454
Acquisition indebtedness 4,250 --
Accrued expenses 1,484 1,468
Deferred revenue 681 559
Notes payable - accrued interest 257 79
Notes payable current portion 2,280 1,812
Liabilities of discontinued operations 717 4,181
--------- ---------
TOTAL CURRENT LIABILITIES 20,034 16,450
DEFERRED REVENUE - long term 86 91
LONG TERM NOTE PAYABLE 7,652 3,505
--------- ---------
TOTAL LIABILITIES 27,772 20,046
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized; 583,124
and 683,317 shares issued and outstanding as of March 31, 2005 and June
30, 2004, respectively 1 1
Common stock, $.0001 par value, 150,000,000 shares authorized; 74,633,144
and 58,430,597 shares issued and outstanding as of March 31, 2005 and June
30, 2004 respectively 7 5
Additional paid-in capital 109,048 100,822
Deferred compensation (103) --
Accumulated other comprehensive loss (199) (170)
Accumulated deficit (85,708) (75,055)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 23,046 25,603
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 50,818 $ 45,649
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME (LOSS)
(Unaudited)
(in thousands, except per share data)
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------------- -----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
REVENUES:
Product Revenues $ 11,936 $ 4,673 $ 31,081 $ 13,735
Service Revenues 7,113 7,423 22,753 21,087
------------ ------------ ------------ ------------
Total revenues 19,049 12,096 53,834 34,822
------------ ------------ ------------ ------------
COST OF REVENUES:
Cost of products 10,383 3,846 25,984 11,893
Cost of services 5,450 5,767 17,801 16,809
------------ ------------ ------------ ------------
Total cost of revenues 15,833 9,613 43,785 28,702
------------ ------------ ------------ ------------
GROSS PROFIT 3,216 2,483 10,049 6,120
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling expenses 3,096 1,494 7,469 5,134
General and administrative expenses 1,490 985 4,231 3,098
Non cash expense for warrants 51 -- 94 --
Depreciation and amortization 732 791 2,273 2,132
Goodwill Impairment -- -- 6,026 3,000
------------ ------------ ------------ ------------
Total operating expenses 5,369 3,270 20,094 13,364
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (2,153) (787) (9,691) (7,244)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of marketable securities -- -- -- (107)
Loss on extinguishment of debt (336) (336) --
Loss on investment (604) (604) --
Interest expense (529) (199) (1,205) (700)
Other expense -- -- (50)
Interest income 8 2 20 95
------------ ------------ ------------ ------------
Total other income (expense) (1,461) (197) (2,553) (712)
LOSS FROM CONTINUING OPERATIONS $ (3,614) $ (984) $ (12,244) $ (7,956)
DISCONTINUED OPERATIONS
Gain (loss) on disposal of discontinued operations (83) (23) 1,593 (228)
------------ ------------ ------------ ------------
NET LOSS $ (3,697) $ (1,007) $ (10,651) $ (8,184)
============ ============ ============ ============
NET LOSS PER SHARE: Basic and Diluted
Continuing Operations (.05) (.02) (.20) (.17)
Discontinued Operations -- -- .03 (.01)
------------ ------------ ------------ ------------
$ (.05) $ (.02) $ (.17) $ (.18)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION -
Basic and Diluted 66,811,175 48,215,944 62,760,620 46,453,466
============ ============ ============ ============
NET LOSS $ (3,697) $ (1,077) $ (10,651) $ (8,184)
COMPREHENSIVE LOSS, NET OF TAX
Change in unrealized gain (loss) on
available-for-sale- securities 8 1 29 95
------------ ------------ ------------ ------------
COMPREHENSIVE LOSS $ (3,689) $ (1,006) $ (10,680) $ (8,089)
============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
---------------------------
Nine Months Ended
March 31,
---------------------------
2005 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss - Continuing operations $(12,244) (7,956)
-------- --------
Adjustments to reconcile net loss, excluding discontinued operations,
to net cash used in operating activities:
Depreciation and amortization 2,187 1,971
Amortization of debt discount 89 --
Amortization of deferred financing costs 292 --
Amortization of capitalized software costs 82 161
Amortization of warrants issued for services 87 --
Loss on extinguishment of debt 336 --
Loss on marketable securities -- 107
Interest on note payable -- 33
Impairment of goodwill 6,026 3,000
Loss on preferred investment 604 --
Notes receivable 378 --
Changes in operating assets and liabilities:
Accounts receivable (698) (37)
Inventory 405 (45)
Prepaid expenses 48 (366)
Deposits and other assets (305) 51
Accounts payable (1,459) (5,108)
Deferred revenue (26) 471
Accrued expenses (958) (875)
Restricted cash 62 (110)
-------- --------
Total adjustments 7,150 (849)
-------- --------
NET CASH USED IN CONTINUING OPERATIONS (5,094) (8,805)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES OF DISCONTINUED OPERATIONS (1,871) (1,695)
-------- --------
NET CASH USED IN OPERATING ACTIVITIES (6,965) (10,500)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Other notes receivable (130) (47)
Cash proceeds from the sale of marketable securities -- 71
Cash paid for acquisitions (6,486) --
Cash received from Redrock acquisition 405 --
Cash received from ITI acquisition 106 --
Capital expenditures (622) (134)
-------- --------
NET CASH (USED IN) INVESTING ACTIVITIES (6,597) (110)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from debt financing 4,775 3,500
Net proceeds under line of credit (78) 1,735
Issuance of Common Stock, net of expenses 6,884 5,375
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 11,581 10,610
-------- --------
NET DECREASE IN CASH (1,982) --
CASH AT BEGINNING OF PERIOD 2,810 --
-------- --------
CASH AT END OF PERIOD $ 828 $ --
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands, except share data)
Nine Months Ended
March 31,
----------------------
2005 2004
------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 616 $ 490
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 60 --
Issuance of stock in connection with convertible debt 40 --
Conversion of senior subordinated debt converted 509 --
Acquisition of Red Rock Communications in 2004:
Cash paid to shareholders 3,000 --
Gross cash acquired 405 --
Contingent consideration 2,000 --
Acquisition of Integration Technologies Inc. in 2004:
Cash paid to shareholders 2,500 --
Gross cash acquired 105 --
Contingent consideration 2,250
Acquisition of AMR in 2004:
Cash paid to shareholders 786 --
Entellus earnout paid 200
The accompanying notes are an integral part of these condensed consolidated
financial statements.
DYNTEK, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(UNAUDITED)
1. Basis of Presentation
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 States 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 process 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.
2. Liquidity and Financial Condition
The Company incurred a net loss of $10,651,000 for the nine months ended March
31, 2005 including an aggregate of $9,428,000 in non-cash charges principally
consisting of a $6,026,000 goodwill impairment charge, $604,000 write-down of a
preferred stock investment, $378,000 in note reserves and $2,273,000 of
depreciation and amortization. At March 31, 2005, the Company had a working
capital deficiency of $1,958,000, which includes $4,250,000 of consideration
payable to the sellers of Redrock Communications, Inc. and Integration
Technologies, Inc.
The Company believes that its cash on hand and cash it expects to generate from
operations will sustain the business at least through June 30, 2006. 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.
3. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant inter-company transactions have
been eliminated.
Revenue Recognition.
The Company applies the revenue recognition principles set forth under AICPA
Statement of Position ("SOP") 97-2 "Software Revenue Recognition" and Securities
and Exchange Commission Staff Accounting Bulletin ("SAB") 104 "Revenue
Recognition" with respect to all of
its revenue. Accordingly, the Company records revenue when (i) persuasive
evidence of an arrangement exists, (ii) delivery has occurred, (iii) the
vendor's fee is fixed or determinable, and (iv) collectability is probable.
The Company also reviews all of its product sale arrangements to determine
whether it has consummated such sales as a principal or an agent by applying the
criteria set forth in Emerging Issues Task Force Issue ("EITF") No. 99-19
"Reporting Revenue Gross as a Principal vs. Net as an Agent". The Company
records revenue gross in circumstances in which its role in consummating a sale
is more closely aligned with a majority of factors that would indicate it acted
as a principal and net when its role in consummating a sale is more closely
aligned with a majority of factors that would indicate it acted as an agent.
A summary of the Company's specific revenue recognition policies, as they relate
to specific revenue streams, is as follows:
Computer Hardware Product Revenues
The Company requires all of its computer hardware product sales to be supported
by a written contract or other evidence of a sale transaction that clearly
indicates the selling price to the customer, shipping terms, payment terms
(generally 30 days) and refund policy, if any. Selling prices of the products
are fixed at the time the sale is consummated.
The Company recognizes revenue on computer hardware sales at the time in which
it receives a confirmation that the goods were either tendered at their
destination when shipped "FOB destination," or transferred to a shipping agent
when "FOB shipping point."
Software Product Revenues
The Company is an authorized reseller of computer software licenses which may
include a post contract customer support arrangement and access to product and
upgrades and enhancements that are provided exclusively by the manufacturer
following delivery and the customer's acceptance of the software product.
Technical support and access to upgrades and enhancements to these software
products are solely the responsibility of the software manufacturer, which
arrangement is contractually known to the customer at the time the sale is
consummated.
The Company's software product sales are supported by a written contract or
other evidence of a sale transaction, which generally consists of a customer
purchase order or on-line authorization. These forms of evidence clearly
indicate the selling price to the customer, shipping terms, payment terms
(generally 30 days) and refund policy, if any. The selling prices of these
products are fixed at the time the sale is consummated.
The Company recognizes revenue upon the sale of computer software licenses when
(a) it confirms that the customer has either accepted delivery of the software
or has been provided with a manufacturer's authorization code ("key") to permit
access to the product and (b) the license term has commenced.
Technical Services Revenue
The Company provides information technology services that it bills based on
hours of service time provided at its standard hourly billing rates. The Company
recognizes revenue under these arrangements upon after the services are
delivered and the customer has acknowledged their acceptance of the services by
approving a work order milestone or completion order.
The Company also provides technical services under certain fixed price
contracts. The Company recognizes revenue under these arrangements when the
projects are completed and accepted by the customer. The Company is also a party
to certain unit-price contracts that it bills based on the number of service
units provided (generally user seats) multiplied by the
agreed-upon contract unit price per month. The Company recognizes revenue over
the period of the contract.
BPO Services Revenue
The Company provides business process outsourcing ("BPO") services, which
primarily include its child support service contracts in the states of Kansas,
and Nebraska. The Company provides these services under fixed price (flat
monthly fee) contracts and recognizes this revenue as the services are provided
and billed.
In the state of North Carolina, we have one contract subject to revenue-sharing
related to child support services. Under that contract a fee from amounts
collected is shared with the county on a percentage basis, and revenue is
recognized monthly in arrears as a percentage of the total amount of collections
received.
Inventories
The inventory consists primarily of finished goods in-transit which are recorded
at the lower of cost or market.
The Company had included $144,000 at June 30, 2004, of computer equipment in
conjunction with its fixed unit priced Seat Management contracts as inventory.
However that amount has been reclassified to Property and Equipment as of June
30, 2004 for comparative purposes. The amount of equipment associated with the
contracts as of March 31, 2005 was $485,000. The Company recognizes the revenue
and expense monthly over the period of the contract, typically thirty-six
months.
Use Of 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 goodwill, and accounting for discontinued
operations.
Goodwill
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 the Company) 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. 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. We have recorded
goodwill in connection with the Company's acquisitions, most recently the
acquisitions of Redrock Communications in September 2004 and Integration
Technologies, Inc. in October 2004, and recorded goodwill in the amount of
$4,455,000 and $4,393,000, respectively. In these instances, goodwill was
determined by comparing the purchase price and related transaction costs with
the fair value of the net tangible assets and liabilities acquired, as set forth
in Note 14.
Common Stock Purchase Warrants Issued in Private Placement Transactions
The Company accounts for the issuance of common stock purchase warrants issued
in connection with sales of its common stock in accordance with the provisions
of EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock".
Based on the provisions of EITF 00-19, the Company classifies as equity any
contracts that (i) require physical settlement or net-share settlement or (ii)
gives the company a choice of net-cash settlement or settlement in its own
shares (physical settlement or net-share settlement). The Company classifies as
assets or liabilities any contracts that (i) require net-cash settlement
(including a requirement to net cash settle the contract if an event occurs and
if that event is outside the control of the company) (ii) give the counterparty
a choice of net-cash settlement or settlement in shares (physical settlement or
net-share settlement).
Fair Value Of Financial Instruments
The carrying amounts reported in the balance sheet for cash, trade receivables,
accounts payable and accrued expenses approximate fair value based on the
short-term maturity of these instruments. The carrying amounts of notes
receivable and notes payable approximate fair value as such instruments feature
contractual interest rates that are consistent with current market rates of
interest.
Long Lived Assets
The Company periodically reviews the carrying values of its long lived assets in
accordance with SFAS 144 "Long Lived Assets" when events or changes in
circumstances would indicate that it is more likely than not that their carrying
values may exceed their realizable value and record impairment charges when
necessary. The Company has determined that no impairment charges are necessary
during the quarter ended March 31, 2005.
Discontinued Operations
During the fiscal year ended June 30, 2003, the Company adopted a plan to sell
its transportation brokerage operations in the state of Virginia. These
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.
Recently Issued 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 did not have a 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 equivalents
in earning per share are anti-dilutive.
4. 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 March 31, 2005, the unrealized loss on such securities
amounted to $199,000.
5. Investment in Preferred Stock
During the year ended June 30, 2004, the Company agreed to convert a $1,104,000
note receivable due from Private Label Cosmetics, Inc. ("PLC") into 1,000 shares
of PLC preferred stock which it currently holds as an investment. The preferred
shares are convertible, at the Company's option, into 306 shares of PLC Common
Stock and feature a liquidation provision in the event PLC is sold. Dividends
are payable at $10,000 per quarter beginning March 31, 2005.
In February 2005, the Company received a letter from, and was contacted by, a
private investor group (the "Prospective Investors") in which the Prospective
Investors expressed an interest in acquiring the assets of PLC, which
transaction could include a negotiated settlement of the
Company's preferred stock investment. Based on this information, the Company
determined that the maximum amount of a recovery of its preferred investment is
unlikely to exceed $500,000. Accordingly the Company recorded a $604,000 charge
to operations during the quarter ended March 31, 2005 to reduce the carrying
amount of this investment to its estimated net realizable value.
6. Notes Receivable
Laborsoft Corporation
In September 2003, the Company converted $636,000 of trade accounts receivable
due from LaborSoft Corporation ("LaborSoft"), a 25% equity investee (Note 17),
into a Promissory Note and Security Agreement. The Promissory Note bears
interest at the prime rate, (4.75% at March 31, 2005) and matures on September
21, 2006. LaborSoft granted the Company a security interest in its substantially
all of its assets which include accounts receivable, equipment, software, and
other intellectual property, inventory and intangible assets. The Company
established a $200,000 reserve of this note in fiscal year 2004.
At December 31, 2004, the Company converted an additional $130,000 of trade
accounts receivable into an additional promissory note that bears interest at
the prime rate and matures on December 31, 2007. The Company increased its
reserve on these notes by $378,000 during the quarter ended March 31, 2005 due
to difficulty that Laborsoft has been experiencing in making scheduled interest
payments.
Chief Executive Officer
On January 2, 2001, the Company advanced $170,000 to Steven Ross, its Chief
Executive Officer, which is 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 March 31, 2005, the
remaining principal balance on this note amounts to $100,000.
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% (7.75% at March 31, 2005). 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 March 31, 2005, $3,651,000 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 at 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 "Investor Warrants"). The Investor 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.
The Company issued the Senior Notes with an effective beneficial conversion
feature amounting to $74,747 at their date of issuance based on an allocation of
the offering proceeds to the Senior Notes, Investor Warrants and Additional
Warrants based on their relative fair values. After giving effect to the
allocation of such proceeds in accordance with Accounting Principles Board
Opinion No. 14 "Accounting for Convertible Debt and Debt Issued with Stock
Purchase Warrants" ("APB 14") the Company recorded an aggregate debt discount
amounting to $490,392. Amortization of the discounts amounted to $74,821 during
the nine months ended March 31, 2005 and is included as a component of interest
expense in the accompanying statement of operations.
The Company accounted for the issuance of the Notes and the aforementioned
warrants and calculated the amount of the effective beneficial conversion in
accordance with EITF Issue No. 00-27 "Accounting for Convertible Securities with
Contingent Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios."
The Company incurred $604,357 of expenses in connection with this transaction
including $559,603 of fees paid to Duncan Capital LLC, the placement agent in
this transaction, which consist of cash in the amount $515,357 and 692,308
common stock warrants (the "Placement Warrants") with a fair value of $44,246,
and other expenses paid to third parties amounting to $44,754. The Placement
Warrants are immediately exercisable at $.7475 per share and expire on September
30, 2009.
The Company registered for resale the underlying shares of Common Stock issuable
upon the conversion of the Notes and the exercise of the associated warrants on
Form S-3 filed with the Securities and Exchange Commission on November 17, 2004.
In January 2005, holders of $501,000 in principal and $7,631 in interest of
Senior Notes converted their notes into 782,505 shares of the Company's Common
Stock. At March 31, 2005, the Company currently had $3,937,775 of its 9% Senior
Notes outstanding.
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 replaced 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 provided for a $1,000,000 increase in the principal balance of
the previous notes and a deferred all principal payments due under the Amended
Note until December 1, 2005. In exchange, the Company reduced the conversion
price under the Amended Note to $0.65 per share. The aggregate principal due
under the Amended Note at the date of the amendment amounted to $6,649,999 and
is convertible into the Company's common stock at the option of Laurus Funds.
Substantially all assets of the Company have been pledged as security for this
obligation.
The Amended Note provides for interest payable at the greater of the prime rate
plus 1% per annum or 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 and (ii) the market price for such shares is
greater than 115% of $0.65 per share, the contractual conversion price under the
Amended Note. Any payments of principal that the Company may choose to make
under the Amended Note are subject to a 2% prepayment premium.
In connection with this transaction, the Company also issued to the Laurus
Funds, a five-year amended and restated warrant to purchase 1,046,150 shares of
the Company's common stock, exercisable at $0.65 per share (the "Amended
Warrant"). The Amended Warrant replaced 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.
The Company accounted for the issuance of the Amended Note in accordance with
the guidelines enumerated in EITF Issue No. 96-19 "Debtor's Accounting for a
Modification or Exchange of Debt Instruments." EITF 96-19 provides that a
substantial modification of terms in an existing debt instrument should be
accounted for like, and reported in the same manner as, an extinguishment of
debt. Further, EITF 96-19 indicates that the modification of a debt instrument
by a debtor and a creditor in a non-troubled debt situation is deemed to have
been accomplished with debt instruments that are substantially different if the
present value of the cash flows under the terms of the new debt instrument is at
least 10 percent different from the present value of the remaining cash flows
under the terms of the original instrument at the date of the modification.
The Company evaluated its issuance of the Amended Note to determine whether the
increase in principal and extension of the maturity date resulted in the
issuance of a substantially different debt instrument. The Company determined
that after giving effect to the all cash flows associated and expenses incurred
in connection with its issuance of the Amended Note, that its had issued a
substantially different debt instrument that constructively resulted in an
extinguishment of the original debt instrument. The Company recorded an
extinguishment loss in the amount of $336,000 that is included in the
accompanying statements of operations for the three and nine months ended March
31, 2005.
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 to 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 two have been settled and paid as of March 31, 2005. All
Transportation Vendors holding settled and paid claims have been dismissed from
the Interpleader Matter and pending state court lawsuits, if any, have also been
dismissed. Of the two remaining unpaid claims, one is settled and will be paid
in full by June 1, 2005 and will be dismissed from the Interpleader Matter at
that time.
The Company is still in negotiations and is proceeding with litigation
with the one remaining Transportation Vendor which 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.
Consulting Services Agreement
On October 15, 2004, the Company entered into a one year consulting services
agreement with DC Asset Management, LLC ("DCAM") that provides for DCAM to
assist the Company with identifying and screening acquisition candidates and
structuring mergers and acquisitions and other transactions. As Consideration,
the Company issued a five-year warrant to purchase up to 1,150,000 shares of its
common stock at an exercise price of $.50 per share, which exercise was
subsequently increased to $.52 per share in February 2005.
The fair value of the warrants amounts to $189,883, is included in deferred
compensation in the accompanying balance sheet and is being amortized over the
term of the agreement. Amortization expense under the agreement amounted to $
87,000 and is included in general and administrative expenses in the
accompanying statement of operations for the nine months ended March 31, 2005.
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 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 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 Nine Months Ended
------------------ -----------------
Periods Ended March 31, 2005 2004 2005 2004
----------------------- -------- -------- -------- --------
Net Loss $ (3,697) $ (1,007) $(10,651) $ (8,184)
Stock-based employee compensation
cost, net of tax effect, under fair
value accounting 35 33 140 297
-------- -------- -------- --------
Pro-forma net loss under Fair Value Method $ (3,732) $ (1,040) $(10,791) $ (8,481)
======== ======== ======== ========
Loss per share:
Basic and Diluted $ (.05) $ (.02) $ (.17) $ (.18)
======== ======== ======== ========
Pro-forma loss share: Basic and Diluted $ (.05) $ (.02) $ (.17) $ (.18)
======== ======== ======== ========
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 3.0 years
Weighted average risk-free interest rate 3.12% 1.79%
Expected volatility 35% 77%
12. Stockholders' Equity
On August 14, 2001, the Company's preferred stock became convertible into its
Class A common stock, at a rate of 2.5 common shares for each preferred share
tendered. As of March 31, 2005, 1,606,676 of such shares have been converted
into 4,016,691 shares of Common stock including 100,193 preferred shares
converted into 250,483 Class A common shares during the nine months ended March
31, 2005. The Company has an aggregate of 583,124 preferred shares still
outstanding at March 31, 2005 that are convertible into 1,457,810 Class A common
shares.
Common Stock Held In Escrow
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 March 31, 2005. However, the shares do not have any
voting rights nor are they eligible for dividends, if declared, while they are
in escrow. The issuance relates to the purchase of certain assets and contracts
from AMR Networks. The escrowed shares may be earned and distributed over a
three year period of 100,000 shares annually upon annual fiscal year achievement
of $500,000 of gross profit.
Issuances of Common Stock and Common Stock Purchase Warrants in Private
Placements of Debt
As described in Note 10, the Company issued the Company issued a warrant to
purchase 1,150,000 shares of Common Stock to DCAM on October 15, 2004 in
connection with a one year consulting services agreement.
As described in Note 8, the Company completed a private placement of its Senior
Notes on October 15, 2004, in which transaction it issued 3,414,442 Investor
Warrants, 554,540 Additional Warrants 692,308 Placement Warrants.
As of 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.
On January 18, 2005, the Company issued 782,505 shares of Common Stock to
certain holders of the Company's Senior Subordinated Convertible Notes,
described in Note 8, upon the conversion of $508,631 in principal and interest
due to the holders of such Senior Notes.
Private Placement of Common Stock
On February 10, 2005, the Company entered into a Securities Purchase Agreement
with certain accredited investors who purchased an aggregate of 14,802,692
shares of Common Stock and warrants to purchase an aggregate of 3,701,919 shares
of Common Stock for approximately $7,700,000. The Common Stock and the
corresponding warrant were sold at a price of $.52 per share of common stock
issued. Each warrant entitles its holder to purchase that number of shares of
Common Stock equal to 25% of the Common Stock purchased by such holder at an
exercise price of $.66 per share. The warrants are exercisable for a period
beginning six months from issuance and ending five years thereafter. In
connection with the issuance of Common Stock and warrants in this transaction,
the Company filed a registration statement on Form S-3 in February 2005.
Registration Rights Agreements
Substantially all of the warrants the Company has issued in various private
placement transactions are subject to registration rights agreements which
stipulate that the Company will use its commercially reasonable efforts to cause
a registration statement to be declared effective under the Securities Act as
promptly as possible. Substantially all of the Company's warrants are
exercisable by the holders at any time irrespective of whether the registration
statement has been declared effective. In addition, the Company is not (and
never is) precluded from delivering unregistered stock to any warrant holder who
elects to exercise their warrants in the event that the Company's registration
statement with respect to the stock issuable pursuant to such warrants has not
been declared effective.
The Company's registration rights agreements generally contain a provision
requiring the Company to pay defined nominal monetary damages if it has not
caused a registration statement to be declared effective. The monetary amounts
under these agreements would accrue until such time that the unregistered shares
may be sold (without any action on the part of the Company) under Rule 144. The
Company is in compliance with all of its registration rights agreements and in
the past has not has not failed to cause any registration statements to be
declared effective under any such agreements.
Since the Company (a) is not precluded from issuing unregistered shares in the
event of its failure to cause a registration statement to be declared effective,
(b) is permitted to net share settle its warrants by issuing unregistered
shares, and (c) has met all of the other criteria for equity classification
under EITF 00-19, it has classified its warrants as equity instruments.
13. Loss 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 123,551,501 and 69,915,192 were excluded in
the diluted weighted average calculation for the three months ended March 31,
2005 and March 31, 2004 respectively as their effect would be anti-dilutive.
Total outstanding stock, options, convertible preferred stock, convertible debt
and warrants are as follows:
--------------------------------------------------------
As of March 31,
2005 2004
Common stock 74,633,144 49,711,654
Options and warrants 30,061,274 13,915,420
Convertible debt 16,734,172 3,888,888
Convertible preferred stock 1,457,810 2,399,230
-------------------------
122,886,400 69,915,192
=========================
14. Business Acquisitions
Redrock 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 maximum amount of
$1,500,000, based upon Redrock's EBITDA for the period of July 1, 2004 through
June 30, 2005 (the "Earn-Out Payment") 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
Dispute"). 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 intends to withhold the Earn-Out
Payment 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 Earn-Out 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
Earn-Out 1,500
Liabilities assumed 2,095
------
Total consideration $7,095
------
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 4,455
------
Fair value of assets acquired $7,095
------
In February 2005, the Company and the Sellers entered into a Satisfaction
and Release Agreement based on performance of the Redrock business through
January 31, 2005, and the opportunity for the Company to consolidate the Redrock
operations with other operations of the Company. Based on these considerations
and the EBITDA of the Redrock business through such date, the Company agreed to
pay the Earn Out payment of $1,500,000 to the Sellers on July 30, 2005, subject
to any indemnification offset under the Redrock Dispute.
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").
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 based on the average closing sale price per share (the "Share
Price") of such common stock 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 assuming such rules are applicable. 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
Earn-out 2,250
Liabilities assumed 2,542
------
Total consideration $7,292
------
Assets acquired:
----------------
Cash 105
Accounts receivable, net 1,952
Inventory 12
Prepaid expenses, deposits and other assets 101
Property and equipment 329
Customer list 400
Goodwill 4,393
------
Fair value of assets acquired $7,292
------
In February 2005, the Company and the Shareholders entered into a
Satisfaction and Release Agreement based on performance of the ITI business
through January 31, 2005, the performance of certain former ITI employees who
had undertaken additional responsibilities at the Company, and the opportunity
for the Company to consolidate the ITI operations with other operations of the
Company. Based on these considerations and the EBITDA of the ITI business
through such date, the Company agreed to pay the amount of $2,250,000 to the
Shareholders on July 30, 2005 in satisfaction of the earn-out cash payments
based upon ITI's EBITDA and revenue.
The following unaudited pro-forma information reflects the results of continuing
operations of the Company as though the acquisitions had been consummated as of
July 1, 2003 (in thousands).
- -----------------------------------------------------------
(000's) Nine Month ended March 31,
- -----------------------------------------------------------
2005 2004
- -----------------------------------------------------------
Revenue $57,993 $50,974
- -----------------------------------------------------------
Net Loss (10,218) (9,715)
- -----------------------------------------------------------
Net Loss per share $.11 $.21
- -----------------------------------------------------------
15. Discontinued Operations
During 2003, the Company disposed of its non-emergency transportation business.
As of March 31, 2005, the total remaining liabilities of discontinued operations
amounted to $717,000. A significant portion of such payables are owed to the
Transportation Vendors involved in the Interpleader 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 Outsourcing
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,
New York, Michigan Florida, Massachusetts, Nevada, and Virginia, 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):
Business Information
Process Technology Total
Outsourcing Services -----
----------- --------
Three months ended March 31, 2005
- ---------------------------------
Sales to external customers $2,456 $16,593 $19,049
Depreciation and amortization expense 117 615 732
Goodwill impairment -- -- --
Operating income (loss) 47 (2,200) (2,153)
Net interest expense -- 529 529
Total assets 8,336 42,482 50,818
Capital expenditures -- 78 78
Three months ended March 31, 2004
- ---------------------------------
Sales to external customers $2,145 $9,951 $12,096
Depreciation and amortization expense 123 668 791
Goodwill impairment -- -- --
Operating income (loss) 234 (1,021) --
Net interest expense -- 199 199
Total assets 22,509 26,565 49,074
Capital expenditures -- 18 18
Nine months ended March 31, 2005
- --------------------------------
Sales to external customers $7,333 $48,501 $53,834
Depreciation and amortization expense 351 1,922 2,273
Goodwill impairment 5,741 285 6,026
Operating (loss) (5,637) (4,054) (9,691)
Net interest expense -- 1,205 1,205
Total assets 8,336 42,482 50,818
Capital expenditures 27 595 622
Nine months ended March 31, 2004
- --------------------------------
Sales to external customers $7,159 $27,663 $34,822
Depreciation and amortization expense 345 1,787 2,132
Goodwill impairment -- -- --
Operating (loss) (2,903) (4,341) (7,244)
Net interest expense -- 700 700
Total assets 22,509 26,565 49,074
Capital expenditures 78 56 134
17. Related-Party Transactions
In March 2001, the Company purchased 25% of the equity of 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, a position which he served until August 2004,
at which time he resigned. Through December 2004, the Company also provided
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 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS 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 Senior Subordinated Convertible Notes,
discussed in Note 8, and/or the Amended Note to Laurus Funds, discussed in
Note 9, when any becomes due, respectively, or to replace such instruments
with alternative financing;
o Our ability to raise equity capital or debt in the future, if needed,
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;
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, voice and data convergence,
enterprise access, network infrastructure and technology management solutions.
We serve as a source of products and services primarily to state and local
government clients, educational institutions and mid-market commercial clients.
Our practice areas incorporate an approach and methodology derived from over 18
years of experience in the assessment, design, implementation, management and
support of technology solutions. We provide our clients with a suite of
professional IT services, including security risk assessment, design and
remediation; technology project management; secure access and connectivity
consulting; remote network monitoring and management; network and system
diagnostics; product maintenance and support; technology training; and
integration of network computing products and applications. We also provide
total solutions for our clients through sales and installation of network
computer products and computer applications from leading vendors and
manufacturers.
We provide our clients with a solutions-based approach based on
multi-disciplinary practices in security, access infrastructure, converged
networks, IP telephony or voice-over IP ("VOIP"), and application
infrastructure. We are focusing on growing our multi-disciplinary practices and
related product 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
the leading IT spending states. Moreover, we intend to build upon our track
record of award-winning vendor performance to strengthen relationships with
product manufacturers and distributors in order to enhance our competitive
advantage and ensure delivery of high quality IT products and services to our
clients.
We recognize revenue from sales of products and services. 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. The majority of our services are provided under
purchase orders or bid contracts with government entities. (See "Revenue
Recognition," below)
Costs of services consist primarily of salaries of services personnel and
related expenses incurred in providing such services, and the cost of outsourced
service labor. Costs of products consist of our cost of products purchased and
sold to our customers. Selling, general and administrative expenses consist
primarily of salaries and benefits of personnel responsible for administrative,
finance, 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, and other general
administrative 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):
Revenues
For the Three Months ended For the Nine Months ended
---------------------------------------------------------------------------------------------------------
March 31, March 31,
---------------------------------------------------------------------------------------------------------
Percentage Amount Percentage
2005 2004 change 2005 2004 change Amount
---------------------------------------------------------------------------------------------------------
Product(1) $ 7,044 $4,673 51% $2,371 $19,315 13,735 41% $ 5,580
Service(1) 5,542 7,423 (25%) (1,881) 16,609 21,087 (21%) (4,478)
------- ------ ---- ------ ------- ------- ---- -------
Total (1) 12,586 12,096 4% 490 35,924 34,822 3% 1,102
Product(2) 3,239 n/a 100% 3,239 8,239 n/a 100% 8,239
Service(2) 534 n/a 100% 534 3,586 n/a 100% 3,586
------- ------ ---- ------ ------- ------- ---- -------
Total(2) 3,773 n/a 100% 3,773 11,825 n/a 100% 11,825
Product(3) 1,653 n/a 100% 1,653 3,527 n/a 100% 3,527
Service(3) 1,037 n/a 100% 1,037 2,558 n/a 100% 2,558
------- ------ ---- ------ ------- ------- ---- -------
Total(3) 2,690 n/a 100% 2,690 6,085 n/a 100% 6,085
Totals $19,049 $12,096 57% $6,953 $53,834 $34,822 55% $19,012
======= ======= ==== ====== ======= ======= ==== =======
(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 March 31, 2005 and 2004
Revenues for the three months ended March 31, 2005 amounted to approximately
$19,049,000 as compared with revenues of approximately $12,096,000 for the
comparable 2004 period, an increase of approximately 57 percent. The $6,953,000
increase in revenue during the quarter is primarily attributable to an increase
of $6,463,000 in revenues from our Southwest region, comprised of the former
businesses of Redrock and ITI. Products accounted for approximately 63% of our
revenues during the three-month period, and services accounted for 37%. The
decrease in service revenue from the prior period is due primarily to the
expiration of a large services contract with the State of New York.
Our customers are primarily state and local government entities and mid-sized
corporations in diversified industries. For the three months ended March 31,
2005, 48% of our customers were commercial entities compared to 52% government
and education clients. This represents a significant change in customer mix from
the corresponding period in 2004 when 18% of our customers were commercial
entities and 82% of our customers were government and education clients. The
change in mix results from our decision to reduce our dependence overall on
state and local government business and to grow our commercial business. This
change was
effected through the addition of the Redrock and ITI businesses in our Southwest
region, which had a stronger commercial emphasis, and an increased focus in
other regions on commercial clients.
Twenty-five of our customers accounted for 47% of our total revenues and 37% 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.
Nine Months ended March 31, 2005 and 2004
Revenues for the nine month period ended March 31, 2005 amounted to
approximately $53,834,000, as compared to revenues of approximately $34,822,000
during the same nine-month period for the prior fiscal year, an increase of
approximately 55%. This $19,012,000 increase resulted primarily from $17,916,000
in additional revenues from our Southwest region, which was formed subsequent to
the acquisitions of Redrock in September 2004 and ITI in October 2004. Products
comprised approximately 58% of our revenues during the nine month period, and
services comprised approximately 42%.
Gross Profit
Three Months ended March 31, 2005 and 2004
Gross profit for the three month period ended March 31, 2005 was $3,216,000,
compared to $2,483,000 during the comparable 2004 period. Gross profit margin
from service revenue increased from 22% in the 2004 period to 23% in the 2005
period. However, gross profit margin from product sales decreased from 18% in
the three months ended March 31, 2004 to 13% during the three months ended March
31, 2005. This, together with the impact of a higher relative percentage of
products sold in the 2005 period, led overall gross profit margin to decrease
from 20% in the 2004 period to 17% in the 2005 period. The decrease in product
margin was primarily due to approximately $2 million in sales of low margin
products to certain state government customers upon contract renewals. The
increase in service margin revenue reflects continued improvements in
utilization and an increase in sales of more comprehensive service offerings.
Although we have improved our service margins, and will continue to seek
additional improvements, our product margins are subject to competitive
pressures and fluctuations from quarter to quarter depending on the mix of
products sold.
Nine Months ended March 31, 2005 and 2004
Gross profit margin during the nine months ended March 31, 2005 increased to 20%
from 19% in the comparable nine month period in the prior year. Gross profit
margin from product sales increased from 13% to 16%, and gross profit margin
from service revenue increased from 23% to 24%. These increases were primarily
due to the sale of higher margin products during the nine period and higher
margins in services resulting from improved utilization of our service
consultants.
We continue to face competitive market pressures which may impact the gross
profit on our product revenue and service related revenue. 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
improve profit margins and compete effectively and profitably in all areas,
given the intense competition currently existing in the IT 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):
For the Three Months ended For the Nine Months ended
March 31, March 31,
Dollars Percentage of Dollars Percentage of
Revenues Revenues
2005 2004 2005 2004 2005 2004 2005 2004
----------------------------------------------------------------------------------------------------
Selling(1) $ 2,090 $ 1,494 17% 12% $ 5,191 5,134 14% 15%
General &
Administrative(1) 1,490 985 12% 8% 3,637 3,098 10% 9%
Depreciation &
Amortization(1) 619 791 5% 7% 2,022 2,132 6% 6%
Goodwill impairment -- 0 -- -- 6,026 3,000 17% 8%
Other(1) 51 0 -- -- 83 0 * --
------- ------- ---- ---- ------- ----- ---- ----
Total $ 4,250 $ 3,270 34% 27% $16,959 13,364 47% 38%
Selling(2) 1,006 n/a 15% n/a 2,278 n/a 13% n/a
General & n/a n/a 241 n/a 1% n/a
Administrative(2) -- n/a -- n/a 251 n/a 1% n/a
Depreciation &
Amortization(2) 113 2%
Other(2) -- n/a -- n/a 11 n/a * n/a
------- ------- ---- ---- ------- ----- ---- ----
Total $ 1,119 n/a 17% n/a $ 2,781 n/a 15% n/a
Totals $ 5,369 $ 3,270 28% 27% $19,740 $13,364 37% 38%
======= ======= ==== ==== ======= ======= ==== ====
(1) Expenses from Redrock and Integration Technologies are excluded for
comparative purposes
(2) Represents expenses generated by Redrock following its acquisition
on August 1, 2004 and Integration Technologies following its
acquisition on October 1, 2004. Redrock and Integration Technologies
operations were combined on February 11, 2005. Therefore, Selling,
General and Administrative expenses are now combined.
* less than 1%
Three Months ending March 31, 2005 and 2004
Selling, general and administrative expenses increased to approximately
$4,586,000 in the three months ended March 31, 2005 from approximately
$2,479,000 in the comparable 2004 period. Expressed as a percentage of revenues,
sales and marketing costs increased from 12% of revenues in the three month
period ended March 31, 2004 to 14% of revenues in the comparable 2005 period.
General and administrative expenses were 8% of revenues in the three month
period ended March 31, 2004 and 8% of revenues in the comparable 2005 period.
The overall increase in expenses was primarily due to increased selling costs on
a higher revenue base, the addition of sales personnel, management and
administration from the ITI and Redrock acquisitions, and additional costs
incurred in the integration of those businesses in our Southwest region.
Nine Months ending March 31, 2005 and 2004
Selling, general and administrative expenses increased to approximately
$11,700,000 in the nine months ended March 31, 2005 from approximately
$8,232,000 in the comparable 2004 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 quarters ended December 31, 2004 and September 30, 2004.
Expressed as a percentage of net revenues, selling, general and administrative
expenses were 21% as compared to 24% in the comparable 2004 period. The decrease
was primarily related to additional selling, general and administrative expenses
on a higher revenue base during the nine month period ending March 31, 2005.
Net Income
Three Months ending March 31, 2005 and 2004
Our net loss for the three months ended March 31, 2005 was $3,697,000 compared
to a net loss of $1,077,000 for the quarter ended March 31, 2004. The net loss
in the March 31, 2005 period includes approximately $2,292,000 in non-cash
items, including depreciation and amortization of $732,000, a non-cash expense
for warrants of $51,000, write-downs of investments totaling $982,000, a loss on
extinguishment of debt of $336,000, $134,000 of deferred financing cost
amortization and $57,000 of debt discount. The decrease in net margin is also
attributable to the decrease in gross profit margin from product sales from 18%
in the three months ended March 31, 2004 to 13% in the comparable 2005 period,
and an increase in selling, general and administrative expenses as a percentage
of revenues from 20% in the three months ended March 31, 2004 to 24% in the
comparable 2005 period.
Nine Months ending March 31, 2005 and 2004
Our net loss for the nine months ended March 31, 2005 was $10,651,000 compared
to a net loss of $8,184,000 for the nine months ended March 31, 2004. The net
loss in the nine month period ended March 31, 2005 includes a goodwill
impairment of $6,026,000, compared to a goodwill impairment of $3,000,000 for
the comparable nine-month period in the prior year. Without the goodwill
write-down, the net loss for the nine months ended March 31, 2005 would have
been $4,626,000, compared to $5,184,000 for the comparable nine-month period
ended March 31, 2004. Gross profit increased from $6,120,000 for the nine month
period ended March 31, 2004 to $10,049,000 for the nine-month period ended March
31, 2005. The Company also had a gain from the disposal of discontinued
operations of $1,593,000 during the nine month period ended March 31, 2005.
Discontinued Operations
Net loss from discontinued operations was $83,000 for the three months ended
March 31, 2005 compared to a net loss of $23,000 for the three months ended
March 31, 2004. The increase is attributable to legal and professional fees
associated with the processing of settlement payments during the three months
ended March 31, 2005.
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
March 31, 2005 June 30, 2004
-------------- -------------
Cash and cash equivalents $ 1,245 $ 3,289
Working capital $(1,958) $ 281
Working capital without giving effect to acquisition liability $ 2,292 $ 281
Current ratio 0.90:1 1.02:1
Current ratio without giving effect to acquisition liability 1.15:1 1.02:1
Notes payable (current portion) $ 2,537 $ 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 nine months ended March 31, 2005, we used cash of approximately
$5,094,000 in operating activities and $1,871,000 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 paid a deferred cash payment
of $500,000 sixty (60) days after the closing date of the transaction, and we
are obligated to pay an earn-out cash payment of $1,500,000 by July 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 of $2,250,000 by July 30, 2005.
We had a working capital deficiency of $1,958,000 as of March 31, 2005. As a
result of the foregoing, our cash decreased by $1,982,000.
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, approximately $6,884,000 net of expenses, of Common Stock of
the Company at a price of $0.52 per share. In connection with such purchase, the
Investors received warrants to purchase an aggregate of 3,701,919 shares of
Common Stock for an exercise price of $0.66 per share, and cannot be exercised
for a period of six months from issuance.
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 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% (7.75% at March 31, 2005). Additionally, a
0.15% discount fee is charged at the time of purchase, proceeds received by the
Company under the Textron facility are treated as borrowings. As of March 31,
2005, the outstanding balance under such credit facility amounted to $3,651,000.
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 1-3 3-5 than 5
Total year years years years
Contractual Obligations
Convertible Debt Obligations 10,189 2,537 7,652 -- --
Operating Lease Obligations 2,642 1,005 990 647 --
------- ------- ------- ------- ----
Total $12,831 $ 3,542 $ 8,642 $ 647 --
======= ======= ======= ======= ====
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 goodwill, and accounting for discontinued
operations.
Revenue Recognition. We apply the revenue recognition principles set forth under
SOP 97-2 and SAB 104 with respect to all of our revenue. We adhere strictly to
the criteria set forth in paragraph .08 of SOP 97-2 and outlined in SAB 104
which provides for revenue to be recognized when (i) persuasive evidence of an
arrangement exists, (ii) delivery has occurred, (iii) the vendor's fee is fixed
or determinable, and (iv) collectability is probable.
A summary of our revenue recognition policies, as they relate to our specific
revenue streams, is as follows:
Computer Hardware Product Revenues
We require our hardware product sales to be supported by a written contract or
other evidence of a sale transaction that clearly indicates the selling price to
the customer, shipping terms, payment terms (generally 30 days) and refund
policy, if any.
Since our hardware sales are supported by a contract or other document that
clearly indicates the terms of the transaction, and our selling price is fixed
at the time the sale is consummated, we record revenue on these sales at the
time in which we receive a confirmation that the goods
were tendered at their destination when shipped "FOB destination," or upon
confirmation that shipment has occurred when shipped "FOB shipping point."
Software Product Revenues
We make substantially all of our software product sales as a reseller of
licenses which may include a post contract customer support arrangement and
access to product and upgrades and enhancements that are provided exclusively by
the manufacturer following delivery and the customer's acceptance of the
software product. We do not presently sell any software that we develop
internally. Any responsibility for technical support and access to upgrades and
enhancements to these software products are solely the responsibility of the
software manufacturer, which arrangement is known to the customer at the time
the sale is consummated. With respect to delivery, we require that the customer
has received transfer of the software or, at a minimum, an authorization code
("key") to permit access to the product. If a software license is delivered to
the customer, but the license term has not begun, we do not record the revenue
prior to inception of the license term.
We require our software product sales to be supported by a written contract or
other evidence of a sale transaction, which generally consists of a customer
purchase order or on-line authorization. These forms of evidence clearly
indicate the selling price to the customer, shipping terms, payment terms
(generally 30 days) and refund policy, if any. The selling prices of these
products are fixed at the time the sale is consummated.
For product sales, we apply the factors discussed in EITF 99-19 in determining
whether to recognize product revenues on a gross or net basis. In a substantial
majority of our transactions, we (i) act as principal; (ii) take title to the
products; and (iii) have the risks and rewards of ownership, including the risk
of loss for collection, delivery or returns. For these transactions, we
recognize revenues based on the gross amounts billed to our customers. In
certain circumstances, based on an analysis of the factors set forth in EITF
99-19, we have determined that we were acting as an agent, and therefore
recognize revenues on a net basis. For the nine months ended March 31, 2005,
revenues recognized on a net basis totaled approximately $762,000, or 2% of
total product revenues during the period.
Technical Services Revenue
We generally bill our customers for professional IT services based on hours of
time that we spend on any given assignment at our hourly billing rates. As it
relates to delivery of these services, we recognize revenue under these
arrangements as the work is completed and the customer has indicated their
acceptance of our services by approving a work order milestone or completion
order. For certain engagements, we enter fixed bid contracts, and we recognize
revenue as phases of the project are completed and accepted by our client. For
our seat management services, we enter unit-price contracts (e.g., price per
user for seat management), and we recognize revenue based on number of units
multiplied by the agreed-upon contract unit price per month.
BPO Services Revenue
For our business process outsourcing ("BPO") services, which primarily include
our child support service contracts in the states of Kansas, and Nebraska, we
provide services under a fixed price (flat monthly fee) contract, and recognize
revenue as the services are provided and billed. In the state of North Carolina,
we have one contract subject to revenue-sharing related to child support
services. Under that contract a fee from amounts collected is shared with the
county on a percentage basis, and revenue is recognized monthly in arrears as a
percentage of the total amount of collections received.
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.
Goodwill. 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 the Company)
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. 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.
We have recorded goodwill in connection with the Company's acquisitions, most
recently the acquisitions of Redrock Communications in September 2004 and
Integration Technologies, Inc. in October 2004, and recorded goodwill in the
amount of $4,455,000 and $4,393,000, respectively. In these instances, goodwill
was determined by comparing the purchase price and related transaction costs
with the fair value of the net tangible assets and liabilities acquired, as set
forth in Note 14.
Basis of Presentation. During the fiscal year ended June 30, 2003, the Company
adopted a plan to sell our transportation brokerage operations in the state of
Virginia. 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.
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 46 and issued
Interpretation Number 46R, "Consolidation of Variable Interest Entities - an
Interpretation of ARB 51" ("FIN 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 June 15,
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 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.
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 March 31, 2005, 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 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, the Senior Subordinated Convertible
Notes and the Laurus Funds Note as of March 31, 2005.
- --------------------------------------------------------------------------------
Weighted Average
Principal Balance Interest Rate
- --------------------------------------------------------------------------------
Factoring credit facility $3,651,000 6.75%
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Senior Subordinated Convertible Notes $3,937,775 9.0%
- --------------------------------------------------------------------------------
Secured Convertible Laurus Note $6,649,999 5.75%
- --------------------------------------------------------------------------------
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,
regarding the effectiveness of the design and operation of the Company's
disclosure controls and procedures. 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 that occurred during the three months
ended March 31, 2005 that have materially affected, or are reasonably likely to
materially 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"). Pursuant to 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 two have been settled and paid as of March 31, 2005. All
Transportation Vendors holding settled and paid claims have been dismissed from
the Interpleader Matter and pending state court lawsuits, if any, have also been
dismissed. Of the two remaining unpaid claims, one is settled and will be paid
in full by June 1, 2005 and will be dismissed from the Interpleader Matter at
that time.
The Company is still in negotiations and is proceeding with litigation with one
remaining Transportation Vendor which 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 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.
ITEM 6. EXHIBITS
(a) Exhibits.
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.
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/ Steven J. Ross
---------------------------------
Steven J. Ross
President and Chief Executive Officer
Date: May 16, 2005