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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 31, 2003
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
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DYNTEK, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 95-4228470
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
18881 Von Karman Avenue, #250
Irvine, CA 92612
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (949) 955-0078
--------------
Check whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months, and (2) has been subject to such filings requirements for
the past 90 days. Yes X No
--- ---
The number of shares outstanding of the issuer's Class A Common Stock,
$.0001 par value, as of May 9, 2003 was 35,475,943.
DYNTEK, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION Page
Number
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - March 31, 2003 3
and June 30, 2002
Condensed Consolidated Statements of Operations and Comprehensive Loss - For the Three 4
Months and Nine Months ended March 31, 2003 and 2002
Condensed Consolidated Statements of Cash Flows - For the 5
Nine Months ended March 31, 2003 and 2002
Notes to Condensed Consolidated Financial Statements 6 - 14
Item 2. Management's Discussion and Analysis of Financial 15 - 19
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURE 21
CERTIFICATIONS 22-24
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)
DYNTEK, INC. AND SUBSIDIARIES
-----------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(in thousands, except per share data)
March 31, June 30,
ASSETS 2003 2002
-------- --------
CURRENT ASSETS: Unaudited
Cash (includes restricted cash of $721 and $986) $ 1,230 $ 1,012
Accounts receivable, net of allowance for doubtful accounts of $464 and $609 9,183 15,023
Tax refund receivable -- 245
Inventories 257 1,008
Costs and estimated earnings in excess of billings on uncompleted contracts -- 3,015
Prepaid expenses and other assets 168 128
Note receivable - current portion 187 375
Other receivables 95 779
-------- --------
TOTAL CURRENT ASSETS 11,120 21,585
RESTRICTED CASH 763 995
INVESTMENTS - Marketable Securities 328 366
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,897 and $2,619 556 1,040
GOODWILL 40,688 40,688
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $540 and $378 537 698
ACQUIRED CUSTOMER LIST, net of accumulated amortization of $4,446 and $3,025 7,893 9,304
PURCHASED SOFTWARE, net of accumulated amortization of $454 and $325 235 365
NOTES RECEIVABLE, long term, including receivable from officer $100 1,017 1,017
NON-CURRENT ASSETS OF DISCONTINUED OPERATIONS -- 3,915
DEPOSITS AND OTHER ASSETS 327 462
-------- --------
$ 63,464 $ 80,435
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 14,405 $ 16,963
Line of credit 760 6,347
Accrued expenses 2,659 4,437
Deferred revenue 1,754 4,658
Audit assessment -- 1,861
Notes payable 678 1,250
Net current liabilities of discontinued operations -- 144
-------- --------
TOTAL CURRENT LIABILITIES 20,256 35,660
DEFERRED REVENUE - long term 763 995
NOTE PAYABLE to STOCKHOLDER 5,000 --
-------- --------
TOTAL LIABILITIES 26,019 36,655
-------- --------
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000; shares authorized:
1,605,182 and 1,616,397 shares issued and outstanding as of March 31,
2003 and June 30, 2002,
respectively 1 1
Class A Common stock, $.0001 par value, 70,000,000 shares authorized; 35,507,332
shares and 23,533,692 shares issued and outstanding 4 2
Class B Common stock, $.0001 par value, 20,000,000 shares authorized; 0 shares
and 18,336,663 shares issued and outstanding as of March 31, 2003 and June 30,
2002, respectively -- 2
Additional paid-in-capital 81,472 86,193
Other comprehensive loss (199) (131)
Deficit (43,833) (42,287)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 37,445 43,780
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 63,464 $ 80,435
======== ========
See notes to condensed consolidated financial statements
-3-
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited) (in thousands,
except per share data)
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUES:
Product Revenues $ 5,051 7,974 16,176 $ 20,481
Service Revenues 6,961 8,539 21,824 19,848
------------ ------------ ------------ ------------
Total revenues 12,012 16,513 38,000 40,329
------------ ------------ ------------ ------------
COST OF REVENUES:
Cost of products 4,135 6,839 13,496 17,378
Cost of services 5,370 6,289 17,189 14,421
------------ ------------ ------------ ------------
Total cost of revenues 9,505 13,128 30,685 31,799
------------ ------------ ------------ ------------
GROSS PROFIT 2,507 3,385 7,315 8,530
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling expenses 1,802 3,121 5,348 7,229
General and administrative expenses 496 1,331 2,365 3,419
Application development -- -- -- 492
Depreciation and amortization 689 912 2,101 2,022
------------ ------------ ------------ ------------
Total operating expenses 2,987 5,364 9,814 13,162
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (480) (1,979) (2,499) (4,632)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of marketable securities -- -- -- (1,241)
Interest expense (316) (641) (905) (2,267)
Interest income 48 10 64 31
Reversal of state audit assessment & other 1,948 -- 1,948 --
Equity interest in loss of investee (10) (28) (72) (220)
------------ ------------ ------------ ------------
Total other income (expense) 1,670 (659) 1,035 (3,697)
------------ ------------ ------------ ------------
INCOME/(LOSS) BEFORE INCOME TAX 1,190 (2,638) (1,464) (8,329)
INCOME TAX -- 4 1 47
------------ ------------ ------------ ------------
NET INCOME / (LOSS) FROM CONTINUING OPERATIONS $ 1,190 $ (2,642) $ (1,465) $ (8,376)
DISCONTINUED OPERATIONS
Gain on disposal of discontinued operations 2,791 -- 2,791 --
Loss on discontinued operations (3,133) (2,948) (2,871) (2,948)
------------ ------------ ------------ ------------
LOSS FROM DISCONTINUED OPERATIONS (342) (2,948) (80) (2,948)
------------ ------------ ------------ ------------
NET INCOME/(LOSS) $ 848 $ (5,590) $ (1,545) $ (11,324)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE: Basic
Continuing Operations .03 (.06) (.03) (.29)
Discontinued Operations (.01) (.08) (.01) (.11)
------------ ------------ ------------ ------------
$ .02 $ (.14) $ (.04) $ (.40)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE: Diluted
Continuing Operations .02 (.06) (.03) (.29)
Discontinued Operations (.01) (.08) (.01) (.11)
------------ ------------ ------------ ------------
$ .01 $ (.14) $ (.04) $ (.40)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION -
Basic 35,504,391 40,850,300 36,537,342 28,076,632
Diluted 46,556,536 40,850,300 36,537,342 28,076,632
NET INCOME /(LOSS) $ 848 $ (5,590) $ (1,545) $ (11,324)
COMPREHENSIVE LOSS, NET OF TAX
Change in unrealized gain (loss) on
available-for-sale-securities (21) (67) (68) 846
------------ ------------ ------------ ------------
COMPREHENSIVE LOSS $ 827 $ (5,657) $ (1,613) $ (10,478)
============ ============ ============ ============
See notes to condensed consolidated financial statements
-4-
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
Nine months ended
March 31,
-----------------------
2003 2002
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,545) (11,324)
Deduct: Loss from discontinued operations (80) (2,948)
------- -------
Net loss, excluding discontinued operations (1,465) (8,376)
------- -------
Adjustments to reconcile net loss, excluding discontinued operations, to
net cash provided by( used in) operating activities:
Gain on discontinued operations (2,791) --
Depreciation and amortization 2,017 1,934
Amortization of capitalized software costs 161 162
Amortization of deferred finance costs -- 160
Equity interest in investee 72 220
Loss on sale of marketable securities -- 1,241
Beneficial conversion feature of short-term notes -- 763
Amortization of debt discount on short-term notes -- 591
Interest on short term note payable 428 --
Settlement of Exodus future royalties, net (425) --
State audit assessment (1,861) 51
Changes in operating assets and liabilities:
Accounts receivable 5,840 2,798
Inventory 751 679
Costs and estimated earnings in excess of billings on uncompleted
contracts 3,015 (1,061)
Prepaid expenses and other current assets 238 142
Deposits and other assets 63 (116)
Accounts payable (2,558) 449
Deferred revenue (2,904) 1,614
Accrued expenses (1,114) (417)
------- -------
Total adjustments 932 9,210
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (533) 834
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Notes Receivable 188 --
Cash proceeds from sale to First Transit 6,450 --
Cash proceeds from purchase of subsidiary securities -- 13
Cash proceeds from sale of marketable securities -- 362
Capital expenditures (22) (118)
------- -------
NET CASH PROVIDED BY INVESTING ACTIVITIES 6,616 257
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) proceeds under bank line of credit (5,587) (770)
Notes payable (25)
Cash proceeds from the sale of securities 696 1,607
Cash proceeds from exercise of stock options -- 131
Issuance of short term notes payable, net -- 1,508
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (4,916) 2,476
------- -------
NET CASH USED IN DISCONTINUED OPERATIONS (949) (2,948)
------- -------
NET INCREASE (DECREASE) IN CASH 218 619
CASH AT BEGINNING OF YEAR 1,012 1,309
CASH AT END OF PERIOD $ 1,230 1,928
======= =======
See notes to condensed consolidated financial statements
-5-
DYNTEK, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003
(UNAUDITED)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of DynTek, Inc. and
Subsidiaries ("DynTek") or ("the Company")have been prepared in accordance with
generally accepted accounting principles for interim financial statements and
with the instructions to Form 10-Q and Article 10 of Regulations S-X.
Accordingly, they do not include all of the information and disclosures required
for annual financial statements. These financial statements should be read in
conjunction with the consolidated financial statements and related footnotes for
the year ended June 30, 2002 included in the Form 10-K for the year then ended
and Form 10-K/A filed on October 13, 2002.
The accompanying financial statements reflect all adjustments, which, in the
opinion of management consist of normal recurring items, are necessary for a
fair presentation in conformity with accounting principles generally accepted in
the United States of America. These adjustments include certain
reclassifications to reflect the disposal of certain non-emergency
transportation services which was a component of our business outsourcing
segment. Preparing financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. The results of operations for any interim period are not
necessarily indicative of the results attainable for a full fiscal year.
Accounting Policies
In November 2002, Financial Accounting Standards Board "FASB" issued FASB
Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 addresses the disclosure requirements of a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that is has issued. FIN 45 also requires a guarantor to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are
effective for our year ended June 30, 2003. The liability recognition
requirements will be applicable prospectively to all guarantees issued or
modified after December 31, 2002.
The Financial Accounting Standards Board "FASB" issued statement of Financial
Accounting Standards ("SFAS") No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities." This standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146
replaces the existing guidance provided by EITF 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 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002.
The Company evaluates the recoverability of it's Goodwill and Other intangibles
in accordance with the Statement of Financial Accounting Standards Board
"SFASB" No. 142, Goodwill and Other Intangible Assets. As of March 31, 2003,
the Company has determined there have been no events to indicate that any,
impairment has occured which would require an adjustment to reduce the carrying
value of goodwill. The Company will be conducting it's annual test of existing
goodwill at June 30, 2003. The results of this annual testing of goodwill will
determine if further adjustments to reduce the carrying value are required.
The FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure - an amendment of FASB Statement No. 123"
that provide alternatives methods of transition for a voluntary change to the
fair value based method accounting for stock-based employee compensation. The
provisions of this Statement are effective for fiscal years beginning after
December 15, 2002.
During the current quarter, the Company adopted Statement of financial
Accounting Standard No. 148, "Accounting for Stock-based Compensation-Transition
and Disclosure." This statement amended Statement No. 123, "Accounting for
Stock-based Compensation." As permitted under Statement No. 123, the Company
continues to apply the Accounting Principles Board Opinion No. 25, "Accounting
-6-
for Stock Issued to Employees." As required under Statement No. 148, the
following table present pro- forma net income and basic and diluted earnings
(loss) per share as if the fair value-based method had been applied to all
awards.
----------------------------------------------------------------------------------------------
Three Months Nine Months
2003 2002 2003 2002
-------- ---------- --------- -----------
Periods Ended March 31,
Net Income (Loss) $ 848 $ (5,590) $ (1,545) $ (11,324)
Stock-based employee compensation
cost, net of tax effect, under fair
value accounting 69 147 207 441
-------- ---------- ------ -----------
Pro-forma net loss under Fair Value
Method $ 779 $ (5,737) (1,752) $ (11,765)
-------- ---------- ------ -----------
Income (Loss) per share
Basic .02 (.14) (.04) (.40)
Diluted .01 (.14) (.04) (.40)
Per share stock-based employee
compensation cost, net of tax
effect, under fair value accounting (.00) (.01) (.01) (.02)
Pro-forma loss share basic .02 (.15) (.05) (.42)
Pro-forma loss share diluted $ .01 $ (.15) $ (.05) $ (.42)
------------------------------------------------------------------------------------------------
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option valuation model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. Because the Company's stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value estimate of
its stock options. In calculating the fair values of the stock options, the
following assumptions were used:
Fiscal year Fiscal year
2003 grants 2002 grants
----------- ------
Dividend yield - -
Weighted average expected life: 3.6 years 5.5 years
Weighted average risk-free interest rate 2.5% 3.7%
Expected volatility 136% 53%
The Company has adopted the above pronouncements during the current quarter and
there was no material effect on the Company's consolidated financial statements.
2. Going Concern
As indicated by the accompanying consolidated financial statements, the Company
has incurred consolidated net losses. Additionally, the Company has significant
deficits in working capital. These factors raise substantial doubt about the
Company's ability to continue as a going concern.
The accompanying consolidated financial statements have been prepared assuming
the Company will be able to continue as a going concern. Accordingly, the
consolidated financial statements do not include any adjustments relative to the
recoverability and classification of assets, or the amounts and classification
-7-
of liabilities that might be necessary in the event the Company is unable to
continue operations.
3. Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation 46, Consolidation of Variable
Interest Entities. In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. Interpretation 46 requires a variable interest entity to
be consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. The consolidation
requirements of Interpretation 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidation requirements apply to
older entities in the first fiscal year or interim period beginning after June
15, 2003. Certain of the disclosure requirements apply in all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. The adoption of FASB Interpretation 46 is not
expected to have an impact on the Company's financial statements.
In April 2003, Financial Accounting Standards Board, "FASB" issued Statement of
Financial Accounting Standard, SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
Statement 133. This Statement is effective for contracts entered into or
modified after June 30, 2003, except as stated below and for hedging
relationships designated after June 30, 2003. The guidance should be applied
prospectively. The provisions of this Statement that relate to Statement 133
Implementation Issues that have been effective for fiscal quarters that began
prior to June 15, 2003, should continue to be applied in accordance with their
respective effective dates. In addition, certain provisions relating to forward
purchases or sales of when-issued securities or other securities that do not yet
exist, should be applied to existing contracts as well as new contracts entered
into after June 30, 2003. The adoption of SFAS No. 149 is not expected to have
an impact on the Company's financial statements.
4. Restricted Cash
As of March 31, 2003, cash of $ 1,484,000 has been 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, $721,000 will be released during the
2003 calendar year. The non-current portion, $763,000, has been classified as a
non-current asset.
5. Credit Facility
The credit agreement with Foothill Capital Corporation (the "Foothill
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 outstanding borrowings bear interest at
1% over Wells Fargo base rate (4.25% at March 31, 2003) with a minimum rate of
7%. The term of the agreement has been extended through March 31, 2004 under
similar terms. The Company's Subsidiary, DynTek Services is required to maintain
certain financial covenants, based upon defined EBITDA, tangible net worth and
interest coverage ratio of the subsidiary. DynTek Services is not in compliance
with the tangible net worth covenant and other provisions of the Foothill
agreement as of March 31, 2003. The Company has not received a waiver from
Foothill for non compliance with the financial covenant and such other
provisions, since the Company is actively seeking alternative financing, as
described below.
-8-
On March 14, 2003, the Foothill Agreement was amended in connection with the
consent for the asset sale of contracts to First Transit (see footnote 11).
Under the terms of the amendment, the Company agreed to reduce the maximum
outstanding loan balance to $3,100,000 on March 14, 2003, to $2,750,000 on the
date that the second payment was received from First Transit; and the maximum
loan is reduced by $100,000 per week commencing April 21, 2003. At March 31,
2003 the outstanding loan balance was $760,000, and the Company has complied
with the terms of the loan balance reduction requirements since that date.
With the knowledge of Foothill, the Company is actively involved in negotiating
an alternative lending agreement, which will be collateralized by its accounts
receivables but there are no assurances the Company will be successful.
6. Marketable Securities
Marketable securities have been classified as available for sale securities at
March 31, 2003 and, accordingly, the unrealized loss resulting from valuing such
securities at market value is reflected as a component of stockholders' equity.
At March 31, 2003, the unrealized loss on securities was $199,000.
7. Commitments, Contingencies, and Other Agreements
During the quarter ended March 31, 2003 the Company made payments of $206,000
due on a judgment that was entered against Data Systems in favor of J. Alan
Moore in Mecklenburg County Superior Court Division, North Carolina on July 28,
2000. The plaintiff was awarded a judgment of $572,000 plus reasonable attorney
fees and interest totaling $ 778,000 and is included in the accrued expenses on
the balance sheet. At March 31, 2003, $572,000 was outstanding. Payments
totaling $ 459,000 have been made subsequent to March 31, 2003. As of May 13,
2003, $113,000 remained due and is reported in accrued expenses on the
accompanying financials.
On August 20, 2002, a settlement and dismissal order was approved and filed in
the New York County Clerk's Office from a stockholder's derivative action by
Paul Miletich. The action was originally filed on July 10, 2000, naming the
Company as a nominal defendant. As a part of the settlement, the Company
received 300,000 shares of DynTek common stock and 125,000 shares of MedEmerg
common stock, as full settlement of a guarantee provided to the Company.
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 were received and were the remaining
shares of MedEmerg common stock, held as marketable securities. No gain or loss
was recorded in connection with the settlement.
On December 31, 2002, the Company settled all amounts due of approximately
$713,000, net of a related receivable of $187,000, under the previous agreement
to purchase the assets of Exodus Communications, Inc. ("Exodus") for a total
amount of $100,000, payable over three months ending March 31, 2003. As of March
31, 2003, $75,000 remains due and payable under this agreement. This amount is
recorded in the balance sheet as included in accrued expenses.
On January 29, 2002, the Company was named as a third-party defendant in a
matter brought by Computer Associates International, Inc. ("CA") against the
City of Boston ("COB"), in United States District Court, District of
Massachusetts (Case Number 01-10566-EFH). CA filed suit against COB alleging,
among others, that COB breached a contract with CA, that COB violated copyright
laws, and that COB owes the balance due under a multi-phase purchase agreement.
While CA has not asserted a specific damages amount, the total multi-phase
contract was in an amount of approximately $2 million. COB subsequently named
the Company as a third-party defendant, alleging that COB is entitled to
indemnification from the Company based on an alleged contract between the
Company and COB, that COB is entitled to contribution from the Company for any
-9-
amounts COB is ordered to pay CA, and that the Company misrepresented material
facts with respect to CA's product, services, and cost. COB's third-party
complaint against the Company seeks all damages as a result of the Company's
alleged acts. The matter is currently in the discovery stage. Company management
believes that COB's claims against the Company are without merit and the Company
intends to vigorously contest the claims asserted against it. However, there is
no assurance that the resolution of this matter will be favorable for the
Company.
Effective December 15, 2002 the Company entered into a mutual Settlement
Agreement to cancel a contract to provide non-emergency transportation brokerage
services in certain regions of the Commonwealth of Virginia. The terms of the
Settlement Agreement provide that the Company issue certain payments due to
transportation provider vendors according to an agreed-upon schedule, which
extends through June 2003. The Company has included the third-party
transportation provider liabilities in its accounts payable as of March 31,
2003, and believes that it is in compliance with the terms of the Settlement
Agreement. Several of the vendors that provided transportation services in the
Commonwealth of Virginia have initiated legal demands for payment. Some of the
demands, either in whole or in part, have been disputed by the Company as being
without merit. As of May 6, 2003 actions for collection have commenced in 6
separate proceedings. Ali Medical,et.al, a joint case of 23 providers for
approximately $950,000, is the largest of the claims. On April 28, 2003, the
Company has removed this matter from the Circuit Court of the City of Richmond,
Virginia to the United States District Court for the East District of Virginia.
The Company has filed a Motion for a More Definitive Statement for the basis of
the joining of the plaintiffs to a single claim. The remaining five proceedings
are for an aggregate amount of approximately $767,000 a portion of which has
been disputed based on billings for services that were not provided under the
agreements or on billings which were outside the terms of the subcontracts. The
Company believes that these six claims will be fully resolved following
evaluation of the claims against those services authorized by the Company and
those rates permitted in subcontracts. However, the Company is unable to predict
the outcome of these claims and, accordingly, no adjustments have been made to
the financial statements.
In February 2003, four actions were dismissed in Civil Court of New York, two
between the Company and Stride & Associates in the aggregate amount of $40,000,
and two between the Company and consultants in the aggregate amount of $53,000.
Due to the expiration of the statute of limitations to obtain a judgment against
the Company; a liability carried on its books since 1995 has been written off as
of March 31, 2003, along with the accrued interest on the debt. In connection
with the write-off, the company recorded other income of $1,862,000, and offset
interest expense in the amount of $52,000. The liability was originally recorded
as a result of audit findings 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, as a result of an
audit by the California State Controller's Office, Division of Audits, which was
conducted on behalf of the California Department of Health Services. On January
26, 2000, the California Court of Appeals upheld the audit findings, but the
California Department of Health Services never filed an action to collect the
amount in question.
On October 11, 2002, Merisel Americas, Inc. filed a breach of contract complaint
in Superior Court of California, Southwest District. The complaint arose from
the Company's failure to make payments within the terms of the reseller
agreement. The Company does not dispute the claim of $483,000 and is negotiating
payment terms. This amount is included in the Company's accounts payable.
8. Stockholders' Equity
On August 14, 2001, the Company's preferred stock became convertible into the
Company's Class A common stock, at a rate of 2.5 common shares for each
preferred share tendered. As of March 31, 2003, 584,618 of such shares were
converted into 1,460,496 shares of Class A common stock, with a remainder of
1,605,182 shares not yet converted.
-10-
During September 2002, in connection with the settlement of the Miletich
Derivative Action, the Company received 300,000 shares of its Class A Common
Stock. Such shares were held at cost as treasury stock at December 31, 2002, and
the Company has since retired the shares.
In June 2002, the Company sold 1,389,293 shares of Common Stock for $1.50 per
share to accredited investors, and converted short-term notes payable into
1,042,039 shares of Class A Common Stock for $1.50 per share to accredited
investors. Part of the share issuances were completed in June 2002, and the
remaining shares were issued during July 2002. During the nine months ended
March 31, 2003, 1,501,844 shares of Class A Common Stock were issued in
connection with this placement and conversion of short-term notes.
In July 2002, 24,534 shares of Class A Common Stock were issued to an accredited
investor as an extinguishment of an account payable.
During the nine months ended March 31, 2003 11,215 shares of Preferred Stock
were converted into 28,037 Class A Common shares. An additional 72,562
previously retired shares were reissued, which had previously been retired in
error.
During August 2002, the Company repurchased and retired 8,000,000 shares of its
Class B Common Stock and converted the remaining 10,336,663 shares of Class B
Common Stock into the same number of Class A Common Stock shares.
In March 2003, the Company engaged The Damon Group, a shareholder as financial
advisors and as sole placement agents for the Company in connection with the
structuring, issuance and sale of up to approximately $1,200,000 of
equity-linked securities of the Company as follows: DynTek Common Stock shall be
issued at a price of $0.50 per share, warrants shall be issued in connection
with this Offering at a rate of one warrant for each $1 invested. Such warrants
shall bear an exercise price of $1.50 per share. The Warrants shall be
exercisable for a period of five years. Upon consummation of the Offering, in
consideration of their services as placement agent and underwriter, the Company
shall pay The Damon Group a fee in DynTek Common Stock in an amount that is
equal to 30% of the aggregate shares issued in the Offering. This Agreement is
effective until May 31, 2003, subject to extension by the Company for up to 90
additional days.
9. Earnings per Share
Basic earnings per share is computed on the basis of the weighted average number
of common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options using the "treasury stock method". Common
stock equivalents consisting of options, warrants, and convertible preferred
stock are not included in the calculation of diluted earnings per share if the
results are anti-dilutive.
- -------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
2003 2002 2003 2002
---------- ---------- --------- ----------
Denominator for basic earnings per 35,504,391 40,850,300 36,537,342 28,076,632
share - weighted average outstanding
Options and warrants 5,988,235 - - -
Convertible preferred stock 5,063,910 4,052,563 4,686,912 4,052,563
---------- ---------- ---------- ----------
Denominator for diluted earnings per
share - weighted average outstanding 46,556,536 40,850,300 36,537,342 28,076,632
- -------------------------------------------------------------------------------------------------
-11-
Total outstanding stock, options and warrants is as follows:
-------------------------------------------------------------------
As of March 31,
2003 2002
-------------- ------------
Common stock 35,507,332 42,994,668
Options and warrants 5,988,235 5,991,121
Convertible preferred stock 4,012,955 4,052,563
-------------- ------------
45,508,522 53,038,352
-------------------------------------------------------------------
10. Dyncorp Settlement Agreement
On August 20, 2002, DynTek entered into the Settlement Agreement with DynCorp
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, DMR in
December 2001. 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 DMR 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 recorded as an
offset to costs incurred under the Virginia contract. 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. As of March 31, 2003, interest payments of approximately
$320,000 included in current notes payable were past due under the terms of the
Note, and an additional payment due on April 1, 2003 of approximately $190,000
remains due. The Company is currently in negotiations regarding the payment
terms of this Note.
11. First Transit Inc. Agreement
On March 14, 2003, effective as of March 1, 2003, the Company entered into an
Asset Purchase Agreement with First Transit, Inc., pursuant to which the Company
sold to First Transit, Inc. certain specific assets relating to the
transportation management division of Services. The assets sold consisting of
the Company interests in three contracts to provide non-emergency transportation
related services and related assets used in connection with performance of such
contracts by Services as well as the assumption of all vendor and services
sub-contract agreements relating to the contracts. The Purchase Price consisting
of: (i) $3,700,000 (less a $500,000 Holdback) paid at closing on March 14, 2003,
(ii) $2,750,000 to be paid on April 1, 2003 and (iii) up to $1,750,000 to be
paid in the event that First Transit, Inc. is able to obtain extension of the
Illinois Department of Public Aid contract for a period of up to three years
beyond May 31, 2004 under certain specified conditions. As part of the
Agreement, DynTek Services also agreed to not compete with First Transit in the
business which was sold.
12. Discontinued Operations
As a result of the First Transit Inc. Agreemrs and a mutual Settlement
Agreement the Company entered into on December 15, 2002, to cancel a contract
to provide non-emergency transportation brokerage services with the Commonwealth
-12-
of Virginia, the Company has discontinued all non-emergency transportation
services which was a component and separate reporting unit of the Company's
business outsourcing segment.
Major assets disposed (in thousands):
2003
----
Purchase Price $ 6,450
Goodwill (2,850)
Acquired customer list (560)
Property, Plant & Equipment , net (249)
--------
Net Gain on Sale of Discontinued Operations $ 2,791
- --------------------------------------------------------------------
The results of the discontinued operations are (in thousands):
2003 2002
---- ----
Three months ended March 31,
Sales to external customers $2,005 $11,602
Loss from Discontinued Operations, net (342) (2,948)
Nine months ended March 31,
Sales to external customers $22,983 $11,602
Loss from Discontinued Operations, net (80) (2,948)
-13-
13. Business Segments
The following table provides actual selected financial data for our business
segments (in thousands):
Reportable Business Segments
----------------------------------------------------
Business
Process Network
Outsourcing Services Total
Nine months ended March 31, 2003
Sales to external customers $7,854 $30,146 $38,000
Depreciation and amortization expense 363 1,738 2,101
Operating income (loss) (123) (2,376) (2,499)
Net interest expense (income) 433 408 841
Total assets 37,345 26,119 63,464
Capital expenditures 5 17 22
Nine months ended March 31, 2002
Sales to external customers $2,520 $37,809 $40,329
Depreciation and amortization expense 346 1,676 2,022
Operating income (loss) (817) (3,815) (4,632)
Net interest expense (income) 140 2,096 2,236
Total assets 47,278 33,241 80,519
Capital expenditures 84 34 118
Three months ended March 31, 2003
Sales to external customers 2,499 $9,513 $12,012
Depreciation and amortization expense 119 570 689
Operating income (loss) 576 (1,056) (480)
Net interest expense (income) 56 212 268
Total assets 37,345 26,119 63,464
Capital expenditures - 16 16
Three months ended March 31, 2002
Sales to external customers $2,520 $13,993 $16,513
Depreciation and amortization expense 346 566 912
Operating income (loss) (817) (1,162) (1,979)
Net interest expense (income) 140 491 631
Total assets 47,278 33,241 80,519
Capital expenditures 18 (15) 3
15. 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. As of March 31, 2003, the Company had outstanding receivables for
such services in the total amount of $500,000, representing unpaid charges since
April 2001 and an allowance reserve for bad debts with respect thereto 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 $392,000. Such
losses have reduced the carrying value of the Laborsoft investment, which is
recorded in deposits and other assets, to $64,000 at March 31, 2003.
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS
Forward-Looking Statements
When used in the Form 10-Q and in future filings by the Company with
the Securities and Exchange Commission, the words or phrases "will likely
result" and "the Company expects," "will continue," "is anticipated,"
"estimated," "project," or "outlook" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company wishes to caution readers
not to place undue reliance on any such forward-looking statements, each of
which speaks only as of the date made. Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical earnings and those presently anticipated or projected. Such
risks and uncertainties include, among others, success in reaching target
markets for services and products in a highly competitive market and the ability
to attract future customers, the size and timing of additional significant
orders and their fulfillment, the success of the Company's business emphasis,
the ability to finance and sustain operations, including the ability either to
maintain and extend the Foothill Agreement when it becomes due or to replace the
Foothill Agreement with alternative financing, the ability to raise equity
capital in the future, despite continuing losses from operations and a "going
concern" opinion from our auditors, the Company's ability to arrange
successfully for extended payment terms for certain overdue obligations and
judgments against the Company or to successfully refinance obligations in the
event, that the holders of such overdue or otherwise defaulted obligations
declare the Company in default thereunder, the ability to fulfill the Company's
obligations to third parties, and ability to defend successfully certain ongoing
litigation over contract performance, the size and timing of additional
significant orders and their fulfillment, the ability to turn contract backlog
into revenue and net income, the continuing desire of state and local
governments to outsource to private contractors and the ability of the Company
to obtain extensions of the remaining profitable DMR contracts at their
maturity, the performance of governmental services, the ability to develop and
upgrade our technology, and the continuation of general economic and business
conditions that are conducive to governmental outsourcing of service
performance. The Company has no obligation to publicly release the results of
any revisions, which may be made to any forward-looking statements to reflect
anticipated or unanticipated events or circumstances occurring after the date of
such statements.
RESULTS OF CONTINUING OPERATIONS
The three months ended March 31, 2003 (the "2003 Three Month Period") as
compared to the three months ended March 31, 2002 (the "2002 Three Month
Period").
Revenues for the 2003 Three Month Period decreased to approximately
$12,012,000 from approximately $16,513,000 for the 2002 Three Month Period. The
revenue mix of product and services was 42% and 58%, respectively, for the 2003
Three Month Period, as compared to 49% and 51%, respectively, for the 2002 Three
Month Period. This change in revenue mix is primarily due to the increased
offerings in our service business.
Cost of revenues for the 2003 Three Month Period decreased to
approximately $9,505,000 from approximately $13,128,000 for the 2002 Three Month
Period, due to the decrease in revenue. The overall gross margin percentage
increased to 21% for the 2003 Three Month Period from 20% for the 2002 Three
Month Period.
-15-
Selling, general and administrative expenses for the 2003 Three Month
Period decreased to approximately $2,298,000 from approximately $4,452,000 for
the 2002 Three Month Period. The Company has realized cost savings from
consolidating administration centers, personnel and management that were assumed
in the December 27, 2001 merger of DMR and from discontinued operations. As a
percentage of total revenues, such costs decreased to 19% during the 2003 Three
Month Period, from 27% in the prior 2002 Three Month Period.
Depreciation and amortization expense for the 2003 Three Month Period
decreased to approximately $689,000 from approximately $912,000 for the 2002
Three Month Period. This decrease is primarily attributable to the March 2003
sale of depreciable assets relating to the non-emergency Transportation
contracts sold to First Transit Inc.
Interest income for the 2003 Three Month Period increased to
approximately $48,000 from approximately $10,000 for the 2002 Three Month
Period. Interest expense for the 2003 Three Month Period was approximately
$316,000, as compared to $641,000 during the 2002 Three Month Period. This
decreased expense is a result of interest on the short-term convertible notes
payable incurred during the 2002 Three Month Period that did not recur during
the 2003 Three Month Period. The decrease was offset by $187,000 of interest
accrued on the DynCorp note during the 2003 Three Month Period that did not
incur in the 2002 Three Month Period. The interest from the Foothill line of
credit borrowings decreased $19,000 during the 2003 Three Month Period due to
lower average borrowings.
We recognized our pro-rata portion of the losses incurred by an
affiliate, LaborSoft, in the amount of $10,000 during the 2003 Three Month
Period compared to $28,000 during the 2002 Three Month Period. The decrease is a
result of the improvement of LaborSoft's operations. Such losses have reduced
the carrying value of our investment in LaborSoft to $63,000 at March 31, 2003.
Net income was $1,190,000 for the 2003 Three Month Period, as compared
to a loss of $2,642,000 for the 2002 Three Month Period. The loss reduction of
$3,832,000 is attributed primarily to the 2003 write off of the debt to the
State of California of $1,861,000, to a decrease of selling and G&A expenses.
The nine months ended March 31, 2003 (the "2003 Nine
Month Period") as compared to the nine months
ended March 31, 2002 (the "2002 Nine Month Period").
Revenues for the 2003 Nine Month Period decreased to approximately $
38,000,000 from approximately $ 40,329,000 for the 2002 Nine Month Period. The
revenue mix from product sales and services was 43% and 57%, respectively, for
the 2003 Nine Month Period, as compared to 51% and 49%, respectively, for the
2002 Nine Month Period. This change in revenue mix is primarily due to the
increased service revenues from expanded service offerings following the
acquisition of DMR in December 2001, which include the DMR business for a larger
period of the 2003 Nine Month Period than the 2002 Nine Month Period.
Cost of revenues for the 2003 Nine Month Period decreased to
approximately $30,685,000 from approximately $31,799,000 for the 2002 Nine Month
Period. The overall gross margin percentage decreased to 19% for the 2003 Nine
Month Period from 21% for the 2002 Nine Month Period.
Selling, general and administrative expenses for the 2003 Nine Month
Period decreased to approximately $7,713,000 from approximately $10,648,000 for
the 2002 Nine Month Period. The Company has realized cost savings from
consolidating administration centers, personnel and management that were assumed
in the December 27, 2001 merger of DMR and from discontinued operations. As a
percentage of total revenues, such costs decreased to 20% during the 2003 Nine
Month Period, from 26% in the prior 2002 Nine Month Period.
-16-
There were no product development expenses for the 2003 Nine Month
Period compared to approximately $492,000 for the 2002 Nine Month Period. This
is due to a restructuring of the Company to reduce software development
activities related to new products, notwithstanding the continuation of normal
software development services provided to customers under ongoing service
agreements. Depreciation and amortization expense for the 2003 Nine Month Period
increased to approximately $2,101,000 from approximately $2,022,000 for the 2002
Nine Month Period. This increase is primarily attributable to the addition of
amortizable intangible assets recorded in the December 27, 2001 merger of DMR.
Interest income for the 2003 Nine Month Period increased to
approximately $64,000 from approximately $31,000 for the 2002 Nine Month Period.
This increase is attributable to interest earned on interest-bearing
investments. Interest expense for the 2003 Nine Month Period was approximately
$905,000, as compared to $2,267,000 during the 2002 Nine Month Period. This
decrease in interest expense was a result of a decrease in interest on short
term notes payable, which included non-cash charges for the beneficial
conversion feature ($916,000) and the amortization of debt discount ($590,000).
Such decrease was offset by an increase in interest expense from the DynCorp
Note in the amount of approximately $510,000 during the 2003 Nine Month Period.
During the quarter ended December 31, 2001, marketable securities were
sold, for net proceeds of $ 362,000 and a recognized loss of $1,241,000, of
which $980,000 was previously provided as a valuation reserve as unrealized loss
on securities. The Company has recognized its pro-rata portion of the losses
incurred by an affiliate, in the amount of $72,000 during the 2003 Nine Month
Period compared to $220,000 during the 2002 Nine Month Period.
The decrease in net loss to $1,465,000 for the 2003 Nine Month Period,
as compared to a loss of $8,376,000 for the 2002 Nine Month Period, is
attributed primarily to the 2002 loss on sale of marketable securities, interest
on the short-term convertible notes, write off of the state of California debt
and to the consolidation and decrease of selling and administrative expenses.
Liquidity and Capital Resources
As of March 31, 2003 the Company had a working capital deficiency of
approximately $9,136,000 compared to a working capital deficiency of $14,075,000
at June 30, 2002. This increase in working capital is primarily due to the
$6,450,000 asset sale to with First Transit (See Note 11 to the Condensed
Consolidated Financial Statements).
The credit agreement with Foothill Capital Corporation (the "Foothill
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 outstanding borrowings bear interest at
1% over Wells Fargo base rate (4.25% at March 31, 2003) with a minimum rate of
7%. The term of the agreement has been extended through March 31, 2004 under
similar terms. The Company's Subsidiary, DynTek Services is required to maintain
certain financial covenants, based upon defined EBITDA, tangible net worth and
interest coverage ratio of the subsidiary.
The Company is not in compliance with the tangible net worth covenant as of
March 31, 2003 and other provisions of the Foothill Agreement, as well as the
terms of certain other indebtedness, all of which could result in the
acceleration of such indebtedness and which acceleration could have serious
consequences for the Company's business and operations (including foreclosure
against the Company's operating assets in the case of Foothill). However,
despite awareness of these breaches, none of the Company's creditors under the
Foothill Agreement or such instruments of indebtedness have acted to declare the
Company in default of it's obligations thereunder or taken steps to accelerate
and demand full payment for the Company's outstanding obligations. The Company
is in discussions with Foothill and such other creditors with respect to
arrangements for payment or other termination of such obligations, and the
-17-
Company believes that it has reached oral understandings with Foothill and such
other creditors that defaults under the subject instruments of indebtedness will
not be declared during the course of such ongoing discussions.
On March 14, 2003, the Foothill Agreement was amended in connection with the
consent for the asset sale of contracts to First Transit. Under the terms of the
amendment, the Company agreed to reduce the maximum outstanding loan balance to
$3,100,000 on March 14, 2003, to $2,750,000 on the date that the second payment
was received from First Transit; and shall reduce the maximum loan by $100,000
per week commencing April 21, 2003. At March 31, 2003 the outstanding loan
balance was $760,000, and the Company has complied with the terms of the amended
Agreement. The reductions in the maximum loan amount available under the
Foothill Agreement had resulted in an inability to borrow funds that would
otherwise be available based on the existing collateral represented by
receivables. Prior to such loan amount reductions as of March 31, 2003,
additional borrowings of approximately $1,500,000 would have been available.
The Company is actively involved in negotiating an alternative lending
agreement, which will be collateralized by its accounts receivables. Expressions
of interest with acceptable terms have been received from several institutions.
While there is no assurance that such negotiations will be successful,
management believes that an alternative agreement will be secured in the near
future.
During the quarter ended March 31, 2003 the Company made payments of $206,000
due on a judgment that was entered against Data Systems in favor of J. Alan
Moore in Mecklenburg County Superior Court Division, North Carolina on July 28,
2000. The plaintiff was awarded a judgment of $572,000 plus reasonable attorney
fees and interest totaling $ 778,000. At March 31, 2003, $572,000 was
outstanding. Payments totaling $ 459,000 have been made subsequent to March 31,
2003. As of May 9, 2003 $113,000 remained due.
On December 31, 2002, the Company settled all amounts due of approximately
$713,000 net of a related receivable of $187,000, under the previous agreement
to purchase the assets of Exodus Communications, Inc. ("Exodus") for a total
amount of $100,000, payable over three months ending March 31, 2003. As of March
31, 2003, $75,000 remains due and payable under this agreement.
Due to the expiration of the statute of limitations to obtain a judgment against
the Company; a liability carried on its books since 1995 has been written off as
of March 31, 2003, along with the accrued interest. In connection with the
write-off, the company recorded other income of $1,862,000, and offset interest
expense in the amount of $52,000. The liability was originally recorded as a
result of audit findings 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, as a result of an audit by the
California State Controller's Office, Division of Audits, which was conducted on
behalf of the California Department of Health Services. On January 26, 2000, the
California Court of Appeals upheld the audit findings, but the California
Department of Health Services never filed an action to collect the amount in
question.
On October 11, 2002, Merisel Americas, Inc. filed a breach of contract complaint
in Superior Court of California, Southwest District. The complaint arose from
the Company's failure to make payments within the terms of the reseller
agreement. The Company does not dispute the claim of $483,000 and is negotiating
payment terms. This amount is included in the Company's accounts payable.
We may expand the scope of our product offerings by pursuing acquisition
candidates with complementary technologies, services or products. Should we
commence such acquisitions, we anticipate that we would finance the transactions
with a combination of working capital and the issuance of additional equity
securities. There can be no assurance, however, that we will be successful in
identifying appropriate acquisition candidates or that, if appropriate
candidates are identified, that we will be successful in obtaining the necessary
financing to complete the acquisitions.
-18-
We have 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, cash received in 1999 from the sale of discontinued operations,
cash received from DynCorp in settlement of issues resulting from the DMR merger
and cash received from the divesting of non-emergency transportation business to
First Transit, Inc. We received an explanatory paragraph about our ability to
continue as a going concern from our auditors in connection with the audit of
our financial statements for the 2002 fiscal year end and since the end of the
2002 fiscal year we have continued to generate losses from our continuing
operations and negative cash flows from our operations. During the next 12
months, we will be required to make payments that may exceed the positive cash
flows that may be generated from operations. We are planning to negotiate
extended payment terms wherever possible, including with respect to the Moore
judgment, the payments to Virginia transportation vendors, and Merisel America.
However, there is no assurance that extended payment terms offered by us will be
acceptable.
The Company is in active negotiations to replace the credit facility with
Foothill. Expressions of interest with acceptable terms have been received from
several institutions. While the Company believes that alternative financing will
be available at acceptable terms, there is no guarantee that such financing, or
the terms thereof, will be available. Our inability to gain financing would have
a material adverse effect on our business and future prospects.
As additional funds are necessary, we would consider divesting long-term
contracts or business components that are not core to our business expansion
plans, reducing the scope of our operations and business development efforts
requiring investment, or seeking other forms of financing. Should we not
generate sufficient cash flow from operations to support our ongoing
obligations, or if we are unable to arrange successfully for extended payment
terms for those obligations to obtain financing from some other source, or to
arrange compromises, amendments, terminations or waivers of obligations as
necessary, our continuing operations will be severely compromised.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Foothill Agreement exposes the Company to the risk of earnings or cash flow
loss due to changes in market interest rates. The Foothill Agreement accrues
interest at 1% over Norwest Bank prime (4.25% at March 31, 2003) with a minimum
rate of 7%.
The table below provides information on the Foothill Agreement as of December
31, 2002.
- ------------------------------ --------------------- ------------------------------------------
Weighted Average
Principal Balance Interest Rate at December 31, 2002
----------------- ----------------------------------
- ------------------------------ --------------------- ------------------------------------------
Revolving credit facility $ 760,000 7%
- ------------------------------ --------------------- ------------------------------------------
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation as of a date within 90 days of the filing of this Form
10-Q, our Chief Executive Officer and Chief Financial Officer have concluded
that the our disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports that the company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. There have been no significant changes in
our internal controls or in other factors that could significantly affect those
controls subsequent to the date of their evaluation.
-19-
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Effective December 15, 2002 the Company entered into a mutual Settlement
Agreement to cancel a contract to provide non-emergency transportation brokerage
services in certain regions of the Commonwealth of Virginia. The terms of the
Settlement Agreement provide that the Company issue certain payments due to
transportation provider vendors according to an agreed-upon schedule, which
extends through June 2003. The Company has included the third-party
transportation provider liabilities in its accounts payable as of March 31,
2003, and believes that it is in compliance with the terms of the Settlement
Agreement. Several of the vendors that provided transportation services in the
Commonwealth of Virginia have initiated legal demands for payment. Some of the
demands, either in whole or in part, have been disputed by the Company as being
without merit. As of May 6, 2003 actions for collection have commenced in 6
separate proceedings. Ali Medical,et.al, a joint case of 23 providers for
approximately $950,000, is the largest of the claims. On April 28, 2003, the
Company removed this matter from the Circuit Court of the City of Richmond,
Virginia to the United States District Court for the East District of Virginia.
The Company has filed a Motion for a More Definitive Statement for the basis of
the joining of the plaintiffs to a single claim. The remaining 5 proceedings are
for an aggregate amount of approximately $767,000 a portion of which has been
disputed based on billings for services that were not provided under the
agreements or on billings which were outside the terms of the subcontracts, and
each of such cases is based upon distinct factual allegations. The Company
believes that these 6 claims will be fully resolved following evaluation of the
claims against those services authorized by the Company and those rates
permitted in subcontracts.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 of
Steven Ross
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 of
Steven Ross
(b) Reports on Form 8-K
Current Report on Form 8-K filed March 18, 2003, in connection
with the disposition of assets, Asset Purchase Agreement with
First Transit Inc.
-20-
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DYNTEK, INC.
By:/s/James Linesch
--------------------
James Linesch
Chief Financial Officer
Date: May 20, 2003
-21-
CERTIFICATIONS
I, Steven J. Ross, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DynTek, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 20, 2003
By: Steven J. Ross
----------------------------
Steven J. Ross
Chief Executive Officer
-22-
I, James Linesch, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DynTek, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 20, 2003
By: /s/ James Linesch
-----------------------------
James Linesch
Chief Financial Officer
-23-