UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
or
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file No. 0-12641
DALRADA FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0021693
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (IRS EMPLOYER ID NO.)
ORGANIZATION)
9449 BALBOA AVENUE, SUITE 211
SAN DIEGO, CA 92123
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (858) 277-5300
N/A
(FORMER NAME AND ADDRESS, IF CHANGED SINCE LAST REPORT)
Check whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
The number of shares outstanding of the registrant's common stock as of November
18, 2004 was 631,187,872.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [ X]
PART I - FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Consolidated Balance Sheet - September 30, 2004 (unaudited) 3
Consolidated Statements of Operations - 3 months ended
September 30, 2004 and 2003 (unaudited) 4
Consolidated Statements of Cash Flows - 3 months ended
September 30, 2004 and 2003 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 7
ITEM 2. Management's Discussion and Analysis or Plan of Operations 13
ITEM 3. Controls and Procedures 26
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 26
ITEM 2. Unregistered Sale of Equity Securities and Use of Proceeds 27
ITEM 3. Defaults Upon Senior Securities 27
ITEM 4. Submission of Matters To A Vote of Security Holders 27
ITEM 5. Other Information 27
ITEM 6. Exhibits 27
SIGNATURES 27
CERTIFICATIONS 28
2
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
SEPTEMBER
30, 2004
-----------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 56
Accounts receivable, net of allowance of $66 726
Inventories, net of reserve of $15 --
Prepaid expenses and other current assets 645
----------
TOTAL CURRENT ASSETS 1,427
----------
PATENT, net of accumulated amortization of $210 1,408
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $1,994 151
OTHER ASSETS 21
----------
TOTAL ASSETS $ 3,007
==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Borrowings under bank notes payable $ 3,220
Notes payable, current portion (including related party note of $1,558) 2,166
Convertible debentures, net of discount of $31 783
Accounts payable 1,339
Obligations under capital lease 10
PEO payroll taxes and other payroll deductions 6,022
Other accrued expenses 10,404
----------
TOTAL CURRENT LIABILITIES 23,944
----------
CONVERTIBLE DEBENTURES, net of current portion and net of discounts of $254 107
NOTES PAYABLE, net of current portion (including related party note of $288) 503
CAPITAL LEASE, net of current portion 61
----------
TOTAL LIABILITIES 24,615
----------
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; 602,417,418 shares issued and outstanding 3,012
Common stock warrants 475
Additional paid-in capital 83,080
Accumulated deficit (108,595)
----------
TOTAL STOCKHOLDERS' DEFICIT (21,608)
----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 3,007
==========
The accompanying notes are an integral part of these
consolidated financial statements.
3
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
--------------------------
SEPTEMBER SEPTEMBER
30, 2004 30, 2003
------------ -----------
(unaudited) (unaudited)
REVENUES
Sales of products $ 125 $ 131
Software sales, licenses and royalties 26 36
Temporary staffing services 3,905 767
PEO Services 372 1,427
---------- ----------
TOTAL REVENUES 4,428 2,361
---------- ----------
COST OF REVENUES
Cost of products sold 23 83
Cost of software sales, licenses and royalties 3 3
Cost of temporary staffing 3,548 693
Cost of PEO services 280 1,270
---------- ----------
TOTAL COST OF REVENUES 3,854 2,049
---------- ----------
---------- ----------
GROSS PROFIT 574 312
---------- ----------
OPERATING EXPENSES
Selling, general and administrative 1,009 1,904
Research and development -- --
---------- ----------
TOTAL OPERATING EXPENSES 1,009 1,904
---------- ----------
INCOME (LOSS) FROM OPERATIONS (435) (1,592)
---------- ----------
OTHER INCOME (EXPENSES):
Interest and financing costs, net (483) (328)
Gain on extinguishment of debt -- --
Loss on disposition of assets -- --
Other, net -- 3
---------- ----------
TOTAL OTHER INCOME (EXPENSE) (483) (325)
---------- ----------
LOSS BEFORE PROVISION FOR INCOME TAXES
AND DISCONTINUED OPERATIONS (918) (1,917)
PROVISION FOR INCOME TAXES -- --
---------- ----------
NET LOSS FROM CONTINUING OPERATIONS (918) (1,917)
---------- ----------
DISCONTINUED OPERATON:
Loss from operations of discontinued operation -- (436)
Gain on disposition of discontinued operation -- --
---------- ----------
-- (436)
---------- ----------
NET LOSS (918) (2,353)
PREFERRED STOCK DIVIDENDS (5) (5)
NET LOSS ATTRIBUTED TO COMMON
---------- ----------
STOCKHOLDERS $ (923) $ (2,358)
========== ==========
NET LOSS PER SHARE - BASIC
Continuing operations $ (0.00) $ (0.01)
Discontinued operations -- (0.00)
---------- ----------
$ (0.00) $ (0.01)
========== ==========
WEIGHTED AVERAGE COMMON EQUIVALENT
SHARES OUSTANDING - BASIC 585,977 240,556
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
4
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
-------------------------
SEPTEMBER SEPTEMBER
30, 2004 30, 2003
--------- ---------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations $ (918) $ (1,917)
Adjustment to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 39 42
Stock issued for services 10 269
Amortization of debt discounts 223 237
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (144) 933
Inventories -- (1)
Prepaid expenses and other current assets (201) (154)
Other assets (21) 190
Increase (decrease) in:
Accounts payable and accrued expenses (295) (2,224)
PEO liabilities 871 2,761
--------- ---------
Net cash provided by (used in) operating activities from continuing operations (436) 136
Net cash used in operating activities from discontinued operations -- (601)
--------- ---------
Net cash used in operating activities (436) (465)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment -- (83)
--------- ---------
Net cash used in investing activities from continuing operations -- (83)
Net cash used in investing activities from discontinued operations -- (41)
--------- ---------
Net cash used in investing activities -- (124)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in cash overdraft, net -- (87)
Net borrowings under bank notes payable -- (25)
Proceeds from notes payable 275 --
Repayments of notes payable (9) (34)
Repayments of capital lease obligations (2) (1)
--------- ---------
Net cash provided by (used in) financing activities from continuing operations 264 (147)
Net cash used in financing activities from discontinued operations -- (2)
--------- ---------
Net cash provided by (used in) investing activities 264 (149)
--------- ---------
CASH OF DISCONTINUED OPERATION -- (399)
NET DECREASE IN CASH AND
CASH EQUIVALENTS (172) (1,137)
CASH AND CASH EQUIVALENTS, Beginning of period 228 1,223
--------- ---------
CASH AND CASH EQUIVALENTS, End of period $ 56 $ 86
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
5
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
NON-CASH INVESTING AND FINANCING ACTIVITIES
During the three months ended September 30, 2004, the Company issued: (1)
1,950,000 shares of its common stock for services valued at $10; (2) 10,108,676
shares of its common stock for debt of $21; and (3) 38,000,000 shares of its
common stock for the conversion of convertible debentures in the amount of $175.
During the three months ended September 30, 2003, the Company issued: 1)
5,220,000 shares of its common stock for services valued at $129; 2) 10,272,110
shares of its common stock for compensation valued at $140; 3) 20,260,000 shares
of its common stock for debt of $405; and 4) 48,400,337 shares of its common
stock for the conversion of convertible debentures in the amount of $346.
6
DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES
(formerly Imaging Technologies Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Dalrada
Financial Corporation and Subsidiaries (the "Company" or "DRDF") have been
prepared pursuant to the rules of the Securities and Exchange Commission (the
"SEC") for quarterly reports on Form 10-QSB and do not include all of the
information and note disclosures required by accounting principles generally
accepted in the United States of America. These financial statements and notes
herein are unaudited, but in the opinion of management, include all the
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the Company's financial position, results of operations,
and cash flows for the periods presented. These financial statements should be
read in conjunction with the Company's audited financial statements and notes
thereto for the years ended June 30, 2004 included in the Company's annual
report on Form 10-KSB filed with the SEC. Interim operating results are not
necessarily indicative of operating results for any future interim period or for
the full year. The consolidated financial statements include the accounts of the
Company and its majority-owned subsidiaries. All inter-company transactions have
been eliminated.
RECLASSIFICATIONS
-----------------
Certain reclassifications have been made to the prior years' financial
statements to conform to the current year presentation. These reclassifications
had no effect on previously reported results of operations or retained earnings.
Comprehensive Income
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No.
130 establishes standards for reporting and presentation of comprehensive income
and its components in a full set of financial statements. During the three
months ended September 30, 2004 and 2003, the Company had no elements of
comprehensive income.
NOTE 2. GOING CONCERN CONSIDERATIONS
The accompanying unaudited consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. For the three months
ended September 30, 2004, the Company had a net loss of $918. As of September
30, 2004, the Company had a negative working capital deficiency of $22,517 and
had a stockholders' deficit of $21,608. 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 the Company's ability to continue as a going concern.
The Company must obtain additional funds to provide adequate working capital and
finance operations. However, there can be no assurance that the Company will be
able to complete any additional debt or equity financings on favorable terms or
at all, or that any such financings, if completed, will be adequate to meet the
Company's capital requirements including compliance with the Imperial Bank
settlement agreement. Any additional equity or convertible debt financings could
result in substantial dilution to the Company's stockholders. If adequate funds
are not available, the Company may be required to delay, reduce or eliminate
some or all of its planned activities, including any potential mergers or
acquisitions. The Company's inability to fund its capital requirements would
have a material adverse effect on the Company. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
7
NOTE 3. STOCK BASED COMPENSATION
The Company accounts for employee stock options in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees". Under APB 25, the Company does not recognize compensation expense
related to options issued under the Company's employee stock option plans,
unless the option is granted at a price below market price on the date of grant.
In 1996, SFAS No. 123 "Accounting for Stock-Based Compensation", became
effective for the Company. SFAS No. 123, which prescribes the recognition of
compensation expense based on the fair value of options on the grant date,
allows companies to continue applying APB 25 if certain pro forma disclosures
are made assuming hypothetical fair value method, for which the Company uses the
Black-Scholes option-pricing model.
For non-employee stock based compensation, the Company recognizes an expense in
accordance with SFAS No. 123 and values the equity securities based on the fair
value of the security on the date of grant. For stock-based awards, the value is
based on the market value for the stock on the date of grant and if the stock
has restrictions as to transferability, a discount is provided for lack of
tradability. Stock option awards are valued using the Black-Scholes
option-pricing model.
The Company applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for its stock option plans. The Company has opted
under SFAS No. 123 to disclose its stock-based compensation with no financial
effect. The pro forma effects of applying SFAS No. 123 in this initial phase-in
period are not necessarily representative of the effects on reported net income
or loss for future years. Had compensation expense for the Company's stock
option plans been determined based upon the fair value at the grant date for
awards under these plans consistent with the methodology prescribed under SFAS
No. 123, the Company's pro forma net loss and net loss per share would have been
as follows for the three months ended September 30,2004:
(In thousands, except share amounts) 2004 2003
---- ----
Net loss attributed to common stockholders
As reported $ (923) $2,358)
Compensation recognized under APB No. 25 -- --
Compensation recognized under SFAS No. 123 -- --
-------- -------
Pro forma $ (923) $2,358)
======== =======
Basic earnings (loss) per share
As reported $ (0.00) $(0.01)
======== =======
Pro forma $ (0.00) $(0.01)
This option valuation model requires input of highly subjective assumptions.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing model does not necessarily provide a reliable single
measure of fair value of its employee stock options.
The weighted average fair value of the options granted during fiscal years 2004
and 2003 is estimated on the date of grant using the Black-Scholes
option-pricing model. All options granted in fiscal years 2004 and 2003 vested
immediately. The weighted average fair values and weighted average assumptions
used in calculating the fair values were as follows for the years ended June 30:
2004 2003
---- ----
Fair Value of options granted N/A $ 0.015
Risk free interest rate N/A 3.5%
Expected life (years) N/A 3
Expected volatility N/A 421%
Expected dividends N/A 0%
8
NOTE 4. EARNINGS (LOSS) PER COMMON SHARE
The Company reports earnings (loss) per share in accordance with SFAS No. 128,
"Earnings per Share." Basic earnings (loss) per share are computed by dividing
income (loss) available to common stockholders by the weighted average number of
common shares available. Diluted earnings (loss) per share is computed similar
to basic earnings (loss) per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the potential common shares had been issued and if the additional common
shares were dilutive. Diluted earnings (loss) per share have not been presented
since the effect of the assumed conversion of options and warrants to purchase
common shares would have an anti-dilutive effect. The following potential common
shares have been excluded from the computation of diluted net loss per share for
the three months ended September 30, 2004: warrants - 26,563,435 and stock
options - 39,150,000.
NOTE 5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (an interpretation of Accounting Research Bulletin
(ARB) No. 51, Consolidated Financial Statements). Interpretation 46 addresses
consolidation by business enterprises of entities to which the usual condition
of consolidation described in ARB-51 does not apply. The Interpretation changes
the criteria by which one company includes another entity in its consolidated
financial statements. The general requirement to consolidate under ARB-51 is
based on the presumption that an enterprise's financial statement should include
all of the entities in which it has a controlling financial interest (i.e.,
majority voting interest). Interpretation 46 requires a variable interest entity
to be consolidated by a company that does not have a majority voting interest,
but nevertheless, is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. A company that consolidates a variable interest entity
is called the primary beneficiary of that entity. In December 2003, the FASB
concluded to revise certain elements of FIN 46, primarily to clarify the
required accounting for interests in variable interest entities. FIN-46R
replaces FIN-46 that was issued in January 2003. FIN-46R exempts certain
entities from its requirements and provides for special effective dates for
entities that have fully or partially applied FIN-46 as of December 24, 2003. In
certain situations, entities have the option of applying or continuing to apply
FIN-46 for a short period of time before applying FIN-46R. In general, for all
entities that were previously considered special purpose entities, FIN 46 should
be applied for registrants who file under Regulation SX in periods ending after
March 31, 2004, and for registrants who file under Regulation SB, in periods
ending after December 15, 2004. The Company does not expect the adoption to have
a material impact on the Company's financial position or results of operations.
During April 2003, the FASB issued SFAS 149 - "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities", effective for contracts entered
into or modified after September 30, 2003, except as stated below and for
hedging relationships designated after September 30, 2003. In addition, except
as stated below, all provisions of this Statement should be applied
prospectively. The provisions of this Statement that relate to Statement 133
Implementation Issues that have been effective for fiscal quarters that began
prior to June 15, 2003, should continue to be applied in accordance with their
respective effective dates. In addition, paragraphs 7(a) and 23(a), which relate
to forward purchases or sales of when-issued securities or other securities that
do not yet exist, should be applied to both existing contracts and new contracts
entered into after September 30, 2003. The adoption of this statement had no
impact on the Company's consolidated financial statements.
During May 2003, the FASB issued SFAS 150 - "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity", effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective for public entities at the beginning of the first interim period
beginning after June 15, 2003. This Statement establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a freestanding financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those instruments were
previously classified as equity. Some of the provisions of this Statement are
consistent with the current definition of liabilities in FASB Concepts Statement
No. 6, Elements of Consolidated Financial Statements. The adoption of this
statement had no impact on the Company's consolidated financial statements.
9
In December 2003, the FASB issued a revised SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" which replaces the
previously issued Statement. The revised Statement increases the existing
disclosures for defined benefit pension plans and other defined benefit
postretirement plans. However, it does not change the measurement or recognition
of those plans as required under SFAS No. 87, "Employers' Accounting for
Pensions," SFAS No. 88, "Employers' Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination Benefits," and SFAS No.
106, "Employers' Accounting for Postretirement Benefits Other Than Pensions."
Specifically, the revised Statement requires companies to provide additional
disclosures about pension plan assets, benefit obligations, cash flows, and
benefit costs of defined benefit pension plans and other defined benefit
postretirement plans. Also, companies are required to provide a breakdown of
plan assets by category, such as debt, equity and real estate, and to provide
certain expected rates of return and target allocation percentages for these
asset categories. The Company has implemented this pronouncement and has
concluded that the adoption has no material impact to the consolidated financial
statements.
In December 2003, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB 104 supersedes
SAB 101, "Revenue Recognition in Consolidated Financial Statements." SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, superseded as a result of the issuance
of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Consolidated
Financial Statements Frequently Asked Questions and Answers ("the FAQ") issued
with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition.
Selected portions of the FAQ have been incorporated into SAB 104. While the
wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the
revenue recognition principles of SAB 101 remain largely unchanged by the
issuance of SAB 104, which was effective upon issuance. The adoption of SAB 104
did not impact the consolidated financial statements.
NOTE 6. CONVERTIBLE NOTES PAYABLE
Listed below is a roll-forward schedule of the convertible debentures:
(In Thousands)
Balance at June 30, 2004 $ 871
Issuance of convertible debentures during the three months
ended September 30, 2004 --
Increase in debt discount and beneficial conversion feature --
Converted into common stock (175)
Amortization of value of warrants and preferential
conversion feature 194
------
Balance at September 30, 2004 $ 890
======
NOTE 7. NOTES PAYABLE
On July 1, 2004, the Company entered into two note payable obligations
aggregating $275,000 that bear interest at an annual rate of 40% and are due on
September 30, 2004. In addition, in connection with these two notes payable, the
Company issued to the holder a total of 5,000,000 warrants to purchase shares of
the Company's common stock for $0.005 per shares. The estimated value of the
warrants of $28,500 was determined using the Black-Scholes option pricing model
and the following assumptions: term of 5 years, a risk free interest rate of
3.5%, a dividend yield of 0% and volatility of 426%. As of September 30, 2004,
the entire $28,500 has been amortized to financings costs in the accompanying
consolidated statements of operations.
10
NOTE 8. STOCKHOLDERS' DEFICIENCY
Stock Issuances
During the three months ended September 30, 2004, DRDF issued the following:
o 1,950,000 shares of its common stock for legal and consulting
services valued at $10. The value of the services was
determined using the market value of DRDF's common stock on
the date of issuance;
o 10,108,676 shares of its common stock for debt of $21; and
o 38,000,000 shares of its common stock for the conversion of
convertible debentures in the amount of $175.
NOTE 9. SEGMENT INFORMATION
The Company managed and internally reported the Company's business has four
reportable segments, principally, (1) products and accessories, (2) software,
(3) temporary staffing, and (4) PEO services.
Segment information for the three months ended September 30, 2004 is as follows:
(IN THOUSANDS)
TEMPORARY PEO
PRODUCTS SOFTWARE STAFFING SERVICES TOTAL
-------- -------- -------- -------- -----
3-months ended 9/30/04
----------------------
Revenues $ 125 $ 26 $ 3,905 $ 372 $ 4,428
Operating income (loss) (327) (64) 48 (92) (435)
3-months ended 9/30/04
----------------------
Revenues $ 131 $ 36 $ 767 $ 1,427 $ 2,361
Operating income (loss) (368) (935) 40 (329) (1,592)
NOTE 10. DISPOSITION OF GREENLAND CORPORATION
In January 2004, the Company determined to discontinue operations of Greenland
Corporation, its professional employment business division, and sold its shares
in Greenland, back to Greenland. Effective March 1, 2004, the Company completed
the sale of Greenland. Effective March 1, 2004, four new directors were elected
to serve on Greenland's Board of Directors due to the resignation of the four
directors nominated by DRDF. The operations of Greenland have been shown as
discontinued operations in the accompanying consolidated statements of
operations.
The operations of Greenland for the three month period ended September 30, 2003
are shown as discontinued operations.
NOTE 11. RELATED PARTY TRANSACTIONS
Warning Management Services, Inc.
The Company CEO and Chairman, Mr. Brian Bonar, is also the CEO and Chairman of
Warning Management, Inc. Warning a public company, located in Southern
California. Warning's operations consist of a modeling agency and providing
temporary staffing services to government agencies and private companies.
GUARANTEE OF INDEBTEDNESS OF WARNING
------------------------------------
As of September 8, 2004, Warning Management Services, Inc. ("Warning") purchased
all of the issued and outstanding shares of Employment Systems, Inc. ("ESI") for
$1,500. The purchase was $750 cash paid at the closing and a $750 note payable.
In connection with this transaction, the Company agreed to be a guarantor of the
$750 note payable. As inducement to enter into this guarantee, the Company was
given a non-cancelable 2-year payroll processing contract with ESI. Management
has evaluated this contingent liability and has determined that no loss is
anticipated as a result of this guarantee.
11
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 for PEO service with
Warning. The Company receives from Warning a monthly administrative fee of $12
and a $20 deposit as an advance against payments due pursuant to this agreement.
The Company recorded revenue totaling $24 during the three months ended
September 30, 2004 from Warning.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company
Annual Report on Form 10-KSB for the year ended June 30, 2004. The statements
contained in this Report on Form 10-QSB that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, including statements regarding our expectations, hopes, intentions
or strategies regarding the future. Forward-looking statements include
statements regarding: future product or product development; future research and
development spending and our product development strategies, and are generally
identifiable by the use of the words "may", "should", "expect", "anticipate",
"estimates", "believe", "intend", or "project" or the negative thereof or other
variations thereon or comparable terminology. Forward-looking statements involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements (or industry results, performance or
achievements) expressed or implied by these forward-looking statements to be
materially different from those predicted. The factors that could affect our
actual results include, but are not limited to, the following: general economic
and business conditions, both nationally and in the regions in which we operate;
competition; changes in business strategy or development plans; our inability to
retain key employees; our inability to obtain sufficient financing to continue
to expand operations; and changes in demand for products by our customers.
OVERVIEW
We provide a variety of financial services to small and medium-size businesses.
These services allow our customers to outsource many human resources tasks,
including payroll processing, workers' compensation insurance, health insurance,
employee benefits, 401k investment services, personal financial management, and
income tax consultation. In November 2001, we began to provide these services to
relieve some of the negative impact they have on the business operations of our
existing and potential customers. To this end, through strategic acquisitions,
we became a professional employer organization ("PEO").
We provide financial services principally through our wholly-owned SourceOne
Group, Inc. ("SOG") subsidiary. These units provide a broad range of financial
services, including: benefits and payroll administration, health and workers'
compensation insurance programs, personnel records management, and employer
liability management. Through our Jackson Staffing subsidiary (and MedicalHR and
CallCenterHR operating units), we provide temporary staffing services to small
and medium-sized businesses - primarily to call centers and medical facilities.
In January 2003, we completed the acquisition of controlling interest
(approximately 85%) in the shares of Greenland Corporation whose shares are
traded on the NASD Electronic Bulletin Board under the symbol GRLC.
Subsequently, in March 2004, we entered into an agreement with Greenland to
return most of our shares in Greenland in return for Greenland's forgiveness of
certain DRDF indebtedness and business opportunities.
In January 2003, we completed the acquisition of a controlling interest (85%) in
the shares of Quik Pix, Inc. ("QPI"). QPI shares are traded on the National
Quotation Bureau Pink Sheets under the symbol QPIX. QPI is a visual marketing
support firm located in Buena Park, California. Its principal service is to
provide photographic and digital images mounted for customer displays in
tradeshow and other displays .Its principal product, PhotoMotion is a patented
color medium of multi-image transparencies. The process uses existing originals
to create the illusion of movement, and allows for three to five distinct images
to be displayed with an existing lightbox.
In September 2003, we hired two key persons and acquired the operations of the
temporary staffing service then owned by Jackson Staffing, LLC. In order to
formalize this arrangement, we entered into an acquisition agreement with
Jackson Staffing effective September 1, 2003 and accordingly, the financial
statements of Jackson Staffing from September 1, 2003 are included in our
financial statements.
13
In April 2004, we transferred our ColorBlind software technology to QPI.
ColorBlind software provides color management to improve the accuracy of color
reproduction - especially as it relates to matching color between different
devices in a network, such as monitors and printers. ColorBlind software
products are marketed internationally through direct distribution, resellers,
and on the internet through our color.com website.
Our business continues to experience operational and liquidity challenges.
Accordingly, year-to-year financial comparisons may be of limited usefulness now
and for the next several periods due to anticipated changes in our business as
these changes relate to potential acquisitions of new businesses and changes in
products and services.
On June 28, 2004, we completed an acquisition of certain assets of M&M Nursing
(M&M"). The purchase price was 5,000,000 shares of our common stock valued at
$31 plus the assumption of $204 of liabilities. M&M is a temporary staffing
agency primarily for nurses.
Our current strategy is: to expand our financial services businesses, including
PEO services and temporary staffing, and to continue to commercialize imaging
technologies, including PhotoMotion Images and ColorBlind color management
software through our QPI subsidiary.
To successfully execute our current strategy, we will need to improve our
working capital position. The report of our independent auditors accompanying
our June 30, 2004 financial statements included in our Annual Report on Form
10KSB includes an explanatory paragraph indicating there is a substantial doubt
about our ability to continue as a going concern, due primarily to our recent
loss from operations, the decreases in our working capital and net worth. We
plan to overcome the circumstances that impact our ability to remain a going
concern through a combination of achieving profitability, raising additional
debt and equity financing, and renegotiating existing obligations.
In recent years, we have been working to reduce costs through the reduction in
staff and reorganizing our business activities. Additionally, we have sought to
reduce our debt through debt to equity conversions. We continue to pursue the
acquisition of businesses that will grow our business.
There can be no assurance that we will be able to complete any additional debt
or equity financings on favorable terms or at all, or that any such financings,
if completed, will be adequate to meet our capital requirements. Any additional
equity or convertible debt financings could result in substantial dilution to
our shareholders. If adequate funds are not available, we may be required to
delay, reduce or eliminate some or all of our planned activities, including any
potential mergers or acquisitions. Our inability to fund our capital
requirements would have a material adverse effect on the Company.
RESTRUCTURING AND NEW BUSINESS UNITS
In April 2004, we transferred our ColorBlind software products and technologies
to our QPI subsidiary in order to focus on financial services and enable QPI to
concentrate on imaging technology products and services.
ACQUISITIONS, DISPOSITIONS AND SALE OF BUSINESS UNITS
In August 2002, we entered into an agreement to acquire controlling interest in
Greenland Corporation. Greenland shares are traded on the Electronic Bulletin
Board under the symbol GRLC. On January 14, 2003, we completed the acquisition
of shares, representing controlling interest, of Greenland. The terms of the
acquisitions were disclosed on Form 8-K filed January 21, 2003.
Pursuant to a mutual agreement between the Board of Directors of both Greenland
Corporation and us, Greenland has been separated from us, effective February,
23, 2004. Under the separation agreement, Greenland forgave its note receivable
from us of $2,250 together with any accrued interest thereon in consideration
for our granting our acquisition rights to acquire ePEO Link to Greenland. In
addition, for returning 95,949,610 shares of Greenland common stock acquired by
us pursuant to our acquisition agreement with Greenland in January 2003,
Greenland forgave its inter-company account receivable from us, which amount
aggregated approximately $1,375. Further, the agreement provided for us to
effect the resignation of our Directors who also served on the Board of
Directors of Greenland, which was completed in March 2004.
14
In September 2003, we hired two key persons, and acquired the operations of the
temporary staffing service then owned by Jackson Staffing, LLC. In order to
formalize this arrangement, we entered into an acquisition agreement with
Jackson Staffing effective September 1, 2003 and accordingly, the financial
statements of Jackson Staffing from September 1, 2003 are included in our
financial statements. On June 28, 2004, we completed an acquisition of certain
assets of M&M Nursing (M&M"). The purchase price was 5,000,000 shares of our
common stock valued at $31 plus the assumption of $204 of liabilities. M&M is a
temporary staffing agency primarily for nurses. The financial statements of M&M
from July 1, 2004 are included in our financial statements.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discuss our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. On an on-going basis, we evaluate our estimates and
judgments, including those related to allowance for doubtful accounts, value of
intangible assets and valuation of non-cash compensation. We base our estimates
and judgments on historical experiences and on various other factors that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. The most significant
accounting estimates inherent in the preparation of our consolidated financial
statements include estimates as to the appropriate carrying value of certain
assets and liabilities which are not readily apparent from other sources,
primarily allowance for doubtful accounts, estimated fair value of equity
instruments used for compensation, estimated tax liabilities fro PEO operations
and estimated liabilities associated with Worker's Compensation liabilities.
These accounting policies are described at relevant sections in this discussion
and analysis and in the notes to the consolidated financial statements included
in our Annual Report on Form l0-KSB for the fiscal year ended June 30, 2004.
REVENUE RECOGNITION
PEO SERVICE FEES AND WORKSITE EMPLOYEE PAYROLL COSTS
----------------------------------------------------
We recognize our revenues associated with our PEO business pursuant to EITF
99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent." Our
revenues are reported net of worksite employee payroll cost (net method).
Pursuant to discussions with the Securities and Exchange Commission staff, we
changed our presentation of revenues from the gross method to an approach that
presents our revenues net of worksite employee payroll costs (net method)
primarily because we are not generally responsible for the output and quality of
work performed by the worksite employees.
In determining the pricing of the markup component of the gross billings, we
take into consideration our estimates of the costs directly associated with our
worksite employees, including payroll taxes, benefits and workers' compensation
costs, plus an acceptable gross profit margin. As a result, our operating
results are significantly impacted by our ability to accurately estimate,
control and manage our direct costs relative to the revenues derived from the
markup component of our gross billings.
Consistent with our revenue recognition policy, our direct costs do not include
the payroll cost of our worksite employees. Our direct costs associated with our
revenue generating activities are comprised of all other costs related to our
worksite employees, such as the employer portion of payroll-related taxes,
employee benefit plan premiums and workers' compensation insurance premiums.
15
SALES OF PRODUCTS
-----------------
Revenue is recognized when earned. Our revenue recognition policies are in
compliance with all applicable accounting regulations, including American
Institute of Certified Public Accountants (AICPA) Statement of Position (SOP)
97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, With
Respect to Certain Transactions. Revenue from products licensed to original
equipment manufacturers is recorded when OEMs ship licensed products while
revenue from certain license programs is recorded when the software has been
delivered and the customer is invoiced. Revenue from packaged product sales to
and through distributors and resellers is recorded when related products are
shipped. Maintenance and subscription revenue is recognized ratably over the
contract period. When the revenue recognition criteria required for distributor
and reseller arrangements are not met, revenue is recognized as payments are
received. Provisions are recorded for returns and bad debts. Our software
arrangements do not contain multiple elements, and we do not offer post contract
support.
TEMPORARY STAFFING
------------------
We record gross revenue for temporary staffing. We have concluded that gross
reporting is appropriate because we (i) have the risk of identifying and hiring
qualified employees, (ii) have the discretion to select the employees and
establish their price and duties and (iii) bear the risk for services that are
not fully paid for by customers. Temporary staffing revenues are recognized when
the services are rendered by our temporary employees. Temporary employees placed
by us are our legal employees while they are working on assignments. We pay all
related costs of employment, including workers' compensation insurance, state
and federal unemployment taxes, social security and certain fringe benefits. We
assume the risk of acceptability of our employees to our customers.
RESULTS OF OPERATIONS (IN $000)
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
------------------------------------------------------------------------------
30, 2003
--------
REVENUES
Total revenues were $4,428 and $2,361 for the three months ended September 30,
2004 and 2003, respectively; an increase of $2,067 (88%). The increase was due
primarily to the addition of temporary staffing services, which contributed
$3,905 of revenues for the three months ended September 30, 2004.
PEO SERVICES
PEO revenues were $372 and $1,427 for the three months ended September 30, 2004
and 2003, respectively; a decrease of $1,055 (74%) due primarily to the decrease
in our PEO customer base.
TEMPORARY STAFFING
In September 2003, we entered into an agreement to purchase a temporary staffing
business through the organization of CallCenterHR and MedicalHR and the
acquisition of Jackson Staffing. In June 2004, we entered into an agreement to
purchase certain assets of M&M Nursing, a temporary staffing agency for nurses.
Temporary Staffing revenues were $3,905 and $767 for the three months ended
September 30, 2004 and 2003, respectively; an increase of $3,138 (409%). The
significant increase is due to the acquisition of Jackson Staffing and M&M
Nursing.
IMAGING PRODUCTS
Sales of imaging products were generated principally from our QPI subsidiary.
Imaging Products revenues were $125 and $131 for the three months ended
September 30, 2004 and 2003, respectively; a decrease of $6 (5%).
SOFTWARE
Software revenues were $26 and $36 for the three months ended September 30, 2004
and 2003, respectively; a decrease of $10 (28%). The reduction in software
revenues was due to a delay in completing certain versions of our software which
can be used with multiple computer operating systems. Revenues from licenses and
royalties for the periods were insignificant.
16
Royalties and licensing fees vary from quarter to quarter and are dependent on
the sales of products sold by OEM customers using our technologies. These
revenues continue to decline as we have elected to transfer our ColorBlind
software to QPI, which has accelerated product development and begun to
implement a more aggressive product sales program.
COST OF PRODUCTS SOLD
Cost of PEO services for the three months ended September 30, 2004 and 2003 $280
(75% of PEO revenues) and $1,270 (89% of PEO revenues), respectively. The
increase in gross profit is due primarily to us being able to provide more
profitable services to our PEO customers.
Costs of temporary staffing for the three months ended September 30, 2004 was
$3,548 (91% of temporary staffing revenue) and $693 (90% of temporary staffing
revenue), respectively. The significant increase is due to the increase in
temporary staffing revenue.
Cost of products sold for the three months ended September 30, 2004 and 2003
were $23 (18% of product sales) and $83 (63% of product sales), respectively.
Product sales continue to decline as we concentrate on other products and
services. The increase in margins is due primarily to changes in product mix and
our competitive position with customers.
Cost of software, licenses and royalties for the three months ended September
30, 2004 and 2003 were $3 (12% of software, license and royalties revenue) and
$3 (8% of software, license and royalties revenue), respectively.
OPERATING EXPENSES
Operating expenses have consisted primarily of salaries and commissions of sales
and marketing personnel, salaries and related costs for general corporate
functions, including finance, accounting, facilities and legal, advertising,
rent, depreciation and amortization, and other marketing related expenses, and
fees for professional services.
Operating expenses for the three months ended September 30, 2004 and 2003 were
$1,009 and $1,904, respectively; a decrease of $895 (47%). The significant
decrease is due to a reduction of payroll and related benefits due to a
significant reduction in our personnel. Also, as disclosed in "Significant
Accounting Policies and Estimates", we rely on estimates for such liabilities
related to, among other areas, worker's compensation and accrued payroll taxes.
During the three months ended September 30, 2004, we changed our estimate of
workers' compensation claims aggregating approximately $200.
OTHER INCOME AND EXPENSE
Interest expense for the three months ended September 30, 2004 and 2003 was $483
and $328 respectively; an increase of $155 (47%). The increase is principally
due to i) the write off of the unamortized debt discounts associated with the
conversion of debentures into common stock, ii) the penalties and interest
incurred for not registering shares underlying the conversion of certain
convertible debentures, and iii) an increase in the amount of debt outstanding.
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 three months
ended September 30, 2004 and the year ended June 30, 2004, we issued an
additional 50,058,676 and 371,126,679 shares, respectively. These shares of
common stock were issued primarily for corporate expenses in lieu of cash, for
acquisition of businesses, for the conversion of convertible debentures and
other debt, and for the exercise of warrants.
As of June 30, 2004, we had negative working capital of $22,517, a decrease in
working capital of $581 since June 30, 2004. This decrease was due primarily to
the increase in PEO payroll tax liabilities.
17
Net cash used in operating activities was $436 for the three months ended
September 30, 2004 as compared to net cash used in activities of $465 for the
prior-year period; a decrease of $29.
Cash provided by financing activities was $264 for the three months ended
September 30, 2004, an increase of $411 from the prior-year period. The increase
is principally a result of $275 received from the issuance of a note payable.
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 September 30, 2004, was
approximately $425.
Our capital requirements depend on numerous factors, including market acceptance
of our products and services, the resources we devote to marketing and selling
our products and services, and other factors. The report of our independent
auditors accompanying our June 30, 2004 financial statements includes an
explanatory paragraph indicating there is a substantial doubt about our ability
to continue as a going concern, due primarily to the decreases in our working
capital and net worth.
CONTINGENT LIABILITY
--------------------
The Company accrues and discloses contingent liabilities in its consolidated
financial statements in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 5, Accounting for Contingencies. SFAS No. 5 requires
accrual of contingent liabilities that are considered probable to occur and that
can be reasonably estimated. For contingent liabilities that are considered
reasonably possible to occur, financial statement disclosure is required,
including the range of possible loss if it can be reasonably determined. The
Company has disclosed in its audited financial statements several issues that it
believes are reasonably possible to occur, although it cannot determine the
range of possible loss in all cases. As these issues develop, the Company will
continue to evaluate the probability of future loss and the potential range of
such losses. If such evaluation were to determine that a loss was probable and
the loss could be reasonably estimated, the Company would be required to accrue
its estimated loss, which would reduce net income in the period that such
determination was made.
Off-Balance Sheet Arrangements
------------------------------
There are no off balance sheet arrangements that have or are reasonably likely
to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors, except
for the following.. As of September 8, 2004, Warning Management Services, Inc.
("Warning") purchased all of the issued and outstanding shares of Employment
Systems, Inc. ("ESI") for $1,500. The purchase was $750 cash paid at the closing
and a $750 note payable. In connection with this transaction, the Company agreed
to be a guarantor of the $750 note payable. Our CEO, Brian Bonar, is also the
CEO of Warning. As inducement to enter into this guarantee, we were given a
non-cancelable 2-year payroll processing contract with ESI. Currently the $750
note payable is in dispute. Warning is claiming that certain representations
made by ESI were not correct and is proposing that the purchase price be
reduced, thus reducing the $750 note payable to $258. Management has evaluated
this contingent liability and has determined that no loss is anticipated as a
result of this guarantee.
RISKS AND UNCERTAINTIES
Risks Relating to our Business:
-------------------------------
IF WE ARE UNABLE TO SECURE FUTURE CAPITAL, WE WILL BE UNABLE TO CONTINUE OUR
OPERATIONS.
Our business has not been profitable in the past and it may not be profitable in
the future. We may incur losses on a quarterly or annual basis for a number of
reasons, some within and others outside our control. See "Potential Fluctuation
in Our Quarterly Performance." The growth of our business will require the
commitment of substantial capital resources. If funds are not available from
operations, we will need additional funds. We may seek such additional funding
through public and private financing, including debt or equity financing.
Adequate funds for these purposes, whether through financial markets or from
other sources, may not be available when we need them. Even if funds are
available, the terms under which the funds are available to us may not be
acceptable to us. Insufficient funds may require us to delay, reduce or
eliminate some or all of our planned activities.
18
To successfully execute our current strategy, we will need to improve our
working capital position. The report of our independent auditors accompanying
the Company's June 30, 2003 financial statements includes an explanatory
paragraph indicating there is a substantial doubt about the Company's ability to
continue as a going concern, due primarily to the decreases in our working
capital and net worth. The Company plans to overcome the circumstances that
impact our ability to remain a going concern through a combination of increased
revenues and decreased costs, with interim cash flow deficiencies being
addressed through additional equity financing.
IF OUR QUARTERLY PERFORMANCE CONTINUES TO FLUCTUATE, IT MAY HAVE A NEGATIVE
IMPACT ON OUR BUSINESS.
Our quarterly operating results can fluctuate significantly depending on a
number of factors, any one of which could have a negative impact on our results
of operations. We may experience significant quarterly fluctuations in revenues
and operating expenses as we introduce new products and services. Accordingly,
any inaccuracy in our forecasts could adversely affect our financial condition
and results of operations. Demand for our products and services could be
adversely affected by a slowdown in the overall demand for imaging products
and/or financial and PEO services. Our failure to complete shipments during a
quarter could have a material adverse effect on our results of operations for
that quarter. Quarterly results are not necessarily indicative of future
performance for any particular period.
SINCE MANY OF OUR COMPETITORS HAVE GREATER FINANCIAL AND MARKETING RESOURCES
THAN WE DO, WE MAY EXPERIENCE A REDUCTION IN MARKET SHARE AND REVENUES.
The markets for our products and services are highly competitive and rapidly
changing. Some of our current and prospective competitors have significantly
greater financial, technical, and marketing resources than we do. Our ability to
compete in our markets depends on a number of factors, some within and others
outside our control. These factors include: the frequency and success of product
and services introductions by us and by our competitors, the selling prices of
our products and services and of our competitors' products and services, the
performance of our products and of our competitors' products, product
distribution by us and by our competitors, our marketing ability and the
marketing ability of our competitors, and the quality of customer support
offered by us and by our competitors.
The PEO industry is highly fragmented. While many of our competitors have
limited operations, there are several PEO companies equal or substantially
greater in size than ours. We also encounter competition from "fee-for-service"
companies such as payroll processing firms, insurance companies, and human
resources consultants. The large PEO companies have substantially more resources
than us and provide a broader range of resources than we do.
IF WE ACQUIRE COMPLEMENTARY BUSINESSES, WE MAY NOT BE ABLE TO EFFECTIVELY
INTEGRATE THEM INTO OUR CURRENT OPERATIONS, WHICH WOULD ADVERSELY AFFECT OUR
OVERALL FINANCIAL PERFORMANCE.
In order to grow our business, we may acquire businesses that we believe are
complementary. To successfully implement this strategy, we must identify
suitable acquisition candidates, acquire these candidates on acceptable terms,
integrate their operations and technology successfully with ours, retain
existing customers and maintain the goodwill of the acquired business. We may
fail in our efforts to implement one or more of these tasks. Moreover, in
pursuing acquisition opportunities, we may compete for acquisition targets with
other companies with similar growth strategies. Some of these competitors may be
larger and have greater financial and other resources than we do. Competition
for these acquisition targets likely could also result in increased prices of
acquisition targets and a diminished pool of companies available for
acquisition. Our overall financial performance will be materially and adversely
affected if we are unable to manage internal or acquisition-based growth
effectively. Acquisitions involve a number of risks, including: integrating
acquired products and technologies in a timely manner, integrating businesses
and employees with our business, managing geographically-dispersed operations,
reductions in our reported operating results from acquisition-related charges
and amortization of goodwill, potential increases in stock compensation expense
and increased compensation expense resulting from newly-hired employees, the
diversion of management attention, the assumption of unknown liabilities,
potential disputes with the sellers of one or more acquired entities, our
inability to maintain customers or goodwill of an acquired business, the need to
divest unwanted assets or products, and the possible failure to retain key
acquired personnel.
19
Client satisfaction or performance problems with an acquired business could also
have a material adverse effect on our reputation, and any acquired business
could significantly under perform relative to our expectations. We cannot be
certain that we will be able to integrate acquired businesses, products or
technologies successfully or in a timely manner in accordance with our strategic
objectives, which could have a material adverse effect on our overall financial
performance.
In addition, if we issue equity securities as consideration for any future
acquisitions, existing stockholders will experience ownership dilution and these
equity securities may have rights, preferences or privileges superior to those
of our common stock.
IF WE ARE UNABLE TO DEVELOP AND/OR ACQUIRE NEW PRODUCTS IN A TIMELY MANNER, WE
MAY EXPERIENCE A SIGNIFICANT DECLINE IN SALES AND REVENUES, WHICH MAY HURT OUR
ABILITY TO CONTINUE OPERATIONS.
The markets for our products are characterized by rapidly evolving technology,
frequent new product introductions and significant price competition.
Consequently, short product life cycles and reductions in product selling prices
due to competitive pressures over the life of a product are common. Our future
success will depend on our ability to continue to develop new versions of our
ColorBlind software, and to acquire competitive products from other
manufacturers. We monitor new technology developments and coordinate with
suppliers, distributors and dealers to enhance our products and to lower costs.
If we are unable to develop and acquire new, competitive products in a timely
manner, our financial condition and results of operations will be adversely
affected.
IF WE ARE FOUND TO BE INFRINGING ON A COMPETITOR'S INTELLECTUAL PROPERTY RIGHTS
OR IF WE ARE REQUIRED TO DEFEND AGAINST A CLAIM OF INFRINGEMENT, WE MAY BE
REQUIRED TO REDESIGN OUR PRODUCTS OR DEFEND A LEGAL ACTION AT SUBSTANTIAL COSTS
TO US.
We currently hold only one patent through our QPI subsidiary for its Photomotion
product. Our software products 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.
IF OUR DISTRIBUTORS REDUCE OR DISCONTINUE SALES OF OUR PRODUCTS, OUR BUSINESS
MAY BE MATERIALLY AND ADVERSELY AFFECTED.
Our products are marketed and sold through a distribution channel of value added
resellers, manufacturers' representatives, retail vendors, and systems
integrators. We have a small network of dealers and distributors in the United
States and internationally. We support our worldwide distribution network and
end-user customers through operations headquartered in San Diego.
Portions of our sales are made through distributors, who may carry competing
product lines. These distributors could reduce or discontinue sales of our
products, which could adversely affect us. These independent distributors may
not devote the resources necessary to provide effective sales and marketing
support of our products. In addition, we are dependent upon the continued
viability and financial stability of these distributors, many of which are small
organizations with limited capital. These distributors, in turn, are
substantially dependent on general economic conditions and other unique factors
affecting our markets.
INCREASES IN HEALTH INSURANCE PREMIUMS, UNEMPLOYMENT TAXES, AND WORKERS'
COMPENSATION RATES WILL HAVE A SIGNIFICANT EFFECT ON OUR FUTURE FINANCIAL
PERFORMANCE.
Health insurance premiums, state unemployment taxes, and workers' compensation
rates are, in part, determined by our PEO companies' claims experience, and
comprise a significant portion of our direct costs. We employ risk management
procedures in an attempt to control claims incidence and structure our benefits
contracts to provide as much cost stability as possible. However, should we
20
experience a large increase in claims activity, the unemployment taxes, health
insurance premiums, or workers' compensation insurance rates we pay could
increase. Our ability to incorporate such increases into service fees to clients
is generally constrained by contractual agreements with our clients.
Consequently, we could experience a delay before such increases could be
reflected in the service fees we charge. As a result, such increases could have
a material adverse effect on our financial condition or results of operations.
WE CARRY SUBSTANTIAL LIABILITY FOR WORKSITE EMPLOYEE PAYROLL AND BENEFITS COSTS.
Under our client service agreements, we become a co-employer of worksite
employees and we assume the obligations to pay the salaries, wages, and related
benefits costs and payroll taxes of such worksite employees. We assume such
obligations as a principal, not merely as an agent of the client company. Our
obligations include responsibility for (a) payment of the salaries and wages for
work performed by worksite employees, regardless of whether the client company
makes timely payment to us of the associated service fee; and (2) providing
benefits to worksite employees even if the costs incurred by us to provide such
benefits exceed the fees paid by the client company. If a client company does
not pay us, or if the costs of benefits provided to worksite employees exceed
the fees paid by a client company, our ultimate liability for worksite employee
payroll and benefits costs could have a material adverse effect on the our
financial condition or results of operations.
AS A MAJOR EMPLOYER, OUR OPERATIONS ARE AFFECTED BY NUMEROUS FEDERAL, STATE, AND
LOCAL LAWS RELATED TO LABOR, TAX, AND EMPLOYMENT MATTERS.
By entering into a co-employer relationship with employees assigned to work at
client company locations, we assume certain obligations and responsibilities or
an employer under these laws. However, many of these laws (such as the Employee
Retirement Income Security Act ("ERISA") and federal and state employment tax
laws) do not specifically address the obligations and responsibilities of
non-traditional employers such as PEOs; and the definition of "employer" under
these laws is not uniform. Additionally, some of the states in which we operate
have not addressed the PEO relationship for purposes of compliance with
applicable state laws governing the employer/employee relationship. If these
other federal or state laws are ultimately applied to our PEO relationship with
our worksite employees in a manner adverse to us, such an application could have
a material adverse effect on our financial condition or results of operations.
While many states do not explicitly regulate PEOs, over 20 states have passed
laws that have licensing or registration requirements for PEOs, and several
other states are considering such regulation. 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. There
can be no assurance that we will be able to satisfy licensing requirements of
other applicable relations for all states. Additionally, there can be no
assurance that we will be able to renew our licenses in all states.
THE MAINTENANCE OF HEALTH AND WORKERS' COMPENSATION INSURANCE PLANS THAT COVER
WORKSITE EMPLOYEES IS A SIGNIFICANT PART OF OUR BUSINESS.
The current health and workers' compensation contracts are provided by vendors
with whom we have an established relationship, and on terms that we believe to
be favorable. While we believe that replacement contracts could be secured on
competitive terms without causing significant disruption to our business, there
can be no assurance in this regard.
OUR STANDARD AGREEMENTS WITH PEO CLIENTS ARE SUBJECT TO CANCELLATION ON 60-DAYS
WRITTEN NOTICE BY EITHER THE COMPANY OR THE CLIENT.
Accordingly, the short-term nature of our client service agreements make us
vulnerable to potential cancellations by existing clients, which could
materially and adversely affect our financial condition and results of
operations. Additionally, our results of operations are dependent, in part, upon
our ability to retain or replace client companies upon the termination or
cancellation of our agreements.
21
A NUMBER OF PEO INDUSTRY LEGAL ISSUES REMAIN UNRESOLVED WITH RESPECT TO THE
CO-EMPLOYMENT AGREEMENT BETWEEN A PEO AND ITS WORKSITE EMPLOYEES, INCLUDING
QUESTIONS CONCERNING THE ULTIMATE LIABILITY FOR VIOLATIONS OF EMPLOYMENT AND
DISCRIMINATION LAWS.
Our client service agreement establishes a contractual division of
responsibilities between our clients and us for various personnel management
matters, including compliance with and liability under various government
regulations. However, because we act as a co-employer, we may be subject to
liability for violations of these or other laws despite these contractual
provisions, even if we do not participate in such violations. Although our
agreement provides that the client is to indemnify us for any liability
attributable to the conduct of the client, we may not be able to collect on such
a contractual indemnification claim, and thus may be responsible for satisfying
such liabilities. Additionally, worksite employees may be deemed to be our
agents, subjecting us to liability for the actions of such worksite employees.
IF THE SUPERIOR SECURITY INTEREST HELD BY IMPERIAL BANK IS REMOVED AND IF ALL OF
THE LAWSUITS CURRENTLY FILED WERE DECIDED AGAINST US AND/OR ALL THE JUDGMENTS
CURRENTLY OBTAINED AGAINST US WERE TO BE IMMEDIATELY COLLECTED, WE WOULD HAVE TO
CEASE OUR OPERATIONS.
Throughout fiscal 2001, 2002 and 2003, and through the date of this filing,
approximately fifty trade creditors have made claims and/or filed actions
alleging the failure of us to pay our obligations to them in a total amount
exceeding $3 million. These actions are in various stages of litigation, with
many resulting in judgments being entered against us. Several of those who have
obtained judgments have filed judgment liens on our assets. These claims range
in value from less than one thousand dollars to just over one million dollars,
with the great majority being less than twenty thousand dollars. Should we be
required to pay the full amount demanded in each of these claims and lawsuits,
we may have to cease our operations. However, to date, the superior security
interest held by Imperial Bank has prevented nearly all of these trade creditors
from collecting on their judgments.
IF OUR OPERATIONS CONTINUE TO RESULT IN A NET LOSS, NEGATIVE WORKING CAPITAL AND
A DECLINE IN NET WORTH, AND WE ARE UNABLE TO OBTAIN NEEDED FUNDING, WE MAY BE
FORCED TO DISCONTINUE OPERATIONS.
For several recent periods, up through the present, we had a net loss and
negative working capital, which raises substantial doubt about our ability to
continue as a going concern. Our losses have resulted primarily from an
inability to achieve revenue targets due to insufficient working capital. Our
ability to continue operations will depend on positive cash flow, if any, from
future operations and on our ability to raise additional funds through equity or
debt financing. Although we have reduced our work force, suspended some of our
operations, and entered into new market segments (financial services), if we are
unable to achieve the necessary revenues or raise or obtain needed funding, we
may be forced to discontinue operations.
IF AN OPERATIONAL RECEIVER IS REINSTATED TO CONTROL OUR OPERATIONS, WE MAY NOT
BE ABLE TO CARRY OUT OUR BUSINESS PLAN.
On August 20, 1999, at the request of Imperial Bank, our primary lender, the
Superior Court, San Diego appointed an operational receiver to us. On August 23,
1999, the operational receiver took control of our day-to-day operations. On
June 21, 2000, the Superior Court, San Diego issued an order dismissing the
operational receiver as a part of a settlement of litigation with Imperial Bank
pursuant to the Settlement Agreement effective as of June 20, 2000. The
Settlement Agreement requires that we make monthly payments of $150,000 to
Imperial Bank until the indebtedness is paid in full. This agreement does not
require us to pay any interest unless we default on the settlement agreement and
fail to cure the default. Regardless, we have continued to accrue interest on
this debt until it has been paid and there is no possibility that such interest
will become due and payable. However, in the future, without additional funding
sufficient to satisfy Imperial Bank and our other creditors, as well as
providing for our working capital, there can be no assurances that an
operational receiver may not be reinstated. If an operational receiver is
reinstated, we will not be able to expand our products nor will we have complete
control over sales policies or the allocation of funds.
22
The penalty for noncompliance of the Settlement Agreement is a stipulated
judgment that allows Imperial Bank to immediately reinstate the operational
receiver and begin liquidation proceedings against us. Our current arrangement
with CoAmerica Bank (formerly Imperial Bank) reduces are monthly payments of
$50,000. The remaining balance due as of September 30, 2004, is $3.1 million.
WE HAVE NOT REMAINED CURRENT IN OUR PAYMENT OF FEDERAL AND STATE INCOME AND
OTHER PAYROLL-RELATED TAXES WITHHELD IN OUR PEO BUSINESS.
We have not been able to remain current in our payments of federal and state tax
obligations related to our PEO operations. We are currently working with the
Internal Revenue Service and state agencies to resolve these issues and
establish repayment plans. If we are not able to establish repayment plans that
allow us to continue our operations, we may be forced to cease doing business in
the financial services marketplace. The amount due as of September 30, 2004 is
approximately $6.4 million.
RISKS RELATING TO OUR STOCK:
THE ISSUANCE OF THE SHARES IN THIS OFFERING, PLUS THE EXISTING OUTSTANDING
CONVERTIBLE NOTES, WILL RESULT IN DILUTION.
There are a large number of shares underlying the convertible note and warrants
in this offering that may be available for future sale and the sale of these
shares may depress the market price of DRDF's common stock and may cause
substantial dilution to DRDF's existing stockholders.
The number of shares of common stock issuable upon conversion of the convertible
note in this offering may increase if the market price of DRDF's stock declines.
All of the shares, including all of the shares issuable upon conversion of the
notes and debentures and upon exercise of DRDF's warrants, may be sold without
restriction. The sale of these shares may adversely affect the market price of
DRDF's common stock. The issuance of shares upon conversion of the convertible
notes and debentures and exercise of outstanding warrants will also cause
immediate and substantial dilution to DRDF's existing stockholders and may make
it difficult to obtain additional capital.
The following gives examples of the number of shares that would be issued if the
debentures in this offering were converted at one time at prices representing
70%, 50%, and 25% of the current market price (assuming a market price of
approximately $0.01. As of September 30, 2004, we had 602,417,418 shares of
common stock outstanding.
- 70% of current stock price:
DRDF's stock converted at 70% of current stock price would result in a debenture
conversion rate of $.007 cents. To convert the $800,000 convertible debenture
would require 114,285,714 shares of DRDF's common stock, or 19% of DRDF's
current outstanding shares.
- 50% of current stock price:
DRDF's stock converted at 50% of current stock price would result in a debenture
conversion rate of $.005 cents. To convert the $800,000 convertible debenture
would require 160,000,000 shares of DRDF's common stock, or 26% of DRDF's
current outstanding shares.
- 25% of current stock price
DRDF's stock converted at 25% of current stock price would result in a debenture
conversion rate of $.0025 cents. To convert the $800,000 of convertible
debentures would require 320,000,000 shares of DRDF's common stock, or 54% of
DRDF's current outstanding shares.
THE OVERHANG AFFECT FROM THE RESALE OF THE SELLING SHAREHOLDERS SECURITIES ON
THE MARKET COULD RESULT IN LOWER STOCK PRICES WHEN CONVERTED
Overhang can translate into a potential decrease in DRDF's market price per
share. The common stock underlying unconverted debentures represents overhang.
These debentures are converted into common stock at a discount to the market
price providing the debenture holder the ability to sell his or her stock at or
below market and still make a profit, which is incentive for the holder to sell
23
the shares as quickly as possible to ensure as much profit as possible in case
the stock price falls. If the share volume cannot absorb the discounted shares,
DRDF's market price per share will likely decrease. As the market price
decreases, each subsequent conversion will require a larger quantity of shares.
SHORT SELLING COMMON STOCK BY WARRANT AND DEBENTURE HOLDERS MAY DRIVE DOWN THE
MARKET PRICE OF DRDF'S STOCK.
The warrant and debenture holder may sell shares of DRDF's common stock on the
market before exercising the warrant or converting the debenture. The stock is
usually offered at or below market since the warrant and debenture holders
receive stock at a discount to market. Once the sale is completed the holders
exercise or convert a like dollar amount of shares. If the stock sale lowered
the market price, upon exercise or conversion, the holders would receive a
greater number of shares then they would have absent the short sale. This
pattern may result in the spiraling down of DRDF's stock's market price.
THE MARKET PRICE OF OUR COMMON STOCK HISTORICALLY HAS FLUCTUATED SIGNIFICANTLY.
Our stock price could fluctuate significantly in the future based upon any
number of factors such as: general stock market trends, announcements of
developments related to our business, fluctuations in our operating results, a
shortfall in our revenues or earnings compared to the estimates of securities
analysts, announcements of technological innovations, new products or
enhancements by us or our competitors, general conditions in the markets we
serve, general conditions in the worldwide economy, developments in patents or
other intellectual property rights, and developments in our relationships with
our customers and suppliers.
In addition, in recent years the stock market in general, and the market for
shares of technology and other stocks have experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
affected companies. Similarly, the market price of our common stock may
fluctuate significantly based upon factors unrelated to our operating
performance.
DRDF'S COMMON STOCK IS SUBJECT TO THE "PENNY STOCK" RULES OF THE SEC AND THE
TRADING MARKET IN DRDF'S SECURITIES IS LIMITED, WHICH MAKES TRANSACTIONS IN
DRDF'S STOCK CUMBERSOME AND MAY REDUCE THE VALUE OF AN INVESTMENT IN DRDF'S
STOCK.
DRDF's shares of Common Stock are "penny stocks" as defined in the Exchange Act,
which are quoted in the over-the-counter market on the OTC Bulletin Board. As a
result, an investor may find it more difficult to dispose of or obtain accurate
quotations as to the price of the shares of the Common Stock being registered
hereby. In addition, the "penny stock" rules adopted by the Commission under the
Exchange Act subject the sale of the shares of the Common Stock to certain
regulations which impose sales practice requirements on broker-dealers. For
example, broker-dealers selling such securities must, prior to effecting the
transaction, provide their customers with a document that discloses the risks of
investing in such securities. Included in this document are the following:
- The bid and offer price quotes for the penny stock, and the
number of shares to which the quoted prices apply.
- The brokerage firm's compensation for the trade.
- The compensation received by the brokerages firm's salesperson
for the trade.
In addition, the brokerage firm must send the investor:
- Monthly account statement that gives an estimate of the value
of each penny stock in your account.
- A written statement of your financial situation and investment
goals.
24
Legal remedies, which may be available to you, are as follows:
- If penny stocks are sold to you in violation of your rights
listed above, or other federal or state securities laws, you
may be able to cancel your purchase and get your money back.
- If the stocks are sold in a fraudulent manner, you may be able
to sue the persons and firms that caused the fraud for
damages.
- If you have signed an arbitration agreement, however, you may
have to pursue your claim through arbitration.
If the person purchasing the securities is someone other than an accredited
investor or an established customer of the broker-dealer, the broker-dealer must
also approve the potential customer's account by obtaining information
concerning the customer's financial situation, investment experience and
investment objectives. The broker-dealer must also make a determination whether
the transaction is suitable for the customer and whether the customer has
sufficient knowledge and experience in financial matters to be reasonably
expected to be capable of evaluating the risk of transactions in such
securities. Accordingly, the Commission's rules may limit the number of
potential purchasers of the shares of the Common Stock.
RESALE RESTRICTIONS ON TRANSFERRING "PENNY STOCKS" ARE SOMETIMES IMPOSED BY SOME
STATES, WHICH MAY MAKE TRANSACTIONS IN OUR STOCK CUMBERSOME AND MAY REDUCE THE
VALUE OF AN INVESTMENT IN OUR STOCK.
Various state securities laws impose restrictions on transferring "penny stocks"
and as a result, investors in the Common Stock may have their ability to sell
their shares of the Common Stock impaired. For example, the Utah Securities
Commission prohibits brokers from soliciting buyers for "penny stocks", which
makes selling them more difficult.
DRDF'S ABSENCE OF DIVIDENDS OR THE ABILITY TO PAY THEM PLACES A LIMITATION ON
ANY INVESTORS RETURN.
DRDF anticipates that for the foreseeable future, earnings will be retained for
the development of its business. Accordingly, DRDF does not anticipate paying
dividends on the common stock in the foreseeable future. The payment of future
dividends will be at the sole discretion of DRDF's Board of Directors and will
depend on DRDF's general business condition.
Information about forward-looking statements
--------------------------------------------
This report contains certain forward-looking statements, which involve
substantial risks and uncertainties. These forward-looking statements can
generally be identified because the context of the statement includes words such
as "may," "will," "except," "anticipate," "intend," "estimate," "continue,"
"believe," or other similar words. Similarly, this prospectus also contains
forward-looking statements about our future. Forward-looking statements include
statements about our plans, objectives, goals, strategies, expectations for the
future, future performance and events, underlying assumptions for all of the
above, and other statements, which are not statements of historical facts.
These forward-looking statements involve risks and uncertainties discussed in
the risk factor section, which could cause our actual results to materially
differ from our forward-looking statements. We make these forward-looking
statements based on our analysis of internal and external historical trends, but
there can be no assurance that we will achieve the results set forth in these
forward-looking statements. Our forward-looking statements are expressed in good
faith and we believe that there is a reasonable basis for us to make them.
We have no obligation to update or revise these forward-looking statements to
reflect future events.
25
ITEM 3. CONTROLS AND PROCEDURES
As required by SEC rules, we have evaluated the effectiveness of the design and
operation of our disclosure controls and procedures at the end of the period
covered by this report. This evaluation was carried out under the supervision
and with the participation of our management, including our principal executive
officer and principal financial officer. Based on this evaluation, these
officers have concluded that the design and operation of our disclosure controls
and procedures are effective. There were no changes in our internal control over
financial reporting or in other factors that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by us in the reports that we file under the Exchange Act is
accumulated and communicated to our management, including principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 1999, the law firms of Weiss & Yourman and Stull, Stull & Brody made
a public announcement that they had filed a lawsuit against the Company and
certain current and past officers and/or directors, alleging violation of
federal securities laws and, in November 1999, the lawsuit, filed in the name of
Nahid Nazarian Behfarin, on her own behalf and others purported to be similarly
situated, was served on the Company. In January 2003, the Company entered into a
Stipulation of Settlement with the plaintiffs. It agreed to pay the plaintiffs
5,000,000 shares of common stock and $200 in cash. The Parties have accepted the
settlement. DRDF has issued the shares, and its insurance carrier has paid the
$200 cash payment. Pursuant to a hearing in May 2003 the Court provided approval
to the settlement.
On August 22, 2002, the Company was sued by its former landlord, Carmel Mountain
#8 Associates, L.P. or past due rent on its former facilities at 15175
Innovation Drive, San Diego, CA 92127.
DRDF was a party to a lawsuit filed by Symphony Partners, L.P. related to its
acquisition of SourceOne Group, LLC. As reported on Form 8-K, dated July 22,
2003, the plaintiffs sought payment of $702. In June 2003, the Company entered
into a settlement with the plaintiffs for a cash payment of $274, which has been
paid.
DRDF is one of dozens of companies sued by The Massachusetts Institute of
Technology, et al., related to a patent held by the plaintiffs that may be
related to part of the Company's ColorBlind software. Subsequent to the period
reported in this filing, in June 2003, the Company entered into a settlement
with the plaintiffs who have agreed to dismiss their claims against DRDF with
prejudice in exchange for a settlement fee payment of $10, which has been paid.
The Company has been sued in Illinois state court along with AIA/Mirriman, its
insurance brokers by the Arena Football League-2 ("AFS"). Damages payable to
AF2, should they win the suit, could exceed $700. The Company expects to defend
its position and rely on representations of its insurance brokers.
Throughout fiscal 2003 and 2004, and through the date of this filing, trade
creditors have made claims and/or filed actions alleging the failure of the
Company to pay its obligations to them in a total amount exceeding $3,000. These
actions are in various stages of litigation, with many resulting in judgments
being entered against the Company. Several of those who have obtained judgments
have filed judgment liens on the Company's assets. These claims range in value
from less than one thousand dollars to just over one million dollars, with the
great majority being less than twenty thousand dollars.
26
In connection with the Company's acquisition of controlling interest of Quik
Pix, Inc., we are unaware of any pending litigation. From time to time, QPI may
be involved in litigation relating to claims arising out of its operations in
the normal course of business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Common Stock
------------
During the three months ended September 30, 2004, DRDF issued the following:
o 1,950,000 shares of its common stock for legal and consulting
services valued at $10. The value of the services was
determined using the market value of DRDF's common stock on
the date of issuance;
o 10,108,676 shares of its common stock for debt of $21; and
o 38,000,000 shares of its common stock for the conversion of
convertible debentures in the amount of $175.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is currently in default on certain bank loans that have an aggregate
outstanding balance at September 30, 2004 of $3,220,000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
31.1 Rule 13a-14(a) Certification
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
--------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 22, 2004
DALRADA FINANCIAL CORPORATION
(Registrant)
By: /S/ Brian Bonar
-------------------------------------
Brian Bonar
Chairman , Chief Executive Officer, and Acting Chief Financial Officer
27