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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2002
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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0001 par value
(Title of Class)
Series A Preferred Stock, $.0001 par value
(Title of Class)
Indicate by check mark 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, and (2) has been subject to such filings
requirements for the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the issuer as of September 30, 2002 was approximately
$22,432,463.
The number of shares outstanding of the issuer's Common Stock, $.0001 par value,
as of September 30, 2002 was 35,421,733.
Documents incorporated by reference: None
PART I
ITEM 1. BUSINESS
GENERAL
DynTek, Inc. is a professional services firm specializing in information
technology solutions and business process outsource services for state and local
government agencies. We operate our business through our sole active subsidiary,
DynTek Services, Inc. Depending upon the context, the term DynTek, or "we",
refers to either DynTek alone, or DynTek and its subsidiary.
We provide information technology support services and enabling
technologies to state and local government customers, which are used to increase
efficiency in operations and improve access to government functions. We offer
comprehensive information technology services for such customers including
consulting, infrastructure planning and deployment, information technology
application development, legacy systems integration, information technology
system support and, following the merger with DynCorp Management Services (DMR)
in December 2001, business process outsourcing services for state government
agencies.
On April 25, 2001, we entered into an Agreement and Plan of Merger, and an
Agreement and Plan of Reorganization (the "Plan of Reorganization") each with
DMR, Newport Acquisition Corp. and DynCorp. The Reorganization Agreement was
subsequently amended four times. On December 27, 2001, we entered into a Fourth
Amendment to the Agreement and Plan of Merger with DynTek, Newport Acquisition
Corp., TekInsight Services, Inc., DynCorp and DMR. Pursuant to the
Reorganization Agreement, as amended, DMR was merged with and into TekInsight
Services, Inc. and renamed DynTek Services, Inc. The initial merger
consideration delivered to DynCorp consisted of 18,336,663 shares of DynTek
Class B common stock, subject to additional shares of Class B common stock being
issued to DynCorp as additional merger consideration under the terms of the
Reorganization Agreement.
On August 20, 2002, we entered into a Stock Purchase and Settlement
Agreement (the "Settlement Agreement") with DynCorp, pursuant to which disputes,
including those resulting from the December 2001 merger with DMR were settled.
As a part of the Settlement Agreement, we repurchased a portion of the DynTek
Class B common stock from DynCorp and the remaining Class B common stock held by
DynCorp (constituting the balance of all outstanding Class B common stock) were
converted by DynCorp to DynTek Class A common stock.
The following wholly owned subsidiaries have discontinued operations:
Physicians Support Services, Inc., a California corporation; Clinishare Diabetes
Centers, Inc. d/b/a SugarFree Centers, Inc.; and USC-Michigan, Inc., a Michigan
corporation; PCS, Inc.-West, a Michigan Corporation and BugSolver.com, Inc., a
Delaware corporation.
INDUSTRY OVERVIEW
Government agencies are undergoing a rapid transformation in how they
manage their data and serve their citizenry. This transformation is driven by
the broadening impact of the Internet, the increasing need for real-time
information, regulatory changes, the speed and complexity of technology and
operating system advancements. State and local government agencies are
undergoing the most rapid changes, since this is where individuals have most of
their interaction with the public sector. According to the Gartner Group, Inc.
"Trends in U.S. State and Local Governments Market Trends" report, published in
March 2002, state and local government information technology, or IT, spending
is forecast to increase over the next four years at a rate of 8 percent
annually, from approximately $44 billion in 2000, to reach over $56 billion by
2005.
Fiscal and service delivery pressures have led state and local
governments increasingly to seek outside, non-governmental business partners who
can assume and ensure the delivery of high quality services at less cost and
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greater quality than traditional government service offerings. State and local
government agencies are also finding that certain business processes can be
better operated and managed by private sector companies. For example, state
and local government agencies providing child support services have been
significantly impacted by growing caseloads and additional federal regulation.
State agencies providing non-emergency Medicaid transportation are increasingly
outsourcing these efforts.
Government organizations rely heavily on outside contractors to provide
skilled resources to accomplish technology and business process outsourcing
programs. We believe that this reliance will continue to intensify in many
government agencies due to the difficulties faced in recruiting and retaining
highly skilled professionals in a competitive labor market for persons with
specialized expertise. We believe that government agencies will increasingly
outsource programs as a means of simplifying the implementation and management
of government services.
We believe that the markets we serve now demand a comprehensive
business solution from service providers, grounded in specific and relevant
business knowledge and proven experience, rather than simply the provision of
limited or generic services or offering only technology-specific solutions. We
offer comprehensive solutions to address the needs of our markets. We engage in
large-scale systems development projects involving full-service solutions that
combine hardware, legacy systems integration, systems engineering and systems
support operations. We integrate data with services to provide efficient and
low-cost business processes.
CURRENT OPERATIONS
Information Technology Services
We provide a range of specialized information technology, or IT,
infrastructure services: system architectural design, network security services,
legacy systems integration, network engineering, applications development, help
desk support and operational support. In conjunction with these service
offerings, we also sell hardware and software to our customers. Operations are
distributed primarily among seven states; California, Florida, Louisiana,
Massachusetts, Michigan, Texas, and New York, with employees situated in
locations that are convenient to client sites.
Services are contracted primarily through Indefinite
Delivery-Indefinite Quantity-type, or IDIQ, contracts that may be awarded by a
state or local government agency to more than a single vendor. After the
government sponsor awards the contract to multiple vendors, DynTek may then
compete with other companies identified in the multiple IDIQ contracts for
individual orders issued under the contract from time to time by the government
customer. Government contracts for IT infrastructure services awarded
specifically to us alone are generally short-term task orders granted under
multi-project contract vehicles. The scope of services provided to any given
customer can vary, according to project size and the internal client IT
resources available. While the majority of our IT infrastructure services
revenues are derived from specific projects, as contracted, we also derive
revenues from ongoing customer relationships which generate a considerable
number of recurring engagements. Hardware and software maintenance agreements
provide a significant portion of the service revenues. Such services are
provided through a combination of in-house technicians, as well as subcontractor
third-party suppliers of the services.
We offer states, municipalities and government agencies products for
designing and implementing custom Internet presences utilizing a proprietary
suite of customizable software modules, called ePluribus. Each module can
provide a different online service which can interface with existing customer
websites and can be integrated into existing customer databases. The ePluribus
products and related services currently being used enable governments to process
transactions such as tax payments, violation payments, licensing renewals and
public recreation scheduling.
Business Process Outsourcing
As a part of the DMR business acquired in December 2001, DynTek has
contracted to be responsible for outsourced program operations for state
government agencies in several areas. Typically these contracts are for
3
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.
One of our focus areas is serving as a broker, on behalf of the
governmental "primary" contracting entity, for the arrangement of non-emergency
medical transportation for eligible Medicaid, general relief and welfare
recipients. Under these contracts, DynTek may assume the responsibility for
some, or all, of the following functions: educate recipients about
transportation services available, establish a network of transportation
providers, verify individual Medicaid eligibility and medical necessity, set up
call center and serve as the central point of contact with recipients, authorize
transportation and schedule trips, contract with and pay transportation
providers and track costs and services and report results to the contracting
agency.
Another area of focus is performance of privatized child support
enforcement services, pursuant to which DynTek assumes responsibility for the
determination and location of legally established paternity and support
obligations, enforcement of court or administrative orders for such obligations,
location of absent responsible parents or other persons obligated for such
payments and location of relevant assets which may be used for satisfaction of
such obligations.
In addition to direct business process outsourcing, DynTek also
provides consulting expertise to state and local governments interested in
designing and evaluating outsourced operations. Our business process outsourcing
customers have included various governmental departments in the states of
Connecticut, Arkansas, Virginia, Illinois, North Carolina, Kansas and Nebraska.
Following the acquisition of the DMR business in December 2001, we now
provide business process outsourcing services which are accounted for as a
separate segment. For a presentation of financial information with respect to
our two business segments for the year ended June 30, 2002, see Note 17 in Item
8. We have not restated the corresponding items of segment information for
earlier periods, as we did not conduct business outsourcing services prior to
December 2001.
CUSTOMERS
Our customers are primarily agencies of state governments and
municipalities with large-volume information and technology needs, or the
primary vendors to those governments and agencies. Among the information
technology customers, the State of New York and its agencies comprised
approximately 21% of our revenues for the fiscal year ended June 30, 2002 and
approximately 30% of revenues for the fiscal year ended June 30, 2001. We sell
products and services to the State of New York and its agencies as an authorized
vendor to provide system peripheral equipment to New York state agencies. The
Company is also an authorized reseller of Novell, Nortel Systems and Cisco
products and software to the State of New York. The State of Louisiana and its
agencies accounted for approximately 7% of our revenues for the fiscal year
ended June 30, 2002 and approximately 13% of revenues for the fiscal year ended
June 30, 2001. Louisiana awarded a renewable one-year contract in July 1996 to
provide network service, help desk support and maintenance support to multiple
state agencies. The contract expired in June 2001 and the State provided
temporary extensions until August 30, 2002, when the contract was awarded to
another company.
Among our business process outsourcing customers, the Commonwealth of
Virginia Non Emergency Transportation (VA NET) contract comprised approximately
24% of our revenues for the six months (period under management) ended June 30,
2002. We did not have revenues under the VA NET contract in the prior fiscal
year ended June 30, 2001, since the contract was not under our management during
that period. It is expected that, during the period January 1, 2002 through June
30, 2003, the VA NET contract will generate revenues of approximately $41
million. This contract may include options for renewal, based upon mutual
consent of the parties and the consent of our principal lender, Foothill
Capital, for up to four successive one-year periods. The contract provides for
services to be delivered on a fixed-fee basis. The State of Connecticut Non
Emergency Transportation contract comprised approximately 12% ofour revenues for
the six months (period under management) ended June 30, 2002.
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The VA Net contract also requires a performance bond in order to
qualify as the service provider. Currently DynCorp is providing the bond;
however, its obligation to do so expires in December 2002, at which time we will
be required to replace the bond. If we are unable to replace the bond and
DynCorp is unwilling to continue to provide it, we could be deemed to be in
default under the terms of the contract.
No other single customer or state accounted for more than 10% of our
revenue during fiscal 2002. Generally, our products and services are purchased
by individual state agencies issuing their own purchase orders under master
contract agreements between DynTek and the State through which the agency gets
the authority to issue a valid purchase order.
SALES AND MARKETING
Our sales and marketing objective is to develop relationships with
clients that result in both repeat and long-term engagements. We use an internal
sales force in conjunction with partnership alliances with our vendors. Our
sales team derives leads through industry networking, referrals from existing
clients, government agencies' requests for proposals, or RFP's, strategic
partnerships with third party vendors under which we jointly bid and perform
certain engagements, and sales and marketing activities directed to specific
customers.
In addition to the use of our sales team, outsource services contracts
are secured through open competitions conducted by states and municipalities. We
receive and review numerous RFPs, from governmental entities for the provision
of services and identify those that are suitable for responsive bid. In
government contract award procedures, following proposal submission, contracts
are often awarded based on subsequent negotiations with the bidder offering the
most attractive proposal, price and other contracting factors. In certain cases
low price may be the determining factor, while in others price may be secondary
when compared with the quality of technical skills or management approach.
We employ a team selling approach for marketing our offerings to each
customer. Our subject matter experts collaborate with our service delivery
professionals to identify a comprehensive service and product offering mix that
meets customer needs. As a result of our particular mix of service offerings, we
believe that we have the ability to penetrate markets quickly with sales of an
array of different products and services and lower our per customer sales
acquisition costs as a result of each customer having the availability of many
products and services from which to choose.
BACKLOG
Our backlog represents an estimate of the remaining future revenues
from existing firm contracts, which are principally for the provision of
services. Our backlog estimate includes revenues expected under the current
terms of executed contracts and does not assume any contract renewals or
extensions, however, our backlog estimate may vary from the revenues actually
realized because services provided under each included contract fluctuates from
period to period based on services usage criteria set forth in each contract.
Our information technology contracts typically are funded incrementally
and are specific-task driven, with the exception of our annual maintenance and
help desk support contracts. Therefore, our firm backlog at any point in time
only represents a small portion of the projected aggregate value of our
contracts. Our backlog only becomes firm as work progresses throughout the term
of a contract, as specific orders under the contract are placed. Our backlog is
typically subject to large variations from quarter to quarter. As a result, we
do not consider order backlog a significant indicator of our future information
technology services revenue.
Our outsource services contracts firm backlog, calculated based upon
the criterion identified above, is approximately $100 million as of June 30,
2002, realizable primarily over the next 24 months. We did not assume
responsibility for these contracts until December 27, 2001, so comparable data
as of June 30, 2001 is not available.
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VENDORS
In connection with the rendering of our information technology services
and products, we purchase microcomputers and related products directly from
manufacturers and indirectly through distributors such as Gates Arrow, Tech Data
and Ingram Micro Corporation. In general, we are authorized by a manufacturer to
sell their products, whether the products are purchased from distributors or
directly from manufacturers. We are an authorized reseller for microcomputers,
workstations, and related products of over 50 manufacturers. Our sales of
products manufactured by Compaq, Cisco and Novell accounted for approximately
49% of our product revenues in the information technologies segment during the
last fiscal year (18% of total revenue during the last fiscal year). Typically,
vendor agreements provide that we have been appointed, on a non-exclusive basis,
as an authorized reseller of specified products at specified locations. The
agreements generally are terminable on 30 to 90 days' notice or immediately upon
the occurrence of certain events, and are subject to periodic renewal. The loss
of a major manufacturer or the deterioration of our relationship with a major
manufacturer could have a material adverse effect on our business as certain
product offerings that are requested by customers would not be available to us.
COMPETITION
The information technology and business process outsourcing markets are
highly competitive and are served by numerous national and local firms. Market
participants include systems consulting and integration firms, including
national accounting firms and related entities, the internal information systems
and service groups of our prospective clients, professional services companies,
hardware and application software vendors, and divisions of large integrated
technology companies and outsourcing companies.
We believe that the principal competitive factors in our industry
include reputation, project management expertise, industry expertise, speed of
development and implementation, technical expertise, competitive pricing and the
ability to deliver results on a fixed price or transaction basis as well as a
time and materials basis. We believe that our ability to compete also depends in
part on a number of competitive factors outside our control, including the
ability of our clients or competitors to hire, retain and motivate project
managers and other senior technical staff, the ownership by competitors of
software used by potential clients, the price at which others offer comparable
services, the ability of our clients to perform the services themselves, and the
extent of our competitors' responsiveness to client needs. We anticipate that
our experience, reputation, industry focus and broad range of services provide
significant competitive advantages which we expect will enable us to compete
effectively in our markets.
FUTURE STRATEGY
Our strategy is to continue to grow by capitalizing on our core
competencies in the information technologies and outsourced services markets.
Our strategies for obtaining this objective include:
Increased Market Penetration. We intend to capitalize on our long-term
relationships with government clients and our reputation within the government
market to cross-sell our full range of services to our existing client base and
to expand into organizations for which we have not already performed services.
We intend to pursue these opportunities through a continued active sales and
marketing effort and by continuing to promote the success stories stemming from
our aggressive application of successful solutions. We also intend to leverage
our relationships with our technology providers and their sales resources to
obtain new government clients.
Continue to Develop Complementary Services. We intend to continue
broadening our range of services in order to respond to the evolving needs of
our clients and to provide additional cross-selling opportunities. We intend to
continue to internally develop innovative consulting practices, technologies,
and methodologies that are required by government entities in order to
effectively deliver public services.
6
Recruit Highly Skilled Professionals. We intend to hire and retain
outstanding professionals, provide incentives to achieve corporate goals and
maintain a culture that fosters innovation. We will continue to emphasize
professional development and training of our employees. We will maintain an
active internal communications program to promote a team culture and foster high
employee morale. We will also continue to emphasize our corporate technology
infrastructure to facilitate the sharing of knowledge among our employees.
Pursue Strategic Acquisitions. We plan to broaden our capabilities and
client base and extend our geographic presence in state and local government
markets by acquiring select businesses. Acquired businesses will perform similar
technical work for organizations outside our current client base, will support
solution sets that are consistent with and extend our web-enabling strategy, or
will be located in geographic areas strategic to significant state and local
governments and programs.
INTELLECTUAL PROPERTY RIGHTS
Our success is dependent, in part, upon our proprietary processes,
components and other intellectual property rights. We do not have any patents or
patent applications pending. We rely on a combination of trade secret,
nondisclosure and other contractual agreements, and copyright and trademark
laws, to protect our proprietary rights. Existing trade secret and copyright
laws afford us only limited protection. We enter into confidentiality agreements
with our employees and our contractors and limit access to and distribution of
our proprietary information. There can be no assurance that the steps we have
taken in this regard will be adequate to deter misappropriation of our
proprietary information or that we will be able to detect unauthorized use and
take appropriate steps to enforce our intellectual property rights.
A portion of our business involves the development of software
applications for specific client engagements. Although ownership of
client-specific software is generally retained by the client, we retain some
rights to the applications, processes and intellectual property developed in
connection with client engagements.
HUMAN RESOURCES
As of June 30, 2002, DynTek and its subsidiaries had 395 employees. We
also employ 78 contract consultants for technical support. The Company also
employs, through two subcontractor agreements, approximately 80 customer service
representatives. We believe that our relationships with our employees are good.
INSURANCE COVERAGE
The Company maintains general liability insurance, which includes
directors and officers liability coverage, and workers compensation and
professional liability insurance in amounts deemed adequate by the Board of
Directors.
ITEM 2. PROPERTIES
DynTek's corporate headquarters is located in Irvine, California, in a
leased facility consisting of approximately 6,500 square feet of office space
rented under a lease expiring in October 2005. There is an administrative office
located in Farmington Hills, Michigan, in a leased facility consisting of
approximately 11,500 square feet of office space, 4,300 square feet of which has
been sublet to another tenant. This lease expires in November 2002. A
technical facility is also located in Farmington Hills, Michigan with
approximately 7,000 square feet rented under a lease expiring in March 2003. We
believe that we will be able to renew both leases that expire within the next
six months on commercially reasonable terms or that if we are unable to renew
them, suitable replacement space would be available on commercially reasonable
terms.
7
We also lease 5 separate direct sales offices and 18 other commercial
facilities containing an aggregate of approximately 82,000 square feet under
leases with terms ranging from month-to-month to five years. Such
facilities are used in connection with the provision of various services to our
customers. None of these properties is unique, all are expected to continue to
be utilized in the operation of our business and they are believed to be
adequate for the present needs of the business.
ITEM 3. LEGAL PROCEEDINGS
MILETICH DERIVATIVE ACTION
On July 10, 2000, we were named as a nominal defendant in a
stockholder's derivative action brought in the Supreme Court of New York, New
York County, on behalf of DynTek by Paul Miletich. On August 20, 2002, a final
order approving settlement and dismissing action by Paul Miletich was filed in
the New York County Clerk's Office. The settlement approved a stipulation that
The Rubin Family Trust transfer to DynTek 300,000 shares of DynTek common stock
and 125,000 shares of MedEmerg common stock, as full settlement of a guarantee
provided by Mr. Rubin pertaining to a transaction with StyleSite Marketing.
Additionally, the insurance underwriters for DynTek paid the Company $300,000 on
behalf of the director defendants. DynTek reimbursed plaintiff's counsel for
fees and expenses of $330,000, of which 20% was paid in MedEmerg common stock
(approximately 80,000 shares). The shares of DynTek common stock received were
retired and the remaining shares of MedEmerg common stock are being held as
marketable securities. No gain or loss was recorded in connection with the
settlement.
COMPUTER ASSOCIATES
On January 29, 2002, DynTek was named as a third-party defendant in a
matter initially between Computer Associates International, Inc. (CA) and the
City of Boston (COB), in United States District Court, District of Massachusetts
(Case Number 01-10566-EFH). CA had filed suit against COB alleging that COB
breached a contract with CA, infringed on copyrights of CA, and engaged in
tortious behavior in its dealings with CA. We were subsequently joined as a
defendant because we were the authorized reseller for CA and supplied various CA
software programs and services to COB on behalf of CA. To the extent that CA may
have sustained damages, a demand for indemnification from us has been made by
COB. The complaint demands relief from judgment in the amount of $600,000 plus
other costs, which is the initial contract amount. CA has additionally commenced
a claim against COB for breach of copyright and the balance due under a
multi-phase purchase agreement. While a specific claim for damages has not been
asserted, the total multi-phase contract was in an amount of approximately $2
million. Settlement discussions are currently undertaken by CA and COB. We
believe that COB will not prevail with an indemnification claim against the
Company and that the matter will be resolved between CA and COB through a mutual
settlement. However, there is no assurance that the settlement will be reached
or that indemnification claims will not be asserted against us.
OTHER MATTERS
As a result of the merger with Data Systems, we assumed the liability
for any potential enforcement action which could be taken against the Company by
the Securities and Exchange Commission, or the SEC. The SEC staff has advised
Data Systems orally that they would make no recommendation for any enforcement
proceedings against Data Systems following its merger with DynTek Services.
On July 28, 2000, a judgment was entered against Data Systems in favor
of J. Alan Moore in Mecklenburg County Superior Court Division, North Carolina.
The plaintiff was awarded a judgment of $572,000 plus reasonable attorney fees
and interest. While the Company has appealed this decision, accruals for this
contingency have been established in an aggregate amount of approximately
$700,000. The Company is in negotiations with the plaintiff regarding settlement
terms.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held an Annual Meeting of stockholders on August 20, 2002 to consider
the election of directors and the ratification of the appointment by the Board
of Directors of Grassi & Co., P.C. as independent accountants for the year ended
June 30, 2002.
The following four individuals were elected by the stockholders to
serve as Class A directors for terms expiring at our 2003 Annual Meeting or
until their successors are elected and qualified:
Votes Cast For Abstentions
----------------------------- ------------
Class A Common Series A Class A Common
Name Stock Preferred Stock Series A Preferred
- ---- ----- ---------- ------------- ------------------
Steven J. Ross 12,235,833 1,556,273 107,552 5,368
James Linesch 12,235,833 1,556,273 107,552 5,368
Brian D. Bookmeier 12,307,333 1,556,273 36,052 5,368
Michael W. Grieves 12,307,333 1,556,273 36,052 5,368
In addition, the following three individuals were nominated for
re-election as Class B directors. Class B directors are elected by holders of
our Class B common stock. However, immediately following our annual meeting, we
entered into the Stock Purchase and Settlement Agreement with DynCorp, our sole
Class B holder, pursuant to which we repurchased a portion of our Class B common
stock and converted the remaining shares to Class A common stock. Accordingly,
as stated below, no votes were cast in favor of the Class B directors.
Votes Cast For Abstained
David L. Reichardt 0 18,336,663
Marshall B. Mandell 0 18,336,663
Thomas R. Davies 0 18,336,663
Following the Annual Meeting, the Board of Directors consisted of the
four Class A directors named above. The Board then decreased the number of
directors from seven to five, pursuant to the provisions of our by-laws, leaving
one vacancy on the Board of Directors. Subsequently, the Board appointed
Marshall Toplansky as the fifth Class A director to serve until our 2003 Annual
Meeting, or until his successor is elected and qualified.
At the Annual Meeting, the stockholders also ratified the appointment
of Grassi & Co. as independent accountants for the year ended June 30, 2002 by
the following vote: 12,262,186 shares of Class A Common Stock, 18,336,663 shares
of Class B Common Stock, and 1,556,260 shares of Series A Preferred Stock were
voted in favor, 75,299 shares of Class A Common Stock, 0 shares of Class B
Common Stock, and 4,385 shares of Series A Preferred Stock were voted against,
and 5,900 shares of Class A Common Stock, 0 shares of Class B Common Stock, and
546 shares of Preferred Stock were held in abstention.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The principal market for trading DynTek's our Common Stock and Class A
Warrants is the Nasdaq Small Cap Market ("Nasdaq"), although our Common Stock
and Class A Warrants are also traded on the Boston Stock Exchange.
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PRICE RANGE OF OUTSTANDING COMMON STOCK
On December 18, 1992, our Common Stock began trading on Nasdaq and has
been quoted on Nasdaq at all times since that date.
The following table sets forth the high and low bid prices for each
fiscal quarter during the fiscal years ended June 30, 2001 and 2002, as reported
by Nasdaq. Such quotations reflect inter-dealer prices, without retail mark-up,
markdown or commission and do not necessarily represent actual transactions.
FISCAL YEAR ENDED JUNE 30, 2001 HIGH LOW
----- ---
First quarter ended September 30, 2000 $2.81 $2.00
Second quarter ended December 31, 2000 1.84 .75
Third quarter ended March 31, 2001 1.69 .88
Fourth quarter ended June 30, 2001 2.70 1.71
FISCAL YEAR ENDED JUNE 30, 2002 HIGH LOW
----- ---
First quarter ended September 30, 2001 $2.55 $1.53
Second quarter ended December 31, 2001 2.64 1.63
Third quarter ended March 31, 2002 2.44 1.86
Fourth quarter ended June 30, 2002 2.11 1.56
FISCAL YEAR ENDED JUNE 30, 2003 HIGH LOW
----- ---
First quarter ended September 30, 2002 $1.90 $0.80
On September 23, 2002, the last trade price for a share of Common Stock
was $0.86, as reported on Nasdaq. We estimate that we have in excess of 300
beneficial holders of our Common Stock.
DIVIDEND POLICY
We have never paid cash dividends on our Common Stock and do not
anticipate paying cash dividends in the foreseeable future, but rather intend to
retain future earnings, if any, for reinvestment in our future business. Any
future determination to pay cash dividends will be in compliance with our
contractual obligations (including our credit agreement with Foothill Capital),
and otherwise at the discretion of the Board of Directors and based upon our
financial condition, results of operations, capital requirements and such other
factors as the Board of Directors deems relevant.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities to be Weighted-average future issuance under equity
issued upon exercise of exercise price of compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
------------- ------------------- ------------------- ------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders................. 3,421,996 $1.81 1,121,000
Equity compensation plans not
approved by security
holders................. 2,569,125 $1.94 0
Total........ 5,991,121 $1.86 1,121,000
10
RECENT SALES OF UNREGISTERED SECURITIES
During the three years ended June 30, 2002, we issued the following
securities in private offerings exempt from the Securities Act of 1933, as
amended (the "Securities Act"). Unless otherwise noted, we relied on the general
exemption provided under Section 4(2) thereof:
o During the fiscal year ended June 30, 2002, we issued 229,000
options to accredited investors for services rendered, at exercise prices
between $2.00 and $2.28.
o In June 2002, we sold 2,431,332 shares of our Common Stock for
$1.50 per share to accredited investors, and issued warrants to purchase
1,215,666 shares of our Common Stock for $1.50 per share. At June 30, 2002,
941,155 of the share certificates had been issued and during July 2002 the
remaining 1,490,177 share certificates were issued. In connection with
these sales, we paid to a related party a fee of $262,000.
o On November 1, 2001, we issued an aggregate of $1,057,000 in principal
of short-term notes payable that bear interest at 12% per annum during a
term of 90 days and an aggregate of $750,000 in principal of short-term
notes payable that bear interest at 8% per annum during a term of 180 days.
In connection with the acquisition of these notes, the investors received a
warrant to acquire one-third of a share of Class A common stock for each
dollar of note principal, bearing exercise prices of $1.50 and $1.70 per
share and are exercisable for three years. These short-term notes payable
and warrants were sold to accredited investors in reliance on the exemption
from registration under the Securities Act, provided by Rule 506 of
Regulation D of the Securities Act as a private offering transaction and
are convertible to Class A common stock. During the quarter ended March 31,
2002, $300,000 of such notes was repaid and the balance of the principal
and accrued interest was converted into 1,042,039 shares of the offering in
June 2002, mentioned above. Of this amount, 355,372 shares were issued in
June 2002 and 686,667 shares were issued in July 2002.
o In March 2001, we issued 2,718,550 shares of our common stock to
accredited investors. The aggregate net proceeds of this offering were
$2,718,550. These shares were sold in reliance on the exemption from
registration under the Securities Act, provided by Rule 506 of Regulation D
of the Securities Act as a private offering transaction. In connection with
these sales, we paid to a related party a fee of 7% in cash.
o During the fiscal year ended June 30, 2001, we issued 121,500
options to accredited investors for services rendered, at exercise prices
between $0.59 and $2.22.
o In September 2000, our subsidiary, BugSolver, issued 1,000,000 shares
of preferred stock. The aggregate equity investment received for these
shares was $3,000,000. For one year, the shares are convertible to
1,500,000 shares of our common stock. These shares were issued to
accredited investors in reliance on the exemption from registration under
the Securities Act, provided by Rule 506 of Regulation D of the Securities
Act as a private offering transaction. In this connection, a finder's fee
of $150,000 was paid to a related party, together with options to purchase
50,000 shares of BugSolver's common stock at $3.00 per share. In July 2001,
the shares were converted into 1,500,000 shares of our Class A common
stock, in accordance with the terms of the agreement.
o In September 2000, we issued 129,730 shares of our common stock to
Amtech Associates, Inc., an accredited investor, in consideration for a
finders fee/consultation services rendered to Data Systems in connection
with the merger with Data Systems.
o On June 1, 2000, we granted 120,000 options to the Exigo Group and
100,000 options to Core Strategies, each an accredited investor, at $3.00
per share, as consideration for services rendered.
o On February 15, 2000, we issued two warrants exerciseable through
February 15, 2005 to acquire an aggregate of 300,000 shares of our common
stock at $4.0625 per share as a part of the compensation granted to Early
Bird Capital, an accredited investor and an investment banking firm, in
connection with a consulting agreement.
11
ITEM 6. SELECTED FINANCIAL DATA
On August 14, 2000, we acquired the assets of Data Systems Network
Corporation, causing an increase in the revenues and costs of the Company
for the fiscal year ended June 30, 2001. On December 27, 2001, we acquired
the assets of DynCorp Management Resources, Inc., causing an increase in
the revenues and costs of the Company for the fiscal year ended June 30,
2002.
DynTek, Inc.
Selected Financial Data
Years ended June 30,
in (000's)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Operating revenues $ $ 44,910 1,962 1,515 $ 997
83,041
Loss from continuing operations (19,413) (10,822) (3,947) (479) (1,153)
Income loss from continuing operations per
share (0.67) (0.63) (0.25) (0.03) (0.11)
Total assets 33,997 12,525 16,488 9,913
80,519
Long term debt - - - 18 664
Redeemable preferred stock - - - 1,219
1,616
Dividends per share common stock - - - - -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
When used in this Form 10-K and in our future filings with the
Securities and Exchange Commission, the words or phrases "will likely result",
"we expect," "will continue," "is anticipated," "estimated," "project," or
"outlook" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. We wish to caution readers not to place undue reliance on any such
forward-looking statements, each of which speaks only as of the date made. Such
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. Such risks and uncertainties include, among others,
success in reaching target markets for our services and products and the ability
to attract future customers, the success of our business emphasis, the ability
to finance operations, including the ability to maintain and extend the Foothill
credit agreement when it becomes due and the ability to raise equity capital in
the future, the ability to fulfill our obligations to third parties, including
the ability to obtain performance bonds to support certain such contractual
obligations, the ability to turn contract backlog into revenue and net income,
the continuing desire of state and local governments to outsource to private
contractors, the performance of governmental services, and the continuation of
general economic and business conditions that are conducive to governmental
outsourcing of service performance. We have no obligation to publicly release
the results of any revisions which may be made to any forward-looking statements
to reflect anticipated or unanticipated events or circumstances occurring after
the date of such statements.
Results of Operations
The following table sets forth, for the periods indicated, the relative
percentages that certain income and expense items bear to net sales.
12
Year Ended June 30,
2002 2001 2000
---- ---- ----
Product Sales 37% 55% -
Service Sales 63% 45% 100%
Cost of Product Sales 84% 17% -
Cost of Service Sales 90% 25% 69%
Gross profit 11% 21% 31%
Selling expense 13% 19% 3%
General & administrative 8% 9% 161%
Application development costs - 7% 14%
Loss from operations (23)% (24)% (166)%
Interest income - - 22%
Total income (loss) from discontinued operations - - 6%
Net income/(loss) (23)% (24%) (202)%
===== ===== ======
Fiscal years ended June 30, 2002 and June 30, 2001
Revenues for the fiscal year ended June 30, 2002 increased to
approximately $83,041,000 from approximately $44,910,000 during the prior year,
or a 89% increase from the fiscal year ended June 30, 2001. These increases were
primarily due to the December 27, 2001 merger with DynCorp Management Resources
(DMR). The revenue mix of product and services was 37% and 63%, respectively,
for the 2002 fiscal year, as compared to 55% and 45%, respectively, for the 2001
fiscal year. This change in revenue mix is primarily due to the increased
service revenues from business process outsourcing contracts.
Cost of revenues for the fiscal year ended June 30, 2002 increased to
approximately $73,964,000 from approximately $35,492,000 during the fiscal year
ended June 30, 2001. The increase is primarily due to the December 27, 2001
merger with DMR. The cost of revenue percentage increased to 88% for the 2002
fiscal year from 79% during the 2001 fiscal year. Cost of sales increased, as a
percentage of sales, primarily due to the increased operating costs related to
the Virginia contract. During the 2002 fiscal year, the Virginia contract
generated approximately $24 million, or 29%, of the total revenues with a gross
margin loss of $2,383,000.
Selling, general and administrative expenses increased to approximately
$17,408,000 for the fiscal year ended June 30, 2002, from approximately
$13,389,000 for the 2001 fiscal year period. The increase is primarily due to
the December 27, 2001 merger with DynCorp Management Resources (DMR). As a
percentage of total revenues, such costs decreased to 21% during fiscal 2002,
from 28% in the prior fiscal year. Application development costs decreased to
$325,000 during fiscal 2002, from $721,000 during the prior fiscal year. The
Company is not developing new applications at this time, and is enhancing
current applications on a task-order basis, with such costs charged to cost of
sales.
Options were issued for services rendered with a value of $325,000
during the fiscal year ended June 30, 2002, as compared to $721,000 during the
prior fiscal year.
Depreciation and amortization expense increased to approximately
$2,934,000 for the fiscal year ended June 30, 2002, from approximately
$2,747,000 for the 2001 fiscal year. The increase is primarily due to the
December 27, 2001 merger with DMR, which resulted in increased amortization
expense on intangible assets acquired. Such increase was offset by a decrease in
goodwill amortization expense of $429,000 resulting from the adoption of FASB
142.
Interest expense for the fiscal year ended June 30, 2002 was
$2,582,000, as compared to $592,000 for the fiscal year ended June 30, 2001. The
increase is due to higher levels of borrowing under the secured line of credit
13
to support the working capital requirements of the expanded company following
the merger with DMR. The increased expense is also a result of interest and
finance costs on short-term convertible notes payable incurred during the fiscal
year 2002, of $1,156,000. The increase in interest income from June 30, 2001of
$112,000 to $294,000 at June 30, 2002 is due primarily to the accrued interest
from the Private Label Cosmetics note receivable. Interest income was
approximately $112,000 for the 2001 fiscal year.
The loss on marketable securities increased to $1,241,000 from $480,000
the prior year. To increase available working capital, the sale of securities in
an unfavorable market was necessary.
The net loss of $19,413,000 for the fiscal year ended June 30, 2002 is
primarily attributed to losses from operations including the business process
outsourcing operations acquired in the merger with DMR, and to the expanded
infrastructure required to support the larger business.
Fiscal years ended June 30, 2001 and June 30, 2000
Revenues for the fiscal year ended June 30, 2001 increased to
approximately $44,910,000 from approximately $1,962,000 during the prior year,
or a 96% increase from the fiscal year ended June 30, 2000. These increases were
primarily due to the August 14, 2000 merger with Data Systems. The revenue mix
of product and services was 55% and 45%, respectively, for the 2001 fiscal year.
Cost of revenues for the fiscal year ended June 30, 2001 increased to
approximately $35,492,000 from approximately $1,373,000 during the fiscal year
Ended June 30, 2000. The cost of revenue percentage increased to 79% for the
2001 fiscal year from 70.0% during the 2000 fiscal year. This increase was
due to the August 14, 2000 merger with Data Systems. The nature of revenues, and
the costs thereof, has changed substantially from the prior year periods
compared above. During the current fiscal year, revenues are predominately from
services and products sold to government customers. The revenues generated from
product sales normally produce a lower gross margin percentage when compared to
those of service revenues. During the prior fiscal year, revenues were
predominately from consulting services rendered by the Company's development
group. For the fiscal year ended June 30, 2001, the product cost of revenue was
82.7% of such sales and the service costs of revenue were 74.7% of such sales.
Selling, general and administrative expenses increased to approximately
$13,389,000 for the fiscal year ended June 30, 2001, from approximately
$3,528,000 for the 2000 fiscal year period. This increase was due to the August
14, 2000 merger with Data Systems, which brought with it a corporate
infrastructure, including the functions of finance, purchasing, human resources,
sales and marketing. In addition, TekInsight hired outside consultants to assist
in developing the sales strategy and marketing efforts needed to bring
TekInsight's products and services to the market. Of such selling, general and
administrative expenses, stock options issued for services comprised $721,000 of
the total costs for the fiscal year ended June 30, 2001 and $327,000 of the
total costs for the fiscal year ended June 30, 2000.
Application development expense for the fiscal year ended June 30, 2001
increased to approximately $2,945,000 from approximately $276,000 for the prior
fiscal year. The increase is due to the costs associated with the
enhancements to the Company's ProductivIT product and the development costs for
the Company's eGovernment modules. Previously, DynTek capitalized the
ProductivIT costs during the developmental stage and, now that the product is
being introduced to market, the costs are expensed when incurred.
Depreciation and amortization expense increased to approximately
$2,747,000 for the fiscal year ended June 30, 2001, from approximately $43,000
for the 2000 fiscal year. This increase was due to the August 14, 2000 merger
with Data Systems, which resulted in increased amortization expense on
intangible assets.
Interest income decreased to approximately $112,000 for the fiscal year
ended June 30, 2001, from approximately $433,000 for the 2000 fiscal year. This
decrease is attributable to decreased interest earned on the certificates of
deposit investments, resulting from diminished working capital. Interest expense
for the fiscal year ended June 30, 2001 was approximately $592,000. This expense
is a result of the credit line facility acquired in the August 14, 2000 Data
Systems merger.
14
Total other expense remained unchanged for the fiscal year ended June
30, 2001, from the prior fiscal year. However, the composition of such costs
changed from year to year. The loss on marketable securities decreased to
$480,000 from $1,191,000 in the prior year. During the fiscal year ended June
30, 2001, the Company incurred interest expense of $592,000, which was not
present in the prior year period due to the assumption of the revolving line of
credit with Foothill Capital for working capital purposes.
The net loss of $10,763,000 for the fiscal year ended June 30, 2001 is
primarily attributed to the costs of developing and marketing the Company's
ProductivIT product, without material corresponding revenues, and to software
development and market introduction costs for its products.
Liquidity and Capital Resources
As of June 30, 2002 the Company had a working capital deficiency of
approximately $14 million compared to a working capital deficiency of $5 million
at June 30, 2001. This decrease in working capital is primarily due to the
acquisition of DMR during the 2002 fiscal year and to losses from operations.
On September 27, 2001 and November 1, 2001, the Company issued
$1,807,000 aggregate principal of short-term convertible notes. At the
maturity dates, an aggregate of $300,000 principal of such notes was repaid. The
balance of the notes, including accrued interest, of $1,563,000 were converted
into the subscriptions as described below.
The Company received subscriptions in the aggregate amount of
$3,647,000 (inclusive of the conversion of short-term notes described above)
during the quarter ended March 31, 2002 to purchase Units, with each Unit
consisting of one share of the Company's Class A Common Stock and one Class A
Common Stock purchase warrant. Each warrant entitles the holder to purchase
one-half share of Class A Common Stock at a price of $1.50 per share. The
company paid a finder a cash fee of ten percent (10%) of the proceeds from the
sale of the Units.
On May 23, 2002, a note receivable became due in the principal amount
of $1,800,000 plus accrued interest. The Company had recorded a net realizable
value of $1,500,000 for this receivable. Prior to the maturity date, the debtor
re-negotiated the payment terms. Under the revised terms, the debtor paid the
Company $600,000 and conveyed a promissory note for $1,292,000, payable in 48
monthly installments and bearing interest at 7.5% per annum. The note is secured
by shares of the common stock of the debtor, which will be progressively
released as collateral on a quarterly basis provided that the monthly payments
are received on a timely basis.
The Foothill Agreement provides for a revolving line of credit not to
exceed $15,000,000. The available line of credit at June 30, 2002, according to
the collateral formula, was approximately $10,907,000 of which $6,232,000 was
outstanding. Borrowing limits are determined based on a collateral formula,
which includes 85% of qualified trade receivables. Also, borrowings bear
interest at 1% over Norwest Bank prime (4.75% at June 30, 2002) with a minimum
rate of 7%. The term of the agreement has been extended through March 31, 2004
under terms similar to the current agreement. The Company has received a waiver
from Foothill, as of June 30, 2002, for non-compliance with the financial
covenants. Company may not be in compliance with all of its
covenants at September 30, 2002 and is in discussions with Foothill
regarding the revision of certain covenants.
In a matter relating to a prior business of the Company that was
divested in 1998, one of the Company's discontinued wholly owned subsidiaries
was issued a Letter of Demand for $1.3 million by the California State
Controller's Office, Division of Audits. Additionally, accrued interest on the
amount demanded was also sought. On January 26, 2000, the California Court of
Appeals upheld the Demand. The Company has provided a reserve for the principal
amount of $1,340,000 plus $521,000 in accrued interest, or $1,861,000 in total
as of June 30, 2002. The California State Controller's Office has not taken
legal action to obtain a judgment against the Company in order to collect this
obligation.
In connection with its merger with Data Systems in August 2000, the
Company assumed the liability for a judgment that was entered against Data
Systems on July 28, 2000. The plaintiff was awarded a judgment of $572,000 plus
reasonable attorney fees and interest. Accruals for this contingency have been
15
established in an aggregate amount of approximately $700,000. The Company is
awaiting negotiations with the plaintiff regarding settlement terms.
In connection with the merger with DMR, the Company assumed a contract
with the Commonwealth of Virginia for non-emergency medical transportation
services. The contract extends until June 30, 2003, with aggregate revenues of
approximately $41 million remaining following the December 27, 2001 merger. The
contract is a fixed-fee agreement, with the Company providing complete
transportation services, as stipulated, including the hiring of transportation
providers. Directly following the merger, estimated losses from this contract
exceeded estimates prepared prior to the merger date. The Company's estimate of
losses from the contract, prepared following the merger date, was approximately
$7,383,000. In August 2002, the Company completed a negotiated settlement with
DynCorp regarding this contract, whereby DynCorp reimbursed the Company for $5
million of the unanticipated operating expenses incurred to perform under the
Contract. Such reimbursement has been applied to the estimate to complete the
contract. The balance of the estimated losses to complete the contract, in the
amount of $2,383,000, was recognized as a loss during the fiscal year ended June
30, 2002. Such losses have been accrued in the loss estimate, net of the
reimbursement from DynCorp. The Commonwealth of Virginia has notified the
Company of its intention to solicit bids for the renewal of the services award
following June 30, 2002. The Company will submit a competitive bid; however,
there is no assurance that such bid will be accepted as the provider of services
in the future.
At the time of the merger with DMR, the Company protested what it
believed to be inadequate net working capital conveyed to them in relation to
the Company's expectations based upon financial reports received for periods
leading up to the merger date. As a result of discussions and negotiations with
DynCorp, the parent company of DMR, DynCorp reimbursed DynTek $2,600,000 for
excess accounts payable assumed in the merger. During the six months following
the merger, the results of operations under the DMR contracts assumed were
generally below profit expectations, primarily as a result of the losses from
the Virginia contract described above. Primarily as a result of such losses,
DynCorp agreed to sell back to the Company 8 million of the Class B shares
issued in connection with the merger, at a price of $0.625 per share, which is
considerably lower than the per share price established for the merger value of
approximately $2.20, and below the market price of the shares at the time of the
settlement. In connection with the buy-back of shares, DynCorp accepted a
long-term note from DynTek as payment for the shares, in the amount of $5
million. The note provides for quarterly principal payments of $200,000,
commencing in January 2004, and interest payments at a rate of 15%. Any unpaid
balance of principal and accrued interest is due in January 2007. Additionally,
the Company provided warrants for 7,500,000 shares of Class A common stock
exercisable for three years at $4.00 per share.
In March 2001, the Company purchased 25% of the equity in LaborSoft
Corporation ("LaborSoft"), a company providing labor relations software to labor
unions and commercial customers to supplement other market segment services. As
a result of its investment, the Company assigned one of its directors to become
the chairman of the board of directors of LaborSoft. The Company has a service
agreement to provide infrastructure services to LaborSoft, on a cost plus
fee-for-service basis common in the industry and can terminate services upon 30
day notification. These monthly charges are approximately $20,000/month. As of
June 30, 2002, the Company had outstanding receivables for such services in the
total amount of $502,000, representing unpaid charges since April 2001 and an
allowance reserve of $200,000. Due to the significant investment in LaborSoft,
the Company has recognized its pro-rata portion of the losses incurred by this
affiliate, since March 2001, in the amount of $320,000. Such losses have reduced
the carrying value of its investment to $136,000 at June 30, 2002.
The Company may expand the scope of its product offerings by pursuing
acquisition candidates with complementary technologies, services or products.
Should the Company commence such acquisitions, it anticipates that it would
finance the transactions with a combination of its working capital and the
issuance of additional equity securities. The Company would attempt to secure
additional funding, including equity financing where appropriate, for
acquisitions. There can be no assurance, however, that the Company will be
successful in identifying appropriate acquisition candidates or that, if
appropriate candidates are identified, that the Company will be successful in
obtaining the necessary financing to complete the acquisitions.
The Company has had recurring losses from continuing operations and
negative cash flows from operations. Such losses have been funded primarily from
16
cash received in 1998 from the sale of discontinued operations and cash received
from DynCorp in settlement of issues resulting from the DMR merger. As
additional funds are necessary, the Company would consider reducing the scope of
its operations, divesting of long-term contracts or business segments, or
seeking other forms of financing. However, additional financing may not be
available. If adequate funds are not available on acceptable terms, the Company
may not be able to sustain ongoing operations or execute its business strategy.
DynTek's consolidated financial statements have been prepared assuming that the
Company will continue as a going concern, however, the report by our independent
auditors on our financial statements for the fiscal year ended June 30, 2002
raises substantial doubt as to our ability to continue as a going concern.
Recent Accounting Standards
In July 2001 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." These standards become
effective for fiscal years beginning after December 15, 2001. The new rules
require business combinations initiated after June 30, 2002 to be accounted for
using the purchase method of accounting and goodwill acquired after June 30,
2002 will not be amortized. Under SFAS 142, the Company discontinued the
periodic amortization of goodwill effective with the adoption of the new
Statement. Also, the Company now has to test any remaining goodwill for possible
impairment within six months of adopting the Statement, and periodically
thereafter, based on new valuation criteria set forth in the Statement. Further,
the Statement has new criteria for purchase price allocation. The Statement
becomes effective in fiscal 2003, however, the Company has elected early
adoption in fiscal 2002. Based on acquisitions completed as of June 30,
2002, application of the goodwill non-amortization provisions of these rules
resulted in a reduction to expenses of approximately $430,000 for fiscal year
2002. At June 30, 2002, an analysis of the goodwill resulted in an aggregate
impairment of $4,251,000, which was charged to expense during the fiscal year
ended June 30, 2002.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-lived
Assets". SFAS 144 supercedes Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-lived Assets and Assets to be
Disposed of" and the accounting and reporting provisions of Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements",
to eliminate the exception to consolidation for a subsidiary for which control
is likely to be temporary. The provision for SFAS 144 will be effective for
fiscal years beginning after December 15, 2001. The most significant changes
made by SFAS 144 are: (1) removes goodwill from its scope and, therefore,
eliminates the requirements of SFAS 121 to allocate goodwill to long-lived
assets to be tested for impairment, and (2) describes a probability-weighted
cash flow estimation approach to deal with situations in which alternative
course of action to recover the carrying amount of long-lived assets are under
consideration or a range is estimated for the amount of possible future cash
flows. The Company has not yet determined the effect SFAS 144 will have on its
consolidated financial position or results of operations.
On April 30, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statement No. 4, 44 and 64, Amendment of FASB Statement No.13, and
Technical Corrections." The rescission of SFAS No.4, "Reporting Gains and Losses
from Extinguishments," and SFAS No.64, "Extinguishments of Debt made to Satisfy
Sinking Fund Requirements," which amended SFAS No.4, will affect income
statement classification of gains and losses from extinguishment of debt. SFAS
No.4 requires that gains and losses from extinguishment of debt be classified as
an extraordinary item, if material. Under SFAS No. 145, extinguishment of debt
is now considered a risk management strategy by the reporting enterprise and the
FASB does not believe it should be considered extraordinary under the criteria
in APB Opinion No.30, "Reporting the Results of Operations-Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," unless the debt extinguishment
meets the unusual in nature and infrequency of occurrence criteria in APB
Opinion No. 30. SFAS No. 145 will be effective for fiscal years beginning after
May 15, 2002. Upon adoption, extinguishments of debt shall be classified under
the criteria in APB Opinion No. 30.
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullified Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
17
recognized when the liability is incurred. A fundamental conclusion reached by
the FASB in this statement is that an entity's commitment to a plan, by itself,
does not create a present obligation to others that meets the definition of a
liability. SFAS No. 146 also establishes that fair value is the objective for
initial measurement of the liability. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The Company has not yet determined the
impact of SFAS No.146 on its financial position and results of operations, if
any.
Critical Accounting Policies
The Securities and Exchange Commission ("SEC") recently issued proposed guidance
for disclosure of critical accounting policies. The SEC defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effects of matters that are inherently uncertain and
may change in subsequent periods. To the extent that final SEC rules on this
subject may require disclosures in addition to those the Company already makes,
the Company intends to adopt such additional disclosure requirements once the
final rules required are adopted.
Factors That May Affect Future Results
The following factors, among others, could cause actual results to
differ materially from those contained in forward-looking statements in this
Form 10-K.
Inability to Obtain Additional Financing, if Needed, Could Limit our
Ability to Continue as a Going Concern. We have had recurring losses from
continuing operations and negative cash flows from operations. Such losses have
been funded primarily from cash received from the sales of our stock and from
debt financings, as well as cash received from the sale of discontinued
operations. We have implemented and will continue to implement cost reductions
designed to minimize such losses. However, if our existing cash balances are not
sufficient to meet our liquidity needs, support our future expansion needs and
achieve our strategic goals, we may require additional funds. If adequate funds
are not available on acceptable terms, we may not be able to sustain our ongoing
operations or execute our business strategy. The report by our independent
auditors on our financial statements for the fiscal year ended June 30, 2002
raises substantial doubt as to our ability to continue as a going concern. We
will continue to pursue a number of initiatives intended to minimize our losses,
however, we cannot assure you that we will ultimately be able to continue as a
going concern.
Inability to Comply with Terms of the Foothill Credit Agreement, to
Continue to Obtain Waivers and to Roll Over the Agreement when it becomes due.
Our financing arrangement with Foothill requires us to meet certain conditions
and financial covenants. Our ability to receive financing on our accounts
receivable and to finance our future operations or capital expenditures is
dependent upon our meeting these conditions and financial covenants. In
particular, if we do not receive at least $903,560 of cash proceeds of equity
financing by November 20, 2002, or if we extend the VA Net contract beyond June
30, 2003 or modify the contract or enter into a settlement agreement with
Virginia concerning the contract without the consent of Foothill, we will be in
default under the terms of our financing arrangement with Foothill. To date, we
have received waivers from Foothill of certain conditions and covenants,
however, we cannot guarantee that we will continue to receive such waivers in
the future. If we are in default under the Foothill arrangement and the default
is not waived, Foothill could declare all amounts outstanding thereunder,
including accrued interest, to be immediately due and payable. If this were to
occur, we may not be able to repay such debt or borrow sufficient funds to
refinance it. In addition, we may not be able to extend the agreement with
Foothill when it becomes due on March 31, 2004. Even if new financing from
Foothill or replacement financing were available, it might not be on terms that
are acceptable to us. If we are unable to repay or refinance our outstanding
debt, or borrow additional funds in the future, it would have a material adverse
effect on our business, financial condition and results of operations.
Dependence on Contracts with Government Agencies. The majority of our
revenues are derived from sales to government agencies. Such government agencies
may be subject to budget cuts or budgetary constraints or a reduction or
discontinuation of funding. A significant reduction in funds available for
government agencies to purchase professional services and related products would
have a material adverse effect on our business, financial condition and results
of operations.
18
Inability to Attract and Retain Professional Staff Necessary for
Existing and Future Projects. Our success depends in large part upon our ability
to attract, retain, train, manage and motivate skilled employees, particularly
project managers and other senior technical personnel. There is significant
competition for employees with the skills required to perform the services we
offer. In particular, qualified project managers and senior technical and
professional staff are in great demand and competition for such persons is
likely to increase. If we are unable to attract, retain and train skilled
employees, it could impair our ability to adequately manage and staff our
existing projects and to bid for or obtain new projects, which would have a
material adverse effect on our business, financial condition and results of
operations. In addition, the failure of our employees to achieve expected levels
of performance could adversely affect our business. There can be no assurance
that a sufficient number of skilled employees will continue to be available, or
that we will be successful in training, retaining and motivating current or
future employees.
Substantial Competition in the Information Technology and Consulting
Services Markets. The information technology products and related services
markets are highly competitive and are served by numerous international,
national and local firms. There can be no assurance that we will be able to
compete effectively in these markets. Market participants include systems
consulting and integration firms, including national accounting firms and
related entities, the internal information systems groups of our prospective
clients, professional services companies, hardware and application software
vendors, and divisions of large integrated technology companies and outsourcing
companies. Many of these competitors have significantly greater financial,
technical and marketing resources, generate greater revenues and have greater
name recognition than we do. In addition, there are relatively low barriers to
entry into the IT products and related services markets, and we have faced, and
expect to continue to face, additional competition from new entrants into the IT
products and related services markets.
Potential Failure to Identify, Acquire or Integrate New Acquisitions. A
component of our business strategy is to expand our presence in new or existing
markets by acquiring additional businesses. There can be no assurance that we
will be able to identify, acquire or profitably manage additional businesses or
integrate successfully any acquired businesses without substantial expense,
delay or other operational or financial problems. Acquisitions involve a number
of special risks, including the diversion of management's attention, failure to
retain key personnel, increased general and administrative expenses, client
dissatisfaction or performance problems with an acquired firm, assumption of
unknown liabilities, and other unanticipated events or circumstances. Any of
these risks could have a material adverse effect on our business, financial
condition and results of operations.
Dependence on Significant Personnel. Our success depends in large part
upon the continued services of a number of significant employees. Although we
have entered into employment agreements with certain significant employees,
these employees and other significant employees who have not entered into
employment agreements may terminate their employment at any time. The loss of
the services of any significant employee could have a material adverse effect on
our business. In addition, if one or more of our significant employees resigns
to join a competitor or to form a competing company, the loss of such personnel
and any resulting loss of existing or potential clients to any such competitor
could have a material adverse effect on our business, financial condition and
results of operations.
Inability to Gain Performance Bonds for Contracts. Some of the
contracts that we bid for require performance bonds in order to qualify as the
service provider. We may not be able to secure such bonds, which would inhibit
our ability to successfully gain certain new contract awards. In particular, the
VA NET contract requires a performance bond. This performance bond is currently
supplied by DynCorp, however, the obligation for DynCorp to provide the
performance bond on the VA NET contract expires in December 2002, at which time
DynTek is obligated to replace the performance bond. If we are unable to replace
the bond and DynCorp is unwilling to continue to provide it, we could be deemed
to be in default on this term of the agreement, and VA Net may be able to cancel
the contract. As stated above, the VA Net contract accounted for 17% of our
revenues for the year ended June 30, 2002, even though the contract was only in
existence for 6 months during the fiscal year. Accordingly, cancellation of this
contract would have a significant negative impact on our revenue.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
DYNTEK, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
Page Number
INDEPENDENT AUDITORS' REPORT 21
CONSOLIDATED BALANCE SHEETS AS OF
JUNE 30, 2002 AND 2001 22
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS) FOR THE YEARS
ENDED JUNE 30, 2002, 2001 AND 2000 23
CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
JUNE 30, 2002, 2001 AND 2000 24
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2002, 2001 AND 2000 25 - 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 27 - 43
20
INDEPENDENT AUDITORS' REPORT
To the Stockholders and
Board of Directors
DynTek, Inc.
We have audited the accompanying consolidated balance sheets of DynTek, Inc. and
Subsidiaries as of June 30, 2002 and 2001, and the related consolidated
statements of operations, comprehensive income (loss), changes in stockholders'
equity and cash flows for each of the three years in the period ended June 30,
2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of DynTek, Inc. and
Subsidiaries as of June 30, 2002 and 2001 and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2002, in conformity with accounting principles generally accepted in
the United States of America.
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed in Note 1 (b) to the
financial statements, the Company has had recurring losses from continuing
operations, negative cash flows from operations, and has a working capital
deficiency of approximately $14,000,000 at June 30, 2002, that raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also discussed in Note 1 (b). The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/S/ GRASSI & CO., P.C.
----------------------------
Grassi & Co., P.C.
Certified Public Accountants
October 11, 2002
New York, New York
21
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
-------------- ----------------
ASSETS June 30, 2002 June 30, 2001
------
-------------- ----------------
CURRENT ASSETS:
Cash (includes restricted cash of $986 and $804) $ 1,012 $ 1,309
Accounts receivable, net of allowance for doubtful accounts of $609 and 15,023 6,835
$205
Tax refund receivable 245 -
Inventories 1,008 1,617
Costs and estimated earnings in excess of billings on uncompleted contracts 3,015 -
Prepaid expenses and other assets 128 424
Note receivable - current portion 375 1,500
Other receivables, including receivable from officer of $0 and $170 779 870
-------------- ----------------
TOTAL CURRENT ASSETS 21,585 12,555
RESTRICTED CASH - 995 -
INVESTMENTS - Marketable Securities 366 846
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,844 and $2,056 1,514 669
GOODWILL 43,538 8,466
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $387 and $1,175 698 914
ACQUIRED CUSTOMER LIST, net of accumulated amortization of $3,110 and $1,351 9,979 9,459
PURCHASED SOFTWARE, net of accumulated amortization of $325 and $152 365 538
NOTES RECEIVABLE, long term, including receivable from officer of $100 1,017 -
DEPOSITS AND OTHER ASSETS 462 550
-------------- ----------------
$ 80,519 $ 33,997
============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 16,963 $ 8,821
Line of credit 6,347 2,503
Accrued expenses 4,437 3,163
Deferred revenue 4,658 1,261
Audit assessment 1,861 1,792
Notes payable 1,250 -
Capital Leases, net of long term portion 144 -
-------------- ----------------
TOTAL CURRENT LIABILITIES 35,660 17,540
-------------- ----------------
DEFERRED REVENUE - long term 995 -
LONG TERM PORTION CAPITAL LEASE 84
MINORITY INTEREST IN SUBSIDIARY - 222
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized; 1,616,397 1 1
and 2,189,800 shares issued and outstanding as of June 30, 2002 and June 30,
2001, respectively
Class A Common stock, $.0001 par value, 70,000,000 shares authorized; 2 2
23,533,692 shares and 19,470,346 shares issued and outstanding as of June
30, 2002 and June 30, 2001, respectively
Class B Common stock, $.0001 par value, 20,000,000 shares authorized;
18,336,663 shares issued and outstanding as of June 30, 2002 2
Additional paid-in capital 86,193 40,060
Accumulated other comprehensive loss (131) (954)
Accumulated deficit (42,287) (22,874)
-------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 43,780 16,235
-------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 80,519 $ 33,997
============== ================
See notes to consolidated financial statements.
22
DYNTEK, INC. AND SUBSIDIARIES
-----------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
---------------------------------------------------------------------
(in thousands, except share data)
Years Ended June 30,
----------------------------------------------
2002 2001 2000
------------- ------------ -------------
REVENUES
Product Revenues $ 31,055 $ 24,650 $ -
Service Revenues 51,986 20,260 1,962
------------- ------------ -------------
TOTAL REVENUES 83,041 44,910 1,962
------------- ------------ -------------
COST OF REVENUES
Cost of Products 26,392 20,371 -
Cost of Services (net of $5 million reimbursement in 47,572 15,121 1,373
2002)
------------- ------------ -------------
TOTAL COST OF REVENUES 73,964 35,492 1,373
------------- ------------ -------------
GROSS PROFIT 9,077 9,418 589
------------- ------------ -------------
OPERATING EXPENSES:
Selling costs 10,507 8,614 59
General and administrative expenses (exclusive of
non-cash charges for options and warrants shown 6,572 4,054 3,142
below)
Non-cash charges for options and warrants 325 721 327
Application development 492 2,945 276
Depreciation and amortization 2,934 2,747 43
Impairment of goodwill 4,251 - -
------------- ------------ -------------
TOTAL OPERATING EXPENSES 25,081 19,081 3,847
------------- ------------ -------------
LOSS FROM OPERATIONS (16,004) (9,663) (3,258)
------------- ------------ -------------
OTHER INCOME (EXPENSE)
Loss on marketable securities (1,241) (480) (1,191)
Equity interest in loss of investee (220) (100) -
Interest expense (2,582) (592) -
Interest income 294 112 433
Other income (expense), net 141 (175) (476)
------------- ------------ -------------
TOTAL OTHER EXPENSE (3,607) (1,235) (1,234)
------------- ------------ -------------
LOSS FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES (19,611) (10,898) (4,492)
INCOME TAX BENEFIT (198) (76) (545)
------------- ------------ -------------
LOSS FROM CONTINUING OPERATIONS (19,413) (10,822) (3,947)
------------- ------------ -------------
DISCONTINUED OPERATIONS
Gain (loss) from discontinued operations, net of -
applicable income taxes of $149 in 2000 59 (29)
------------- ------------ -------------
TOTAL INCOME (LOSS) FROM DISCONTINUED OPERATIONS - 59 (29)
------------- ------------ -------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $ (19,413) $ (10,763) $ (3,976)
============= ============ =============
NET LOSS PER SHARE:
Continued $ (0.67) $ (0.63) $ (0.25)
Discontinued (0.00) (0.00) (0.00)
------------- ------------ -------------
NET LOSS PER SHARE - basic and diluted $ (0.67) $ (0.63) $ (0.25)
============= ============ =============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN
COMPUTATION 29,103,092 17,168,883 15,878,749
============ ========== ============
NET LOSS $ (19,413) $ (10,763) $ (3,976)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Unrealized gain (loss) on available-for-sale securities 823 (1,918) (1,482)
------------- ------------ -------------
COMPREHENSIVE LOSS $ (18,590) $ (12,681) $ (5,458)
============= ============ =============
See notes to consolidated financial statements.
23
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
Un-realized
Gain Total
Addition (Loss) Accum- Stock-
Class A Common Class B Common Paid-In on ulated holders'
Preferred Stock Stock Stock Capital Securities Deficit Equity
---------------- ---------------- ---------------- -------- ---------- -------- -----------
Shares Amount Shares Amount Shares Amount
Balance - June 30, 1999 1,000 $ 505 15,349 $ 2 - - $ 18,797 $ 2,447 $ (8,135) $ 13,616
Shares issued upon
converting Redeemable
Series "B" Preferred
Stock (1,000) (505) 500 - 505 -
Options exercised for 65 - 85 85
cash
Shares issued in
connection with
acquisition of Big
Technologies, Inc. 380 - 1,050 1,050
Changes in unrealized
gain (loss) on
securities
available-for-sale (1,483) (1,483)
Options issued in
connection with
consulting agreements 327 327
Net Loss (3,976) (3,976)
-------- ------- ------ ------- -------- -------- ------- ------
Balance - June 30, 2000 - - 16,294 2 20,764 964 (12,111) 9,619
Shares issued in
connection with the
acquisition of Data
Systems Network
Corporation 2,190 1 130 - 12,800 12,801
Shares issued in
connection with the
exercise of employee
stock options 250 - 337 337
Shares issued in
connection with the
acquisition of Big
Technologies, Inc. 78 - 217 217
Options issued in
connection with
consulting agreements 779 779
Shares issued in 2,718 - 2,535 2,535
connection with private
offering
Shares issued in
connection with
BugSolver, Inc. private
offering 2,850 2,850
Minority interest in (222) (222)
BugSolver, Inc.
subsidiary
Changes in unrealized
gain (loss) on
securities
available-for-sale (1,918) (1,918)
Net Loss (10,763) (10,763)
-------- ------- ------ ------- ------ ---- -------- -------- ------- ------
Balance - June 30, 2001 2,190 1 19,470 2 40,060 (954) (22,874) 16,235
Shares issued in
connection with the
acquisition of DMR 18,337 2 40,339 40,341
Shares issued in
connection with the
exercise of employee
stock options 184 - 131 131
Conversion of
short-term notes to
private offering 316 4 474
Conversion of
short-term notes to
subscriptions due - - 1,089 1,563
Shares issued in
connection with private
offering 625 62 938 1,412
Cash received,
subscriptions due in
connection with private
offering 872 411
Shares due for services
rendered 58 45
Discount on short-term 591 591
notes payable
Deferred finance costs 115 115
Beneficial conversion
feature 763 763
Convert preferred stock
to common (574) - 1,433 - -
Convert shares issued
in connection with
BugSolver, Inc. private
offering 1,500 - 222 222
Shares issued in
connection with the
acquisition of Big
Technologies 78 - 216 216
Options issued for
services 325 325
Retirement of shares (72) - - -
Changes in unrealized
gain (loss) on
securities available
for sale 823 823
Net loss (19,413) (19,413)
-------- ------- ------ ------- ------ ----- -------- -------- ------- ------
Balance - June 30, 2002 1,616 $ 1 23,534 $ 2 18,337 $ 2 $ 86,193 $ (131) $(42,287) $ 43,780
======== ======= ====== ======= ====== ===== ======== ======== ======= ======
See notes to consolidated financial statements.
24
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended June 30,
----------------------------------------
2002 2001 2000
----------- --------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (19,413) $ (10,763) $ (3,976)
----------- --------- ----------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 2,720 2,037 43
Amortization of debt discount on short-term notes 591 - -
Amortization of capitalized software costs 216 473 316
Write-down of capitalized software costs - 237 266
Equity interest in loss of investee 220 100 -
Beneficial conversion feature of short-term notes 763 - -
Reserve for valuation of note receivable - 300 476
Loss (gain) on marketable securities 1,241 480 1,191
Shares issued for services 45 - -
Options and warrants issued for services 325 721 327
Impairment of goodwill 4,251 - -
Forgiveness of loan receivable from officer 70 - -
Changes in operating assets and liabilities:
Accounts receivable (871) (1,551) (303)
Interest receivable (392) - -
Interest receivable - - 25
Refund receivable (245) - (70)
Inventory 609 - -
Costs and estimated earnings in excess of billings on uncompleted (3,015) - -
contracts
Capitalized software costs - (287) (591)
Prepaid expenses 331 (606) (280)
Deferred finance costs - - -
Other notes receivable 109 - -
Deposits and other assets (132) 109 3
Accounts payable 2,419 2,836 348
Deferred revenue 3,124 67 11
State audit reserve 69 70 323
Accrued expenses 923 (1,930) 48
Income tax payable - - (628)
Accrued termination costs - - (67)
Restricted cash for over one year (995) - -
----------- --------- ----------
Total adjustments 12,376 3,056 1,438
----------- --------- ----------
NET CASH USED IN OPERATING ACTIVITIES (7,037) (7,707) (2,538)
----------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received from purchase of subsidiary 13 1,313 -
Purchase of subsidary net of cash acquired (1,110) - -
Cash proceeds from the sale of securities 62 - 519
Cash disbursements for the purchase of securities - (90) (1,255)
Capital expenditures (131) (551) (70)
Net cash paid for acquisition - (456) (150)
Collection on note receivable 600 - -
Decrease in note receivable - - (248)
----------- --------- ----------
NET CASH PROVIDED (USED IN) INVESTING ACTIVITIES (566) 216 (1,204)
----------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of related party loans - (220) -
Proceeds from debt financing 1,508 - -
Net proceeds (repayments) under bank line of credit 3,844 (664) -
Issuance of subsidiary securities, net of expenses - 2,851 -
Issuance of Common Stock, net of expenses 1,954 2,872 85
----------- --------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 7,306 4,839 85
----------- --------- ----------
NET DECREASE IN CASH (297) (2,652) (3,657)
CASH AT BEGINNING OF YEAR 1,309 3,961 7,618
----------- --------- ----------
CASH AT END OF YEAR $ 1,012 $ 1,309 $ 3,961
=========== ========= ==========
See notes to consolidated financial statements.
25
DYNTEK, INC. AND SUBSIDIARIES
- -----------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)
Years Ended June 30,
---------------------------------------
2002 2001 2000
---- ---- ----
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 690 $ 592 $ -
Cash paid for income taxes $ 47 $ - $ 314
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING
ACTIVITIES:
Convertible notes converted to common stock $ 1,563 $ - $ -
Redeemable preferred stock converted to common stock $ - $ - $ 505
Private offering of common stock $ - $ - $ -
Issuance of common stock in conjunction with acquisition of company $ 40,341 $ 517 $ 1,050
Exchange of preferred stock in conjunction with acquisition of company $ - $ 12,500 $ -
Payment of acquisition costs with common stock $ - $ 300 $ -
Accounts payable converted to note payable $ 1,250 $ - $ -
Purhase of equipment through capital lease $ 228 $ - $ -
See notes to consolidated financial statements.
26
DYNTEK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
A. Organization Summary - DynTek, Inc. ("DynTek") was
initially incorporated in Delaware on May 27, 1989 as Universal
Self Care, Inc. In January 1998 the Company changed its name to
Tadeo Holdings, Inc. In November 1999 the Company changed its name
to TekInsight, and in December 2001 the Company changed its name
to DynTek, Inc.
On December 27, 2001 the Company completed a merger with DynCorp
Management Resources (see footnote 7.)
DynTek is a professional services firm specializing in information
technology solutions and business process outsourcing for state
and local government organizations. Depending upon the context,
the term DynTek refers to either DynTek alone, or DynTek and its
active subsidiary, DynTek Services.
DynTek is the parent corporation for the following wholly owned
subsidiaries that have discontinued operations: Physicians
Support Services, Inc., a California corporation; Clinishare
Diabetes Centers, Inc. d/b/a SugarFree Centers, Inc.; and
USC-Michigan, Inc., a Michigan corporation and its wholly-owned
subsidiary, PCS, Inc.-West, a Michigan Corporation,
Bugsolver.com, Inc., a Delaware corporation.
B. Basis of Presentation - The accompanying consolidated financial
statements have been prepared assuming that the Company will
continue as a going concern. The Company has had recurring losses
from continuing operations and negative cash flows from
operations. Such losses have been funded primarily from cash
received from sales of stock and cash received in 1998 from the
sale of discontinued operations, as well as debt financings. In
addition, the Company has a working capital deficiency of
approximately $14 million at June 30, 2002. The Company has
implemented and will continue to implement cost reductions
designed to minimize such losses. If additional funds are
necessary, the Company would consider the sale of certain
long-term contracts or a part of a business segment, or would
seek other forms of financing. The recovery of assets and
continuation of future operations are dependent upon the
Company's ability to obtain additional debt or equity financing
and its ability to generate revenues sufficient to its
operations. The accompanying consolidated financial statements do
not include any adjustments that might be necessary should the
Company be unable to continue as a going concern.
C. 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.
D. Revenue Recognition - The Company licenses software to end users
under license agreements. The Company recognizes revenues in
accordance with Statement of Position 97-2 ("SOP 97-2") as
amended by Statement of Position 98-9 ("SOP 98-9"), issued by the
American Institute of Certified Accountants. Under SOP 97-2,
revenue from software licensing is recognized upon shipment of
the software provided that the fee is fixed or determinable and
that collectability of the revenue is probable. If an acceptance
period is required, revenues are recognized upon the earlier of
customer acceptance or the expiration of the acceptance period
unless some additional performance target is mandated. In the
latter case, revenue is recognized upon satisfaction of that
target, as defined in the applicable software license agreement.
SOP 98-9 amends certain aspects of 97-2 to require recognition of
revenue using the "residual method" under certain circumstances.
Revenues derived from business processing outsourcing service
engagements is recorded on the accrual basis as services are
performed. The length of the Company's contracts varies but
typically ranges from one to two years. Under contracts that
27
involve a fixed payment structure, revenues are recognized under
the percentage-of-completion method. Under this method, progress
towards completion is recognized according to estimates. This
method is used because management considers this method the most
appropriate in the circumstances.
Contract costs include all direct materials, direct labor and
other indirect costs such as, supplies and site office expenses.
General and administrative costs are charged to expense as
incurred. Provisions for estimated losses on uncompleted contracts
are made in the period in which such losses are determined.
Changes in job performance, job conditions, and estimated
profitability, including those arising from final contract
settlements, may result in revisions to costs and income, and such
changes are recognized in the period in which the revisions are
determined.
E. Property and Equipment - Property and equipment is stated at
cost and is depreciated on a straight-line basis over the
estimated useful lives of the assets. Leasehold improvements are
amortized over the term of their respective leases or service
lives of the improvements, whichever is shorter.
F. Income (loss) per Common Share - Basic earnings per share has
been calculated based upon the weighted average number of common
shares outstanding. Convertible preferred stock, options and
warrants have been excluded as common stock equivalents in the
diluted earnings per share because they are either antidilutive,
or their effect is not material. Total shares issued if
outstanding options and warrants were exercised net of repurchased
shares at the yearly average price amounts to 103,000 shares and
680,000 shares for fiscal 2002 and 2001, respectively.
G. Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that effect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.
H. Cash and Cash Equivalents - The Company considers all highly
liquid temporary cash investments with an original maturity of
three months or less when purchased, to be cash equivalents.
I. Stock Based Compensation - The Company accounts for employee stock
transactions in accordance with APB Opinion No. 25, "Accounting
For Stock Issued To Employees." The Company has adopted the
proforma disclosure requirements of Statement of Financial
Accounting Standards No. 123, "Accounting For Stock-Based
Compensation."
J. 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.
K. Goodwill and Amortization - In July 2001, the FASB issued SFAS
No. 141 "Business Combinations" and SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS 141 is effective for all business
combinations completed after June 30, 2001. SFAS 142 is effective
for fiscal years beginning after December 15, 2001. Effective
November 1, 2001, the Company elected early adoption of SFAS No.
142. SFAS No. 142 eliminates the amortization for goodwill and
other intangible assets with indefinite lives. Intangible assets
with lives restricted by contractual, legal, or other means will
continue to be amortized over their useful lives. Goodwill and
other intangible assets not subject to amortization are tested
for impairment annually or more frequently if events or changes
in circumstances indicate that the asset might be impaired. SFAS
No. 142 requires a two-step process for testing impairment.
First, the fair value of each reporting unit is compared to its
carrying value to determine whether an indication of impairment
exists. If impairment is indicated, then the implied fair value
of the reporting unit's goodwill is determined by allocating the
unit's fair value to its assets and liabilities (including any
28
unrecognized intangible assets) as if the reporting unit had been
acquired in a business combination. The amount of impairment for
goodwill and other intangible assets is measured as the excess of
its carrying value over its implied fair value. The Company
conducted the initial test of the carrying value of its existing
goodwill during the second quarter of fiscal 2002, and, as a
result, the Company concluded that there was no impairment of
goodwill at that time. At June 30, 2002, the Company conducted
its annual assessment of the carrying value of its goodwill, as
required by SFAS No. 142. Such analysis resulted in impairment of
goodwill in the aggregate amount of $4,251,000, which has been
charged to expense during the fiscal year ended June 30, 2002.
In accordance with SFAS No. 142, the Company discontinued
amortization of goodwill effective November 1, 2001. The pro
forma effects of the adoption of SFAS No. 142 on net income and
basic and diluted earnings per share are as follows:
Fiscal Years Ended June 30,
2002 2001 2000
---- ---- ----
Net loss, as reported $ (19,413) $ (10,763) $ (3,976)
Intangible amortization net of $0 tax 385 13
----------- ----------- ---------
Net loss, pro forma $ (19,413) $ (10,378) $ (3,963)
=========== =========== =========
Basic earnings per share:
Net income per share, as reported $ (0.67) $ (0.63) $ (0.25)
Intangible amortization, net of $0 tax 0.00 0.02 0.00
----------- ----------- ---------
Net income per share, pro forma $ (0.67) $ (0.60) $ (0.25)
=========== =========== =========
Diluted earnings per share:
Net income per share, as reported $ (0.67) $ (0.63) $ (0.25)
Intangible amortization, net of $0 tax 0.00 0.02 0.00
----------- ----------- ---------
Net income per share, pro forma $ (0.67) $ (0.60) $ (0.25)
=========== =========== =========
L. Comprehensive Income - Comprehensive income is comprised
of net income (loss) and all changes to the statements of
stockholders' equity, except those due to investments by
stockholders, changes in paid-in capital and distributions.
M. Inventories - Inventories consist primarily of goods in transit,
which are recorded at the lower of cost or market.
N. Advertising Costs - Costs related to advertising and
promotion of services are charged to operating expense as
incurred. Advertising expense was $206,000, $524,000 and $276,000
for the years ended June 30, 2002, 2001 and 2000, respectively.
O. Application Development - Application development costs are
direct costs associated with developing software features or
programs for sale to the Company's customers. Such costs are
charged to expense as incurred.
P. Shipping and Handling Costs - The Company accounts for shipping
and handling costs as a component of "Cost of Product Revenues."
These costs are primarily the direct freight costs related to the
"drop shipment" of products to the Company's customers. Total
cost was $258,000 in fiscal 2002 and $123,000 in fiscal 2001.
Q. New Accounting Pronouncements - In August 2001, the FASB
issued Statement of Financial Accounting Standards No. 144 ("SFAS
144"), "Accounting for the Impairment or Disposal of Long-lived
29
Assets." SFAS 144 supercedes Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-lived
Assets and Assets to be Disposed of" and the accounting and
reporting provisions of Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions." SFAS 144 also
amends Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," to eliminate the exception to consolidation
for a subsidiary for which control is likely to be temporary. The
provision for SFAS 144 will be effective for fiscal years
beginning after December 15, 2001. The most significant changes
made by SFAS 144 are: (1) removes goodwill from its scope and,
therefore, eliminates the requirements of SFAS 121 to allocate
goodwill to long-lived assets to be tested for impairment, and (2)
describes a probability-weighted cash flow estimation approach to
deal with situations in which alternative course of action to
recover the carrying amount of long-lived assets are under
consideration or a range is estimated for the amount of possible
future cash flows. The Company has not yet determined the effect
SFAS 144 will have on its consolidated financial position or
results of operations. Management's assessment is that this
Statement will not have a material impact on the Company's
financial position or results of operations.
On April 30, 2002, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 145, "Rescission of FASB Statement No. 4, 44 and 64,
Amendment of FASB Statement No.13, and Technical Corrections." The
rescission of SFAS No.4, "Reporting Gains and Losses from
Extinguishments," and SFAS No.64, "Extinguishments of Debt made to
Satisfy Sinking Fund Requirements," which amended SFAS No.4, will
affect income statement classification of gains and losses from
extinguishment of debt. SFAS No.4 requires that gains and losses
from extinguishment of debt be classified as an extraordinary
item, if material. Under SFAS No. 145, extinguishment of debt is
now considered a risk management strategy by the reporting
enterprise and the FASB does not believe it should be considered
extraordinary under the criteria in APB Opinion No.30, "Reporting
the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," unless the debt extinguishment
meets the unusual in nature and infrequency of occurrence criteria
in APB Opinion No. 30. SFAS No. 145 will be effective for fiscal
years beginning after May 15, 2002. Upon adoption, extinguishments
of debt shall be classified under the criteria in APB Opinion No.
30.
In June 2002, the FASB issued SFAS No.146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146
addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullified Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No.
146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred.
A fundamental conclusion reached by the FASB in this statement is
that an entity's commitment to a plan, by itself, does not create
a present obligation to others that meets the definition of a
liability. SFAS No. 146 also establishes that fair value is the
objective for initial measurement of the liability. The provisions
of this statement are effective for exit or disposal activities
that are initiated after December 31, 2002, with early application
encouraged. The Company has not yet determined the impact of SFAS
No.146 on its financial position and results of operations, if
any.
2. ReStricted Cash
----------------
At June 30, 2002, cash of $1,981,000 was received in connection with
maintenance agreements. Such cash is restricted and will become available to the
Company as revenue is recognized according to the terms of the respective
agreements. Of this amount, approximately $986,000 will be released during the
fiscal year ended June 30, 2003. The non-current portion, $995,000, has been
classified as a non-current asset.
30
3. ALLOWANCE FOR DOUBTFUL ACCOUNTS AND NOTE RECEIVABLE
(thousands of dollars)
Additions:
--------------------------
Balance at Charged to Charged to Balance
beginning cost and Other Deduc- at end
Accounts Receivable Reserves: of year expenses Accounts tions of year
----------------------------- ------- -------- -------- ----- -------
Year ended June 30, 2002 $ 205 $ 366 $ 38 $ $ 609
Year ended June 30, 2001 $ 124 $ - $ 170 $ 89 $ 205
Year ended June 30, 2000 $ - $ 124 $ - $ - $ 124
Note Receivable Reserve:
Year ended June 30, 2002 $ $ $ $ $
Year ended June 30, 2001 $ - $ 300 $ - $ - $ 300
Year ended June 30, 2000 $ - $ - $ - $ - $ -
During the fiscal year ended June 30, 2002, the Company assumed the net
accounts receivable of DMR (see Note 7. "BUSINESS ACQUISITIONS"). The allowance
recorded in this acquisition was $183,000.
4. PREPAID EXPENSES AND OTHER ASSETS
(thousands of dollars):
2002 2001
---- ----
Prepaid insurance $ 45 $ 23
Prepaid acquisition costs - 206
Prepaid maintenance 36 96
Prepaid bank charges 9 37
Other prepaid costs 38 62
---------- ---------
$ 128 $ 424
========== =========
5. Credit Facility
The credit agreement provides for a revolving line of credit not to
exceed $15,000,000. Borrowing limits are determined based on a collateral
formula, which includes 85% of qualified trade receivables. The available line
of credit at June 30, 2002, according to the collateral formula, was
approximately $10,907,000 of which $6,232,000 was outstanding. Also,
borrowings bear interest at 1% over Norwest Bank prime (4.75% at June 30, 2002)
with a minimum rate of 7%. The term of the agreement has been extended through
March 31, 2004 under terms similar to the current agreement. The Company has
received a waiver from Foothill, as of June 30, 2002, for non-compliance with
the financial covenants . The Company may not in be in compliance with
all of its covenants at September 30, 2002 and is in discussions with
Foothill regarding the revision of certain covenants.
6. Marketable Securities
Marketable securities have been classified as available for sale
securities at June 30, 2002 and, accordingly, the unrealized gain resulting from
valuing such securities at market value is reflected as a component of
stockholders' equity. At June 30, 2002, the unrealized loss on securities was
$131,000.
31
7. BUSINESS ACQUISITIONS
On December 27, 2001, the Company acquired all of the outstanding
capital stock of DynCorp Management Resources ("DMR"), from DynCorp, Inc.
(DynCorp). DMR provides professional services to state and local government
markets with primary focus on Information Technology and Business Process
Outsourcing services. Initial merger consideration consisted of 18,336,663
shares of new Class B Common Stock, equal to two-thirds of the previously
outstanding shares of Common Stock and two-thirds of all shares of the Common
Stock issuable upon conversion, redemption or exchange of any outstanding shares
of Preferred Stock of the Company or any of its subsidiaries. The Class B
shareholders have the right to separately elect Class B directors that represent
the number of Class B shares outstanding in relation to the total number of
Class A and Class B shares outstanding (initially three directors). The Company
by-laws were amended to provide for supermajority voting rights (80% of the
directors) on certain matters, so that the Class B directors must vote for such
matters in order to be approved by the board. Supermajority matters include
approval of mergers, share issuances, asset sales and the incurring of
indebtedness. As of June 30, 2002 DynCorp owned approximately 40% of the
outstanding shares of the Company's Common Stock plus the number of the
Company's shares of Preferred Stock, as if converted to Common Stock, and had
the right to elect 40% of the members of the Board of Directors. See Note 18,
"Subsequent Events" for information on DynCorp's continued investment in DynTek.
In connection with this acquisition, the Company assumed numerous
ongoing customer relationships, representing the majority of its revenues.
In the acquisition, the Company recorded $40,827,000 in total goodwill and
intangible assets allocated as follows: $38,727,000 in goodwill, which will be
tested for impairment of value on a periodic basis, and $2,100,000 in
capitalized customer contracts amortized over 5 years. Property and equipment
were evaluated for adjustments to fair value, and generally were recorded at its
carrying value as acquired, which were considered to approximate fair value.
At the time of the merger with DMR, the Company protested what it believed to be
inadequate net working capital conveyed to them in relation to the Company's
expectations based upon financial reports received for periods leading up to the
merger date. As a result of discussions and negotiations with DynCorp, the
parent company of DMR, DynCorp reimbursed DynTek $2,600,000 for excess accounts
payable assumed in the merger. Such reimbursement has been treated as a
reduction in the accounts payable assumed in the merger.
On August 22, 2002, DynTek completed a stock purchase and settlement
agreement with DynCorp regarding DynCorp's investment in DynTek equity
securities (see Note 22, "Subsequent Event").
A summary of the business assets acquired is as follows:
(Amounts in thousands)
Consideration paid:
Stock issued $ 40,341
Acquisition costs 1,110
Liabilities assumed 8,066
----------------
Total consideration $ 49,517
================
Assets acquired:
Cash $ 13
Accounts receivable, net 7,317
Prepaid expenses, deposits and other assets 29
Deferred costs 58
Property and equipment 1,273
Customer list 2,100
Goodwill 38,727
----------------
Fair value of assets acquired $ 49,517
================
32
Proforma combined operating results, assuming a combination at July 1,
are as follows:
Years ended June 30,
2002 2001
---- ----
Revenue $ 110,577 $ 72,615
================= ================
Net loss $ (32,940) $ (12,329)
================= ================
Net loss per share $ (1.13) $ (0.72)
================= ================
Weighted average shares outstanding 17,168,883
29,103,092
================= ================
In February 2002, the Company purchased the assets of Exodus
Communications, Inc. ("Exodus") for $175,000, including an assignment to the
Company of the Exodus subsidiary's contracts with its existing customers. Prior
to the purchase, the Company had provided services to Exodus under two service
agreements. Under one of the agreements, the Company collected accounts
receivable on behalf of the Exodus subsidiary on a collection fee basis. The
second agreement provided for the Company to maintain the ongoing operations of
the Exodus subsidiary, with a contingent fee being earned upon the collection of
receivables generated from the Company's providing services to existing
customers under the current terms of their agreements. Under the purchase
agreement and the service agreements, the Company is obligated to pay a net
amount of approximately $242,000 as of June 30, 2002.
8. NOTE RECEIVABLE
As a result of a prior transaction with Azurel, Ltd., DynTek assumed a
$1.8 million subordinated note made by Private Label Cosmetics, Inc. (PLC) and
Fashion Laboratories, Inc, which had been reduced to a net realizable value of
$1.5 million, since the note was provided as collateral for a loan in this
amount. The note became due on May 23, 2002. Prior to the maturity date, DynTek
and PLC agreed to payment terms to satisfy the balloon payment due. Under the
revised terms, PLC paid DynTek $600,000 and conveyed a promissory note for
$1,292,000, payable in 48 monthly installments and bearing interest at 7.5% per
annum. The note is secured by 342 shares of the common stock of PLC, which will
be progressively released from escrow on a quarterly basis provided that the
monthly payments are received on a timely basis.
9. PROPERTY AND EQUIPMENT
----------------------
Furniture, fixtures and equipment are as follows (in thousands of
dollars):
June 30,
----------------------------------
2002 2001
---- ----
Property and equipment $ 916 $ 805
Computer software 9 9
Computer equipment 3,391 1,869
Machinery and equipment 3 3
Leasehold improvements 39 39
------------ ------------
4,358 2,725
Less: accumulated depreciation (2,844) (2,056)
------------ ------------
$ 1,514 $ 669
============ ============
10. OTHER RECEIVABLES
In June 1999, DynTek recorded a receivable in the amount of $500,000 in
connection with a transaction with StyleSite Marketing ("Style"). Such
receivable was guaranteed by a third party. On August 20, 2002, the receivable
was satisfied by the transfer, from the third party to DynTek, of 300,000 shares
of DynTek common stock and 125,000 shares of MedEmerg common stock. See Note 21.
LEGAL MATTERS - Miletich Derivative Action.
In connection with an employment agreement, the Company provided a loan
to its chief executive officer in the amount of $170,000. The loan is secured by
the value of the executive's stock options and equity holdings in the Company.
In January, 2002, $70,000 of the note was forgiven by the company as a bonus to
the executive. The Company has provided loans to other employees in the
aggregate amount of $35,000, with various payment terms. In connection with a
settlement agreement, the Company has recorded a note receivable in the amount
of $100,000 of which $50,000 plus interest was paid in January 2002 and the
remaining $50,000 is outstanding and payable in January 2003.
11. NOTES PAYABLE
In June 2002, the Company negotiated a settlement with a subcontractor
for outstanding payments due. As payment in full for outstanding accounts
payable from services rendered, the Company provided a note payable of $250,000
and arranged for DynCorp to pay the subcontractor $1 million on the Company's
behalf, as a short-term advance to the Company. The promissory note to the
subcontractor for $250,000 bears interest at 8% per annum and is payable over
three years in twelve (12) equal quarterly installments of $23,640. The interim
advance from DynCorp was payable in its entirety on or before December 31, 2002.
The advance from DynCorp was repaid as a part of the settlement agreement with
DynCorp in August 2002. See note 22. Subsequent Event.
On September 27, 2001 and November 1, 2001, the Company issued
$1,807,000 aggregate principal of convertible notes. $750,000 principal of such
notes bear interest at 12% per annum during a term of 180 days and $1,057,500
principal of such notes bear interest at 8% per annum for a term of 90 days.
Since the Company granted conversion rights to the investors at prices below the
quoted market prices for the stock, the Company has recorded an expense, in the
aggregate amount of $763,000, in connection with these notes. The Company has
amortized a debt discount, in connection with these notes, in the aggregate
amount of $591,000, which is included in interest expense. During the quarter
ended June 30, 2002, $300,000 of such notes was repaid and the balance due, of
principal and accrued expense, was converted into a common stock offering by the
Company. See note 15. J. Stockholders' Equity.
12. CONCENTRATION OF RISK
a. The Company maintains cash balances at a financial institution which
are insured by Federal Deposit Insurance Corporation up to $100,000.
The Company's cash balances exceeded such insured limits at certain
times during the fiscal year.
b. The concentration of credit risk in the Company's accounts receivable,
with respect to state and local government customers, is mitigated by
the Company's credit evaluation process, credit limits, monitoring
procedures and reasonably short collection terms. Credit losses have
been within management's expectations and the Company does not require
collateral to support accounts receivable.
c. Customers are primarily agencies of state governments and
municipalities with large-volume information and technology needs, or
the primary vendors to those governments and agencies. Among the
information technology customers, the State of New York and its
agencies comprised approximately 21% of the Company's revenues for the
fiscal year ended June 30, 2002 and approximately 30% of revenues for
the fiscal year ended June 30, 2001. The Company sells products and
services to the State of New York and its agencies as an authorized
vendor to provide system peripheral equipment to New York state
agencies. The Company is also an authorized reseller of Novell, Nortel
Systems and Cisco products and software to the State of New York. The
State of Louisiana and its agencies accounted for approximately 7% of
34
revenues for the fiscal year ended June 30, 2002 and approximately 13%
of revenues for the fiscal year ended June 30, 2001. Louisiana awarded
a renewable one-year contract in July 1996 to provide network service,
help desk support and maintenance support to multiple state agencies.
The contract expired in June 2001 and the State provided temporary
extensions until August 30, 2002, when the contract was awarded to
another company.
Among the Company's business process outsourcing customers, the
Commonwealth of Virginia Non Emergency Transportation contract, which
was acquired with the DMR merger, comprised approximately 24% of
revenues for the six months (period under management) ended June 30,
2002 and 23% of the Company's total accounts receivable. There were no
revenues in the prior fiscal year ended June 30, 2001, since the
contract was not under the Company's management during that period.
This contract may include options for renewal, based upon mutual
consent of the parties, for up to four successive one-year periods. The
contract provides for services to be delivered on a fixed-fee basis.
The State of Connecticut Non Emergency Transportation contract
comprised approximately 12% of the Company's revenue for the six months
(period under management) ended June 30, 2002.
No other single customer or state accounted for more than 10% of
revenue during fiscal 2002. Generally, products and services are
purchased by individual state agencies issuing their own purchase
orders under master contract agreements between the Company and the
State through which the agency gets the authority to issue a valid
purchase order.
D. Company sales of products manufactured by three hardware manufacturers
accounted for approximately 49% of the product revenues in the
information technologies segment during the last fiscal year (18% of
total revenue during the last fiscal year). Typically, vendor
agreements provide that the Company have been appointed, on a
non-exclusive basis, as an authorized reseller of specified products at
specified locations. The agreements generally are terminable on 30 to
90 days' notice or immediately upon the occurrence of certain events,
and are subject to periodic renewal.
13. AUDIT ASSESSMENT
In a matter relating to a prior business of the Company, divested in 1998,
one of the Company's discontinued wholly owned subsidiaries was issued a Letter
of Demand for $1.3 million, as a result of an audit by the California State
Controller's Office, Division of Audits. Additionally, accrued interest on the
amount demanded was also sought. On January 20, 1999, the Superior Court
recommended that the Demand be upheld. On January 26, 2000, the California Court
of Appeals upheld the Demand. The Company has provided a reserve for the
principal amount of $1,340,000 plus $521,000 in accrued interest, or $1,861,000
in total as of June 30, 2002. The Company has decided not to appeal the
decisions. The California State Controller's Office has not taken legal action
to obtain a judgment against the Company in order to collect this obligation.
14. INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes ("SFAS No. 109"). SFAS
No. 109 requires the recognition of deferred tax assets and liabilities for both
the expected impact of differences between the financial statements and tax
basis of assets and liabilities, and for the expected future tax benefit to be
derived from tax loss and tax credit carry forwards. SFAS No. 109 additionally
requires the establishment of a valuation allowance to reflect the likelihood of
realization of deferred tax assets.
35
Deferred tax assets and liabilities at June 30, consist of the following:
(amounts in thousands)
2002 2001 2000
---- ---- ----
Deferred tax assets:
Nol operating loss carry forwards $ 16,660 $ $ -
9,431
Allowance for doubtful accounts 207 70 -
Unrealized loss on investments 45 324 506
Depreciation 200 192 -
Allowance on note receivable - 102 162
Accrued settlement reserve - - 108
Accrued vacation 215 141 -
Capital loss carryforward - 336 -
Other - - 125
------------- ------------- -------------
17,327 10,596 900
Deferred tax liabilities
Amortization (244) (311) -
Less valuation allowance (17,083) (10,285) (900)
------------- ------------- -------------
$ - $ - $ -
============= ============= =============
The benefit for income taxes from continuing operations differs from
the amount computed applying the statutory federal income tax rate to loss
before income taxes as follows:
In 000's Year ended June 30,
-------------------------------------------------------
2002 2001 2000
-------------- --------------- ----------------
Income tax benefit computed at statutory rate $ (6,600) $ 3,660 $ 1,528
Income tax benefit not recognized $ (6,402) $ (3,584) $ (983)
-------------- --------------- ----------------
Income tax benefit $ 198 $ 76 $ 545
============== =============== ================
The Company has net operating losses of approximately $49,000,000, of which
approximately $30,000,000 is subject to limitations under Section 382 of the
Internal Revenue Code. The net operating loss carryforwards expire in 2009-2019.
15. STOCKHOLDERS' EQUITY
A. Preferred Stock - The Certificate of Incorporation of the
Company authorizes the issuance of a maximum of 10,000,000 shares
of preferred stock. The Company's Board of Directors is vested
with the authority to divide the class of preferred shares into
series and to fix and determine the relative rights and
preferences of shares of any such series to the extent permitted
by the laws of the State of Delaware and the Articles of
Incorporation.
B. In connection with its December 1992 public offering, the
Company has 1,143,800 Class A warrants outstanding to purchase
Common Stock at $3.30 per share, which originally expired on
December 17, 2000. On December 6, 2000, such warrants were
extended, at a price of $2.00 per share, until December 11, 2005.
C. On February 15, 2000, the Company issued two warrants
execrable through February 15, 2005 to acquire an aggregate of
300,000 shares of our Class A common stock at $4.0625 per share as
a part of the compensation granted to Early Bird Capital, an
investment banking firm, in connection with a consulting
agreement.
36
D. On June 1, 2000, the Company granted 100,000 options to Core
Strategies, at $3.00 per share, as consideration for services
rendered.
E. On June 1, 2000, the Company granted 120,000 options to the Exigo
Group, at $3.00 per share, as consideration for services
rendered.
F. In August 2000, the Company issued 2,185,755 shares of Series A
Convertible Preferred Stock in connection with the acquisition of
Data Systems. On August 14, 2002, such shares became convertible
into the Company's Class A Common Stock at a ration of one share
of preferred stock for 2.5 shares of common stock. During the
fiscal year ended June 30, 2002, approximately 574,000 shares of
Class A Preferred Stock were converted into approximately
1,433,000 shares of Class A Common Stock.
G. In September 2000, the Company issued 129,730 shares of our Class
A common stock to Amtech Associates, Inc. in consideration for a
finders fee/consultation services rendered to Data Systems in
connection with the merger with Data Systems.
H. On September 30, 2000, the Company received an equity investment
of $3,000,000 for 1,000,000 shares of preferred stock issued by a
subsidiary. In July 2002, such shares were converted into
1,500,000 shares of DynTek common stock, in accordance with the
terms of the agreement. In connection with this financing, a
finder's fee of $150,000 was paid to a related party. In July
2001, the shares were converted into 1,500,000 shares of Class A
common stock, in accordance with the terms of the agreement.
I. In March 2001, the Company sold 2,718,550 shares of its common
stock for $1.00 per share. In connection with these placements,
the Company paid to a related party a fee of 7% in cash, and
issued options to purchase 271,855 shares of its common stock,
under the 1992 Stock Option Plan.
J. During the fiscal year ended June 30, 2001, the Company issued
121,500 options to accredited investors for services rendered, at
exercise prices between $0.59 and $2.22.
K. On November 1, 2001, the Company issued an aggregate of
$1,057,000 in principal of short-term notes payable that bear
interest at 12% per annum during a term of 90 days and an
aggregate of $750,000 in principal of short-term notes payable
that bear interest at 8% per annum during a term of 180 days. In
connection with the acquisition of these notes, the investors
received a warrant to acquire one-third of a share of Class A
common stock for each dollar of note principal, bearing exercise
prices of $1.50 and $1.70 per share and are exercisable for three
years. The notes were convertible to shares of the Company's
Class A common stock at a price of $1.50 per share. During the
quarter ended March 31, 2002, the Company repaid $300,000 of such
notes and the balance of the principal and accrued interest was
converted into 1,042,039 shares of the offering in June 2002,
mentioned below. Of this amount, 315,889 shares were issued in
June 2002 and 726,150 shares were issued in July 2002.
L. In June 2002, the Company sold 1,389,293 shares of Common Stock
for $1.50 per share to accredited investors, and issued warrants
to purchase 1,215,666 shares of Common Stock for $1.50 per share.
At June 30, 2002, 625,266 of the share certificates had been
issued and during July 2002 the remaining 764,027 share
certificates were issued. In connection with these sales, the
Company paid to a related party a fee of $262,000.
M. During the fiscal year ended June 30, 2002, the Company
issued 229,000 options to accredited investors for services
rendered, at exercise prices between $2.00 and $2.28.
16. STOCK OPTION AND EMPLOYEE BENEFIT PLANS
A. The 1992 Employee Stock Option Plan was adopted by the
Board of Directors in 1992 and 500,000 shares of common stock were
initially reserved for issuance upon the exercise of options
granted pursuant to the plan. Options granted under the 1992 plan
37
may be either incentive options within the meaning of Section 422
of the Internal Revenue Service Code of 1986, non-qualified
options, or options not intended to be incentive options.
The 1992 plan provides for the grant of options that are intended
to qualify as incentive stock options, or ISOs, under Section 422
of the Internal Revenue Code to employees of the Company, as well
as the grant of non-qualifying options, or NSOs, to officers,
directors or key employees of DynTek or other individuals whose
participation in the 1992 plan is determined to be in the best
interest of DynTek by the compensation committee. In August 2000,
Directors and Shareholders approved an increase in the number of
shares authorized for issuance upon exercise of options granted
pursuant to the Plan from 500,000 to 2,000,000. As of June 30,
2002, 1,999,521 shares were subject to options granted under the
plan, net of forfeitures.
B. In November 1997, the Company established the 1997 Stock
Option Plan for Non-employee Directors, which authorizes the
issuance of options to purchase up to 300,000 shares of Common
Stock at an exercise price of 100% of the Common Stock's market
price. Subsequent to its adoption at the annual meeting in
February 1998, options to purchase 170,000 shares of Common Stock
have been issued under the 1997 plan at prices between $0.97 and
$3.78.
C. The 2001 Employee Stock Option Plan was adopted by the
Board of Directors in 2001 and 2,000,000 shares of common stock
were initially reserved for issuance upon the exercise of options
granted pursuant to the plan. Options granted under the 2001 plan
may be either incentive options within the meaning of Section 422
of the Internal Revenue Service Code of 1986, non-qualified
options, or options not intended to be incentive options.
The 2001 plan provides for the grant of options that are intended
to qualify as incentive stock options, or ISOs, under Section 422
of the Internal Revenue Code to employees of the Company, as well
as the grant of non-qualifying options, or NSOs, to officers,
directors or key employees of DynTek or other individuals whose
participation in the 2001 plan is determined to be in the best
interest of DynTek by the compensation committee. As of June
30, 2002, 879,000 shares were subject to options granted under the
plan, net of forfeitures.
D. In connection with a merger, on August 14, 2000, the
Company assumed the existing Data Systems Network Corp Stock
Option Plan. Options granted under the Plan were either incentive
options within the meaning of Section 422 of the Internal Revenue
Service Code of 1986, non-qualified options, or options not
intended to be incentive options. Following the assumption of the
Plan, no further options have been granted under the Plan.
E. DynTek maintains a defined contribution 401(k) plan that
covers substantially all employees. Contributions to the Plan may
be made by DynTek (which are discretionary) or by plan
participants through elective salary reductions. During the fiscal
year ended June 30, 2002, contribution expense was $150,000. No
contributions were made to the plan by DynTek during the fiscal
years ended June 30, 2001 and 2000.
17. ACCOUNTING FOR STOCK OPTIONS
The Company accounts for stock options issued to employees under APB
Opinion No. 25, "Accounting for Stock Issued to Employees," under which no
compensation expense is recognized if the exercise price equals the stock market
value on the measurement date (generally the grant date). The Company has
adopted the pro forma disclosure requirements of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation."
For disclosure purposes, the fair value of each option is measured at
the grant date using the Black-Scholes option-pricing model with the following
weighted average assumptions used for stock options granted during the fiscal
years ended June 30, 2002, 2001 and 2000, respectively; annual dividends of
$0.00 for all years; expected volatility of 53% for the fiscal year ended June
30, 2002, 208% for the fiscal year ended June 30, 2001, and 136% for the fiscal
38
year ended June 30, 2000; risk free interest rate of 3.7% for the fiscal year
ended June 30, 2002, 5.3% for the fiscal year ended June 30, 2001 and 6.3% for
the fiscal year ended June 30, 2000, and expected life of five years for all
fiscal years.
If the Company had recognized compensation cost in accordance with SFAS
No. 123, the Company's pro forma net loss and loss per share would have been $20
million and $.67 for the fiscal year ended June 30, 2002, $12 million and $.70
for the fiscal year ended June 30, 2001, and $4.6 million and $.29 for the
fiscal year ended June 30, 2000.
During the fiscal year ended June 30, 2002, 229,000 warrants were
issued in connection with services rendered to the Company, all of which were
vested. The Company recorded expense for the value of these options in the total
amount of $325,000. The Company also recognized expenses during the fiscal years
ended June 30, 2001 and June 30, 2000, resulting from options granted for
services, in the amount of $721,000 and $327,000 respectively.
The following table summarizes the changes in options and warrants
outstanding and the related exercise prices for the shares of the Company's
Common Stock:
Stock options under Plans Other Options and Warrants
------------------------------------------------ -------------------------------------------
Weighted Weighted
Weighted Average Average
Average Remaining Remaining
Exercise Contractual Contractual
Life Life
Shares Price (years) Exerciseable Shares Price (years) Exerciseable
------ ----- ------- ------------ ------ ----- ------- ------------
Outstanding at June 30, 1999 167,000 1.61 4.1 167,000 1,996,667 1.69 3.9 1,996,667
==== ======== ==== =========
Granted 32,500 3.66 1,087,500 3.39
Canceled
Exercised
----------- -----------
Outstanding at June 30, 2000 199,500 1.94 3.2 197,000 3,084,167 2.29 3.1 3,084,167
==== ======== ==== =========
Granted 2,023,521 1.39 144,000 1.12
Canceled (56,500) 1.25 (754,167) 2.58
Exercised (250,000) 1.35
Assumed Data Systems Plan 468,730 2.78
----------- -----------
Outstanding at June 30, 2001 2,635,251 1.60 7.7 1,510,522 2,224,000 2.22 2.6 2,201,500
==== ========== ==== =========
Granted 963,000 2.06 1,259,225 1.61
Canceled (67,116) 1.77 (839,389) 2.27
Exercised (109,139) 0.97 (74,711) 0.94
----------- -----------
Outstanding at June 30, 2002 3,421,996 1.81 5.6 2,221,377 2,569,125 1.94 2.8 2,364,125
---------- ==== ========== ---------- ==== =========
18. BUSINESS SEGMENTS
-----------------
DynTek's operations for the fiscal year 2002 are organized along its
product lines and include two segments - Business Process Outsource Services and
Network Services segments. The Network Service segment provides a range of
specialized IT infrastructure services: system architectural design, legacy
systems integration, network engineering, applications development, network
security services, help desk support and operational support, primarily to state
and local government entities. In conjunction with these service offerings, it
also sells hardware and software to its customers. Operations are distributed
primarily among seven states (including the principal executive office),
California, Florida, Louisiana, Massachusetts, Michigan, Texas, and New York,
with employees situated in locations that are convenient to client sites.
The Business Process Outsourcing segment contracts outsourced program
operations for state government agencies in several areas including the
privatization of child support enforcement services, the arrangement of
non-emergency medical transportation for eligible Medicaid, general relief and
welfare recipients and other consulting expertise to state and local governments
interested in designing and evaluating outsourced operations. Our business
process outsourcing customers have included various governmental departments in
the states of Connecticut, Arkansas, Virginia, Illinois, North Carolina, Kansas
and Nebraska. Typically these contracts are for multi-year periods of
39
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. The Commonwealth of Virginia and State
of Connecticut non-emergency transportation contracts account for 51% and 26% of
the revenue for this segment respectively.
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 segment
was acquired as a unit, management has retained separate reporting and review
criteria for that unit. The following table provides actual selected financial
data for our business segments (in thousands):
Reportable Business Segments
---------------------------------------------------
Business
Process Network
Outsourcing Services Total
Fiscal year ended June 30, 2002 ------------- ---------- ---------
Sales to external customers 27,915 55,126 83,041
Depreciation and amortization expense 73 2,861 2,934
Operating Income (loss) (3,470) (15,943) (19,413)
Net interest expense (income) 7 2,281 2,288
Total assets 47,738 32,781 80,519
Capital expenditures 56 75 131
During fiscal 2001 and 2000, the Company did not have segment
reporting, since the only business segment was Network Services.
19. COMMITMENTS, CONTINGENCIES, AND OTHER AGREEMENTS
------------------------------------------------
The Company is obligated under five non-cancelable leases for aggregate base
annual rent of approximately $355,000 (Michigan), $190,752 (California),
$164,000 (Louisiana) and $163,000 (New York City) through March 2003, August
2005, May 2006 and November 2002, respectively. A portion of one of the Michigan
locations has been subleased for aggregate rent of $72,000 annually, plus an
allocation of 42.5% of common area expenses. The Company also leases, under
non-cancelable leases, 5 separate direct sales offices and 18 other commercial
facilities containing an aggregate of approximately 102,000 square feet under
leases with terms ranging from month-to-month to five years. Total rent expense
for the fiscal years ended June 30, 2002, 2001 and 2000 was $1,534,000, $705,000
and $93,000 respectively. At June 30, 2002, minimum rental commitments under
noncancellable operating leases are as follows:
Fiscal Year Amount
----------- --------
2003 1,241
2004 742
2005 691
2006 395
-------
$ 3,068
As a result of the merger with Data Systems, the Company assumed the
liability for a potential enforcement action undertaken by the SEC. The SEC
staff has advised Data Systems orally that following its merger with DynTek
Services, resulting in Data Systems no longer having any public shareholders,
the SEC staff would make no recommendation for any enforcement proceedings
against Data Systems.
40
On July 28, 2000, a judgment was entered against Data Systems in favor
of J. Alan Moore in Mecklenburg County Superior Court Division, North Carolina.
The plaintiff was awarded a judgment of $572,000 plus reasonable attorney fees
and interest, and the award was affirmed on appeal. An accrual has been
established in an aggregate amount of approximately $700,000. The Company is in
negotiations with the plaintiff regarding settlement terms.
The Company was issued a Letter of Demand for $1.8 million. See Note 13.
AUDIT ASSESSMENT.
20. RELATED PARTY TRANSACTIONS
--------------------------
In March 2001, the Company purchased 25% of the equity in LaborSoft
Corporation ("LaborSoft"), a company providing labor relations software to labor
unions and commercial customers to supplement other market segment services. As
a result of its investment, the Company assigned one of its directors to become
the chairman of the board of directors of LaborSoft. The Company has a service
agreement to provide infrastructure services to LaborSoft, on a cost plus
fee-for-service basis which is common in the industry and can terminate services
upon 30 day notification. These monthly charges are approximately $20,000/month.
As of June 30, 2002, the Company had outstanding receivables for such services
in the total amount of $502,000, representing unpaid charges since April 2001
and an allowance reserve of $200,000. The Company accounts for its investment
under the equity method of accounting, and has therefore recognized its pro-rata
portion of the losses incurred by this affiliate, since March 2001, in the
amount of $320,000. Such losses have reduced the carrying value of its
investment to $136,000 at June 30, 2002.
21. LEGAL MATTERS
-------------
MILETICH DERIVATIVE ACTION
On July 10, 2000, the Company was named as a nominal defendant in a
stockholder's derivative action brought in the Supreme Court of New York, New
York County, on behalf of DynTek by Paul Miletich. On August 20, 2002, a final
order approving settlement and dismissing action by Paul Miletich was filed in
the New York County Clerk's Office. The settlement approved a stipulation that
The Rubin Family Trust transfer to DynTek 300,000 shares of DynTek common stock
and 125,000 shares of MedEmerg common stock, as full settlement of a guarantee
provided by Mr. Rubin pertaining to a transaction with StyleSite Marketing.
Additionally, the insurance underwriters for DynTek paid the Company $300,000 on
behalf of the director defendants. DynTek reimbursed plaintiff's counsel for
fees and expenses of $330,000, of which 20% was paid in MedEmerg stock (80,488
shares). The shares of DynTek common stock received were retired and the
remaining shares of MedEmerg common stock are being held as marketable
securities. No gain or loss was recorded in connection with the settlement.
COMPUTER ASSOCIATES
On January 29, 2002, the Company was named as a third-party defendant
in a matter initially between Computer Associates International, Inc. (CA) and
the City of Boston (COB), in United States District Court, District of
Massachusetts (Case Number 01-10566-EFH). CA had filed suit against COB alleging
that COB breached a contract with CA, infringed on copyrights of CA, and engaged
in tortuous behavior in its dealings with CA. The Company was subsequently
joined as a defendant because it was the authorized reseller for CA and supplied
various CA software programs and services to COB on behalf of CA. To the extent
that CA may have sustained damages, a demand for indemnification from the
Company has been made by COB. The complaint demands relief from judgment in the
amount of $600,000 plus other costs, which is the initial contract amount. CA
has additionally commenced a claim against COB for breach of copyright and the
balance due under a multi-phase purchase agreement. While a specific claim for
damages has not been asserted, the total multi-phase contract was in an amount
of approximately $2 million. Settlement discussions are currently undertaken by
CA and COB. Company management believes that COB will not prevail with an
indemnification claim against the Company and that the matter will be resolved
between CA and COB through a mutual settlement. However, there is no assurance
that the settlement will be reached or that indemnification claims will not be
asserted against the Company.
41
STRIDE & ASSOCIATES
On March 20, 2002, two actions were commenced against the Company by
Stride & Associates (Stride) in Civil Court of New York, regarding the alleged
breach of two contracts in the aggregate amount of $40,000, for amounts due this
placement firm from the alleged hiring of two consultants by the Company.
Additionally, the two consultants have commenced separate actions in the Civil
Court of New York for compensation due in the aggregate amount of $53,000. We
believe that neither of these consultants was hired by the Company, and that the
actions by Stride are without merit. Additionally, the work performed by the
consultants pertained to a project undertaken by the Company's former Chief
Technology Officer, which was separate from any projects undertaken by the
Company. The Company believes that, to the extent that any damages may be
awarded, the costs shall be indemnified by the former Chief Technology Officer.
LIFELINE AMBULANCE SERVICES, INC.
On September 16, 2002 a Notice and Motion for Judgment was filed in the
Circuit Court of Pulaski County, Virginia alleging non-payment for
transportation services alleged to have been provided in support of the Virginia
Non-Emergency Transportation contract and alleged to have been valued in excess
of $516,000. The Company believes that this claim is without merit in that it
did not request or authorize the services upon which the claim is based and that
the fair value was paid for all services requested from Lifeline Ambulance
Services.
OTHER MATTERS
As a result of the merger with Data Systems, the Company assumed the
liability for any potential enforcement action which could be taken against the
Company by the Securities and Exchange Commission, or the SEC. The SEC staff has
advised Data Systems orally that they would make no recommendation for any
enforcement proceedings against Data Systems following its merger with DynTek
Services.
On July 28, 2000, a judgment was entered against Data Systems in favor
of J. Alan Moore in Mecklenburg County Superior Court Division, North Carolina.
The plaintiff was awarded a judgment of $572,000 plus reasonable attorney fees
and interest. While the Company has appealed this decision, accruals for this
contingency have been established in an aggregate amount of approximately
$700,000. The Company is in negotiations with the plaintiff regarding settlement
terms.
22. SUBSEQUENT EVENT
----------------
On August 20, 2002, DynTek, Inc. ("DynTek") entered into a Stock
Purchase and Settlement Agreement with DynCorp (the "Settlement Agreement"), its
principal stockholder, pursuant to which each of DynTek and DynCorp agreed to
settle all disputes between them, including those resulting from DynTek's
acquisition by merger of DynCorp's former wholly-owned subsidiary, DynCorp
Management Resources, Inc., in December 2001 (the "Merger"). As part of the
Settlement Agreement, DynCorp sold to DynTek 8,000,000 shares of DynTek Class B
common stock at a price of $.625 per share, converted its remaining 10,336,663
shares of Class B common stock (constituting the balance of all outstanding
Class B common stock) to DynTek Class A common stock, paid to DynTek $5 million
to defray losses incurred by DynTek from its operations under the terms of a
contract with the Commonwealth of Virginia acquired by DynTek in connection with
the Merger, and provided a general release to DynTek and its affiliates from any
and all claims that it might have against such persons. Such reimbursement of $5
million has been treated as an offset to costs incurred under the Virginia
contract during the fiscal year ended June 30, 2002. Under the Settlement
Agreement, DynTek agreed to pay for the Class B common stock shares acquired
from DynCorp with a $5 million principal unsecured, subordinated note maturing
on January 2, 2007, bearing interest at 15%. DynTek also agreed to issue to
DynCorp warrants to acquire 7,500,000 shares of Class A common stock exercisable
for three years at $4.00 per share (the "Warrants"), grant demand registration
rights with respect to the Warrants and DynCorp's Class A common stock shares
(including those to be acquired upon Warrant exercise), and provide a general
release to DynCorp and its affiliates from any and all claims that it might have
against such persons.
42
23. UNAUDITED QUARTERLY DATA
Selected Quarterly Financial Data
(Dollars in thousands, except per share data)
Sep.30 Dec.31 Mar.31 Jun.30 Sep.30 Dec.31 Mar.31 Jun.30
2000 2000 2001 2001 2001 2001 2002 2002
---- ---- ---- ---- ---- ---- ---- ----
Revenue $ 8,147 $ 10,705 $ 12,728 $ 13,330 $ 11,586 $ 12,229 $ 28,115 $ 31,111
Gross Profit $ 1,852 $ 2,369 $ 2,453 $ 2,745 $ 2,437 $ 2,708 $ 785 $ 3,147
Net loss $ (2,127) $ (2,049) $ (2,390) $ (4,197) $ (1,653) $ (4,081) $ (5,590) $ (8,089)
Basic and
diluted loss
per share $ (0.13) $ (0.12) $ (0.14) $ (0.24) $ (0.08) $ (0.18) $ (0.18) $ (0.28)
43
ITEM 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
PART III
Item 10. Directors and Executive Officers
The information required to be included as Part III to this Report on
Form 10-K will be incorporated by reference from DynTek's definitive proxy
statement, if such definitive proxy statement or information statement is filed
with the Commission not later than October 28, 2002. If such information is not
so incorporated by reference, such information shall be filed as part of an
amendment to DynTek's Report on Form 10-K for the fiscal year ended June 30,
2000 not later than October 28, 2002.
Item 11. Executive Compensation
The information required to be included as Part III to this Report on
Form 10-K will be incorporated by reference from DynTek's definitive proxy
statement, if such definitive proxy statement or information statement is filed
with the Commission not later than October 28, 2002. If such information is not
so incorporated by reference, such information shall be filed as part of an
amendment to DynTek's Report on Form 10-K for the fiscal year ended June 30,
2000 not later than October 28, 2002.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information required to be included as Part III to this Report on
Form 10-K will be incorporated by reference from DynTek's definitive proxy
statement, if such definitive proxy statement or information statement is filed
with the Commission not later than October 28, 2002. If such information is not
so incorporated by reference, such information shall be filed as part of an
amendment to DynTek's Report on Form 10-K for the fiscal year ended June 30,
2000 not later than October 28, 2002.
Item 13. Certain Relationships and Related Transactions
The information required to be included as Part III to this Report on
Form 10-K will be incorporated by reference from DynTek's definitive proxy
statement, if such definitive proxy statement or information statement is filed
with the Commission not later than October 28, 2002. If such information is not
so incorporated by reference, such information shall be filed as part of an
amendment to DynTek's Report on Form 10-K for the fiscal year ended June 30,
2000 not later than October 28, 2002.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) SEE, ITEM 8.
"Financial statements and supplemental data."
44
(b) LIST OF REPORTS ON FORM 8-K
(1) Current Report on Form 8-K filed August 20,
2002, in connection with Stock Purchase and
Settlement Agreement.
(2) Current Report on Form 8-K/A filed August 30,
2002, in connection with financial statements omitted
from the Form 8-K filed August 20, 2002.
(c) EXHIBITS
NUMBER DESCRIPTION OF EXHIBIT
2.1 Agreement and Plan of Merger, as amended, dated February 18, 2000 between DynTek, DynTek
Services, Inc. and Data Systems Network Corporation. (6)
2.2 Second Amendment to the Agreement and Plan of Merger dated as of June 28, 2000 between
DynTek, Inc. DynTek Services, Inc. and Data Systems Network Corporation. (10)
2.3 Agreement and Plan of Reorganization, dated as of April 25, 2001, among DynCorp Management
Resources, Inc., Newport Acquisition Corp., DynCorp and DynTek, Inc. (17)
2.4 Agreement and Plan of Merger, dated as of April 25, 2001, among DynCorp Management
Resources, Inc., Newport Acquisition Corp., DynCorp and DynTek, Inc. (17)
2.5 Stock Option Agreement, dated as of April 25, 2001 between DynTek, Inc. and DynCorp. (17)
2.6 First Amendment to Agreement and Plan of Reorganization, dated as of July 9, 2001, among
DynCorp Management Resources, Inc., Newport Acquisition Corp., DynCorp and DynTek, Inc. (17)
3.1(b) Amended and Restated Charter of the Company. (2)
3.2 Amended and Restated By-Laws of the Company. (2)
4.1(a) Specimen Certificate of the Company's Common Stock. (1)
4.1(b) Specimen of Redeemable Common Stock Purchase Warrant. (3)
4.2 Form of Warrant Agent Agreement between the Company and American Stock Transfer and Trust
Company. (1)
4.3 Amended Warrant Agreement between the Company and American Stock Transfer and Trust
Company, dated November 30, 1999. (6)
4.3 Form of Underwriter's Warrant Agreement. (4)
4.4 1992 Employee Incentive Stock Option Plan, including form of Incentive Stock Option
Agreement. (1)
4.5 1998 Non-Employee Director Stock Option Plan. (5)
4.6 Form of Amendment to 1992 Employee Incentive Stock Option Plan. (9)
4.7 Second Amended Warrant Agreement, dated as of November 30, 2000, between DynTek, Inc. and
American Stock Transfer & Trust Company. (15)
4.8 Third Amended Warrant Agreement, dated as of April 10, 2001, between DynTek, Inc. and
American Stock Transfer & Trust Company. (16)
4.9 Form of Series A convertible preferred stock certificate of DynTek, Inc. (10)
4.10 2001 Employee Incentive Stock Option Plan (21)
45
10.1 Letter Agreement between Core Strategies, LLC and DynTek, Inc., dated May 24, 2000. (10)
10.2 Form of Consulting Agreement between The Exigo Group and DynTek, Inc., dated June 1, 2000.
(10)
10.3 Agreement and Plan of Merger, dated May 17, 2000, between DynTek, Inc., Big Tech
Acquisition Corp. and Big Technologies, Inc. (8)
10.4 Form of Non-Competitive, Confidentiality and Inventions Agreement between Big Technologies,
Inc. and Employees. (8)
10.5 Guaranty, dated as of August 11, 2000, made by DynTek, Inc. in favor of Foothill Capital
Corporation. (11)
10.6 Amendment No. 6 and Waiver to Loan and Security agreement, dated as of August 11, 2000,
among Foothill Capital Corporation, DynTek Services, Inc. and Data Systems Network
Corporation. (11)
10.7 Loan and Security Agreement, dated as of September 30, 1998, between DynTek Services, Inc.
(as successor to Data Systems Network Corporation) and Foothill Capital Corporation. (12)
10.8 Employment Agreement, dated as of August 14, 2000, between DynTek, Inc. and James Linesch.
(13)
10.9 Letter Agreement, dated as of July 28, 2001, between DynTek Services, Inc. (as successor to
Data Systems Network Corporation) and Interactive Frontiers, Inc. (13)
10.10 Amendment No. 1, dated December 12, 2000, to Amendment No. 6 and Waiver, among Foothill
Capital Corporation, DynTek Services, Inc. and Data Systems Network Corporation. (14)
10.11 Amendment No. 2, dated as of December 29, 2000, to Amendment No. 8 and Waiver, among
Foothill Capital Corporation, DynTek Services, Inc. and Data Systems Network Corporation.
(14)
10.12 Amendment No. 3, dated as of January 12, 2001, to Amendment No. 8 and Waiver, among
Foothill Capital Corporation, DynTek Services, Inc. and Data Systems Network Corporation.
(14)
10.13 Amendment No. 4, dated as of January 26, 2001, to Amendment No. 8 and Waiver, among
Foothill Capital Corporation, DynTek Services, Inc. and Data Systems Network Corporation.
(14)
10.14 Letter Agreement, dated November 3, 2000, between DynTek, Inc. and LaborSoft Corporation.
(14)
10.15 Amendment No. 9 to Loan and Security Agreement, dated as of March 30, 2001, among Foothill
Capital Corporation, and DynTek Services, Inc. (18)
10.16 Employment Agreement, dated as of January 2, 2001, between DynTek, Inc. and Steven J. Ross.
(18)
10.17 Amendment No. 10 to Loan and Security Agreement, dated as of June 30, 2001 among Foothill
Capital Corporation, and DynTek Services, Inc. (19)
10.18 Stock Purchase and Settlement Agreement, dated August 20, 2002, between DynCorp and DynTek,
Inc. (20)
10.19 Promissory Note, dated August 20, 2002, made by DynTek, Inc. in favor of DynCorp, for
$5,000,000 in principal amount. (20)
10.20 Warrant, dated August 20, 2002, made in favor of DynCorp for 7,500,000 shares of Class A
Common Stock. (20)
46
10.21 General Release, dated August 20, 2002, of DynTek, Inc. by DynCorp. (20)
10.22 General Release, dated August 20, 2002, of DynCorp by DynTek, Inc. (20)
10.23 Amendment No. 14 and Waiver to Loan and Security Agreement, dated August 20, 2002, among
DynTek Services, Inc., DynTek, Inc. and Foothill Capital Corporation. (20)
21. DynTek subsidiaries. (10)
23. Consent of Grassi & Co., P.C.
99.1 Section 906 Certification of Steven J. Ross
99.2 Section 906 Certification of James Linesch
- -----------
1. Incorporated by reference, filed as an exhibit to Amendment No. 1 to the Registrant's
Registration Statement on Form S-1 filed on October 13, 1992.
2. Incorporated by reference, filed as an exhibit to Amendment No. 2 to the Registrant's
Registration Statement on Form S-1 filed on November 10, 1992.
3. Incorporated by reference, filed as an exhibit to Amendment No. 4 to the Registrant's
Registration Statement on Form S-1 filed on December 4, 1992.
4. Incorporated by reference, filed as an exhibit to Amendment No. 5 to the Registrant's
Registration Statement on Form S-1 filed on December 8, 1992.
5. Incorporated by reference, filed as an exhibit to the Company's Report on Form 10-Q, filed
on December 24, 1998.
6. Incorporated by reference, filed as an Exhibit to the Company Current Report on Form 8-K,
filed on December 6, 1999.
7. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed on February 29, 2000.
8. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed on May 19, 2000.
9. Incorporated by reference, filed as an Exhibit to the Company's Registration Statement on
Form S-4, filed on May 1, 2000 (File No. 333-36044).
10. Incorporated by reference, filed as an Exhibit to the Company's Amendment No. 1 to
Registration Statement on Form S-4, filed on July 13, 2000 (File No. 333-36044).
11. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed on August 24, 2000.
12. Incorporated by reference, filed as an Exhibit to
the Quarterly Report on Form 10-Q of Data Systems Network
Corporation for the quarter ended September 30, 1998.
13. Incorporated by reference, filed as an Exhibit to the Company's Annual Report on Form
10-K/A, filed on October 27, 2000.
14. Incorporated by reference, filed as an Exhibit to the Company's Quarterly Report of Form
10-Q, filed on December 31, 2000.
15. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed on January 11, 2001.
16. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed on April 17, 2001.
47
17. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed May 2, 2001.
18. Incorporated by reference, filed as an Exhibit to the Company's Quarterly Report on Form
10-Q, filed May 15, 2001.
19. Incorporated by reference, filed as an exhibit to the Company's Annual Report on Form 10-K,
filed on September 26, 2001.
20. Incorporated by reference, filed as an Exhibit to the Company's Current Report on Form 8-K,
filed August 20, 2002.
21. Incorporation by reference, filed as Annex D to the Company's definitive Proxy Statement
for Special Meeting of Stockholders on November 20, 2001, filed November 5, 2001
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
DATED: October 14, 2002
DYNTEK, INC.
BY: /s/ Steven J. Ross
---------------------------------
Steven J. Ross, President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
President, Chief Executive
/s/ Steven J. Ross Officer and Chairman October 14, 2002
- ------------------------------------------
Steven J. Ross
Chief Financial Officer, Chief
/s/ James Linesch Accounting Officer, Executive October 14, 2002
- ------------------------------------------ Vice President, Director and
James LinescH Secretary
Director
/s/ Brian D. Bookmeier October 14, 2002
- ------------------------------------------
Brian D. Bookmeier
Director
/s/ Michael Grieves October 14, 2002
- ------------------------------------------
Michael Grieves
Director
/s/ Marshall Toplansky October 14, 2002
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Marshall Toplansky
49
CERTIFICATIONS
I, Steven J. Ross, certify that:
1. I have reviewed this annual report on Form 10-K of DynTek, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
annual report.
Date: October 14, 2002. /S/ Steven J. Ross
----------------------
Steven J. Ross
Chief Executive Officer
50
I, James Linesch, certify that:
1. I have reviewed this annual report on Form 10-K of DynTek, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
annual report.
Date: October 14, 2002. James Linesch
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James Linesch
Chief Financial Officer