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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 December 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
DYNTEK, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 95-4228470
-------- ----------
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
18881 Von Karman Avenue, #250
Irvine, CA 92612
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (949) 955-0078
--------------
Indicate by check whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filings
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares outstanding of the issuer's Class A Common Stock,
$.0001 par value, as of February 1, 2004 was 46,761,572.
DYNTEK, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION Page
Number
------
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - December 31, 2003 (unaudited)
and June 30, 2003 3
Condensed Consolidated Statements of Operations and Comprehensive Loss
(unaudited) - For the Three Months and Six Months Ended December 31,
2003 and 2002 4
Condensed Consolidated Statements of Cash Flows (unaudited) - For the
Six Months Ended December 31, 2003 and 2002 5 - 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7 - 16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 17 - 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 23-24
Item 6. Exhibits and Reports on Form 8-K 24-25
SIGNATURE 26
-2-
PART 1 - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS December 31, June 30,
2003 2003
------------ --------
CURRENT ASSETS: (unaudited)
Cash - Restricted 941 920
Accounts receivable, net of allowance for doubtful accounts of $139 and $463 6,608 9,370
Inventories 513 351
Prepaid expenses and other assets 98 151
Other receivables 120 122
-------- --------
TOTAL CURRENT ASSETS 8,280 10,914
RESTRICTED CASH - over one year 210 317
INVESTMENTS - Marketable Securities 199 282
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $3,004 and $2,904 640 624
GOODWILL 28,214 31,214
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $701 and $594 375 483
ACQUIRED CUSTOMER LIST, net of accumulated amortization of $6,008 and $4,955 6,549 7,602
PURCHASED SOFTWARE, net of accumulated amortization of $584 and $498 106 192
NOTES RECEIVABLE, long term, including receivable from officer of $100, net of
allowance for doubtful accounts of $200 517 1,204
DEPOSITS AND OTHER ASSETS 1,377 295
-------- --------
$ 46,467 $ 53,127
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,922 $ 11,714
Line of credit 1,887 708
Accrued expenses 1,571 2,271
Deferred revenue 924 981
Notes payable-accrued interest -- 625
Current liabilities of discontinued operations 4,803 5,888
-------- --------
TOTAL CURRENT LIABILITIES 18,107 22,187
DEFERRED REVENUE - long term 210 317
LONG TERM NOTE PAYABLE -- 5,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized; 1,231,331
and 1,490,437 shares issued and outstanding as of December 31, 2003 and
June 30, 2003, respectively 1 1
Class A Common stock, $.0001 par value, 70,000,000 shares authorized;
46,720,235 shares and 38,382,705 shares issued and outstanding as of
December 31, 2003 and June 30, 2003 respectively 4 4
Additional paid-in capital 91,525 81,918
Accumulated other comprehensive loss (148) (244)
Accumulated deficit (63,232) (56,056)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 28,150 25,623
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 46,467 $ 53,127
======== ========
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 Six Months Ended
December 31, December 31,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUES:
Product Revenues $ 3,470 $ 4,963 $ 9,063 $ 11,125
Service Revenues 6,331 6,877 13,664 14,863
------------ ------------ ------------ ------------
Total revenues 9,801 11,840 22,727 25,988
------------ ------------ ------------ ------------
COST OF REVENUES:
Cost of products 3,086 4,094 8,047 9,361
Cost of services 5,362 5,770 11,042 11,814
------------ ------------ ------------ ------------
Total cost of revenues 8,448 9,864 19,090 21,175
------------ ------------ ------------ ------------
GROSS PROFIT 1,353 1,976 3,637 4,813
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling expenses 1,817 1,310 3,639 3,437
General and administrative expenses 1,259 904 2,113 1,988
Depreciation and amortization 668 704 1,341 1,412
Goodwill Impairment 3,000 -- 3,000 --
------------ ------------ ------------ ------------
Total operating expenses 6,744 2,918 10,093 6,837
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (5,391) (942) (6,456) (2,024)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of marketable securities -- -- (107) --
Interest expense (147) (420) (502) (585)
Interest income 88 3 93 16
Equity interest in loss of investee -- (34) -- (62)
------------ ------------ ------------ ------------
Total other income (expense) (59) (451) (516) (631)
LOSS FROM CONTINUING OPERATIONS $ (5,450) $ (1,385) $ (6,972) $ (2,655)
DISCONTINUED OPERATIONS
Gain (loss) on disposal of discontinued operations (30) 177 (205) 262
------------ ------------ ------------ ------------
NET LOSS $ (5,480) $ (1,208) $ (7,177) $ (2,393)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE: Basic and Diluted
Continuing Operations (.12) (.04) (.16) (.07)
Discontinued Operations -- .01 (.01) .01
------------ ------------ ------------ ------------
$ (.12) $ (.03) $ (.17) $ (.06)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION -
Basic and Diluted 44,102,624 35,461,592 43,345,273 37,053,818
============ ============ ============ ============
NET LOSS $ (5,480) $ (1,208) $ (7,177) $ (2,393)
COMPREHENSIVE LOSS, NET OF TAX
Change in unrealized gain (loss) on available-for-sale-
securities 22 (52) 96 (47)
------------ ------------ ------------ ------------
COMPREHENSIVE LOSS $ (5,458) $ (1,260) $ (7,081) $ (2,441)
============ ============ ============ ============
See notes to condensed consolidated financial statements
-4-
DYNTEK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Six months ended
December 31,
------------------
2003 2002
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss - Continuing Operations $(6,971) (2,656)
------- -------
Adjustments to reconcile net loss, excluding discontinued operations, to
net cash provided by (used in) operating activities:
Depreciation and amortization 1,245 1,304
Amortization of capitalized software costs 108 108
Equity interest in investee -- 62
Loss on sale of marketable securities 107 --
Interest on note payable -- 260
Settlement of future royalties, net -- (425)
Impairment of goodwill 3,000
State audit assessment -- 34
Changes in operating assets and liabilities:
Accounts receivable 2,345 4.184
Inventories (162) 720
Prepaid expenses and other current assets 55 (5)
Deposits and other assets 22 79
Accounts payable (2,792) (3,781)
Deferred revenue (57) (463)
Restricted cash (21) (90)
Accrued expenses (694) (894)
------- -------
Total adjustments 3,156 1,093
NET CASH (USED IN) CONTINUING OPERATIONS (3,827) (1,563)
------- -------
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS (1,301) 4,835
------- -------
NET CASH (USED IN) PROVIDED BY OPERATIONS (5,116) 3,272
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Notes Receivable -- 311
Cash proceeds from sale of marketable securities 71 --
Capital expenditures (116) (6)
------- -------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (45) 305
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds (repayments) under bank line of credit 1,179 (3,569)
Net Cash proceeds from the issuance of common stock 3,982 (8)
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 5,161 (3,577)
------- -------
NET INCREASE (DECREASE) IN CASH -- --
CASH AT BEGINNING OF YEAR -- --
------- -------
CASH AT END OF PERIOD $ -- $ --
======= =======
See notes to condensed consolidated financial statements
-5-
DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands, except share data)
Six months
ended
December 31,
---------------
2003 2002
------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 355 $ 291
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:
Forgiveness by shareholders of note payable and accrued interest $5,625 $ --
Buyback of common stock in conjunction with note payable $ -- $5,000
Exchange of note receivable for 300,000 shares of common stock $ -- $ 430
See notes to condensed consolidated financial statements
-6-
DYNTEK, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003
(UNAUDITED)
1. Basis of Presentation and Management's Liquidity Plans
The accompanying unaudited condensed consolidated financial statements of
DynTek, Inc. and Subsidiaries ("DynTek", "the Company", or "we") have been
prepared in accordance with accounting principles generally accepted in the
United State of America, 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 condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and related
footnotes for the year ended June 30, 2003 included in the Form 10-K for the
year then ended.
The accompanying condensed consolidated financial statements reflect all
adjustments, which, in the opinion of management consist of normal recurring
items, 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 condensed consolidated financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses. The results of operations
for any interim period are not necessarily indicative of the results attainable
for a full fiscal year.
As of December 31, 2003, the Company had a working capital deficiency of
approximately $9.8 million. During January 2004, the Company received proceeds
from a convertible debt placement of $3.5 million.
The Company during fiscal 2004 is planning further reductions of administrative
overhead expenses as well as pursing new business opportunities and expansion of
services offered to customers. The Company believes that its present cash on
hand as well as obtaining additional debt and/or equity financing should provide
adequate funding through December 31, 2004. However, there can be no assurances
that the Company will have sufficient funds to implement its current plan. In
such an event, the Company could be forced to significantly alter its plan and
reduce its operating expenses or would consider divesting of certain contracts
or other assets that may not be critical to the future success of the Company.
2. Accounting Policies
The accounting policies followed by the Company are set forth in Note 1 to the
Company's consolidated financial statements as filed in its Form 10-K for the
year ended June 30, 2003.
During the current fiscal year the Company adopted, the Statement of Financial
Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
addresses certain financial instruments that, under previous guidance, could be
accounted for as equity, but now must be classified as liabilities in statements
of financial position. These financial instruments include: (1) mandatorily
redeemable financial instruments, (2) obligations to repurchase the issuer's
equity shares by transferring assets, and (3) obligations to issue a variable
number of shares. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. There was
no effect on the condensed consolidated financial statements from the adoption
of this pronouncement.
-7-
3. Marketable Securities
Marketable securities have been classified as available for sale securities at
December 31, 2003 and, accordingly, the unrealized loss resulting from valuing
such securities at market value is reflected as a component of stockholders'
equity. At December 31, 2003, the unrealized loss on such securities was
$148,000.
4. Note Receivable
On October 3, 2003, the Company received 1,000 shares of Non-Voting Convertible
Preferred Stock from Private Label Cosmetic, Inc. ("PLC") in exchange for their
surrender to PLC of a note receivable in the amount of $1,104,000 which is
included in other assets. The shares of preferred stock are convertible at the
Company's option into 306 shares of common stock of PLC. Such shares have been
placed in escrow in connection with the Stock Pledge Agreement and shall remain
there for such conversion. Commencing the quarter ended March 31, 2005, these
shares of preferred stock become entitled to receive a dividend of $10,000 per
quarter, payable at the end of the quarter.
5. Goodwill and Other Intangibles
The Company evaluates the recoverability of its goodwill and other intangibles
in accordance with the Statement of Financial Accounting Standards Board
("SFAS") No. 142, Goodwill and Other Intangible Assets. As of December 31, 2003,
goodwill associated with certain child support enforcement outsource services
contracts was evaluated for impairment. Due to a re-focus of business strategy,
the Company has determined that the projected revenues from contract renewals in
the future will be lower and as a result, the Company has determined in
accordance with the provisions of SFAS No. 142, that there has been impairment
of goodwill requiring an adjustment of $3,000,000 to reduce the carrying value
of goodwill. The Company will be conducting its annual test of existing goodwill
at June 30, 2004. The results of this annual testing of goodwill will determine
if further adjustments to reduce the carrying value are required.
6. Credit Facility
On June 30, 2003, the Company entered into a 12 month credit facility agreement
with annual automatic renewals (the "Textron Factoring Facility") with an agency
of Textron Financial Corporation ("Textron"). The Textron Factoring Facility
provides a full notification factoring facility for up to $7 million of working
capital collateralized by accounts receivable, inventory, general intangibles
and other assets. Eligible accounts receivable expected to be collected within
90 days are purchased with recourse, with a holdback amount of 15%. Interest is
charged on the outstanding balance at Prime rate plus 2.5% (6.5% at December 31,
2003). Additionally, a 0.25% discount fee is charged at the time of purchase.
The Textron Factoring Facility replaced the former agreement with Foothill
Capital. As of December 31, 2003, $1,887,000 was outstanding under the
agreement.
-8-
7. Commitments, Contingencies, and Other Agreements
COMMONWEALTH OF VIRGINIA
Effective December 15, 2002, the Company entered into a mutual Settlement
Agreement to cancel a contract to provide non-emergency transportation brokerage
services in certain regions of the Commonwealth of Virginia. The terms of the
Settlement Agreement provided that the Company make payments to transportation
provider vendors according to an agreed-upon schedule, which expired in June
2003. This was extended under an interim letter understanding. In connection
with initially entering into the contract, a performance bond was posted by a
third party guarantor to guarantee payment to the transportation provider
vendors up to the bond amount of $2.4 million. A number of such vendors caused
the bond to be called, requiring the bond amount to be deposited in an escrow
account and initiating a process of disbursing the $2.4 million to vendors with
valid claims. The bonding company filed an inter-pleader action on July 22,
2003. In a separate transaction, the Company has entered into a limited release
of indemnification to reimburse the guarantor for funding the bond. As a result,
the Company's liability to such vendors will in effect be extinguished to the
extent of the funds disbursed. The amount of $2.4 million deposited in escrow
for the payment to the Company's vendors has not yet been recorded as an offset
to the Company's accounts payable. When the individual claims are determined for
each vendor, in accordance with court procedures, the inter-plead funds shall be
disbursed and the payable shall be reduced accordingly. Should valid claims
remain outstanding after the disbursement of the inter-pleader funds, certain
vendors may continue to pursue their claims after the inter-pleader proceedings
are concluded, however, such claims may not exceed the amounts determined by the
courts to be due. The courts are currently in the process of assembling the
amounts of the claims due. The Company believes a substantial amount of these
claims are without merit based on billings for services that were not provided
under the agreements or on billings which were outside the terms of the
subcontracts, or may already have been settled with claimants. Since August
2003, the Company has made payments in the aggregate amount of approximately
$100,000 per month to various providers. As of December 31, 2003, the Company
paid $534,000 to providers as a result of this offer.
A number of the vendors that provided transportation services in the
Commonwealth of Virginia have initiated separate legal demands for payment. Some
of the demands, either in whole or in part, have been disputed by the Company as
being without merit or have been settled. As of December 31, 2003, actions for
collection are pending in 12 separate proceedings. Ali Medical,et.al, a joint
case of 27 providers for approximately $1,042,000 is the largest of the claims.
The Ali Medical joint case was consolidated with the above-referenced
inter-pleader action for all purposes. The Ali Medical claimants are considered
cross-claimants in the inter-pleader action. In addition to the Ali Medical
claimants, an additional six defendants in the inter-pleader action have filed
cross-claims for an aggregate amount of approximately $449,000. The remaining 11
proceedings which claim an aggregate amount of approximately $669,000 have been
temporarily stayed by an order of the court overseeing the inter-pleader action.
In both the outside lawsuits and the cross-claims all or a portion of the
amounts claimed have been disputed.
Provisions in the Company's condensed consolidated financial statements for the
estimated settlement amounts for these and other potential similar claims are
considered adequate; however, the Company is unable to predict the outcome of
these claims.
-9-
OTHER AGREEMENTS
On April 7, 2003 Westcon, Inc. filed a breach of contract complaint in the
Supreme Court of New York State, County of Westchester. The complaint arose from
the Company's failure to make payments within the terms of the reseller
agreement. The Company does not dispute the amount due of $ 413,000 and is
currently negotiating payment terms. Such amount is included in the Company's
accounts payable.
On July 7, 2003, a Settlement Agreement was reached in a matter brought by
Computer Associates International, Inc. against the City of Boston, in United
States District Court, District of Massachusetts (Case Number 01-10566-EFH), in
which the Company was named as a third-party defendant. Under the Agreement, the
parties mutually released each other from any further claims on this matter.
Effective October 8, 2003, the Company and James Linesch, its Chief Financial
Officer, entered into an Amendment to Employment Agreement, with respect to his
Employment Agreement dated August 14, 2000 as previously amended on August 15,
2001. Under the revised terms, the Company reduced Mr. Linesch's salary from an
annual rate of $200,000 to $150,000 effective November 1, 2003. On November 1,
2004, his salary shall be further reduced to an annual rate of $100,000 for one
year, and the Employment Agreement shall terminate on October 31, 2005 without
further obligation by the Company.
On October 16, 2003, the board of directors approved an increase in the base
salary of Steven J. Ross, its Chief Executive Officer, from $400,000 to $440,000
effective October 1, 2003.
On November 4, 2003, New England Financial filed a breach of contract complaint
in Orange County Superior Court of California. The complaint arose from the
cancellation of a contract for health insurance benefits and non payment of
remaining fees. The claim is for $ 534,000 of which the company partially
disputes and is currently negotiating settlement terms.
8. Other Settlements
On October 11, 2002, Merisel Americas, Inc. ("Merisel") 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. In July 2003, the Company entered into an agreement with
Merisel to repay the liability and accrued interest and expenses, with an
obligation to make payments over the next 12 months in an aggregate amount of
$567,000 which is included in accounts payable. As of December 31, 2003 $267,000
of this amount remained outstanding.
As of December 31, 2003, $20,000 remains due and payable under a settlement
agreement with Exodus Communications, Inc. The Company is making progress
payments to pay off this liability by the end of February, 2004.
9. First Transit Agreement
On March 1, 2003, the Company entered into an Asset Purchase Agreement (the
"First Transit Agreement") with First Transit, Inc. ("First Transit"), pursuant
to which it sold to First Transit certain specific assets relating to its
discontinued transportation management business originally acquired in December
2002. The assets sold consisted of interests in three contracts to provide
non-emergency transportation related services and related assets used in
connection with the performance of such contracts, as well as the assumption of
all vendor and services sub-contract agreements relating to the acquired
contracts. The purchase price consisted of cash payments of $6,450,000 and an
obligation for First Transit to pay up to $1,750,000 in the event that First
Transit is able to obtain extension of the Company's former Illinois Department
of Public Aid transportation services contract for a period of up to three years
beyond May 31, 2004 under certain specified conditions.
-10-
10. Stock Based Compensation
During the year ended June 30, 2003, the Company adopted SFAS 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 (APB) No. 25, "Accounting for Stock Issued
to Employees." As required under Statement No. 148, the following table presents
pro- forma net loss and basic and diluted loss per share as if the fair
value-based method had been applied to all awards.
Three Months Ended Six Months Ended
------------------ ------------------
Periods Ended December 31, 2003 2002 2003 2002
- -------------------------- ------ ------ ------ ------
Net Loss $5,480 $1,208 $7,177 $2,393
Stock-based employee compensation
cost, net of tax effect, under
fair value accounting 9 49 18 98
------ ------ ------ ------
Pro-forma net loss under Fair Value
Method $5,489 $1,257 $7,195 $2,491
====== ====== ====== ======
Loss per share
Basic and Diluted $ .12 $ .03 $ .17 $ .06
Per share stock-based employee
compensation cost, net of tax
effect, under fair value
accounting $ -- $ -- $ -- $ --
------ ------ ------ ------
Pro-forma loss share basic & diluted $ .12 $ .03 $ .17 $ .06
====== ====== ====== ======
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
2004 grants 2003 grants
----------- -----------
Dividend yield -- --
Weighted average expected life: 3 years 3.6 years
Weighted average risk-free interest rate 1.79% 2.5%
Expected volatility 89% 136%
-11-
11. Stockholders' Equity
On August 14, 2001, the Company's preferred stock became convertible into the
Company's Class A common stock, at a rate of 2.5 common shares for each
preferred share tendered. As of December 31, 2003, 958,469 of such shares were
converted into 2,396,173 shares of Class A common stock, with a remainder of
1,231,331 shares not yet converted.
On July 3, 2003, an investor group cancelled a note payable by the Company of $5
million plus accrued interest of $625,000 which was recorded as an increase to
additional paid-in-capital. The note was acquired by the group in connection
with their private purchase of 10,336,663 shares of the Company's Common Stock
from DynCorp, Inc. The investor group also cancelled a warrant to acquire
7,500,000 shares of Company Common Stock that they acquired in the same
transaction.
In July 2003, the Company sold 4,198,000 shares of its Common Stock at $0.50 per
share, for aggregate proceeds, net of costs, of approximately $1.8 million.
On October 9, 2003, the Company issued 50,000 shares of its Common Stock as
payment of an outstanding payable for services rendered in connection with the
DynCorp Management Acquisition on December 27, 2001.
On October 16, 2003, the Company issued 108,434 shares of its Common Stock
valued at $90,000 in connection with the April 1, 2003 Asset Purchase Agreement
with Entellus Technology Group.
Under agreements dated as of December 5, 2003, the Company entered into a series
of agreements, including a Securities Purchase Agreement and a Registration
Rights Agreement, in connection with a private placement of shares of the
Company's common stock, par value $0.0001 per share ("Common Stock"), at a price
equal to $0.66 per share for an aggregate gross purchase price of $2,200,000. On
December 9, 2003, the Company closed the private placement and issued 3,333,333
shares of Common Stock to the purchasers and two tranches of common stock
purchase warrants. One tranche to purchase up to 20% of the Common Stock issued
at an exercise price equal to $1.00 per share (the "20% Investor Warrants") and
the other tranche to purchase up to 30% of the Common Stock issued at an
exercise price equal to $0.75 per share (the "30% Investor Warrants"). Both the
20% Investor Warrants and the 30% Investor Warrants are exercisable immediately
at closing and have a five-year term of exercise. In addition, the placement
agent received, placement agent fee (including expense reimbursement) of
$189,050 and placement agent warrants equal to 10% of the aggregate shares of
Common Stock issued on the closing date (and issuable under 20% Investor
Warrants and 30% Investor Warrants) at an exercise price of $0.91 per share.
Pursuant to an amendment to the above-identified Registration Rights Agreement
and Allonges to the 20% Investor Warrants granted by the Company, all dated as
of January 15, 2004, in connection with the permitted inclusion of 3,000,000
additional shares held by third parties is the registration statement filed
pursuant to the Registration Rights Agreement identified above, the exercise
price of the 20% Investor Warrants was reduced to $0.75 per share.
-12-
12. Earnings per Share
Basic earnings per share is computed on the basis of the weighted average number
of common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options using the "treasury stock method". Common
stock equivalents consisting of options, warrants, and convertible preferred
stock totaling 64,331,225 were not included in the calculation of diluted
earnings per share as the results would be anti-dilutive.
Total outstanding stock, options, convertible preferred stock and warrants as of
December 31, 2003 are as follows:
--------------------------------------------
Shares
Outstanding
-----------
Common stock 46,720,235
Options and warrants 14,532,662
Convertible preferred stock 3,078,328
----------
64,331,225
==========
13. Discontinued Operations
During 2003, the Company disposed of its non-emergency transportation business.
As of December 31, 2003, total remaining liabilities of discontinued operations
were $4,803,000. A significant portion of such payables are owed to third party
vendors and are subject to an inter-pleader action (see note 7 Commitments,
Contingencies and Other Agreements - COMMONWEALTH OF VIRGINIA).
14. Business Segments
DynTek's operations are organized along its product lines and include two
segments - Information Technology Services and Business Process Outsource
Services segments. The Information Technology Services segment provides a range
of specialized IT infrastructure services: system architectural design, legacy
systems integration, network engineering, applications development, network
security services, help desk support and operational support, primarily to state
and local government entities. In conjunction with these service offerings, it
also sells hardware and software to its customers. Operations are distributed
primarily among nine states (including the principal executive office),
California, Florida, Louisiana, Massachusetts, Michigan, Texas, New Mexico,
Virginia and New York, with employees situated in locations that are convenient
to client sites.
The Business Process Outsourcing segment contracts outsourced program operations
for state government agencies in several areas including the privatization of
child support enforcement services. Our business process outsourcing customers
have included various governmental departments in the states of Virginia, North
Carolina, Kansas and Nebraska. Typically these contracts are for multi-year
periods of performance, with options to renew for additional periods. Such
contracts are generally awarded through competitive procurements. Payment is
based on either fixed-price, fixed-unit- price based on contractual allocations,
revenue sharing, or a combination of the above.
Our reportable segments are business units that offer different services and
contract types and are managed separately due to the expertise and different
managed key factors in each area. Since the separate business 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):
-13-
Reportable Business Segments:
Business Information
Process Technology
Outsourcing Services Total
----------- -------- --------
Three months ended December 31, 2003
- ------------------------------------
Sales to external customers $ 2,302 $ 7,499 $ 9,801
Depreciation and amortization expense 111 557 668
Operating income (loss) (3,001) (2,390) (5,391)
Net interest expense (income) -- 59 59
Total assets 22,299 24,169 46,468
Capital expenditures -- 35 35
Three months ended December 31, 2002
- ------------------------------------
Sales to external customers $ 2,894 $ 8,946 $ 11,840
Depreciation and amortization expense 123 581 704
Operating income (loss) (260) (682) (942)
Net interest expense (income) 353 63 416
Total assets 28,175 25,925 54,100
Capital expenditures -- -- --
Six months ended December 31, 2003
- ----------------------------------
Sales to external customers $ 5,014 $ 17,713 $ 22,727
Depreciation and amortization expense 222 1,119 1,341
Operating income (loss) (3,137) (3,319) (6,456)
Net interest expense (income) -- 409 409
Total assets 22,299 24,169 46,468
Capital expenditures 78 38 116
Six months ended December 31, 2002
- ----------------------------------
Sales to external customers $ 5,356 $ 20,632 $ 25,988
Depreciation and amortization expense 244 1,168 1,412
Operating income (loss) (703) (1,321) (2,024)
Net interest expense (income) 447 140 587
Total assets 28,175 25,925 54,100
Capital expenditures 5 1 6
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. 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 December 31, 2003.
-14-
On September 30, 2003, the Company received additional security collateral for
its receivable from LaborSoft by obtaining a Promissory Note and Security
Agreement for the amount of $636,000 owed by LaborSoft for the value of
previously delivered services for which the Company has not been compensated.
Under the Promissory Note, LaborSoft shall pay interest on the amount, at the
prime rate (4.0% as of December 31, 2003), with the principal amount due on
September 21, 2006. Under the Security Agreement LaborSoft granted the Company a
security interest in the assets of LaborSoft including receivables, equipment,
software, and other intellectual property, inventory and other intangible assets
of LaborSoft. The Company maintains a reserve against this Promissory Note of
$200,000.
16. Subsequent Events
At a closing on January 29, 2004, the Company sold an additional $300,000 of
Common Stock, 30% Investor Warrants and 20% Investor Warrants to three
investors, becoming obligated to issue to the investors 454,545 shares of Common
Stock, 30% Investor Warrants to acquire 136,364 shares of Common Stock and 20%
Investor Warrants to acquire 90,909 shares of Common Stock, all on the same
terms as offered to the investors in the December 2003 private placement, as
amended by the January 15, 2004 Registration Right Agreement Amendment and
Allonges. The placement agent for this $300,000 offering received $24,000 in
cash and warrants, exercisable at $.091 per share, to acquire 68,182 shares of
Common Stock.
On January 30, 2004, DynTek closed the private placement of a $3,500,000
principal secured convertible three-year term note to an institutional investor,
Laurus Funds. This note bears interest at the greater of the Prime Rate or 4%,
plus 1%, with interest payable monthly on a current basis commencing in March
2004 and level payments of principal commencing August 1, 2004. The note is
convertible to DynTek common stock at the option of the investor. Monthly
payments of principal and accrued interest under the note can be made by DynTek
delivering common stock shares instead, if at the time such stock payment is
delivered (i) there exists an effective registration statement covering the
distribution of such shares by the investor and (ii) the market price for such
shares is greater than 115% of $.90 per share, the price fixed for conversion to
common stock of amounts outstanding under the note. Subject to the same
restrictions on stock payments of monthly accrued interest and principal, the
entire principal and accrued interest of the note may be prepaid by DynTek in
common stock. Any amounts of note principal paid in cash, including prepayments
of the entire note principal, shall be subject to a 2% premium payment (which is
increased to a 4% premium payment in the event that an effective registration
statement covering the conversion shares is not in place). Principal and
interest under the note, and other obligations of DynTek to Laurus Funds under
the ancillary agreements entered into in connection with the private placement,
are secured by all assets of DynTek and its principal operating subsidiary. As
part of the transaction, the investor also received a five-year warrant to
purchase 425,000 shares of DynTek common stock, exercisable as follows: 125,000
shares at $1.1225 per share; 175,000 shares at $1.347 per share; and 125,000
shares at $1.5715 per share. DynTek paid to the investor's affiliate a closing
fee equal to $122,500, agreed to make renewal payments to such affiliate equal
to .5% of outstanding note principal on each anniversary of the closing and paid
$29,500 as reimbursement for the investor's legal and due diligence expenses.
Under the terms of its Investment Banking Advisory Agreement with Duncan
Capital, in connection with closing the Laurus Funds private placement the
Company became obligated (i) to pay to Duncan Capital a fee equal to $280,000
(8% of offering proceeds), $210,000 in cash and $70,000 in the form of 77,778
shares of DynTek common stock (at a value of $0.90 per share), and (ii) to issue
additional warrants to Duncan Capital to acquire 388,889 shares of DynTek common
stock at $0.99 per share.
-15-
As a result of a delay in filing a required registration statement with respect
to the distribution of Company Common Stock by certain investors, the Company
has agreed to issue warrants to such investors. When issued such warrants will
give the investors the right to acquire, in the aggregate, up to 2,596,558
shares of common stock at $0.75 per share, all of which underlying shares of
common stock are subject to registration rights.
17. Recent Accounting Pronouncements
The following pronouncements have been issued by the Financial Accounting
Standards Board ("FASB").
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have a
sufficient equity at risk for the entity to finance its activities without
additional financial support from other parties. FIN 46 is effective for all new
variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after December 15, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative instruments and Hedging Activities." This Statement amends and
clarifies SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement clarifies the accounting guidance on (1) derivative
instruments (including certain derivative instruments embedded in other
contracts) and (2) hedging activities that fall within the scope of the SFAS
No.133. SFAS No.149 also amends certain other existing pronouncements, which
will result in more consistent reporting of contracts that are derivatives in
their entirety or that contain embedded derivatives that warrant separate
accounting. SFAS No. 149 is effective (1) for contracts entered into or modified
after December 31, 2003, with certain exceptions, and (2) for hedging
relationships designated after December 31, 2003. The guidance is to be applied
prospectively.
Management does not believe that the adoption of any of these pronouncements
will have a material effect on the Company's condensed consolidated financial
statements.
-16-
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 Textron Factoring Facility when it becomes due or to replace it with
alternative financing, the ability to raise equity capital in the future,
despite historical losses from operations, 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
and the acquisition of other services and products. 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 December 31, 2003 (the "2003 Three Month Period") as
compared to the three months ended December 31, 2002 (the "2002 Three Month
Period").
Revenues for the 2003 Three Month Period decreased to $9,801,000 from
$11,840,000 for the 2002 Three Month Period. This decrease was associated with
decreased orders from customers, resulting primarily from reduced or delayed
information technology spending budgets during the period. The revenue mix of
product and services was 35% and 65%, respectively, for the 2003 Three Month
Period, as compared to 42% and 58%, respectively, for the 2002 Three Month
Period.
Cost of revenues for the 2003 Three Month Period decreased to $8,448,000 from
$9,865,000 for the 2002 Three Month Period, due to the decrease in revenue. The
overall gross margin percentage decreased to 14% for the 2003 Three Month Period
from 17% for the 2002 Three Month Period. This decrease in margin primarily
resulted from lower margins on software license sales .
-17-
Selling, general and administrative expenses for the 2003 Three Month Period
increased to $3,076,000 from $2,214,000 for the 2002 Three Month Period. The
increase is due primarily from an expansion in sales personnel in new geographic
regions and lines of business. As a percentage of total revenues, such costs
increased to 31% during the 2003 Three Month Period, from 19% in the prior 2002
Three Month Period.
Due to a re-focus of business strategy, the Company has determined that the
projected revenues from contract renewals in the future may be lower than in
prior projections, used for impairment analysis. As a result, the Company has
determined that there has been impairment of goodwill requiring an adjustment of
$3,000,000 to reduce the carrying value of goodwill for the outsourced
management business.
Depreciation and amortization expense for the 2003 Three Month Period decreased
to $668,000 from $704,000 for the 2002 Three Month Period.
Interest expense for the 2003 Three Month Period was $147,000, as compared to
$420,000 during the 2002 Three Month Period. Interest of $250,000 was attributed
to long term note payable in the 2002 Three Month Period which did not exist in
the comparable 2003 period. Interest from the credit facility borrowings
decreased $23,000 during the 2003 Three Month Period due to reduced fees on the
new Textron Factoring Facility entered into on June 30, 2003.
Net loss from continuing operations was $5,450,000 for the 2003 Three Month
Period, as compared to a net loss of $1,385,000 for the 2002 Three Month Period.
The increase in loss attributed primarily to factors identified above.
The six months ended December 31, 2003 (the "2003 Six Month Period") as compared
to the six months ended December 31, 2002 (the "2002 Six Month Period").
Revenues for the 2003 Six Month Period decreased to approximately $ 22,727,000
from approximately $ 25,988,000 for the 2002 Six Month Period. This decrease was
associated with decreased orders from customers, resulting primarily from
reduced or delayed information technology spending budgets during the period.
The revenue mix from product sales and services was 40% and 60%, respectively,
for the 2003 Six Month Period, as compared to 43% and 57%, respectively, for the
2002 Six Month Period.
Cost of revenues for the 2003 Six Month Period decreased to approximately
$19,089,000 from approximately $21,175,000 for the 2002 Six Month Period. The
overall gross margin percentage was 16% for the 2003 Six Month Period and 19%
for the 2002 Six Month Period. This decrease in margin primarily resulted from
lower margins on software license sales .
Selling, general and administrative expenses for the 2003 Six Month Period
increased to approximately $5,752,000 from approximately $5,425,000 for the 2002
Six Month Period. The increase is due primarily from an expansion in sales
personnel in new geographic regions and lines of business.
Due to a re-focus of business strategy, the Company has determined that the
projected revenues from contract renewals in the future may be lower than in
prior projections, used for impairment analysis. As a result, the Company has
determined that there has been impairment of goodwill requiring an adjustment of
$3,000,000 to reduce the carrying value of goodwill for the outsourced
management business during the 2003 Six Month Period.
-18-
Depreciation and amortization expense for the 2003 Six Month Period decreased to
approximately $1,341,000 from approximately $1,412,000 for the 2002 Six Month
Period.
Interest income for the 2003 Six Month Period increased to approximately $93,000
from approximately $16,000 for the 2002 Six Month Period. This increase is
attributable to the amount of interest earned on the interest-bearing investment
in Private Label Cosmetics. Interest expense for the 2003 Six Month Period was
approximately $502,000, as compared to $603,000 during the 2002 Six Month
Period.
During the six months ended December 31, 2003, marketable securities were sold,
for net proceeds of $ 71,000 and a recognized loss of $107,000, of which $81,000
was previously provided as a valuation reserve as unrealized loss on securities.
The Company had recognized its pro-rata portion of the losses incurred by an
affiliate, in the amount of $62,000 during the 2002 Six Month Period compared.
The increase in net loss to $6,972,000 for the 2003 Six Month Period, as
compared to a loss of $2,655,000 for the 2002 Six Month Period, is attributed
primarily to the reasons stated above.
RESULTS OF DISCONTINUED OPERATIONS
Net loss from discontinued operations was $30,000 for the 2003 Three Month
Period as compared to a net gain of $177,000 for the 2002 Three Month Period.
Net loss was approximately $ 205,000 for the 2003 Six Month Period compared to a
net gain of $ 262,000 for the 2002 Six Month Period. This is attributed to the
continued legal and facility costs of the discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2003, the Company had a working capital deficiency of
approximately $9,800,000. The Company anticipates a reduction in this deficiency
as its accounts payable are reduced due to disbursement of proceeds from a third
party's performance bond to certain former vendors to the Company.
The Company obtained a limited release of indemnification from DynCorp of its
obligation to pay to a bonding company, and limited release of the Company's
obligation to reimburse DynCorp for its obligation to fund, respectively, an
amount of approximately $2.4 million under a performance bond related to the
Company's discontinued transportation services business. As a result of being
released from its obligations with respect to indemnification under and
reimbursement with respect to the bond in an amount up to approximately $2.4
million the Company's liability to former providers whose service payments are
covered by the bond has in effect been reduced by approximately $2.4 million.
Such liability to the vendors is currently reflected in current liabilities from
discontinued operations, and will be eliminated from current liabilities from
discontinued operations as and to the extent that the bond proceeds are used to
satisfy those obligations to such vendors. When the individual claims are
determined for each provider, in accordance with court procedures, the
approximately $2.4 million subject to the bond will be disbursed. Should valid
vendor claims remain outstanding after disbursement of the approximately $2.4
million covered by the bond, certain providers may continue to pursue their
claims against the Company. While vendor actions with respect to the bond are in
process, the Company has offered to make payments in the aggregate of
approximately $100,000 per month, commencing in September 2003, to providers
with valid claims, until whatever shortfall amount as the Company determines to
exist in excess of the aggregate approximately $2.4 million is paid. Through
December 30, 2003, the Company has itself paid $534,000 to such providers.
-19-
On March 1, 2003, the Company entered into the First Transit Agreement with
First Transit, pursuant to which it sold to First Transit certain specified
assets relating to its discontinued transportation management business
originally acquired in December 2002. The assets sold consisted of interests in
three contracts to provide non-emergency transportation related services and
related assets used in connection with the performance of such contracts, as
well as the assumption of all vendor and services sub-contract agreements
relating to the acquired contracts. The purchase price consisted of cash
payments of $6,450,000 and an obligation to pay up to $1,750,000 in the event
that First Transit is able to obtain extension of the Company's former Illinois
Department of Public Aid transportation services contract for a period of up to
three years beyond May 31, 2004 under certain specified conditions.
On June 30, 2003, the Company entered into a 12 month renewable Textron Credit
Facility with an agency of Textron. The Textron Credit Facility provides a full
notification factoring facility for up to $7 million of working capital.
Eligible accounts receivable expected to be collected within 90 days from
invoice date are purchased with recourse, with a holdback amount of 15%.
Interest is charged on the outstanding balance at the Prime rate plus 2.5% (6.5%
at December 31, 2003). Additionally, a 0.25% discount fee is charged at the time
of purchase. The Textron Credit Facility replaced the former agreement with
Foothill Capital. As of December 31, 2003, $1,887,000 was outstanding under the
Textron Credit Facility.
Under agreements dated as of December 5, 2003, the Company entered into a series
of agreements, including a Securities Purchase Agreement and a Registration
Rights Agreement, in connection with a private placement of shares of the
Company's common stock, par value $0.0001 per share ("Common Stock"), at a price
equal to $0.66 per share for an aggregate gross purchase price of $2,200,000. On
December 9, 2003, the Company closed the private placement and issued 3,333,333
shares of Common Stock to the purchasers and two tranches of common stock
purchase warrants. One tranche to purchase up to 20% of the Common Stock issued
at an exercise price equal to $1.00 per share (the "20% Investor Warrants") and
the other tranche to purchase up to 30% of the Common Stock issued at an
exercise price equal to $0.75 per share (the "30% Investor Warrants"). Both the
20% Investor Warrants and the 30% Investor Warrants are exercisable immediately
at closing and have a five-year term of exercise. In addition, the placement
agent received, placement agent fee (including expense reimbursement) of
$189,050 and placement agent warrants equal to 10% of the aggregate shares of
Common Stock issued on the closing date (and issuable under 20% Investor
Warrants and 30% Investor Warrants) at an exercise price of $0.91 per share.
At a closing on January 29, 2004, the Company sold an additional $300,000 of
Common Stock, 30% Investor Warrants and 20% Investor Warrants to three
investors, becoming obligated to issue to the investors 454,545 shares of Common
Stock, 30% Investor Warrants to acquire 136,364 shares of Common Stock and 20%
Investor Warrants to acquire 90,909 shares of Common Stock, all on the same
terms as offered to the investors in the December 2003 private placement, as
amended by the January 15, 2004 Registration Right Agreement Amendment and
Allonges. The placement agent for this $300,000 offering received $24,000 in
cash and warrants, exercisable at $.091 per share, to acquire 68,182 shares of
Common Stock.
-20-
On January 30, 2004, DynTek closed the private placement of a $3,500,000
principal secured convertible three-year term note to an institutional investor,
Laurus Funds. This note bears interest at the greater of the Prime Rate or 4%,
plus 1%, with interest payable monthly on a current basis commencing in March
2004 and level payments of principal commencing August 1, 2004. The note is
convertible to DynTek common stock at the option of the investor. Monthly
payments of principal and accrued interest under the note can be made by DynTek
delivering common stock shares instead, if at the time such stock payment is
delivered (i) there exists an effective registration statement covering the
distribution of such shares by the investor and (ii) the market price for such
shares is greater than 115% of $.90 per share, the price fixed for conversion to
common stock of amounts outstanding under the note. Subject to the same
restrictions on stock payments of monthly accrued interest and principal, the
entire principal and accrued interest of the note may be prepaid by DynTek in
common stock. Any amounts of note principal paid in cash, including prepayments
of the entire note principal, shall be subject to a 2% premium payment (which is
increased to a 4% premium payment in the event that an effective registration
statement covering the conversion shares is not in place). Principal and
interest under the note, and other obligations of DynTek to Laurus Funds under
the ancillary agreements entered into in connection with the private placement,
are secured by all assets of DynTek and its principal operating subsidiary. As
part of the transaction, the investor also received a five-year warrant to
purchase 425,000 shares of DynTek common stock, exercisable as follows: 125,000
shares at $1.1225 per share; 175,000 shares at $1.347 per share; and 125,000
shares at $1.5715 per share. DynTek paid to the investor's affiliate a closing
fee equal to $122,500, agreed to make renewal payments to such affiliate equal
to .5% of outstanding note principal on each anniversary of the closing and paid
$29,500 as reimbursement for the investor's legal and due diligence expenses.
Under the terms of its Investment Banking Advisory Agreement with Duncan
Capital, in connection with closing the Laurus Funds private placement the
Company became obligated (i) to pay to Duncan Capital a fee equal to $280,000
(8% of offering proceeds), $210,000 in cash and $70,000 in the form of 77,778
shares of DynTek common stock (at a value of $0.90 per share), and (ii) to issue
additional warrants to Duncan Capital to acquire 388,889 shares of DynTek common
stock at $0.99 per share.
The Company anticipates continued improvement in its cash flows during fiscal
2004 by implementing reductions of administrative overhead expenses as well as
aggressively pursuing new customer relationships and expanding the services
offered to existing customers. The Company is also negotiating with vendors for
improved payment terms. The Company believes that its present cash on hand as
well as the additional debt and/or equity financing for which it is currently
negotiating should provide adequate funding through at least December 31, 2004.
However, there can be no assurances that the Company will have sufficient funds
to implement its current business plan. If sufficient funds are not available,
the Company could be forced to significantly alter its plan and reduce its
operating expenses or would consider divesting of certain contracts or other
assets that may not be critical to the future success of the Company.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's financial statements and accompanying notes are prepared in
accordance with accounting principles generally accepted in the United States.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. Critical accounting policies for us include
revenue recognition, impairment of investment securities, impairment of
goodwill, accounting for contingencies and accounting for discontinued
operations.
Basis of Presentation. During the fiscal year ended June 30, 2003, the Company
adopted a plan to sell our transportation brokerage operations. The operations
are accounted for as a discontinued operation, and, accordingly, amounts in the
consolidated financial statements and related notes for all periods presented
reflect discontinued operation accounting.
Revenue Recognition. The Company's policy follows the guidance from SEC Staff
Accounting Bulletin ("SAB") 101 "Revenue Recognition in Financial Statements".
SAB 101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. The Company recognizes revenues when persuasive
evidence of an arrangement exists, the product has been shipped or the services
have been provided to the client, the sales price is fixed or determinable, and
collectibility is reasonably assured.
-21-
Generally, information technology processing revenues are recognized as services
are provided to the client. Revenues from annual maintenance contracts services
provided by the Company are deferred and recognized ratably over the maintenance
period. Revenues from hardware sales are recognized upon delivery to the client
and when uncertainties regarding customer acceptance have expired. Revenues for
business process outsourcing services are recognized as services are rendered,
normally invoiced on a monthly basis. Revenues on unit-price contracts are
recognized at the contractual selling prices of work completed and accepted by
the client. Revenues on time and material contracts are recognized at the
contractual rates as the labor hours and direct expenses are incurred.
Collectibility of Receivables. A considerable amount of judgment is required to
assess the ultimate realization of receivables, including assessing the
probability of collection and the current credit worthiness of our clients.
Probability of collection is based upon the assessment of the client's financial
condition through the review of its current financial statements or credit
reports.
SFAS 142, Goodwill and Other Intangible Assets, The Company evaluates the
recoverability of its goodwill and other intangibles in accordance with the
Statement of Financial Accounting Standards Board ("SFAS") No. 142, Goodwill and
Other Intangible Assets. As of December 31, 2003, goodwill associated with
certain child support enforcement outsource services contracts was evaluated for
impairment. Due to a re-focus of business strategy, the Company has determined
that the projected revenues from contract renewals in the future will be lower
and as a result, the Company has determined in accordance with the provisions of
SFAS No. 142, that there has been impairment of goodwill requiring an adjustment
of $3,000,000 to reduce the carrying value of goodwill. The Company will be
conducting its annual test of existing goodwill at June 30, 2004. The results of
this annual testing of goodwill will determine if further adjustments to reduce
the carrying value are required.
RECENT ACCOUNTING STANDARDS
The following pronouncements have been issued by the FASB.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51." FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity if
the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional financial support from other
parties. FIN 46 is effective for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after December 15, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement clarifies the accounting guidance on (1) derivative
instruments (including certain derivative instruments embedded in other
contracts) and (2) hedging activities that fall within the scope of the SFAS
133. SFAS 149 also amends certain other existing pronouncements, which will
result in more consistent reporting of contracts that are derivatives in their
entirety or that contain embedded derivatives that warrant separate accounting.
SFAS 149 is effective (1) for contracts entered into or modified after December
31, 2003, with certain exceptions, and (2) for hedging relationships designated
after December 31, 2003. The guidance is to be applied prospectively.
-22-
Management does not believe that the adoption of any of these pronouncements
will have a material effect on the Company's condensed consolidated financial
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Textron Factoring Facility exposes the Company to the risk of earnings or
cash flow loss due to changes in market interest rates. The Textron Credit
Facility requires interest to be paid at 2.5% over the prime rate. The Laurus
Funds convertible secured term note exposes the Company to similar risks, and
requires interest to be paid at 1% over the prime rate. The table below provides
information on the Textron Credit Facility as of December 31, 2003 and the
Laurus Funds note as of February 1, 2004.
- --------------------------------------------------------------------------------
Weighted Average
Principal Balance Interest Rate
- --------------------------------------------------------------------------------
Factoring credit facility $ 1,887,000 6.5%
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Secured Convertible Note $ 3,500,000 5.0%
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ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of
the Company's management, including its Chief Executive Officer, or CEO and
Chief Financial Officer, or CFO, of the effectiveness of the Company's
disclosure controls and procedures as of December 31, 2003. Based on that
evaluation, the Company's management, including its CEO and CFO, have concluded
that the Company's disclosure controls and procedures are effective to ensure
that the information required to be disclosed in the Company filings or which it
submits under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. There have been no changes in the Company's
internal controls over financial reporting or in other factors identified in
this evaluation that occurred during the six months ended December 31, 2003 that
have materially affected, or are reasonably materially likely to affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
COMMONWEALTH OF VIRGINIA
Effective December 15, 2002, the Company entered into a mutual Settlement
Agreement to cancel a contract to provide non-emergency transportation brokerage
services in certain regions of the Commonwealth of Virginia. The terms of the
Settlement Agreement provided that the Company make payments to transportation
provider vendors according to an agreed-upon schedule, which extended through
June 2003. This was extended under an interim letter understanding. In
connection with initially entering the contract, a performance bond was posted
by a third party to guarantee payment to the transportation provider vendors up
to the bond amount of $2.4 million. A number of such vendors caused the bond to
be called, requiring the bond amount to be deposited in an escrow account and
initiating a process of disbursing the $2.4 million to vendors with valid
claims. The bonding company filed an inter-pleader action on July 22, 2003. In a
separate transaction, the Company has entered into a limited release of
indemnification to reimburse the guarantor for funding the bond. As a result,
the Company's liability to such vendors will in effect have been extinguished to
the extent of the funds disbursed. The amount of $2.4 million deposited in
escrow for the payment to the Company's vendors has not yet been recorded as an
offset to the Company's accounts payable. When the individual claims are
determined for each vendor, in accordance with court procedures, the inter-plead
funds shall be disbursed and the payable shall be reduced accordingly. Should
valid claims remain outstanding after the disbursement of the inter-plead funds,
certain vendors may continue to pursue their claims after the inter-pleader
proceedings are concluded, however, such claims may not exceed the amounts
determined by the courts to be due. The courts are currently in the process of
assembling the amounts of the claims of due from these vendors; however, initial
indications are that the aggregate of the inter-pleader claims filed will not
exceed the combined total of the bond amount and the Company payables currently
recorded as due to such vendors. The Company believes a substantially amount of
these claims are without merit based on billings for services that were not
provided under the agreements or on billings which were outside the terms of the
subcontracts, or may already have been settled with claimants. Since August
2003, the Company has made payments in the aggregate amount of approximately
$100,000 per month to various providers.
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A number of the vendors that provided transportation services in the
Commonwealth of Virginia have initiated separate legal demands for payment. Some
of the demands, either in whole or in part, have been disputed by the Company as
being without merit or have been settled. As of December 31, 2003, actions for
collection are pending in 12 separate proceedings. Ali Medical,et.al, a joint
case of 27 providers for approximately $1,042,000 is the largest of the claims.
The Ali Medical joint case was consolidated with the above-referenced
inter-pleader action for all purposes. The Ali Medical claimants are considered
cross-claimants in the inter-pleader action. In addition to the Ali Medical
claimants, an additional six defendants in the inter-pleader action have filed
cross-claims for an aggregate amount of approximately $449,000. The remaining
eleven proceedings which claim an aggregate amount of approximately $669,000
have been temporarily stayed by an order of the court overseeing the
inter-pleader action. In both the outside lawsuits and the cross-claims all or a
portion of the amounts claimed have been disputed.
Provisions in the Company's condensed consolidated financial statements for the
estimated settlement amounts for these and other potential similar claims are
considered adequate; however, the Company is unable to predict the outcome of
these claims.
On November 4, 2003, New England Financial filed a breach of contract complaint
in Orange County Superior Court of California. The complaint arose from the
cancellation of a contract for health insurance benefits and non payment of
remaining fees. The claim is for $ 534,000 of which the company partially
disputes and is currently negotiating settlement terms.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Letter agreement amendment, dated as of January 15, 2004, to
Registration Rights Agreement dated as of December 5, 2003.
10.2 Form of Allonge to 20% Investor Warrants, dated as of January
15, 2004.
31.1 Rule 13a-14(a) / 15d-14(a), Certification of Steven J. Ross.
31.2 Rule 13a-14(a) / 15d-14(a), Certification of James Linesch.
32.1 Section 1350 Certification of Steven J. Ross.
32.2 Section 1350 Certification of James Linesch.
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(b) Reports on Form 8-K
The following reports on Form 8-K were filed by the Company during the quarter
ended December 31, 2003:
(1) On December 9, 2003, the Company filed a Current Report on Form 8-K
attaching the consents of the Company's independent certified accountant, Marcum
& Kliegman LLP, and its former independent certified accountant, Grassi & Co.
LLP.
(2) On December 10, 2003, the Company filed a Current Report on Form 8-K in
connection with a series of agreements, including a Securities Purchase
Agreement and a Registration Rights Agreement, with certain accredited investors
for a private placement of shares of the Company's common stock.
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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: February 17, 2004