UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
Amendment 2
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
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 NO.)
INCORPORATION OR ORGANIZATION)
9449 BALBOA AVENUE, SUITE 211
SAN DIEGO, CA 92123
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (858) 277-5300
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 16,
2005 was 682,396,197.
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, 2005 (unaudited) 3 Consolidated
Statements of Operations - 3 and 9 months ended March 31, 2005 and 2004
(unaudited) 4 Consolidated Statements of Cash Flows - 9 months ended March
31, 2005 and 2004 (unaudited) 5 Notes to Consolidated Financial Statements
(unaudited) 7
ITEM 2. Management's Discussion and Analysis or Plan of Operations 15
ITEM 3. Controls and Procedures 22
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 23
ITEM 2. Unregistered Sale of Equity Securities and Use of Proceeds 23
ITEM 3. Defaults Upon Senior Securities 24
ITEM 4. Submission of Matters To A Vote of Security Holders 24
ITEM 5. Other Information 24
ITEM 6. Exhibits 24
SIGNATURES 24
CERTIFICATIONS 25
2
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
MARCH 31, 2005
---------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 295
Accounts receivable, net of allowance of $96 1,139
Inventories, net of reserve of $15 --
Prepaid expenses and other current assets 761
---------------
TOTAL CURRENT ASSETS 2,195
---------------
PATENT, net of accumulated amortization of $270 1,348
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,021 267
---------------
TOTAL ASSETS $ 3,810
===============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Borrowings under bank notes payable $ 3,220
Lines of credit 209
Notes payable, current portion (including related party note of $1,561) 2,113
Convertible debentures, net of discount of $5 809
Accounts payable 805
Obligations under capital lease 10
PEO payroll taxes and other payroll deductions 6,723
Other accrued expenses 10,419
---------------
TOTAL CURRENT LIABILITIES 24,308
---------------
CONVERTIBLE DEBENTURES, net of current portion and net of discounts of $198 163
NOTES PAYABLE, net of current portion (including related party note of $282) 500
CAPITAL LEASE, net of current portion 44
---------------
TOTAL LIABILITIES 25,015
---------------
MINORITY INTEREST --
COMMITMENTS AND CONTINGENCIES --
STOCKHOLDERS' DEFICIT
Series A convertible, redeemable preferred stock, $1,000 par value,
7,500 shares authorized 420.5 shares issued and outstanding 420
Common stock; $0.005 par value; 1,000,000,000 shares
authorized; 682,396,197 shares issued and outstanding 3,412
Common stock warrants 475
Additional paid-in capital 82,823
Accumulated deficit (108,335)
---------------
TOTAL STOCKHOLDERS' DEFICIT (21,205)
---------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 3,810
===============
The accompanying notes are an integral part of these consolidated financial
statements.
3
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------- --------------------------------
MARCH MARCH MARCH MARCH
31, 2005 31, 2004 31, 2005 31, 2004
------------- ------------- ------------- -------------
(unaudited) (unaudited)
(unaudited) (unaudited)
REVENUES
Sales of products $ 137 $ 91 $ 468 $ 546
Software sales, licenses and royalties 9 30 48 66
Temporary staffing services 4,095 2,892 11,749 6,328
PEO Services 1,208 475 2,058 2,545
------------- ------------- ------------- -------------
TOTAL REVENUES 5,449 3,488 14,323 9,485
------------- ------------- ------------- -------------
COST OF REVENUES
Cost of products sold 23 28 59 156
Cost of software sales, licenses and royalties 1 -- 4 3
Cost of temporary staffing 3,591 2,663 10,539 5,657
Cost of PEO services 1,088 384 1,716 2,280
------------- ------------- ------------- -------------
TOTAL COST OF REVENUES 4,703 3,075 12,318 8,096
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
GROSS PROFIT 746 413 2,005 1,389
------------- ------------- ------------- -------------
OPERATING EXPENSES
Selling, general and administrative 904 (71) 2,870 4,006
Research and development -- -- -- --
------------- ------------- ------------- -------------
TOTAL OPERATING EXPENSES 904 (71) 2,870 4,006
------------- ------------- ------------- -------------
INCOME (LOSS) FROM OPERATIONS (158) 484 (865) (2,617)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSES):
Interest and financing costs, net (394) (434) (1,208) (1,363)
Gain on extinguishment of debt 165 228 425 853
Gain resulting from reconciliation of payroll
tax liabilities to taxing authorities 454 -- 990 --
Other, net -- 1 -- (18)
------------- ------------- ------------- -------------
TOTAL OTHER INCOME (EXPENSE) 225 (205) 207 (528)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS 67 279 (658) (3,145)
PROVISION FOR INCOME TAXES -- -- -- --
------------- ------------- ------------- -------------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS 67 279 (658) (3,145)
------------- ------------- ------------- -------------
DISCONTINUED OPERATON:
Gain on disposition of discontinued operations -- 5,049 -- 5,049
Loss from operations of discontinued operation -- (693) -- (2,052)
------------- ------------- ------------- -------------
-- 4,356 -- 2,997
------------- ------------- ------------- -------------
NET INCOME (LOSS) 67 4,635 (658) (148)
PREFERRED STOCK DIVIDENDS (5) (5) (15) (15)
------------- ------------- ------------- -------------
NET INCOME (LOSS) ATTRIBUTED TO COMMON STOCKHOLDERS $ 62 $ 4,630 $ (673) $ (163)
============= ============= ============= =============
NET INCOME (LOSS) PER SHARE - BASIC
Continuing operations $ 0.00 $ 0.00 $ (0.00) $ (0.01)
Discontinued operations -- 0.01 -- 0.01
------------- ------------- ------------- -------------
$ 0.00 $ 0.01 $ (0.00) $ (0.00)
============= ============= ============= =============
WEIGHTED AVERAGE COMMON EQUIVALENT SHARES
OUSTANDING - BASIC 682,396 348,926 635,914 292,602
============= ============= ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
4
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
NINE MONTHS ENDED
------------------------------------
MARCH 31, 2005 MARCH 31, 2004
--------------- ---------------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations $ (658) $ (3,145)
Adjustment to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 130 265
Stock issued for services 42 368
Amortization of debt discounts 305 626
Gain on forgiveness of inter-company debt from Greenland -- (1,375)
Gain resulting from reconciliation of payroll tax liabilities
to taxing authorities (990) --
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (557) (21)
Prepaid expenses and other current assets (317) (13)
Other assets -- 38
Increase (decrease) in:
Accounts payable and accrued expenses (703) 230
PEO liabilities 2,562 1,467
--------------- ---------------
Net cash provided by (used in) operating activities from continuing operations (186) (1,560)
Net cash used in operating activities from discontinued operations -- (678)
--------------- ---------------
Net cash used in operating activities (186) (2,238)
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment (147) (158)
--------------- ---------------
Net cash used in investing activities from continuing operations (147) (158)
Net cash used in investing activities from discontinued operations -- --
--------------- ---------------
Net cash used in investing activities (147) (158)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in cash overdraft, net -- (87)
Line of credit, net 209 --
Net borrowings under bank notes payable -- (25)
Proceeds from sale of common stock -- 177
Proceeds from convertible debentures -- 800
Proceeds from notes payable 336 --
Repayments of notes payable (126) (165)
Repayments of capital lease obligations (19) (6)
--------------- ---------------
Net cash provided by (used in) financing activities from continuing operations 400 694
Net cash used in financing activities from discontinued operations -- 678
--------------- ---------------
Net cash provided by (used in) investing activities 400 1,372
--------------- ---------------
NET DECREASE IN CASH AND CASH EQUIVALENTS 67 (1,024)
CASH AND CASH EQUIVALENTS, Beginning of period 228 1,223
--------------- ---------------
CASH AND CASH EQUIVALENTS, End of period $ 295 $ 199
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
5
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
NINE MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
NON-CASH INVESTING AND FINANCING ACTIVITIES
During the nine months ended March 31, 2005, the Company issued: (1) 8,623,110
shares of its common stock for services valued at $42; (2) 20,880,130 shares of
its common stock for debt of $38; (3) 62,534,215 shares of its common stock for
penalties of $94; and (4) 38,000,000 shares of its common stock for the
conversion of convertible debentures in the amount of $175.
During the nine months ended March 31, 2004, the Company issued: (1) 7,445,000
shares of its common stock for services valued at $160,150; (2) 10,272,110
shares of its common stock for compensation valued at $140,332; (3) 25,297,220
shares of its common stock for debt of $471,542; and (4) 141,204,581 shares of
its common stock for the conversion of convertible debentures in the amount of
$1,342,464.
6
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
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 years ended June 30, 2004 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.
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, 2005 and 2004, 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, 2005, the Company had a net loss of $658. As of March 31, 2005,
the Company had a negative working capital deficiency of $22,113 and had a
stockholders' deficit of $21,205. In addition, the Company is in default on
certain note payable obligations, is being sued by numerous trade creditors for
nonpayment of amounts due and is late on its filings of payroll tax returns in
certain of its PEO division. The Company is also deficient in its payments
relating to payroll tax liabilities. These conditions raise substantial doubt
about the Company's ability to continue as a going concern.
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 including compliance with the Imperial Bank
settlement agreement. Any additional equity or convertible debt financings could
result in substantial dilution to the Company's stockholders. If adequate funds
are not available, the Company may be required to delay, reduce or eliminate
some or all of its planned activities, including any potential mergers or
acquisitions. 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.
7
NOTE 3. STOCK BASED COMPENSATION
The Company accounts for employee stock options in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees". Under APB 25, the Company does not recognize compensation expense
related to options issued under the Company's employee stock option plans,
unless the option is granted at a price below market price on the date of grant.
In 1996, SFAS No. 123 "Accounting for Stock-Based Compensation", became
effective for the Company. SFAS No. 123, which prescribes the recognition of
compensation expense based on the fair value of options on the grant date,
allows companies to continue applying APB 25 if certain pro forma disclosures
are made assuming hypothetical fair value method, for which the Company uses the
Black-Scholes option-pricing model.
For non-employee stock based compensation, the Company recognizes an expense in
accordance with SFAS No. 123 and values the equity securities based on the fair
value of the security on the date of grant. For stock-based awards, the value is
based on the market value for the stock on the date of grant and if the stock
has restrictions as to transferability, a discount is provided for lack of
tradability. Stock option awards are valued using the Black-Scholes
option-pricing model.
The Company applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for its stock option plans. The Company has opted
under SFAS No. 123 to disclose its stock-based compensation with no financial
effect. The pro forma effects of applying SFAS No. 123 in this initial phase-in
period are not necessarily representative of the effects on reported net income
or loss for future years. Had compensation expense for the Company's stock
option plans been determined based upon the fair value at the grant date for
awards under these plans consistent with the methodology prescribed under SFAS
No. 123, the Company's pro forma net loss and net loss per share would have been
as follows for the nine months ended March 31, 2005 and 2004:
(In thousands, except share amounts) 2004 2003
----------- ----------
Net loss attributed to common stockholders
As reported $ (673) $ (163)
Compensation recognized under APB No. 25 -- --
Compensation recognized under SFAS No. 123 -- (825)
----------- ----------
Pro forma $ (673) $ (988)
=========== ==========
Basic earnings (loss) per share
As reported $ (0.00) $ (0.00)
Pro forma $ (0.00) $ (0.03)
This option valuation model requires input of highly subjective assumptions.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing model does not necessarily provide a reliable single
measure of fair value of its employee stock options.
The weighted average fair value of the options granted during fiscal years 2004
and 2003 is estimated on the date of grant using the Black-Scholes
option-pricing model. All options granted in fiscal years 2004 and 2003 vested
immediately. The weighted average fair values and weighted average assumptions
used in calculating the fair values were as follows for the years ended June 30:
2004 2003
----------- ----------
Fair Value of options granted N/A $ 0.015
Risk free interest rate N/A 3.5%
Expected life (years) N/A 3
Expected volatility N/A 421%
Expected dividends N/A 0%
No options have been issued during fiscal year 2005.
8
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. Diluted earnings (loss) per share have not been presented
since the effect of the assumed conversion of options and warrants to purchase
common shares would have an anti-dilutive effect. The following potential common
shares have been excluded from the computation of diluted net loss per share for
the nine months ended March 31, 2005: warrants - 26,563,435 and stock options -
39,150,000.
Below is a computation of earnings per share for the three months ended March
31, 2004. Basic and diluted loss per share are the same for the nine months
ended March 31, 2004 and the three and nine months ended March 31, 2005:
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------------------------------
2005 2004
-------------------------------------- ----------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations $ 67 $ 279
Preferred stock dividends (5) (5)
--------- ---------
62 274
Discontinued operations -- 4,356
--------- ---------
Net income (loss) attributed to common
stockholders $ 62 $ 4,630
========= =========
Weighed shares outstanding 682,396 348,926
========= =========
Continuing operations $ 0.00 $ 0.00
Discontinued operations $ -- $ 0.01
--------- ---------
$ 0.00 $ 0.01
========= =========
DILUTED EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations $ 67 $ 279
Preferred stock dividends (5) (5)
Interest on convertible debentures 25 41
Amortization of discounts on convertible
debentures 41 151
--------- ---------
128 466
Discontinued operations -- 4,356
--------- ---------
Net income (loss) attributed to common
stockholders $ 128 $ 4,822
========= =========
Weighed shares outstanding 682,396 348,926
========== ==========
Conversion of convertible debentures into
common stock 729,689 193,619
---------- ----------
1,412,085 542,545
========== ==========
Continuing operations $ 0.00 $ 0.00
Discontinued operations $ -- $ 0.01
--------- ---------
$ 0.00 $ 0.01
========= =========
9
NINE MONTHS ENDED MARCH 31,
----------------------------------------------------------------------------
2005 2004
-------------------------------------- ----------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing
operations $ (658) $ (3,145)
Preferred stock dividends (15) (15)
--------- ---------
(673) (3,160)
Discontinued operations -- 2,997
--------- ---------
Net income (loss) attributed to common
stockholders $ (673) $ (163)
========= =========
Weighed shares outstanding 635,914 292,602
Continuing operations $ (0.00) $ (0.01)
Discontinued operations $ -- $ 0.01
--------- ---------
$ (0.00) $ (0.00)
========= =========
DILUTED EARNINGS (LOSS) PER SHARE -- N/A
NOTE 5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, entitled INVENTORY COSTS -- AN
AMENDMENT OF ARB NO. 43, CHAPTER 4. SFAS No. 151 amends the guidance in ARB No.
43, Chapter 4, entitled INVENTORY PRICING [June 1953], to clarify the accounting
for "abnormal amounts" of idle facility expense, freight, handling costs, and
wasted material [spoilage]. Before revision by SFAS No. 151, the guidance that
existed in ARB No. 43 stipulated that these type items may be "so abnormal" that
the appropriate accounting treatment would be to expense these costs as incurred
[i.e., these costs would be current-period charges]. SFAS No. 151 requires that
these type items be recognized as current-period charges WITHOUT REGARD to
whether the "so abnormal" criterion has been met. Additionally, SFAS No. 151
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. The
adoption of SFAS 151 did not impact the consolidated financial statements.
10
In December 2004, the FASB issued SFAS No. 152, entitled ACCOUNTING FOR REAL
ESTATE TIME-SHARING TRANSACTIONS -- AN AMENDMENT OF FASB STATEMENTS NO. 66 AND
67. SFAS No. 152 amends SFAS No. 66 to reference the financial accounting and
reporting guidance for real estate time-sharing transactions that is provided in
AICPA Statement of Position 04-2. SFAS No. 152 also amends SFAS No. 67 to state
that the guidance for (a) incidental operations and (b) costs incurred to sell
real estate projects does not apply to real estate time-sharing transactions.
The accounting for those operations and costs is subject to the guidance of SOP
04-2. This statement is effective for financial statements for fiscal years
beginning after June 15, 2005. The adoption of SFAS 152 did not impact the
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 153, entitled EXCHANGES OF
NONMONETARY ASSETS -- AN AMENDMENT OF APB OPINION No.29. SFAS No. 153 amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of nonmonetary
assets that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The adoption of SFAS 153 did
not impact the consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised), entitled SHARE-BASED
PAYMENT. This revised Statement eliminates the alternative to use APB Opinion
No. 25's intrinsic value method of accounting that was provided in SFAS No. 123
as originally issued. Under Opinion 25, issuing stock options to employees
generally resulted in recognition of no compensation cost. This Statement
requires entities to recognize the cost of employee services received in
exchange for awards of equity instruments based on the grant-date fair value of
those awards. For public companies that file as a small business issuer, this
Statement is effective as of the beginning of the first interim or annual
reporting period that begins after December 15, 2005. The adoption of SFAS 123
(Revised) will impact the consolidated financial statements as the Company in
the future if it continues to issue equity instruments to employees.
NOTE 6. FACTORING LINES OF CREDIT
The Company's temporary staffing division entered into a factoring agreement
that expires in January 2007 and in renewable for successive periods of 12
months assuming certain conditions are met. The agreement provides for the
Company to sell to the factor accounts receivables at a discount of
approximately 2% for each 30 day period the balances remain unpaid.
NOTE 7. CONVERTIBLE NOTES PAYABLE
Listed below is a roll-forward schedule of the convertible debentures:
(In Thousands)
Balance at June 30, 2004 $ 871
Issuance of convertible debentures during the six months
ended March 31, 2005 --
Increase in debt discount and beneficial conversion feature --
Converted into common stock (175)
Amortization of value of warrants and preferential
conversion feature 276
---------
Balance at March 31, 2005 $ 972
=========
11
NOTE 8. NOTES PAYABLE
On July 1, 2004, the Company entered into two note payable obligations
aggregating $275,000 that bear interest at an annual rate of 40% and are due on
September 30, 2004. During the three months ended March 31, 2005, the Company
repaid $85,000 on these two notes. In addition, in connection with these two
notes payable, the Company issued to the holder a total of 5,000,000 warrants to
purchase shares of the Company's common stock for $0.005 per shares. The
estimated value of the warrants of $28,500 was determined using the
Black-Scholes option pricing model and the following assumptions: term of 5
years, a risk free interest rate of 3.5%, a dividend yield of 0% and volatility
of 426%. As of September 30, 2004, the entire $28,500 has been amortized to
financings costs in the accompanying consolidated statements of operations.
NOTE 9. STOCKHOLDERS' DEFICIENCY
Stock Issuances
---------------
During the nine months ended March 31, 2005, DRDF issued the following:
o 8,623,110 shares of its common stock for legal, accounting and
consulting services valued at $42.
o 20,880,130 shares of its common stock for debt of $38;
o 62,534,215 shares of its common stock for penalties of $94;
and
o 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:
o for services - the market value of the Company's common stock
at the date of issuance;
o for debt conversions - at contractually obligated amounts.
NOTE 10. 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, 2005 is as follows:
(IN THOUSANDS)
TEMPORARY PEO
PRODUCTS SOFTWARE STAFFING SERVICES TOTAL
-------- -------- -------- -------- -----
9-months ended 3/31/05
----------------------
Revenues $ 468 $ 48 $ 11,749 $ 2,058 $ 14,323
Operating income (loss) (237) (357) (103) (168) (865)
9-months ended 3/31/04
----------------------
Revenues $ 546 $ 66 $ 6,328 $ 2,545 $ 9,485
Operating income (loss) (733) (2,999) 204 911 (2,617)
12
NOTE 11. DISPOSITION OF GREENLAND CORPORATION
In January 2004, the Company determined to discontinue operations of Greenland
Corporation, its professional employment business division, and sold its shares
in Greenland, back to Greenland. Effective March 1, 2004, the Company completed
the sale of Greenland. Effective March 1, 2004, four new directors were elected
to serve on Greenland's Board of Directors due to the resignation of the four
directors nominated by DRDF. The operations of Greenland have been shown as
discontinued operations in the accompanying consolidated statements of
operations.
The operations of Greenland for the six month period ended March 31, 2004 are
shown as discontinued operations.
NOTE 12. RELATED PARTY TRANSACTIONS
Warning Management Services, Inc.
The Company CEO and Chairman, Mr. Brian Bonar, is also the CEO and Chairman of
Warning Management, 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.
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.
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. Management
has evaluated this contingent liability and has determined that no loss is
anticipated as a result of this guarantee.
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. The
Company recorded revenue totaling approximately $154 during the nine months
ended March 31, 2005
NOTE 13. GAIN RESULTING FROM RECONCILIATION OF PAYROLL TAX LIABILITES TO TAXING
AUTHORITIES
During the three and nine months ended March 31, 2005, the Company recorded an
adjustment to earnings of $454 and $990, 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.
13
NOTE 14. OTHER ACCRUED EXPENSES
Other accrued expenses at March 31, 2005 consisted of the following as of:
Interest $ 3,655
Payroll and sales tax payable 658
IRS levy penalties and interest 387
Accrued salaries and related liabilities 624
Other 1,296
-------
$10,419
=======
NOTE 15. LITIGATION
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 $750,000.00 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. As such, the guarantees
allegedly provided by the Company and ESI could thereby be invalided. Discovery
has commenced but is not complete at this time. Trial has not been set.
Management has fully cooperated in our investigation of the facts and we intend
to defend against the claims asserted.
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 and each of its co-defendants have challenged the
legal sufficiency of Plaintiff's claims and allegations. However, the court has
not yet ruled on the multiple challenges although we believe that the claims
generally lack merit. Discovery has commenced but is not complete at this time.
Trial has not been set. Management has fully cooperated in our investigation of
the facts and we intend to continue with vigorous defense against the claims
asserted.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company
Annual Report on Form 10-KSB for the year ended June 30, 2004. 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.
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 Buena Park, 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
15
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.
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.
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, 2004 financial statements included in our Annual Report on Form
10KSB 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, the Company is late in our filing of payroll tax returns for certain
of our PEO divisions. 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.
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.
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.
16
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 of Financial Condition and Results of
Operations discuss our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. On an on-going basis, we evaluate our estimates and
judgments, including those related to allowance for doubtful accounts, value of
intangible assets and valuation of non-cash compensation. We base our estimates
and judgments on historical experiences and on various other factors that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. The most significant
accounting estimates inherent in the preparation of our consolidated financial
statements include estimates as to the appropriate carrying value of certain
assets and liabilities which are not readily apparent from other sources,
primarily allowance for doubtful accounts, estimated fair value of equity
instruments used for compensation, estimated tax liabilities fro 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 fiscal year ended June 30, 2004.
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.
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
17
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.
RESULTS OF OPERATIONS (IN $000)
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004
-------------------------------------------------------------------------------
REVENUES
Total revenues were $5,449 and $3,488 for the three months ended March 31, 2005
and 2004, respectively; an increase of $1,961 (56%). The increase was due
primarily to the addition of temporary staffing services, which contributed
$4,095 of revenues for the three months ended March 31, 2005 compared to $2,892
for the three months ended March 31, 2004 and an increase in PEO service revenue
which was $1,208 for the three months ended March 31, 2005 compared to $475 for
the same period in 2004.
PEO SERVICES
PEO revenues were $1,208 and $475 for the three months ended March 31, 2005 and
2004, respectively; an increase of $733 (154%) due primarily to the increase in
our PEO customer base.
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 $4,095 and $2,892 for the three months ended
March 31, 2005 and 2004, respectively; an increase of $1,203 (42%). The
significant increase is due to the acquisition of Jackson Staffing and M&M
Nursing.
PRODUCTS
Sales of products were generated principally from our QPI subsidiary. Products
revenues were $137 and $91 for the three months ended March 31, 2005 and 2004,
respectively; an increase of $46 (51%). The increase is principally due to
additional sales of photographic and digital images though our QPI subsidiary.
SOFTWARE
Software revenues were $9 and $30 for the three months ended March 31, 2005 and
2004, respectively; a decrease of $21 (70%). 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 QPI, which has accelerated product development and begun to
implement a more aggressive product sales program.
18
COST OF PRODUCTS SOLD
Cost of PEO services for the three months ended March 31, 2005 and 2004 $1,088
(90% of PEO revenues) and $384 (81% 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, 2005 and 2004
was $3,591 (88% of temporary staffing revenue) and $2,663 (92% of temporary
staffing revenue), respectively.
Cost of products sold for the three months ended March 31, 2005 and 2004 were
$23 (17% of product sales) and $28 (31% of product sales), respectively.
Cost of software, licenses and royalties for the three months ended March 31,
2005 and 2004 were $1 (11% of software, license and royalties revenue) and $0
(0% 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, 2005 and 2004 were $904
and $(71), respectively; an increase of $975. 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 three month period ended March 31, 2004, we changed our estimate of
workers' compensation and accrued payroll taxes, which resulted in a negative
cost of PEO operations. The cumulative changes in estimates for these accounts
aggregated approximately $1.2 million in the quarterly period ended March 31,
2004.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the three months ended March 31, 2005
and 2004 was $394 and $434 respectively; a decrease of $40 (9%). The decrease is
principally due to the write off of the unamortized debt discounts associated
with the conversion of debentures into common stock for the three months ended
March 31, 2004 (there were no conversion during the three months ended March 31,
2005) offset by an increase due to the amount of debt outstanding.
GAIN ON EXTINGUISHMENT OF DEBT
Gain on the extinguishment of debt was $165 and $228 for the three months ended
March 31, 2005 and 2004, 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 three months ended March 31, 2005, we recorded as other income an
adjustment of accrued PEO payroll taxes payable of $454 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 updates 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.
19
NINE MONTHS ENDED MARCH 31, 2005 COMPARED TO NINE MONTHS ENDED MARCH 31, 2004
-----------------------------------------------------------------------------
REVENUES
Total revenues were $14,323 and $9,485 for the nine months ended March 31, 2005
and 2004, respectively; an increase of $4,838 (51%). The principal reason for
the increase is due to a full nine months of revenue from our temporary staffing
division for the nine months ended March 31, 2005 as compared to only seven
months for the same period in 2004.
PEO SERVICES
PEO revenues were $2,058 and $2,545 for the nine months ended March 31, 2005 and
2004, respectively; a decrease of $487 (19%) due primarily to the decrease in
our PEO customer base in the first half of fiscal 2005 offset by an increase in
the third fiscal quarter.
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 $11,749 and $6,328 for the nine months ended
March 31, 2005 and 2004, respectively; an increase of $5,421 (86%). The
significant increase is due to the acquisition of Jackson Staffing and M&M
Nursing.
PRODUCTS
Sales of products were generated principally from our QPI subsidiary. Products
revenues were $468 and $546 for the nine months ended March 31, 2005 and 2004,
respectively; a decrease of $78 (14%).
SOFTWARE
Software revenues were $48 and $66 for the nine months ended March 31, 2005 and
2004, respectively; a decrease of $18 (27%). 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 QPI, which has accelerated product development and begun to
implement a more aggressive product sales program.
COST OF PRODUCTS SOLD
Cost of PEO services for the nine months ended March 31, 2005 and 2004 $1,716
(83% of PEO revenues) and $2,280 (90% of PEO revenues), respectively. The
increase in gross profit is due primarily to us being able to provide more
profitable services to our PEO customers, offset by higher employee benefit
costs in the quarter ended March 31, 2005.
Costs of temporary staffing for the nine months ended March 31, 2005 and 2004
was $10,539 (90% of temporary staffing revenue) and $5,657 (89% of temporary
staffing revenue), respectively. The significant increase is due to the increase
in temporary staffing revenue.
Cost of products sold for the nine months ended March 31, 2005 and 2004 were $59
(13% of product sales) and $156 (29% of product sales), respectively.
Cost of software, licenses and royalties for the nine months ended March 31,
2005 and 2004 were $4 (8% of software, license and royalties revenue) and $3 (5%
of software, license and royalties revenue), respectively.
20
OPERATING EXPENSES
Operating expenses for the nine months ended March 31, 2005 and 2004 were $2,870
and $4,006, respectively; a decrease of $1,136 (28%). The decrease is due to a
reduction of payroll and related benefits due to a significant reduction in our
personnel. 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, 2005, we changed our estimate of workers' compensation claims
aggregating approximately $700 and $1,200 for the nine months ended March 31,
2005 and 2004, respectively.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the nine months ended March 31, 2005
and 2004 was $1,208 and $1,363 respectively; a decrease of $155 (11%). The
decrease 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, 2004 (there were fewer conversions during the nine months
ended March 31, 2005) offset by an increase due to the amount of debt
outstanding.
GAIN ON EXTINGUISHMENT OF DEBT
Gain on the extinguishment of debt was $425 and $853 for the nine months ended
March 31, 2005 and 2004,, 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, 2005, we recorded as other income an
adjustment of accrued PEO payroll taxes payable of $990 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 updates 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, 2005 and the year ended June 30, 2004, we issued an additional
130,037,455 and 371,126,679 shares, respectively. These shares of common stock
were issued primarily for corporate expenses in lieu of cash, for acquisition of
businesses, for the conversion of convertible debentures and other debt, and for
the exercise of warrants.
As of March 31, 2005, we had negative working capital of $22,113, a decrease in
working capital of $245 since June 30, 2004.
Net cash used in operating activities was $186 for the nine months ended March
31, 2005 as compared to net cash used in activities of $1,560 for the prior-year
period; a decrease of $1,374.
Cash provided by financing activities was $400 for the nine months ended March
31, 2005, a decrease of $294 from the prior-year period.
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, 2005, was
approximately $498.
21
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, 2004 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.
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 Sheet 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, thus reducing the $750 note payable to $258. Management has evaluated
this contingent liability and has determined that no loss is anticipated as a
result of this guarantee.
ITEM 3. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer (hired January 2, 2005),
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 end of the period
covered by this quarterly report (the "Evaluation Date"). This evaluation was
carried out under the supervision and with the participation of our management,
including our chief executive officer and chief financial officer. Based on this
evaluation, as of the Evaluation Date, we have started the process of upgrading
our corporate general ledger system, and are in the process of developing a plan
to improve the efficiency of the design and operations of our disclosure
controls. This plan will need to take in consideration the input of our auditors
upon the completion of our June 30, 2005 year-end audit. The project to upgrade
the general ledger system is a major project and is estimated to be complet ed
in December 2005. Except for the hiring of our chief accounting officer, there
were no changes in our internal control over financial reporting or in other
factors that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. However, since we did not
meet the timely filing requirements, our chief executive and chief financial
officers have concluded that our disclosure and procedures were not effective as
of the quarter period ending March 31, 2005.
Similar to the prior quarter, this current quarterly report was not filed on a
timely basis as a result of additional research and confirmations required in
establishing the basis for a reasonable reliance on the disclosures of certain
large liabilities. We are in the process, with the assistance of our external
auditors, of determining what steps need to be taken to ensure that this area
will not be an issue in future reporting. In addition, with the assistance of
our external auditors and in conjunction with our June fiscal year-end audit, we
looking at what other areas need additional controls to ensure the timely
reporting of required information in the future.
As discussed above, we have hired a new chief financial officer effective
January 2, 2005. Our new chief financial officer has embarked on a project to
upgrade the general ledger system in each of our subsidiaries and to create a
new system for recording and closing our corporate ledgers and consolidation all
of our subsidiaries. That process is projected be completed by the end of
December 2005, and is anticipated to result in a decrease in the amount of time
necessary to complete our quarterly and annual financial statements commencing
with the quarter ended December 31, 2005. We will update our discussion of
internal control changes in our 10-K for the year ended June 30, 2005 and our
next 10-Q for the quarter ended September 30, 2005
Disclosure controls and procedures that are our controls are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SEC's rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by us in the
reports that we file under the Exchange Act is accumulated and communicated to
our management, including principal executive officer and principal financial
officer, as appropriate, to allow timely decisions regarding required
disclosure.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 1999, the law firms of Weiss & Yourman and Stull, Stull & Brody made
a public announcement that they had filed a lawsuit against the Company and
certain current and past officers and/or directors, alleging violation of
federal securities laws and, in November 1999, the lawsuit, filed in the name of
Nahid Nazarian Behfarin, on her own behalf and others purported to be similarly
situated, was served on the Company. In January 2003, the Company entered into a
Stipulation of Settlement with the plaintiffs. It agreed to pay the plaintiffs
5,000,000 shares of common stock and $200 in cash. The Parties have accepted the
settlement. DRDF has issued the shares, and its insurance carrier has paid the
$200 cash payment. Pursuant to a hearing in May 2003 the Court provided approval
to the settlement.
On August 22, 2002, the Company was sued by its former landlord, Carmel Mountain
#8 Associates, L.P. or past due rent on its former facilities at 15175
Innovation Drive, San Diego, CA 92127.
DRDF was a party to a lawsuit filed by Symphony Partners, L.P. related to its
acquisition of SourceOne Group, LLC. As reported on Form 8-K, dated July 22,
2003, the plaintiffs sought payment of $702. In June 2003, the Company entered
into a settlement with the plaintiffs for a cash payment of $274, which has been
paid.
DRDF is one of dozens of companies sued by The Massachusetts Institute of
Technology, et al., related to a patent held by the plaintiffs that may be
related to part of the Company's ColorBlind software. Subsequent to the period
reported in this filing, in June 2003, the Company entered into a settlement
with the plaintiffs who have agreed to dismiss their claims against DRDF with
prejudice in exchange for a settlement fee payment of $10, which has been paid.
The Company has been sued in Illinois state court along with AIA/Mirriman, its
insurance brokers by the Arena Football League-2 ("AFS"). Damages payable to
AF2, should they win the suit, could exceed $700. The Company expects to defend
its position and rely on representations of its insurance brokers.
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 $750,000.00 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. As such, the guarantees
allegedly provided by the Company and ESI could thereby be invalided. Discovery
has commenced but is not complete at this time. Trial has not been set.
Management has fully cooperated in our investigation of the facts and we intend
to defend against the claims asserted.
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 and each of its co-defendants have challenged the
legal sufficiency of Plaintiff's claims and allegations. However, the court has
not yet ruled on the multiple challenges although we believe that the claims
generally lack merit. Discovery has commenced but is not complete at this time.
Trial has not been set. Management has fully cooperated in our investigation of
the facts and we intend to continue with vigorous defense against the claims
asserted.
Throughout fiscal 2003 and 2004, and through the date of this filing, 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 $3,000. 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 one thousand dollars to just over one million dollars, with the
great majority being less than twenty thousand dollars.
In connection with the Company's acquisition of controlling interest of Quik
Pix, Inc., we are unaware of any pending litigation. From time to time, QPI may
be involved in litigation relating to claims arising out of its operations in
the normal course of business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Common Stock
------------
During the three months ended March 31, 2005, DRDF issued the following:
o 210 shares of its common stock for services valued at 1
dollar. The value of the services was determined using the
market value of DRDF's common stock on the date of issuance;
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is currently in default on certain bank loans that have an aggregate
outstanding balance at March 31, 2005 of $3,220,000.
23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
31.1 Rule 13a-14(a) Certification of CEO
31.2 Rule 13a-14(a) Certification of CFO
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 of CEO
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 of CFO
SIGNATURES
--------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 10, 2005
DALRADA FINANCIAL CORPORATION
(Registrant)
By: /S/ Brian Bonar
-------------------------------------
Brian Bonar
Chairman and Chief Executive Officer
By: /S/ Randall Jones
-------------------------------------
Randall Jones
Chief Financial Officer
24