UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
or
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-12641
DALRADA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 38-3713274
(State or other jurisdiction of (IRS Employer ID Number)
incorporation or organization)
9449 BALBOA AVENUE, SUITE 210
SAN DIEGO, CA 92123
(Address of principal executive offices)
Registrant's telephone number, including area code:
(858) 427 8700
N/A
(Former name and address, if changed since last report)
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 past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
The number of shares outstanding of the registrant's common stock as of May 15,
2007 was 5,136,392.
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). (Check one): Yes [ ] No [X]
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
PART I - FINANCIAL INFORMATION
Page
ITEM 1. Consolidated Financial Statements
Consolidated Balance Sheet - March 31, 2007 (unaudited) 2
Consolidated Statements of Operations - three and nine months ended
March 31, 2007 and 2006 (unaudited) 3
Consolidated Statement of Stockholders' Deficit - nine months ended
March 31, 2007 (unaudited) 4
Consolidated Statements of Cash Flows - nine months ended
March 31, 2007 and 2006 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 7
ITEM 2. Management's Discussion and Analysis or Plan of Operations 22
ITEM 3. Controls and Procedures 28
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 29
ITEM 2. Unregistered Sale of Equity Securities and Use of Proceeds 29
ITEM 3. Defaults Upon Senior Securities 29
ITEM 4. Submission of Matters To A Vote of Security Holders 29
ITEM 5. Other Information 29
ITEM 6. Exhibits 30
SIGNATURES 30
CERTIFICATIONS
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheet
(in thousands, except share data)
March 31,
2007
---------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ --
Accounts receivable, net of allowance of $248 6,514
Debt issue costs 194
Other current assets 1,284
---------
TOTAL CURRENT ASSETS 7,992
---------
CUSTOMER LIST, net of accumulated amortization of $181 513
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $144 615
WORKER'S COMPENSATION DEPOSIT 311
---------
TOTAL ASSETS $ 9,431
=========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Cash overdraft $ 399
Notes payable, current portion (includes related party notes of $1,620) 2,370
Accounts payable 2,848
PEO payroll taxes and other payroll deductions 9,822
Other accrued expenses 5,145
Warrant liability 4,357
Accrued derivative liability 2,165
---------
TOTAL CURRENT LIABILITIES 27,106
---------
CONVERTIBLE DEBENTURES, net of discounts of $2,694 4,981
NOTES PAYABLE, net of current portion (includes related party note of $9,735) 10,473
---------
TOTAL LIABILITIES 42,560
---------
COMMITMENTS AND CONTINGENCIES --
STOCKHOLDERS' DEFICIT
Series A convertible, redeemable preferred stock, $1,000 par value,
7,500 shares authorized 420.5 shares issued and outstanding 420
Common stock; $0.005 par value; 1,000,000,000 shares
authorized; 5,136,392 shares issued and outstanding 26
Common stock warrants
Additional paid-in capital 88,969
Prepaid consulting (132)
Accumulated deficit (122,412)
---------
TOTAL STOCKHOLDERS' DEFICIT (33,129)
---------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 9,431
=========
The accompanying notes are an integral part of these consolidated financial statements
2
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share data)
Three Months Nine Months
--------------------------- ---------------------------
March 31, March 31, March 31, March 31,
2007 2006 2007 2006
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
REVENUES
Temporary staffing services $ 33,770 $ -- $ 41,270 $ --
PEO Services 10,482 90 26,229 772
Other 122 841 1,136 1,434
----------- ----------- ----------- -----------
TOTAL REVENUES 44,374 931 68,635 2,206
----------- ----------- ----------- -----------
COST OF REVENUES
Cost of temporary staffing 32,342 -- 39,092 --
Cost of PEO services 10,981 14 25,502 667
Other -- -- -- --
----------- ----------- ----------- -----------
TOTAL COST OF REVENUES 43,323 14 64,594 667
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
GROSS PROFIT 1,051 917 4,041 1,539
----------- ----------- ----------- -----------
OPERATING EXPENSES
Selling, general and administrative 4,460 1,395 10,298 3,569
----------- ----------- ----------- -----------
TOTAL OPERATING EXPENSES 4,460 1,395 10,298 3,569
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (3,409) (478) (6,257) (2,030)
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSES):
Interest expense (686) (1,135) (3,657) (1,480)
Note payable settlement -- (915) -- (1,231)
Penalties and interest (1,822) (282) (1,822) (849)
Gain on extinguishment of debt 47 3,444 550 9,047
Change in derivative and warrant liabilities 689 (720) (1,901) (821)
Gain resulting from reconciliation of payroll tax
liabilities to taxing authorities -- 1,924 -- 1,924
Other, net (20) -- 16 --
----------- ----------- ----------- -----------
TOTAL OTHER INCOME (EXPENSE) (1,792) 2,316 (6,814) 6,590
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS (5,201) 1,838 (13,071) 4,560
PROVISION FOR INCOME TAXES 208 -- 208 --
INCOME (LOSS) BEFORE MINORITY INTEREST AND
----------- ----------- ----------- -----------
DISCONTINUED OPEATIONS (5,409) 1,838 (13,279) 4,560
----------- ----------- ----------- -----------
MINORITY INTEREST IN SUBSIDIARY (INCOME) -- -- -- --
----------- ----------- ----------- -----------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS (5,409) 1,838 (13,279) 4,560
----------- ----------- ----------- -----------
DISCONTINUED OPERATION:
Loss from discontinued operation -- -- (22) (520)
----------- ----------- ----------- -----------
NET INCOME (LOSS) (5,409) 1,838 (13,301) 4,040
PREFERRED STOCK DIVIDENDS (5) (5) (15) (15)
NET INCOME (LOSS) ATTRIBUTED TO COMMON
----------- ----------- ----------- -----------
STOCKHOLDERS $ (5,414) $ 1,833 $ (13,316) $ 4,025
=========== =========== =========== ===========
EARNINGS (LOSS) PER SHARE - BASIC
Continuing operations $ (1.09) $ 0.44 $ (2.69) $ 1.16
Discontinued operations -- -- (0.00) (0.13)
----------- ----------- ----------- -----------
$ (1.09) $ 0.44 $ (2.38) $ 1.03
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON EQUIVALENT
SHARES OUSTANDING - BASIC 4,971,914 4,164,407 4,936,369 3,925,057
=========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements
3
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statement of Stockholders' Deficit
(in thousands, except share data)
(Unaudited)
Additional
Series A Preferred Stock Common Stock Paid-in Prepaid Accumulated
Shares Amount Shares Amount Capital Consulting Deficit Total
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, June 30, 2006 420.5 420 4,920,066 25 87,451 (245) (109,271) (21,620)
Adjusted for separation of
reporting entity 160 160
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, June 30, 2006, as restated 420.5 420 4,920,066 25 87,451 (245) (109,111) (21,460)
Amortization of prepaid consulting 113 113
Common stock issued for:
Conversion of notes payable 216,326 1 126 127
Value of vested options issued to
officers and directors 1,392 1,392
Net loss (13,301) (13,301)
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, March 31, 2007 420.5 $ 420 5,136,392 $ 26 $ 88,969 $ (132) $(122,412) $ (33,129)
========= ========= ========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements
4
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands, except share data)
Nine Months Ended
---------------------
March 31, March 31,
2007 2006
-------- --------
(uanudited) (uanudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(13,301) $ 4,040
Adjustment to reconcile net income (loss) to net cash
used in operating activities
Depreciation and amortization 214 23
Stock issued for services -- 15
Amortization of prepaid consulting 113 19
Amortization of debt discounts 2,885 553
Settlements with investors -- 1,231
Change in value of warrant and accrued derivative liabilities 1,901 821
Gain on extinguishment of debt (550) (9,047)
Gain resulting from reconciliation of payroll tax liabilities to
taxing authorities -- (1,924)
Value of vested option issued to officers and directors 1,392 --
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (4,075) (609)
Other current assets (581) 54
Due from affiliates 6,914 885
Worker's compensation deposit 58 --
Other assets 205 --
Increase (decrease) in:
Accounts payable and accrued expenses 1,567 (97)
PEO liabilities 1,940 1,717
-------- --------
Net cash used in operating activities (1,318) (2,319)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired with (paid for) acquisition (178) --
Purchase of furniture and equipment (48) (158)
Increase in restricted cash -- (1,922)
-------- --------
Net cash used in investing activities (226) (2,080)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in cash overdraft, net 399 174
Line of credit, net -- 69
Proceeds from notes payable -- 4,608
Repayments of notes payable (230) (485)
Repayment of borrowings under bank notes payable -- (483)
Repayments of capital lease obligations -- (4)
-------- --------
Net cash provided by financing activities 169 3,879
-------- --------
NET DECREASE IN CASH AND
CASH EQUIVALENTS (1,375) (520)
CASH AND CASH EQUIVALENTS, Beginning of period 1,375 --
-------- --------
CASH AND CASH EQUIVALENTS, End of period $ -- $ (520)
======== ========
The accompanying notes are an integral part of these consolidated financial statements
5
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(in thousands, except share data)
Nine Months Ended
--------------------
March 31, March 31,
2007 2006
-------- --------
(uanudited) (uanudited)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ -- $ --
======== ========
Income taxes paid $ -- $ --
======== ========
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:
Conversion of convertible debentures into common stock $ -- $278,000
======== ========
Conversion of accounts payable and accrued liabilities into
common stock $ 127 $ 100
======== ========
Net assets acquired in business combinations:
Cash $ 72 $ --
Receivables 1,781 --
Other current assets 477 --
Property and equipment 384 --
Worker's compensation deposit 369 --
Customer list 127 --
Other assets 205 --
Accounts payable 30 --
Accrued expenses 2,397 --
Line of credit 500 --
Notes payable 238 --
The accompanying notes are an integral part of these consolidated financial statements
6
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Dalrada
Financial Corporation and Subsidiaries (the "Company" or "DFCO") have been
prepared pursuant to the rules of the Securities and Exchange Commission (the
"SEC") for quarterly reports on Form 10-QSB and do not include all of the
information and note disclosures required by accounting principles generally
accepted in the United States of America. These financial statements and notes
herein are unaudited, but in the opinion of management, include all the
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the Company's financial position, results of operations,
and cash flows for the periods presented. These financial statements should be
read in conjunction with the Company's audited financial statements and notes
thereto for the year ended June 30, 2006 included in the Company's annual report
on Form 10-KSB filed with the SEC. Interim operating results are not necessarily
indicative of operating results for any future interim period or for the full
year ended June 30, 2007. The consolidated financial statements include the
accounts of the Company and its majority-owned subsidiaries. All inter-company
transactions have been eliminated.
STOCK SPLIT
On September 15, 2006, the Company authorized a one for two hundred (1 for 200)
reverse stock split of its common stock. There was no change made to the par
value of the Company's common stock. All share information for common shares has
been retroactively restated for this reverse stock split.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' financial
statements to conform to the current year presentation. These reclassifications
had no effect on previously reported results of operations or retained earnings.
COMPREHENSIVE INCOME
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No.
130 establishes standards for reporting and presentation of comprehensive income
and its components in a full set of financial statements. During the nine months
ended March 31, 2007, the Company had no elements of comprehensive income.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2006, FASB issued SFAS 157 `Fair Value Measurements'. This
Statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements. However, for some entities, the application of this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial statements.
In September 2006, FASB issued SFAS 158 `Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans--an amendment of FASB Statements
No. 87, 88, 106, and 132(R)' This Statement improves financial reporting by
requiring an employer to recognize the overfunded or underfunded status of a
defined benefit postretirement plan (other than a multiemployer plan) as an
asset or liability in its statement of financial position and to recognize
changes in that funded status in the year in which the changes occur through
comprehensive income of a business entity or changes in unrestricted net assets
of a not-for-profit organization. This Statement also improves financial
reporting by requiring an employer to measure the funded status of a plan as of
the date of its year-end statement of financial position, with limited
exceptions. An employer with publicly traded equity securities is required to
initially recognize the funded status of a defined benefit postretirement plan
and to provide the required disclosures as of the end of the fiscal year ending
after December 15, 2006. An employer without publicly traded equity securities
is required to recognize the funded status of a defined benefit postretirement
plan and to provide the required disclosures as of the end of the fiscal year
ending after June 15, 2007. However, an employer without publicly traded equity
7
securities is required to disclose the following information in the notes to
financial statements for a fiscal year ending after December 15, 2006, but
before June 16, 2007, unless it has applied the recognition provisions of this
Statement in preparing those financial statements. The requirement to measure
plan assets and benefit obligations as of the date of the employer's fiscal
year-end statement of financial position is effective for fiscal years ending
after December 15, 2008. The management is currently evaluating the effect of
this pronouncement on financial statements.
In February of 2007 the FASB issued SFAS 159, "The Fair Value Option for
Financial Assets and Financial Liabilities--Including an amendment of FASB
Statement No. 115." The statement permits entities to choose to measure many
financial instruments and certain other items at fair value. The objective is to
improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. The statement is effective as of the beginning of an entity's first
fiscal year that begins after November 15, 2007. The company is analyzing the
potential accounting treatment.
FASB Staff Position on FAS No. 115-1 and FAS No. 124-1 ("the FSP"), "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments,"
was issued in November 2005 and addresses the determination of when an
investment is considered impaired, whether the impairment on an investment is
other-than-temporary and how to measure an impairment loss. The FSP also
addresses accounting considerations subsequent to the recognition of
other-than-temporary impairments on a debt security, and requires certain
disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. The FSP replaces the impairment guidance on
Emerging Issues Task Force (EITF) Issue No. 03-1 with references to existing
authoritative literature concerning other-than-temporary determinations. Under
the FSP, losses arising from impairment deemed to be other-than-temporary, must
be recognized in earnings at an amount equal to the entire difference between
the securities cost and its fair value at the financial statement date, without
considering partial recoveries subsequent to that date. The FSP also required
that an investor recognize other-than-temporary impairment losses when a
decision to sell a security has been made and the investor does not expect the
fair value of the security to fully recover prior to the expected time of sale.
The FSP is effective for reporting periods beginning after December 15, 2005.
The adoption of this statement will not have a material impact on our
consolidated financial statements.
FASB Interpretation 48 prescribes a recognition threshold and a measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. Benefits from tax
positions should be recognized in the financial statements only when it is more
likely than not that the tax position will be sustained upon examination by the
appropriate taxing authority that would have full knowledge of all relevant
information. The amount of tax benefits to be recognized for a tax position that
meets the more-likely-than-not recognition threshold is measured as the largest
amount of benefit that is greater than fifty percent likely of being realized
upon ultimate settlement. Tax benefits relating to tax positions that previously
failed to meet the more-likely-than-not recognition threshold should be
recognized in the first subsequent financial reporting period in which that
threshold is met or certain other events have occurred. Previously recognized
tax benefits relating to tax positions that no longer meet the
more-likely-than-not recognition threshold should be derecognized in the first
subsequent financial reporting period in which that threshold is no longer met.
Interpretation 48 also provides guidance on the accounting for and disclosure of
tax reserves for unrecognized tax benefits, interest and penalties and
accounting in interim periods. Interpretation 48 is effective for fiscal years
beginning after December 15, 2006. The change in net assets as a result of
applying this pronouncement will be a change in accounting principle with the
cumulative effect of the change required to be treated as an adjustment to the
opening balance of retained earnings on January 1, 2007, except in certain cases
involving uncertainties relating to income taxes in purchase business
combinations. In such instances, the impact of the adoption of Interpretation 48
will result in an adjustment to goodwill. The adoption of this standard had no
material impact on the Company's consolidated financial statements.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements," ("SAB 108"),which provides interpretive guidance on the
consideration of the effects of prior year misstatements in quantifying current
year misstatements for the purpose of a materiality assessment. The Company
adopted SAB 108 in the fourth quarter of 2006 with no impact on its consolidated
financial statements.
8
NOTE 2. GOING CONCERN CONSIDERATIONS
The accompanying unaudited consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. For the nine months
ended March 31, 2007, the Company had a net loss of $13,301. As of March 31,
2007, the Company had a working capital deficiency of $19,114 and had a
stockholders' deficit of $33,129. In addition, the Company is delinquent on
payroll tax obligations and has been sued by trade creditors for nonpayment of
amounts due. The Company is also delinquent in its payments relating to payroll
tax liabilities. These conditions raise substantial doubt about its ability to
continue as a going concern. Management believes that it can continue to raise
debt and equity financing to support its operations.
The Company must obtain additional funds to provide adequate working capital and
finance operations. However, there can be no assurance that the Company will be
able to complete any additional debt or equity financings on favorable terms or
at all, or that any such financings, if completed, will be adequate to meet the
Company's capital requirements. Any additional equity or convertible debt
financings could result in substantial dilution to the Company's stockholders.
If adequate funds are not available, the Company may be required to delay,
reduce or eliminate some or all of its planned activities. The Company's
inability to fund its capital requirements would have a material adverse effect
on the Company. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
NOTE 3. CHANGE IN REPORTING ENTITY
On March 29, 2007, the Company completed a separation and sale agreement with an
effective date of January 1, 2007 with its majority owned subsidiary, The Solvis
Group, Inc. ("Solvis"). The purpose of this transaction between the Company and
Solvis was to separate the two companies into unrelated reporting entities.
Solvis was principally in the business of leasing staff to its customers on a
temporary basis. In connection with this separation agreement, the Company also
sold its Heritage Staffing, Inc. subsidiary to Solvis. The terms of the
separation and sale agreement provided for the Company issuing two notes payable
in the amount of $11,300 and returning shares of Solvis common stock currently
owned by the Company which reduced the Company's ownership in Solvis from
approximately 85% to approximately 9.9%. In return, the Company received cash,
accounts receivable, a forgiveness of intercompany debt and Solvis' clients that
are California based staff leasing customers. The Company has valued its 9.9%
investment in Solvis at its historical cost of $0. There are certain payroll tax
liabilities of Solvis that the Company may still be liable to pay if not paid by
Solvis.
For accounting purposes, this transaction has been recorded as a change in
reporting entity. The Company has reported the effect of this change in
reporting entity in the financial statements as a prior-period adjustment by
adjusting the assets and liabilities balances of the first reporting period
presented. An offsetting adjustment of $160 has been made to the opening balance
of accumulated deficit for the first period presented in the accompanying
financial statements. The accompanying financial statements have been restated
to reflect this change in reporting entity as if it occurred on the beginning of
the earliest period presented.
The effect of the separation and sale agreement for operations of the Company as
of June 30, 2006 and for the nine months ended March 31, 2007 and 2006 are
presented below:
9
AS OF JUNE 30, 2006
(in thousands)
NEW OLD
REPORTING REPORTING
ASSETS ENTITY ENTITY DIFFERENCE
--------- --------- ---------
CURRENT ASSETS
Cash and cash equivalents $ 1,375 $ 3,260 $ (1,885)
Accounts receivable, net 5 1,211 (1,206)
Debt issue costs 359 359 --
Other current assets 226 3,019 (2,793)
Net assets of discontinued operations 22 22 --
--------- --------- ---------
TOTAL CURRENT ASSETS 1,987 7,871 (5,884)
--------- --------- ---------
CUSTOMER LIST, net 544 586 (42)
PROPERTY AND EQUIPMENT, net 239 355 (116)
WORKER'S COMPENSATION DEPOSIT -- 3,072 (3,072)
INVESTMENT IN ALLIANCE INSURANCE GROUP -- 1,400 (1,400)
RECEIVABLE FROM RELATED PARTY -- 1,400 (1,400)
OTHER LONG-TERM ASSETS -- 14 (14)
--------- --------- ---------
TOTAL ASSETS $ 2,770 $ 14,698 $ (11,928)
========= ========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Notes payable, current portion 1,022 5,156 (4,134)
Accounts payable 1,402 1,736 (334)
PEO payroll taxes and other payroll deductions 7,882 8,451 (569)
Accrued payroll and related payroll taxes and deductions 75 9,303 (9,228)
Other accrued expenses 2,818 3,520 (702)
Due to affiliate 3,756 -- 3,756
Warrant liability 3,138 3,138 --
Accrued derivative liability 1,483 1,483 --
--------- --------- ---------
TOTAL CURRENT LIABILITIES 21,576 32,787 (11,211)
--------- --------- ---------
CONVERTIBLE DEBENTURES, net of discounts 2,261 2,261 --
NOTES PAYABLE, net of current portion 393 1,270 (877)
--------- --------- ---------
TOTAL LIABILITIES 24,230 36,318 (12,088)
--------- --------- ---------
MINORITY INTEREST -- -- --
COMMITMENTS AND CONTINGENCIES -- -- --
STOCKHOLDERS' DEFICIT
Series A convertible, redeemable preferred stock, $1,000 par value,
7,500 shares authorized 420.5 shares issued and outstanding 420 420 --
Common stock; $0.005 par value; 1,000,000,000 shares
authorized; 4,920,066 shares issued and outstanding 25 25 --
Additional paid-in capital 87,451 87,451 --
Prepaid consulting (245) (245) --
Accumulated deficit (109,111) (109,271) 160
--------- --------- ---------
TOTAL STOCKHOLDERS' DEFICIT (21,460) (21,620) 160
--------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 2,770 $ 14,698 $ (11,928)
========= ========= =========
10
FOR THE NINE MONTHS ENDED MARCH 31, 2007
(in thousands)
NEW OLD
REPORTING REPORTING
ENTITY ENTITY DIFFERENCE
--------- --------- ---------
REVENUES
Temporary staffing services $ 41,270 $ 100,367 $ (59,097)
PEO Services 26,229 26,229 --
Other 1,136 1,201 (65)
--------- --------- ---------
TOTAL REVENUES 68,635 127,797 (59,162)
--------- --------- ---------
COST OF REVENUES
Cost of temporary staffing 39,092 91,480 (52,388)
Cost of PEO services 25,502 25,502 --
Other -- 20 (20)
--------- --------- ---------
TOTAL COST OF REVENUES 64,594 117,002 (52,408)
--------- --------- ---------
GROSS PROFIT 4,041 10,795 (6,754)
--------- --------- ---------
OPERATING EXPENSES
Selling, general and administrative 10,298 12,545 (2,247)
--------- --------- ---------
TOTAL OPERATING EXPENSES 10,298 12,545 (2,247)
--------- --------- ---------
LOSS FROM OPERATIONS (6,257) (1,750) (4,507)
--------- --------- ---------
OTHER INCOME (EXPENSES):
Interest expense (3,657) (3,775) 118
Penalties and interest (1,822) (1,822) --
Gain on extinguishment of debt 550 655 (105)
Change in derivative and warrant liabilities (1,901) (1,901) --
Other, net 16 (7) 23
--------- --------- ---------
TOTAL OTHER INCOME (EXPENSE) (6,814) (6,850) 36
--------- --------- ---------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS (13,071) (8,600) (4,471)
PROVISION FOR INCOME TAXES 208 208 --
INCOME (LOSS) BEFORE MINORITY INTEREST AND
--------- --------- ---------
DISCONTINUED OPEATIONS (13,279) (8,808) (4,471)
--------- --------- ---------
MINORITY INTEREST IN SUBSIDIARY (INCOME) -- (550) 550
--------- --------- ---------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS (13,279) (9,358) (3,921)
--------- --------- ---------
DISCONTINUED OPERATION:
Loss from discontinued operation (22) (22) --
--------- --------- ---------
NET INCOME (LOSS) (13,301) (9,380) (3,921)
PREFERRED STOCK DIVIDENDS (15) (15) --
--------- --------- ---------
NET INCOME (LOSS) ATTRIBUTED TO COMMON STOCKHOLDERS $ (13,316) $ (9,395) $ (3,921)
========= ========= =========
EARNINGS (LOSS) PER SHARE - BASIC
Continuing operations $ (2.69) $ (1.79) $ (0.91)
Discontinued operations (0.00) (0.00) --
--------- --------- ---------
$ (2.69) $ (1.79) $ (0.91)
========= ========= =========
11
FOR THE NINE MONTHS ENDED MARCH 31, 2006
(in thousands)
NEW OLD
REPORTING REPORTING
ENTITY ENTITY DIFFERENCE
-------- -------- --------
REVENUES
Temporary staffing services $ -- $ 47,400 $(47,400)
PEO Services 772 772 --
Other 1,434 590 844
-------- -------- --------
TOTAL REVENUES 2,206 48,762 (46,556)
-------- -------- --------
COST OF REVENUES
Cost of temporary staffing -- 41,737 (41,737)
Cost of PEO services 667 668 (1)
Other -- 26 (26)
-------- -------- --------
TOTAL COST OF REVENUES 667 42,431 (41,764)
-------- -------- --------
GROSS PROFIT 1,539 6,331 (4,792)
-------- -------- --------
OPERATING EXPENSES
Selling, general and administrative 3,569 6,610 (3,041)
-------- -------- --------
TOTAL OPERATING EXPENSES 3,569 6,610 (3,041)
-------- -------- --------
LOSS FROM OPERATIONS (2,030) (279) (1,751)
-------- -------- --------
OTHER INCOME (EXPENSES):
Interest expense (1,480) (1,670) 190
Note payable settlement (1,231) (1,231) --
Penalties and interest (849) (849) --
Gain on extinguishment of debt 9,047 9,207 (160)
Change in derivative and warrant liabilities (821) (821) --
Gain resulting from reconciliation of
payroll tax liabilities to taxing authorities 1,924 1,924 --
Other, net -- (67) 67
-------- -------- --------
TOTAL OTHER INCOME (EXPENSE) 6,590 6,493 97
-------- -------- --------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS 4,560 6,214 (1,654)
PROVISION FOR INCOME TAXES -- -- --
-------- -------- --------
INCOME (LOSS) BEFORE MINORITY INTEREST AND
DISCONTINUED OPEATIONS 4,560 6,214 (1,654)
-------- -------- --------
MINORITY INTEREST IN SUBSIDIARY (INCOME) -- (256) 256
-------- -------- --------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS 4,560 5,958 (1,398)
-------- -------- --------
DISCONTINUED OPERATION:
Loss from discontinued operation (520) (520) --
-------- -------- --------
NET INCOME (LOSS) 4,040 5,438 (1,398)
PREFERRED STOCK DIVIDENDS (15) (15) --
-------- -------- --------
NET INCOME (LOSS) ATTRIBUTED TO COMMON STOCKHOLDERS $ 4,025 $ 5,423 $ (1,398)
======== ======== ========
EARNINGS (LOSS) PER SHARE - BASIC
Continuing operations $ 1.16 $ 1.58 $ (0.42)
Discontinued operations (0.13) (0.13) --
-------- -------- --------
$ 1.03 $ 1.38 $ (0.36)
======== ======== ========
12
NOTE 4. STOCK BASED COMPENSATION
The Company adopted SFAS No. 123 (Revised 2004), SHARE BASED PAYMENT ("SFAS No.
123R"), under the modified-prospective transition method on January 1, 2006.
SFAS No. 123R requires companies to measure and recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value. Share-based compensation recognized under the
modified-prospective transition method of SFAS No. 123R includes share-based
compensation based on the grant-date fair value determined in accordance with
the original provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, for all share-based payments granted prior to and not yet vested
as of January 1, 2006 and share-based compensation based on the grant-date
fair-value determined in accordance with SFAS No. 123R for all share-based
payments granted after January 1, 2006. SFAS No. 123R eliminates the ability to
account for the award of these instruments under the intrinsic value method
prescribed by Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, and allowed under the original provisions of SFAS No.
123. Prior to the adoption of SFAS No. 123R, the Company accounted for our stock
option plans using the intrinsic value method in accordance with the provisions
of APB Opinion No. 25 and related interpretations.
For periods presented prior to the adoption of SFAS No. 123R, pro forma
information regarding net loss and loss per share as required by SFAS No. 123R
has been determined as if the Company had accounted for its employee stock
options under the original provisions of SFAS No. 123. The fair value of these
options was estimated using the Black-Scholes option pricing model. For purposes
of pro forma disclosure, the estimated fair value of the options is amortized to
expense over the option's vesting period. The pro forma information regarding
the effect on operations that is required by SFAS 123 has not been presented
since there is no pro forma expense to be shown for the six months ended
December 31, 2005. During the nine months ended March 31, 2007, the Company
Recognized an expense of $1,392 related to vested options issued to officers
and directors in accordance with SFAS 123R.
NOTE 5. EARNINGS (LOSS) PER COMMON SHARE
The Company reports earnings (loss) per share in accordance with SFAS No. 128,
"Earnings per Share." Basic earnings (loss) per share are computed by dividing
income (loss) available to common stockholders by the weighted average number of
common shares available. Diluted earnings (loss) per share is computed similar
to basic earnings (loss) per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the potential common shares had been issued and if the additional common
shares were dilutive. The following potential common shares have been excluded
from the computation of diluted net loss per share for the nine months ended
March 31, 2007: warrants - 7,330,000 and stock options - nil. All warrants are
anti-dilutive at March 31, 2007 since the Company incurred a net loss.
13
Below is the computation of basic and diluted earnings per share:
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------
2007 2006
----------------------------------- ------------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
---------- ---------- ---------- ---------- --------- ----------
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations $ (5,409) $ 1,838
Preferred stock dividends (5) (5)
---------- ----------
(5,414) 1,833
Discontinued operations -- --
---------- ----------
Net income (loss) attributed to common stockholders $ (5,414) $ 1,833
========== ==========
Weighed shares outstanding 4,971,914 4,164,407
Continuing operations $ (1.09) $ 0.44
Discontinued operations $ -- $ --
---------- ----------
$ (1.09) $ 0.44
========== ==========
DILUTED EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations N/A $ 1,838
Preferred stock dividends (5)
Interest on convertible debentures 156
Amortization of discounts on convertible debentures 112
----------
2,101
Discontinued operations --
----------
Net income (loss) attributed to common stockholders $ 2,101
==========
Weighed shares outstanding 4,164,407
Conversion of convertible debentures into common stock 12,411
----------
4,176,818
==========
Continuing operations $ 0.50
Discontinued operations $ --
----------
$ 0.50
==========
14
NINE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------
2007 2006
------------------------------------ ------------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
---------- ---------- ---------- ---------- --------- ----------
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations $ (13,279) $ 4,560
Preferred stock dividends (15) (15)
---------- ----------
(13,294) 4,545
Discontinued operations (22) (520)
---------- ----------
Net income (loss) attributed to common stockholders $ (13,316) $ 4,025
========== ==========
Weighed shares outstanding 4,936,369 3,925,057
Continuing operations $ (2.69) $ 1.16
Discontinued operations (0.00) (0.13)
---------- ----------
$ (2.69) $ 1.03
========== ==========
DILUTED EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations N/A $ 4,560
Preferred stock dividends (15)
Interest on convertible debentures 216
Amortization of discounts on convertible debentures 526
----------
5,287
Discontinued operations (520)
----------
Net income (loss) attributed to common stockholders $ 4,767
==========
Weighed shares outstanding 3,925,057
Conversion of convertible debentures into common stock 12,411
----------
3,937,468
==========
Continuing operations $ 1.34
Discontinued operations $ (0.13)
----------
$ 1.21
==========
15
NOTE 6. ACQUISITION
On September 12, 2006, DFCO acquired all the outstanding stock for All Staffing
Inc., a Tennessee corporation for $250 in cash and a warrant to purchase 450,000
shares to DFCO's stock, to be valued at $3,000 36 months after issuance
(closing), subject to adjustment.
All Staffing Inc, established in 1991, is a Professional Employer Organization
(PEO) located in Lansford, PA. The Company has clients in PA, NJ and NY. All
Staffing provides comprehensive outsourcing of human resource and benefit
administration, as well as payroll and tax processing as a co-employer with its
client companies. All Staffing will undertake certain employment processes and
administration for the benefit of all the Dalrada Financial companies.
The operating results of All Staffing beginning September 12, 2006 are included
in the accompanying consolidated statements of operations.
The total purchase price was valued at $250 and is summarized as follows in
accordance with SFAS No. 141 and 142:
Cash $ 72
Accounts receivable 1,781
Other current assets 477
Property and equipment 384
Worker's compensation deposit 369
Customer list 127
Other assets 205
Accounts payable (30)
Accrued expenses (2,397)
Line of credit (500)
Notes payable (238)
-------
Purchase price $ 250
=======
The customer list is being amortized over 48 months.
NOTE 7. CONVERTIBLE DEBT FINANCING AND DERIVATIVE LIABILITIES
In accordance with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended ("SFAS 133"), the holder's conversion right
provision, interest rate adjustment provision, liquidated damages clause, cash
premium option, and the redemption option (collectively, the debt features)
contained in the terms governing the Notes are not clearly and closely related
to the characteristics of the Notes. Accordingly, the features qualified as
embedded derivative instruments at issuance and, because they do not qualify for
any scope exceptions within SFAS 133, they were required by SFAS 133 to be
accounted for separately from the debt instrument and recorded as derivative
financial instruments.
During the nine months ended March 31, 2007, we recorded an other expense item
of $682 and $1,219, which relates to the convertible debt features and warrants,
respectively, to reflect the change in fair value of the derivative liability.
At each balance sheet date, we adjust the derivative financial instruments to
their estimated fair value and analyze the instruments to determine their
classification as a liability or equity. As of March 31, 2007, the estimated
fair value of our derivative liability was $2,165, as well as a warrant
liability of $4,357.
16
NOTES PAYABLE
During the year ended June 30, 2006, the Company issued notes to third parties,
which included six investors. As part of the several financing transactions,
the Company also issued warrants to purchase shares of stock at various exercise
prices.
Date of Note Amount of Notes Conversion Price(1) Term of Note
------------ --------------- ------------------- ------------
February 9, 2006 (1) $ 130 $ 0.452 2 years
February 13, 2006 $ 7,545 75% (3) 2 years
Date of Warrants Issued Number of Warrants Exercise Price Term of Warrants
----------------------- ------------------ -------------- ----------------
February 13, 2006 6,760,000 $ 0.105 7 years
February 13, 2006 (2) 520,000 $ 0.105 7 years
(1) = no warrants issued with this financing transaction.
(2) = no debt associated with these warrants.
(3) = 75% of 20-day pre-conversion market-based price.
The notes contain provisions on interest accrual at the "prime rate" published
in The Wall Street Journal from time to time, plus three percent (3%). The
Interest Rate shall not be less than fifteen percent (15%). Interest shall be
calculated on a 360 day year. Interest on the Principal Amount shall be payable
monthly, commencing 120 days from the closing and on the first day of each
consecutive calendar month thereafter (each, a "Repayment Date") and on the
Maturity Date.
Following the occurrence and during the continuance of an Event of Default (as
discussed in the Note), the annual interest rate on the Note shall automatically
be increased by two percent (2%) per month until such Event of Default is cured.
Debt features. The Holder shall have the right, but not the obligation, to
convert all or any portion of the then aggregate outstanding Principal Amount of
this Note, together with interest and fees due hereon, into shares of Common
Stock.
The proceeds from the financing transactions were allocated to the debt features
and to the warrants based upon their fair values. After the latter allocations,
the remaining value, if any, is allocated to the Note on the financial
statements.
The debt discount is being accreted using the effective interest method over the
term of the note.
The value of the discount on the converted notes on the books is being accreted
over the term of the note (two years). For the nine months ended March 31, 2007,
the Company accreted $2,720, of debt discount related to the Notes.
WARRANTS ISSUED
The estimated fair value of the warrants at issuance were as follows:
Date of Warrants Issued Number of Warrants Value at Issuance Volatility Factor
----------------------- ------------------ ----------------- -----------------
February 13, 2006 6,760,000 $ 3,582 72%
February 13, 2006 520,000 $ 302 72%
17
These amounts have been classified as a derivative instrument and recorded as a
liability on the Company's balance sheet in accordance with current
authoritative guidance. The estimated fair value of the warrants was determined
using the Black-Scholes option-pricing model with a closing price of on the date
of issuance and the respective exercise price, a 7.0 year term, and the
volatility factor relative to the date of issuance. The model uses several
assumptions including: historical stock price volatility (utilizing a rolling
120 day period), risk-free interest rate (3.50%), remaining time till maturity,
and the closing price of the Company's common stock to determine estimated fair
value of the derivative liability. In valuing the warrants at March 31, 2007,
the Company used the closing price of $0.61, the respective exercise price, as
well as the remaining term on each warrant, as well as a volatility of 157%. In
accordance with the provisions of SFAS No. 133, Accounting for Derivative
Instruments, the Company is required to adjust the carrying value of the
instrument to its fair value at each balance sheet date and recognize any change
since the prior balance sheet date as a component of Other Income (Expense). The
warrant derivative liability at March 31, 2007, had increased to a fair value of
$4,357, due in part to an increase in the market value of the Company's common
stock to $0.61 from $0.15 at June 30, 2006 amount, as well as an increase in the
volatility from 90% to 157% which resulted in other expense of $1,219 on the
Company's books.
The recorded value of such warrants can fluctuate significantly based on
fluctuations in the market value of the underlying securities of the issuer of
the warrants, as well as in the volatility of the stock price during the term
used for observation and the term remaining for the warrants.
DEBT FEATURES
In accordance with Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended
("SFAS 133"), the debt features provision (collectively, the features) contained
in the terms governing the Notes are not clearly and closely related to the
characteristics of the Notes. Accordingly, the features qualified as embedded
derivative instruments at issuance and, because they do not qualify for any
scope exception within SFAS 133, they were required by SFAS 133 to be accounted
for separately from the debt instrument and recorded as derivative financial
instruments.
Pursuant to the terms of the Notes, these notes are convertible at the option of
the holder, at anytime on or prior to maturity. There is an additional interest
rate adjustment feature, a liquidated damages clause, a cash premium option, as
well as the redemption option. The debt features represents an embedded
derivative that is required to be accounted for apart from the underlying Notes.
At issuance of the Notes, the debt features had an estimated initial fair value
as follows, which was recorded as a discount to the Notes and a derivative
liability on the consolidated balance sheet.
Debt Features
-------------
Date of Note Amount of Notes Value at Issuance Carrying Value
------------ --------------- ----------------- --------------
January 27, 2006 $ 112 $ 69 $ 43
February 9, 2006 $ 246 $ 133 $ 113
February 13, 2006 $ 7,545 $ 2,515 $ 1,448
In subsequent periods, if the price of the security changes, the embedded
derivative financial instrument related to the debt features will be adjusted to
the fair value with the corresponding charge or credit to other expense or
income. In valuing the debt features at March 31, 2007, the company used the
closing price of $0.61 and the respective conversion price, a remaining term
coinciding with each contract, and a volatility of 0%. For the nine months ended
March 31, 2007, due in part to an increase in the market value of the Company's
common stock to $0.61 the Company recorded other expense on the consolidated
statement of operations for the change in fair value of the debt features of
approximately $682. At March 31, 2007, the estimated fair value of the debt
features was approximately $2,165.
The recorded value of the debt features related to the Notes can fluctuate
significantly based on fluctuations in the fair value of the Company's common
stock, as well as in the volatility of the stock price during the term used for
observation and the term remaining for the warrants.
The significant fluctuations can create significant income and expense items on
the financial statements of the Company.
18
Because the terms of the convertible notes ("notes") require such
classification, the accounting rules required additional convertible notes and
non-employee warrants to also be classified as liabilities, regardless of the
terms of the new notes and / or warrants. This presumption has been made due to
the company no longer having the control to physical or net share settle
subsequent convertible instruments because it is tainted by the terms of the
notes. Were the notes to not have contained those terms or even if the
transactions were not entered into, it could have altered the treatment of the
other notes and the conversion features of the latter agreement may have
resulted in a different accounting treatment from the liability classification.
The notes and warrants, as well as any subsequent convertible notes or warrants,
will be treated as derivative liabilities until all such provisions are settled.
For the nine months ended March 31, 2007, the Company recorded other expense of
$1,219 and $682, related to the increase in value of the debt features and
warrants. A tabular reconciliation of this adjustment follows:
For the nine months ended March 31, 2007:
$ 1,219 expense, increase in value of warrant liability
$ 682 expense, increase in value of derivative liability
-------
$ 1,901 other expense related to convertible debt
For the nine months ended March 31, 2007, the Company recorded $2,720 of
interest expense related to the accretion of debt related to the convertible
financing.
For the nine months ended March 31, 2007:
$ 2,720 of interest expense related to accretion of convertible debt
-------
$ 2,720 of interest expense related to convertible debt
The balance of the carrying value of the convertible debt as of March 31, 2007
is:
$ 1,605 original carrying value on convertible debt
$ (228) converted to equity
$ 3,604 accretion of convertible debt
-------
$ 4,981 March 31, 2007 carrying value of debt
The balance of the carrying value of the derivative liability as of March 31,
2007 is:
$ 2,717 original value of derivative liability
$(1,234) income, decrease in value of derivative liability
-------
$ 1,483 June 30, 2006 value of derivative liability
$ 682 expense, increase in value of derivative liability
-------
$ 2,165 March 31, 2007 value of derivative liability
The balance of the carrying value of the warrant liability as of March 31, 2007
is:
$ 3,892 original carrying value of warrant liability
$ (754) income, decrease in value of warrant liability
-------
$ 3,138 June 30, 2006 value of warrant liability
$ 1,219 expense, increase in value of warrant liability
-------
$ 4,357 March 31, 2007 value of warrant liability
19
NOTE 8. NOTES PAYABLE
The following summarizes notes payable (including amounts due to a related
party) at March 31, 2007:
Notes payable to The Solvis Group; interest at 8% per annum;
monthly principal payments of $85 beginning on April 1, 2007
with any unpaid principal and interest due on April 1, 2012. $ 8,060
Notes payable to The Solvis Group; interest at 8% per annum;
monthly principal payments of $50 beginning on April 1, 2007
with any unpaid principal and interest due on April 1, 2012. 3,240
Notes payable to related party 55
Note payable to a former director 750
Note payable to individuals assumed with acquisition of All Staffing 738
---------
12,843
Less current portion (2,370)
---------
Long-term portion $ 10,473
=========
NOTE 9. STOCKHOLDERS' DEFICIENCY
STOCK ISSUANCES
During the nine months ended March 31, 2007, the Company issued 216,326 shares
of common stock for the settlement of certain notes payable and accrued
interest.
COMMON STOCK WARRANTS
The following is a summary of the warrant activity:
UNDERLYING COMMON
PRICE PER SHARE SHARES
-------------------- -------------------
JUNE 30, 2006 $0.105 7,280,000
Granted - -
Exercised - -
Canceled - -
-------------------
EXERCISABLE AT MARCH 31, 2007 $0.105 7,280,000
-------------------
The weighted average remaining contractual life of warrants outstanding at March
31, 2007 is 5.85 years. The intrinsic value of the outstanding warrants at March
31, 2007 was $3,676. The exercise prices for warrants outstanding at March 31,
2007 are as follows:
NUMBER OF EXERCISE
WARRANTS PRICE
---------------- --------------------
7,280,000 $ 0.105
----------------
7,280,000
================
Stock Option Activity
The following is a summary of the stock option activity:
STOCK OPTION PLANS
UNDERLYING
PRICE PER COMMON
SHARE SHARES
-------------------- -----------------
JUNE 30, 2006 $2.00 - $5.00 340,000
Granted $0.36 - $1.10 2,050,910
Exercised - -
Canceled/Expired $0.36 - $5.00 (135,000)
-----------------
EXERCISABLE AT MARCH 31, 2007 2,255,910
-----------------
20
NOTE 10. RELATED PARTY TRANSACTIONS
The Company's CEO and Chairman, Mr. Brian Bonar, is also the Chairman of Warning
Management Services, Inc. Warning a public company, located in Southern
California. Warning's operations consist of a modeling agency and providing
temporary staffing services to government agencies and private companies.
In September, 2006, the Company entered into a new Agreement to provide
Administrative Payroll Services to Employment Systems, Inc., ("ESI") a wholly
owned subsidiary of Warning. For the nine months ended March 31, 2007 and 2006,
the Company invoiced ESI for services rendered of $320 and $401, respectively.
NOTE 11. LITIGATION
The Company and its SourceOne Group ("SOG") subsidiary have been sued by the
Arena Football 2 Operating Company, LLC ("Arena") in Wayne County Circuit Court,
Michigan. In April 2006, Dalrada and SourceOne Group, Inc. entered into a
settlement with AF2 Operating Company, LLC and other parties involved in the
matter of AF2 Operating Company, LLC v. SourceOne Group Inc., et al. The net
result of the settlement was that Dalrada and SourceOne Group, Inc. are
obligated to make a net settlement payment of $203.
The Company and SOG have been sued by Liberty Mutual Insurance Company
("Liberty") in the United States District Court for the Northern District of
Illinois. The initial claim by Liberty was estimated by Liberty to be $829 and
is now claimed to exceed $1,000. In July 2006, the judge dismissed Dalrada from
the litigation and dismissed many, but not all, of the claims against SourceOne
Group. Management has vigorously contested the claims made by Liberty. Trial is
scheduled for October 2007.
On March 17, 2005, Greenland Corporation ("Plaintiff"), filed an amended
complaint in the Superior Court of California, County of San Diego, Case No.
GIC842605, against the Company and multiple other individuals and entities
resulting from a transaction as evidenced by the "Agreement to Acquire Shares"
dated August 9, 2002, whereby the Company obtained a controlling equity interest
in Plaintiff. Plaintiff contends that the Company engaged in various forms of
wrongdoing including breach of fiduciary duty, conversion, conspiracy and aiding
and abetting. The Company has filed a cross-complaint alleging various causes of
action against Plaintiff and its officers, directors and/or managing agents
including Thomas J. Beener, Gene Cross, George Godwin, and Edward Sano. The
subject cross-complaint seeks pecuniary and punitive damages resulting from
various fraudulent transactions as well as legal malpractice against Mr. Beener.
In July 2006, the matter was settled with Dalrada paying $150 of legal fees
incurred by Greenland.
On August 29, 2005, United Bank & Trust filed suit against the Company and other
parties. The allegations of the lawsuit are that the Company guaranteed certain
debt owed by InfoServices, Inc. and is liable in the amount of $678. The Company
has settled this matter and at March 31, 2007, the remaining amount due is $189.
The Company was in a dispute with former creditors regarding the amount of debt
converted into common stock. These creditors were seeking damages totaling $316.
The Company proposed a settlement in the amount of $316, based on the advice of
the Company's legal counsel. Consequently, $316 was charged to operations in the
accompanying financial statements for the year ended June 30, 2006. The
plaintiffs have accepted the settlement offer.
NOTE 12. GAIN ON SETTLEMENT OF DEBT
During the nine months ended March 31, 2007 and 2006, the Company recognized a
gain on settlement of debt of $550 and $$9,047, respectively, which resulted
primarily from the write off of stale accounts payable and judgments and the
settlement of certain notes payable. The Company, based upon an opinion provided
by independent legal counsel, has been released as the obligator of these
liabilities. Accordingly, management has elected to adjust its accounts payable
and to classify such adjustments as settlement of debt.
NOTE 13. DISCONTINUED OPERATIONS
In November 2005, the Company determined to discontinue operations of Master
Staffing, its executive recruiting division. The decision was based on the
Master Staffing lack of ability to generate sufficient revenue and the Company's
lack of expertise in the executive recruiting business. The Company has
completely closed Master Staffing.
For the nine months ended March 31, 2007 and 2006, Master Staffing's revenues
were $0 and $11, respectively; losses from operations were $22 and $520,
respectively. The results of operations of Master Staffing have been reported
separately as discontinued operations.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(in thousands, except share data)
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto included on Form 10-KSB for
the year ended June 30, 2006. The statements contained in this Report on Form
10-QSB that are not purely historical are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including statements
regarding our expectations, hopes, intentions or strategies regarding the
future. Forward-looking statements include statements regarding: future product
or product development; future research and development spending and our product
development strategies, and are generally identifiable by the use of the words
"may", "should", "expect", "anticipate", "estimates", "believe", "intend", or
"project" or the negative thereof or other variations thereon or comparable
terminology. Forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, performance
or achievements (or industry results, performance or achievements) expressed or
implied by these forward-looking statements to be materially different from
those predicted. The factors that could affect our actual results include, but
are not limited to, the following: general economic and business conditions,
both nationally and in the regions in which we operate; competition; changes in
business strategy or development plans; our inability to retain key employees;
our inability to obtain sufficient financing to continue to expand operations;
and changes in demand for products by our customers.
OVERVIEW
We provide financial and human resource management services, including staffing
services and PEO services. Staffing services revenues are generated primarily
from short-term staffing, contract staffing, and on-site management. PEO service
fees are generated from contractual agreements with clients under which we act
as a co-employer of our client's workforce with responsibility for some or all
of the client's human resource functions. We recognize revenues from our
staffing services for all amounts invoiced, including direct payroll, employer
payroll-related taxes, workers' compensation coverage and an administrative
fee). PEO service fee revenues are recognized on a net basis in accordance with
Emerging Issues Task Force No.99-19, "REPORTING REVENUES GROSS AS A PRINCIPAL
VERSUS NET AS AN AGENT" ("EITF No.99-19"). Therefore PEO service fee revenues
represent the gross margin generated from our PEO services after deducting the
amounts invoiced to PEO customers for direct payroll expenses such as salaries,
wages, health insurance and employee out-of-pocket expenses incurred incidental
to employment. These amounts are also excluded from cost of revenues. PEO
service fees also include amounts invoiced to our clients for employer
payroll-related taxes and workers' compensation coverage.
Our business is conducted in California, Colorado, Pennsylvania and Texas. In
addition to seeking new markets, we expect to derive most of our revenues from
our current markets for the near term. Any weakness in economic conditions or
changes in the regulatory environments in these regions could have a material
adverse effect on our financial results.
Our services and products are marketed through our operating divisions and
subsidiaries. PEO and staffing services are marketed by Dalrada Financial
Services (formerly Strategic Staff Leasing), and All Staffing (acquired in
September 2006).
Our business continues to experience some liquidity problems. Accordingly,
year-to-year comparisons may be of limited usefulness as our business continues
to experience rapid growth.
Our current strategy is to expand our financial service business, including
staff leasing, PEO services, and value added products and services to small and
medium-size businesses.
To successfully execute our current strategy, we will need to improve our
working capital position. The report of our independent auditors accompanying
our June 30, 2006 financial statements included in Form 10KSB for the year ended
June 30, 2006 includes an explanatory paragraph indicating there is a
substantial doubt about our ability to continue as a going concern, due
primarily to a working capital deficiency and negative net worth, which is
exacerbated by our losses in prior years. In addition, we are current on all our
payroll tax filings and have made current payroll tax deposits since October 1,
2006.
22
We have sought to reduce our debt through debt to equity conversions. In
February 2006 we issued promissory notes for $7,545, which consisted of a
rolling over of approximate $2,545 in existing debt and $5,000 in cash. The
proceeds were used primarily to pay off promissory notes, convertible note debt,
factoring debt, and other debt and to establish collateral backed ACH credit
lines.
There can be no assurance that we will be able to complete any additional debt
or equity financings on favorable terms or at all, or that any such financings,
if completed, will be adequate to meet our capital requirements. Any additional
equity or convertible debt financings could result in substantial dilution to
our shareholders. If adequate funds are not available, we may be required to
delay, reduce or eliminate some or all of our planned activities, including any
potential mergers or acquisitions. Our inability to fund our capital
requirements would have a material adverse effect on the Company.
On March 29, 2007, we completed a separation and sale agreement with an
effective date of January 1, 2007 with its majority owned subsidiary, The Solvis
Group, Inc. (Solvis). The purpose of this transaction between us and Solvis was
to separate the two companies into unrelated reporting entities. Solvis was
principally in the business of leasing staff to its customers on a temporary
basis. In connection with this separation agreement, we also sold our Heritage
Staffing, Inc. subsidiary to Solvis. The terms of the separation and sale
agreement provided for us issuing two notes payable in the amount of $11,300 and
returning shares of Solvis common stock currently owned by us which reduced our
ownership in Solvis from approximately 85% to approximately 9.9%. In return, we
received cash, accounts receivable, a forgiveness of intercompany debt and
Solvis' clients that are California based staff leasing customers. There are
certain payroll tax liabilities of Solvis that we may still be liable to pay if
not paid by Solvis.
For accounting purposes, this transaction has been recorded as a change in
reporting entity. We have reported the effect of this change in reporting entity
in the financial statements as a prior-period adjustment by adjusting the assets
and liabilities balances of the first reporting period presented. An offsetting
adjustment of $160 has been made to the opening balance of accumulated deficit
for the first period presented in the accompanying financial statements. The
accompanying financial statements have been restated to reflect this change in
reporting entity as if it occurred on the beginning of the earliest period
presented.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Discussion and Analysis of Financial Condition and Results of Operations discuss
our consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America.
The preparation of these consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. On an
on-going basis, we evaluate our estimates and judgments, including those related
to allowance for doubtful accounts, value of intangible assets and valuation of
non-cash compensation. We base our estimates and judgments on historical
experiences and on various other factors that we believe to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying value of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions. The most significant accounting estimates
inherent in the preparation of our consolidated financial statements include
estimates as to the appropriate carrying value of certain assets and liabilities
which are not readily apparent from other sources, primarily allowance for
doubtful accounts, estimated fair value of equity instruments used for
compensation, estimated tax liabilities from PEO operations and estimated
liabilities associated with worker's compensation liabilities. These accounting
policies are described at relevant sections in this discussion and analysis and
in the notes to the consolidated financial statements included elsewhere in this
Form l0-KSB.
REVENUE RECOGNITION
PEO SERVICE FEES AND WORKSITE EMPLOYEE PAYROLL COSTS
We recognize our revenues associated with our PEO business pursuant to EITF
99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent." Our
revenues are reported net of worksite employee payroll cost (net method).
Pursuant to discussions with the Securities and Exchange Commission staff, we
changed our presentation of revenues from the gross method to an approach that
presents our revenues net of worksite employee payroll costs (net method)
primarily because we are not generally responsible for the output and quality of
work performed by the worksite employees.
23
In determining the pricing of the markup component of the gross billings, we
take into consideration our estimates of the costs directly associated with our
worksite employees, including payroll taxes, benefits and workers' compensation
costs, plus an acceptable gross profit margin. As a result, our operating
results are significantly impacted by our ability to accurately estimate,
control and manage our direct costs relative to the revenues derived from the
markup component of our gross billings.
Consistent with our revenue recognition policy, our direct costs do not include
the payroll cost of our worksite employees. Our direct costs associated with our
revenue generating activities are comprised of all other costs related to our
worksite employees, such as the employer portion of payroll-related taxes,
employee benefit plan premiums and workers' compensation insurance premiums.
TEMPORARY STAFFING
We record gross revenue for temporary staffing. We have concluded that gross
reporting is appropriate because we (i) have the risk of identifying and hiring
qualified employees, (ii) have the discretion to select the employees and
establish their price and duties and (iii) bear the risk for services that are
not fully paid for by customers. Temporary staffing revenues are recognized when
the services are rendered by our temporary employees. Temporary employees placed
by us are our legal employees while they are working on assignments. We pay all
related costs of employment, including workers' compensation insurance, state
and federal unemployment taxes, social security and certain fringe benefits. We
assume the risk of acceptability of our employees to our customers.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We are required to make estimates of the collectibility of accounts receivables.
Management analyzes historical bad debts, customer concentrations, customer
creditworthiness, current economic trends and changes in the customers' payment
tendencies when evaluating the adequacy of the allowance for doubtful accounts.
If the financial condition of our customers deteriorates, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
INTANGIBLE ASSETS AND GOODWIL
We assess the recoverability of intangible assets and goodwill annually and
whenever events or changes in circumstances indicate that the carrying value
might be impaired. Factors that are considered include significant
underperformance relative to expected historical or projected future operating
results, significant negative industry trends and significant change in the
manner of use of the acquired assets. Management's current assessment of the
carrying value of intangible assets and goodwill indicates there was no
impairment as of March 31, 2007. If these estimates or their related assumptions
change in the future, we may be required to record impairment charges for these
assets.
SALES OF PRODUCTS
Revenue is recognized when earned. Our revenue recognition policies are in
compliance with all applicable accounting regulations, including American
Institute of Certified Public Accountants (AICPA) Statement of Position (SOP)
97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2,
Revenue from packaged product sales to and through distributors and resellers is
recorded when related products are shipped. Maintenance and subscription
revenue, if any, is recognized ratably over the contract period. When the
revenue recognition criteria required for distributor and reseller arrangements
are not met, revenue is recognized as payments are received. Provisions are
recorded for returns and bad debts. Our software arrangements do not contain
multiple elements, and we do not offer post contract support.
RESULTS OF OPERATIONS (IN $000)
THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THREE MONTHS ENDED MARCH 31, 2006
REVENUES
Total revenues were $44,374 and $931for the three months ended March 31, 2007
and 2006, respectively; an increase of $43,443 (4,663%). The principal reason
for the increase is due the acquisition of Strategic Staffing on May 1, 2006 and
All Staffing on September 12, 2006.
STAFFING
Revenues from our staffing business units were $33,770 and $0 for the three
months ended March 31, 2007 and 2006, respectively; an increase of $33,770. The
principal reason for the increase is due the acquisition of Strategic Staffing
on May 1, 2006 and All Staffing on September 12, 2006.
24
PEO SERVICES
PEO revenues were $10,482 and $90 for the three months ended March 31, 2007 and
2006, respectively; an increase of $10,392 which is due to the aforementioned
acquisitions.
Under current GAAP rules, we are required to book PEO revenues on a net fee
basis rather than as gross billed payrolls. Gross billing for the three months
ended March 31, 2007 and 2006 were approximately $31,763 and $270 respectively.
COST OF PRODUCTS SOLD
Costs of staffing for the three months ended March 31, 2007 and 2006 was $32,342
(95.8% of temporary staffing revenue) and $0, respectively. The increase in is
due to the aforementioned acquisitions.
Cost of PEO services for the three months ended March 31, 2007 and 2006 was
$10,981 (104.8% of PEO revenues) and $14 (15.6% of PEO revenues), respectively.
The decrease in gross profit is due primarily to higher workers' compensation
costs and the aforementioned acquisitions.
OPERATING EXPENSES
Operating expenses for the three months ended March 31, 2007 and 2006 were
$4,460 and $1,395, respectively; an increase of $3,065 (219.7%). The increase is
due to additional operating costs with the acquisition of Strategic Staffing and
All Staffing and to the recognition of $1,392 in stock option compensation
expense in accordance with SFAS 123R.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the three months ended March 31, 2007
and 2006 was $686 and $1,135 respectively; a decrease of $449 (39.6%). The
decrease was principally due to higher amortization of debt discounts for the
three months ended March 31, 2006.
PENALTIES AND INTEREST
During the three months ended March 31, 2007 and 2006, the Company recognized
penalties and interest expense on its tax obligations of $1,822 and $282,
respectively.
GAIN ON EXTINGUISHMENT OF DEBT
During the three months ended March 31, 2007 and 2006, the Company recognized a
gain on settlement of debt of $47 and $3,444, respectively, which resulted
primarily from the write off of stale accounts payable and the settlement of
bank debt and judgments. We, based upon an opinion provided by independent
legal counsel, have been released as the obligator of these liabilities.
CHANGES IN DERIVATIVES AND WARRANTY LIABILITIES
For the three months ended March 31, 2007, we recorded other income of $689
related to the change in the value of the debt features and warrants principally
a result of the decrease in our stock price. For the three months ended March
31, 2006, we recorded other expense of $720 related to the change in the value
of the debt features and warrants principally a result of the increase in our
stock price.
NINE MONTHS ENDED MARCH 31, 2007 COMPARED TO NINE MONTHS ENDED MARCH 31, 2006
REVENUES
Total revenues were $68,635 and $2,206 for the nine months ended March 31, 2007
and 2006, respectively; an increase of $66,439 (3,011%). The principal reason
for the increase is due the acquisition of Strategic Staffing on May 1, 2006 and
All Staffing on September 12, 2006.
STAFFING
Revenues from our staffing business units were $41,270 and $0 for the nine
months ended March 31, 2007 and 2006, respectively; an increase of $41,270. The
principal reason for the increase is due the acquisition of Strategic Staffing
on May 1, 2006 and All Staffing on September 12, 2006.
PEO SERVICES
PEO revenues were $26,229 and $772 for the nine months ended March 31, 2007 and
2006, respectively; an increase of $25,457 (3,298%) which is due to the
aforementioned acquisitions.
25
Under current GAAP rules, we are required to book PEO revenues on a net fee
basis rather than as gross billed payrolls. Gross billing for the nine months
ended March 31, 2007 and 2006 were approximately $79,482 and $2,339,
respectively.
COST OF PRODUCTS SOLD
Costs of staffing for the nine months ended March 31, 2007 and 2006 was $39,092
(94.7% of temporary staffing revenue) and $0, respectively. The increase in is
due to the aforementioned acquisitions.
Cost of PEO services for the nine months ended March 31, 2007 and 2006 was
$25,502 (97.2% of PEO revenues) and $667 (86.4% of PEO revenues), respectively.
The decrease in gross profit is due primarily to higher workers' compensation
costs and the aforementioned acquisitions.
OPERATING EXPENSES
Operating expenses for the nine months ended March 31, 2007 and 2006 were
$10,298 and $3,569, respectively; an increase of $6,729 (188.5%). The increase
is due to the additions operating costs with the acquisition of Strategic
Staffing and All Staffing and to the recognition of $1,392 in stock option
compensation expense in accordance with SFAS 123R.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the nine months ended March 31, 2007
and 2006 was $3,657 and $1,480 respectively; an increase of $2,177 (147.1%). The
increase was principally due to the increase in debt associated with the
February 2006 refinancing, the amortization of debt discount and debt issue cost
associated with the February 2006 refinancing and a non-registration penalty.
PENALTIES AND INTEREST
During the nine months ended March 31, 2007 and 2006, the Company recognized
penalties and interest expense on its tax obligations of $1,822 and $849,
respectively.
GAIN ON EXTINGUISHMENT OF DEBT
During the nine months ended March 31, 2007 and 2006, the Company recognized a
gain on settlement of debt of $550 and $9,047, respectively, which resulted
primarily from the write off of stale accounts payable and the settlement of
bank debt and judgments. We, based upon an opinion provided by independent
legal counsel, have been released as the obligator of these liabilities.
CHANGES IN DERIVATIVES AND WARRANTY LIABILITIES
For the nine months ended March 31, 2007, we recorded other expense of $1,219
and $682, related to the increase in value of the debt features and warrants. A
tabular reconciliation of this adjustment follows:
For the nine months ended March 31, 2007:
$ 1,219 expense, increase in value of warrant liability
$ 682 expense, increase in value of derivative liability
-------
$ 1,901 other expense related to convertible debt
For the nine months ended March 31, 2007, the Company recorded $2,720 of
interest expense related to the accretion of debt related to the convertible
financing.
For the nine months ended March 31, 2007:
$ 2,720 of interest expense related to accretion of convertible debt
-------
$ 2,720 of interest expense related to convertible debt
The balance of the carrying value of the convertible debt as of March 31, 2007
is:
$ 1,605 original carrying value on convertible debt
$ (228) converted to equity
$ 3,604 accretion of convertible debt
-------
$ 4,981 March 31, 2007 carrying value of debt
26
The balance of the carrying value of the derivative liability as of March 31,
2007 is:
$ 2,717 original value of derivative liability
$(1,234) income, decrease in value of derivative liability
-------
$ 1,483 June 30, 2006 value of derivative liability
$ 682 expense, increase in value of derivative liability
-------
$ 2,165 March 31, 2007 value of derivative liability
The balance of the carrying value of the warrant liability as of March 31, 2007
is:
$ 3,892 original carrying value of warrant liability
$ (754) income, decrease in value of warrant liability
-------
$ 3,138 June 30, 2006 value of warrant liability
$ 1,219 expense, increase in value of warrant liability
-------
$ 4,357 March 31, 2007 value of warrant liability
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our operations primarily through cash generated
from operations, debt financing, and the sale of equity securities.
Additionally, in order to facilitate our growth and future liquidity, we have
made some strategic acquisitions.
As a result of some of our financing activities, there has been a significant
increase in the number of issued and outstanding shares. During the year ended
June 30, 2006 and the year ended June 30, 2005, we issued an additional
1,241,283 and 914,450 post split shares, respectively. These shares of common
stock were issued primarily for corporate expenses in lieu of cash, for
acquisition of businesses, for the conversion of convertible debentures and
other debt, and for the exercise of warrants.
As of March 31, 2007, we had negative working capital of $19,114. The Company is
current on filing payroll tax returns, but owes approximately $9.8 million in
past due payroll taxes, interest and penalties.
Net cash used in operating activities was $1,318 for the nine months ended March
31, 2007 as compared $2,319 for the nine months ended March 31, 2006; an
decrease of $1,001.
Cash provided by financing activities was $169 for the nine months ended March
31, 2007 as compared to $3,879 for the nine months ended March 31, 2006, a
increase of $3,710 from the nine months ended March 31, 2006. The primary reason
for the increase was due to the issuance of notes payable during the nine months
ended March 31, 2006.
We have no material commitments for capital expenditures. Our 5% convertible
preferred stock (which ranks prior to our common stock), carries cumulative
dividends, when and as declared, at an annual rate of $50 per share. The
aggregate amount of such dividends in arrears at March 31, 2007 was
approximately $489.
Our capital requirements depend on numerous factors, including market acceptance
of our products and services, the resources we devote to marketing and selling
our products and services, and other factors. The report of our independent
auditors accompanying our June 30, 2006 financial statements includes an
explanatory paragraph indicating there is a substantial doubt about our ability
to continue as a going concern, due primarily to the deficit in our working
capital and net worth.
CONTINGENT LIABILITY
The Company accrues and discloses contingent liabilities in its consolidated
financial statements in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 5, Accounting for Contingencies. SFAS No. 5 requires
accrual of contingent liabilities that are considered probable to occur and that
can be reasonably estimated. For contingent liabilities that are considered
reasonably possible to occur, financial statement disclosure is required,
including the range of possible loss if it can be reasonably determined. The
Company has disclosed in its audited financial statements several issues that it
believes are reasonably possible to occur, although it cannot determine the
range of possible loss in all cases. As these issues develop, the Company will
continue to evaluate the probability of future loss and the potential range of
such losses. If such evaluation were to determine that a loss was probable and
the loss could be reasonably estimated, the Company would be required to accrue
its estimated loss, which would reduce net income in the period that such
determination was made.
27
OFF-BALANCE ARRANGEMENTS
There are no off balance sheet arrangements that have or are reasonably likely
to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.
Warning Model Management, Inc. reached a settlement with Berryman & Henigar
Enterprises, during the nine months ended March 31, 2007, to pay the aggregate
sum of $380, which has been paid in full. Accordingly, Dalrada's guarantee of
this indebtedness in no longer applicable.
ITEM 3. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of the period ended March 31, 2007, covered by this
quarterly report (the "Evaluation Date"), and based on such evaluation, such
officers have concluded, as of the Evaluation Date, that our disclosure controls
and procedures were not effective in ensuring that all information required to
be disclosed in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission rules and forms.
The material weaknesses in internal control over financial reporting resulting
from the Chief Executive Officer and Chief Financial Officer's evaluation are
described below. In addition there are inherent limitations to the effectiveness
of any system of disclosure controls and procedures. Even effective disclosure
controls and procedures can only provide reasonable assurance of achieving their
control objectives.
Except as described below, during our third quarter of fiscal 2006, there were
no changes made in our internal control over financial reporting that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting. Attached as Exhibits 31.1 and 31.2 to this
annual report are certifications of the Chief Executive Officer and Chief
Financial Officer required in accordance with Rule 13a-14(a) of the Exchange
Act. This portion of the Company's quarterly report includes the information
concerning the controls evaluation referred to in the certifications and should
be read in conjunction with the certifications for a more complete understanding
of the topics presented.
In conjunction with their audit of our fiscal year 2005 consolidated financial
statements, PMB & Co., LLP (PMB), our independent registered public accounting
firm, identified and orally reported to management and the Audit Committee the
material weaknesses under standards established by the Public Company Accounting
Oversight Board (PCAOB). A material weakness is a significant deficiency, or
combination of significant deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. A significant deficiency is a
control deficiency, or combination of control deficiencies, that adversely
affects our ability to initiate, authorize, record, process, or report external
financial data reliably in accordance with generally accepted accounting
principles such that there is a more than a remote likelihood that a
misstatement of our annual or interim financial statements that is more than
inconsequential will not be prevented or detected.
The material weaknesses were identified as:
(1) Planning and implementation of our Accounting System; (2) Financial
Statement closing process; (3) Ineffective Information Technology control
environment, including the design of our information security and data
protection controls; (4) Untimely detection and assessment of impairment of
intangible assets (i.e., patents where indicators of impairment are present; (5)
Inadequate review of the valuation of certain payroll tax liabilities that
resulted in post-closing journal entries to properly reflect our payroll tax
liabilities; (6) Proper recording of conversion of debt into shares of common
stock, including the ability of certain managers to record journal entries
without adequate review or supporting documentation and an inability by
management to adequately review the issuance of common stock; and, (7) Lack of
the necessary depth of personnel with sufficient technical accounting experience
with U.S. GAAP to perform an adequate and effective secondary review of
technical accounting matters. We will continue to evaluate the material
weaknesses and will take all necessary action to correct the internal control
deficiencies identified. We will also further develop and enhance our internal
control policies, procedures, systems and staff to allow us to mitigate the risk
that material accounting errors might go undetected and be included in our
consolidated financial statements.
28
We contemplate undertaking a thorough review of our internal controls as part of
our preparation for compliance with the requirements under Section 404 of the
Sarbanes-Oxley Act of 2002 and we are using this review to further assist in
identifying and correcting control deficiencies. At this time, we have not
completed our review of the existing controls and their effectiveness. Unless
and until the material weaknesses described above, or any identified during this
review, are completely remedied, evaluated and tested, there can be no
assurances that we will be able to assert that our internal control over
financial reporting is effective, pursuant to the rules adopted by the SEC under
Section 404, when those rules take effect.
At present, we have taken steps to improve our internal controls through the
acquisition and implementation of new accounting systems and additional
personnel in our finance departments.
PART II - OTHER INFORMATION
(in thousands, except per share data)
ITEM 1. LEGAL PROCEEDINGS
The Company and its SourceOne Group ("SOG") subsidiary have been sued by the
Arena Football 2 Operating Company, LLC ("Arena") in Wayne County Circuit Court,
Michigan. In April 2006, Dalrada and SourceOne Group, Inc. entered into a
settlement with AF2 Operating Company, LLC and other parties involved in the
matter of AF2 Operating Company, LLC v. SourceOne Group Inc., et al. The net
result of the settlement was that Dalrada and SourceOne Group, Inc. are
obligated to make a net settlement payment of $203.
The Company and SOG have been sued by Liberty Mutual Insurance Company
("Liberty") in the United States District Court for the Northern District of
Illinois. The initial claim by Liberty was estimated by Liberty to be $829 and
is now claimed to exceed $1,000. In July 2006, the judge dismissed Dalrada from
the litigation and dismissed many, but not all, of the claims against SourceOne
Group. Management has vigorously contested the claims made by Liberty. Trial is
scheduled for October 2007.
On March 17, 2005, Greenland Corporation ("Plaintiff"), filed an amended
complaint in the Superior Court of California, County of San Diego, Case No.
GIC842605, against the Company and multiple other individuals and entities
resulting from a transaction as evidenced by the "Agreement to Acquire Shares"
dated August 9, 2002, whereby the Company obtained a controlling equity interest
in Plaintiff. Plaintiff contends that the Company engaged in various forms of
wrongdoing including breach of fiduciary duty, conversion, conspiracy and aiding
and abetting. The Company has filed a cross-complaint alleging various causes of
action against Plaintiff and its officers, directors and/or managing agents
including Thomas J. Beener, Gene Cross, George Godwin, and Edward Sano. The
subject cross-complaint seeks pecuniary and punitive damages resulting from
various fraudulent transactions as well as legal malpractice against Mr. Beener.
In July 2006, the matter was settled with Dalrada paying $150 of legal fees
incurred by Greenland.
On August 29, 2005, United Bank & Trust filed suit against the Company and other
parties. The allegations of the lawsuit are that the Company guaranteed certain
debt owed by InfoServices, Inc. and is liable in the amount of $678. The Company
has settled this matter and at March 31, 2007, the remaining amount due is $189.
The Company was in a dispute with former creditors regarding the amount of debt
converted into common stock. These creditors were seeking damages totaling $316.
The Company proposed a settlement in the amount of $316, based on the advice of
the Company's legal counsel. Consequently, $316 was charged to operations in the
accompanying financial statements for the year ended June 30, 2006. The
plaintiffs have accepted the settlement offer.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the three months ended March 31, 2007, the Company issued 166,326 shares
of common stock for the settlement of certain notes payable and accrued
interest.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
29
ITEM 6. EXHIBITS
a) Exhibits
31.1 Rule 13a-14(a) Certification of CEO
31.2 Rule 13a-14(a) Certification of CFO
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 of CEO
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 of CFO
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 21, 2007
DALRADA FINANCIAL CORPORATION
(Registrant)
By: /S/ Brian Bonar
-------------------------------------
Brian Bonar
Chairman and Chief Executive Officer
By: /S/ David P. Lieberman
-------------------------------------
David P. Lieberman
Chief Financial Officer
30