U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended June 30, 2006.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from _____ to ______
COMMISSION FILE NUMBER 0-12641
DALRADA FINANCIAL CORPORATION
(Name of small business issuer in its charter)
DELAWARE 13-0021693
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9449 BALBOA AVENUE, SUITE 210
SAN DIEGO, CA 92123
(Address of principal executive offices)
Registrant's Telephone number, including area code: (858) 451-6120
Securities registered under 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Act: Common Stock Indicate by
check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-B is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. Yes [ ] No [X]
The issuer had revenues of $70,380,000 for the fiscal year ended June 30, 2006.
The aggregate market value of the voting stock held by non-affiliates on June
30, 2006 was approximately $,3085,998 based on the average of the bid and asked
prices of the issuer's common stock in the over-the-counter market on such date
as reported by the OTC Bulletin Board. As of June 30, 2006 4,886,248 post split
shares of the issuer's Common Stock were outstanding. As of September 15, 2006
4,886,248 post split shares of the issuer's Common Stock were outstanding.
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]
DOCUMENTS INCORPORATED BY REFERENCE
None
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT: YES [ ] NO [X]
1
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
2006 ANNUAL REPORT ON FORM 10-KSB
TABLE OF CONTENTS
PART I PAGE
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ITEM 1. Business 3
ITEM 2. Properties 9
ITEM 3. Legal Proceedings 9
ITEM 4. Submission of Matters to a Vote of Security Holders 11
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 12
ITEM 6. Management's Discussion and Analysis of Financial Conditions
and Results of Operations 12
ITEM 7. Financial Statements 21
ITEM8. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 21
ITEM8A. Controls and Procedures 21
ITEM 8B. Other Information 22
PART III
ITEM 9. Directors and Executive Officers of the Registrant 23
ITEM 10. Executive Compensation 25
ITEM 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 26
ITEM 12. Certain Relationships and Related Transactions 29
PART IV
ITEM 13. Exhibits and Financial Statement Schedules 30
ITEM 14. Principal Accountant Fees and Services 33
FINANCIAL STATEMENTS F-1
SIGNATURES
EXHIBIT INDEX
2
PART 1.
ITEM 1. DESCRIPTION OF BUSINESS
Dalrada Financial Corporation (OTCBB symbol: DFCO) ("DFCO" or the "Company") was
incorporated in March 1982 under the laws of the State of California, and
reincorporated in May 1983 under the laws of the State of Delaware. The
Company's principal executive offices are located at 9949 Balboa Avenue, Suite
210, San Diego, CA 92123. The Company's main phone number is (858) 277-5300.
We provide financial services to small and medium-size business. Our clients
rely on us to provide services that relieve them from many of the day-to-day
tasks that negatively impact their core business operations, such as payroll
processing, human resources support, workers' compensation insurance, safety
programs, employee benefits, and other administrative services.
Our business is predominantly related to staffing - staff leasing, temporary
staffing and co-employment. We provide core services as well as a wide selection
of employee and employer benefits, which we present as the Benefits Bank(TM).
These aftermarket products include health insurance, business insurance, 401k
plans, 125 cafeteria plan, tool reimbursement, deferred compensation programs,
voluntary benefits, debit cards, and discount programs for employees.
FINANCIAL AND HUMAN RESOURCES SERVICES
We provide a variety of financial, staffing, professional employer organization
outsourcing (PEO) and human resources services to small and medium-size
businesses. These services allow our customers to outsource many human resources
tasks, including payroll processing, workers' compensation insurance, employee
benefits administration, risk management and human resource administration.
These financial services relieve existing and potential customers of the burdens
associated with personnel management and control.
As a human resource department and strategic business partner for our clients,
our service offerings allow our clients to:
o comply with ever evolving complex employment related regulatory and
tax issues;
o increase productivity by improving employee satisfaction and
retention;
o reduce payroll expenses with lower workers' compensation costs; and
o focus on core business activities instead of human resource matters.
We also provide our products and services through our subsidiaries and
divisions: SourceOne Group, Inc. ("SOG"), Heritage Staffing and The Solvis
Group, Inc., ("Solvis"). Solvis operates several operating units, including
CallCenterHR(TM), Solvis Financial Services, Solvis Medical Staffing and Solvis
Home Health Care.
Our temporary staffing services include on-demand or short-term staffing
assignments, long-term or indefinite-term contract staffing and on-site
management. This segment of our business is primarily devoted to medical, light
industrial, and call center staffing.
In a co-employment or PEO contract arrangement, we become a co-employer of the
client's existing workforce and assume some or all of the client's human
resource management responsibilities. Our product and services mix is similar,
but the relationship with our PEO client is characterized by shared
responsibility for employees.
IMAGING PRODUCTS
In January 2003, we completed the acquisition of a controlling in the shares of
Quik Pix, Inc. ("QPI"), located in Anaheim, California. At the time of
acquisition, QPI's principal business was providing products and services
associated with visual marketing support. QPI revenues consist primarily of
developing and mounting photographic and digital images for use in display
advertising for tradeshows and customer building interiors. QPI also has a
proprietary product PhotoMotion Images(TM), ("PhotoMotion") which is a patented
color medium of multi-image transparencies. DFCO moved its ColorBlind(TM)
software business into QPI. The business is in the process of being sold to
another company, which will be concluded by the end of October 2006.
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In July 2005, QPI acquired The Solvis Group, Inc. ("Solvis") from DFCO and
changed its name to The Solvis Group and its trading symbol to SLVG. Solvis
currently trades on the Pink Sheets(R).
MARKET OVERVIEW - FINANCIAL AND HUMAN RESOURCES SERVICES
The burdens placed on small and medium-sized employers by the complex legal and
regulatory issues related to human resources management caused our industry
segment to grow beginning in the 1980's. While various service providers have
been available to assist these businesses with specific tasks, companies like
ours emerged as providers of a more comprehensive range of services relating to
the employer/employee relationship. We assume broad aspects of the
employer/employee relationship for our clients. Because we provide
employee-related services to a large number of employees, we provide economies
of scale that provide our clients employment-related functions more efficiently,
provide a greater variety of employee benefits, and devote more attention to
human resources management.
We believe that the demand for our services is driven by (1) the trend by small
and medium-sized businesses toward outsourcing management tasks outside of core
competencies; (2) the difficulty of providing competitive health care and
related benefits to attract and retain employees; (3) the increasing costs of
health and workers' compensation insurance coverage and workplace safety
programs; and (4) complex regulation of labor and employment issues and the
related costs of compliance.
MARKET OVERVIEW - IMAGING PRODUCTS
During FY 2006 we continued to operate a business unit, Quik Pix (a division of
The Solvis Group) to market our proprietary imaging products and to provide
photographic services to selected clientele.
ColorBlind software is a suite of software applications, which allow users to
build color profiles of images in order to insure accurate output on digital
devices such as printers, plotters, scanners, monitors, and cameras.
Photomotion is a patented process for adding multiple images to backlit static
displays that appear to change as the viewer passes by the image. The
PhotoMotion process uses existing original art to create an illusion of
movement; and allows for separate and distinct image displays. It allows for
three to five distinct images to be displayed within an existing light box.
Images appear to change or "morph" as the viewer passes the display.
We offer a spectrum of services allowing a client to produce color visuals
(digital and photographic). We also offer a full range of color laboratory
reproduction services.
The Company is in the process of selling this business unit to another company,
with a planned closing of the transaction in October 2006.
FINANCIAL AND HUMAN RESOURCE SERVICES
STRATEGIC OBJECTIVE
Our long-term strategic objective is to becoming a leading provider of human
resource outsourcing services for small and medium-sized businesses. We
differentiate our strategic position by offering a full spectrum of staffing
services. The integrated nature of our platform assists our clients and
customers in strengthening their organizational structure to meet their business
objectives. Our operating and growth strategies are described below.
OPERATING STRATEGY
SALES: Our selling premise is that the aggregate cost providing human resources
support in-house or purchasing separate services from multiple vendors is
greater than the cost of purchasing from one independent source. We believe that
we offer cost savings and managerial efficiencies to clients. Companies with
multiple vendors often fail to realize the benefits and economies of scale of
having a single, integrated source of human resource services.
We provide a broad range of human resource management tools and related
financial services that meet critical personnel needs. Our solutions allow
clients to maximize the value realized from integrating human resource needs by
establishing a partnership with a single vendor.
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OPERATIONAL EFFICIENCIES: We recently reorganized our senior management into
four regions in order to decentralize our management philosophy and structure to
enhance our client contact and response. Our experienced senior managers possess
the technical and management skills to be proactive in addressing the
marketplace as well as being responsive to client needs. We believe that this
investment in the re-organized structure and in the hiring of industry
experienced senior managers will provide us with a platform to grow our
business.
WORKERS COMPENSATION AND RISK MANAGEMENT: We have committed to minimize workers'
compensation risk through disciplined underwriting processes. Our risk managers
corroborate the underwriting data by assessing the candidate's operating
culture, workplace safety standards and human resource administration
philosophies, including compensation rates and benefit levels. If the client's
safe-work culture or adherence to workplace safety procedures declines to
unsatisfactory levels, we reserve the right to terminate the relationship under
the terms of our contract.
We provide workers' compensation insurance through an independent carrier and
coordinate rates, compliance, claims, safety programs, and medical review. We
provide coverage through an A-rated national carrier and take responsibility for
payment of premiums and the deposit of adequate reserves against claims.
GROWTH STRATEGY
EXPAND REGION AND BRANCH OFFICE OPERATIONS. Our strategy is to increase
penetration of our existing markets by enhancing our reputation and increasing
brand awareness in the regions and cities in which we operate. We believe that
there is substantial opportunity to further penetrate these territories by the
effective use of insurance broker networks, referrals, and marketing efforts
within the local business community.
INCREASE VALUE-ADDED PRODUCTS AND SERVICES. We believe that our partnership
philosophy provides us with the opportunity to expand our staffing services and
add on services. We will be able to continue our base level of service fees per
client employee and to increase our business through products and programs such
as employee benefits, which are expected to provide incremental profits and to
improve client retention.
INFORMATION SYSTEMS. We have invested in new payroll processing systems,
financial information systems and related process management systems during this
past year. We intend to add a comprehensive human resource management system
during the next year. The combination of these efforts are expected to provided
us with a scalable platform to enable efficient growth. The systems will allow
our customer service and human resource personnel to increase productivity while
maintaining high levels of quality service.
STRATEGIC ACQUISITION. In May 2006 we acquired Strategic Staff Leasing, Inc.,a
Dallas, Texas-based provider of benefits and PEO services. In September 2006 we
acquired All Staffing, Inc.- a PEO serving Pennsylvania, New Jersey and New
York. All Staffing billed approximately $100 million in non-GAAP gross revenues
for 2005. We expect to continue to seek acquisitions that will effectively
support our growth strategy.
PRODUCTS AND SERVICES.
Our business provides a broad range of services associated with human resources
management. These include benefits and payroll administration, health and
workers' compensation insurance programs, voluntary benefits programs, personnel
records management, employer liability management, employee recruiting and
selection, performance management, and training and development services.
We perform a wide variety of processing and record keeping tasks, mostly related
to payroll administration and government compliance. Specific examples include
payroll processing, payroll tax deposits, quarterly payroll tax reporting,
employee file maintenance, unemployment claims processing, workers' compensation
claims management and reporting and safety programs.
We provide workers' compensation insurance through independent carriers and
coordinate rates, compliance, claims, safety programs, and medical review. We
provide coverage through an A-rated national carrier and take responsibility for
payment of premiums and the deposit of adequate reserves against claims.
We sponsor benefit plans including individual and group health coverage, 401(k)
and 125-Flex plans, and others. We are responsible for the costs and premiums
associated with these plans, act as plan sponsor and administrator of the plans,
negotiate the terms and costs of the plans, maintain the plans in accordance
with applicable federal and state regulations, and serve as liaison for the
delivery of such benefits to worksite employees.
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We provide a variety of personnel management services, which provide our client
companies access to resources normally found in the human resources departments
of larger companies. Our client companies have access to a personnel guide,
which sets forth a systematic approach to administering personnel policies and
practices and is often customized to fit a client company's particular work
culture/environment. We assume many employment-related responsibilities
associated with administrative functions and benefit plans administration. Upon
request, we can also provide our clients guidance on avoiding liability for
discrimination, sexual harassment, and civil rights violations. We employ
counsel specializing in employment law.
Our business represents a distribution channel for a wide variety of employer
and employee benefit programs such as 401(k) plans, 125-Flex plans, legal
services, tax consulting, payroll advances, and insurance programs. Our
intention is to expand our business through offering a variety of financial
services.
Our Company is growing rapidly, but profit margins are small. Consequently,
profitability depends on (1) economies of scale leading to greater operating
efficiencies; and (2) value-added services such as training, education, Internet
support, and other services that may be used by employers and employees.
The income model for the service segment of our business generally revolves
around fees charged for our services. While gross profit is low, gross revenues
are generally substantial. To this end, the Company intends to pursue
acquisitions of small firms and strategic alliances with similar companies as
ours.
STAFFING SERVICES
Staffing services include on-demand or short-term staffing assignments, contract
staffing, long-term or indefinite-term on-site management, and human resource
administration:
Short-term staffing involves demands for employees caused by such factors as
seasonality, fluctuations in customer demand, vacations, illnesses, parental
leave and special projects.
Contract staffing refers to providing employees for our clients for a period of
more than three months or an indefinite period.
We employ an experienced on site manager at a client's place of business under
certain contractual arrangements. The manager is responsible for conducting all
recruiting, screening, interviewing, testing, hiring and employee placement
functions at the client's facility for a long-term or indefinite period.
We use a variety of methods to recruit our work force for staffing services. The
employee application process may include an interview, skills assessment test,
reference verification, and background checks. We use a pre-employment screening
process to find and select applicants who are appropriately qualified for
employment.
We have not experienced any material liability due to claims arising out of
negligent acts or misconduct by our staffing services employees by staffing
employees that are not under our direct control while working at a customer's
business.
PEO SERVICES
In certain circumstances, we become a co-employer of the client's existing
workforce in a PEO contract and assume responsibility for some or all of the
human resource management responsibilities, including payroll and payroll taxes,
employee benefits, health insurance, workers' compensation coverage, workplace
safety programs, compliance with federal and state employment laws, labor and
workplace regulatory requirements, and related administrative responsibilities.
We have the right to hire and fire our worksite employees, while the client's
management remains responsible for recruiting, work assignments, supervision and
training.
6
Prior to entering into a co-employer arrangement, we perform an analysis of the
potential client's actual personnel and workers' compensation costs based on
information provided. We recommend safety improvement procedures and equipment
following a risk assessment. The potential client must agree to implement
recommended changes as part of the co-employer arrangement.
Most service agreements provide for an initial term of one year with renewal
provisions. Our agreements generally permit cancellation by either party upon 30
days' written notice. In addition, we may terminate the agreement at any time
for specified reasons, including nonpayment or failure to comply with our
workplace safety requests or as the result of worsening safety record or OSHA
violations. The form of PEO services agreement also provides for indemnification
of us by the client against losses arising out of any default by the client
under the agreement, including failure to comply with any employment-related,
health and safety, or immigration laws or regulations.
IMAGING PRODUCTS AND SERVICES
During FY2006 we continued to provide imaging products and services through Quik
Pix, a division of The Solvis Group. This business segment includes our
proprietary ColorBlind color management software, our patented PhotoMotion
Visual Images, and photographic services.
We are in the process of selling this business unit to another company with a
planned closing of the transaction in October 2006.
SALES AND MARKETING
Sales efforts are conducted by our regional and branch managers and by local
sales representatives, often coupled with ties with insurance brokers. Our
corporate office is responsible for product development, product management and
the development of sales materials. Our sales activities are primarily focused
on branch-level business relationships. Referrals by insurance brokers have been
an important contributor in building our sales.
COMPETITION
The financial and human resources services business is highly competitive, with
over 800 firms operating in the U.S. There are several staffing services firms
that operate on a nationwide basis with revenues and resources far greater than
ours, such as Manpower, Inc and Kelly Services, Inc; in addition, we compete
with local and regional staffing firms for customers and employees. The
competitive factors that dominate the industry include price and quality
placements of employees in a timely manner. We price our services competitively,
provide premier customer service and manage the placement process.
Some large PEO companies are owned by insurance carriers and some are public
companies whose shares trade on Nasdaq, including Administaff, Inc., Team Staff,
Inc., Barrett Business Services, Gevity HR, Inc. and Staff Leasing, Inc.
Competition includes staffing firms, payroll processors and financial services
firms. As workers compensation insurance is often the key element in a client's
decision to engage a PEO, competition among PEOs is often on the availability of
cost competitive insurance. Our competitive position is enhanced by having a
high deductible workers compensation plan with an A rated carrier. Our
procedures to manage claims had resulted in a low claims loss experience in the
last fiscal year.
The markets for our imaging products and services are also highly competitive
and rapidly changing. Our ability to compete in our markets depends on a number
of factors, including the success and timing of product and services
introductions by us and our competitors, selling prices, performance,
distribution, marketing ability, and customer support.
WORKERS' COMPENSATION PROGRAM
Workers' compensation is a principal service we provide. We, as employer of
record, are responsible for applicable statutory compliance for workers'
compensation coverage. Our risk management activities are closely related to our
underwriting approach.
INSURANCE FOR WORKERS' COMPENSATION. In April 2005, we obtained a high
deductible policy with an A rated national carrier in order to manage our
financial exposure from catastrophic injuries and fatalities. Regulations
governing self-insured employers often require the employer to maintain surety
deposits of government securities, letters of credit or other financial
instruments to cover workers' claims in the event the employer is unable to pay
for such claims.
7
Our excess workers' compensation insurance annual policy provided coverage for
single occurrences exceeding $250,000 with an aggregate stop loss provision of
$4,000,000. We were required to post a $2.625 million reserve with the carrier
from which claims would be paid until all claims are settled. As of the end of
the policy year, ending April 30, 2006, based upon an independent actuary
report, we reserved $615,000 in pending claims against the remaining collateral
fund; producing an approximate $1.8 million in excess reserves.
For the next policy year beginning May 2006, the carrier slightly raised our
stop loss rates, but required us to deposit only $1.6 million in the claims
collateral fund as the result of our low claims experience in the prior year.
However we are anticipating that, despite our risk management program and claims
management program, we may not be able to duplicate the low claims experience of
2006 and may trend closer to traditional loss experiences of the general
population.
CLAIMS MANAGEMENT . Our workers' compensation expense is tied directly to the
incidence and severity of workplace injuries. We attempt to contain workers'
compensation costs through an aggressive claims management process. We employ a
managed-care system to minimize medical costs and income loss costs by assigning
injured workers, as provided for in certain service agreements with our clients,
to short-term assignments which are safe for the injured worker. We utilize TPAs
for principal claims management expertise. Typical management procedures include
performing thorough and prompt on-site investigations of claims filed by
employees, working with physicians to encourage efficient medical management of
cases, denying questionable claims and attempting to negotiate early settlements
to eliminate future case development and costs.
WORKERS' COMPENSATION INSURANCE COSTS . The costs associated with our high
deductible workers' compensation program include case reserves for reported
claims, an additional expense provision for potential future increases in the
cost of open injury claims, fees payable to our TPAs, administrative fees
payable to state and federal workers' compensation regulatory agencies, premiums
for excess workers' compensation insurance, and legal fees.
WORKERS' COMPENSATION CLAIMS EXPERIENCE AND RESERVES: We recognize our liability
for the ultimate payment of incurred claims and claims adjustment expenses by
accruing liabilities which represent estimates of future amounts necessary to
pay claims and related expenses with respect to covered events that have
occurred. When a claim involving a probable loss is reported, our TPA
establishes a case reserve for the estimated amount of ultimate loss. The
estimate reflects an informed judgment based on established case reserving
practices and the experience and knowledge of the TPA regarding the nature and
expected value of the claim, as well as the estimated expense of settling the
claim, including legal and other fees and expenses of administering claims. The
adequacy of such case reserves depends on the professional judgment of each TPA
to properly and comprehensively evaluate the economic consequences of each
claim. On an aggregate basis, we have established an additional reserve for both
future adverse loss development in excess of initial case reserves on open
claims.
As part of the case reserving process, historical data is reviewed and
consideration is given to the anticipated effect of various factors, including
known and anticipated legal developments, inflation and economic conditions. We
have engaged an independent actuary to assist management in estimating the total
future costs of claims, including potential future adverse loss development. We
believe our total accrued workers' compensation claims liabilities at June 30,
2006, are adequate. It is possible, however, that our actual future workers'
compensation obligations may exceed the amount of our accrued liabilities, with
a corresponding negative effect on future earnings, due to such factors such as
unanticipated adverse loss development of known claims, and to a much lesser
extent, if any, of claims incurred but not reported.
OPERATIONS
Our corporate headquarters facility in San Diego, California houses most of our
administrative operations. Human resource services operations are conducted from
the Company's headquarters offices and branch offices in Michigan (3),
California (4), Colorado, Texas, and Pennsylvania (2). All of our offices are
leased.
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INTELLECTUAL PROPERTY
We have obtained U.S. registration for several of our trade names or trademarks,
including ColorBlind, Photomotion Images, MedicalHR, CallCenterHR, SourceOne
Group, and The Benefits Bank. These trade names are used to distinguish our
products and services in the markets we serve.
If we fail to establish that we have not violated any asserted rights of others,
we could be prohibited from marketing the associated product and/or services,
and we could be liable for damages. We rely on a combination of trade secret,
copyright and trademark protection, and non-disclosure agreements to protect our
proprietary rights.
Software products related to our imaging operations are copyrighted. However,
copyright protection does not prevent other companies from emulating the
features and benefits provided by our software. We protect our software source
code as trade secrets and make our proprietary source code available to OEM
customers only under limited circumstances and specific security and
confidentiality constraints. We hold the patent for Photomotion. These products
exist in a rapidly changing business environment. Consequently, we believe the
effectiveness of patents, trade secrets, and copyright protection is less
important in influencing long term success than the experience of our employees
and our contractual relationships. Due to lack of sales of the Photomotion, we
have fully written-off the value of the related patent as of June 2005 year end.
MANUFACTURING, PRODUCTION, AND SOURCES OF SUPPLY: - IMAGING PRODUCTS
We manufacture our software products and imaging products in-house and through
selected outside vendors.
RESEARCH AND DEVELOPMENT - IMAGING PRODUCTS
Some of our imaging products are characterized by rapidly evolving technology,
frequent new product introductions, and significant price competition. We have
entered into no formal projects in research and development for several years;
however, we do make modifications to existing products on an as-needed basis to
maintain their currency.
GOVERNMENT REGULATION
While many states do not explicitly regulate companies like ours, over 20 states
have passed laws that have licensing or registration requirements for
professional employer organizations ("PEO"), which is a component of our
business. Such laws vary from state to state, but generally provide for
monitoring the fiscal responsibility of PEOs and, in some cases, codify and
clarify the co-employment relationship for unemployment, workers' compensation,
and other purposes under state law. We estimate that the annual cost of
compliance with these regulations is approximately $250,000.
EMPLOYEES
Our Company (including subsidiaries, but not including employees pursuant to
staffing and/or co-employer client contracts) employed a total of 75 individuals
worldwide as of September 30, 2006. Of this number, 30 were involved in sales
and marketing, 13 in corporate administration and finance, 40 were in human
resources, payroll, and benefits administration, and 2 in technical support.
There is no union representation for any of our employees.
ITEM 2. DESCRIPTION OF PROPERTY
DFCO owns no real property. We lease or month-to-month rent all corporate and
branch office facilities. At June 30, 2006, our leases had expiration dates
ranging from less than one year to five years with total minimum payments
through 2011 of approximately $1.38 million.
ITEM 3. 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 led it to
enter into the agreement with Arena. These claims are currently pending.
9
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 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.
In July 2006, the matter was settled with Dalrada paying $150 thousand in legal
fees incurred by Greenland.
On August 29, 2005, United Bank & Trust filed suit against the Company and other
parties. The allegations of the lawsuit are that the Company guaranteed certain
debt owed by InfoServices, Inc. and is liable in the amount of $678. The 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 $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 $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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS ANNUAL MEETING OF
STOCKHOLDERS HELD ON MAY 25, 2006
At the Company's annual meeting of stockholders, held on May 25, 2006, the
following proposals were voted upon and approved:
1. The election of five persons named in the accompanying Proxy Statement to
serve as directors on the Company's board of directors (the "Board") and until
their successors are duly elected and qualified;
2. To approve an amendment to the Certificate of Incorporation in order to
effect a stock combination (reverse split) of the Common Stock in an exchange
ratio of one newly issued share for each two hundred outstanding shares of
Common Stock;
3. To ratify the appointment of Pohl, McNabola, Berg and Company, LLP, as the
Company's independent auditors for the fiscal year ending June 30, 2006; and
4. To consider and transact such other business as may properly come before
the Meeting or any adjournment(s) thereof.
The reverse split (Item 2 above) became effective as of September 15, 2006.
10
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
(a) Our common stock is quoted on the Over-the Counter Bulletin Board, also
called the OTCBB, under the trading symbol "DFCO". The following table set forth
the quarterly high and low bid prices per share for our common stock. The bid
prices reflect inter-dealer prices, without retail markup, markdown, or
commission and may not represent actual transactions.
Post Split
High Low
---- ---
Year ended June 30, 2005
First quarter $ 0.94 $ 0.46
Second quarter 0.60 0.36
Third quarter 0.76 0.40
Fourth Quarter 1.26 0.42
Year Ended June 30, 2006
First quarter $ 0.94 $ 0.46
Second quarter 1.06 0.50
Third quarter 1.98 0.70
Fourth quarter 1.34 0.50
As of June 30, 2006, there were approximately 518 registered shareholders of
DFCO's Common Stock and 997,175,961, (4,886,248 post split) issued and
outstanding. The stock split was effective on September 15, 2006.
TRANSFER AGENT AND REGISTRAR
DFCO's transfer agent is Atlas Stock Transfer, 5899 South State Street, Salt
Lake City, Utah 54107, (801)266-7151.
RECENT SALES OF UNREGISTERED SECURITIES
DFCO made the following sales of stock without registration using the exceptions
available under the Securities Act of 1933, as amended, including unregistered
sales made pursuant to Section 4(2) of the Securities Act of 1933, as follows:
FISCAL YEAR 2005
Issuances are in pre-split shares.
On July 12, 2004, 38,000,000 shares (190,000 post split shares) were issued to
the Longview Fund, LP as a partial conversion of a convertible debenture valued
at $175,560 of principal at $0.00462 per share. These shares were issued
pursuant to the exemption provided by Section 4(2) of the Securities Act of
1933, as amended. We made a determination that Longview Fund, LP was a
sophisticated investor with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
On July 26, 2004, 450,000 shares (2,250 post split shares) were issued to
Technipower, Inc, at $.005 per share. These shares were issued pursuant to the
exemption provided by Section 4(2) of the Securities Act of 1933, as amended. We
made a determination that Technipower, Inc. was a sophisticated investor with
enough knowledge and experience in business to evaluate the risks and merits of
the investment.
On September 28, 2004 Allen, Sheridan and Temple were issued an aggregate of
1,500,000 shares (7,500 post split shares) at $0.0025 per share. These shares
were issued pursuant to the exemption provided by Section 4(2) of the Securities
Act of 1933, as amended. We made a determination that the investors were
sophisticated investors with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
On September 28, 2004, 10,108,706 shares (50,544 post split shares) were issued
to Bristol Investment Fund, Ltd. as a partial conversion of $17,500 of principal
and $3,728.22 of interest at $0.0021 per share. These shares were issued
pursuant to the exemption provided by Section 4(2) of the Securities Act of
1933, as amended. We made a determination that Bristol Investment Fund, Ltd. was
a sophisticated investor with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
11
On October 19, 2004, David Whiteford , Michael Brann , and Jason Brann were
issued 375,000, 576,950 and 576,950 shares (1,875, 2,885 and 2,885 post split
shares respectively) of Dalrada common stock respectively valued at $.00458 a
shares for they service they performed in relation to the acquisition of Jackson
Staffing. These shares were issued pursuant to the exemption provided by Section
4(2) of the Securities Act of 1933, as amended. We made a determination that
David Whiteford, Michael Brann and Jason Brann were sophisticated investors with
enough knowledge and experience in business to evaluate the risks and merits of
the investment.
On October 19, 2004, Anne Woelk was issued 144,000 shares (720 post split
shares) valued at $.00500 a share for administrative services rendered. These
shares were issued pursuant to the exemption provided by Section 4(2) of the
Securities Act of 1933, as amended. We made a determination that Anne Woelk was
a sophisticated investor with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
On October 25, 2004, Dominick Zack was issued 4,000,000 shares (20,000 post
split shares) valued at $.00500 a share for accounting services rendered in
relation to the Jackson Staffing subsidiary. These shares were issued pursuant
to the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Dominick Zack was a sophisticated investor
with enough knowledge and experience in business to evaluate the risks and
merits of the investment.
On October 25, 2004, Deborah McNeil was issued 1,000,000 shares (5,000 post
split shares) valued at $.00500 a share for accounting services rendered in
relation to the Jackson Staffing subsidiary. These shares were issued pursuant
to the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Deborah McNeil was a sophisticated
investor with enough knowledge and experience in business to evaluate the risks
and merits of the investment.
On December 3, 2004, 23,757,224 shares (118,786 post split shares) were issued
to Bristol Investment Fund, Ltd. for conversion of $29,000 of principal and
$6,635.84 of interest at $0.00154 per share. These shares were issued pursuant
to the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Bristol Investment Fund, Ltd., was a
sophisticated investor with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
On December 13, 2004, 21,121,413 shares (105,607 post split shares) were issued
to Stonestreet Limited Partnership at $0.00151 per share for conversion of a
convertible debenture valued at $30,000 plus $1893.56 in interest. These shares
were issued pursuant to the exemption provided by Section 4(2) of the Securities
Act of 1933, as amended. We made a determination that Stonestreet Limited
Partnership was a sophisticated investor with enough knowledge and experience in
business to evaluate the risks and merits of the investment.
On April 8, 2005, 46,852,670 shares (234,263 post split shares) were issued to
Balmore S.A. at $0.00181 per share for conversion of a convertible debenture
valued at $65,000 plus $19,803.33 in interest. These shares were issued pursuant
to the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Balmore S.A. was a sophisticated investor
with enough knowledge and experience in business to evaluate the risks and
merits of the investment.
On June 13, 2005, 6,000,000 shares ( 30,000 post split shares) were issued to
John Capezzuto at $0.005 per share. These shares were issued pursuant to the
exemption provided by Section 4(2) of the Securities Act of 1933, as amended. We
made a determination that John Capezzuto was a sophisticated investor with
enough knowledge and experience in business to evaluate the risks and merits of
the investment.
On June 21, 2005, 525,000 shares ( 2,625 post split shares) were issued to Brian
Bonar (CEO) at $0.005 per share. These shares were issued pursuant to the
exemption provided by Section 4(2) of the Securities Act of 1933, as amended.
FISCAL YEAR 2006
Issuances are in pre-split shares.
12
On July 12, 2005, 17,659,540 shares (88,298 post split shares) were issued to
Bristol Investment Fund, Ltd. at $0.001267 per share for conversion of a
convertible debenture valued at $22,374.67. These shares were issued pursuant to
the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Bristol Investment Fund, Ltd was a
sophisticated investor with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
On September 16, 2005, 5,000,000 shares (25,000 post split shares) were issued
to Joseph Maleki at $0.003 per share. These shares were issued pursuant to the
exemption provided by Section 4(2) of the Securities Act of 1933, as amended. We
made a determination that Joseph Maleki was a sophisticated investor with enough
knowledge and experience in business to evaluate the risks and merits of the
investment.
On November 23, 2005, 33,698,362 shares (168,492 post split shares) were issued
to Balmore S.A. at $0.0017 per share for conversion of a convertible debenture
valued at $50,000 plus $7,287.21 in interest. These shares were issued pursuant
to the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Balmore S.A. was a sophisticated investor
with enough knowledge and experience in business to evaluate the risks and
merits of the investment.
On February 2, 2006, 10,000,000 shares (50,000 post split shares) were issued to
Balmore S.A. at $0.00236 per share for conversion of interest valued at $23,660
These shares were issued pursuant to the exemption provided by Section 4(2) of
the Securities Act of 1933, as amended. We made a determination that Balmore
S.A. was a sophisticated investor with enough knowledge and experience in
business to evaluate the risks and merits of the investment.
On February 2, 2006, 20,000,000 shares (100,000 post split shares) were issued
to the Longview Fund at $0.00226 per share for conversion of interest valued at
$45,200. These shares were issued pursuant to the exemption provided by Section
4(2) of the Securities Act of 1933, as amended. We made a determination that the
Longview Fund LP. was a sophisticated investor with enough knowledge and
experience in business to evaluate the risks and merits of the investment.
On March 13, 2006, 51,178,167 shares (255,891 post split shares) were issued to
Balmore S.A. at $0.00226 per share for conversion of a convertible debenture
valued at $126,077 plus interest valued at $2,662.58. These shares were issued
pursuant to the exemption provided by Section 4(2) of the Securities Act of
1933, as amended. We made a determination that Balmore S.A. was a sophisticated
investor with enough knowledge and experience in business to evaluate the risks
and merits of the investment.
On March 13, 2006, 50,195,478 shares (250,978 post split shares) were issued to
th Longview Fund LP. at $0.00226 per share for conversion of a convertible
debenture valued at $112,226 plus interest valued at $1,125.78. These shares
were issued pursuant to the exemption provided by Section 4(2) of the Securities
Act of 1933, as amended. We made a determination that the Longview Fund LP. was
a sophisticated investor with enough knowledge and experience in business to
evaluate the risks and merits of the investment.
On March 13, 200, 5,000,000 shares (25,000 post split shares) were issued to
Naccarato & Associates at $0.00226 per share. These shares were issued pursuant
to the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Naccarato & Associates was a sophisticated
investor with enough knowledge and experience in business to evaluate the risks
and merits of the investment.
On March 13, 2006, 5,000,000 shares (25,000 post split shares) were issued to
Grushko & Mittman PC at $0.00226 per share. These shares were issued pursuant to
the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended. We made a determination that Grushko & Mittman PC was a sophisticated
investor with enough knowledge and experience in business to evaluate the risks
and merits of the investment.
On March 14, 2006, 50,000,000 shares (250,000 post split shares) were issued to
Brian Bonar (CEO) at $0.005 per share. These shares were issued pursuant to the
exemption provided by Section 4(2) of the Securities Act of 1933, as amended.
On May 23, 2006, 25 shares (1 post split share) were issued to Mr. Kessleman at
$0.005 per share. These shares were issued pursuant to the exemption provided by
Section 4(2) of the Securities Act of 1933, as amended. We made a determination
that Mr. Kesselman was a sophisticated investor with enough knowledge and
experience in business to evaluate the risks and merits of the investment.
13
ITEM 6. 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 elsewhere in this
Form 10-KSB. The statements contained in this Report on Form 10-KSB that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, including statements regarding our
expectations, hopes, intentions or strategies regarding the future.
Forward-looking statements include statements regarding: future product or
product development; future research and development spending and our product
development strategies, and are generally identifiable by the use of the words
"may", "should", "expect", "anticipate", "estimates", "believe", "intend", or
"project" or the negative thereof or other variations thereon or comparable
terminology. Forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, performance
or achievements (or industry results, performance or achievements) expressed or
implied by these forward-looking statements to be materially different from
those predicted. The factors that could affect our actual results include, but
are not limited to, the following: general economic and business conditions,
both nationally and in the regions in which we operate; competition; changes in
business strategy or development plans; our inability to retain key employees;
our inability to obtain sufficient financing to continue to expand operations;
and changes in demand for products by our customers.
OVERVIEW
We provide financial and human resource management services, including staffing
services and PEO services. Staffing services revenues are generated primarily
from short-term staffing, contract staffing, and on-site management. PEO service
fees are generated from contractual agreements with clients under which we act
as a co-employer of our client's workforce with responsibility for some or all
of the client's human resource functions. We recognize revenues from our
staffing services for all amounts invoiced, including direct payroll, employer
payroll-related taxes, workers' compensation coverage and an administrative
fee). PEO service fee revenues are recognized on a net basis in accordance with
Emerging Issues Task Force No.99-19, "REPORTING REVENUES GROSS AS A PRINCIPAL
VERSUS NET AS AN AGENT " ("EITF No.99-19"). Therefore PEO service fee revenues
represent the gross margin generated from our PEO services after deducting the
amounts invoiced to PEO customers for direct payroll expenses such as salaries,
wages, health insurance and employee out-of-pocket expenses incurred incidental
to employment. These amounts are also excluded from cost of revenues. PEO
service fees also include amounts invoiced to our clients for employer
payroll-related taxes and workers' compensation coverage.
Our business is conducted in California, Michigan, Colorado, Pennsylvania and
Texas. In addition to seeking new markets, we expect to derive most of our
revenues from our current markets for the near term. Any weakness in economic
conditions or changes in the regulatory environments in these regions could have
a material adverse effect on our financial results.
Our services and products are marketed through our operating divisions and
subsidiaries. PEO services are marketed by Dalrada Financial Services (formerly
Strategic Staff Leasing), and All Staffing (acquired subsequent to year -end).
Our staffing services revenues are obtained by: Heritage Staffing and our Solvis
subsidiary (which includes CallCenterHR, Solvis Medical Staffing, and Solvis
Home Health Care).
Our business continues to experience some liquidity problems. Accordingly,
year-to-year comparisons may be of limited usefulness as our business continues
to experience rapid growth.
Our current strategy is to expand our financial service business, including
staff leasing, PEO services, and value added products and services to small and
medium-size businesses.
To successfully execute our current strategy, we will need to improve our
working capital position. The report of our independent auditors accompanying
our June 30, 2006 financial statements included elsewhere in this Form 10KSB
includes an explanatory paragraph indicating there is a substantial doubt about
our ability to continue as a going concern, due primarily to a working capital
deficiency and negative net worth, which is exacerbated by our losses in prior
years. In addition, we are 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 and
renegotiating existing obligations. In addition, we continue to work with the
Internal Revenue Service and State taxing Authorities to reconcile and resolve
all open accounts and issues.
14
We have sought to reduce our debt through debt to equity conversions. In
February 2006 we issued promissory notes for $7,545,000, which consisted of a
rolling over of approximate $2,545,000 in existing debt and $5,000,000 in cash.
The proceeds were used primarily to pay off promissory notes, convertible note
debt, factoring debt, and other debt and to establish collateral backed ACH
credit lines.
There can be no assurance that we will be able to complete any additional debt
or equity financings on favorable terms or at all, or that any such financings,
if completed, will be adequate to meet our capital requirements. Any additional
equity or convertible debt financings could result in substantial dilution to
our shareholders. If adequate funds are not available, we may be required to
delay, reduce or eliminate some or all of our planned activities, including any
potential mergers or acquisitions. Our inability to fund our capital
requirements would have a material adverse effect on the Company.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Discussion and Analysis of Financial Condition and Results of Operations discuss
our consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America.
The preparation of these consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. On an
on-going basis, we evaluate our estimates and judgments, including those related
to allowance for doubtful accounts, value of intangible assets and valuation of
non-cash compensation. We base our estimates and judgments on historical
experiences and on various other factors that we believe to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying value of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions. The most significant accounting estimates
inherent in the preparation of our consolidated financial statements include
estimates as to the appropriate carrying value of certain assets and liabilities
which are not readily apparent from other sources, primarily allowance for
doubtful accounts, estimated fair value of equity instruments used for
compensation, estimated tax liabilities from PEO operations and estimated
liabilities associated with worker's compensation liabilities. These accounting
policies are described at relevant sections in this discussion and analysis and
in the notes to the consolidated financial statements included elsewhere in this
Form l0-KSB.
REVENUE RECOGNITION
PEO SERVICE FEES AND WORKSITE EMPLOYEE PAYROLL COSTS
We recognize our revenues associated with our PEO business pursuant to EITF
99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent." Our
revenues are reported net of worksite employee payroll cost (net method).
Pursuant to discussions with the Securities and Exchange Commission staff, we
changed our presentation of revenues from the gross method to an approach that
presents our revenues net of worksite employee payroll costs (net method)
primarily because we are not generally responsible for the output and quality of
work performed by the worksite employees.
In determining the pricing of the markup component of the gross billings, we
take into consideration our estimates of the costs directly associated with our
worksite employees, including payroll taxes, benefits and workers' compensation
costs, plus an acceptable gross profit margin. As a result, our operating
results are significantly impacted by our ability to accurately estimate,
control and manage our direct costs relative to the revenues derived from the
markup component of our gross billings.
Consistent with our revenue recognition policy, our direct costs do not include
the payroll cost of our worksite employees. Our direct costs associated with our
revenue generating activities are comprised of all other costs related to our
worksite employees, such as the employer portion of payroll-related taxes,
employee benefit plan premiums and workers' compensation insurance premiums.
TEMPORARY STAFFING
We record gross revenue for temporary staffing. We have concluded that gross
reporting is appropriate because we (i) have the risk of identifying and hiring
qualified employees, (ii) have the discretion to select the employees and
establish their price and duties and (iii) bear the risk for services that are
not fully paid for by customers. Temporary staffing revenues are recognized when
the services are rendered by our temporary employees. Temporary employees placed
by us are our legal employees while they are working on assignments. We pay all
related costs of employment, including workers' compensation insurance, state
and federal unemployment taxes, social security and certain fringe benefits. We
assume the risk of acceptability of our employees to our customers.
15
WORKERS' COMPENSATION RESERVES
We are self-insured for workers' compensation coverage in a majority of our PEO
and staffing employees up to $250,000 per occurrence and up to an aggregate
total of $4 million for plan year 2006, ended April 30, 2006, and up to $6
million for plan year ending April 30, 2007. Accruals for workers' compensation
expense are made based upon our claims experience and a quarterly independent
actuarial analysis, utilizing past experience, as well as claim cost development
trends and current workers' compensation industry loss information. We believe
the amount accrued is adequate to cover all known and unreported claims at June
30, 2006. However, if the actual costs of such claims and related expenses
exceed the amount estimated, additional reserves may be required, which could
have a material adverse effect on our operating results.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We are required to make estimates of the collectibility of accounts receivables.
Management analyzes historical bad debts, customer concentrations, customer
creditworthiness, current economic trends and changes in the customers' payment
tendencies when evaluating the adequacy of the allowance for doubtful accounts.
If the financial condition of our customers deteriorates, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
INTANGIBLE ASSETS AND GOODWIL
We assess the recoverability of intangible assets and goodwill annually and
whenever events or changes in circumstances indicate that the carrying value
might be impaired. Factors that are considered include significant
underperformance relative to expected historical or projected future operating
results, significant negative industry trends and significant change in the
manner of use of the acquired assets. Management's current assessment of the
carrying value of intangible assets and goodwill indicates there was no
impairment as of June 30, 2006. If these estimates or their related assumptions
change in the future, we may be required to record impairment charges for these
assets.
SALES OF PRODUCTS
Revenue is recognized when earned. Our revenue recognition policies are in
compliance with all applicable accounting regulations, including American
Institute of Certified Public Accountants (AICPA) Statement of Position (SOP)
97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2,
Revenue from packaged product sales to and through distributors and resellers is
recorded when related products are shipped. Maintenance and subscription
revenue, if any, is recognized ratably over the contract period. When the
revenue recognition criteria required for distributor and reseller arrangements
are not met, revenue is recognized as payments are received. Provisions are
recorded for returns and bad debts. Our software arrangements do not contain
multiple elements, and we do not offer post contract support.
RESULTS OF OPERATIONS (IN $000)
YEAR ENDED JUNE 30, 2006 COMPARED TO YEAR ENDED JUNE 30, 2005
REVENUES
Total revenues were $70,380 and $19,476 for the year ended June 30, 2006 and
2005, respectively; an increase of $50,904 (261%). The principal reason for the
increase is due an overall increase in revenue in our staffing businesses.
Revenues of approximately $1.3 million were not recorded as a result of a
dispute with a customer. $6.5 million of revenues were recorded as net fees only
in accordance with EITF 99-19 GAAP requirements.
16
STAFFING
During fiscal 2005, certain staffing business units were renamed Solvis Group,
Inc. Heritage Staff Leasing and Solvis revenues were $68,226 and $17,029 for the
year ended June 30, 2006 and 2005, respectively; an increase of $51,197 (300%).
The principal reason for the increase is due to an increase in revenue from our
staffing activities and our focus on this segment of our business - in
California and in medical staffing.
Due to a dispute with a customer, we elected not to book approximately $1.3
million in additional staffing revenues. However, costs associated with this
activity have been included in our staffing cost of sales.
PEO SERVICES
PEO revenues were $1,382 and $1,930 for the year ended June 30, 2006 and 2005,
respectively; a decrease of $548 (28%) due primarily to a decrease in our PEO
customer base in California and our increased focus to expand our staffing
business.
Under current GAAP rules, we are required to book PEO revenues on a net fee
basis rather than as gross billed payrolls, which were approximately $6.5
million in the fiscal year.
PRODUCTS AND MANGEMENT FEES
Sales of products and software were generated from sales of imaging products in
Solvis (imaging unit) and from management fees charged to a related party.
Products revenues were $772 and $517 for the year ended June 30, 2006 and 2005,
respectively; an increase of $255 (49%). The increase is principally due to the
recognition of a full year of management fees charged to a related party for the
outsourcing of its human resources administration and payroll processing.
COST OF PRODUCTS SOLD
Costs of staffing for the year ended June 30, 2006 and 2005 was $62,897 (92% of
temporary staffing revenue) and $15,010 (88% of temporary staffing revenue),
respectively. The decrease in gross profit is due primarily to the dramatic
increase in low margin staffing business and our election to provide these
services with more aggressive pricing in order to achieve greater market
penetration.
Cost of PEO services for the year ended June 30, 2006 and 2005 was $998 (72% of
PEO revenues) and $1,424 (74% of PEO revenues), respectively. The increase in
gross profit is due primarily to lower workers' compensation costs.
Cost of products and software for the year ended June 30, 2006 and 2005 was $34
(4% of product revenue) and $96 (19% of product revenue), respectively. The
increase in gross profit was due to the significant growth in management fees.
OPERATING EXPENSES
Operating expenses for the year ended June 30, 2006 and 2005 were $11,190 and
$6,750 and, respectively; an increase of $4,440 (66%). The increase is due to
expenditures associated with building our business infrastructure (systems and
staff) to accommodate our anticipated revenue growth, which was 261% greater
than our prior fiscal year. Additionally we adjusted our accounting estimates,
including legal and bad debt contingencies and other re-classifications, of
approximately $3.2 million.
During the year ended June 30, 2005, we determined that the cost of our
PhotoMotion patent was not recoverable and took a write-off related to the
patent of $1,348.
OTHER INCOME AND EXPENSE
Interest expense and financing costs for the year ended June 30, 2006 and 2005
was $2,697 and $1709 respectively; an increase of 988 (58%). The increase was
principally due to the increase in the factoring of accounts receivable,
(associated with the revenue growth primarily for staffing), the increase in
debt associated with the February 2006 refinancing and the payoff of accrued
interest as part of the refinancing. See Note 8 of the attached financial
statements for further explanation of the refinancing and related derivative
costs.
17
Also associated with the February refinancing of debt was the loss on settlement
of accrued interest, penalties and debt amounting to $908. There was no loss on
settlements in 2005.
GAIN ON EXTINGUISHMENT OF DEBT
During the year ended June 30, 2006 and 2005, the Company recognized a gain on
settlement of debt of $8,546 and $829, respectively. For the year ended June 30,
2006, the recognized a gain of $4,120 related to the settlement of two notes
payable to banks. (See Note 6 in attached financial statements) and a gain of
$2,140 related to the settlement of notes payable and accrued interest with a
former director (See Note 9 in attached financial statements). The remaining
gain of $2,286 for the year ended June 30, 2006 and the gain of $829 for the
year ended June 30, 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.
GAIN FROM RECONCILIATION OF PAYROLL TAX LIABILITES TO TAXING AUTHORITIES
For the years ended June 30, 2006 and 2005, we recorded as other income an
adjustment of accrued PEO payroll taxes payable of $1924 and $1,895,
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; accordingly we recognized penalties and
interest as of June 30, 2006 and 2005 $1,101 and $1,312, respectively.
CHANGES IN DERIVATIVES AND WARRANTY LIABILITIES
For the year ended June 30, 2006:
$ 754 income, decrease in value of warrant liability
$,1,234 income, decrease in value of derivative liability
-------
$ 1,988 other income related to convertible debt
For the year ended June 30, 2006, the Company recorded $884 of interest expense
related to the accretion of debt related to the convertible financing.
For the year ended June 30, 2006:
$ 884 of interest expense related to accretion of convertible debt
-------
$ 884 of interest expense related to convertible debt
The balance of the carrying value of the convertible debt as of June 30, 2006
is:
$ 1,605 original carrying value on convertible debt
$ (228) converted to equity
884 accretion of convertible debt
-------
$ 2,261 June 30, 2006 carrying value of debt
The balance of the carrying value of the derivative liability as of June 30,
2006 is:
$ 2,717 original value of derivative liability
$(1,234) income, decrease in value of derivative liability
-------
$ 1,483 June 30, 2006 value of derivative liability
The balance of the carrying value of the warrant liability as of June 30, 2006
is:
$ 3,892 original carrying value of warrant liability
$ (754) income, decrease in value of warrant liability
-------
$ 3,138 June 30, 2006 value of warrant liability
18
During the year ended June 30, 2006, the Company discussed with the lead
investor the refinancing of certain convertible notes, including disputed
amounts for accrued interest, penalties and note balances. As part of the
funding described above we recognized an additional settlement of accrued
interest, penalties and balances for $908. Please refer to Note 8 in the
attached financial statements for additional detail.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our operations primarily through cash generated
from operations, debt financing, and the sale of equity securities.
Additionally, in order to facilitate our growth and future liquidity, we have
made some strategic acquisitions.
As a result of some of our financing activities, there has been a significant
increase in the number of issued and outstanding shares. During the year ended
June 30, 2006 and the year ended June 30, 2005, we issued an additional
1,241,283 and 914,450 post split shares, respectively. These shares of common
stock were issued primarily for corporate expenses in lieu of cash, for
acquisition of businesses, for the conversion of convertible debentures and
other debt, and for the exercise of warrants.
As of June 30, 2006, we had negative working capital of $24,916, an increase in
working capital of $1,864 since June 30, 2005.
The Company is late on filing payroll tax returns and owes approximately $18.5
million in payroll taxes. Net cash provided by operating activities was $2,148
for the year ended June 30, 2006 as compared to net cash used in activities of
$4,351 for the prior-year period; an increase of $6,499. The principal reasons
are the increase of $2,158 improvement in working capital (current assets less
current liabilities) as the result of cost containment programs and the payoff
of certain liabilities as part of the refinancing of February 2006. Also
contributing was the payment of the worker's compensation premium and the
worker's compensation deposit paid during the year ended June 30, 2005, which
was absorbed during fiscal 2006 with the significant year to year growth.
Cash provided by financing activities was $1,039 for the year ended June 30,
2006 as compared to $4,482 for the year ended June 30, 2005, a decrease of
$3,443 from the prior-year period. The primary reason for the decrease was the
net effect of the February 2006 refinancing and payoff of certain liabilities as
compared to increases in notes payable associated with new workers' compensation
policies obtain in FY 2005.
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 June 30, 2006, was
approximately $474.
Our capital requirements depend on numerous factors, including market acceptance
of our products and services, the resources we devote to marketing and selling
our products and services, and other factors. The report of our independent
auditors accompanying our June 30, 2006 financial statements includes an
explanatory paragraph indicating there is a substantial doubt about our ability
to continue as a going concern, due primarily to the deficit in our working
capital and net worth.
CONTINGENT LIABILITY
The Company accrues and discloses contingent liabilities in its consolidated
financial statements in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 5, Accounting for Contingencies. SFAS No. 5 requires
accrual of contingent liabilities that are considered probable to occur and that
can be reasonably estimated. For contingent liabilities that are considered
reasonably possible to occur, financial statement disclosure is required,
including the range of possible loss if it can be reasonably determined. The
Company has disclosed in its audited financial statements several issues that it
believes are reasonably possible to occur, although it cannot determine the
range of possible loss in all cases. As these issues develop, the Company will
continue to evaluate the probability of future loss and the potential range of
such losses. If such evaluation were to determine that a loss was probable and
the loss could be reasonably estimated, the Company would be required to accrue
its estimated loss, which would reduce net income in the period that such
determination was made. During the fiscal year ended June 30, 2006, the Company
recorded $530,000 in loss reserves , as opposed FY 2005 in which the Company
recorded approximately $463,000 in loss reserves.
19
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, 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.
Warning Model Management, Inc. reached a settlement with Berryman & Henigar
Enterprises, subsequent to June 30, 2006, to pay the aggregate sum of $380,
which has been paid in full. Accordingly, Dalrada's guarantee of this
indebtedness in no longer applicable.
ITEM 7. FINANCIAL STATEMENTS
The report of our independent auditors and our financial statements are set
forth in this report beginning on Page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES.
(a) 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 June 30, 2006, covered by this
annual 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 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.
However, there were some material weaknesses in internal control over financial
reporting resulting from the Chief Executive Officer and Chief Financial
Officer's evaluation, which are described below. 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.
(b) EXCEPT AS DESCRIBED BELOW, DURING OUR FOURTH 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 annual
report includes the information concerning the controls evaluation referred to
in the certifications and should be read in conjunction with the certifications
for a more complete understanding of the topics presented.
In conjunction with their audit of our fiscal year 2005 consolidated financial
statements, PMB & Co., LLP (PMB), the Company's 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 the Company's 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 the company's annual or interim financial statements that is
more than inconsequential will not be prevented or detected.
20
The material weaknesses were identified as:
Planning and implementation of the Company's Accounting System; (2) Financial
Statement closing process; (3) Ineffective Information Technology control
environment, including the design of the Company's 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 the Company's
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
In conjunction with their audit of our fiscal year 2006 consolidated financial
statements, PMB & Co., LLP (PMB), the Company's 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 the Company's 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 the company's 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 the Company's Accounting System; (2)
Financial Statement closing process; (3) Ineffective Information Technology
control environment, including the design of the Company's information security
and data protection controls; (4) Proper recording of journal entries without
adequate review or supporting documentation; (5) 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; Lack of formal review process of expense reimbursements made to senior
management. The Company will continue to evaluate the material weaknesses and
will take all necessary action to correct the internal control deficiencies
identified. The Company will also further develop and enhance its internal
control policies, procedures, systems and staff to allow it to mitigate the risk
that material accounting errors might go undetected and be included in its
consolidated financial statements.
The Company contemplates undertaking a thorough review of its internal controls
as part of the Company's preparation for compliance with the requirements under
Section 404 of the Sarbanes-Oxley Act of 2002 and the Company is using this
review to further assist in identifying and correcting control deficiencies. At
this time, the Company has not completed its 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 the Company will be able to assert that
its internal control over financial reporting is effective, pursuant to the
rules adopted by the SEC under Section 404, when those rules take effect.
ITEM 8B.
None
21
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The directors and executive officers of the Company, their ages and positions
with the Company as of June 30, 2006 are as follows:
NAME AGE SINCE DIRECTOR/TITLE
-------------------------------------------------
Brian Bonar 59 1995 Director and Chief Executive Officer
Richard H. Green 70 2000 Director
Robert A. Dietrich 60 2000 Acting Chief Accounting Officer
4/16/06 to 9/30/06
Eric W. Gaer 58 2000 Director; Vice President
David Lieberman 61 2006 Director; Chief Financial officer and
Chief Operations Officer effective
10/1/06
Stanley Hirschman 61 2006 Director
BRIAN BONAR has served as a director of the Company since August 1995 and became
the Company's Chairman of the Board in December 1999. From August 1992 through
April 1994, Mr. Bonar served as the Company's Director of Technology Sales and
from April 1994 through September 1994 as the Company's Vice President, Sales
and Marketing. In September 1994, Mr. Bonar became the Company's Executive Vice
President and, in July 1997, was appointed as the Company's President and Chief
Operating Officer. In April 1998 Mr. Bonar assumed the post of CEO. From 1991 to
1992, Mr. Bonar was Vice President of Worldwide Sales and Marketing for Bezier
Systems, Inc., a San Jose, California-based manufacturer and marketer of laser
printers. From 1990 to 1991, he was Worldwide Sales Manager for Adaptec, Inc., a
San Jose-based laser printer controller developer. From 1988 to 1990, Mr. Bonar
was Vice President of Sales and Marketing for Rastek Corporation, a laser
printer controller developed located in Huntsville, Alabama. From 1984 to 1988,
Mr. Bonar was employed as Executive Director of Engineering at QMS, Inc., an
Alabama-based developer and manufacturer of high-performance color and
monochrome printing solutions. Prior to these positions, Mr. Bonar was employed
by IBM, U.K. Ltd. for approximately 17 years.
DR. RICHARD H. GREEN has served as a director since September 2000. He is
currently the President of International Power & Environmental Company (IPEC), a
consulting company located in San Diego, California. From 1993 through 1995, he
served as Deputy Secretary of the State of California Environmental Protection
Agency (Cal/EPA). From 1988 through 1993 Dr. Green served as Manager of Program
Engineering and Review Office in the Office of Technology and Applications at
the Jet Propulsion Laboratory (JPL) in Pasadena, California, where he had held
various management positions since 1967. From 1965 through 1967, Dr. Green
served as Senior Engineer for The Boeing Company, Space Division. From 1983
through 1985, Dr. Green held the Corwin D. Denny Chair as Professor of Energy
and Director of the Energy Institute at the University of LaVerne, and from 1961
through 1964 served as Assistant Professor of Civil Engineering (Environmental
Sciences) at Washington State University. Dr. Green currently is a member of the
Governing Board of Pasadena City College. Dr. Green completed his bachelor's
degree at Whitman College in 1958, his Master of Science at Washington State
University in 1961, and his Ph.D. at Washington State University, under a United
States Public Health Services Career Development Award, in 1965.
ROBERT A. DIETRICH had served as a director of the Company since January 200. He
resigned as a director as of March 1, 2006 and was appointed acting Chief
Accounting Officer as of April 16, 2006. For a period of time during 2002 he
served as Chief Accounting Officer and President of Source One Group. He is
currently the Chief Financial Officer of The Solvis Group, Inc. an 85% owned
subsidiary of the Company. He has served as Director, COO and CFO of Security
First International Holdings, Inc. ("SFNH:PK"). During 2004 and 2005 he was
President and CEO of Energy Transfer Corporation, a privately held bio-energy
company. In 2003 and 2004 he was Founder and Chief Financial Officer of Modofood
USA, Inc., a privately held food technology enterprise. In 1998 he helped found
Cyber Air Communications, Inc. in which he served as a Director and President
until 2002. Mr. Dietrich has been performing investment banking and consulting
services for clients since 1990. Prior to that he has served as CEO, COO or CFO
of privately held middle market companies. He is an accounting graduate from
Notre Dame and possesses an MBA from U. of Detroit. He possesses a CPA
certificate from Illinois (inactive).
22
ERIC W. GAER has served as a director since marhc 2000 and since the fall of
2005 and Vice President - Marketing and Investor Relatioins. Since 1998, Mr.
Gaer has been the President and CEO of Arroyo Development Corporation, a
privately-held, San Diego-based management consulting company, which also holds
California real estate and insurance broker licenses. From 1996 to 1998, he was
Chairman and CEO of Greenland Corporation, a publicly-held high technology
company in San Diego, California. In 1995, he was CEO of Ariel Systems, Inc., a
privately-held engineering development company in Vista, California. Over the
past 30 years, Mr. Gaer has served in executive management positions at a
variety of technology companies, including Imaging Technologies, Daybreak
Technologies, Venture Software, and Merisel. In 1970, he received a Bachelor's
Degree in mass communications from California State University, Northridge.
DAVID LIEBERMAN has been the Chief Financial Officer for John Goyak &
Associates, Inc., an aerospace consulting firm located in Las Vegas, NV since
2003. Previously, Mr. Lieberman was the President of Lieberman Associates from
2000 to 2003 where he acted as the Chief Financial Officer for various public
and non-public companies located in NV and CA. Mr. Lieberman has over thirty
years of financial experience beginning with five years as an accountant with
Price Waterhouse from 1967 through 1972
STANLEY HIRSCHMAN has been President of CPointe Associates, a Plano, Texas based
executive management and consulting firm since 1997. CPointe specializes in
business solutions for companies with emerging technologies and is well-versed
in the challenges of regulated corporate governance. He is also Chairman of the
Board of Bravo Foods International, a director of Bronco Energy Fund, Energy &
Engine Technology, GoldSpring, and 5 G Wireless Corporation and is a former
chairman of Mustang Software, Inc. While at Mustang, Mr. Hirschman took a
hands-on role in the planning and execution of the strategic initiative to
increase shareholder value resulting in the successful acquisition of the
company by Quintus Corporation. Prior to establishing CPointe Associates, he was
Vice President Operations, Software Etc., Inc., a 396 retail store software
chain, from 1989 until 1996. He also held senior executive management positions
with T.J. Maxx, Gap Stores and Banana Republic. Stan is a member of the National
Association of Corporate Directors and participates regularly in the KMPG Audit
Committee Roundtable. He is active in community affairs and serves on the
Advisory Board of the Salvation Army Adult Rehabilitation Centers.
AUDIT COMMITTEE FINANCIAL EXPERT
The Audit Committee of the Board of Directors consists of Mr. Dietrich (until
February 2006 ), Dr. Green and Stanley Hirschman (as of February 2006) all of
whom are independent and qualify as financial experts under SEC regulations.
COMPLIANCE WITH SECTION 16 OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires DFCO's directors
and executive officers, and persons who own more than 10% of a registered class
of DFCO's equity securities to file with the Securities and Exchange Commission
initial reports of ownership and reports of changes in ownership of Common Stock
and other DFCO equity securities. Officers, directors and greater than 10%
shareholders are required by SEC regulations to furnish DFCO with copies of all
Section 16(a) forms they file.
To DFCO's knowledge, based solely on its review of the copies of such reports
furnished to the company and written representations that no other reports were
required during the fiscal year ended June 30, 2006, all Section 16(a) filing
requirements applicable to its officers, directors and greater than 10%
beneficial owners were complied with.
BUSINESS ETHICS CONFLICTS OF INTERESTS POLICY
The Company has adopted a Policy Statement on Business Ethics and Conflicts of
Interest, which was approved by the Board of Directors, applicable to all
employees, which is attached as exhibit 33.1 to this report.
23
ITEM 10. EXECUTIVE COMPENSATION
Payouts Annual Compensation Long-Term Comp Awards
------- ------------------- ---------------------
(a) (b) (C) (d) (e) (f) (g) (h) (i)
Securities
Other Restricted Underlying LTIP
Annual Stock Options/ Payouts All Other
Year Salary Bonus Comp ($)(4) Awards ($) (SAR) (#)(5) ($) COMP ($)
---- ------ ----- ----------- ---------- ------------ --- --------
Brian Bonar,
Chairman/CEO 2006 $588(3) 183 91 $252
2005 $282 (4) 0
2004 $157 0 $150 35,000(5)
Robert A. Dietrich, 2006 $75
James R. Downey,
COO/CAO (1) 2004 $100 $20
Randall Jones (2) 2006
2005 $120 $40
(1) Mr. Downey joined the Company effective January 6, 2003 and resigned
effective January 1, 2004
(2) Mr. Jones resigned as Chief Operating Officer effective April 15, 2006.
(3) Mr. Bonar received salary compensation during FY2006 not paid in 2003-($63),
2004-( $129) and 2005- ($30).
(4) Mr. Bonar received bonus compensation during 2006 not paid in 2004- ($5) and
2005- ($37).
(5) Post split
The following table provides information on Options/SARs granted in the 2006
Fiscal Year to the Named Officers.
----------------------
Potential Realizable
Value at Assumed
Percent of Annual Rates of
Number of Total Stock Price
Securities Options/SARs Appreciation for
Underlying Granted to Exercise or Option Term (4)
Options/SARs Employees in Base Price Expiration ----------------------
Name Granted (#) Fiscal Year ($/Share) Date 5% ($) 10% ($)
------------------------ ------------- --------------- ------------- -------------- ---------- ----------
Brian Bonar 0 0%
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table provides information on option exercises in the 2006 Fiscal
Year by the Named Officers and the value of such Named Officers' unexercised
options at June 30, 2006. Warrants to purchase Common Stock are included as
options. No stock appreciation rights were held by them at the end of the 2006
Fiscal Year.
Shares
------------- Number of Securities Value of Unexercised
Acquired on Value Underlying Unexercised In-the-money Options/SAR
Name Exercise (#) Realized ($) Options/SAR's at FY-end (#) At Fiscal Year End ($) (2)
------------------------ ------------- --------------- --------------------------- ------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
Brian Bonar -- -- -- -- --
COMPENSATION OF DIRECTORS
Each member of the Board of Directors of the Company receives a fee of $500 from
the Company for each meeting attended.
24
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT, AND CHANGE-IN-CONTROL
ARRANGEMENTS
The Company entered into five year employment agreement with Brian Bonar, Chief
Executive Officer, on January 1, 2006. Under the terms of the Agreement, Mr.
Bonar shall earn $393,000 per annum in initial salary, subject to annual
increases of up to ten (10) percent, based upon performance criteria. Mr. Bonar
shall be eligible to earn quarterly bonus of $47,000 based upon the Company
achieving a net profit for that quarter. Mr. Bonar shall be issued common stock
of DFCO sufficient to provide a ten (10) percent ownership position post reverse
split, which shares be maintained for a period of two years.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee, during fiscal 2006, consisted of Messrs.Gaer and
Green. Mr. Green was not an officer or employee of the Company at any time
during the 2006 Fiscal Year; but was engaged as a consultant during the year.
Mr. Gaer is currently employed as a Vice President of the Company and has
resigned from the Committee..
AUDIT COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Audit Committee currently consists of Messrs. Green and Hirschman. Neither
of these individuals was an officer or employee of the Company at any time
during the 2006 Fiscal Year. Mr. Green was a paid consultant to the Company
during the year.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information known to DFCO with
respect to the beneficial ownership of DFCO's common stock as of June 30, 2006
by (i) each person who is known by the Company to own beneficially more than 5%
of the Company's common stock, (ii) each of DFCO's directors and executive
officers, and (iii) all officers and directors of DFCO as a group. Except as
otherwise listed below, the address of each person is c/o Dalrada Financial
Corporation., 9449 Balboa Avenue, Suite 210, San Diego, CA 92123
SHARES BENEFICIALLY PERCENT OF CLASS
NAME AND ADDRESS OF BENEFICIAL OWNER (1) OWNED (2)
---------------------------------------- ----- ---
Post Split
Longview Fund, LP (3) 9,969,775 (14) 67.11%
600 Montgomery Street 44th floor
San Francisco, CA 94111
Longview Equity Fund, LP (4) 2,663,584 (15) 35.28%
600 Montgomery Street 44th floor
San Francisco, CA 94111
Longview Int'l Equity Fund, LP (5) 1,311,915 (16) 21.17%
600 Montgomery Street 44th floor
San Francisco, CA 94111
Alpha Capital Aktiengesellschaft (6) 1,596,430 (17) 24.63%
Pradafant
9490 Furstentums
Vaduz, Liechtenstein
Balmore S.A. (7) 3,231,478 (18) 39.81%
P.O. Box 146, Road Town
Tortola, BVI
Howard Schraub (8) 795,100 (19) 14.00%
c/o Howard Associates, Inc.
525 East 72nd Street
New York, NY 10021
Directors and Officers
Brian Bonar (9) 450,000 8.43%
Robert A. Dietrich (10) (20) 119,375 2.38%
Stephen J. Fryer (11) (21) 94,375 1.89%
Eric W. Gaer (12) 121,425 2.42%
Richard Green (13) 129,375 2.58%
All current directors and executive officers
(Group of 5) 914,605 17.70%
25
(1) Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock subject to options or
warrants currently exercisable or convertible, or exercisable or convertible
within 60 days of August 31, 2005 are deemed outstanding for computing the
percentage of the person holding such option or warrant but are not deemed
outstanding for computing the percentage of any other person. Except as pursuant
to applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of common stock
beneficially owned.
(2) Percentage based on 4,886,248 post split shares of common stock outstanding
as of June 30, 2006, plus shares underlying each shareholder's convertible note
and warrants.
(3) Longview Fund, LP is a private investment fund that is in the business of
investing publicly-traded securities for their own accounts and is structured as
a limited liability company whose members are the investors in the fund. The
General Partner of the fund is Viking Asset Management, LLC, a California
limited liability company which manages the operations of the fund. Peter T.
Benz is the managing member of Viking Asset Management, LLC. As the control
person of the shares owned by Longview Fund, LP, Mr. Benz may be viewed as the
beneficial owner of such shares pursuant to Rule 13d-3 under the Securities
Exchange Act of 1934.
(4) Longview Equity Fund, LP is a private investment fund that is in the
business of investing publicly-traded securities for their own accounts and is
structured as a limited liability company whose members are the investors in the
fund. The General Partner of the fund is Viking Asset Management, LLC, a
California limited liability company which manages the operations of the fund.
Peter T. Benz is the managing member of Viking Asset Management, LLC. As the
control person of the shares owned by Longview Equity Fund, LP, Wayne Coleson
may be viewed as the beneficial owner of such shares pursuant to Rule 13d-3
under the Securities Exchange Act of 1934.
(5) Longview International Equity Fund, LP is a private investment fund that is
in the business of investing publicly-traded securities for their own accounts
and is structured as a limited liability company whose members are the investors
in the fund. The General Partner of the fund is Viking Asset Management, LLC, a
California limited liability company which manages the operations of the fund.
Peter T. Benz is the managing member of Viking Asset Management, LLC. As the
control person of the shares owned by Longview International Equity Fund, LP,
Wayne Coleson may be viewed as the beneficial owner of such shares pursuant to
Rule 13d-3 under the Securities Exchange Act of 1934.
(6) Alpha Capital Aktiengesellschaft: In accordance with Rule 13d-3 under the
Securities Exchange Act of 1934, Konard Ackerman may be deemed the control
person of the shares owned by such entity. ALPHA Capital AG is a private
investment fund that is owned by all its investors and managed by Mr. Ackerman.
Mr. Ackerman disclaims beneficial ownership of the shares of common stock being
registered hereto.
(7) Balmore S.A.: In accordance with Rule 13d-3 under the Securities Exchange
Act of 1934, F. Morax may be deemed the control person of the shares owned by
such entity. Balmore S.A. is a private investment fund that is owned by all its
investors and managed by Mr. Morax. Mr. Morax disclaims beneficial ownership of
the shares of common stock being registered hereto.
(8) Howard Schraub is an individual.
26
(9) Includes 95,038 post split shares issuable upon exercise of warrants that
are currently exercisable or will become exercisable within 60 days after June
30, 2006.
(10) Includes 56,923 post split shares issuable upon exercise of warrants that
are currently exercisable or will become exercisable within 60 days after June
30, 2006.
(11) Includes 37,266 post split shares issuable upon exercise of warrants that
are currently exercisable or will become exercisable within 60 days after June
30, 2006.
(12) Includes 49,680 post split shares issuable upon exercise of warrants that
are currently exercisable or will become exercisable within 60 days after June
30, 2006.
(13) Includes 9,969,500 49,848 post split shares issuable upon exercise of
warrants that are currently exercisable or will become exercisable within 60
days after June 30, 2006.
(14) Concerning Longview Fund, LP: Assuming $3,761,707 of Convertible Debentures
converted at $0.00285 plus 3,370,288 post split warrants.
(15) Concerning Longview Equity Fund, LP: Assuming $1,005,000 of Convertible
Debentures converted at $0.00285 plus 900,427 post split warrants.
(16) Concerning Longview International Equity Fund, LP: Assuming $495,000 of
Convertible Debentures converted at $0.00285 plus 443,494 post split warrants.
(17) Concerning Alpha Capital Aktiengesellschaft: Assuming $602,425 of
Convertible Debentures converted at $0.00285 plus 539,742 post split warrants.
(18) Concerning Balmore S.A.: Assuming $1,380,969 of Convertible Debentures
converted at $0.00285 and $119,737 converted at $0.00226 plus 247,453,268
1,237,266 post split warrants.
(19) Concerning Howard Schraub: Assuming $300,000 of Convertible Debentures
converted at $0.00285 plus 268,784 post split warrants.
(20) Robert A. Dietrich resigned as a Director effective March 1, 2006 for
personal reasons.
(21) Stephen J. Fryer resigned as a Director effective March 1, 2006 for
personal reasons.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH OFFICERS AND KEY EXECUTIVES
During the year ended June 30, 2005, the Company issued 36,361 post split shares
of common stock to the Company's CEO as payment for accrued expenses and a note
payable in the aggregate amount of $109.
During the year ended June 30, 2006 , Mr. Bonar was issued 250,000 post split
shares pursuant to his employment agreement with the Company in the aggregate
amount of $250,000.
TRANSACTIONS WITH A RELATED PARTY
In April 2004, the Company had a PEO services client whose Chairman of the Board
is the Company's current CEO and Chairman. The Company received fees of $520 and
$390 during the years ended June 30, 2006 and 2005, respectively. The
transaction is at fair value.
WARNING MANAGEMENT SERVICES, INC.
The Company's CEO and Chairman, Mr. Brian Bonar, is also the CEO and Chairman of
Warning Management Services, Inc. Warning a public company, located in Southern
California. Warning's operations consist of a modeling agency and providing
temporary staffing services to government agencies and private companies.
Warning leases offices to the Company, on a month-to-month basis and charges the
Company $4680 per month rent.
27
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 years ended June 30, 2006 and 2005, the Company has invoiced Warning $87 for
management services and $7 for management services, respectively.
ITEM 13. EXHIBITS, LIST AND REPORTS IN FORM 8-K
Number Exhibits
3(a) Certificate of Incorporation of the Company, as amended, and
currently in effect. See also below (Incorporated by reference to
Exhibit 3(a) to 1988 Form 10-K) *
3(b) Certificate of Amendment of Certificate of Incorporation of the
Company, filed February 8, 1995, as amended, and currently in effect
(Incorporated by reference to Exhibit 3(b) to 1995 Form 10-K *
3(c) Certificate of Amendment of Certificate of Incorporation of the
Company, filed May 23, 1997, as amended, and currently in effect
(Incorporated by reference to 1997 Form 10-K) *
3(d) Certificate of Amendment of Certificate of Incorporation, filed
January 12, 1999, as amended and currently in effect (Incorporated
by reference to Form 10-Q for the period ended December 31, 1998) *
3(e) Certificate Eliminating Reference to Certain Series of Shares of
Stock from the Certificate of Incorporation, filed January 12, 1999,
as amended and currently in effect (Incorporated by reference to
Form 10-Q for the period ended December 31, 1998)*
3(f) By-Laws of the Company, as amended, and currently in effect
(Incorporated by reference to Exhibit 3(b) to 1987 Form 10-K) *
3(g) Certificate of Amendment of Certificate of Incorporation, filed May
12, 2000, as amended and currently in effect (Incorporated by
reference to Exhibit 3(g) to 2001 Form 10-K) *
4(a) Amended Certificate of Designation of Imaging Technologies
Corporation with respect to the 5% Convertible Preferred Stock
(Incorporated by reference to Exhibit 4(d) to 1987 Form 10-K) *
4(b) Amended Certificate of Designation of Imaging Technologies
Corporation with respect to the 5% Series B Convertible Preferred
Stock (Incorporated by reference to Exhibit 4(b) to 1988 Form 10-K)
*
4(c) Certificate of Designations, Preferences and Rights of Series C
Convertible Preferred Stock of Imaging Technologies Corporation
(Incorporated by reference to Exhibit 4(c) to 1998 Form 10-K) *
4(d) Certificate of Designation, Powers, Preferences and Rights of the
Series of Preferred Stock to be Designated Series D Convertible
Preferred Stock, filed January 13, 1999 (Incorporated by reference
to Form 10-Q for the period ended December 31, 1998)*
4(e) Certificate of Designation, Powers, Preferences and Rights of the
Series of Preferred Stock to be Designated Series E Convertible
Preferred Stock, filed January 28, 1999 (Incorporated by reference
to Form 10-Q for the period ended December 31, 1998)*
10(a) Private Equity Line of Credit Agreement by and among certain
investors and the Company (Incorporated by reference to Form 8-K,
filed July 26, 2000) *
28
10(b) Convertible Note Purchase Agreement dated December 12, 2000 between
the Company and Amro International, S.A., Balmore Funds, S.A., and
Celeste Trust Reg. (Incorporated by reference to Form 8-K, filed
January 19, 2001. *
10(g) Share Purchase Agreement, dated December 1, 2000, between ITEC and
EduAdvantage.com, Inc. (Incorporated by reference to Form 10-Q for
the period ended September 30, 2000) *
10(h) Convertible Promissory Note dated September 21, 2001 between the
Company and Stonestreet Limited Partnership. (Incorporated by
reference to Exhibit 10(u) of 2001 Form 10-K) *
10(i) Convertible Note Purchase Agreement dated September 21, 2001 between
the Company and Stonestreet Limited Partnership. (Incorporated by
reference to Exhibit 10(v) of 2001 Form 10-K) *
10(j) Registration Rights Agreement dated September 21, 2001 between the
Company and Stonestreet Limited Partnership. (Incorporated by
reference to Exhibit 10(w) of 2001 Form 10-K) *
10(k) Form of Warrant to Purchase 11,278,195 Shares of Common Stock of
ITEC, dated September 21, 2001, between ITEC and Stonestreet Limited
Partnership. (Incorporated by reference to Exhibit 10(x) of 2001
Form 10-K) *
10(l) Asset Purchase Agreement, dated October 25, 2001, among the Company
and Lisa Lavin, Gary J. Lavin, and Roland A. Fernando. (Incorporated
by reference to Exhibit 10(a) to September 2001 Form 10-Q) *
10(m) Audited Financial Statements of SourceOne Group, LLC. (Incorporated
by reference to Form 8-K filed on January 25, 2002) *
10(n) Secured Convertible Debenture issued by the Company to Bristol
Ivestment Fund, Ltd., dated January 22, 2002. (Incorporated by
reference to Exhibit 10(a) of December 2001 Form 10-Q) *
10(o) Securities Purchase Agreement between the Company and Bristol
Investment Fund, Ltd., dated January 22, 2002. (Incorporated by
reference to Exhibit 10(b) of December 2001 Form 10-Q) *
10(p) Registration Rights Agreement between the Company and Bristol
Investment Fund, Ltd., dated January 22, 2002. (Incorporated by
reference to Exhibit 10(c) of December 2001 Form 10-Q) *
10(q) Transaction Fee Agreement between the Company and Alexander Dunham
Securities, Inc., dated January 22, 2002. (Incorporated by reference
to Exhibit 10(d) of December 2001 Form 10-Q) *
10(r) Stock Purchase Warrant issued to Alexander Dunham Securities, Inc.,
dated January 22, 2002. (Incorporated by reference to Exhibit 10(e)
of December 2001 Form 10-Q) *
10(s) Stock Purchase Warrant issued to Bristol Investment Fund, Ltd.,
dated January 22, 2002. (Incorporated by reference to Exhibit 10(f)
of December 2001 Form 10-Q) *
10(t) Security Agreement between the Company and Bristol Investment Fund,
Ltd., dated January 22, 2002. (Incorporated by reference to Exhibit
10(g) of December 2001 Form 10-Q) *
10(u) Convertible Promissory Note between the Company and Stonestreet
Limited Partnership, dated November 7, 2001. (Incorporated by
reference to Exhibit 10(h) of December 2001 Form 10-Q) *
29
10(v) Convertible Note Purchase Agreement between the Company and
Stonestreet Partnership, dated November 7, 2001. (Incorporated by
reference to Exhibit 10(i) of December 2001 Form 10-Q) *
10(w) Registration Rights Agreement between the Company and Stonestreet
Limited Partnership, dated November 7, 2001. (Incorporated by
reference to Exhibit 10(j) of December 2001 Form 10-Q) *
10(x) Stock Purchase Warrant issued to Stonestreet Limited Partnership,
dated November 7, 2001 . (Incorporated by reference to Exhibit 10(k)
of December 2001 Form 10-Q *
10(y) Acquisition Agreement between the Company and Dream Canvas, Inc.,
dated May 17, 2002; subject to completion of its terms.
(Incorporated by reference to Exhibit 10(y) of Form 10-K filed
November 18, 2002.) *
10(z) Closing Agreement between the Company and Quik Pix, Inc., dated July
23, 2002, subject to completion of its terms. (Incorporated by
reference to Exhibit 10(z) of Form 10-K filed November 18, 2002.) *
10(aa) Agreement to Acquire Shares between the Company and Greenland
Corporation, dated August 5, 2002, subject to completion of its
terms.(Incorporated by reference to Exhibit 10(aa) to Form 10-K
filed November 18, 2002.) *
10(ab) Acquisition Agreement, dated December 13, 2002, between the Company
and Baseline Worldwide, Limited. (Incorporated by reference to
Exhibit 99.3 of Form 8-K filed December 19, 2002.) *
10(ac) Secured Promissory Note in the amount of $2,250,000 issued by the
Company to Greenland Corporation, dated January 7, 2003.
(Incorporated by reference to Exhibit 99.1 of Form 8-K filed January
21, 2003.) *
10(ad) Security Agreement, dated January 7, 2003, between the Company and
Greenland Corporation. (Incorporated by reference to Exhibit 99.2 of
Form 8-K filed January 21, 2003.) *
10(ae) Agreement to Acquire Shares, dated August 9, 2002 between the
Company and Greenland Corporation. (Incorporated by reference to
Exhibit 99.3 of Form 8-K filed January 21, 2003.) *
10(af) Closing Agreement, dated January 7, 2003, between the Company and
Greenland Corporation. (Incorporated by reference to Exhibit 99.4 of
Form 8-K filed January 21, 2003.) *
10(ag) Share Acquisition Agreement, dated June 12, 2002, between the
Company and Quik Pix, Inc. (Incorporated by reference to Exhibit
99.5 of Form 8-K filed January 21, 2003.) *
10(ah) Closing Agreement, dated July 23, 2002, between the Company and Quik
Pix, Inc. (Incorporated by reference to Exhibit 99.6 of Form 8-K
filed January 21, 2003.) *
10(ai) Stock Purchase Agreement among the Company, Greenland Corporation,
and ExpertHR- Oklahoma, dated March 18, 2003. (Incorporated by
reference to Exhibit 10(j) to Form 10-Q filed May 20, 3003). *
10(aj) Assignment of Patent between John Capezzuto and Quik Pix, Inc. dated
January 14, 2003. *
10(ak) Promissory Note between the Company and John Capezzuto dated June 1,
2003 (signed June 9, 2003). *
30
10(al) Promissory Note between the Company and John Capezzuto dated June 9,
2003 *
10(am) Agreement and Assignment of Rights, dated February 1, 2003, between
Accord Human Resources, Inc. and Greenland Corporation, and Imaging
Technologies. (Incorporated by reference to Exhibit 10(k) of Form
10-KSB filed April 7, 2003 by Greenland Corporation.) *
10(an) Agreement and Assignment of Rights, dated March 1, 2003, between
StaffPro Leasing 2, Greenland Corporation, and ExpertHR.
(Incorporated by reference to Exhibit 10(l) of Form 10-KSB filed
April 7, 2003 by Greenland Corporation.) *
10(ao) Promissory Note, dated March 1, 2003, payable to StaffPro Leasing 2
by Greenland Corporation. (Incorporated by reference to Exhibit
10(k) of Form 10-KSB filed April 7, 2003 by Greenland Corporation.)
*
10(op) Agreement to Acquire Shares between the Company and The Christensen
Group, et al, dated April 1, 2003. *
10(aq) Agreement and Assignment of Rights, dated October 24, 2003, between
SourceOne Group, Inc. and ePEO Link, incorporated by reference to
Exhibit 10(a) of Form 10-Q, filed November 24, 2003. *
10(ar) Alpha Capital Aktiengsellschaft December 17, 2003 convertible note,
incorporated by reference to Exhibit 10(a) to Form 10-QSB, filed
February 13, 2004. *
10(as) Gamma Opportunity Capital Partners, LP December 17, 2003 convertible
note, incorporated by reference to Exhibit 10(c) to Form 10-QSB,
filed February 13, 2004. *
10(at) Gamma Opportunity Capital Partners, LP December 17, 2003 warrant,
incorporated by reference to Exhibit 10(d) to Form 10-QSB, filed
February 13, 2004. *
10(au) Longview Fund, LP December 17, 2003 convertible note, incorporated
by reference to Exhibit 10(e) to Form 10-QSB, filed February 13,
2004. *
10(av) Longview, LP December 17, 2003 warrant, incorporated by reference to
Exhibit 10(f) to Form 10-QSB, filed February 13, 2004. *
10(aw) Stonestreet Limited Partnership December 17, 2003 convertible note,
incorporated by reference to Exhibit 10(g) to Form 10-QSB, filed
February 13, 2004. *
10(ax) Stonestreet Limited Partnership December 17, 2003 warrant,
incorporated by reference to Exhibit 10(h) to Form 10-QSB, filed
February 13, 2004. *
10(ay) Subscription Agreement December 17, 2003, incorporated by reference
to Exhibit 10(i) to Form 10-QSB, filed February 13, 2004. *
31
10(az) Agreement of Acquisition between the Company and Quik Pix, Inc.,
dated April 16, 2004, incorporated by reference to Exhibit 10.1 to
Form 10-QSB, filed May 19, 2004.
10(bb) Employment agreement, Chief Executive Officer
21 List of Subsidiaries of the Company *
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a) (Section 302 of the Sarbanes-Oxley Act of 2002) **
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a) (Section 302 of the Sarbanes-Oxley Act of 2002) **
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C.ss.1350 (Section 906 of the Sarbanes-Oxley Act of 2002) **
All exhibits except those followed by an asterisk (*) are incorporated by
reference only and a copy is not included in this Form 10-K filing. Those
exhibits followed by a double asterisk (**) are included as part of this filing.
The Company will furnish a copy of any exhibit to a requesting shareholder upon
payment of the Company's reasonable expenses in furnishing such exhibit.
(b) Reports on Form 8-K
Date Subject
---- -------
5/24/2005 Transfer Solvis Group to Quik Pix, Inc. a wholly owed subsidiary
9/20/2005 Appointment of Chief Financial Officer
2/13/2006 ITEM 1.01: Private Placement
4/15/2006 ITEM 5.02: Resignations and appointments of directors and officers
09/18/06 ITEM 2.01. Acquisition of All Staffing, Inc. a Tennessee corporation
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Company paid or accrued the following fees in each of the prior two fiscal
years to its independent certified public accountants, Pohl, McNabola Berg &
Company, LLP
For the Year Ended June 30,
--------------------------------------------------------------
2006 2005
Audit Fees $140,000 $110,000
Audit-Related Fees $75,000 95,023
Tax Fees - -
All Other Fees - -
-------- --------
--------------------------------------------------------------
Total Fees $215,000 $205,033
"Audit Fees" consisted of fees billed for services rendered for the audit of the
Company's annual financial statements and audit related fees are for review of
the financial statements included in the Company's quarterly reports on Form
10-QSB.
AUDIT COMMITTEE'S PRE-APPROVAL POLICIES AND PROCEDURES
The Audit committee is in the process of establishing a pre-approval policy and
procedure.
PERCENTAGE OF HOURS EXPENDED
There were no hours expended on the principal accountant's engagement to audit
the registrant's financial statements for the most recent fiscal year that were
attributed to work performed by persons other than the principal accountant's
full-time, permanent employees.
32
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DALRADA FINANCIAL CORPORATION
By: /s/ BRIAN BONAR
--------------------------------------------
Brian Bonar, Chief Executive Officer
Dated: October XX, 2006
By: /s/ David Lieberman
--------------------------------------------
David Lieberman, Chief Accounting Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints, Brian Bonar as his attorney-in-fact, each
with full power of substitution and resubstitution, for him or her in any and
all capacities, to sign any and all amendments to this Annual Report on Form
10-K (including post-effective amendments), and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in connection therewith as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming that said
attorney-in-fact, or his substitute or substitutes, may lawfully do or cause to
be done by virtue hereof. Pursuant to the requirements of the Securities
Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by
the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------------------------------------------------------------------------------
/s/ Brian Bonar Chairman of the Board of Directors, October 13 , 2005
----------- Chief Executive Officer, and
Brian Bonar (PRINCIPAL EXECUTIVE OFFICER)
/s/ David Lieberman Director; Chief Accounting Officer October 13, 2005
---------------
David Lieberman
/s/ Eric W. Gaer Director October 13, 2005
------------
Eric W. Gaer
/s/ Stanley Hirschman Director October 13 , 2005
-----------------
Stanley Hirschman
/s/ Richard H. Green Director October 13 , 2005
----------------
Richard H. Green
33
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2006 AND 2005
CONTENTS
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Report on Audited Consolidated Financial Statements F-1
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheet as of June 30, 2006 F-2
Consolidated Statements of Operations for the years ended
June 30, 2006 and 2005 F-3
Consolidated Statements of Stockholders' Deficit for the
years ended June 30, 2006 and 2005 F-4
Consolidated Statements of Cash Flows for the years ended
June 30, 2006 and 2005 F-5
Notes to Consolidated Financial Statements F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Dalrada Financial Corporation
San Diego, California
We have audited the accompanying consolidated balance sheet of Dalrada Financial
Corporation and Subsidiaries as of June 30, 2006, and the related consolidated
statements of operations, stockholders' deficit and cash flows for years ended
June 30, 2006 and 2005. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company
Oversight Board (United States). Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Dalrada
Financial Corporation and Subsidiaries as of June 30, 2006 and the consolidated
results of their operations and their consolidated cash flows for each of the
years ended June 30, 2006 and 2005, in conformity with accounting principles
generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
accompanying consolidated financial statements, for the year ended June 30, 2006
the Company experienced a loss from continuing operations of $4,739,000 and as
of June 30, 2006, the Company had a negative working capital deficit of
$24,916,000 and had a negative stockholders' deficit of $21,620,000. In
addition, the Company is in default on certain note payable obligations and is
being sued by numerous trade creditors for nonpayment of amounts due. The
Company is also deficient in its payments relating to payroll tax liabilities.
These conditions raise substantial doubt about its ability to continue as a
going concern. Management's plan in regard to these matters is also discussed in
Note 1. These consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ POHL, McNABOLA, BERG & COMPANY, LLP
POHL, McNABOLA, BERG & COMPANY, LLP
CERTIFIED PUBLIC ACCOUNTANTS
San Francisco, California
October 13, 2006
F-1
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheet
(in thousands, except share data)
JUNE 30,
2006
---------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 3,260
Accounts receivable, net of allowance of $639 (includes related party balance of $1,065) 1,211
Debt issue costs 359
Other current assets 3,019
Net assets of discontinued operations 22
---------------
TOTAL CURRENT ASSETS 7,871
---------------
CUSTOMER LIST, net of accumulated amortization of $54 586
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $368 355
WORKER'S COMPENSATION DEPOSIT 3,072
INVESTMENT IN ALLIANCE INSURANCE GROUP 1,400
RECEIVABLE FROM RELATED PARTY 1,400
OTHER LONG-TERM ASSETS 14
---------------
TOTAL ASSETS $ 14,698
===============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Notes payable, current portion (includes related party note of $65) 5,156
Accounts payable (includes related party balance of $758) 1,736
PEO payroll taxes and other payroll deductions 8,451
Accrued payroll and related payroll taxes and deductions 9,303
Other accrued expenses (includes related party balance of $108) 3,520
Warrant liability 3,138
Accrued derivative liability 1,483
---------------
TOTAL CURRENT LIABILITIES 32,787
---------------
CONVERTIBLE DEBENTURES, net of discounts of $5,414 2,261
NOTES PAYABLE, net of current portion (includes related party note of $393) 1,270
---------------
TOTAL LIABILITIES 36,318
---------------
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; 4,917,527 shares issued and outstanding 25
Common stock warrants 475
Additional paid-in capital 86,976
Prepaid consulting (245)
Accumulated deficit (109,271)
---------------
TOTAL STOCKHOLDERS' DEFICIT (21,620)
---------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 14,698
===============
The accompanying notes are an integral part of these consolidated financial statements
F-2
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share data)
YEARS ENDED
----------------------------
JUNE 30, JUNE 30,
2006 2005
------------- -------------
REVENUES
Temporary staffing services $ 68,226 $ 17,029
PEO Services 1,382 1,930
Sales of products 772 517
------------- -------------
TOTAL REVENUES 70,380 19,476
------------- -------------
COST OF REVENUES
Cost of temporary staffing 62,897 15,010
Cost of PEO services 998 1,424
Cost of products sold 34 96
------------- -------------
TOTAL COST OF REVENUES 63,929 16,530
------------- -------------
------------- -------------
GROSS PROFIT 6,451 2,946
------------- -------------
OPERATING EXPENSES
Selling, general and administrative 11,190 5,402
Impairment of patent - 1,348
------------- -------------
TOTAL OPERATING EXPENSES 11,190 6,750
------------- -------------
INCOME (LOSS) FROM OPERATIONS (4,739) (3,804)
------------- -------------
OTHER INCOME (EXPENSES):
Interest expense (2,697) (1,709)
Settlement with investors (908)
Penalties and interest (1,101) (1,312)
Gain on extinguishment of debt 8,546 829
Gain resulting from reconciliation of payroll tax liabilities
to taxing authorities 1,924 1,895
Change in derivative and warrant liabilities 1,988
Other, net 14 -
------------- -------------
TOTAL OTHER INCOME (EXPENSE) 7,766 (297)
------------- -------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS 3,027 (4,101)
PROVISION FOR INCOME TAXES 40 -
------------- -------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND
DISCONTINUED OPEATIONS 2,987 (4,101)
------------- -------------
MINORITY INTEREST IN SUBSIDIARY (INCOME) LOSS - 59
------------- -------------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS 2,987 (4,042)
------------- -------------
DISCONTINUED OPERATION:
Loss from discontinued operation (363) (176)
------------- -------------
(363) (176)
------------- -------------
NET INCOME (LOSS) 2,624 (4,218)
PREFERRED STOCK DIVIDENDS (21) (21)
------------- -------------
NET INCOME (LOSS) ATTRIBUTED TO COMMON
STOCKHOLDERS $ 2,603 $ (4,239)
============= =============
NET INCOME (LOSS) PER SHARE - BASIC
Continuing operations $ 0.72 $ (1.23)
Discontinued operations (0.09) (0.05)
------------- -------------
$ 0.63 $ (1.29)
============= =============
WEIGHTED AVERAGE COMMON EQUIVALENT
SHARES OUSTANDING - BASIC 4,110,203 3,292,181
NET INCOME (LOSS) PER SHARE - DILUTED
Continuing operations $ 0.37 $ (1.29)
Discontinued operations (0.02) -
------------- -------------
$ 0.35 $ (1.29)
============= =============
WEIGHTED AVERAGE COMMON EQUIVALENT
SHARES OUSTANDING - DILUTED 19,347,977 3,292,181
============= =============
The accompanying notes are an integral part of these consolidated financial statements
F-3
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statement of Stockholders' Deficit
(in thousands, except share data)
COMMON ADDITIONAL
SERIES A PREFERRED STOCK COMMON STOCK STOCK PAID-IN
SHARES AMOUNT SHARES AMOUNT WARRANTS CAPITAL
------ ------ ------ ------ -------- -------
BALANCE, JUNE 30, 2004 420.5 420 2,761,794 14 475 85,843
Issuance of common stock for:
Services 73,115 73
Conversion of liabilities 841,335 4 388
Value of warrants issued with notes 28
Value of warrants issued in Heritage acquisition 14
Contribution of Solvis Group to QPI resulting
in minority interest (59)
Net loss
----------------------- -------------------------- -----------------------------
BALANCE, JUNE 30, 2005 420.5 420 3,676,244 18 475 86,287
Issuance of common stock for:
Services and executive compensation 327,625 2 316
Convertible debentures 651,237 3 275
Conversion of liabilities 262,421 2 98
Value of warrants issued for consulting services
Amortization of prepaid consulting
Net income
----------------------- -------------------------- -----------------------------
BALANCE, JUNE 30, 2006 420.5 $ 420 4,917,527 25 $ 475 $ 86,976
======================= ========================== =============================
(continued)
PREPAID ACCUMULATED
CONSULTING DEFICIT TOTAL
---------- ------- -----
BALANCE, JUNE 30, 2004 - (107,677) (20,925)
Issuance of common stock for:
Services 73
Conversion of liabilities 392
Value of warrants issued with notes 28
Value of warrants issued in Heritage acquisition 14
Contribution of Solvis Group to QPI resulting
in minority interest (59)
Net loss (4,218) (4,218)
------------ ----------------------------
BALANCE, JUNE 30, 2005 - (111,895) (24,695)
Issuance of common stock for: -
Services and executive compensation 318
Convertible debentures 278
Conversion of liabilities 100
Value of warrants issued for consulting services (302) (302)
Amortization of prepaid consulting 57 57
Net income 2,624 2,624
------------ ----------------------------
BALANCE, JUNE 30, 2006 $ (245) $ (109,271) $ (21,620)
============ ============================
The accompanying notes are an integral part of these consolidated financial statements
F-4
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands, except share data)
YEAR ENDED
--------------------------
JUNE 30, JUNE 30,
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations $ 2,987 $ (4,042)
Adjustment to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 150 173
Stock issued for services 268 73
Amortization of prepaid consulting 57
Amortization of debt discounts 1,137 337
Settlements with investors 908
Change in value of warrant and accrued derivative liabilities (1,988)
Value of repriced options/warrants - -
Gain on extinguishment of debt (8,546) (829)
Gain on forgiveness of inter-company debt from Greenland
Gain resulting from reconciliation of payroll tax liabilities
to taxing authorities (1,924) (264)
Minority interest - (59)
Loss on write-off of patent - 1,348
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable 618 (832)
Prepaid worker's compensation premiums 1,130 (1,130)
Other current assets (1,979) (596)
Worker's compensation deposit (447) (2,625)
Other assets (3) (11)
Increase (decrease) in:
Accounts payable and accrued expenses 36 533
Accrued payroll and related payroll taxes and deductions 8,519 (139)
PEO liabilities 1,600 3,888
------------ ------------
Net cash provided by (used in) operating activities from continuing operations 2,523 (4,175)
Net cash used in operating activities from discontinued operations (375) (176)
------------ ------------
Net cash used in operating activities 2,148 (4,351)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired with (paid for) acquisition 122 (20)
Purchase of furniture and equipment (220) (168)
------------ ------------
Net cash provided by (used in) investing activities from continuing operations (98) (188)
Net cash used in investing activities from discontinued operations - -
------------ ------------
Net cash provided by (used in) investing activities (98) (188)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in cash overdraft, net (162) 167
Line of credit, net (769) 769
Proceeds from notes payable 3,253 3,990
Proceeds from issuance of convertible debentures 5,000 -
Payment of debt issue costs (392) -
Repayments of notes payable (5,404) (423)
Repayments of borrowings under bank notes payable (483) -
Repayments of capital lease obligations (4) (21)
------------ ------------
Net cash provided by financing activities from continuing operations 1,039 4,482
Net cash provided by financing activities from discontinued operations - -
------------ ------------
Net cash provided by financing activities 1,039 4,482
------------ ------------
NET DECREASE IN CASH AND
CASH EQUIVALENTS 3,089 (57)
CASH AND CASH EQUIVALENTS, Beginning of year 171 228
------------ ------------
CASH AND CASH EQUIVALENTS, End of year $ 3,260 $ 171
============ ============
The accompanying notes are an integral part of these consolidated financial statements
F-5
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(in thousands, except share data)
YEARS ENDED
--------------------------------
JUNE 30, JUNE 30,
2006 2005
--------------- ---------------
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 $ 241
=============== ===============
Conversion of accounts payable and accrued liabilities into
common stock $ 100 $ 151
=============== ===============
Note payable issued for purchase of interest in Alliance Group $ 2,800 $ -
=============== ===============
Net assets acquired in business combinations:
Cash $ 122 $ -
Receivables 415 -
Property and equipment - 7
Customer list 567 72
Accounts payable and accrued liabilities 546 -
The accompanying notes are an integral part of these consolidated financial statements
F-6
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Dalrada Financial Corporation ("DFCO" or the "Company"), incorporated under the
laws of the state of California in March 1982 and subsequently reincorporated
under the laws of the state of Delaware in May 1983, and its following active
subsidiaries (there are ten inactive subsidiaries not listed):
a) SourceOne Group, Inc., - 100% owned by DFCO;
b) The Christianson Group - 100% owned by DFCO;
c) Heritage Staffing Group, Inc. - 100% owned by DFCO;
d) Strategic Alternative Staffing, LLC - 100% owned by DFCO and
e) Quik Pix, Inc. - 85% owned by DFCO.
All significant intercompany accounts and transactions have been eliminated.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. For the year ended June 30,
2006, the Company experienced a loss from continuing operations of $4,739 and as
of June 30, 2006, the Company had a negative working capital deficit of $24,916
and had a negative stockholders' deficit of $21,620. 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.
STOCK SPLITS
On September 15, 2006, the Company authorized a one for two hundred (1 for 200)
reverse stock split of its common stock. All share information for common shares
has been retroactively restated for this reverse stock split.
NATURE OF BUSINESS
The Company provides a variety of financial, staffing, professional employer
organization outsourcing (PEO) and human resources services to small and
medium-size businesses. These services allow the Company's customers to
outsource many human resources tasks, including payroll processing, workers'
compensation insurance, employee benefits administration, risk management and
human resource administration. These financial services relieve existing and
potential customers of the burdens associated with personnel management and
control.
DFCO provides services through its subsidiaries and divisions: SourceOne Group,
Inc. ("SOG") and Heritage Staffing; in addition, through The Solvis Group, Inc.,
("Solvis") an 85% owned subsidiary that includes the operating units:
CallCenterHR (TM), Solvis Financial Services, Solvis Medical Staffing and Solvis
home Health Care. These companies and business units provide a broad range of
financial services, including: benefits and payroll administration, health and
workers' compensation insurance programs, personnel records management, employer
liability management, risk management and safety, and temporary staffing
services, to small and medium-sized businesses. Solvis' services cover a broad
range of services including payroll debit cards, health insurance, 401(k) and
125-Flex plans, supplemental insurance, payroll advances, and other value-added
benefits.
F-7
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
Staffing services include on-demand or short-term staffing assignments,
long-term or indefinite-term contract staffing and on-site management. In a PEO
contract arrangement, the Company becomes a co-employer of the client's existing
workforce and assumes some or all of the client's human resource management
responsibilities.
As a human resource department and strategic business partner for the Company's
clients, its service offerings allow its clients to:
o comply with ever evolving complex employment related regulatory and
tax issues;
o increase productivity by improving employee satisfaction and
retention;
o reduce payroll expenses with lower workers' compensation costs; and
o focus on core business activities instead of human resource matters.
In January 2003, the Company completed the acquisition of a controlling in the
shares of Quik Pix, Inc. ("QPI"), located in Anaheim, California. At the time of
acquisition, QPI's principal business was providing products and services
associated with visual marketing support. QPI revenues consist primarily of
developing and mounting photographic and digital images for use in display
advertising for tradeshows and customer building interiors. QPI also has a
proprietary product PhotoMotion Images(TM), ("Photomotion") which is a patented
color medium of multi-image transparencies. DFCO moved its ColorBlind(TM)
software business into QPI. The business is in the process of being sold to
another company, which will be concluded by the end of October 2006.
In July 2005, QPI acquired The Solvis Group, Inc. ("Solvis") from DFCO and
changed its name to The Solvis Group and its trading symbol to SLVG. Solvis
current trades on the Pink Sheets(R). As of June 30, 2006, Solvis is a
wholly-owned subsidiary of QPI.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reported periods. Significant estimates made by the Company's
management include but are not limited to recoverability of property and
equipment, payroll tax liabilities, reserves for contingent liabilities and
deferred taxes. Actual results could materially differ from those estimates.
F-8
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
REVENUE RECOGNITION
PEO SERVICE FEES AND WORKSITE EMPLOYEE PAYROLL COSTS
The Company recognizes its revenues associated with its PEO business pursuant to
EITF 99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent." The
Company's revenues are reported net of worksite employee payroll cost (net
method). Pursuant to discussions with the Securities and Exchange Commission
staff, the Company changed its presentation of revenues from the gross method to
an approach that presents its revenues net of worksite employee payroll costs
(net method) primarily because the Company is 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, the
Company takes into consideration its estimates of the costs directly associated
with its worksite employees, including payroll taxes, benefits and workers'
compensation costs, plus an acceptable gross profit margin. As a result, the
Company's operating results are significantly impacted by the Company's ability
to accurately estimate, control and manage its direct costs relative to the
revenues derived from the markup component of the Company's gross billings.
Consistent with its revenue recognition policy, the Company's direct costs do
not include the payroll cost of its worksite employees. The Company's direct
costs associated with its revenue generating activities are comprised of all
other costs related to its 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. The Company's 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. The Company's
software arrangements do not contain multiple elements, and the Company does not
offer post contract support.
TEMPORARY STAFFING
The Company records gross revenue for temporary staffing. The Company has
concluded that gross reporting is appropriate because the Company (i) has the
risk and responsibility of identifying and hiring qualified employees, (ii) has
the discretion to select the employees and establish their price and duties and
(iii) bears the risk for services that are not fully paid for by customers.
Temporary staffing revenues are recognized when the services are rendered by the
Company's temporary employees. Temporary employees placed by the Company are the
Company's legal employees while they are working on assignments. The Company
pays all related costs of employment, including workers' compensation insurance,
state and federal unemployment taxes, social security and certain fringe
benefits. The Company assumes the risk of acceptability of its employees to its
customers.
F-9
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
WORKER'S COMPENSATION
In April 2005, the Company obtained a high deductible policy with an A rated
national carrier in order to manage its financial exposure from catastrophic
injuries and fatalities. Regulations governing self-insured employers often
require the employer to maintain surety deposits of government securities,
letters of credit or other financial instruments to cover workers' claims in the
event the employer is unable to pay for such claims. The Company's excess
workers' compensation insurance annual policy provided coverage for single
occurrences exceeding $250 with an aggregate stop loss provision of $4,000. The
Company was required to post a $2,625 reserve with the carrier from which claims
would be paid until all claims are settled. As of the end of the policy year,
ending April 30, 2006, based upon an independent actuary report, the Company
reserved $615 in pending claims against the remaining collateral fund; producing
an approximate $1,800 in excess reserves. For the next policy year beginning May
2006, the carrier raised the Company's stop loss rates, but required the Company
to deposit only $1,600 in the claims collateral fund as the result of the
Company's low claims experience in the prior year.
CONTINGENT LIABILITIES
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.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the current year's presentation. These
reclassifications had no effect on previously reported results of operations or
retained earnings.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
F-10
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
CONCENTRATION OF CREDIT RISK
The Company places its cash in what it believes to be credit-worthy financial
institutions. However, cash balances may exceed FDIC and SPIC insured levels at
various times during the year.
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable. The Company generally
requires clients to pay invoices for service fees no later than one day prior to
the applicable payroll date. As such, the Company generally does not require
collateral.
Additionally, during 2005, 96% of revenue derived from temporary staffing was
from two clients and during 2006 47% of revenue derived from temporary staffing
was from two clients.
ALLOWANCE METHOD USED TO RECORD BAD DEBTS
The Company provides an allowance for doubtful accounts equal to the estimated
uncollectible amounts. The Company's estimate is based on historical collection
experience and a review of the current status of trade accounts receivable. It
is reasonably possible that the Company's estimate of the allowance for doubtful
accounts will change. Accounts receivable are presented net of an allowance for
doubtful accounts of $639 at June 30, 2006. Accounts deemed uncollectible are
written off against the allowance.
LONG-LIVED ASSETS AND INTANGIBLE ASSETS
In accordance with SFAS Nos. 142 and 144, long-lived assets to be held and used
are analyzed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. SFAS No. 142
relates to assets with an indefinite life where as SFAS 144 relates to assets
that can be amortized and the life determinable. The Company evaluates at each
balance sheet date whether events and circumstances have occurred that indicate
possible impairment. If there are indications of impairment, the Company uses
future undiscounted cash flows of the related asset or asset grouping over the
remaining life in measuring whether the assets are recoverable. In the event
such cash flows are not expected to be sufficient to recover the recorded asset
values, the assets are written down to their estimated fair value. Long-lived
assets to be disposed of are reported at the lower of carrying amount or fair
value of asset less the cost to sell.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation, including
amortization of assets recorded under capitalized leases, is generally computed
on a straight-line basis over the estimated useful lives of assets ranging from
three to seven years. Amortization of leasehold improvements is provided over
the initial term of the lease, on a straight-line basis. Maintenance, repairs,
and minor renewals and betterments are charged to expense.
F-11
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The Company reviews the carrying value of property and equipment for impairment
whenever events and circumstances indicate that the carrying value of an asset
may not be recoverable from the estimated future cash flows expected to result
from its use and eventual disposition. In cases where undiscounted expected
future cash flows are less than the carrying value, an impairment loss is
recognized equal to an amount by which the carrying value exceeds the fair value
of assets. The factors considered by management in performing this assessment
include current operating results, trends and prospects, and the effects of
obsolescence, demand, competition, and other economic factors.
CUSTOMER LISTS
Customer lists includes customer purchased with the acquisition of certain
assets of Heritage and SSL. The customer lists for Heritage and SSL are being
amortized over their estimated useful life of 36 and 48 months, respectively,
using the straight-line method. Amortization expense for the fiscal years 2007,
2008, 2009 and 2010 is expected to be $166, $160, $142 and $118, respectively.
PATENT COSTS
Patent costs include direct costs of obtaining the patent. Costs for new patents
are capitalized and amortized over the estimated useful life of the patent,
generally over the life of the patent on a straight-line method. The cost of
patents in process is not amortized until issuance. During the year ended June
30, 2005, the Company determined that the cost of the patent was not recoverable
and took a write-off related to the patent of $1,348.
ADVERTISING COSTS
The Company expenses advertising and promotion costs as incurred. During fiscal
2006 and 2005, the Company incurred advertising and promotion costs of
approximately $84 and $135, respectively.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred.
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 shareholders 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 Company had the following potential common shares for
the years ended June 30, 2006 and 2005, respectively: warrants - 7,330,000 and
157,817; stock options - 135,000 and 195,750; and convertible securities of
15,237,774 and 2,078,758. For the year ended June 30, 2005, all of the above
diluted shares were considered anti-dilutive since the Company incurred a net
loss. For the year ended June 30, 2006, the warrants and options were considered
anti-dilutive since the average stock price for the year was less than the
exercise price of the warrants and options.
F-12
Below is a computation of earning (loss) per share:
YEAR ENDED JUNE 30,
----------------------------------------------------------------------
2006 2005
---------------------------------- ----------------------------------
INCOME/ PER INCOME/ PER
(LOSS) SHARES SHARE (LOSS) SHARES SHARE
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) from continuing operations $ 2,679 $ (4,042)
Preferred stock dividends (21) (21)
---------- ----------
2,658 (4,063)
Discontinued operations (363) (176)
---------- ----------
Net income (loss) attributed to common
stockholders $ 2,295 $ (4,239)
========== ==========
Weighed shares outstanding 4,100,203 3,292,181
Continuing operations $ 0.65 $(1.23)
Discontinued operations (0.09) (0.05)
-------- --------
$ 0.56 (1.29)
======== ========
DILUTED EARNINGS PER SHARE N/A
Net income from continuing operations $ 2,679
Preferred stock dividends (21)
Interest on convertible debentures 476
Amortization of discounts on convertible
debentures 1,137
----------
4,271
Discontinued operations (363)
----------
Net income (loss) attributed to common
stockholders $ 3,908
==========
Weighed shares outstanding 4,110,203
Conversion of convertible debentures into common stock 15,237,774
-----------
19,347,977
===========
Continuing operations $ 0.22
Discontinued operations $(0.02)
--------
$ 0.20
========
F-13
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
DEBT DISCOUNTS
Debt discounts costs are principally the values attributed to the detachable
warrants issued in connection with the convertible debentures and the value of
the preferential conversion feature associated with the convertible debentures.
These debt issuance costs are accounted for in accordance with Emerging Issues
Task Force ("EITF") 00-27 issued by the Financial Accounting Standards Board
("FASB").
MINORITY INTEREST
On April 1, 2005, the Company contributed its wholly-owned subsidiary, Solvis
Group, Inc. a Michigan corporation, to 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% or $251 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 year ended June 30,
2006 of which 15% or $81 is attributed to minority interest. The net income
attributed to minority interest for the year ended June 30, 2006 of $0 that has
been separately designated in the accompanying statement of operations is the
current year net income related to minority interest of $81 offset by the
unrecorded loss of $192 from the year ended June 30, 2005. The Company has an
unrecorded loss of $111 going into the year ended June 30, 2007.
INCOME TAXES
The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requires
the recognition of deferred tax assets and liabilities for the expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred income taxes are recognized for the
tax consequences in future years of differences between the tax bases of assets
and liabilities and their financial reporting amounts at each period end based
on enacted tax laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized.
The Company recognizes the amount of taxes payable or refundable for the current
year and recognizes deferred tax liabilities and assets for the expected future
tax consequences of events and transactions that have been recognized in the
Company's financial statements or tax returns. The Company currently has
substantial net operating loss carryforwards. The Company has recorded a 100%
valuation allowance against net deferred tax assets due to uncertainty of their
ultimate realization.
F-14
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
STOCK BASED COMPENSATION
The Company adopted SFAS No. 123 (Revised 2004), SHARE BASED PAYMENT ("SFAS No.
123R"), under the modified-prospective transition method on January 1, 2006.
SFAS No. 123R requires companies to measure and recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value. Share-based compensation recognized under the
modified-prospective transition method of SFAS No. 123R includes share-based
compensation based on the grant-date fair value determined in accordance with
the original provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, for all share-based payments granted prior to and not yet vested
as of January 1, 2006 and share-based compensation based on the grant-date
fair-value determined in accordance with SFAS No. 123R for all share-based
payments granted after January 1, 2006. SFAS No. 123R eliminates the ability to
account for the award of these instruments under the intrinsic value method
prescribed by Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, and allowed under the original provisions of SFAS No.
123. Prior to the adoption of SFAS No. 123R, the Company accounted for our stock
option plans using the intrinsic value method in accordance with the provisions
of APB Opinion No. 25 and related interpretations.
For periods presented prior to the adoption of SFAS No. 123R, pro forma
information regarding net loss and loss per share as required by SFAS No. 123R
has been determined as if the Company had accounted for its employee stock
options under the original provisions of SFAS No. 123. The fair value of these
options was estimated using the Black-Scholes option pricing model. For purposes
of pro forma disclosure, the estimated fair value of the options is amortized to
expense over the option's vesting period. The pro forma information regarding
the effect on operations that is required by SFAS 123 has not been presented
since there is no pro forma expense to be shown for the six months ended
December 31, 2005 or the year ended June 30, 2005.
FAIR VALUE OF FINANCIAL INSTRUMENTS
For certain of the Company's financial instruments, including accounts
receivable, inventories, accounts payable, and accrued expenses, the carrying
amounts approximate fair value, due to their relatively short maturities. The
amounts owed for long-term debt also approximate fair value because current
interest rates and terms offered to the Company are at current market rates.
COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, "Reporting Comprehensive Income." This
statement establishes standards for reporting other comprehensive income and its
components in a financial statement. Comprehensive income, as defined, includes
all changes in equity (net assets) during a period from non-owner sources.
Examples of items to be included in comprehensive income, which are excluded
from net income, include foreign currency translation adjustments and unrealized
gains and losses on available-for-sale securities. Comprehensive income is not
presented in the Company's financial statements since the Company did not have
any of the items of other comprehensive income in any period presented.
F-15
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
SEGMENT DISCLOSURE
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," was issued, which changes the way public companies report
information about segments. SFAS No. 131, which is based on the selected segment
information, requires quarterly and entity-wide disclosures about products and
services, major customers, and the material countries in which the entity holds
assets and reports revenues. The Company has four segments.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." This statement applies to all voluntary changes in accounting
principle and requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless this would be
impracticable. This statement also makes a distinction between "retrospective
application" of an accounting principle and the "restatement" of financial
statements to reflect the correction of an error. This statement is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. SFAS No. 154 is not expected to have a material effect
on the financial position or results of operations of the Company.
In February 2006, the 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 SFAF 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. SFAS No. 155 may have a material effect on the
financial position or results of operations of the Company depending upon
management's plans to fund operations.
In March 2006 the 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:
F-16
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
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 financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
statement clarifies the definition of fair value, establishes a framework for
measuring fair value and expands the disclosures on fair value measurements.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.
Management has not determined the effect, if any, the adoption of this statement
will have on the financial statements.
NOTE 2 - PROPERTY AND EQUIPMENT
The cost of property and equipment at June 30, 2006 consisted of the following:
Computer and other equipment $ 611
Office furniture and fixtures 112
Leasehold improvements -
-------------
723
Less accumulated depreciation and amortization (368)
-------------
$ 355
=============
Depreciation expense for the years ended June 30, 2006 and 2005 was $103 and
$77, respectively.
NOTE 3 - RELATED PARTY TRANSACTIONS
TRANSACTIONS WITH OFFICERS AND KEY EXECUTIVES
During the years ended June 30, 2006 and 2005, the Company issued 252,625 and
36,361 shares of common stock to the Company's CEO as payment for compensation
valued at $253 and $109, respectively.
F-17
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
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 year ended June 30, 2006, the Company invoiced Warning for $87 and Warning's
ESI subsidiary for $520 for management services. During the year ended June 30,
2005, the Company invoiced Warning $390 for management services and $45 for
reimbursement of costs. Warning also paid expenses of $38 on behalf of the
Company during the year ended June 30, 2005. As of June 30, 2006, the Company
has an amount due to Warning of $3 that is included in current liabilities.
NOTE 4 - ACQUISITIONS
STRATEGIC ALTERNATIVE STAFFING, LLC.
On May 1, 2006, DFCO completed its acquisition of Strategic Alternative Staffing
LLC ("SSL"). The purchase price was $558 consisting of a $550 note payable to
the owner of SSL and 50,000 warrants to purchase shares of DFCO common stock
valued at $8. SSL is a professional employer organization and a broker of
certain employee benefits. The Company acquired SSL as part of its strategic
growth plan.
The operating results of SSL beginning May 1, 2006 are included in the
accompanying consolidated statements of operations.
F-18
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The total purchase price was valued at $558 and is summarized as follows in
accordance with SFAS No. 141 and 142:
Cash $ 122
Accounts receivable 415
Customer list 567
Accounts payable and accrued expenses (546)
----------------
Purchase price $ 558
================
The customer list is being amortized over 48 months.
The pro forma financial information that the consolidated operations of the
Company as if the SSL acquisition had occurred as of the beginning of the
periods presented is not presented since the operations of SSL prior to the
acquisition by DFCO were immaterial.
HERITAGE STAFFING GROUP, INC.
On April 4, 2005, DFCO completed its acquisition of certain assets of Heritage
Staffing Group, Inc. ("Heritage"). The purchase price was $79 consisting of $20
in cash, a $45 note payable to the owner of Heritage and 25,000 warrants to
purchase shares of DFCO common stock valued at $14. These warrants expired on
March 31, 2006. Heritage is in the temporary staffing business and the Company
acquired certain assets of Heritage to complement it other temporary staffing
business.
The operating results of Heritage beginning April 4, 2005 are included in the
accompanying consolidated statements of operations.
The total purchase price was valued at $80 and is summarized as follows in
accordance with SFAS No. 141 and 142:
Computer equipment $ 4
Furniture and fixtures 3
Customer list 72
----------------
Purchase price $ 79
================
The customer list is being amortized over 36 months.
The pro forma financial information that the consolidated operations of the
Company as if the Heritage acquisition had occurred as of the beginning of the
periods presented is not presented since the operations of Heritage prior to the
acquisition by DFCO were immaterial.
F-19
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
NOTE 5 - INVESTMENT IN ALLIANCE INSURANCE GROUP
On February 3, 2006, Solvis, a subsidiary of DFCO and Employment Systems, Inc.,
("ESI") a wholly owned subsidiary of Warning Management Services, a related
party, purchased an eighteen (18%) percent interest in Alliance Insurance Group
for $2,800. The purpose of the investment was to obtain access to a low cost
worker's compensation insurance policy for both companies.
The $2,800 purchase price is being financed through Bank Direct at 7.25% over 23
months. Both Solvis and ESI are co-signatories on the note. As Solvis is a
co-guarantor of the note, the Company recorded the whole note of $2,800 on its
books and recorded a $1,400 related party receivable from ESI. Additionally, the
Company recorded a $1,400 investment in the insurance company. Solvis' $1,400
investment represents a 9% interest in the insurance company. ESI's $1,400
payable to Solvis is secured by ESI's 9% investment interest in the insurance
company. The Company has accounted for this investment in Alliance Insurance
Group using the cost method.
NOTE 6 - OTHER ACCRUED EXPENSES
Other accrued expenses at June 30, 2006 consisted of the following as of:
Accrued interest and penalties $ 270
Accrued judgments 2,268
Taxes payable 63
Deposits 293
Other 626
----------------
3,520
================
NOTE 7 - 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 8 - 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
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.
F-20
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
NOTE 9 - 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 year ended June 30, 2006, we recorded an other income item of $1,234
and $754, 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 June 30, 2006, the estimated fair
value of our derivative liability was $1,483, as well as a warrant liability of
$3,138. 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
June 30, 2006 the Company used the closing price of $0.15 and the respective
conversion and exercise prices for the warrants.
NOTES PAYABLE
During the year ended June 30, 2006, the Company issued notes to third parties,
which included eight investors. As part of the several financing transactions,
the Company also issued warrants to purchase shares of stock at various exercise
prices.
DATE OF NOTE AMOUNT OF NOTES CONVERSION PRICE(1) TERM OF NOTE
------------ --------------- ------------------- ------------
January 27, 2006 (1) $ 112 $ 0.452 2 years
February 9, 2006 (1) $ 246 $ 0.452 2 years
February 13, 2006 $ 7,545 75% (3) 2 years
DATE OF WARRANTS ISSUED NUMBER OF WARRANTS EXERCISE PRICE TERM OF WARRANTS
----------------------- ------------------ -------------- ----------------
February 13, 2006 6,760,000 $ 1.00 7 years
February 13, 2006 (2) 520,000 $ 1.00 7 years
May 1, 2006 (4) 50,000 $ 20.00 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.
(4) = warrants issued in connection with SSL acquisition
F-21
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
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 June 30, 2006, no liquidating damages have been incurred by the
Company.
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 year ended June 30, 2006, the
Company accreted $884, of debt discount related to the Notes.
WARRANTS ISSUED
The estimated fair value of the warrants at issuance were as follows:
DATE OF WARRANTS ISSUED NUMBER OF WARRANTS VALUE AT ISSUANCE VOLATILITY FACTOR
----------------------- ------------------ ----------------- -----------------
February 13, 2006 6,760,000 $ 3,582 72%
February 13, 2006 520,000 $ 302 72%
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 June 30, 2006, the
Company used the closing price of $0.15, the respective exercise price, as well
as the remaining term on each warrant, as well as a volatility of 90%. 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 June 30, 2006, had decreased to a fair value of
$3,138, due in part to a decrease in the market value of the Company's common
stock to $0.15 from $0.20 at issuance of the February 13, 2006 amount, as well
as an increase in the volatility from 72% to 90% which resulted in an "other
income" item of $754 on the Company's books.
F-22
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The recorded value of such warrants can fluctuate significantly based on
fluctuations in the market value of the underlying securities of the issuer of
the warrants, as well as in the volatility of the stock price during the term
used for observation and the term remaining for the warrants.
DEBT FEATURES
In accordance with Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended
("SFAS 133"), the debt features provision (collectively, the features) contained
in the terms governing the Notes are not clearly and closely related to the
characteristics of the Notes. Accordingly, the features qualified as embedded
derivative instruments at issuance and, because they do not qualify for any
scope exception within SFAS 133, they were required by SFAS 133 to be accounted
for separately from the debt instrument and recorded as derivative financial
instruments.
Pursuant to the terms of the Notes, these notes are convertible at the option of
the holder, at anytime on or prior to maturity. There is an additional interest
rate adjustment feature, a liquidated damages clause, a cash premium option, as
well as the redemption option. The debt features represents an embedded
derivative that is required to be accounted for apart from the underlying Notes.
At issuance of the Notes, the debt features had an estimated initial fair value
as follows, which was recorded as a discount to the Notes and a derivative
liability on the consolidated balance sheet.
DEBT FEATURES
DATE OF NOTE AMOUNT OF NOTES VALUE AT ISSUANCE CARRYING VALUE
------------ --------------- ----------------- --------------
January 27, 2006 $ 112 $ 69 $ 43
February 9, 2006 $ 246 $ 133 $ 113
February 13, 2006 $ 7,545 $ 2,515 $ 1,448
In subsequent periods, if the price of the security changes, the embedded
derivative financial instrument related to the debt features will be adjusted to
the fair value with the corresponding charge or credit to other expense or
income. 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 June 30, 2006, the company
used the closing price of $0.21 and the respective conversion price, a remaining
term coinciding with each contract, and a volatility of 90%. For the year ended
June 30, 2006, due in part to a decrease in the market value of the Company's
common stock to $0.15 the Company recorded an "other income" on the consolidated
statement of operations for the change in fair value of the debt features of
approximately $1,234. At June 30, 2006, the estimated fair value of the debt
features was approximately $1,483.
F-23
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
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 year ended June 30, 2006, we recorded an other income item of $1,234 and
$754, related to the decrease in value of the debt features and warrants. A
tabular reconciliation of this adjustment follows:
For the year ended June 30, 2006:
$ 754 income, decrease in value of warrant liability
$ 1,234 income, decrease in value of derivative liability
--------
$ 1,988 other income related to convertible debt
For the year ended June 30, 2006, the Company recorded $884 of interest expense
related to the accretion of debt related to the convertible financing.
For the year ended June 30, 2006:
$ 884 of interest expense related to accretion of convertible debt
--------
$ 884 of interest expense related to convertible debt
The balance of the carrying value of the convertible debt as of June 30, 2006
is:
$ 1,605 original carrying value on convertible debt
$ (228) converted to equity
$ 884 accretion of convertible debt
--------
$ 2,261 June 30, 2006 carrying value of debt
F-24
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The balance of the carrying value of the derivative liability as of June 30,
2006 is:
$ 2,717 original value of derivative liability
$ (1,234) income, decrease in value of derivative liability
--------
$ 1,483 June 30, 2006 value of derivative liability
The balance of the carrying value of the warrant liability as of June 30, 2006
is:
$ 3,892 original carrying value of warrant liability
$ (754) income, decrease in value of warrant liability
--------
$ 3,138 June 30, 2006 value of warrant liability
During the year ended June 30, 2006, the Company discussed with the lead
investor the refinancing of certain convertible notes, including disputed
amounts for accrued interest, penalties and note balances. As part of the
funding described above we recognized an additional settlement of accrued
interest, penalties and balances for $908.
NOTE 10 - NOTES PAYABLE, INCLUDING AMOUNTS DUE TO RELATED PARTIES
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.
During the year ended June 30, 2006 a subordinated non-convertible note payable
of $1,500 plus accrued interest of $1,390 to a former director was reduced to
$750 and recognized as a gain on extinguishment of debt of $2,140. The former
director indicated that he would be filling to accept $750 as payment in full on
his outstanding obligation including accrued interest.
F-25
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The following summarizes notes payable (including amounts due to a related
party) at June 30, 2006:
Note payable in connection with SSL acquisition,
payable from net profits $ 202
Note payable to two investors, interest at 8% per
annum, payable upon demand 49
Notes payable to related party, interest at 8%,
ranging from payable upon demand to due in 2008 458
Note payable to investor, interest at 10% per
quarter, payable upon demand 70
Note payable to bank related to financing of
worker's compensation deposit, interest at 7.5%,
payable over 10 months through March 2007 2,553
Note payable to Direct Bank related to purchase
of Alliance Insurance Group, interest at 7.5%,
payable over 23 months with balance due in
February 2008 2,340
Note payable to a former director 750
Other 4
-----------
6,426
Less current portion (5,156)
-----------
Long-term portion $ 1,270
===========
Notes payable mature as follows:
During the years ended June 30,
2007 $ 5,156
2008 1,270
-----------
$ 6,426
===========
F-26
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
NOTE 11 - STOCKHOLDERS' DEFICIT
AMENDMENT TO THE CERTIFICATE OF INCORPORATION.
On May 14, 2004, the Company's shareholders approved a Board proposal to amend
the Certificate of Incorporation to increase the number of shares of common
stock that the Company is authorized to issue from 500,000,000 to 1,000,000,000
shares.
5% SERIES A CONVERTIBLE, REDEEMABLE PREFERRED STOCK
Holders of the 5% convertible preferred stock ("Series A") are entitled to
receive, when and as declared by the Board of Directors, but only out of amounts
legally available for the payment thereof, cumulative cash dividends at the
annual rate of $50.00 per share, payable semi-annually.
The 5% convertible preferred stock is convertible, at any time, into shares of
the Company's common stock, at a price of $3.5 per common share. This conversion
price is subject to certain anti-dilution adjustments, in the event of certain
future stock splits or dividends, mergers, consolidations or other similar
events. In addition, the Company shall reserve, and keep reserved, out of its
authorized but un-issued shares of common stock, sufficient shares to effect the
conversion of all shares of the 5% convertible preferred stock.
In the event of any involuntary or voluntary liquidation, dissolution or winding
up of the affairs of the Company, the 5% convertible preferred shareholders
shall be entitled to receive $1 per share, together with accrued dividends, to
the date of distribution or payment, whether or not earned or declared.
The 5% convertible preferred stock is callable, at the Company's option, at call
prices ranging from $210 to $220 per share. No call on the 5% convertible
preferred stock was made during fiscal 2006 and 2005. As of June 30, 2006, the
accumulated dividend in arrears was approximately $474 on the Series A.
COMMON STOCK WARRANTS
The following is a summary of the warrant activity:
UNDERLYING
PRICE PER COMMON
SHARE SHARES
---------------- ---------------
---------------
JUNE 30, 2004 $4.00 - $300.00 107,817
Granted $0.60 - $1.00 50,000
Exercised - -
Canceled - -
---------------
JUNE 30, 2005 $0.60 - $300.00 157,817
Granted $1.00 - $20.00 7,330,000
Exercised - -
Canceled $0.60 - $300.00 (157,817)
---------------
EXERCISABLE AT JUNE 30, 2006 7,330,000
---------------
F-27
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The weighted average remaining contractual life of warrants outstanding at June
30, 2006 is 6.60 years. The intrinsic value of the outstanding warrants at June
30, 2006 was $0. The exercise prices for warrants outstanding at June 30, 2006
are as follows:
NUMBER
OF EXERCISE
WARRANTS PRICE
-------------- --------------
7,280,000 $1.00
50,000 $20.00
--------------
7,330,000
==============
2001 STOCK OPTION AND STOCK PURCHASE PLANS
The Company's shareholders approved the 2001 Stock Option Plan, pursuant to
which 1,000,000 shares of common stock are reserved for issuance to eligible
employees and directors of, and consultants to, the Company or any of its
subsidiaries. Upon expiration, cancellation or termination of unexercised
options, the shares of the Company's Common Stock subject to such options will
again be available for the grant of options under the 2001 Stock Option Plan.
Options granted under the 2001 Stock Option Plan may either be incentive or
nonqualified stock options.
The Company's shareholders approved the 2001 Stock Purchase Plan, as amended,
which enables eligible employees to purchase in the aggregate up to 50,000
shares of common stock.
STOCK OPTION ACTIVITY
The following is a summary of the stock option activity:
STOCK OPTION PLANS
UNDERLYING
PRICE PER COMMON
SHARE SHARES
---------------- ---------------
---------------
JUNE 30, 2004 $2.00 - $5.00 195,750
Granted - -
Exercised - -
Canceled - -
---------------
JUNE 30, 2005 $2.00 - $5.00 195,750
Granted - -
Exercised - -
Canceled/Expired $2.00 - $3.00 (60,750)
---------------
EXERCISABLE AT JUNE 30, 2006 $2.00 - $5.00 135,000
---------------
F-28
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The weighted average remaining contractual life of options outstanding issued
under the Stock Option Plans is 0.17 years at June 30, 2006. The exercise prices
for options outstanding at June 30, 2006 are as follows:
NUMBER
OF EXERCISE
WARRANTS PRICE
-------------- --------------
7,500 $2.00
127,500 $5.00
--------------
135,000
==============
The Company has implemented SFAS 123R for future grants of options to employees.
No unvested option grants to employees were outstanding at June 30, 2006.
COMMON STOCK ISSUED FOR SERVICES AND COMPENSATION
The table below shows all the issuances of common stock for services during the
year ended June 30, 2006 and 2005. The value of the services was derived by
multiplying the market value of the Company's common stock at the date a
transaction for services was entered into by the number of shares issued.
FISCAL 2006
ISSUE SHARES
DATE DESCRIPTION ISSUED AMOUNT
9/16/05 Professional Services 25,000 $ 15
3/13/06 Compensation to officer 50,000 50
6/30/06 Compensation to officer 252,625 253
------------ -------------
327,625 $ 318
============ =============
F-29
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
FISCAL 2005
ISSUE SHARES
DATE DESCRIPTION ISSUED AMOUNT
7/26/04 Strategic planning/marketing 2,250 $ 2
9/28/04 Strategic planning/marketing 7,500 8
10/19/04 Strategic planning/marketing 8,365 8
10/25/05 Strategic planning/marketing 25,000 25
6/13/05 Professional services 30,000 30
------------ -------------
73,115 $ 73
============ =============
NOTE 12 - SEGMENT AND GEOGRAPHIC INFORMATION
During fiscal 2006 and 2005, the Company managed and internally reported the
Company's business as four (4) reportable segments as follows:
(1) professional employer organization
(2) temporary staffing
(3) products;
(4) corporate;
Segment information for the fiscal year ended June 30, 2006 and 2005, was as
follows:
PEO TEMPORARY
BUSINESS STAFFING PRODUCTS CORPORATE TOTAL
SELECTED STATEMENT OF OPERATIONS ACTIVITY:
Fiscal year ended June 30, 2006
Revenues 1,382 68,226 772 - 70,380
Cost of revenues 998 62,897 34 - 62,897
Gross profit 384 5,329 738 - 6,451
Total assets at June 30, 2006 1,304 11,781 146 1,467 14,698
Fiscal year ended June 30, 2005
Revenues 1,930 17,029 517 - 19,476
Cost of revenues 1,424 15,010 96 - 16,530
Gross profit 506 2,019 421 - 2,946
Impairment of patent - - 1,348 - 1,348
F-30
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
All sales were made in the United States of America
NOTE 13 - INCOME TAXES
The Company's provision for income taxes is accounted for in accordance with
SFAS 109. SFAS 109 requires recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under the SFAS 109 asset and liability
method, deferred tax assets and liabilities are determined based upon the
difference between the financial statement and tax bases of assets and
liabilities using the enacted tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is then provided for
deferred tax assets that are more likely than not to not be realized.
The provision (benefit) for income taxes is as follows for the years ended June
30:
2006 2005
------------ ------------
Current - State $ 40 $ -
Deferred benefit - -
------------ ------------
$ 40 $ -
============ ============
The components of deferred income taxes are as follows at June 30:
2006 2005
------------ ------------
Deferred tax assets
Net operating loss carryforwards $ 37,493 $ 38,927
Other 475 524
------------ ------------
37,968 39,451
Valuation allowance (37,968) (39,451)
------------ ------------
$ - $ -
============ ============
The Company's federal and state net operating loss carryforwards expire in
various years through 2017. The Company has made numerous equity issuances that
could result in limitations on the annual utilization of the Company's net
operating loss carryforwards. The Company has not performed an analysis to
determine the effect of such changes.
The provision for income taxes results in an effective rate that differs from
the federal statutory rate. Reconciliation between the actual tax provision and
taxes computed at the statutory rate is as follows for the year ended June 30,
2006:
F-31
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
Tax Percentage
Federal Tax $ 892 34.0%
State tax 157 6.0%
Penalties 374 14.3%
Reserves 200 7.6%
Other (41) (1.6%)
Net operating loss (1,542) (58.8%)
------------ -------------
$ 40 1.5%
============ =============
Reconciliation between the actual tax provision and taxes computed at the
statutory rate is as follows for the year ended June 30, 2005:
Tax Percentage
Federal Tax $ (1,434) 34.0%
State tax (253) 6.0%
Penalties 306 (7.3)
Other 59 (1.4%)
Net operating loss 1,322 (31.3%)
------------ -------------
$ - 0%
============ =============
At June 30, 2006, the Company had federal and state net operating loss ("NOL")
carryforwards of approximately $90,000,000 and $69,000,000, respectively.
Federal NOLs could, if unused, expire in varying amounts in the years 2010
through 2020.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENT
The Company leases its operating facilities under lease agreements that expire
through 2011.
Total rental expense was approximately $335 and $299 for the years ended June
30, 2006 and 2005, respectively.
Future minimum lease payments under non-cancelable capital and operating leases
with initial or remaining terms of one year or more are as follows:
Operating Leases
--------------------
YEAR ENDING JUNE 30,
2007 $ 432
2008 347
2009 192
2010 195
2011 17
--------------------
Net Minimum Lease Payments $ 1,183
====================
F-32
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
LEGAL MATTERS
The Company and its SourceOne Group ("SOG") subsidiary have been sued by the
Arena Football 2 Operating Company, LLC ("Arena") in Wayne County Circuit Court,
Michigan. In April 2006, Dalrada and SourceOne Group, Inc. entered into a
settlement with AF2 Operating Company, LLC and other parties involved in the
matter of AF2 Operating Company, LLC v. SourceOne Group Inc., et al. The net
result of the settlement was that Dalrada and SourceOne Group, Inc. are
obligated to make a net settlement payment of $ 203. 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. In July
2007, the judge dismissed Dalrada from the litigation and dismissed many, but
not all, of the claims against SourceOne Group. Management has vigorously
contested the claims made by Liberty. Trial is scheduled for January 2007.
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 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.
In July 2006, the matter was settled with Dalrada paying $150 of legal fees
incurred by Greenland.
F-33
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
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 $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 $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 year ended June 30, 2006. The
plaintiffs have accepted the settlement offer.
NOTE 15 - GAIN ON SETTLEMENT OF DEBT
During the year ended June 30, 2006 and 2005, the Company recognized a gain on
settlement of debt of $8,546 and $829, respectively. For the year ended June 30,
2006, the recognized a gain of $4,120 related to the settlement of two notes
payable to banks. (See Note 7) and a gain of $2,140 related to the settlement of
notes payable and accrued interest with a former director (See Note 10). The
remaining gain of $2,286 for the year ended June 30, 2006 and the gain of $829
for the year ended June 30, 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 16 - GAIN RESULTING FROM RECONCILIATION OF PAYROLL TAX LIABILITIES TO
TAXING AUTHORITIES
During the years ended June 30, 2006 and 2005, the Company recorded an
adjustment to earnings of $1,924 and $1,895, 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.
F-34
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)
The Company is delinquent in filing its payroll tax returns and owes $8,451 in
delinquent payroll tax payments, interest and penalties.
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 year ended June 30, 2006 and 2005, Master Staffing's revenues were $11
and $0, respectively, and losses from operations were $363 and $176,
respectively. The results of operations of Master Staffing have been reported
separately as discontinued operations.
Master Staffing's net assets at June 30, 2006 were $22, which consisted of
furniture and equipment of $19 and other assets of $3.
NOTE 18 - SUBSEQUENT EVENTS
ALL STAFFING, INC. ACQUISITION
On September 13, 2006 the Company acquired All Staffing, Inc., a Lansford,
Pennsylvania-based company that provides staffing, staffing leasing, and
professional employer organization ("PEO") services to clients in the northeast
U.S. All Staffing establishes an east coast presence for Dalrada, and expands
the Company's organization to include expanded operations to pursue a nationwide
footprint. Dalrada has offices and subsidiaries in Texas, Michigan, California,
and Colorado. The terms of the acquisition include payment of $3.5 million in
cash and common stock.
STOCK SPLITS
On September 15, 2006, the Company authorized a one for two hundred (1 for 200)
reverse stock split of its common stock. All share information for common shares
has been retroactively restated for this reverse stock split.
F-35