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, 2006
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 33-0021693
(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,
2006 was 932,980,414.
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
ITEM 1. Consolidated Financial Statements
Consolidated Balance Sheet - March 31, 2006 (unaudited)
Consolidated Statements of Operations - 3 and 9 months ended March 31, 2006
and 2005 (unaudited)
Consolidated Statements of Cash Flows - 9 months ended March 31, 2006 and
2005 (unaudited)
Notes to Consolidated Financial Statements (unaudited)
ITEM 2. Management's Discussion and Analysis or Plan of Operations
ITEM 3. Controls and Procedures
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
ITEM 2. Unregistered Sale of Equity Securities and Use of Proceeds
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Submission of Matters To A Vote of Security Holders
ITEM 5. Other Information
ITEM 6. Exhibits
SIGNATURES
CERTIFICATIONS
2
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
MARCH 31, 2006
(unaudited)
MARCH 31,
2006
---------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ --
Restricted cash 1,922
Accounts receivable, net of allowance of $0 5,083
Other receivable 190
Debt issue costs 415
Prepaid worker's compensation premiums 521
Other current assets 2,807
--------
TOTAL CURRENT ASSETS 10,938
--------
CUSTOMER LIST, net of accumulated amortization of $24 48
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $1,453 341
WORKER'S COMPENSATION DEPOSIT 1,970
OTHER LONG-TERM ASSETS 14
--------
TOTAL ASSETS $ 13,311
=========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Cash overdraft $ 1,882
Lines of credit 155
Notes payable - related party 125
Accounts payable 1,849
PEO payroll taxes and other payroll deductions 8,563
Other accrued expenses 9,923
Warrant liability 4,618
Accrued derivative liability 2,804
Net liabilities of discontinued operations 78
--------
TOTAL CURRENT LIABILITIES 29,997
--------
NOTES PAYABLE - related party 422
CONVERTIBLE DEBENTURES, net of discounts of $5,942 1,733
--------
TOTAL LIABILITIES 32,152
--------
MINORITY INTEREST 256
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; 932,980,414 shares issued and outstanding 4,665
Common stock warrants 475
Additional paid-in capital 82,083
Prepaid consulting (283)
Accumulated deficit (106,457)
--------
TOTAL STOCKHOLDERS' DEFICIT (19,097)
--------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 13,311
=========
The accompanying notes are an integral part of these consolidated financial statements
3
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
MARCH 31, 2006
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
2006 2005 2006 2005
--------- --------- --------- ---------
(unaudited) (unaudited) (unaudited) (unaudited)
REVENUES
Temporary staffing services $ 18,855 $ 4,095 $ 47,400 $ 11,749
PEO Services 90 1,208 772 2,058
Sales of products (46) 137 585 468
Software sales, licenses and royalties -- 9 5 48
--------- --------- --------- ---------
TOTAL REVENUES 18,899 5,449 48,762 14,323
--------- --------- --------- ---------
COST OF REVENUES
Cost of temporary staffing 16,434 3,591 41,737 10,539
Cost of PEO services 15 1,088 668 1,716
Cost of products sold 8 23 26 59
Cost of software sales, licenses and royalties -- 1 -- 4
--------- --------- --------- ---------
TOTAL COST OF REVENUES 16,457 4,703 42,431 12,318
--------- --------- --------- ---------
GROSS PROFIT 2,442 746 6,331 2,005
--------- --------- --------- ---------
OPERATING EXPENSES
Selling, general and administrative 2,402 904 6,610 2,870
--------- --------- --------- ---------
TOTAL OPERATING EXPENSES 2,402 904 6,610 2,870
--------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 40 (158) (279) (865)
OTHER INCOME (EXPENSES):
Interest expense (1,106) (394) (1,670) (1,208)
Settlements with investors (915) -- (1,231) --
Gain on extinguishment of debt 3,604 165 9,207 425
Penalties and interest (282) -- (849) --
Gain resulting from reconciliation of payroll tax
liabilities to taxing authorities 1,924 454 1,924 990
Other, net (730) -- (888) --
--------- --------- --------- ---------
TOTAL OTHER INCOME (EXPENSE) 2,495 225 6,493 207
--------- --------- --------- ---------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS 2,535 67 6,214 (658)
PROVISION FOR INCOME TAXES -- -- -- --
--------- --------- --------- ---------
INCOME (LOSS) BEFORE MINORITY INTEREST
AND DISCONTINUED OPERATIONS 2,535 67 6,214 (658)
MINORITY INTEREST IN SUBSIDIARY 256 -- 256 --
NET INCOME (LOSS) FROM CONTINUING OPERATIONS 2,279 67 5,958 (658)
DISCONTINUED OPERATIONS:
Loss from operations of discontinued operations -- -- (520)
--------- --------- --------- ---------
NET INCOME (LOSS) $ 2,279 $ 67 $ 5,438 $ (658)
========= ========= ========= =========
PREFERRED STOCK DIVIDENDS (5) (5) (15) (15)
--------- --------- --------- ---------
NET INCOME (LOSS) ATTRIBUTED TO COMMON
STOCKHOLDERS $ 2,274 $ 62 $ 5,423 $ (673)
========= ========= ========= =========
NET INCOME (LOSS) PER SHARE - BASIC
Continuing operations $ 0.00 $ 0.00 $ 0.01 $ (0.00)
Discontinued operations -- -- (0.00) --
--------- --------- --------- ---------
$ 0.00 $ 0.00 $ 0.01 $ (0.00)
========= ========= ========= =========
WEIGHTED AVERAGE COMMON EQUIVALENT
SHARES OUSTANDING - BASIC 832,881 682,396 785,011 635,914
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements
4
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(unaudited)
SERIES A COMMON ADDITIONAL
PREFERRED STOCK COMMON STOCK STOCK PAID-IN PREPAID ACCUMULATED
SHARES AMOUNT SHARES AMOUNT WARRANTS CAPITAL CONSULTING DEFICIT TOTAL
------ ------ ------ ------ -------- ------- ---------- ------- -----
BALANCE, JUNE 30, 2005 420.5 $ 420 735,248,867 $ 3,676 $ 475 $ 82,629 $ - $ (111,895) $ (24,695)
Issuance of common stock for:
Services 15,000,000 75 (10) 65
Convertible debentures 130,247,359 651 (373) 278
Conversion of liabilities 52,484,188 263 (163) 100
Foreign currency translation
adjustment - -
Value of warrants issued for
consulting services (302) (302)
Amortization of prepaid consulting 19 19
-
Net income 5,438 5,438
---------------- ------------------------ ------------------- -------- ----------------------
BALANCE, MARCH 31, 2006 420.5 $ 420 932,980,414 $ 4,665 $ 475 $ 82,083 $ (283) $ (106,457) $ (19,097)
================ ======================== =================== ======== ======================
The accompanying notes are an integral part of these consolidated financial statements
5
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
NINE MONTHS ENDED
---------------------------
MARCH 31, MARCH 31,
2006 2005
------- -------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) from continuing operations $ 5,958 $ (658)
Adjustment to reconcile net loss to net cash
provided by (used in) operating activities from continuing operations
Depreciation and amortization 85 130
Stock issued for services 15 42
Amortizatin of prepaid consulting 19 --
Amortization of debt discounts 553 305
Settlements with investors 1,231 --
Change in value of warrant and accrued derivative liability 821 --
Gain on settlement of debt (9,207) --
Gain resulting from reconciliation of payroll tax
liabilities to taxing authorities (1,924) (990)
Minority interest 256 --
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (3,669) (557)
Other receivables (190) --
Inventories -- --
Prepaid worker's compensation premiums 609 --
Other current assets (1,767) (317)
Worker's compensation deposit 655 --
Other assets (3) --
Increase (decrease) in:
Accounts payable and accrued expenses 5,902 (703)
PEO liabilities 1,712 2,562
----------- -----------
Net cash provided by (used in) operating activities from continuing operations 1,056 (186)
Net cash used in operating activities of discontinued operations (432) --
----------- -----------
Net cash provided by (used in) operating activities 624 (186)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (170) (147)
Increase in restricted cash (1,922) --
----------- -----------
Net cash used in investing activities from continuing operations (2,092) (147)
Net cash used in investing activities of discontinued operations -- --
----------- -----------
Net cash used in investing activities (2,092) (147)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in cash overdraft, net 1,720 --
Line of credit, net (614) 209
Proceeds from notes payable 821 336
Proceeds from issuance of convertible debentures 5,000 --
Payment of debt issue costs (392) --
Repayments of notes payable (4,751) (126)
Repayments of borrowings under bank notes payable (483) --
Repayments of capital lease obligations (4) (19)
----------- -----------
Net cash provided by (used in) financing activities from continuing operations 1,297 400
Net cash used in financing activities of discontinued operations -- --
----------- -----------
Net cash provided by (used in) financing activities 1,297 400
----------- -----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (171) 67
CASH AND CASH EQUIVALENTS, Beginning of period 171 228
----------- -----------
CASH AND CASH EQUIVALENTS, End of period $ -- $ 295
=========== ===========
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 $ 175
=========== ===========
Conversion of accounts payable and accrued liabilities into
common stock $ 100 $ 132
=========== ===========
Summary of new convertible debentures:
Total new convertible debentures $ 7,675,243
Less amounts paid:
Principal note balances (1,828,651)
Accrued Interest-Notes (777,018)
Accrued Penalties-Notes (94,500)
Finders Fees (300,000)
Legal Fees (92,000)
PMF Funding-payoff (216,368)
Bridge loan repayment (600,000)
Bank Payoffs-fees (15,200)
Note Settlement Fees (1,516,607)
-----------
Net Cash Received $ 2,234,899
===========
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 PER-SHARE DATA)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Dalrada
Financial Corporation and Subsidiaries (the "Company" or "DRDF") 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, 2005 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. The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. All inter-company transactions have been
eliminated.
MINORITY INTEREST
-----------------
On April 1, 2005, the Company contributed its wholly-owned subsidiary, Solvis
Group, Inc. a Michigan corporation, to Quality Photographic Imaging, Inc.
("QPI"), an 85%-owned subsidiary of the Company. QPI subsequently changed its
name to The Solvis Group, Inc., a Nevada corporation ("Solvis"). At that date,
Solvis had a stockholders' equity of $393. As a result of this transaction, the
Company recognized minority interest on its consolidated balance sheet in the
amount of $59. During the year ended June 30, 2005, Solvis incurred a net loss
of which 15% is attributed to the minority interest. In the consolidated
statement of operations for the year ended June 30, 2005, the Company has only
recognized the minority interests' share of the net loss to the extent of the
minority interest recorded on the consolidated balance sheet. Solvis had net
income for the nine months ended March 31, 2006 of which 15% or $256 is
attributed to minority interest that has been separately designated in the
accompanying statement of operations.
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, 2006 and 2005, the Company had no elements of comprehensive
income.
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, 2006, the Company had a loss from operations of $279. As of
March 31, 2006, the Company had a working capital deficiency of $19,059 and had
a stockholders' deficit of $19,097. In addition, the Company is in default on
certain note payable obligations, delinquent on payroll tax obligations and is
being sued by numerous 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.
7
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. STOCK BASED COMPENSATION
The Company accounts for its stock-based compensation in accordance with SFAS
No. 123R, "Share-Based Payment, an Amendment of FASB Statement No. 123." The
Company recognizes in the statement of operations the grant-date fair value of
stock options and other equity-based compensation issued to employees and
non-employees. The Company did not grant any new options and no options were
cancelled or exercised during the three months ended March 31, 2006.
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 three and nine months ended March 31, 2005.
NOTE 4. 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, 2006: warrants - 1,456,000 and stock options - 31,500. All options and
warrants are anti-dilutive at March 31, 2006 as the exercise price is greater
than the Company stock price at March 31, 2006.
Below is a computation of earnings (loss) per share for the three and nine
months ended March 31, 2006 and 2005. Basic and diluted loss per share are the
same for the nine months ended March 31, 2005:
THREE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------------
2006 2005
-------------------------------------- -------------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
BASIC EARNINGS PER SHARE
Net income from continuing operations $ 2,279 $ 67
Preferred stock dividends (5) (5)
--------- ---------
2,274 62
Discontinued operations -- --
--------- ---------
Net income attributed to common
stockholders $ 2,274 $ 62
========= =========
Weighted shares outstanding 832,881 682,396
Continuing operations $ 0.00 $ 0.00
Discontinued operations $ -- $ --
--------- ---------
$ 0.00 $ 0.00
========= =========
8
DILUTED EARNINGS PER SHARE
Net income from continuing operations $ 2,279 $ 67
Preferred stock dividends (5) (5)
Interest on convertible debentures 156 25
Amortization of discounts on convertible
debentures 112 41
--------- --------
2,542 128
Discontinued operations -- --
--------- --------
Net income attributed to common
stockholders $ 2,542 $ 128
========= ========
Weighted shares outstanding 832,881 682,396
Conversion of convertible debentures into
common stock 2,482,271 729,689
----------- -----------
3,315,152 1,412,085
=========== ===========
Continuing operations $ 0.00 $ 0.00
Discontinued operations $ -- $ --
----------- -----------
$ 0.00 $ 0.00
=========== ===========
NINE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------------
2006 2005
-------------------------------------- -------------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing
operations $ 5,958 $ (658)
Preferred stock dividends (15) (15)
----------- ----------
5,943 (673)
Discontinued operations (520) --
----------- ----------
Net income (loss) attributed to common
stockholders $ 5,423 $ (673)
=========== ==========
Weighted shares outstanding 785,001 635,914
Continuing operations $ 0.01 $ (0.00)
Discontinued operations $ (0.00) $ --
----------- ----------
$ 0.01 $ (0.00)
=========== ==========
DILUTED EARNINGS PER SHARE N/A
Net income from continuing operations $ 5,958
Preferred stock dividends (15)
Interest on convertible debentures 216
Amortization of discounts on convertible
debentures 526
-----------
6,685
Discontinued operations (520)
-----------
Net income attributed to common
stockholders $ 6,165
===========
Weighted shares outstanding 785,001
Conversion of convertible debentures into common stock 2,482,271
-----------
3,267,272
===========
Continuing operations $ 0.00
Discontinued operations $ (0.00)
9
NOTE 5. BORROWINGS UNDER BANKS NOTES PAYABLE
The Company had outstanding two notes payable to Imperial Bank and Export-Import
Bank in the amounts of $1,490 and $1,730, respectively. In December 2005, the
Company entered into an agreement with these two banks whereby the Company paid
a total of $483 as full satisfaction of all outstanding principal ($3,220) and
accrued interest ($1,383) relating to these two notes payable. The Company
recognized a gain on the settlement of debt related to this transaction of
$4,120.
NOTE 6. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 2006, FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments". SFAS No. 155 amends SFAS No 133, "Accounting for
Derivative Instruments and Hedging Activities", and SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". SFAS No. 155, permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. This statement is effective for all financial instruments acquired
or issued after the beginning of the Company's first fiscal year that begins
after September 15, 2006. Management believes that this statement will not have
a significant impact on the consolidated financial statements.
In March 2006 FASB issued SFAS 156 `Accounting for Servicing of Financial
Assets' this Statement amends FASB Statement No. 140, ACCOUNTING FOR TRANSFERS
AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES, with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement:
1. Requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract.
2. Requires all separately recognized servicing assets and
servicing liabilities to be initially measured at fair value,
if practicable.
3. Permits an entity to choose `Amortization method' or Fair
value measurement method' for each class of separately
recognized servicing assets and servicing liabilities:
4. At its initial adoption, permits a one-time reclassification
of available-for-sale securities to trading securities by
entities with recognized servicing rights, without calling
into question the treatment of other available-for-sale
securities under Statement 115, provided that the
available-for-sale securities are identified in some manner as
offsetting the entity's exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer
elects to subsequently measure at fair value.
5. Requires separate presentation of servicing assets and
servicing liabilities subsequently measured at fair value in
the statement of financial position and additional disclosures
for all separately recognized servicing assets and servicing
liabilities.
This Statement is effective as of the beginning of the Company's first fiscal
year that begins after September 15, 2006. Management believes that this
statement will not have a significant impact on the consolidated financial
statements.
NOTE 7. FACTORING LINES OF CREDIT
The Company's temporary staffing division entered into a factoring agreement
that expires in January 2007 and is renewable for successive periods of 12
months assuming certain conditions are met. The agreement provides for the
Company to borrow against factored accounts receivables at a discount of
10
approximately 2% for each 30 day period the balances remain unpaid. Customer
payments are made directly to the factoring company and there is full recourse
for uncollected accounts. In February 2006, we paid off the factoring line with
the proceeds of the February 13, 2006 notes payable refinancing.
NOTE 8. CONVERTIBLE DEBT FINANCING AND DERIVATIVE LIABILITIES
In accordance with Statement of Financial Accounting Standards 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 123 to be accounted for separately from the debt
instrument and recorded as derivative financial instruments.
During the nine months ended March 31, 2006, we recorded an other expense item
of $87 and $734, which relates to the 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, 2006, the estimated
fair value of our derivative liability was $2,804, as well as a warrant
liability of $4,618. The estimated fair value of the debt features was
determined using the probability weighted averaged expected cash flows / Lattice
Model. The model uses several assumptions, including: historical stock price
volatility (utilizing a rolling 120-day period), risk-free interest rate
(3.50%), remaining maturity, and the closing price of the Company's common stock
to determine estimated fair value of the derivative asset. In valuing the debt
features at March 31, 2006, we used the closing price of $0.0042 and the
respective conversion and exercise prices for the warrants.
NOTES PAYABLE
During the nine months ended March 31, 2006, we issued notes to third parties.
As part of the several financing transactions, we also issued warrants to
purchase shares of stock at various exercise prices.
Date of Note Amount of Notes Conversion Price(1) Term of Note
------------ --------------- ------------------- ------------
January 27, 2006 (1) $ 112 $ 0.00226 2 years
February 9, 2006 (1) $ 246 $ 0.00226 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 1,352,000 $ 0.005 7 years
February 13, 2006 (2) 104,000 $ 0.005 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.
The Notes also provide for liquidated damages on the occurrence of several
events. As of March 31, 2006, no liquidating damages have been incurred by the
company.
11
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, 2006,
the Company accreted $355,893, 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 1,352,000 $ 3,582 72%
February 13, 2006 104,000 $ 302 72%
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, 2006,
the company used the closing price of $0.0042, the respective exercise price, as
well as the remaining term on each warrant, as well as a volatility of 87%. 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, 2006, had increased to a fair value of
$4,618, due in part to an increase in the market value of the Company's common
stock to $0.0042 from $0.0040 at issuance of the February 13, 2006 amount, as
well as an increase in the volatility from 72% to 87% which resulted in an
"other expense" item of $734 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.
12
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. The estimated fair value of the debt features was determined using the
probability weighted averaged expected cash flows / Lattice Model with the
closing price on original date of issuance, a conversion price based on the
terms of the respective contract, a period based on the terms of the notes, and
a volatility factor on 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 maturity, and the closing
price of the Company's common stock to determine estimated fair value of the
derivative liability. In valuing the debt features at March 31, 2006, the
company used the closing price of $0.0042 and the respective conversion price, a
remaining term coinciding with each contract, and a volatility of 87%. For the
nine months ended March 31, 2006, due in part to an increase in the market value
of the Company's common stock to $0.0042 the Company recorded an "other expense"
on the consolidated statement of operations for the change in fair value of the
debt features of approximately $87. At March 31, 2006, the estimated fair value
of the debt features was approximately $2,804.
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.
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, 2006, we recorded an other expense item of
$87 and $734, related to the increase in value of the debt features and
warrants. A tabular reconciliation of this adjustment follows:
For the nine months March 31, 2006:
$ 734 expense, increase in value of warrant liability
$ 87 expense, increase in value of derivative liability
-----
$ 821 other expense related to convertible debt
For the nine months ended March 31, 2006, the company recorded $356 of interest
expense related to the accretion of debt related to the convertible financing.
For the nine months ended March 31, 2006:
$ 356 of interest expense related to accretion of convertible
debt
-----
$ 356 of interest expense related to convertible debt
The balance of the carrying value of the convertible debt as of March 31, 2006
is:
$ 1,605 original carrying value on convertible debt
$ (228) converted to equity
$ 356 accretion of convertible debt
-------
$ 1,733 March 31, 2006 carrying value of debt
13
The balance of the carrying value of the derivative liability as of March 31,
2006 is:
$ 2,717 original value of derivative liability
$ 87 increase in value of derivative liability
-------
$ 2,804 March 31, 2006 value of derivative liability
The balance of the carrying value of the warrant liability as of March 31, 2006
is:
$ 3,884 original carrying value of warrant liability
$ 734 expense, increase in value of warrant liability
-------
$ 4,618 March 31, 2006 value of warrant liability
During the quarter, we discussed with the lead investor the refinancing of
certain convertible notes, including disputed amounts for accrued interest,
penalties and note balances. As of June 30, 2005 we had accrued $250,000 for
contingent liability associated with these convertible notes. As part of the
funding described above we recognized an additional settlement of accrued
interest, penalties and balances for $1,231.
NOTE 9. NOTES PAYABLE
On August 9, 2005, the Company issued two secured promissory notes to two
investors totaling $221. The notes are due on October 9, 2005 and accrue
interest at a rate of 12% per annum. These two notes have not been repaid and
are currently in default. In addition, on December 22, 2005, the Company issued
a promissory note to an investor for $600. The note was due on January 6, 2006
and accrued interest at a rate of 15% per annum through February 1, 2006 and 24%
per annum thereafter until the note is paid in full. This note was repaid from
the proceeds of the February 13, 2006 funding (See Note 8).
During the quarter a subordinated non-convertible note payable of $1,500 plus
accrued interest of $1,390 to a former director was written off and recognized
as a gain on extinguishment of debt. Independent counsel has determined that
under California Code of Civil Procedure Section 337, which imposes a four year
limitations period as to breach of any written agreement, applies as the Company
was in material breach of its obligation as of September 17, 1999.
The following summarizes notes payable to a related party at March 31, 2006:
Payable to related party $ 547
Less current portion (125)
Long-term portion $ 422
NOTE 10. STOCKHOLDERS' DEFICIENCY
STOCK ISSUANCES
---------------
During the nine months ended March 31, 2006, DRDF issued the following:
51,946,135 shares of its common stock for penalties and accrued
interest of $98;
50,195,478 shares of its common stock for conversion of notes payable
and accrued interest of $113;
29,411,767 shares of is common stock upon the $50 conversion of a
convertible debenture; and
15,000,000 shares of its common stock for consulting services valued at
$65.
The value of the common stock issued was determined as follows:
for services - the market value of the Company's common stock at the
date of issuance;
for debt conversions - at contractually obligated amounts.
8,623,110 shares of its common stock for legal, accounting and
consulting services valued at $42.
20,880,130 shares of its common stock for debt of $38;
62,534,215 shares of its common stock for penalties of $94;
and 38,000,000 shares of its common stock for the conversion of
convertible debentures in the amount of $175.
The value of the common stock issued was determined as follows:
for services - the market value of the Company's common stock at the
date of issuance;
for debt conversions - at contractually obligated amounts.
14
NOTE 11. SEGMENT INFORMATION
The Company managed and internally reported the Company's business has four
reportable segments, principally, (1) products and accessories, (2) software,
(3) temporary staffing, and (4) PEO services. Segment information for the nine
months ended March 31, 2006 is as follows:
9-months ended 3/31/06
----------------------
Products Software Staffing PEO Services Total
-------- -------- -------- ------------ -----
Revenues $ 585 $ 5 $ 47,400 $ 772 $ 48,762
Operating
income (loss) (2,204) (51) 1,923 53 (279)
9-months ended 3/31/05
----------------------
Products Software Staffing PEO Services Total
Revenues $ 468 $ 48 $ 11,749 $ 2,058 $ 14,323
Operating
income (loss) (237) (357) (103) (168) (865)
NOTE 12. RELATED PARTY TRANSACTIONS
WARNING MANAGEMENT SERVICES, INC.
---------------------------------
The Company's CEO and Chairman, Mr. Brian Bonar, is also the CEO and Chairman of
Warning Management Services, Inc. In addition, the Company's former CFO, Mr.
Randall A. Jones, is also the CFO 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. Mr. Jones resigned from the Company effective
April 15, 2006.
GUARANTEE OF INDEBTEDNESS OF WARNING
------------------------------------
As of September 8, 2004, Warning Management Services, Inc. ("Warning") purchased
all of the issued and outstanding shares of Employment Systems, Inc. ("ESI") for
$1,500. The purchase was $750 cash paid at the closing and a $750 note payable
by Warning. In connection with this transaction, the Company agreed to be a
guarantor of the $750 note payable. As inducement to enter into this guarantee,
the Company was given a non-cancelable 2-year payroll processing contract with
ESI. The ESI note payable has been settled, paid, and released.
WARNING HAS A MONTH-TO-MONTH LEASE WITH THE COMPANY
---------------------------------------------------
Warning leases offices for its ESI subsidiary, on a month-to-month basis from
the Company that started in October 2004. Monthly rental expense will be
approximately $3 per month.
PEO SERVICES AGREEMENT WITH WARNING PROVIDES FOR A FEE AT PREVAILING MARKET RATE
--------------------------------------------------------------------------------
In April 2004, the Company entered into an Agreement to provide PEO services for
Warning. The Company receives from Warning a monthly administrative fee. During
the six months ended December 31, 2005, the Company has invoiced Warning $274
for management services and $0 for reimbursement of costs. As of December 31,
2006, the Company has a net amount owed by to Warning in the amount of $708.
KAIRE HOLDINGS, INC.
The Company's Source One subsidiary processes the payroll for Effective Health,
Inc. which is a wholly-owned subsidiary of Kaire Holdings, Inc. The Company's
former CFO, Mr. Randall A. Jones, is also the CFO of Kaire Holding, Inc.
15
NOTE 13. GAIN RESULTING FROM RECONCILIATION OF PAYROLL TAX LIABILITES TO
TAXING AUTHORITIES
During the three and nine months ended March 31, 2006, the Company recorded an
adjustment to earnings of $1,924 and $1,924, respectively, resulting from a
reconciliation with the Internal Revenue Service and certain State taxing
authorities of the amounts due for delinquent payment of payroll tax
liabilities. The Company continually updates its estimate of the amount due
related to delinquent payroll taxes and penalties as it receives correspondence
or settlement agreements with the Internal Revenue Service and State taxing
authorities.
NOTE 14. OTHER ACCRUED EXPENSES
Other accrued expenses at March 31, 2006 consisted of the following as of:
Accrued interest and penalties $ 153
Accrued judgments 1,727
Accrued salaries and related liabilities 6,698
Other 1,344
--------
Total $ 9,922
========
NOTE 15. 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 $ 202,500.
In addition, the Company has filed claims against Arena and Arena's agent,
Thilman and Filippini, based on, among other things, the representations made to
SOG that let it to enter into the agreement with Arena. These claims are
currently pending.
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 nature of the specific claims made by Liberty against the Company
and SOG are that the Company and SOG were and are obligated to make additional
premium payments to Liberty for workers' compensation insurance, which is
related to the Arena litigation described above. The initial claim by Liberty
was estimated by Liberty to be $829 and is now claimed to exceed $1,000.
Management has vigorously contested the claims made by Liberty. The case remains
in the discovery phase.
On April 25, 2006, a trial occurred in the matter of LM Insurance Corporation v.
Brian Bonar pending in Superior Court of California for the County of San Diego.
LM Insurance Corporation asserted that SourceOne Group, Inc. had entered into a
policy for insurance coverage and that Brian Bonar had personally guaranteed the
premium payments. The court found in favor of Brian Bonar.
On February 10, 2005, Berryman & Henigar Enterprises ("Plaintiff"), filed a
complaint in the Superior Court of California, County of San Diego, Case No.
GIC842610, against Warning Model Management, Inc. for breach of a promissory
note issued pursuant to terms and conditions of a certain stock purchase and
sale agreement dated September 9, 2004. The Company and its subsidiary,
Employment Systems, Inc. ("ESI"), each allegedly guaranteed payments on the
underlying promissory note. Plaintiff seeks principal damages of $750 in that
regard. Warning Model Management, Inc. has taken the position that Plaintiff
failed to disclose certain material information in the underlying transaction
which thereby negates the promissory note. Warning Model Management, Inc.
reached a settlement, effective as of September 30, 2005 with the Plaintiff,
which requires defendants, collectively, to pay Plaintiff the aggregate sum of
$380. The final payment in the sum of $80 was paid in April 2006. Accordingly,
the matter has been settled and all claims satisfied.
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
16
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.
Trial, which was initially set for April 14, 2006, has now been continued to
September 8, 2006. The Company has and will continue with its vigorous
defense/prosecution of the allegations/claims.
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 case is
in its early stages and discovery has not yet commenced. However, the Company
intends to vigorously defend itself against the claims asserted.
Throughout fiscal 2004 and 2005, trade creditors have made claims and/or filed
actions alleging the failure of the Company to pay its obligations to them in a
total amount exceeding $1,800. These actions are in various stages of
litigation, with many resulting in judgments being entered against the Company.
Several of those who have obtained judgments have filed judgment liens on the
Company's assets. These claims range in value from less than $1 to just over
$1,000, with the great majority being less than $20.
On September 7, 2005, the arbitrator from the American Arbitration Association
awarded to Accord Human Resources a judgment against Greenland Corporation and
the Company as the guarantor, an amount equaling $168. Legal counsel has
estimated that the claim could amount to as much as $214. The Company has
reserved $200 for the claim.
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 three and six months ended December
31, 2005. The plaintiffs have accepted the settlement offer.
NOTE 16. GAIN ON SETTLEMENT OF DEBT
During the nine months ended March 31, 2006 and 2005, the Company recognized a
gain on settlement of debt of $9,207 and $425, respectively. For the nine months
ended March 31, 2006, the recognized a gain of $4,120 related to the settlement
of two notes payable to banks. (See Note 5) The remaining gain for the nine
months ended March 31, 2006 and the gain for the nine months ended March 31,
2005 resulted primarily from the write off of stale accounts payable and
judgments. 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 17. 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 is
completely exiting the executive recruiting business. The Company plans to wind
down the operations of Master Staffing and close its only office over the next
few months.
For the nine months ended March 31, 2006 and 2005, Master Staffing's revenues
were $11 and $0, respectively, and losses from operations were $110 and $0,
respectively. The results of operations of Master Staffing have been reported
separately as discontinued operations.
Master Staffing's net liabilities at March 31, 2006 were $78, which consisted of
furniture and equipment of $19 and accrued liabilities of $100.
NOTE 18. SUBSEQUENT EVENT
Effective April 15, 2006, Mr. Randall Jones, the Company's Chief Financial
Officer resigned.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company
Annual Report on Form 10-KSB for the year ended June 30, 2005. 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 a variety of financial services to small and medium-size businesses.
These services allow our customers to outsource many human resources tasks,
including payroll processing, workers' compensation insurance, health insurance,
employee benefits, 401k investment services, personal financial management, and
income tax consultation. In November 2001, we began to provide these services to
relieve some of the negative impact they have on the business operations of our
existing and potential customers. To this end, through strategic acquisitions,
we became a professional employer organization ("PEO").
We provide financial services principally through our wholly-owned SourceOne
Group, Inc. ("SOG") subsidiary. These units provide a broad range of financial
services, including: benefits and payroll administration, health and workers'
compensation insurance programs, personnel records management, and employer
liability management. Through our Jackson Staffing subsidiary (and MedicalHR and
CallCenterHR operating units), we provide temporary staffing services to small
and medium-sized businesses - primarily to call centers and medical facilities.
In January 2003, we completed the acquisition of controlling interest
(approximately 85%) in the shares of Greenland Corporation whose shares are
traded on the NASD Electronic Bulletin Board under the symbol GRLC.
Subsequently, in March 2004, we entered into an agreement with Greenland to
return most of our shares in Greenland in return for Greenland's forgiveness of
certain DRDF indebtedness and business opportunities. We no longer have an
affiliation with Greenland Corporation.
In January 2003, we completed the acquisition of a controlling interest (85%) in
the shares of Quik Pix, Inc. ("QPI"). QPI shares are traded on the National
Quotation Bureau Pink Sheets under the symbol QPIX. QPI is a visual marketing
support firm located in Anaheim, California. Its principal service is to provide
photographic and digital images mounted for customer displays in tradeshow and
other displays .Its principal product, PhotoMotion is a patented color medium of
multi-image transparencies. The process uses existing originals to create the
illusion of movement, and allows for six to five distinct images to be displayed
with an existing lightbox.
In September 2003, we hired two key persons and acquired the operations of the
temporary staffing service then owned by Jackson Staffing, LLC. In order to
formalize this arrangement, we entered into an acquisition agreement with
Jackson Staffing effective September 1, 2003 and accordingly, the financial
statements of Jackson Staffing from September 1, 2003 are included in our
financial statements.
In April 2004, we transferred our ColorBlind software technology to QPI.
ColorBlind software provides color management to improve the accuracy of color
reproduction - especially as it relates to matching color between different
devices in a network, such as monitors and printers. ColorBlind software
products are marketed internationally through direct distribution, resellers,
and on the internet through our color.com website.
Our business continues to experience operational and liquidity challenges.
Accordingly, year-to-year financial comparisons may be of limited usefulness now
and for the next several periods due to anticipated changes in our business as
these changes relate to potential acquisitions of new businesses and changes in
products and services.
18
On June 28, 2004, we completed an acquisition of certain assets of M&M Nursing
(M&M"). The purchase price was 5,000,000 shares of our common stock valued at
$31 plus the assumption of $204 of liabilities. M&M is a temporary staffing
agency primarily for nurses.
On April 4, 2005, we completed an acquisition of certain assets of Heritage
Staffing Group, Inc. ("Heritage"). The purchase price was $80 consisting of $20
in cash, a $45 note payable to the owner of Heritage and 5,000,000 warrants to
purchase shares of DRDF common stock valued at $14. Heritage is in the temporary
staffing business and we acquired certain assets of Heritage to complement our
other temporary staffing business.
On May 5, 2005 we established a self-insured worker's compensation program. In
connection with this self-insured program, we were required to establish a
worker's compensation deposit in the amount of $2,625. Our maximum exposure
under this self-insured worker's compensation program is $4,200 and we are
liable up to $250 per occurrence. We purchase coverage from a worker's
compensation insurer to cover additional losses above the policy limits. We
believe that we can expand our staffing business as a result of us establishing
this self-insured worker's compensation program
Our current strategy is: to expand our financial services businesses, including
PEO services and temporary staffing, and to continue to commercialize imaging
technologies, including PhotoMotion Images and ColorBlind color management
software through our QPI subsidiary.
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, 2005 consolidated financial statements includes an explanatory
paragraph indicating there is a substantial doubt about our ability to continue
as a going concern, due primarily to our recent loss from operations, the
decreases in our working capital and net worth. In addition, we are late in our
filing of payroll tax returns for certain of our PEO divisions and are
delinquent on the payment of payroll tax withholdings. We plan to overcome the
circumstances that impact our ability to remain a going concern through a
combination of achieving profitability, raising additional debt and equity
financing, and renegotiating existing obligations. In addition, we will continue
to work with the Internal Revenue Service and State taxing Authorities to
reconcile and resolve all open accounts and issues.
On February 13, 2006, the Company issued convertible notes in exchange for gross
proceeds of $5,000, with $4,385 of net proceeds going to the Company. $1,758 of
the net proceeds was used directly to pay debt settlements.
The convertible notes mature in two years, at a 15% per annum interest rate and
call for monthly interest payments with the principal due on maturity. If the
Company defaults on the interest payments, the investors will have the right to
convert the notes into common shares at a seventy-five percent (75%) discount to
market price. In addition, warrants for 1,352,000 shares of common stock with an
exercise price of $.005 were issued to the investors as part of the funding.
These warrants expire in seven years and have a cashless exercise provision.
Concurrent with the funding, certain of the Company's investors holding
convertible notes exchanged such notes plus any related accrued interest and
penalties, for new notes with the same terms as referenced above. These notes
are valued at $2,545.
In recent years, we have been working to reduce costs through the reduction in
staff and reorganizing our business activities. Additionally, we have sought to
reduce our debt through debt to equity conversions. We continue to pursue the
acquisition of businesses that will grow our business.
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.
In order to improve our internal controls, we have recently upgraded our
accounting systems and have added new management to our accounting staff.
19
RESTRUCTURING AND NEW BUSINESS UNITS
In April 2004, we transferred our ColorBlind software products and technologies
to our QPI subsidiary in order to focus on financial services and enable QPI to
concentrate on imaging technology products and services.
ACQUISITIONS, DISPOSITIONS AND SALE OF BUSINESS UNITS
In August 2002, we entered into an agreement to acquire controlling interest in
Greenland Corporation. Greenland shares are traded on the Electronic Bulletin
Board under the symbol GRLC. On January 14, 2003, we completed the acquisition
of shares, representing controlling interest, of Greenland. The terms of the
acquisitions were disclosed on Form 8-K filed January 21, 2003.
Pursuant to a mutual agreement between the Board of Directors of both Greenland
Corporation and us, Greenland has been separated from us, effective February,
23, 2004. Under the separation agreement, Greenland forgave its note receivable
from us of $2,250 together with any accrued interest thereon in consideration
for our granting our acquisition rights to acquire ePEO Link to Greenland. In
addition, for returning 95,949,610 shares of Greenland common stock acquired by
us pursuant to our acquisition agreement with Greenland in January 2003,
Greenland forgave its inter-company account receivable from us, which amount
aggregated approximately $1,375. Further, the agreement provided for us to
effect the resignation of our Directors who also served on the Board of
Directors of Greenland, which was completed in March 2004.
In September 2003, we hired two key persons, and acquired the operations of the
temporary staffing service then owned by Jackson Staffing, LLC. In order to
formalize this arrangement, we entered into an acquisition agreement with
Jackson Staffing effective September 1, 2003 and accordingly, the financial
statements of Jackson Staffing from September 1, 2003 are included in our
financial statements. On June 28, 2004, we completed an acquisition of certain
assets of M&M Nursing (M&M"). The purchase price was 5,000,000 shares of our
common stock valued at $31 plus the assumption of $204 of liabilities. M&M is a
temporary staffing agency primarily for nurses. The financial statements of M&M
from July 1, 2004 are included in our financial statements.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis or Plan 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 in our Annual
Report on Form l0-KSB for the year ended June 30, 2005.
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.
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.
20
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.
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, With
Respect to Certain Transactions. Revenue from products licensed to original
equipment manufacturers is recorded when OEMs ship licensed products while
revenue from certain license programs is recorded when the software has been
delivered and the customer is invoiced. Revenue from packaged product sales to
and through distributors and resellers is recorded when related products are
shipped. Maintenance and subscription revenue 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.
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.
FACTORS AFFECTING QUARTERLY RESULTS
-----------------------------------
We have historically experienced fluctuations in our quarterly operating results
and expect such fluctuations to continue in the future. Our operating results
may fluctuate due to a number of factors such as seasonality, wage limits on
statutory payroll taxes, claims experience for workers' compensation, demand and
competition for our services, and the effect of acquisitions. Our revenue levels
may fluctuate from quarter to quarter primarily due to the impact of seasonality
on our staffing services business and on certain of our PEO clients.. As a
result, we may have greater revenues and net income in the second and third
quarters of our fiscal year. Payroll taxes and benefits fluctuate with the level
of direct payroll costs, but tend to represent a smaller percentage of revenues
and direct payroll later in our fiscal year as federal and state statutory wage
limits for unemployment and social security taxes are exceeded on a per employee
basis. Workers' compensation expense varies with both the frequency and severity
of workplace injury claims reported during a quarter and the estimated future
costs of such claims. Adverse loss development of prior period claims during a
subsequent quarter may also contribute to the volatility in our estimated
workers' compensation expense.
RESULTS OF OPERATIONS
(IN THOUSANDS)
3-MONTHS ENDED MARCH 31, 2006 COMPARED TO 3-MONTHS ENDED MARCH 31, 2005
-----------------------------------------------------------------------
REVENUES
Total revenues were $18,899 and $5,449 for the three months ended March 31, 2006
and 2005, respectively; an increase of $13,450 (247%). The increase was due
primarily to the addition of new clients for staffing services, which
contributed $18,855 of revenues for the three months ended March 31, 2006
compared to $4,095 for the three months ended March 31, 2005 an increase of
$14,760 (360%).
PEO SERVICES
PEO revenues were $90 and $1,208 for the three months ended March 31, 2006 and
2005, respectively; a decrease of $1,118 (93%) due primarily to our emphasize on
providing staffing services.
21
TEMPORARY STAFFING
In September 2003, we entered into an agreement to purchase a temporary staffing
business through the organization of CallCenterHR and MedicalHR and the
acquisition of Jackson Staffing. In June 2004, we entered into an agreement to
purchase certain assets of M&M Nursing, a temporary staffing agency for nurses.
Temporary Staffing revenues were $18,855 and $4,095 for the three months ended
March 31, 2006 and 2005, respectively; an increase of $14,760 (360%). The
significant increase is due to our successful addition of new client companies.
PRODUCTS
Sales of products were generated principally from the Image Tech, Inc. unit of
our 85%-owned Solvis subsidiary. Products revenues were negative $(46) and $137
for the three months ended March 31, 2006 and 2005, respectively; a decrease of
$183 (134%). The decrease is principally due to a general lack of sales activity
related to these operations.
SOFTWARE
Software revenues were $0 and $9 for the three months ended March 31, 2006 and
2005, respectively; a decrease of $9 (100%). Revenues from licenses and
royalties for the past several periods have been insignificant.
COST OF PRODUCTS SOLD
Cost of PEO services for the three months ended March 31, 2006 and 2005 was $15
(17% of PEO revenues) and $1,088 (90% of PEO revenues), respectively. The
decrease in gross profit is due primarily to us incurring additional employee
benefit related costs.
Costs of temporary staffing for the three months ended March 31, 2006 and 2005
was $16,434 (87% of temporary staffing revenue) and $3,591 (88% of temporary
staffing revenue), respectively.
Cost of products sold for the three months ended March 31, 2006 and 2005 were $8
and $23 (17% of product sales), respectively.
Cost of software, licenses and royalties for the three months ended March 31,
2006 and 2005 were $0 and $1 (11% of software, license and royalties revenue),
respectively.
OPERATING EXPENSES
Operating expenses have consisted primarily of salaries and commissions of sales
and marketing personnel, salaries and related costs for general corporate
functions, including finance, accounting, facilities and legal, advertising,
rent, depreciation and amortization, and other marketing related expenses, and
fees for professional services.
Operating expenses for the three months ended March 31, 2006 and 2005 were
$2,402 and $904, respectively; an increase of $1,498. Increases in operating
expenses are reflective of the growth of our business in general, which has
required additional staff and other resources. On a comparative basis, our
operating expenses have declined as a percentage of revenues. Operating expenses
were 13% and 17% of revenues for the three-month periods ended March 31, 2006
and 2005, respectively.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the three months ended March 31, 2006
and 2005 was $1,106 and $394, respectively; an increase of $712 (180%). The
increase is principally due to various penalties and accrued interest on
existing debt converted into new convertible notes payable, plus a new interest
cost of 15% per annum for these notes.
GAIN ON EXTINGUISHMENT OF DEBT
Gain on the extinguishment of debt was $3,604 and $165 for the three months
ended March 31, 2006 and 2005, respectively. The amounts related to accounts
payable, which had become stale and uncollectible under the Statute of
Limitations in the State of California and upon obtaining a legal opinion with
respect to the State of California Statute of Limitations.
22
GAIN FROM RECONCILIATION OF PAYROLL TAX LIABILITES TO TAXING AUTHORITIES
During the three month periods ended March 31, 2006 and 2005, we recorded as
other income an adjustment of accrued payroll taxes payable of $1,924 and $454,
respectively, resulting from reconciliations of certain liabilities with the
Internal Revenue Service and certain State taxing authorities of amounts due for
delinquent payment of payroll tax liabilities. We continually update our
estimate of the amount due related to delinquent payroll taxes and penalties as
we receive correspondence or settlement agreements with the Internal Revenue
Service and State taxing authorities.
9-MONTHS ENDED MARCH 31, 2005 COMPARED TO 9-MONTHS ENDED MARCH 31, 2004
-----------------------------------------------------------------------
REVENUES
Total revenues were $48,762 and $14,323 for the nine months ended March 31, 2006
and 2005, respectively; an increase of $34,439 (240%). The principal reason for
the increase is due to increased temporary staffing revenues as we sign on new
client companies.
PEO SERVICES
PEO revenues were $772 and $2,058 for the nine months ended March 31, 2006 and
2005, respectively; a decrease of $1,286 (62%) due primarily to the decrease in
our PEO customer base and our emphasis over the past year on our staffing
business segment.
TEMPORARY STAFFING
In September 2003, we entered into an agreement to purchase a temporary staffing
business through the organization of CallCenterHR and MedicalHR and the
acquisition of Jackson Staffing. In June 2004, we entered into an agreement to
purchase certain assets of M&M Nursing, a temporary staffing agency for nurses.
These business units are now part of our 85%-owned Solvis subsidiary. Temporary
Staffing revenues were $47,400 and $11,749 for the nine months ended March 31,
2006 and 2005, respectively; an increase of $35,651 (303%). The significant
increase is due to our success at adding new clients.
PRODUCTS
Sales of products were generated principally from our Image Tech, Inc. unit of
our Solvis subsidiary. Products revenues were $585 and $468 and $546 for the
nine months ended March 31, 2006 and 2005, respectively; an increase of $117
(25%).
SOFTWARE
Software revenues were $5 and $48 for the nine months ended March 31, 2006 and
2005, respectively; a decrease of $43 (90%). Revenues from licenses and
royalties for the periods were insignificant.
Royalties and licensing fees vary from quarter to quarter and are dependent on
the sales of products sold by OEM customers using our technologies. These
revenues continue to decline as we have elected to transfer our ColorBlind
software to the Image Tech, Inc. unit of our Solvis subsidiary.
COST OF PRODUCTS SOLD
Costs of temporary staffing for the nine months ended March 31, 2006 and 2005
was $41,737 (88% of staffing revenue) and $10,539 (90% of temporary staffing
revenue), respectively. This business segment traditionally yields small gross
profit margins, which could vary depending on the level of services and support
demanded by clients.
Cost of PEO services for the nine months ended March 31, 2006 and 2005 was $668
(87% of PEO revenues) and $1,716 (83% of PEO revenues), respectively. This
business segment traditionally yields small gross profit margins, which could
vary depending on the level of services and support demanded by clients.
Cost of products sold for the nine months ended March 31, 2006 and 2005 were $26
(4% of product sales) and $59 (13% of product sales), respectively. The increase
in profitability is due to changes in product mix during the period.
23
Cost of software, licenses and royalties for the nine months ended March 31,
2006 and 2005 were $0 and $4 (8% of software, license and royalties revenue),
respectively. Costs for the small amount of software revenues were absent as
these costs were absorbed in prior periods.
OPERATING EXPENSES.
Operating expenses for the nine months ended March 31, 2006 and 2005 were $6,610
(14% of revenues) and $2,870 (20% of revenues), respectively. Although we
reduced our operating expenses as a percentage of revenues, operating expenses
increased overall by $3,740 (130%). The increase is due to an increase of
payroll and other infrastructure required by the rapid growth of our business.
Also, as disclosed in "Significant Accounting Policies and Estimates", we rely
on estimates for such liabilities related to, among other areas, worker's
compensation and accrued payroll taxes. During the nine months ended March 31,
2006, we changed our estimate of workers' compensation claims aggregating
approximately $591 and $700 for the nine months ended March 31, 2005.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the nine months ended March 31, 2006
and 2005 was $1,670 and $1,208 respectively; an increase of $462 (38%). The
increase is principally due to the write off of the unamortized debt discounts
associated with the conversion of debentures into common stock for the nine
months ended March 31, 2006; a higher interest rate on the February 2006 debt
package; and various penalties and accrued interest on existing debt converted
into new convertible notes payable.
GAIN ON EXTINGUISHMENT OF DEBT
Gain on the extinguishment of debt was $9,207 and $425 for the nine months ended
March 31, 2006 and 2005, respectively. The amounts related to accounts payable,
which had become stale and uncollectible under the Statute of Limitations in the
State of California and upon obtaining a legal opinion with respect to the State
of California Statute of Limitations.
GAIN FROM RECONCILIATION OF PAYROLL TAX LIABILITES TO TAXING AUTHORITIES
During the nine months ended March 31, 2006 and 2005, we recorded as other
income an adjustment of accrued payroll taxes payable of $1,924 and $990,
respectively, resulting from reconciliations of certain liabilities with the
Internal Revenue Service and certain State taxing authorities of amounts due for
delinquent payment of payroll tax liabilities. We continually update our
estimate of the amount due related to delinquent payroll taxes and penalties as
we receive correspondence or settlement agreements with the Internal Revenue
Service and State taxing authorities.
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 nine months
ended March 31, 2006 and the year ended June 30, 2005, we issued an additional
197,631,547 shares. 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, 2006, we had negative working capital of $19,059, an increase in
working capital of $8,045 since June 30, 2005. This increase is due primarily to
reduced indebtedness.
Net cash provided by operating activities was $1,056 for the nine months ended
March 31, 2006 as compared to net cash used in activities of $186 for the
prior-year period. The variance of $1,242 was due to $3,662 improvement in net
working capital partially offset by settlements with investors and non-cash
gains.
Cash provided by financing activities was $1,297 for the nine months ended March
31, 2006 compared to cash provided by financing activities of $400. The variance
is due to repayments of notes payable and an increase in temporary bank
overdrafts.
24
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, 2006, was
approximately $555
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, 2005 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 decreases in our working
capital and net worth.
On the last day of the quarter several payrolls were invoiced to our clients
who remit to us the day following. The $1.8 million in overdraft cash is the
result of a timing difference between payroll checks being issued, client
invoices being produced the same day as the payroll and the cash remittance
of the invoice immediately thereafter.
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.
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, except
for the following.. As of September 8, 2004, Warning Management Services, Inc.
("Warning") purchased all of the issued and outstanding shares of Employment
Systems, Inc. ("ESI") for $1,500. The purchase was $750 cash paid at the closing
and a $750 note payable. In connection with this transaction, the Company agreed
to be a guarantor of the $750 note payable. Our CEO, Brian Bonar, is also the
CEO of Warning. As inducement to enter into this guarantee, we were given a
non-cancelable 2-year payroll processing contract with ESI. Currently the $750
note payable is in dispute. Warning is claiming that certain representations
made by ESI were not correct and is proposing that the purchase price be
reduced. Warning reached a settlement, effective as of September 30, 2005 with
the Plaintiff, which requires defendants, collectively, to pay Plaintiff the
aggregate sum of $380. Defendants have made the initial two payments due under
the settlement and the final payment in the sum of $80 was paid in April 2006
and the note has been settled and released.
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, 2006, 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.
25
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.
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.
26
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 $ 202,500.
In addition, the Company has filed claims against Arena and Arena's agent,
Thilman and Filippini, based on, among other things, the representations made to
SOG that let it to enter into the agreement with Arena. These claims are
currently pending.
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 nature of the specific claims made by Liberty against the Company
and SOG are that the Company and SOG were and are obligated to make additional
premium payments to Liberty for workers' compensation insurance, which is
related to the Arena litigation described above. The initial claim by Liberty
was estimated by Liberty to be $829 and is now claimed to exceed $1,000.
Management has vigorously contested the claims made by Liberty. The case remains
in the discovery phase.
On April 25, 2006, a trial occurred in the matter of LM Insurance Corporation v.
Brian Bonar pending in Superior Court of California for the County of San Diego.
LM Insurance Corporation asserted that SourceOne Group, Inc. had entered into a
policy for insurance coverage and that Brian Bonar had personally guaranteed the
premium payments. The court found in favor of Brian Bonar.
On February 10, 2005, Berryman & Henigar Enterprises ("Plaintiff"), filed a
complaint in the Superior Court of California, County of San Diego, Case No.
GIC842610, against Warning Model Management, Inc. for breach of a promissory
note issued pursuant to terms and conditions of a certain stock purchase and
sale agreement dated September 9, 2004. The Company and its subsidiary,
Employment Systems, Inc. ("ESI"), each allegedly guaranteed payments on the
underlying promissory note. Plaintiff seeks principal damages of $750 in that
regard. Warning Model Management, Inc. has taken the position that Plaintiff
failed to disclose certain material information in the underlying transaction
which thereby negates the promissory note. Warning Model Management, Inc.
reached a settlement, effective as of September 30, 2005 with the Plaintiff,
which requires defendants, collectively, to pay Plaintiff the aggregate sum of
$380. Defendants have made the initial two payments due under the settlement and
the final payment in the sum of $80 was paid in April 2006. Accordingly, the
matter has been settled and all claims satisfied.
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.
Trial, which was initially set for April 14, 2006, has now been continued to
September 8, 2006. The Company has and will continue with its vigorous
defense/prosecution of the allegations/claims.
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 case is
in its early stages and discovery has not yet commenced. However, the Company
intends to vigorously defend itself against the claims asserted.
27
Throughout fiscal 2004 and 2005, trade creditors have made claims and/or filed
actions alleging the failure of the Company to pay its obligations to them in a
total amount exceeding $1,800. These actions are in various stages of
litigation, with many resulting in judgments being entered against the Company.
Several of those who have obtained judgments have filed judgment liens on the
Company's assets. These claims range in value from less than $1 to just over
$1,000, with the great majority being less than $20.
On September 7, 2005, the arbitrator from the American Arbitration Association
awarded to Accord Human Resources a judgment against Greenland Corporation and
the Company as the guarantor, an amount equaling $168. Legal counsel has
estimated that the claim could amount to as much as $214. The Company has
reserved $200 for the claim.
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 three and six months ended December
31, 2005. The plaintiffs have accepted the settlement offer.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
COMMON STOCK
During the three months ended March 31, 2006, DRDF issued the following:
30,000,000 shares of its common stock for penalties and accrued
interest of $69
50,195,478 shares of its common stock for conversion of notes payable
and accrued interest of $113
10,000,000 shares of its common stock for consulting services valued at
$50
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
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
(b) Reports on Form 8-K:
1. February 23, 2006: Items 1.01 and 7 - Dalrada Financial Corporation
issued convertible notes to various investors in exchange for Gross
proceeds of $5,000,000, with $4,384,800 of net proceeds going to the
Company. $1,757,902 of the net proceeds were used directly to pay debt
settlements.
2. May 5, 2006: Items 5.01 and 9.01 - Dalrada Financial Corporation
discloses the resignation of two directors and on officer and the
appointment of two mew director and an officer.
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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 22, 2006
DALRADA FINANCIAL CORPORATION
(Registrant)
By: /S/ Brian Bonar
-------------------------------------
Brian Bonar
Chairman and Chief Executive Officer
By: /S/ Robert Dietrich
-------------------------------------
Robert Dietrich
Chief Accounting Officer
29