** **

**U.S. SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Quarter ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition periodfrom         to**

**Commissionfile number 1-11568**

**DYNTEK, INC.**

(Exact Name of Registrantas Specified in its Charter)

| **Delaware**                     |   | **95-4228470**       |
|----------------------------------|--------|----------------------|
| (State or other  jurisdiction of |   | (I.R.S Employer      |
| incorporation or  organization)  |   | Identification  No.) |

 
| **19700 Fairchild Road, Suite 230  Irvine, CA 92612** |
|------------------------------------------------------------|
| (Address of  principal executive offices) (Zip code)       |

Registrant’s telephone number, including area code **(949)271-6700**

Indicate by check whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months, (or for suchshorter period that the Registrant was required to file such reports), and(2) has been subject to such filings requirements for the past 90days.  Yes ý  Noo

Indicateby check mark whether the registrant is a large accelerated filter, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one): 
| Large accelerated  filer  o | Accelerated  filer  o | Non-accelerated  filer  x |
|---------------------------------------|---------------------------------|-------------------------------------|

 

Indicateby check mark whether the Registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).

Yes  o  No  x

As of February 20, 2007, the number of sharesoutstanding of the registrant’s Common Stock, $.0001 par value, was 58,187,640.

 

 

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**DYNTEK, INC. AND SUBSIDIARIES**

**INDEX**
| **PART I — FINANCIAL  INFORMATION**                                                                                                                               |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                        |   |
| Item 1. Condensed Consolidated Financial Statements                                                                                                                         |   |
|                                                                                                                                                                        |   |
| Condensed Consolidated Balance Sheets — as of  December 31, 2006 (unaudited) and June 30, 2006                                                               |   |
|                                                                                                                                                                        |   |
| Condensed Consolidated Statements of Operations and  Comprehensive Loss (unaudited) - For the Three and Six Months Ended  December 31, 2006 and December 31, 2005 |   |
|                                                                                                                                                                        |   |
| Condensed Consolidated Statements of Cash Flows  (unaudited) - For the Six Months Ended December 31, 2006 and  December 31, 2005                                  |   |
|                                                                                                                                                                        |   |
| Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                                                           |   |
|                                                                                                                                                                        |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                         |   |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                                                                                         |   |
| Item  4. Controls and Procedures                                                                                                                                            |   |
|                                                                                                                                                                        |   |
| **PART II  - OTHER INFORMATION**                                                                                                                                       |   |
| Item  1A. Risk Factors                                                                                                                                                      |   |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                                                                                |   |
| Item  6. Exhibits                                                                                                                                                           |   |
|                                                                                                                                                                        |   |
| **SIGNATURE**                                                                                                                                                               |   |

 

2

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**1. PART 1 —FINANCIAL INFORMATION**

**ITEM 1. CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**DYNTEK,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS**(in thousands, except share data)
| ** **                                                                                                                                                                                |   | **December  31, 2006** |   | **June 30, 2006** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
| ** **                                                                                                                                                                                |   | **(Unaudited)**             |   | ** **                  |   |
| ASSETS                                                                                                                                                                                    |   |                        |   |                        |   |
| CURRENT ASSETS:                                                                                                                                                                           |   |                        |   |                        |   |
| Cash                                                                                                                                                                                      |   | $                           | 466    |                        | $      | 546 |   |
| Cash —  Restricted                                                                                                                                                                   |   | 614                         |   | 644                         |   |
| Accounts  receivable, net                                                                                                                                                                 |   | 1,769                       |   | 1,881                       |   |
| Due from NETF                                                                                                                                                                             |   | 2,963                       |   | 2,817                       |   |
| Inventory                                                                                                                                                                                 |   | 53                          |   | 193                         |   |
| Prepaid expenses  and other current assets                                                                                                                                                |   | 324                         |   | 101                         |   |
| Other  receivables                                                                                                                                                                        |   | 137                         |   | 118                         |   |
| TOTAL CURRENT  ASSETS                                                                                                                                                                     |   | 6,326                       |   | 6,300                       |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| RESTRICTED CASH — non  current portion                                                                                                                                               |   | 300                         |   | 559                         |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| PROPERTY AND EQUIPMENT,  net                                                                                                                                                              |   | 777                         |   | 763                         |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| GOODWILL                                                                                                                                                                                  |   | 18,752                      |   | 18,767                      |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| ACQUIRED CUSTOMER  LISTS, net                                                                                                                                                             |   | 4,260                       |   | 2,722                       |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| DEFERRED FINANCING  COSTS, net                                                                                                                                                            |   | 284                         |   | 304                         |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| DEPOSITS AND OTHER  ASSETS                                                                                                                                                                |   | 558                         |   | 273                         |   |
|                                                                                                                                                                                      |   | $                           | 31,257 |                        | $      | 29,688 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                |   |                        |   |                        |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| CURRENT LIABILITIES:                                                                                                                                                                      |   |                        |   |                        |   |
| Cash overdraft                                                                                                                                                                            |   | $                           | 261    |                        | $      | 168 |   |
| Accounts payable                                                                                                                                                                          |   | 2,302                       |   | 2,090                       |   |
| Accrued expenses                                                                                                                                                                          |   | 2,042                       |   | 2,705                       |   |
| Acquisition  indebtedness                                                                                                                                                                 |   | 223                         |   | —                      |   |
| Deferred revenue                                                                                                                                                                          |   | 1,631                       |   | 1,036                       |   |
| Current  liabilities of discontinued operations                                                                                                                                           |   | 258                         |   | 258                         |   |
| TOTAL CURRENT  LIABILITIES                                                                                                                                                                |   | 6,717                       |   | 6,257                       |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| DEFERRED REVENUE — non  current portion                                                                                                                                              |   | 247                         |   | 529                         |   |
| NOTES PAYABLE                                                                                                                                                                             |   | 6,542                       |   | 2,021                       |   |
| TOTAL  LIABILITIES                                                                                                                                                                        |   | 13,506                      |   | 8,807                       |   |
|                                                                                                                                                                                      |   |                        |   |                        |   |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                            |   |                        |   |                        |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                |   |                        |   |                        |   |
| Preferred stock,  $.0001 par value, 10,000,000 shares authorized; 0 and 0 shares issued and  outstanding as of December 31, 2006 and June 30, 2006, respectively                          |   | —                      |   | —                      |   |
| Class A Common  stock, $.0001 par value, 450,000,000 shares authorized; 58,187,640 and  55,180,586 shares issued and outstanding as of December 31, 2006 and June 30,  2006, respectively |   | 6                           |   | 6                           |   |
| Additional  paid-in capital                                                                                                                                                               |   | 148,873                     |   | 146,783                     |   |
| Accumulated  other comprehensive income — foreign currency translation                                                                                                               |   | (73                         | )      | —                      |   |
| Accumulated  deficit                                                                                                                                                                      |   | (131,055                    | )      | (125,908                    | )      |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                                                                                          |   | 17,751                      |   | 20,881                      |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                          |   | $                           | 31,257 |                        | $      | 29,688 |   |

 

The accompanying notes are anintegral part of these condensed consolidated financial statements.

3

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**DYNTEK,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME(LOSS)(Unaudited)(in thousands, except per share data)**
| ** **                                                                      | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| REVENUES:                                                                       | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product Revenues                                                                |       | $                                                   | 12,353     |                                              | $          | 12,428 |   | $ | 29,136 |   | $ | 28,583 |   |
| Service Revenues                                                                |       | 6,170                                               |       | 6,416                                             |       | 11,164 |   | 13,696 |   |
| Total revenues                                                                  |       | 18,523                                              |       | 18,844                                            |       | 40,300 |   | 42,279 |   |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| COST OF  REVENUES:                                                              |       |                                                |       |                                              |       |   |   |   |   |
| Cost of products                                                                |       | 10,437                                              |       | 11,039                                            |       | 25,032 |   | 25,191 |   |
| Cost of services                                                                |       | 4,363                                               |       | 4,616                                             |       | 7,929 |   | 9,785 |   |
| Total cost of revenues                                                          |       | 14,800                                              |       | 15,655                                            |       | 32,961 |   | 34,976 |   |
| GROSS PROFIT                                                                    |       | 3,723                                               |       | 3,189                                             |       | 7,339 |   | 7,303 |   |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| OPERATING  EXPENSES:                                                            |       |                                                |       |                                              |       |   |   |   |   |
| Selling                                                                         |       | 2,640                                               |       | 3,000                                             |       | 5,233 |   | 6,176 |   |
| General and administrative                                                      |       | 1,033                                               |       | 1,051                                             |       | 2,376 |   | 2,485 |   |
| Depreciation and amortization                                                   |       | 679                                                 |       | 650                                               |       | 1,372 |   | 1,380 |   |
| Total operating expenses                                                        |       | 4,352                                               |       | 4,701                                             |       | 8,981 |   | 10,041 |   |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| LOSS FROM  OPERATIONS                                                           |       | (629                                                | )          | (1,512                                            | )          | (1,642 | ) | (2,738 | ) |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| OTHER INCOME  (EXPENSE):                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Gain on marketable securities                                                   |       | —                                              |       | —                                            |       | — |   | 54 |   |
| Interest expense                                                                |       | (1,936                                              | )          | (2,759                                            | )          | (3,490 | ) | (3,493 | ) |
| Other income (expense)                                                          |       | (14                                                 | )          | 1                                                 |       | (12 | ) | — |   |
| Interest income                                                                 |       | 16                                                  |       | 15                                                |       | 35 |   | 24 |   |
| Total other income (expense)                                                    |       | (1,934                                              | )          | (2,744                                            | )          | (3,467 | ) | (3,415 | ) |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| LOSS FROM  CONTINUING OPERATIONS BEFORE INCOME TAXES                            |       | $                                                   | (2,563     | )                                                 | $          | (4,256 | ) | $ | (5,109 | ) | $ | (6,153 | ) |
| INCOME TAX                                                                      |       | —                                              |       | —                                            |       | 38 |   | — |   |
| LOSS FROM  CONTINUING OPERATIONS                                                |       | (2,563                                              | )          | (4,256                                            | )          | (5,147 | ) | (6,153 | ) |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| DISCONTINUED  OPERATIONS                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Gain on disposal of discontinued operations                                     |       | —                                              |       | —                                            |       | — |   | 216 |   |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| NET LOSS                                                                        |       | $                                                   | (2,563     | )                                                 | $          | (4,256 | ) | $ | (5,147 | ) | $ | (5,937 | ) |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| NET LOSS PER  SHARE: Basic and Diluted                                          |       |                                                |       |                                              |       |   |   |   |   |
| Continuing Operations                                                           |       | (.05                                                | )          | (.05                                              | )          | (.09 | ) | (.09 | ) |
| Discontinued Operations                                                         |       | —                                              |       | —                                            |       | — |   | — |   |
|                                                                            |       | $                                                   | (.05       | )                                                 | $          | (.05 | ) | $ | (.09 | ) | $ | (.09 | ) |
| WEIGHTED AVERAGE  NUMBER OF SHARES USED IN COMPUTATION — Basic and Diluted |       | 57,714,466                                          |       | 8,116,464                                         |       | 57,153,408 |   | 7,882,363 |   |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| NET LOSS                                                                        |       | $                                                   | (2,563     | )                                                 | $          | (4,256 | ) | $ | (5,147 | ) | $ | (5,937 | ) |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| OTHER  COMPREHENSIVE INCOME, NET OF TAX                                         |       |                                                |       |                                              |       |   |   |   |   |
| Foreign currency translation gain                                               |       | (85                                                 | )          | —                                            |       | 40 |   | — |   |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| COMPREHENSIVE LOSS                                                              |       | $                                                   | (2,648     | )                                                 | $          | (4,256 | ) | $ | (5,107 | ) | $ | (5,937 | ) |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

4

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**DYNTEK, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**(Unaudited)(in thousands)**
| ** **                                                                                              | ** ** | **Six Months Ended   December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                  |       |                                                    |       |   |   |
| Net loss-Continuing operations                                                                          |       | $                                                       | (5,147     | ) | $ | (6,153 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities:                        |       |                                                    |       |   |   |
| Depreciation and amortization                                                                           |       | 1,372                                                   |       | 1,380 |   |
| Non-cash interest                                                                                       |       | 2,688                                                   |       | 2,371 |   |
| Stock-based compensation                                                                                |       | 676                                                     |       | 205 |   |
| Gain in marketable securities                                                                           |       | —                                                  |       | (54 | ) |
| Changes in operating assets and liabilities:                                                            |       |                                                    |       |   |   |
| Accounts receivable                                                                                     |       | 112                                                     |       | 14,814 |   |
| Due from NETF                                                                                           |       | (146                                                    | )          | (1,214 | ) |
| Inventory                                                                                               |       | 140                                                     |       | 1,090 |   |
| Prepaid expenses and other current assets                                                               |       | (223                                                    | )          | 12 |   |
| Other receivables                                                                                       |       | (19                                                     | )          | (511 | ) |
| Deposits and other assets                                                                               |       | (285                                                    | )          | (68 | ) |
| Accounts payable                                                                                        |       | 211                                                     |       | (4,248 | ) |
| Deferred revenue                                                                                        |       | (228                                                    | )          | 344 |   |
| Accrued expenses                                                                                        |       | (662                                                    | )          | (1,043 | ) |
| Restricted cash                                                                                         |       | 289                                                     |       | (918 | ) |
| Total adjustments                                                                                       |       | 3,925                                                   |       | 12,078 |   |
| NET CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS                                                    |       | (1,222                                                  | )          | 5,925 |   |
|                                                                                                    |       |                                                    |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                  |       |                                                    |       |   |   |
| Cash from disposition of marketable securities                                                          |       | —                                                  |       | 54 |   |
| Cash paid for acquisitions                                                                              |       | (1,576                                                  | )          | (2,530 | ) |
| Capital expenditures                                                                                    |       | (161                                                    | )          | (173 | ) |
| NET CASH USED IN INVESTING ACTIVITIES                                                                   |       | (1,737                                                  | )          | (2,649 | ) |
|                                                                                                    |       |                                                    |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                  |       |                                                    |       |   |   |
| Cash overdraft                                                                                          |       | 93                                                      |       | (967 | ) |
| Proceeds from debt financing                                                                            |       | 3,000                                                   |       | 2,500 |   |
| Deferred financing costs                                                                                |       | (26                                                     | )          | (371 | ) |
| Net proceeds under line of credit                                                                       |       | —                                                  |       | (4,697 | ) |
| Exercise of options and warrants                                                                        |       | 1                                                       |       | — |   |
| Purchase of Treasury stock, net                                                                         |       | (108                                                    | )          | — |   |
| Principal payments                                                                                      |       | —                                                  |       | (605 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                               |       | 2,959                                                   |       | (4,140 | ) |
| CASH FLOWS OF  DISCONTINUED OPERATIONS:                                                                 |       |                                                    |       |   |   |
| Operating cash flows                                                                                    |       | —                                                  |       | 145 |   |
| NET CASH PROVIDED BY DISCONTINUED OPERATIONS                                                            |       | —                                                  |       | 145 |   |
| Effects of  exchange rate changes on monetary assets and liabilities denominated in  foreign currencies |       | (80                                                     | )          | — |   |
| NET INCREASE  (DECREASE) IN CASH                                                                        |       | (79                                                     | )          | (719 | ) |
| CASH AT  BEGINNING OF PERIOD                                                                            |       | 546                                                     |       | 963 |   |
| CASH AT END OF PERIOD                                                                                   |       | $                                                       | 466        |   | $ | 244 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

5

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**DYNTEK, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(UNAUDITED)

(in thousands, exceptshare data)

 
| ** **                                                              | ** ** | **Six Months Ended   December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                      | ** ** | ** **                                              | ** ** | ** ** | ** ** |
|                                                                    |       |                                                    |       |   |   |
| Cash paid for interest                                                  |       | $                                                       | 745        |   | $ | 558 |   |
|                                                                    |       |                                                    |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES |       |                                                    |       |   |   |
| Acquisition of Sensible Security Solutions, Inc. in  2006:              |       |                                                    |       |   |   |
| Fixed assets                                                            |       | 70                                                      |       | — |   |
| Accounts receivable                                                     |       | 32                                                      |       | — |   |
| Intangible assets customer list                                         |       | 1,534                                                   |       | — |   |
| Non cash consideration                                                  |       | (300                                                    | )          | — |   |
| Contingent consideration                                                |       | (223                                                    | )          | — |   |
| Cash paid to acquire businesses                                         |       | 1,113                                                   |       | — |   |
|                                                                    |       |                                                    |       |   |   |
| Acquisition of TekConnect Inc. in 2006:                                 |       |                                                    |       |   |   |
| Intangible assets customer list                                         |       | 1,003                                                   |       | — |   |
| Deferred Revenue (contract obligations)                                 |       | (540                                                    | )          | — |   |
| Cash paid to acquire  businesses                                        |       | 463                                                     |       | — |   |
|                                                                         |            |                                                         |            |  |  |  |  |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

6

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**DYNTEK, INC. &SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTSDecember 31, 2006(UNAUDITED)**

**1.****             ****BASIS OF PRESENTATION**

The accompanying unaudited condensedconsolidated financial statements of DynTek, Inc. and its subsidiaries (“DynTek”,“Company”, or “we”) have been prepared in accordance with accounting principlesgenerally accepted in the United States of America, for interim financialstatements and pursuant to the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosuresrequired for annual financial statements. These condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and related footnotesfor the year ended June 30, 2006 included in the Form 10-K for theyear then ended.

The accompanying condensed consolidatedfinancial statements reflect all adjustments, which, in the opinion ofmanagement consist of normal recurring items that are necessary for a fairpresentation in conformity with accounting principles generally accepted in theUnited States of America.   Preparingcondensed consolidated financial statements requires management to makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses.  Theresults of operations for any interim period are not necessarily indicative ofthe results attainable for a full fiscal year.

**2.****             ****LIQUIDITY AND FINANCIAL CONDITION**

TheCompany provides professional information technology (“IT”) solutions and salesof related products and services to mid-market commercial businesses, state andlocal government agencies, and educational institutions.  During the six months ended December 31,2006, the Company incurred a net loss of $5,147,000, which includes $4,736,000of non-cash charges resulting from $1,372,000 of depreciation and amortization;$676,000 in stock-based compensation; and $2,688,000 in non-cash interestcharges.  At December 31, 2006, theCompany had a working capital deficiency of approximately $391,000.

As described in Note 6,the Company entered into a Second Amendment to Note Purchase Agreement (the “SecondAmendment”) on September 26, 2006 in which the Company issued to Trust A-4 —Lloyd I. Miller a Junior Secured Convertible Note in the aggregate principalamount of $3,000,000 (the “Third Junior Note”) on substantially the same termsset forth in the Junior Note and the Additional Junior Note (both of which aredefined herein) with the additional collateralization of 66% of the Company’sassets and stock of its wholly-owned Canadian subsidiary.  The proceeds of the Third Junior Note arebeing used to finance acquisitions and for general corporate purposes.

On October 6, 2006, theCompany utilized a portion of the proceeds from the Third Junior Note to enterinto Asset Purchase Agreement for substantially all of the assets ofTekConnect, Inc.  In consideration forthe purchased assets, the Company paid to sellers $400,000 at closing, incurred$63,000 of direct acquisition costs and assumed $540,000 pre-existing contractobligations.

TheCompany also utilized a portion of the Third Junior Note on October 27, 2006,when the Company, DynTek Canada, an Ontario corporation and wholly-ownedsubsidiary of the Company (“DynTek Canada”), Sensible Security Solutions, Inc.,an Ontario corporation (“SSS”), and Paul Saucier, an individual and 100% ownerof SSS, entered into an Asset Purchase Agreement for substantially all of theassets of SSS.  In consideration for thepurchased assets, the Company agreed to pay SSS at closing a cash payment of$1,063,000 and 1,485,148 shares of the Company’s common stock based upon theper share fair value in accordance with EITF 99-12. Additional fees inconnection with the acquisition of approximately $50,000 were also paid. Inaddition, the Company has agreed to make additional payments over a three-yearperiod based upon the achievement of certain EBITDA performance targets. Such payments will be paid using a combination of cash and the Company’s commonstock, at the Company’s election, provided that at least half of the paymentswill be in cash (see Note 4). For the period ended December 31, 2006, theearn-out provision was estimated to be $222,926 based upon achieved EBITDA performancetargets and classified as a current liability in accordance with SFAS No. 150.The Company intends to distribute payment, half to be paid in cash and half tobe issuable in shares of the Company’s common stock at a price of $0.20 pershare.

The Companyexperiences timing differences in its operating cash flows resulting fromthe fact that much its revenues are earned near the end of eachquarter and its operating expenses are incurred evenlythroughout the period. The Company also experiences slow collectioncycles with respect to customers that are educational and governmentinstitutions, which has been a growth area of the business.  Although theCompany has experienced low rates of uncollectible accounts, many ofits customers pay beyond their terms.

7

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Slow collections have causedthe Company to incur higher fees under its accounts receivable and productfinancing arrangements with New England Technology Finance, LLC (“NETF”)(see Note 7).   Although the Company uses its facility with NETFto better manage the timing differences in its operating cashflows, accounts receivable due from customers under its newly acquiredCanadian business are currently ineligible for transfer. Thesecircumstances have caused the Company to experience additional constraints onits liquidity, which are likely to continue until such time that theacquired business is fully integrated.

Although theCompany has made substantial efforts to accelerate collections under itsCompany wide operations, slow collection cycles, ongoing timingdifferences and efforts to integrate acquired businesses could causethe Company to seek additional outside financing.

The Company believes thatits strategy of streamlining the business around its core competency ofproviding IT solutions is enabling it to operate under a more efficient coststructure than it had in the past. The Company is also not required to makeprincipal payments under any of its note obligations until June 2009 andits accounts receivable and product financing arrangement with NETF isproviding it with timely working capital resources.

The Company may continueto expand the scope of its products and services offerings by pursuingacquisition candidates with complementary technologies, services or products.The Company would finance such acquisitions (if made) by using its own workingcapital and/or issuing additional debt and equity securities. There can be noassurance, however, that the Company will identify appropriate acquisitioncandidates or that, if appropriate candidates are identified, that it will besuccessful in obtaining the financing needed to complete the acquisitions.

In the event of anyadditional financing, any equity financing would likely result in dilution toour existing stockholders and any debt financing may include restrictivecovenants.

In January 2007, theCompany received a comment letter on a Registration Statement on Form S-1indicating that the Company may have violated Section 5 of the Securities Actin connection with its issuance of the Third Junior Note to the Junior Lender(Note 6).  An investor’s remedy for violations of Section 5 of theSecurities Act could include making a demand for a rescission of theinvestment.  While the Company believes that its issuance of thesesecurities was in compliance with Section 5 and any other applicableregulations, it nonetheless requested and received from the Lenders, waiversand releases of any rescission rights in connection with any such potentialSection 5 violation. The Company obtained such waivers on February 2, 2007.Accordingly, the Company has continued to classify the obligations under thenotes as non-current liabilities in the accompanying balance sheet.

The Company believes thatit has sufficient liquidity to sustain the business through January 31, 2008,however, there can be no assurance that unforeseen circumstances will not havea material affect on the business that could require it to raise additionalcapital or take other measures to sustain operations in the event outsidesources of capital are not available. The Company has not secured anycommitments for new financing at this time nor can it provide any assurancethat new capital will be available to it on acceptable terms, if at all.

**3.****             SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

A.           Principles ofConsolidation - The consolidated financial statements include the accounts ofthe Company and its wholly-owned subsidiaries. All significant inter-companytransactions have been eliminated.

B.             RevenueRecognition.  The Company applies therevenue recognition principles set forth under SOP 97-2 and SAB 104 withrespect to all revenue.  The Companyadheres strictly to the criteria set forth in paragraph .08 of SOP 97-2 andoutlined in SAB 104 which provides for revenue to be recognized when (i)persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii)the vendor’s fee is fixed or determinable, and (iv) collectability is probable.

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*Computer Hardware Product Revenues*

TheCompany requires its hardware product sales to be supported by a writtencontract or other evidence of a sale transaction that clearly indicates theselling price to the customer, shipping terms, payment terms (generally 30days) and refund policy, if any. Since the Company’s hardware sales aresupported by a contract or other document that clearly indicates the terms ofthe transaction, and the selling price is fixed at the time the sale isconsummated, the Company records revenue on these sales at the time in which itreceives a confirmation that the goods were tendered at their destination whenshipped “FOB destination,” or upon confirmation that shipment has occurred whenshipped “FOB shipping point.”

*Software Product Revenues*

TheCompany makes substantially all of its software product sales as a reseller oflicenses, which may include a post contract customer support arrangement andaccess to product and upgrades, and enhancements that are provided exclusivelyby the manufacturer following delivery and the customer’s acceptance of thesoftware product. The Company does not presently sell any software that itdevelops internally.  Any responsibilityfor technical support and access to upgrades and enhancements to these softwareproducts are solely the responsibility of the software manufacturer, whicharrangement is known to the customer at the time the sale is consummated.  With respect to delivery, the Companyrequires that the customer has received transfer of the software or, at aminimum, an authorization code (“key”) to permit access to the product.  If a software license is delivered to thecustomer, but the license term has not begun, the Company does not record therevenue prior to inception of the license term.

TheCompany requires its software product sales to be supported by a writtencontract or other evidence of a sale transaction, which generally consists of acustomer purchase order or on-line authorization.  These forms of evidence clearly indicate theselling price to the customer, shipping terms, payment terms (generally 30 days)and refund policy, if any. The selling prices of these products are fixed atthe time the sale is consummated.

Forproduct sales, the Company applies the factors discussed in Emerging IssuesTask Force Issue “EITF” 99-19 in determining whether to recognize productrevenues on a gross or net basis.

Ina substantial majority of transactions, the Company (i) acts as principal; (ii)takes title to the products; and (iii) has the risks and rewards of ownership,including the risk of loss for collection, delivery or returns.  For these transactions, the Companyrecognizes revenues based on the gross amounts billed to customers.  In certain circumstances, based on ananalysis of the factors set forth in EITF 99-19, the Company has determinedthat it was acting as an agent, and therefore recognizes revenues on a netbasis.  For the six months ended December31, 2006 and 2005 respectively, no revenues were recognized on a net basis.

*IT Services Revenue*

TheCompany generally bills its customers for professional IT services based onhours of time spent on any given assignment at its hourly billing rates. As itrelates to delivery of these services, the Company recognizes revenue underthese arrangements as the work is completed and the customer has indicatedacceptance of services by approving a work order milestone or completionorder.   For certain engagements, theCompany enters fixed bid contracts, and recognizes revenue as phases of theproject are completed and accepted by the client.  For its seat management services, the Companyenters unit-price contracts (e.g., price per user for seat management), andrecognizes revenue based on number of units multiplied by the agreed-uponcontract unit price per month.

C.             Cashand Cash Equivalents — The Company considers all highly liquid temporary cashinvestments with an original maturity of three months or less when purchased,to be cash equivalents.

D.            Allowance forDoubtful Accounts - The Company has a policy of reserving for uncollectibleaccounts based on its best estimate of the amount of probable credit losses inits existing accounts receivable. The Company periodically reviews its accountsreceivable to determine whether an allowance is necessary based on an analysisof past due accounts and other factors that may indicate that the realizationof an account may be in doubt. Account balances deemed to be uncollectible arecharged to the allowance after all means of collection have been exhausted andthe potential for recovery is considered remote.

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The Company sells its eligible accounts receivablewith limited recourse to NETF under each of an Asset Purchase and LiabilityAssumption Agreement and an Asset Purchase Agreement that it entered into withNETF during the year ended June 30, 2006. The Company retains certainservicing rights under a related Master Servicing Agreement that provides forthe Company to manage collections and other ongoing interactions with customersfor certain contractual fees.

TheCompany accounts for its transfers of accounts receivable to NETF under each ofthese agreements in accordance with the provision of *SFAS 140*“Accounting for Transfers andServicing of Financial Assets and Extinguishment of Liabilities” assales of such accounts receivable balances. The gain or loss on sales of receivablesto NETF is determined at the date of transfer based upon the amount at whichthey are transferred to NETF less any fees, discounts and other chargesprovided under the agreements (see Note 7).

E.              Property andEquipment - Property and equipment is stated at cost and is depreciated on astraight-line basis over the estimated useful lives of the assets. Leaseholdimprovements are amortized over the term of their respective leases or servicelives of the improvements, whichever is shorter.

F.              Income (loss) perCommon Share - Basic earnings per share has been calculated based upon theweighted average number of common shares outstanding. Convertible preferredstock, convertible debt, options and warrants have been excluded as commonstock equivalents in the diluted earnings per share because they areanti-dilutive.  The aggregate number ofpotential common stock equivalents outstanding as of December 31, 2006 is asfollows:

|                  | ** ** | **As of December 31,** | ** ** |
|------------------|------------|---------------------------------------|------------|
| ** **       | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| Common stock     |       | 58,187,640                            |       | 8,116,464 |   |
| Warrants         |       | 34,373,473                            |       | 2,349,047 |   |
| Options          |       | 10,107,064                            |       | 360,429 |   |
| Convertible debt |       | 37,723,382                            |       | 2,410,565 |   |
|             |       | 140,391,559                           |       | 13,236,505 |   |

 

G.             Estimates- The Company’s financial statements and accompanying notes are prepared inaccordance with accounting principles generally accepted in the United States.Preparing financial statements requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenue,and expenses. These estimates and assumptions are affected by management’sapplication of accounting policies. Critical accounting policies includerevenue recognition, impairment of goodwill, and accounting for discontinuedoperations.

H.            StockBased Compensation — Effective July 1, 2005, the Company adopted FASB Statementof Financial Accounting Standard (“SFAS”) No. 123R “Share Based Payment”.  This statement is a revision of SFASStatement No. 123, and supersedesAPB Opinion No. 25, and its related implementation guidance. SFAS 123R addressesall forms of share based payment (“SBP”) awards including shares issued underemployee stock purchase plans, stock options, restricted stock and stockappreciation rights. Under SFAS 123R, SBP awards result in a cost that will bemeasured at fair value on the awards’ grant date, based on the estimated numberof awards that are expected to vest that will result in a charge tooperations.  Consequently, during the sixmonths ended December 30, 2005, the Company recognized $205,000 in expenses,which represents the fair value of stock option awards that the Company electedto accelerate vesting during that period. During the six months ended December 31, 2006, the Company recognized$676,000 in expenses, which includes $240,000 for the fair value of stock optionawarded to two non-employee board members; $40,000 of stock grants awarded totwo non-employee board members, and a $200,000 stock grant to a key employee.

I.                 FairValue of Financial Instruments - The carrying amounts reported in the balancesheet for cash, trade receivables, accounts payable and accrued expensesapproximate fair value based on the short-term maturity of theseinstruments.  The carrying amounts ofnotes receivable approximate fair value as such instruments feature contractualinterest rates that are consistent with current market rates of interest. Thecarrying amounts of notes payable approximate fair value because the effectiveyields of such instruments, which includes the effect of contractual interestrates taken together with discounts resulting from the concurrent issuances ofcommon stock purchase warrants, are consistent with current market rates ofinterest.

J.                Goodwill- Goodwill represents the excess of the purchase price over the fair value ofnet assets acquired in business combinations (Note 4).  SFAS 142, Goodwill and Other Intangible Assets, requires that goodwill betested for impairment at the reporting unit level (operating segment or onelevel below an operating segment) on an annual basis (June 30th for the Company) and between annual tests whencircumstances indicate that the recoverability of 

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the carrying amount ofgoodwill may be in doubt. Application of the goodwill impairment test requiresjudgment, including the identification of reporting units, assigning assets andliabilities to reporting units, assigning goodwill to reporting units, anddetermining the fair value. Significant judgments required to estimate the fairvalue of reporting units include estimating future cash flows, determiningappropriate discount rates and other assumptions. Changes in these estimatesand assumptions could materially affect the determination of fair value and/orgoodwill impairment for each reporting unit.

K.            ComprehensiveIncome (Loss) - Comprehensive income (loss) is comprised of net income (loss)and all changes to the statements of stockholders’ equity, except for changesthat relate to investments made by stockholders, changes in paid-in capital anddistributions.

L.              Inventory- Inventory consist primarily of finished goods in transit, which are recordedat the lower of cost or market.

M.         AdvertisingCosts - Costs related to advertising and promotions of services are charged tosales operating expense as incurred. Advertising expense amounted toapproximately $48,100 and $95,900 for the six months ended December 31, 2006and 2005 respectively. These expenses are included in selling expenses in theaccompanying statements of operations.

N.            Shippingand Handling Costs - The Company accounts for shipping and handling costs as acomponent of “Cost of Product Revenues.” These costs are primarily the directfreight costs related to the “drop shipment” of products to the Company’scustomers. Shipping and handling costs amounted to approximately $59,800 and$256,800 for the six months ended December 31, 2006 and 2005, respectively.

O.            ConvertibleNotes - The Company accounts for conversion options embedded in convertiblenotes in accordance with Statement of Financial Accounting Standard (“SFAS)No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS133”) and EITF 00-19 “Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”).SFAS 133 generally requires companies to bifurcate conversion options embeddedin convertible notes from their host instruments and to account for them asfree standing derivative financial instruments in accordance with EITF 00-19.SFAS 133 provides for an exception to this rule when convertible notes, ashost instruments, are deemed to be conventional as that term is described inthe implementation guidance under Appendix A to SFAS 133 and further clarifiedin EITF 05-2 “The Meaning of “Conventional Convertible Debt Instrument”in Issue No. 00-19.

The Company accounts for convertible notes (deemedconventional) in accordance with the provisions of Emerging Issues Task ForceIssue (“EITF”) 98-5 “Accounting for Convertible Securities withBeneficial Conversion Features,” (“EITF 98-5”), EITF 00-27 “Applicationof EITF 98-5 to Certain Convertible Instruments,” Accordingly, theCompany records, as a discount to convertible notes, the intrinsic value ofsuch conversion options based upon the differences between the fair value ofthe underlying common stock at the commitment date of the note transaction andthe effective conversion price embedded in the note. Debt discounts under thesearrangements are amortized over the term of the related debt to their earliestdate of redemption.

P.              Registration Rights- The Company accounts for registration rights as separate derivativeinstruments in accordance with “View C” of EITF Issue No. 05-4, “TheEffect of a Liquidated Damages Clause on a Freestanding Financial InstrumentSubject to EITF Issue No. 00-19, ‘Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock. TheCompany is currently subject to registration rights agreements entered intoconcurrently with the debt obligations described in Note 6, which provide forstock based liquidated damages to be paid to such note holders in the event ofthe Company’s failure to comply with the registration rights agreements. Thepotential number of shares issuable as liquidated damages under this agreementis fixed and determinable. The fair value of the liquidated damage provision isinsignificant to the Company’s financial statements.

Q.            Foreign Currency - Theconsolidated financial statements are presented in United States dollars inaccordance with SFAS No. 52, “Foreign Currency Translation”. The functionalcurrency of DynTek Canada, Inc., the Company’s Canadian Subsidiary is theCanadian dollar.  Foreign denominatedmonetary assets are translated to United States dollars using foreign exchangerates in effect at the balance sheet date. Revenues and expenses are translatedat the average rate of exchange during the period. Gain or losses arising onforeign currency transactions are included in the determination of operatingresults. The effect of foreign currency transaction adjustments wasapproximately $13,500 for the period ended December 31, 2006.

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R.             New AccountingStandards

InSeptember 2006, the FASB issued Statement of Financial Accountings StandardsNo. 157, Fair Value Measurements (“SFAS 157”). This Standard defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements.SFAS 157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. Theadoption of SFAS 157 is not expected to have a material impact on the Company’sfinancial position, results of operations or cash flows.

InJuly 2006, the FASB issued FASB Interpretation No. 48, Accounting forUncertainty in Income Taxes. This Interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.This Interpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition. The Interpretation is effective for fiscal years beginning afterDecember 15, 2006. We have not yet completed our analysis of the impact thisInterpretation will have on our financial condition, results of operations,cash flows or disclosures.

In September 2006, theSecurities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin 108,Considering the Effects on Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements, (“SAB 108”). SAB 108requires registrants to quantify errors using both the income statement method(i.e. iron curtain method) and the rollover method and requires adjustments ifeither method indicates a material error. If a correction in the current year relating to prior year errors ismaterial to the current year, then the prior year financial information needsto be corrected. A correction to the prior year results that are not materialto those years, would not require a restatement process where prior financialswould be amended.  SAB 108 is effectivefor fiscal years ending after November 15, 2006. The Company does not anticipatethat SAB 108 will have a material effect on its financial position, results ofoperations or cash flows.

Otheraccounting standards that have been issued or proposed by the FASB or otherstandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on the consolidated financial statementsupon adoption.

**4.****             ****BUSINESS ACQUISITION**

**SensibleSecurity Solutions, Inc**

OnOctober 27, 2006, the Company, DynTek Canada, an Ontario corporation and whollyowned subsidiary of the Company (“DynTek Canada”), Sensible Security Solutions,Inc., an Ontario corporation (“SSS”), and Paul Saucier, an individual and 100%owner of SSS, entered into an Asset Purchase Agreement for the acquisition byDynTek Canada of substantially all of the assets of SSS. SSS provides majorCanadian organizations, both in the private and public sector, with the designand implementation of comprehensive, enterprise-level anti-virus solutions. TheCompany acquired SSS because it was aligned with the Company’s existing coresecurities practice, provides a greater density within its Canadian region, andprovides for a more comprehensive delivery of its service support coast tocoast.

 In consideration for the purchased assets, theCompany paid SSS at closing a cash payment of $1,063,000 and 1,485,148 sharesof the Company’s common stock based upon the per share fair value in accordancewith EITF 99-12. Additional fees in connection with the acquisition ofapproximately $50,000 were also paid.

TheCompany is obligated to make additional payments of up to $4,700,000 over athree-year period based upon the achievement of certain EBITDA performancetargets. Such payments will be paid quarterly for the first year of theearn-out and annually for each of the next two years using a combination ofcash and the Company’s common stock, at the Company’s election, provided thatat least half of the payments will be in cash. Earn-out awards will becalculated, subject to adjustment, based upon the cumulative effect of achievedEBITDA performance targets during the applicable earn-out period.  Determination and notification of the EBITDAEarn-out shall be provided to SSS within 45 days after the end of each earn-outperiod. Progressive cash payments and/or stock issuances are due within 15 daysof the notification of the EBITDA Earn-out. Earn-out shares issued are to be held in escrow by the Company until thefinal annual EBITDA Earn-out provision is determination. SSS is obligated torepay over payments made by the Company with respect to the cumulative

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effect of achievedannual EBITDA performance; however, the repayment obligation may be satisfiedin either cash or the return of earn-out shares at the sole discretion of SSSand in no event shall the repayment obligation exceed the number of Earn-outshares issued by the Company, in the event that Paul Saucier, the former ownerof SSS, is terminated by the Company without cause, the Company will berequired to pay to SSS pursuant to the earn-out an amount equal to $3.6million, less the aggregate purchase price previously paid to SSS as of thedate of termination.  In addition, if thetotal of the earn-out payments would exceed $3.6 million, then the Company willbe required to continue payments under the earn-out in accordance with theAsset Purchase Agreement (see Note 10).

Forthe period ended December 31, 2006, the Earn-Out provision was estimated to be$222,926 based upon achieved EBITDA performance targets.  The Company intends to distribute payment,half to be paid in cash and half to be issuable in shares of the Company’scommon stock at a price of $0.20 per share.

A summary of the business assets acquired (in thousands)is as follows:

| Consideration paid:                                                           |   |   |   |
|-------------------------------------------------------------------------------|--------|--------|--------|
| Cash                                                                          |   | $      | 1,063  |   |
| Common stock                                                                  |   | 300    |   |
| Earn-Out Cash                                                                 |   | 223    |   |
| Transaction expenses                                                          |   | 50     |   |
| Total consideration                                                           |   | $      | 1,636  |   |
| Allocation of Purchase Price:                                                 |   |   |   |
| Fair value of  tangible assets:                                               |   |   |   |
| Accounts receivable                                                           |   | 32     |   |
| Property and equipment                                                        |   | 70     |   |
| Total tangible assets                                                         |   | 102    |   |
| Value of excess  of purchase price plus net liabilities assumed allocated to: |   |   |   |
| Customer list                                                                 |   | 1,534  |   |
| Fair value of  assets acquired                                                |   | $      | 1,636  |   |

 

Theincrease in the value of intangible assets (customer list) of approximately$1,534,000 will be amortized over a three year period. The valuation of thecustomer list is based upon the best available information to the Company atthis time. The Company plans to further analyze the valuation of the customerlist associated with the SSS acquisition including seeking a valuation by an independentthird party.

As of October 27, 2006,SSS results of operations are being consolidated with the Company’s results ofoperations. The following unaudited pro-forma information reflects the resultsof continuing operations of the Company as though the acquisition of SSS hadbeen consummated as of the beginning of the period presented (in thousands):

 
| ** **         | ** ** | **For the Three  Months ended  December 31** | ** ** | **For the Six**

**Months ended  December 31** | ** ** |
|--------------------|------------|------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **         | ** ** | **2006**                                                         | ** ** | **2005**                                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue            |       | $                                                                | 18,523     |                                                               | $          | 19,012 |   | $ | 41,313 |   | $ | 43,227 |   |
| Net Loss           |       | (2,563                                                           | )          | (4,343                                                             | )          | (3,208 | ) | (3,922 | ) |
| Net Loss per share |       | $                                                                | 0.04       |                                                               | $          | 0.54 |   | $ | 0.09 |   | $ | 0.75 |   |

 

**TekConnect**

On October 6, 2006, theCompany utilized a portion of the proceeds from the Third Junior Note to enterinto Asset Purchase Agreement for substantially all of the assets ofTekConnect, Inc., a privately-held educational technology integration andconsulting firm. In consideration for the purchased assets, the Company paid tosellers $400,000 at closing, incurred $63,000 of direct acquisition costs andassumed $540,000 pre-existing contract obligations.

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A summary of the business assets acquired (inthousands) is as follows:

| Consideration paid:                                                           |   |   |   |
|-------------------------------------------------------------------------------|--------|--------|--------|
| Cash                                                                          |   | 400    |   |
| Transaction expenses                                                          |   | 63     |   |
| Total consideration                                                           |   | $      | 463    |   |
| Allocation of Purchase Price:                                                 |   |   |   |
| Fair value of  liabilites assumed:                                            |   |   |   |
| Liabilities  assumed                                                          |   |   |   |
| Deferred Revenue                                                              |   | 540    |   |
| Total liabilities assumed                                                     |   | 540    |   |
| Net liabilities assumed                                                       |   | (540   | )      |
| Value of excess of purchase price plus net liabilities  assumed allocated to: |   |   |   |
| Customer list                                                                 |   | 1,003  |   |
| Fair value of  assets acquired                                                |   | $      | 463    |   |

 

Asof October 6, 2006, TekConnect results of operating are being consolidated withthe Company’s results of operations. The increase in the value of intangibleassets (customer list) of approximately $1,004,000 will be amortized over athree year period.

**5**.                      **RESTRICTED CASH**

Restrictedcash includes cash received in connection with maintenance agreements that isrestricted until the related revenue is earned and recognized under the termsof the respective agreements, which are three years.  The Company classified $614,000 as a currentasset and $300,000 as a non-current asset, which represents the amount of cashthat will become available to the Company under portions of the contracts thatexpire during and subsequent to the next twelve months, respectively.

**6.             NOTES PAYABLE**

**Senior Notes**

On March 8, 2006, theCompany entered into a Note Purchase Agreement (the “Note Purchase Agreement”)with SACC Partners, L.P. and Lloyd I. Miller, III (the “Senior Lenders”),pursuant to which the Company issued Senior Secured Notes (the “Senior Notes”)in the aggregate principal amount of $6,700,000 with warrants (the “SeniorWarrants”) to purchase up to 19.9% of the Company’s outstanding common stock ona fully diluted basis at the time of exercise. The Senior Notes bear interest at the rate 8% per annum if paid in cash,or 11% per annum if paid in kind, which forms of payment can be made at theCompany’s discretion. Principal payments are due in 36 monthly installmentsbeginning March 31, 2009. Interest is payable quarterly in arrearsbeginning June 30, 2006, unless the Company chooses to make its paymentsin kind, in which case such interest is added to the principal amount of theSenior Notes. The Senior Warrants have an exercise price of $0.001 per shareand expire on December 31, 2016.

The Company may prepaythe Senior Notes at 105% of the aggregate unpaid principal and interest at anytime prior to their maturity. The Senior Notes are also subject to mandatoryprepayment at 105% of the aggregate unpaid principal and interest in the eventof a change in control, as defined. The Company is also required to prepay theSenior Notes upon the occurrence of a substantial asset sale in an amount equalto 50% of the gross proceeds received in such asset sale plus a penalty equalto 2% of the prepayment amount. Pursuant to the terms of the note purchaseagreement, substantial asset sales are defined as any single asset saleresulting in gross proceeds of $100,000 or any series of assets sales occurringduring a twelve month period resulting in gross cumulative proceeds of $100,000or more. Change in control events described in the note purchase agreementrequire approval by the Board of Directors prior to being submitted to a voteof the Company’s shareholders. Accordingly, the redemption provision is notwithin the control of the Senior Note holders.

In accordance with APB 14, the Company allocated $2,982,071of the proceeds to the Senior Notes and $3,717,929 of the proceeds to theSenior Warrants. The aggregate fair value of the Senior Warrants was calculatedusing the Black-Scholes option pricing model based on all outstanding shares ofthe Company’s common stock, outstanding options, Senior Warrants and issuableshares of stock under the conversion and debt settlement agreements (excludingthe Bridge Notes) totaling 13,859,028 Senior Warrants issuable to the holdersof the Senior Notes at the commitment date of this financing transaction. Thedifference between the carrying amount of the Senior Notes and theircontractual redemption amount is being accreted as interest expense toFebruary 2010, their earliest date of redemption.

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The number of shares issuable upon exercise of the warrantsis subject to increase each time the Company issues additional shares of commonstock or common stock equivalents. The incremental number of shares under anyincrease is equal to the amount needed to cause the Senior Warrants to beexercisable for 19.9% of all outstanding common stock on a fully diluted basis.

On May 5, 2006, theCompany completed a second closing of the March 8, 2006 private placementin which 5,729,520 shares of common stock and warrants to purchase an aggregateof 1,145,904 shares of common stock at an exercise price of $0.20 per sharewere issued. The Company also issued to the placement agent in thistransaction, warrants to purchase 1,145,904 shares of common stock ascompensation for services rendered. Accordingly, the number of shares issuableto the holders of the Senior Warrants upon their exercise was increased by1,992,814 shares to an aggregate of up to 15,851,842 shares. The fair value ofthe additional Senior Warrants, which amounted to $850,483, is being amortizedover the remaining term of the Senior Notes.

On June 6, 2006 theCompany, immediately following the completion of its 1 for 10 reverse stocksplit, issued 13,046,574 shares to the Bridge Note holders. Accordingly, thenumber of shares issuable to the holders of the Senior Warrants upon theirexercise was increased by 3,241,284 shares to an aggregate of up to 19,093,126shares. The fair value of the additional Senior Warrants, which amounted to$1,286,480, is being amortized over the remaining term of the Senior Notes.

On June 15, 2006,the Company issued an additional Junior Secured Convertible Note to Trust A-4 —Lloyd I. Miller (“the Junior Lender”) in the aggregate principal amount of$1,000,000 (the “Additional Junior Note”) with substantially identical terms tothe Junior Note issued on March 8, 2006 (see discussion regarding “JuniorNotes” below).  The Additional JuniorNote is convertible into 5,000,000 shares of the Company’s common stock.Accordingly, the number of shares issuable to the holders of the SeniorWarrants upon their exercise was increased by 1,242,197 shares to an aggregateof up to 20,335,323 shares. The fair value of the additional Senior Warrants,which amounted to $344,990, is being amortized over the remaining term of theSenior Notes.

On June 30, 2006,the Company electedto pay interest on the Junior Notes in kind and recorded an aggregate interestcharge of $136,932 for the period ended June 30, 2006 which was added tothe principal amount of the Junior Notes, increasing the convertible shares ofthe notes by 684,658 shares at a conversion price of $0.20 per share.Accordingly, the number of shares issuable to the holders of the SeniorWarrants upon their exercise was increased by 170,096 shares to an aggregate ofup to 20,505,419 shares. The fair value of the additional Senior Warrants,which amounted to $28,587, is being amortized over the remaining term of theSenior Notes.   On June 30, 2006, the Company elected topay interest on the Senior Notes in kind and recorded an aggregate interestcharge of $230,186 for the period ended June 30, 2006 which was added tothe principal amount of the notes.

On July 1, 2006,each of the two non-employee directors of the Company received a stock grantfor 117,647 shares of our common stock, which is equal to $20,000 dividedby the closing price of our common stock as reported on the Over the CounterBulletin Board on June 30, 2006, which was equal to $0.17 per share. Alsoon July 1, 2006, Mr. Ron Ben-Yishay received a stock grant for1,176,471 shares of our common stock, which is equal to $200,000 divided by$0.17 per share.  On July 1, 2006the Company (under its 2005 Plan) granted to two non-employee directors, optionsto purchase an aggregate of 2,100,000 shares of its common stock at $0.17 pershare that have a five year term. Accordingly, the number of shares issuable tothe holders of the Senior Warrants upon their exercise was increased by 872,461shares to an aggregate of up to 21,377,880 shares. The fair value of theadditional Senior Warrants, which amounted to $155,283 and $6,383,751 in thecumulative, is being amortized over the remaining term of the Senior Notes.

On September 26, 2006,the Company issued another Junior Secured Convertible Note to the Junior Lenderin the aggregate principal amount of $3,000,000 (the “Third Junior Note”) withsubstantially identical terms to the Junior Note (as defined below) and theAdditional Junior Note.  The Third JuniorNote is convertible into 15,000,000 shares of the Company’s common stock.Accordingly, the net number of shares issuable to the holders of the SeniorWarrants upon their exercise was increased by 3,592,975 shares to an aggregateof up to 24,970,855 shares. The fair value of the additional Senior Warrantsamounted to $481,528; however the cumulative total of the debt discount per theissuable Senior Warrants connected with the Senior Notes is limited to thecarrying value of the notes, therefore $316,249, or a cumulative of $6,700,000is being amortized over the remaining term of the Senior Notes and $165,279 isa direct charge against non-cash interest expense.

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On September 30, 2006,the Company electedto pay interest on the Junior Notes in kind and recorded an aggregate interestcharge of $150,585 for the period ended September 30, 2006 which was addedto the principal amount of the Junior Notes, increasing the convertible sharesof the notes by 752,927 shares at a conversion price of $0.20 per share.Accordingly, the number of shares issuable to the holders of the SeniorWarrants upon their exercise was increased by 187,057 shares to an aggregate ofup to 25,157,912 shares. The fair value of the additional Senior Warrantsamounted to $26,923 and is being charged directly to interest expense.

As of September 30, 2006, the fair value of the 19.9%Senior Warrants was approximately $6,892,000, however, such discount is limitedto the carrying value of the note. Therefore, only $6,700,000 was recorded as adiscount and approximately $192,000 was charged directly as a component ofinterest expense. Prospectively, any charges incurred due to events causing anincrease in the amount of warrants issuable to the Senior Note warrant holderswill be charged directly as a component of interest expense.

On October 27, 2006, theCompany entered into an Asset Purchase Agreement with SSS.  As part of the consideration, the Companyissued to SSS, and Paul Saucier, an individual, 1,485,148 shares of the Company’scommon stock, based upon a per share value of $0.202.  Accordingly, thenumber of shares issuable to the holders of the Senior Warrants upon theirexercise was increased by 368,969 shares to an aggregate of up to 25,526,881shares. The fair value of the additional Senior Warrants amounted to $88,373and is being charged directly to interest expense.

On December 14, 2006, atthe Annual Meeting of Stockholder, the Company’s stockholders voted to approvethe Company’s 2006 Nonqualified Stock Option Plan (the “2006 Plan”) whichprovides for the grant of nonqualified stock options to members of the Board,employees and consultants.  Thestockholders’ approval of the 2006 Plan resulted in the grant of Board-approvedoptions to purchase an aggregate of grants of 7,805,000 sharesthereunder.  Accordingly, the number of shares issuable to the holders ofthe Senior Warrants upon their exercise was increased by 1,932,088 shares to anaggregate of up to 27,458,969 shares. The fair value of the additional SeniorWarrants amounted to $298,490 and is being charged directly to interestexpense.

On December 19, 2006, the Company entered into asatisfaction and release agreement to terminate the earn-out paymentobligations under the Asset Purchase Agreement entered into between the Companyand AMR Networks, LLC in exchange for issuing shares of the Company’s commonstock having a value of $100,000.  Thecompany issued 677,966 shares of common stock of $0.147 based on the averagetrading price for the proceeding 15 day period The Company also retired 30,000that were originally issued and held in escrow pursuant to the earn-outprovision in the original agreement. Accordingly, the number of shares issuableto the holder of the Senior Warrants upon their exercise was increased by159,506 shares to an aggregate of up to 27,618,475 shares. The fair value ofthe additional Senior Warrants amounted to $22,254 and is being chargeddirectly to interest expense.

On December 31, 2006, theCompany electedto pay interest on the Junior Notes in kind and recorded an aggregate interestcharge of $257,160 for the period ended December 31, 2006 which was added tothe principal amount of the Junior Notes, increasing the convertible shares ofthe notes by 1,285,798 shares at a conversion price of $0.20 per share.Accordingly, the number of shares issuable to the holders of the SeniorWarrants upon their exercise was increased by 319,443 shares to an aggregate ofup to 27,937,919 shares. The fair value of the additional Senior Warrantsamounted to $47,763 and is being charged directly to interest expense.

On December 31, 2006, the Company elected to payinterest on the Senior Notes in kind and recorded an aggregate interest chargeof $197,474 for the period ended December 31, 2006 accreting the principalamount of the notes to $7,319,807.

As of December 31, 2006, the amortization of the debtdiscount in connection with the Senior Note Senior Warrants for the six monthperiod ended December 31, 2006 amounted to $853,335 which discount is acomponent of interest expense in the accompanying statement of operations.The aggregate expense with respect to the incremental number of shares issuableunder the Senior Warrants that was not recorded as additional note discountamounted to $648,163 during the six months ended December 31, 2006.

**Junior Notes**

Under the Note PurchaseAgreement, the Company issued a Junior Secured Convertible Note to the JuniorLender (the Junior Lender and the Senior Lenders are referred to collectivelyas the “Lenders”) in the aggregate principal amount of $3.0 million (the “JuniorNote”). The interest rate for the Junior Note is 10% per annum if paid in cash,or 14% per annum if paid in kind, which forms of payment are at the Company’selection for the first three years. Principal will be payable at the maturitydate of March 1, 2011 and interest is payable quarterly in arrearsbeginning June 30, 2006, unless the Company

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choosesto pay the interest in kind option, in which case the interest will be added tothe principal amount of the Junior Note during the period in which the Companymakes such election. The Junior Note is convertible into common stock of theCompany at any time at the election of the holder at a conversion price of$0.20 per share of common stock. The Junior Note issued to the Junior Lender isconvertible into 15,000,000 shares of the Company’s common stock, assuming theinterest thereon is paid in cash. The Company is restricted from prepaying anyor all of the Junior Notes prior to March 1, 2010 without the consent of theholder of the Junior Notes, which consent is at the sole discretion of the noteholder.

The Company evaluated theconversion feature embedded in the Junior Note to determine whether, under SFAS133, such conversion feature should be bifurcated from its host instrument andaccounted for as a free standing derivative. In performing this analysis theCompany determined that the Junior Notes meet the definition of a conventionaldebt instrument; accordingly, the notes and related conversion option were accountedfor in accordance with the provisions of EITF 98-5 and EITF 00-27.Under this method, the Company recorded a $3,000,000 discount against theentire principal amount of the note, based on the intrinsic value of theembedded conversion option of $0.40 per share as of March 8, 2006multiplied by 15,000,000 shares issuable upon conversion; however, suchdiscount was limited to the carrying value of the note. The discount of$3,000,000 is being amortized over the five year term of the note.

On June 15, 2006,the Company entered into a First Amendment to Note Purchase Agreement (the “FirstAmendment”) with the Lenders pursuant to which the Company issued an additionalJunior Secured Convertible Note to the Junior Lender in the aggregate principalamount of $1,000,000 (the “Additional Junior Note”) on substantially similarterms set forth in the Junior Note. Thus, the interest rate for the AdditionalJunior Note is 10% per annum if paid in cash, or 14% per annum if paid in kind,which is at the Company’s election for the first three years. Principal will bepayable at the maturity date of March 1, 2011 and interest will be payablequarterly in arrears beginning June 30, 2006, unless the Company choosesits payment in kind option, in which case interest will be added to theprincipal amount of the Additional Junior Note during the period that theCompany continues such election. The Additional Junior Note may be convertedinto common stock at any time at the election of the holder at a conversionprice of $0.20 per share of common stock. A portion of the proceeds from theissuance of the Additional Junior Note were used to purchase certain assetsprimarily consisting of a customer list from the Long Island Division ofTekConnect Corporation, (“TekConnect”), and the remaining proceeds are beingused for general corporate purposes. The Junior Note issued to the JuniorLender is convertible into 5,000,000 shares of common stock of the Company,assuming the interest thereunder is paid in cash. The Company recorded a$400,000 discount against the principal amount of the note, based on theintrinsic value of the embedded conversion option of $0.08 per share as ofJune 15, 2006 multiplied by 5,000,000 shares issuable upon conversion. Thediscount of $400,000 is being amortized over the remaining term of the note.

On June 30, 2006, the Company elected to pay intereston all the Junior Notes in kind and recorded an aggregate interest charge of$136,932 for the period ended June 30, 2006 which was added to therespective principal amount of the notes. The interest added to the principalamount is convertible at $0.20 per share into 684,658 shares of the Company’scommon stock. The Company did not record an additional discount because thetrading price as of June 30, 2006 was below the conversion price.

OnSeptember 26, 2006, the Company entered into a Second Amendment to NotePurchase Agreement (the “Second Amendment”) with the Lenders pursuant to whichthe Company issued an additional Junior Secured Convertible Note to the JuniorLender in the aggregate principal amount of $3,000,000 (the “Third Junior Note”)on substantially similar terms set forth in the Junior Note and the AdditionalJunior Note. Thus, the interest rate for the Third Junior Note is 10% per annumif paid in cash, or 14% per annum if paid in kind, which is at the Company’selection for the first three years. Principal will be payable at the maturitydate of March 1, 2011 and interest will be payable quarterly in arrearsbeginning September 30, 2006, unless the Company chooses its payment inkind option, in which case interest will be added to the principal amount ofthe Third Junior Note during the period that the Company continues suchelection. The Third Junior Note may be converted into common stock at any timeat the election of the holder at a conversion price of $0.20 per share ofcommon stock as set on the commitment date of the note transaction. Theconversion price was not beneficial because the fair value of the stock wasless than the conversion price. A portion of the proceeds from the Third JuniorNote were used to purchase substantially all of the assets of SSS, pursuant toan Asset Purchase Agreement dated October 27. The Third Junior Note issued to the Junior Lender is convertible into15,000,000 shares of common stock of the Company, assuming the interestthereunder is paid in cash.

On September 30, 2006, the Company elected to payinterest on all the Junior Notes in kind and recorded an aggregate interestcharge of $150,585 for the period ended September 30, 2006 which was addedto the respective principal amount of the notes. The interest added to theprincipal amount is convertible at $0.20 per share into 752,927 shares of theCompany’s common stock. The Company did not record an additional discountbecause the trading price as of September 30, 2006 was below theconversion price.

 

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On December 31, 2006, the Company elected to pay intereston all the Junior Notes in kind and recorded an aggregate interest charge of$257,160 for the period ended December 31, 2006 which was added to therespective principal amount of the notes. The interest added to the principalamount is convertible at $0.20 per share into 1,285,798 shares of the Company’scommon stock. The Company did not record an additional discount because thetrading price as of December 31, 2006 was below the conversion price.

The combined debt discount pursuant to the on the JuniorNotes of March 8, 2006 and June 15, 2006 was $3,400,000. Amortization ofthe discount has accreted to $550,000 as of December 31, 2006 for which$342,000 is included as a component of interest expense in the accompanyingstatement of operations for the six months ended December 31, 2006.

**Juniorand Senior Notes and Senior Warrants Registration Rights**

The Note PurchaseAgreement relating to the issuances of the Junior and Senior Notes provide thenote holders with demand registration rights that require the Company, within30 days of such demand, to file a registration statement covering the resale ofshares underlying the convertible notes and senior note warrant and to causesuch registration to be declared effective within 90 or 120 days (depending onthe circumstances) thereafter. Such registration rights provide for the Companyto pay a share based penalty in an amount equal to 2% of the shares registrableunder the agreement until such time that the Company becomes compliant or theregistrable shares may be sold without registration or restriction underRule 144. The fair value of the registration rights agreement isinsignificant to the Company’s financial statements. The amount of sharesissuable under this penalty provision is contractually limited to an amountthat may not exceed the authorized but unissued shares of the Company’s commonstock. No demand has been made for registration to date. In addition, theCompany has filed the required registration statement.

In addition to the above,the Company is not precluded from issuing unregistered shares to the holders ofthe convertible notes or Senior Warrants in the event the holder elects toexercise these instruments prior to the time in which registered shares becomeavailable. In addition, the warrants do not feature any cash settlementalternatives that are within the control of the holder. Accordingly, theWarrants are classified as equity instruments in accordance with the provisionsof EITF 00-19.

**7.****            ****DUE FROM NETF**

On August 8, 2005, the Company entered into aseries of related three-year agreements with New England Technology Finance,LLC (“NETF”), an affiliate of Global Technology Finance, which is a provider ofstructured financing solutions to technology companies that operates inpartnership with Credit Suisse First Boston, CIT Group, Inc. and others,that together provided a new working capital credit facility. These agreementsprovide for NETF to purchase, eligible accounts receivable balances and to financequalified product purchases (as defined). This facility is comprised of threecomponents:  (1) an Asset Purchaseand Liability Assumption Agreement (the “APLA”), under which NETF financescertain of the Company’s qualified product purchases in connection withconsummating sales to customers and (2) an Asset Purchase Agreement (the “APA”),and (3) a Master Servicing Agreement (“MSA”).

Qualified productpurchases financed by NETF under the APLA are repaid from collections ofaccounts receivable balances that the Company generates from its sales of suchproducts to customers. The Company transfers title to the invoices to NETF atthe time these sales are financed and delivery is made to the customer. TheCompany pays contractual financing and servicing fees to NETF for its financingof these purchases in an amount that is equal to a percentage of the grossprofit margin on such sales. The percentages fees vary based on the(a) amount of gross profit on such sales and (b) number of days inwhich the receivables from such sales remain uncollected.

NETF remits periodicallyto the Company an amount equal to the monthly gross profit margin on the salesless the contractual fees. The APLA also provides for the Company torepurchase, after 150 days, any amounts that remain unpaid by the customer forreasons other than the customer’s inability to pay as a result of its financialcondition or possible insolvency. NETF pre-approves all product purchases andthe credit worthiness of the Company’s customers under this arrangement as aprecondition to financing the sale.

Under the APA, theCompany transfers eligible accounts receivable to NETF in exchange for advancesof up to 80% of their gross amount.  NETFcharges the Company fees (the “Discount Factor”) in an amount equal to theLIBOR rate plus 4% per annum on advances made at the time of the transfer. TheCompany also retains servicing rights under the MSA. 

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Underthe terms of the MSA, the Company manages collections and other ongoinginteractions with its customers in exchange for fees amounting to approximately20% of the gross invoice amount. NETF settles fees payable to the Company underthis arrangement net of the Discount Factor.

The APA also provides forthe Company to repurchase, after 150 days, any amounts that remain unpaid bythe customer for reasons other than the customers’ inability to pay as a resultof its financial condition or possible insolvency; however such repurchases arelimited to 15% of all receivables transferred to NETF under this arrangement.In addition, NETF pre-approves the credit worthiness of the Company’s customersunder this arrangement as a precondition to purchasing any invoice.

This facility containscustomary affirmative and negative covenants as well as specific provisionsrelated to the quality of the accounts receivables sold. The Company has alsoindemnified NETF for the risk of loss under any transferred balances except forloss incurred as a result of customer credit risk.

During the six monthperiod ended December 31, 2006, the Company sold approximately $27,716,000 ofits product revenue under the terms of the APLA agreement and approximately$9,372,000 of its service revenue under the terms of the APA agreement andincurred aggregate fees of approximately $765,100 which is included as acomponent of interest expense in the accompanying statement of operations.

**8.****             ****STOCKHOLDERS’ EQUITY**

AtJune 30, 2006 there were 55,180,586 shares of the Company’s common stock issuedand outstanding.

Areconciliation of the Company’s common shares issued and outstanding during thesix month period from June 30, 2006 through December 31, 2006 is a s follows:

SummaryReconciliation of Shares Issued and Outstanding

as of December 31, 2006

|                                           | ** ** | **Common Stock** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| Balance — June 30,  2006             |       | 55,180,586            |       |
|                                      |       |                  |       |
| Common stock  issued to directors         |       | 235,294               |       |
| Common stock  issued to employee          |       | 1,176,471             |       |
| Common stock  issued to SSS               |       | 1,485,148             |       |
| Common stock  issued on AMR earn-out, net |       | 647,966               |       |
| Retirement of  treasury stock             |       | (537,825              | )          |
|                                      |       |                  |       |
| Balance — March 31,  2006            |       | 58,187,640            |       |

 

On July 1, 2006, theCompany issued stock grants in the aggregate of 1,411,765 shares of commonstock.  Two non-employee directors of theCompany each received a stock grant for 117,647 shares of our commonstock, which is equal to $20,000 divided by the closing price of our commonstock as reported on the Over the Counter Bulletin Board on June 30, 2006,which was equal to $0.17 per share. Also on July 1, 2006, The Companygranted 1,176,471 shares of its common stock to a Regional Vice President,which was equal to $200,000 divided by $0.17 per share.

On August 14, 2006, theCompany repurchased 537,825 shares of stock held by an investor at a price of$0.20 per share.  These shares wereretired by the written unanimous consent of the Board of Directors on December29, 2006.

OnOctober 27, 2006, the Company entered into an Asset Purchase Agreement withSensible Security Solutions Inc.  As partof the consideration, the Company issued to SSS, and Paul Saucier, anindividual, 1,485,148 shares of the Company’s common stock based upon the pershare fair value in accordance with EITF 99-12 (see Note 4).

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In October 2006, theCompany entered into a satisfaction and release agreement to terminate theearn-out payment obligations owing under the Asset Purchase Agreement, whichwas previously entered into between the Company and AMR Networks, LLC (“AMR”).  In exchange for AMR’s agreement to enter intothe satisfaction and release agreement, the Company agreed to issue AMR a totalof $100,000 in common stock, based on the average trading price for the 15-dayperiod preceding the issuance on December 19, 2006, which equaled $0.1475.  Thus, on December 19, 2006, the Companyissued 677,966 shares of its common stock to AMR, and retired 30,000 sharesthat were originally issued and held in escrow pursuant to the earn-out provisionin the original agreement.

**9.****             ****SHARE-BASED PAYMENT ARRANGEMENTS****

**1997 Plan**

In November 1997 theCompany’s Board of Directors authorized the adoption of the 1997 Stock OptionPlan for non-employee Directors. The 1997 Plan provided for the grant of up to30,000 stock options at an exercise price of 100% of the fair value of theCompany’s common stock on the date of grant. During the six months endedDecember 31, 2006, all remaining options under this plan expired and no furthergrants will be made

**2000 Plan**

On August 14, 2000,the Company assumed the Data Systems Network Corp Stock Option Plan inconnection with a business combination. Options granted under this Plan wereeither ISO’s or NSO’s. No further options may be granted under the Data SystemsPlan. Options granted under this plan expire at various times until 2010.During the six months ended December 31, 2006, 177 options expired and optionsto purchase 5,764 shares of the Company’s Series A Preferred stock at anaverage exercise price of $22.95 per share remain outstanding. Each share ofSeries A Preferred issuable upon the exercise of these options isconvertible into 2.5 shares of the Company’s common stock.

**2001 Plan**

In 2001, the Company’sBoard of Directors authorized the adoption of the 2001 Employee Stock OptionPlan. The 2001 plan, as amended, provides for the grant of up to an aggregate400,000 ISO to employees and NSO’s to officers, directors, key employees orother individuals at the discretion of the compensation committee of the Boardof Directors. During the six months ended December 31, 2006, 27,925 optionswere forfeited and options to purchase 86,300 shares of the Company’s commonstock under this plan at an average price of $6.34 per share remainoutstanding.

**2005 Plan**

In May 2005, theCompany’s Board of Directors authorized the adoption of the 2005 Employee StockOption Plan. The 2005 plan, as amended, provides for the grant of up to anaggregate 3,000,000 ISO to employees and NSO’s to officers, directors, keyemployees or other individuals at the discretion of the compensation committeeof the Board of Directors. During the three months ended December 31, 2006, nooptions were cancelled and options to purchase 2,210,000 shares of the Company’scommon stock under this plan at an average price of $0.31 per share remainoutstanding.

**2006 Plan**

On June 15, 2006, theCompany’s Board of Directors approved the 2006 Nonqualified Stock Option Plan(the “2006 Plan”), which provides for the grant of nonqualified stock optionsto purchase up to an aggregate of 11,790,672 shares of our common stock tomembers of our Board, employees and consultants. Our Board of Directors, or acommittee of two or more members of our Board, administers the 2006 Plan. Theadministrator has full authority to establish rules and regulations for theproper administration of the 2006 Plan, to select the employees, consultantsand directors to whom awards are granted, and to set the date of grant, theexercise price and the other terms and conditions of the awards, consistentwith the terms of the 2006 Plan. The administrator may modify outstandingawards as provided in the 2006 Plan.

The terms of the awardsare subject to the provisions in an option agreement, consistent with the termsof the 2006 Plan. The exercise price of a stock option shall not be less thanthe fair market value of our common stock on the date of grant. No stock optionshall be exercisable later than ten (10) years after the date it is granted.

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The administrator mayamend the 2006 Plan at any time. No such amendment may be made by our Board ofDirectors without the consent of an option holder if such amendment wouldsubstantially affect or impair the rights of such option holder. In addition,the administrator may terminate the 2006 Plan at any time. However, in no eventmay an award be granted pursuant to the 2006 Plan on or after June 15, 2016.

On December 14, 2006, atour Annual Meeting of Stockholders, the Company’s stockholders voted to approvethe 2006 Plan. The exercise price for shares previously granted under the 2006Plan was determined to be $0.155, which was the closing price of the Company’scommon stock on December 14, 2006. As of December 31, 2006, options to purchasean aggregate of up to 7,805,000 shares of common stock were issued andoutstanding.  In accordance with SFAS123R, the Company recognized compensation costs on a prorated basis accordingto the service inception dates of the grants in the amount of $119,031 duringthe three months ended December 31, 2006.

As of December 31, 2006,an aggregate total of 7,805,000 remain outstanding of the total 11,790,672under the 2006 plan.

**ShareBased Payments**

On July 1, 2006 theCompany (under its 2005 Plan) granted to two non-employee directors options topurchase an aggregate of 2,100,000 shares of its common stock at $0.17 pershare, each with a five year term. The stock-based compensation expense for thefair value of the fully vested options granted to the two directors amounted toapproximately $288,000 during the three months ended September 30, 2006.Assumptions relating to the estimated fair value of these stock options, whichthe Company is accounting for in accordance with SFAS 123(R) are as follows:risk—free interest rate of 5.26%; expected dividend yield zero percent;expected option life of five years; and current volatility of 109.24%.  As of December 31, 2006, there are options topurchase 2,210,000 shares of common stock at an average price of $0.31 pershare.

On December 14, 2006 theCompany received shareholder approval for its 2006 option plan and granted toemployees options to purchase an aggregate of 7,805,000 of its common stock at$0.155 per share each with  a five yearterm and a three-year vesting period from the service inception date. TheCompany recognized compensation costs on a prorated basis according to theservice inception dates of the grants under the 2006 Plan in the amount of$119,031 during the three months ended December 31, 2006. The aggregate fairvalue of grants under this plan amounted to $854,750.  Assumptions relating to the estimated fairvalue of these stock options, which the Company is accounting for in accordancewith SFAS 123(R) are as follows: risk—free interest rate of 4.97%;expected dividend yield zero percent; expected option life of five years; andcurrent volatility of 86.56%.  TheCompany also recognized compensation costs of $29,068 for the three monthperiod ended December 31, 2006, which relate only to the options granted to theChief Executive Officer on July 13, 2005 under the 2005 Plan.

The fair value of awardsgranted during the six month period ended December 31, 2006 was estimated atthe date of grant using the Black-Scholes option pricing model. For purposes ofperforming the calculation under the Black-Scholes model, the risk-free rate isbased on the U.S. Treasury yield curve in effect at the time of grant. TheCompany has not paid dividends to date and does not expect to pay dividends inthe foreseeable future due to its substantial accumulated deficit andinitiatives to conserve capital resources. Accordingly, expected dividendyields are currently zero. Expected volatility is principally based on thehistorical volatility of the Company’s stock.

The expensing of sharebased payments in future periods (expectations of vesting) will be based uponall available data including historical cancellations and forfeitures of stockoptions and current employee turnover rates of approximately 30%. The Companywill prospectively monitor employee terminations, exercises and other factorsthat could affect the development of its expectations of vesting of options infuture periods.

A summary of optionactivity for the six months ended December 31, 2006 is as follows:
| **Options_**                           | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual   Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  June 30, 2006     |       | 231,166    |       | 5.33                                    |       |                                                       |       |                            |       |
| Granted                                |       | 9,905,000  |       | 0.16                                    |       |                                                       |       |                            |       |
| Exercised                              |       | —     |       | —                                  |       |                                                       |       |                            |       |
| Forfeited or  expired                  |       | (29,102    | )          | 7.83                                    |       |                                                       |       |                            |       |
| Outstanding at  December 31, 2006 |       | 10,107,064 |       | 0.25                                    |       | 8.48                                                       |       | —                          |       |
| Exercisable at  December 31, 2006 |       | 2,277,024  |       | 0.56                                    |       | 4.58                                                       |       | —                          |       |

 

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The weighted-averagegrant date fair value of options granted during the six moths endedDecember 31, 2006 amounted to $0.16 per share. The weighted averageremaining contractual term of options outstanding gives effect to employeeterminations which, under the provisions of the plans reduces the remaininglife of such vested options to a period of 90 days following the respectivedates of such terminations.

Unrecognized costs underthe 2005 plan are $29,068 and will be expensed during the remainder of fiscalyear 2007 as they are vested. Unrecognized costs under the 2006 Plan are $735,719and will be amortized incrementally over a three-year vesting period.

The Company did notmodify any stock options granted to employees or non employees under any of itsshare-based payments other than accelerating the vesting of options prior toJuly 1, 2005. In addition, the Company did not capitalize the costassociated with stock based compensation awards nor have optionees exercisedany options during the six months ended December 31, 2006.

**10.****      ****COMMITMENTS AND CONTINGENCIES**

On or about October 30,2006, Pangaea Education Systems, LLC (“Pangaea”) filed a lawsuit against theCompany alleging unfair competition, reverse passing off, misappropriation oftrade secrets, copyright infringement and breach of contract arising out ofservices performed in 2003 (the “Action”). Pangaea’s complaint does not specifythe amount of damages sought, but Pangaea has demanded in excess of $2,500,000in preliminary communications with the Company’s counsel. The Company contendsthat this demand is without factual or legal basis, that the Action has nomerit and is aggressively defending the Action.  The Company filed amotion to dismiss in response to the complaint on November 28, 2006. A trial isscheduled for July 2008. The Company intends to continue discussing an informalresolution. While the Company believes it has a strong position, it is notpossible at this time to state the likelihood of an unfavorable outcome orestimate the range of possible loss based on the early stage of the dispute,the positions taken by Pangaea and the inherent uncertainties of litigation.

On October 27, 2006, theCompany’s Canadian wholly owned subsidiary entered into a three-year employmentAgreement with Paul Saucier, the individual owner of SSS.  The agreement stipulates a base salary of$180,000 CAD eligibility for stock based compensation and customary benefits.Under the agreement, the Company is obligated to continue the earn-outprovision of the Asset Purchase Agreement regardless of the continuedemployment status of Mr. Saucier.  Theemployment agreement also stipulates a seperate performance bonus program contingentupon continued employment and severance compensation in the event oftermination without cause.

**11.****      ****CONCENTRATIONS**

                At December 31, 2006, onecustomer accounted for approximately 14% of the gross accounts receivablebalance. 

                At December 31, 2006, two vendorsaccounted for approximately 35% of the gross accounts payable balance. Thesevendors provide outside consulting services for the Company. The Company viewsall of its strategic partners as vital to their operations for which the lossof either of these vendors could result in a temporary disruption in service tovarious customers. The Company believes it has access to alternative vendorsand resources to replace either vendor in the event of a disruption.

**12.****      ****DISCONTINUED OPERATIONS**

During 2003, theCompany disposed of its non-emergency transportation business.  At December 31, 2006, the total remainingliabilities of discontinued operations was $258,000.

**13.****      ****BUSINESS SEGMENTS**

The Company completed itstransition out of its former Business Process Outsourcing Services (“BPO”)Segment during the quarter ended June 30, 2006. Accordingly, the Company’ operated with a single segment, theInformation Technology (“IT”) Solutions Segment, during the six months endedDecember 31, 2006.

The acquisition of SSShas provided us greater density in our core securities practice and increasedour overall presence in the Canadian market. As of the December 31, 2006, our wholly owned subsidiary, DynTek CanadaInc. had total assets of approximately $2,863,000 and total revenue ofapproximately $2,865,000 and a net loss of approximately $80,106 for the sixmonth period ended December 31, 2006.

Segment informationrelating to the Company’s operations for the three and six months endedDecember 31, 2006 and 2005, respectively, is as follows:
| ** **                             | ** ** | **Reportable Business Segments** | ** ** | ** **                             | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **Business**  Process  Outsourcing         | ** ** | **Information  Technology  Solutions** | ** ** | **Total** | ** ** |
| Three months ended  December 31, 2006  |       |                                       |       |                                   |       |   |   |
| Sales  to external customers           |       | $                                          | —     |                                   | $          | 18,523 |   | $ | 18,523 |   |
| Depreciation  and amortization expense |       | —                                     |       | 679                                    |       | 679 |   |
| Net  loss from operations              |       | —                                     |       | (629                                   | )          | (629 | ) |
| Interest  expense                      |       | —                                     |       | (1,936                                 | )          | (1,936 | ) |
| Total  assets                          |       | —                                     |       | 31,252                                 |       | 31,252 |   |
| Capital  expenditures                  |       | —                                     |       | 84                                     |       | 84 |   |
|                                   |       |                                       |       |                                   |       |   |   |
| Three months ended  December 31, 2005  |       |                                       |       |                                   |       |   |   |
| Sales  to external customers           |       | $                                          | 964        |                                   | $          | 17,880 |   | $ | 18,884 |   |
| Depreciation  and amortization expense |       | —                                     |       | 650                                    |       | 650 |   |
| Net  income (loss) from operations     |       | 69                                         |       | (1,581                                 | )          | (1,512 | ) |
| Interest  expense                      |       | —                                     |       | 2,759                                  |       | 2,759 |   |
| Total  assets                          |       | 367                                        |       | 42,000                                 |       | 42,367 |   |
| Capital  expenditures                  |       | —                                     |       | 98                                     |       | 98 |   |
|                                   |       |                                       |       |                                   |       |   |   |
| Six months ended  December 31, 2006    |       |                                       |       |                                   |       |   |   |
| Sales  to external customers           |       | $                                          | —     |                                   | $          | 40,300 |   | $ | 40,300 |   |
| Depreciation  and amortization expense |       | —                                     |       | 1,372                                  |       | 1,372 |   |
| Net  loss from operations              |       | —                                     |       | (1,642                                 | )          | (1,642 | ) |
| Interest  expense                      |       | —                                     |       | (3,490                                 | )          | (3,490 | ) |
| Total  assets                          |       | —                                     |       | 31,252                                 |       | 31,252 |   |
| Capital  expenditures                  |       | —                                     |       | 164                                    |       | 164 |   |
|                                   |       |                                       |       |                                   |       |   |   |
| Six months ended  December 31, 2005    |       |                                       |       |                                   |       |   |   |
| Sales  to external customers           |       | $                                          | 1,949      |                                   | $          | 40,329 |   | $ | 42,279 |   |
| Depreciation  and amortization expense |       | 35                                         |       | 1,345                                  |       | 1,380 |   |
| Net  income (loss) from operations     |       | 115                                        |       | (2,853                                 | )          | (2,738 | ) |
| Interest  expense                      |       | —                                     |       | (3,493                                 | )          | (3,493 | ) |
| Total  assets                          |       | 367                                        |       | 42,000                                 |       | 42,367 |   |
| Capital  expenditures                  |       | —                                     |       | 173                                    |       | 173 |   |

 

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**14.****                    ****SUBSEQUENT EVENTS**

On January 12, 2007, theCompany granted to certain new employees options to purchase an additional1,160,000 stock options under the 2006 Plan at an exercise price of $0.14 pershare. Accordingly, the number of shares issuable to the holder of the SeniorWarrants upon its exercise will increase by approximately 278,252 shares net ofcanceled options.

**ITEM 2.**   MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

The following discussion and analysis of our resultsof operations and financial position should be read in conjunction with ouraudited consolidated financial statements and related notes included in ourAnnual Report on Form 10-K for the year ended June 30, 2005 and theunaudited consolidated financial statements and related notes included in thisQuarterly Report on Form 10-Q. Depending upon the context, the termsDynTek, “we,” “our,” and “us,” refers to either DynTek alone, or DynTek and itssubsidiaries.

**Forward-Looking Statements**

Thisreport contains “forward-looking statements” within the meaning of such term inSection 27A of the Securities Act of 1933, Section 21E of the SecuritiesExchange Act of 1934, and the Private Securities Litigation Reform Act of 1995.We wish to caution readers not to place undue reliance on any suchforward-looking statements, each of which speaks only as of the date made.  Forward-looking statements involve known andunknown risks, uncertainties and other factors which could cause actual financialor operating results, performance or achievements expressed or implied by suchforward-looking statements not to occur or be realized. Such statements aresubject to certain risks and uncertainties that could cause actual results todiffer materially from historical results and those presently anticipated orprojected.  See below, and a discussionof such risks and factors discussed in Item 1 (Business) of Part I and Item 7(Management’s Discussion and Analysis of Financial Condition and Results ofOperations) of Part II of our Annual Report on Form 10-K for the fiscal yearended June 30, 2006 as filed with the Securities and Exchange Commission.  Forward-looking statements made in this Form10-Q generally are based on our best estimates of future results, performancesor achievements, predicated upon current conditions and the most recent resultsof the companies involved and their respective industries. Forward-lookingstatements may be identified by the use of forward-looking terminology such as “may,”“will,” “could,” “should,” “project,” “expect,” “believe,” “estimate,” “anticipate,”“intend,” “continue,” “potential,” “endeavor,” “opportunity” or similar terms, variations of those terms or thenegative of those terms or other variations of those terms or comparable wordsor expressions. Readers should carefully review those risks, as well asadditional risks described in this report and other documents we file from time

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to time with theSecurities and Exchange Commission. Potential risks and uncertainties include, among other things, suchfactors as:

·                  Ourability to reach target markets for services and products and our ability toretain current and attract future customers;

·                  Ourability to attract and retain professional staff, successfully integrateacquired companies into our operations, and our ability to acquire additionalcompanies, if any;

·                  Marketacceptance, revenues and profitability of our current and future products andservices;

·                  Ourability to finance and sustain operations, including the ability to fund,maintain, replace and/or extend the Senior Notes and/or Junior Notes, when due,respectively, or to replace such instruments with alternative financing;

·                  Ourability to raise equity capital or debt in the future, despite historicallosses from operations;

·                  General economic conditions in theUnited States and elsewhere, as well as the economic conditions affecting theindustries in which we operate, our customers and suppliers;

·                  The competitive environment in theregions in which we compete, and the cost-effectiveness of our products andservices;

·                  Politicaland regulatory matters that affect the industries in which we operate;

·                  Ourcontinued ability to trade on the NASD bulletin board; and

·                  Otherrisks detailed in our filings with the Securities and Exchange Commission.

The Company has no obligation to publicly release theresults of any revisions to any forward-looking statements to reflectanticipated or unanticipated events or circumstances occurring after the dateof such statements.

**BusinessOverview**

DynTek, Inc. provides professionalinformation technology (“IT”) solutions and sales of related products andservices to mid-market commercial businesses, state and local governmentagencies, and educational institutions. We operate our business primarilythrough our subsidiary, DynTek Services, Inc. and our Canadian subsidiaryDynTek Canada, Inc.

Weprovide a broad range of multi-disciplinary IT solutions that address thecritical business needs of our clients, including IT security, convergednetworking (including voice-over-internet-protocol “VOIP”), applicationinfrastructure, and access infrastructure. Our primary operations are located in four of the top ten largest ITspending states: California, New York, Florida, and Michigan.  We deliver complex infrastructure technologysolutions through teams of professional consultants in close geographicproximity to our clients.  Members of ourtechnical and consulting services team have advanced certifications withleading vendor-manufacturers, including Microsoft, Cisco, McAfee andCitrix.   As a professional services firmand value-added reseller of hardware and software from leading manufacturers,we help organizations assess, design, build, implement, manage and supporttheir technology infrastructure.

We believe that our services-led approach, combinedwith expertise in multi-disciplinary practice areas such as IT security,converged networking (including VOIP), application infrastructure, and accessinfrastructure, will continue to provide the platform we need to capture anincreasing share of our target markets. Our strategy allows our clients to rely on DynTek as their primary ITvendor.  Additionally, we believe thatour multi-disciplinary capabilities help differentiate us from our competitorsin the markets in which we compete.

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We recognize revenue from sales of products andservices. Services are primarily provided to the client at hourly rates thatare established for each of our employees or third-party contractors based upontheir skill level, experience and the type of work performed. We also provideproject management and consulting work which are billed either by an agreedupon fixed fee or hourly rates, or a combination of both. The majority of ourservices are provided under purchase orders with commercial customers or bidcontracts with government entities.  (See“Revenue Recognition,” below)

Costs of services consistprimarily of salaries of services personnel and related expenses incurred inproviding such services, and the cost of outsourced service labor.  Costs of products consist of our cost ofproducts purchased and sold to our customers. Selling, general andadministrative expenses consist primarily of salaries and benefits of personnelresponsible for administrative, finance, sales and marketing activities and allother corporate overhead expenses. Corporate overhead expenses include rent,telephone and internet charges, insurance premiums, accounting and legal fees,and other general administrative expenses.  Selling, general and administrative costs also include a calculation ofthe fair value of employee stock options and other share-based payment awardscalculated pursuant to SFAS No. 123R.

**Resultsof Operations**

The following table sets forth, for the periodsindicated, the relative percentages that certain income and expense items bearto net sales.

|                                               | ** ** | **Six Months Ended  Dec. 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| Product Revenue                               |       | 72                                            | %          | 68 | % |
| Service  Revenue-Information Technology       |       | 28                                            | %          | 28 | % |
| Service  Revenue-Business Process Outsourcing |       | —                                        | %          | 4 | % |
|                                          |       |                                          |       |   |   |
| Cost of Products                              |       | 86                                            | %          | 88 | % |
| Cost of  Service-Information Technology       |       | 71                                            | %          | 71 | % |
| Cost of  Service-Business Process Outsourcing |       | —                                        | %          | 94 | % |
|                                          |       |                                          |       |   |   |
| Gross profit                                  |       | 18                                            | %          | 17 | % |
|                                          |       |                                          |       |   |   |
| SG & A                               |       | 19                                            | %          | 20 | % |
|                                          |       |                                          |       |   |   |
| Loss from  continuing operations              |       | (13                                           | )%         | (14 | )% |
| Gain (loss) from  discontinued operations     |       | —                                        |       | — | % |
| Net income (loss)                             |       | (13                                           | )%         | (14 | )% |

 

***Six months ended December 31, 2006 andDecember 31, 2005***

**Revenues.**Forthe six months ended December 31, 2006, our revenues decreased toapproximately $40,300,000 from approximately $42,279,000 for the six monthsended December 31, 2005. This $1,979,000, or 5% decrease is principallyattributable to a decrease in our Southwest Region of $3,278,000 as well as the$1,949,000 reduction of revenues due to the transition of the transitionedBusiness Process Outsourcing (“BPO”) business, which was offset by a $2,234,000increase in our Canadian operations as a result of the acquisition of SSS inOctober 2006 and an $1,014,000 increase in the combined IT Solutions revenuesfrom our other regions.

Our product sales increased from $28,583,000during the six months ended December 31, 2005 to $29,136,000 during thesix months ended December 31, 2006, an increase of $553,000, or 2%. Theincrease resulted from approximately $1,624,000 in new product sales within oursecurities practice in our Canadian operation following the SSS acquisition inOctober 2006, a decrease of $2,392,000 in our Southwest region due to a highconcentration of non-repetitive commercial accounts, and an increase of$1,321,000 in the combined IT Solutions sales from all other regions.

Our services revenues decreased from $13,696,000during the six months ended December 31, 2005 to $11,164,000 during thesame period in 2006, a decrease of $2,532,000, or 18%. This decrease resultedfrom a $1,949,000 decrease in service revenues related to the transitioned BPOsegment, as well as a $904,000 decrease in IT service revenue from all otherregions combined, which was offset by the delivery and recognition of $321,000of pre-existing service support obligations assumed in the TekConnectacquisition.

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The following table sets forth for the periodspresented information derived from our consolidated statements of operations(in thousands):

|               | ** ** | **For the Six Months ended December 31** | ** ** |
|---------------|------------|------------------------------------------------------------------------|------------|
| **REVENUES**  | ** ** | **2006**                                                               | ** ** | **2005** | ** ** | **Percentage  change** | ** ** | **Amount** | ** ** |
| ***Product*** |       | $                                                                      | 29,136     |   | 28,583 |   | 2 | % | 553 |   |
| *** ***  |       |                                                                   |       |   |   |   |   |   |   |
| ***Service*** |       | 11,164                                                                 |       | 13,696 |   | (18 | )% | (2,532 | ) |
| *** ***  |       |                                                                   |       |   |   |   |   |   |   |
| ***Total***   |       | 40,300                                                                 |       | 42,279 |   | (5 | )% | 1,979 |   |
|               |            |                                                                        |            |  |  |  |  |  |  |  |

 

Our customers are primarily stateand local government entities, educational institutions, and mid-sizedcorporations in diversified industries. For the six months endedDecember 31, 2006, 42% of our revenues were derived from commercialclients, compared to 36% from government agencies and 22% from educationalinstitutions. For the six months ended December 31, 2005, 58% of ourrevenues were derived from commercial clients, compared to 34% from governmentagencies and 8% from educational institutions.

**Gross profit.**Grossprofit, increased from $7,303,000 in the six months ended December 31,2005 to $7,339,000 in the six months ended December 31, 2006, despite a 5%decline in revenue. Gross margin for the six months ended December 31, 2006 was18%, compared to 17% for the similar period in the prior fiscal year. Ourservices margin remained at 29% for both periods due to improved marginsthrough increased internal resource utilization in our Southwest region. Ourproduct margin increased from 12% to 14%. The increase in overall product grossmargin is primarily the result of new higher margin business within all of ouroperating regions including the Southwest. We will continue to focus onimproving our overall level of service utilization with respect to consultantsthroughout the Company, and a greater mix of higher-end services.  We continue to expect product margins to besubject to competitive pricing pressures and fluctuate from quarter to quarterdepending on the mix of products we provide. We intend to meet the challenges of aggressive price reductions anddiscount pricing by certain product suppliers by focusing our offerings aroundrelatively higher margin practice areas, including security solutions, VOIP,and application delivery.  There can beno assurance, however, that we will be able to improve profit margins,especially for our sale of products, and compete profitably in all areas, giventhe intense competition that exists in the IT industry.

**Selling, general and administrative expenses.**Generaland administrative expenses decreased to approximately $2,376,000 for the sixmonths ended December 31, 2006, from approximately $2,485,000 for the sixmonths ended December 31, 2005. As a percentage of revenues, general andadministrative expenses remained unchanged at 6% for both periods, however,during the period ended December 31, 2006, an aggregate $421,000 in non-cashstock based compensation expense was incurred which included (i) $40,000 instock grants to two non-employee board members, (ii) $288,000 in fully vestedstock option grants, and (iii) $93,000 in employee stock options expense underthe 2006 Plan, calculated using a black scholes pricing model on the fair valueof the options on the date granted. A similar charge was not incurred duringthe same period in 2005. Accordingly the decrease in general and administrativeexpenses in 2006 compared to 2005, excluding the effects of stock-basedcompensation, was approximately $528,000 as a result of restructuring and costreduction programs that we undertook beginning in fiscal year 2005.

Sellingcosts decreased to approximately $5,233,000 for the six months endedDecember 31, 2006 from $6,176,000 in the six months endedDecember 31, 2005. The decrease of $943,000, or 15%, is primarily due to areduction in personnel costs related to restructuring and cost reductionprograms that were implemented. During the six month period ended December 31,2006, a $200,000 stock based compensation expense was incurred for a stockgrant issued in July 2006 and $55,000 in employee stock options under the 2006Plan calculated using a black scholes pricing model on the fair value of theoptions on the date granted..  During thesix month period ended December 31, 2005, a $205,000 charge was incurred for theaccelerated vesting of employee stock options issued primarily to salespersonnel.

Asa percentage of total revenues, the aggregate selling, general andadministrative expenses were 19% during the six months ended December 31, 2006,compared to 21% for the same period ended December 31, 2005.

**Depreciation and amortization expense.**Depreciationand amortization expense decreased to approximately $1,372,000 for thesix-month period ended December 31, 2006, from approximately $1,380,000during the same period in the prior year.

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**Interest expense.**Interestexpense for the six months ended December 31, 2006 increased to$3,490,000, as compared to $3,493,000 for the six months endedDecember 31, 2005. The increase is primarily due to significantly highernon-cash interest for the period ended December 31, 2006 of approximately$2,688,000 compared to only $675,000 for the period ended December 31, 2005.Amortization on the debt discounts on the Senior Notes was approximately$853,000 with approximately $649,000 of non-cash interest related to the fair valueof the issuable Senior Note warrants in excess of the carrying value of theSenior Notes.  The non-cash interestamortization on the debt discounts on the Junior Notes was approximately$342,000. During the six months ended December 31, 2006, the Company elected topay in kind the interest approximately $390,000 of interest on the Senior Notesand approximately $407,000 on the Junior Notes. Amortization of deferredfinancing fees amounted to approximately $47,000. In addition to non cashinterest expense, the Company incurred fees on the APA and APLA agreements wereapproximately $765,000 and miscellaneous charges of $37,000.

The following table sets forth operating expenses forthe periods presented from information derived from our consolidated statementsof operations (in thousands):

|                                                | ** **   | **For the Six Months ended  December 31,** | ** **   |
|------------------------------------------------|--------------|---------------------------------------------------------------------|--------------|
| **OPERATING**                                  | ** **   | **Dollars**                                                         | ** **   | **Percentage of  Revenues** | ** ** |
| **EXPENSES**                                   | ** **   | **2006**                                                            | ** **   | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ***Selling***                                  |         | 5,233                                                               |         | 6,176 |   | 13 | % | 15 | % |
| *** ***                                   | *** *** | *** ***                                                        | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| ***General &  Administrative(1)***    |         | 2,376                                                               |         | 2,485 |   | 6 | % | 6 | % |
| *** ***                                   | *** *** | *** ***                                                        | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| ***Depreciation &  Amortization(1)*** |         | 1,372                                                               |         | 1,380 |   | 3 | % | 3 | % |
| *** ***                                   | *** *** | *** ***                                                        | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| ***Total***                                    |         | 8,981                                                               |         | 10,041 |   | 22 | % | 24 | % |

 

**Net loss.**Ournet loss for the six months ended December 31, 2006 was $5,147,000compared to a net loss of $5,937,000 for the six months ended December 31,2005. Loss from operations during the six months ended December 31, 2006includes depreciation and amortization expense of $1,372,000, non-cash stockbased compensation expense of $676,000, and interest expense of $3,490,000(including non-cash interest of $2,688,000). Loss from operations during the six months ended December 31, 2005includes depreciation and amortization expense of $1,380,000, non-cash stockbased compensation expense of $205,000, and interest expense of $3,493,000(including a non-cash portion of $2,374,000).

***Discontinued Operations.***Therewas no income from discontinued operations for the six months ended December31, 2006 compared to income of $216,000 for the six months ended December 31,2005.

**Resultsof Operations**

The following table setsforth, for the periods indicated, the relative percentages that certain incomeand expense items bear to net sales.

|                                               | ** ** | **Three Months  Ended Dec. 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| Product Revenue                               |       | 67                                              | %          | 66 | % |
| Service  Revenue-Information Technology       |       | 33                                              | %          | 29 | % |
| Service  Revenue-Business Process Outsourcing |       | —                                          | %          | 5 | % |
|                                          |       |                                            |       |   |   |
| Cost of Products                              |       | 84                                              | %          | 89 | % |
| Cost of  Service-Information Technology       |       | 71                                              | %          | 68 | % |
| Cost of  Service-Business Process Outsourcing |       | —                                          | %          | 93 | % |
|                                          |       |                                            |       |   |   |
| Gross profit                                  |       | 20                                              | %          | 17 | % |
|                                          |       |                                            |       |   |   |
| SG & A                               |       | 20                                              | %          | 21 | % |
| Interest expense                              |       | 11                                              | %          | 15 | % |
| Loss from  continuing operations              |       | (15                                             | )%         | (23 | )% |
| Gain (loss) from  discontinued operations     |       | —                                          |       | — |   |
| Net income (loss)                             |       | (15                                             | )%         | (23 | )% |

 

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***Three months ended December 31, 2006 andDecember 31, 2005***

**Revenues.**Forthe three months ended December 31, 2006, our revenues decreased toapproximately $18,523,000 from approximately $18,844,000 for the three monthsended December 31, 2005. The components of this decrease, which amounts to$321,000, or 2%, are attributable to the reduction of revenues of $964,000 fromthe transition of our former BPO and a net increase of $1,204,000 in our ITsolutions business. The IT solution’s increase was comprised of an increase inour Canadian operations of $1,823,000 as a result of the acquisition of SSS inOctober 2006, but a decrease in our Southwest region of $1,742,000.  Combined revenues from all other regionsincreased by $151,000.

Our product sales declined from $12,428,000during the three months ended December 31, 2005 to $12,371,000 during thethree months ended December 31, 2006. This decline of $57,000 was theresult of a $1,660,000 increase in new securities practice product revenue inour Canadian operations from the SSS acquisition in October 2006, a $1,595,000decrease in our Southwest region due to a high concentration of non-repetitivecommercial accounts, and an decrease of $8,000 in the combined IT Solutionssales from all other regions.

Our services revenues decreased from $6,416,000during the three months ended December 31, 2005 to $6,174,000 during thesame period in 2006. This decrease of $244,000, or 4%, resulted from a $964,000decrease in service revenues related to the transitioned BPO segment offset byan increase of $722,000 in IT service revenue from all other regions combined,which included the delivery and recognition of $321,000 of pre-existing servicesupport obligations assumed in the TekConnect acquisition of October 2006.

The following table sets forth for the periodspresented information derived from our consolidated statements of operations(in thousands):

|               | ** ** | **For the Three Months ended December 31** | ** ** |
|---------------|------------|--------------------------------------------------------------------------|------------|
| **REVENUES**  | ** ** | **2006**                                                                 | ** ** | **2005** | ** ** | **Percentage  change** | ** ** | **Amount** | ** ** |
| ***Product*** |       | $                                                                        | 12,353     |   | 12,428 |   | — | % | (73 | ) |
| ** **    |       |                                                                     |       |   |   |   |   |   |   |
| ***Service*** |       | 6,170                                                                    |       | 6,416 |   | (4 | )% | (248 | ) |
| ** **    |       |                                                                     |       |   |   |   |   |   |   |
| ***Total***   |       | 18,523                                                                   |       | 18,844 |   | (2 | )% | (321 | ) |
|               |            |                                                                          |            |  |  |  |  |  |  |  |

 

Our customers are primarilystate and local government entities and mid-sized corporations in diversifiedindustries. For the three months ended December 31, 2006, 47% of ourrevenues were derived from commercial clients, compared to 30% from governmentagencies and 23% from educational institutions. For the three months endedDecember 31, 2005, 68% of our revenues were derived from commercialclients, compared to 28% from government agencies and 4% from educationalinstitutions.

**Gross profit.**Grossprofit increased from $3,189,000 in the quarter ended December 31, 2005 to$3,723,000 in the quarter ended December 31, 2006, an increase of$534,000, or 17%. Gross margin increased from 17% for the three months endedDecember 31, 2005 to 20% for the three months ended December 31, 2006. Ourservices margin increased from 28% to 29% and our product margin increased from11% to nearly 16%. Services margin increased slightly primarily due tocontinued improvement of the utilization of our internal consultants, a greatermix of higher-end services in our IT solutions segment, and the elimination oflower margin BPO services. The increase in overall product gross margin isprimarily due to a higher margin product mix in our product offerings in ourCanadian acquisition, in our core IT solutions, and in our vender partnershipprograms compared to the December quarter in 2005. Although we haveimproved our service margins, and will seek opportunities to make furtherimprovements, product margins in particular are subject to competitive pricingpressures and fluctuate from quarter to quarter depending on the mix ofproducts we provide. We intend to continually meet the challenges of aggressiveprice reductions and discount pricing by certain product suppliers by focusingour offerings around relatively higher margin practice areas, includingsecurity solutions, VOIP, and application delivery. There can be no assurancethat we will be able to improve profit margins over an extended period,especially for our sale of products, and compete profitably in all areas, giventhe intense competition that exists in the IT industry.

**Selling, general and administrative expenses.**Generaland administrative expenses decreased by 2%, to approximately $1,033,000 forthe three months ended December 31, 2006, from approximately $1,051,000for the three months ended December 31, 2005. As a percent of revenues,general and administrative expenses remained unchanged at 6% for both periods;however, during the period ended December 31, 2006, the Company incurred$93,000 in employee stock

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optionexpense under the 2006 Plan, calculated using a black scholes pricing model onthe fair value of the options on the date granted over the vesting period ofthe option. A similar charge was not incurred during the same period in 2005and therefore the decrease in general and administrative expenses realizedduring the December 2006 period compared to 2005 excluding the stock-basedcompensation expense was approximately $109,000. The decrease was primarily theresult of restructuring and cost reduction programs implemented in fiscal year2005.

Selling expenses decreased to approximately$2,640,000 for the three months ended December 31, 2006 from $3,000,000 inthe three months ended December 31, 2005. The decrease of $360,000, or12%, is primarily due to a reduction in personnel costs related torestructuring and cost reduction programs that were implemented. Also duringthe three month period ended December 31, 2006, approximately $55,000 inemployee stock options expense was incurred under the 2006 Plan calculatedusing a black scholes pricing model on the fair value of the options on thedate granted over the vesting period of the option.  During the three month period ended December31, 2005, a similar charge was not incurred.

Asa percentage of total revenues, the aggregate selling, general andadministrative expenses were 20% during the three months ended December 31,2006, compared to 22% for the same period ended December 31, 2005.

**Depreciation and amortization expense.**Depreciationand amortization expense increased to approximately $679,000 for thethree-month period ended December 31, 2006, from approximately $650,000during the same period in the prior year. The increase is primarily due to theaddition of intangible assets related to customer lists from the TekConnect andSSS acquisitions as well as an increase in capital expenditures.

**Interest expense.**Interestexpense for the three months ended December 31, 2006 decreased to$1,936,000, as compared to $2,759,000 for the three months endedDecember 31, 2005. Non-cash interest for the period ended December 31,2006 was approximately $1,538,000. Non-cash interest charges include theamortization on the debt discounts on the Senior Notes which was approximately$432,000 with approximately $458,000 of non-cash interest related to the fairvalue of the issuable Senior Note warrants in excess of the carrying value ofthe Notes.  The non-cash interestamortization of the debt discounts on the Junior Notes was approximately$171,000. During the six months ended December 31, 2006, the Company elected topay in kind approximately $197,000 of interest on the Senior Notes andapproximately $257,000 on the Junior Notes. Amortization of deferred financingfees amounted to approximately $23,000. In addition to non cash interestexpense, the Company incurred fees on the APA and APLA agreements wereapproximately $369,000 and miscellaneous charges of $29,000. Interest expenseduring the three months ended December 31, 2005 included non-cash charges of$2,374,000 incurred in connection with reduction in the conversion price of our9% Notes, and reductions in the exercise prices of warrants issued to holdersof 9% Notes and the Laurus Notes, and the amortization of deferred financingfees. Also included in interest expense during the three months ended December31, 2005 was contractual interest due on notes that we entered into inJanuary and October 2004, a bridge loan in November 2005, and anincrease in the average borrowings under our credit facility.

The following table setsforth operating expenses for the periods presented from information derivedfrom our consolidated statements of operations (in thousands):

|                                             | ** ** | **For the Three Months ended  December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **OPERATING**                               | ** ** | **Dollars**                                                           | ** ** | **Percentage of  Revenues** | ** ** |
| **EXPENSES**                                | ** ** | **2006**                                                              | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ***Selling***                               |       | 2,640                                                                 |       | 3,000 |   | 14 | % | 16 | % |
| *** ***                                |       |                                                                  |       |   |   |   |   |   |   |
| ***General &  Administrative***    |       | 1,033                                                                 |       | 1,051 |   | 6 | % | 6 | % |
| *** ***                                |       |                                                                  |       |   |   |   |   |   |   |
| ***Depreciation &  Amortization*** |       | 679                                                                   |       | 650 |   | 3 | % | 3 | % |
| *** ***                                |       |                                                                  |       |   |   |   |   |   |   |
| ***Total***                                 |       | 4,352                                                                 |       | 4,701 |   | 23 | % | 25 | % |

 

**Net loss.**Ournet loss for the three months ended December 31, 2006 was $2,563,000compared to a net loss of $4,256,000 for the three months endedDecember 31, 2005. The loss during the three months endedDecember 31, 2006 includes interest expense of $1,936,000 (including anon-cash portion of $1,538,000), depreciation and amortization expense of $679,000,and non-cash stock based compensation expense of $148,000. Losses fromoperations during the three months ended December 31, 2005 includesdepreciation and amortization expense of $1,380,000, non-cash stock basedcompensation expense of $205,000, and interest expense of $2,759,000 (includinga non-cash portion of $2,374,000).

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**Liquidity and Capital Resources**

We measure our liquidity in a number of ways, assummarized in the following table:
| ** **                 | ** ** | **(Dollars in thousands)**    | ** ** |
|----------------------------|------------|-----------------------------------------|------------|
| ** **                 | ** ** | **As of  Dec. 31, 2006** | ** ** | **As of  June 30, 2006** | ** ** |
| Cash and cash  equivalents |       | $                                       | 1,080      |   | $ | 1,190 |   |
|                       |       |                                    |       |   |   |
| Working capital            |       | $                                       | (391       | ) | $ | 43 |   |
|                       |       |                                    |       |   |   |
| Current ratio              |       | 0.94:1                                  |       | 1.01:1 |   |

 

Cash and cash equivalentsgenerally consist of cash and money market funds. We consider all highly liquidinvestments purchased with maturities of three months or less to be cashequivalents.

During the six monthsended December 31, 2006, we used approximately $1,222,000 of cash in ouroperating activities.

We incurred a net loss of$5,147,000 for the six months ended December 31, 2006, which includes$4,736,000 of non-cash charges resulting from $1,372,000 of depreciation andamortization, $676,000 in non-cash stock compensation expense, and $2,688,000in non-cash interest charges.

On September 26, 2006,the Company issued another Junior Secured Convertible Note to the Junior Lenderin the aggregate principal amount of $3,000,000.  Thus, at September 30, 2006, the Company hadworking capital of approximately $2,528,000. Proceeds from the additional Junior Note were used to fund twoacquisitions and for general working capital.

On October 6, 2006, theCompany entered into an Asset Purchase Agreement with TekConnect, Inc pursuantto Section 363 of the United States Bankruptcy Code, for substantially allof its assets.  In consideration for thepurchased assets, the Company agreed to pay TekConnect at closing a cashpayment of $400,000. Additional fees in connection with the acquisition ofapproximately $63,000 were also paid.

On October 27, 2006, theCompany, through its wholly-owned subsidiary DynTek Canada, entered into anAsset Purchase Agreement with SSS and Paul Saucier whereby it agreed topurchase substantially all of the assets of SSS. In consideration for thepurchased assets, the Company agreed to pay SSS at closing a cash payment of$1,063,000 and 1,485,148 shares of the Company’s common stock, based upon a pershare value of $0.202. Additional fees in connection with the acquisition ofapproximately $50,000 were also paid. In addition, the Company has agreed tomake additional payments over a three-year period based upon the achievement ofcertain EBITDA performance targets.  Such payments will be paid using acombination of cash and the Company’ common stock, at the Company’s election,provided that at least half of the payments will be in cash. For the periodended December 31, 2006, the earn-out provision was estimated to be $222,926based upon achieved EBITDA performance targets and classified as a currentliability in accordance with SFAS No. 150. The Company intends todistribute such payment, half in cash and half issuable in shares of theCompany’s common stock at a price of $0.20 per share.

We experiencetiming differences in its operating cash flows resulting from the fact thatmuch of our revenues are earned near the end of each quarter and its operatingexpenses are incurred evenly throughout the period. The Company also experienceslow collection cycles since with respect to customers that are educational andgovernment institutions, which has been a growing area of our business.  Although we experience low rates ofuncollectible accounts, many of our customers pay beyond their terms.

Slow collections havecaused the Company to incur higher fees under its accounts receivable andproduct financing arrangements with NETF. The Company also recently used aportion of its cash resources to acquire TekConnect and SSS. The Company, in itsacquisition of TekConnect, assumed approximately $540,000 of pre-existing serviceobligations which 

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have resulted in someincreased costs. Although the Company uses its facility with NETF to bettermanage the timing differences in its operating cash flows, accounts receivabledue from customers under its newly acquired Canadian business are ineligible fortransfer. These circumstances have caused the Company to experience additionalconstraints on its liquidity, which are likely to continue until such time thatthe acquired is fully integrated.

Although theCompany has made substantial efforts to accelerate collections under itsCompany wide operations, slow collection cycles, ongoing timing differences andefforts to integrate acquired businesses could cause the Company to seek additionaloutside financing. Although the Company believes that it has sufficient capitalresources to sustain the business through January 31, 2008, there can be noassurance that unforeseen circumstances will not have a material affect on operations.These circumstances could require the Company to take a variety of measures toconserve and/or improve liquidity including curtailing operations; cuttingcosts seek additional outside financing. The Company has not secured anycommitments for new financing at this time nor can it provide assurance thatany new capital (if needed) will be available to it on acceptable terms, if atall.

The Company believes thatits strategy of streamlining the business around its core competency ofproviding IT solutions is enabling it to operate under a more efficient coststructure than it had in the past. The Company is also not required to makeprincipal payments under any of its note obligations until June 2009 and itsaccounts receivable and product financing arrangement with NETF is providing itwith timely working capital resources.

In the future, we maycontinue to expand the scope of our product and services offerings by pursuingacquisition candidates with complementary technologies, services orproducts.  Should we commence suchacquisitions, we believe that we would finance the transactions with a combinationof our working capital, the issuance of additional equity securities, or theissuance of additional debt instruments. There can be no assurance, however,that we will be successful in identifying appropriate acquisition candidates orthat, if appropriate candidates are identified, that we will be successful inobtaining the necessary financing to complete the acquisitions.

In the event of anyadditional financing, any equity financing would likely result in dilution toour existing stockholders and any debt financing may include restrictivecovenants.

**ContractualObligations**
| ** **                        | ** ** | **Payments due by period  (in thousands)** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                        | ** ** | **Total**                                                      | ** ** | **Less  than 1  year** | ** ** | **1-3 years** | ** ** | **3-5  years** | ** ** | **More  than 5  years** | ** ** |
| *Contractual Obligations*         | * *   | * *                                                       | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Non-Convertible Debt  Obligations |       | 7,320                                                          |       | — |   | — |   | 7,320 |   | — |   |
| Convertible Debt  Obligations     |       | 7,545                                                          |       | — |   | — |   | 7,545 |   | — |   |
| Operating Lease  Obligations      |       | 1,401                                                          |       | 612 |   | 718 |   | 71 |   | — |   |
| Total                             |       | $                                                              | 16,266     |   | $ | 612 |   | $ | 718 |   | $ | 14,936 |   | $ | — |   |
|                                   |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Critical AccountingPolicies and Estimates**

Our financial statementsand accompanying notes are prepared in accordance with accounting principlesgenerally accepted in the United States. Preparing financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenue, and expenses. These estimates andassumptions are affected by management’s application of accounting policies.Critical accounting policies for us include revenue recognition, impairment ofgoodwill, and accounting for discontinued operations.

***Revenue******Recognition.*****  **We apply therevenue recognition principles set forth under SOP 97-2 and SAB 104 withrespect to all of our revenue. We adhere strictly to the criteria set forth inparagraph .08 of SOP 97-2 and outlined in SAB 104 which provides forrevenue to be recognized when (i) persuasive evidence of an arrangement exists,(ii) delivery has occurred, (iii) the vendor’s fee is fixed or determinable,and (iv) collectability is probable. A summary of our revenue recognitionpolicies, as they relate to our specific revenue streams, is as follows:

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*Computer Hardware ProductRevenues*

We require our hardwareproduct sales to be supported by a written contract or other evidence of a saletransaction that clearly indicates the selling price to the customer, shippingterms, payment terms (generally 30 days) and refund policy, if any.

Since our hardware salesare supported by a contract or other document that clearly indicates the termsof the transaction, and our selling price is fixed at the time the sale isconsummated, we record revenue on these sales at the time in which we receive aconfirmation that the goods were tendered at their destination when shipped “FOBdestination,” or upon confirmation that shipment has occurred when shipped “FOBshipping point.”

*Software Product Revenues*

We make substantially allof our software product sales as a reseller of licenses, which may include apost contract customer support arrangement and access to product and upgrades,and enhancements that are provided exclusively by the manufacturer followingdelivery and the customer’s acceptance of the software product. We do notpresently sell any software that we develop internally. Any responsibility fortechnical support and access to upgrades and enhancements to these software productsare solely the responsibility of the software manufacturer, which arrangementis known to the customer at the time the sale is consummated. With respect todelivery, we require that the customer has received transfer of the softwareor, at a minimum, an authorization code (“key”) to permit access to theproduct. If a software license is delivered to the customer, but the licenseterm has not begun, we do not record the revenue prior to inception of thelicense term.

We require our softwareproduct sales to be supported by a written contract or other evidence of a saletransaction, which generally consists of a customer purchase order or on-lineauthorization. These forms of evidence clearly indicate the selling price tothe customer, shipping terms, payment terms (generally 30 days) and refundpolicy, if any. The selling prices of these products are fixed at the time thesale is consummated.

For product sales, weapply the factors discussed in EITF 99-19 “Reporting Revenue Gross as aPrincipal versus Net as an Agent” in determining whether to recognize productrevenues on a gross or net basis. In a substantial majority of ourtransactions, we (i) act as principal; (ii) take title to the products; and(iii) have the risks and rewards of ownership, including the risk of loss forcollection, delivery or returns. For these transactions, we recognize revenuesbased on the gross amounts billed to our customers. In certain circumstances,based on an analysis of the factors set forth in EITF 99-19, we havedetermined that we were acting as an agent, and therefore recognize revenues ona net basis. During the nine months ended December 31, 2006, no revenues wererecognized on a net basis.

*IT Services Revenue*

We generally bill ourcustomers for professional IT services based on hours of time that we spend onany given assignment at our hourly billing rates. As it relates to delivery ofthese services, we recognize revenue under these arrangements as the work iscompleted and the customer has indicated their acceptance of our services byapproving a work order milestone or completion order. For certain engagements,we enter fixed bid contracts, and we recognize revenue as phases of the projectare completed and accepted by our client. For our seat management services, weenter unit-price contracts (e.g., price per user for seat management), and werecognize revenue based on number of units multiplied by the agreed-uponcontract unit price per month.

*BPO Services Revenue*

For our BPO services,which primarily included our child support service contracts in the states ofKansas and Nebraska, we provided services under a fixed price (flat monthlyfee) contract, and recognized revenue as the services are provided and billed.In the state of North Carolina, we had one contract subject to revenue-sharingrelated to child support services. Under that contract, a fee from amountscollected was shared with the county on a percentage basis, and revenue wasrecognized monthly in arrears as a percentage of the total amount of collectionsreceived.

***Collectability of Receivables.*****  **A considerableamount of judgment is required to assess the ultimate realization ofreceivables, including assessing the probability of collection and the currentcredit worthiness of our clients. Probability of collection is based upon theassessment of the client’s financial condition through the review of itscurrent financial statements or credit reports.

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***Goodwill.*****  **SFAS 142,Goodwill and Other Intangible Assets, requires that goodwill be tested forimpairment at the reporting unit level (operating segment or one level below anoperating segment) on an annual basis (June 30th for the company) and betweenannual tests in certain circumstances. Application of the goodwill impairmenttest requires judgment, including the identification of reporting units,assigning assets and liabilities to reporting units, assigning goodwill toreporting units, and determining the fair value. Significant judgments requiredto estimate the fair value of reporting units include estimating future cashflows, determining appropriate discount rates and other assumptions. Changes inthese estimates and assumptions could materially affect the determination offair value and/or goodwill impairment for each reporting unit.

***Convertible Notes.*****  **The companyaccounts for conversion options embedded in convertible notes in accordancewith Statement of Financial Accounting Standard (“SFAS) No. 133 “Accounting forDerivative Instruments and Hedging Activities” (“SFAS 133”) and EITF 00-19“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a company’s Own Stock” (“EITF 00-19”). SFAS 133 generallyrequires companies to bifurcate conversion options embedded in convertiblenotes from their host instruments and to account for them as free standingderivative financial instruments in accordance with EITF 00-19. SFAS 133provides for an exception to this rule when convertible notes, as hostinstruments, are deemed to be conventional as that term is described in theimplementation guidance under Appendix A to SFAS 133 and further clarified inEITF 05-2 “The Meaning of “Conventional Convertible Debt Instrument” inIssue No. 00-19. The company accounts for convertible notes (deemedconventional) in accordance with the provisions of EITF 98-5.

“Accounting forConvertible Securities with Beneficial Conversion Features,” (“EITF 98-5”),EITF 00-27 “Application of EITF 98-5 to Certain ConvertibleInstruments.” Accordingly, the company records, as a discount to convertiblenotes, the intrinsic value of such conversion options based upon thedifferences between the fair value of the underlying common stock at thecommitment date of the note transaction and the effective conversion priceembedded in the note. Debt discounts under these arrangements are amortizedover the term of the related debt to their earliest date of redemption.

**Recent Changes inAccounting Standards**

In September 2006, theFASB issued Statement of Financial Accountings Standards No. 157, Fair ValueMeasurements (“SFAS 157”). This Standard defines fair value, establishes aframework for measuring fair value in generally accepted accounting principlesand expands disclosures about fair value measurements. SFAS 157 is effectivefor financial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. The adoption of SFAS 157 isnot expected to have a material impact on the Company’s financial position,results of operations or cash flows.

In July 2006, theFinancial Accounting Standards Board issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes. This Interpretation prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. This Interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. The Interpretation is effective for fiscal yearsbeginning after December 15, 2006. We have not yet completed our analysis ofthe impact this Interpretation will have on our financial condition, results ofoperations, cash flows or disclosures.

In September 2006, theSecurities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin108, Considering the Effects on Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements, (“SAB 108”). SAB 108requires registrants to quantify errors using both the income statement method(i.e. iron curtain method) and the rollover method and requires adjustments ifeither method indicates a material error. If a correction in the current year relating to prior year errors ismaterial to the current year, then the prior year financial information needsto be corrected. A correction to the prior year results that are not materialto those years, would not require a restatement process where prior financialswould be amended.  SAB 108 is effectivefor fiscal years ending after November 15, 2006. The Company does notanticipate that SAB 108 will have a material effect on its financial position,results of operations or cash flows.

Other accountingstandards that have been issued or proposed by the FASB or otherstandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on the consolidated financial statementsupon adoption.

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**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Market risk associatedwith adverse changes in financial and commodity market prices and rates couldimpact our financial position, operating results or cash flows. We do not haveany variable rate debt instruments and we are not exposed to market risk due tochanges in interest rates such as the prime rate and LIBOR.

Our acquisition ofSensible Security Solutions, Inc. in October of 2006 significantly increasesour presence in the Canadian market and creates greater exposure to foreigncurrency rate fluctuations.  We do notexpect this exposure to be significant.

**ITEM 4. CONTROLS AND PROCEDURES**

As of December 31,2006, the Company carried out an evaluation, under the supervision and with theparticipation of members of our management, including the Company’s ChiefExecutive Officer and the Company’s Chief Financial Officer, of theeffectiveness and operation of the Company’s disclosure controls andprocedures. Based upon that evaluation, the Company’s Chief Executive Officerand the Chief Financial Officer have concluded that the Company’s disclosurecontrols and procedures were not effective as of December 31, 2006, basedon their evaluation of these controls and procedures required by paragraph(b) of Exchange Act Rules 13a-15 and 15d-15.

**DISCLOSURE CONTROLS ANDINTERNAL CONTROLS**

Disclosure controls areprocedures that are designed with the objective of ensuring that informationrequired to be disclosed in our reports filed under the Securities Exchange Actof 1934, as amended, such as this Report, is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms. Disclosure controls are also designed with the objective of ensuringthat such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure. Internalcontrols are procedures which are designed with the objective of providingreasonable assurance that our transactions are properly authorized, recordedand reported and our assets are safeguarded against unauthorized or improperuse, to permit the preparation of our financial statements in conformity with generallyaccepted accounting principles.

Our company is not an “acceleratedfiler” (as defined in the Securities Exchange Act) and is not required todeliver management’s report on control over our financial reporting until ourfiscal year ended June 30, 2008. Nevertheless, we identified certainmatters that constitute material weakness (as defined under the Public CompanyAccounting Oversight Board Auditing Standard No. 2) in our internalcontrols over financial reporting.

The material weaknessesthat we have identified relate to the fact that that our overall financialreporting structure, internal accounting information systems, and currentstaffing levels are not sufficient to support the complexity of our financialreporting requirements. We have experienced employee turnover in our accountingdepartment including the position of Chief Financial Officer at the end ofMarch 2006. As a result, we have experienced difficulty with respect to ourability to record, process and summarize all of the information that we need toclose our books and records on a timely basis and deliver our reports to theSecurities and Exchange Commission within the time frames required under theCommission’s rules. We need to increase the size of our staff and reviewassignments within our accounting department to ensure we have adequatesegregation of duties.

We have also identified aspecific material weakness in our ability to ensure that the accounting for ourequity-based transactions is accurate and complete. Historically, we haveentered into various forms of complex equity transactions involving theapplication of specialized accounting principles. The equity based transactionsthat we consummated specifically relate to stock based compensationarrangements, issuances of complex instruments in financing transactions,modifications to embedded and free standing derivatives and settlements of debtfor equity. We believe that equity transactions we completed in connection withour financial restructuring in March 2006 are unique and occurred as a resultof the fact that our liquidity was highly constrained. Although we believe thatthese events are unique and that our equity based transactions in the futureare likely to be reduced, we are evaluating certain corrective measures toprovide us with the structure we need at such times that we may engage inequity based transactions. These measures could include seeking the assistanceof outside specialists with expertise in these areas.

We believe these materialweaknesses have resulted from liquidity constraints that caused us to focus onusing our resources to implement a financial and operational restructuringplan. We have recently made substantial changes to our operating and capitalstructure and will take corrective measures as appropriate based on thecontinuous evaluation of our

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existingcapabilities and circumstances, the present resources we have available, andpotential resources we may need to make available to effectuate correctivemeasures.

We believe that any suchrisks that may have been created as a result of these material weaknesses arepartially mitigated by the fact that we have minimal assets that are subject tothe risk of misappropriation. In addition, activities during our most recentreporting periods have been regularly reviewed and approved by our ChiefExecutive and Chief Financial Officers. However, we acknowledge that additionalcontrol procedures are necessary to ensure that our all of our transactions areproperly recorded, our assets are appropriately safeguarded and that we canclose and report our results within the time frames required by the Securitiesand Exchange Commission.

As of February 20, 2007,we are presently engaged in a project to evaluate and recommend improvements inour internal systems and controls and we have added additional accountingstaff.  We also have sought outadditional assistance form outside specialist but have not employed anyassistance as of yet.

**PART II - OTHER INFORMATION**

**ITEM1.  LEGAL PROCEEDINGS**

From time to timewe are involved in various legal proceedings and disputes that arise in thenormal course of business. These matters have included intellectual propertydisputes, contract disputes, employment disputes and other matters. On or aboutOctober 30, 2006, Pangaea Education Systems, LLC (“Pangaea”) filed a lawsuitagainst the Company alleging unfair competition, reverse passing off,misappropriation of trade secrets, copyright infringement and breach ofcontract arising out of services performed in 2003 (the “Action”). Pangaea’scomplaint does not specify the amount of damages sought, but Pangaea hasdemanded in excess of $2,500,000 in preliminary communications with the Company’scounsel. The Company contends that this demand is without factual or legalbasis, that the Action has no merit and is aggressively defending theAction.  Trial is scheduled for July 2008. The Company filed a motion todismiss in response to the complaint on November 28, 2006. The Company intendsto continue discussing an informal resolution. While the Company believes ithas a strong position, it is not possible at this time to state the likelihoodof an unfavorable outcome based on the early stage of the dispute, thepositions taken by Pangaea and the inherent uncertainties of litigation.

**ITEM 1A. RISK FACTORS**

Potential risks and uncertainties include, among otherthings, those factors discussed in Item 1 (Business) of Part I and Item 7(Management’s Discussion and Analysis of Financial Condition and Results ofOperations) of Part II of our Annual Report on Form 10-K filed onOctober 13, 2006, Item 2 (Management’s Discussion and Analysis of FinancialCondition and Results of Operations) of Part I of this Quarterly Report onForm 10-Q, and as set forth below in this Item IA. Readers shouldcarefully review those risks, as well as additional risks described in otherdocuments we file from time to time with the Securities and ExchangeCommission. We undertake no obligation to publicly release the results of anyrevisions to any forward-looking statements to reflect anticipated orunanticipated events or circumstances occurring after the date of suchstatements. The following risk factors include material changes to the riskfactors previously disclosed in our Form 10-K filed on October 13, 2006,but are not a complete list of all of our risk factors.

***We will need additional capital in the future, or we will need to scaleback operations***.

We will needcapital in the future, and if it is not available on terms acceptable to us, orat all, and we cannot generate enough cash through existing operations, we mayhave to scale back operations and/or curtail expansion plans. As ofDecember 31, 2006, we had cash and cash equivalents of approximately$1,081,000. We have taken steps during the fiscal year ended June 30, 2006to conserve our capital resources including a reduction of our selling, generaland administrative expenses by approximately $2,400,000 annually. We have alsoreduced the current portion of our debt burden by completing our recapitalizationin March 2006, including canceling certain debt obligations through equityconversion and debt settlement agreements. Additional financing transactionsmay be necessary if we are not able to generate sufficient cash flow fromoperations through revenue growth and overhead reduction to meet ourrequirements.

We are continuingour financial and operational restructuring initiatives and will continue toimplement our strategic business plan. Although we believe that we havesufficient liquidity to sustain the business through January 31, 2008,there is no assurance that unforeseen circumstances will not have a materialaffect on the business that could require us to raise additional capital ortake other measures to sustain operations in the event outside sources ofcapital are not available. We

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have not secured anycommitments for new financing at this time nor can we provide any assurancethat new capital (if needed) will be available to us on acceptable terms, if atall.

***We have a history of operating losses and may not be able to achievelong-term profitability.***

Since our inception in May 1989,we have incurred substantial operating losses. During the six months endedDecember 31, 2006, we generated a net loss of $5,147,000. AtDecember 31, 2006, we had an accumulated deficit of $131,055,000. Therecan be no assurance that our revenues will exceed our operating expenses andcost of revenues in the future.

***The level of our indebtedness could adversely affect ourfinancial condition.***

We havesignificant debt service obligations. As of January 29, 2007, the aggregateprincipal amount owed under our debt instruments was $14.9 million.

The level of ourindebtedness could have important consequences. For example, it could:

·                  increase ourvulnerability to adverse economic and industry conditions;

·                  require us todedicate a substantial portion of our cash flow from operations to the paymentof our indebtedness, thereby reducing the availability of cash to fund workingcapital and capital expenditures and for other general corporate purposes;

·                  restrict us frommaking strategic acquisitions, acquiring new content or exploring otherbusiness opportunities;

·                  limit ourability to obtain financing for working capital, capital expenditures, generalcorporate purposes or acquisitions;

·                  place us at adisadvantage compared to our competitors that have less indebtedness; and

·                  limit ourflexibility in planning for, or reacting to, changes in our business andindustry.

***Dilution in ownership of our shares from the exercise or conversion ofoptions, warrants, and convertible securities.***

There are asignificant number of outstanding options, warrants, and convertible securitiesto acquire shares of our common stock and we may grant additional rights in thefuture. The holders of such options, warrants, and convertible securities canbe expected to exercise them at a time when our common stock is trading at aprice higher than the exercise price of these outstanding options, warrants,and convertible securities. If these options or warrants to purchase our commonstock are exercised, convertible debt is converted or other equity interestsare granted under our 2001, 2005 or 2006 stock option plans, or under otherplans or agreements adopted in the future, such equity interests will have adilutive effect on your ownership of common stock. The existence of suchoptions, warrants, and convertible securities may also adversely affect theterms on which we can obtain additional financing.

As of January 29,2007, we had 58,187,640 shares issued and outstanding. As of such date, we hadoutstanding options to purchase 11,267,064 shares of our common stock, warrantsto purchase approximately 34,616,225 shares of common stock, and $7,544,676 ofconvertible debt, convertible into 37,723,382 shares of common stock. Theprincipal amount of the convertible debt will continue to increase to theextent we elect not to pay interest as it accrues during the first three years,in which case the principal would increase to approximately $10,281,663, andthe number of shares issuable upon conversion would be 51,408,315. We intend toraise capital through offerings of our common stock, securities convertibleinto our common stock, or rights to acquire such securities or our commonstock. Such other rights to acquire our common stock may be issued at exerciseprices or conversion rates that are significantly lower than the price at whichyou may have paid for our shares. In addition, the shares issuable uponexercise of certain of the warrants and upon conversion of convertible debt mayincrease subject to anti-dilutive rights, which we granted to certain warrantand debt holders.

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***Lloyd I. Miller, III beneficially owns a majority ofour outstanding common stock, which may enable him to control many significantstockholder matters and corporate actions and may prevent a change in controlthat would otherwise be beneficial to other stockholders.***

Lloyd I. Millermay be deemed to beneficially own a total of 64,747,903 shares of our commonstock, or 55.9%, as of January 29, 2007, including shares issuable to uponexercise of warrants held by Mr. Miller and his affiliates. The foregoingdoes not take into account the exercise or conversion of other outstandingconvertible or exercisable securities of the Company, which would have theeffect of reducing the percentage beneficial ownership of Mr. Miller.Because of his high percentage of beneficial ownership, Mr. Miller may beable to control matters requiring the vote of stockholders, including theelection of our board of directors and certain other significant corporateactions. This control could delay, defer or prevent others from initiating apotential merger, takeover or other change in our control, even if theseactions would benefit our other stockholders and us. This control couldadversely affect the voting and other rights of our stockholders and coulddepress the market price of our common stock.

***It is possible that we may have violated Section 5 of theSecurities Act.***

In March 2006, weentered into a Note Purchase Agreement (the “Note Purchase Agreement”) withSACC Partners, L.P. and Lloyd I. Miller, III (the “Senior Lenders”), pursuantto which we issued to the Senior Lenders certain Senior Secured Notes in theaggregate principal amount of $6.7 million (the “Senior Notes”).  Underthe Note Purchase Agreement, we also issued a Junior Secured Convertible Noteto Trust A-4 - Lloyd I. Miller (the “Junior Lender” and together with theSenior Lenders, the “Lenders”) in the aggregate principal amount of $3.0million (the “First Junior Note”).  In June 2006, we issued an additionalJunior Secured Convertible Note to Trust A-4 - Lloyd I. Miller in the aggregateprincipal amount of $1.0 million (the “Second Junior Note”).  Pursuant toour contractual obligation to do so, we filed the registration statement ofwhich this prospectus is a part in June 2006 to register for resale, amongother shares, the shares of our common stock into which the First and SecondJunior Notes may be converted. In September 2006, while the registrationstatement was still pending and not yet declared effective, we issued anadditional junior secured convertible note to the Junior Lender in theaggregate principal amount of $3,000,000 (the “Third Junior Note” and togetherwith the First and Second Junior Notes, the “Junior Notes”) on the same termsand conditions as were set forth in the First and Second Junior Notes.

In a commentletter to the registration statement, the SEC notified us that by selling andissuing the Third Junior Note while the registration statement was stillpending, we may have violated Section 5 of the Securities Act.  If theLenders were to have brought an action to rescind the issuance of the Seniorand Junior Notes as a result of the Section 5 violation and prevailed, we wouldhave been required to repurchase the Senior Notes and Junior Notes at theiroriginal purchase price, plus statutory interest from the date ofpurchase.  However, on February 2, 2007, we obtained waivers and releasesfrom the Lenders of any rescission rights and, therefore, we will not recordany contingent liability in connection therewith.  Although we are notaware of any other pending claims or sanctions against us in connection withthe possible Section 5 violation, we still could be subject to enforcementactions by the SEC, resulting in injunctive relief or the imposition offines.  We would vigorously contest any claim that the issuance of theThird Junior Note in the manner described above violated Section 5 of theSecurities Act.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

Our Annual Meeting of Stockholders was held onDecember 14, 2006. At the Annual Meeting, there was submitted to a vote ofsecurity holders the election of directors, ratification of our independentregistered public accounting firm, affirmation of the 2006 Nonqualified StockOption Plan, and an amendment to our Second Amended and Restated Certificate ofIncorporation to authorize our Board to effect a reverse 1-for-20 stock split.Proxies were solicited pursuant to Regulation 14A of the Securities ExchangeAct of 1934. There was no solicitation in opposition to the proposals listed inthe proxy statement. 56,054,526 shares were outstanding. 33,895,203 sharesvoted.

Each director nominated and all other proposalssubmitted to a vote passed, and the voting outcome of each proposal was asfollows:

1.             Election of the following three(3) directors to serve until the next annual meeting of stockholders oruntil their successors are elected and have qualified to serve as directors:

| Name                    | ** ** | **For**    | ** ** | **Against or Withheld** | ** ** |
|-------------------------|------------|------------|------------|-------------------------|------------|
| Casper Zublin, Jr. |       | 33,165,078 |       | 730,125                 |       |
| J. Michael Gullard      |       | 33,419,135 |       | 476,068                 |       |
| Alan B. Howe            |       | 33,419,615 |       | 475,588                 |       |

 

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2.             Ratification of Marcum &Kliegman LLP as our independent registered public accounting firm for thefiscal year ending June 30, 2007:
|  | For: | 33,604,979 | Against: | 209,358 | Abstain: | 80,868 |
|--|------|------------|----------|---------|----------|--------|

 

3.             Approval of the Company’s 2006Nonqualified Stock Option Plan:
|  | For: | 25,296,028 | Against: | 1,574,085 | Abstain: | 8,289 | Broker Non-Vote | 7,016,801 |
|--|------|------------|----------|-----------|----------|-------|-----------------|-----------|

 

4.             Authorization of the Board to amendour Second Amended and Restated Certificate of Incorporation to effect areverse stock split of the Company’s outstanding Common Stock by a ratio of1-for-20:
|  | For: | 31,912,139 | Against: | 1,974,851 | Abstain: | 8,213 |
|--|------|------------|----------|-----------|----------|-------|

 

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**ITEM 6.**        **EXHIBITS**

(a) Exhibits.

31.1                           Certification of Chief Executive Officer Pursuant toRule 13a-14(d) / 15d-14(a) of the Securities Exchange Act of1934.

31.2                           Certification of Chief Financial Officer Pursuantto Rule 13a-14(d) / 15d-14(a) of the Securities Exchange Act of1934.

32.1                           Certification of Chief Executive Officer Pursuantto Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of1934 and 18 U.S.C. Section 1350.

32.2                           Certification of Chief Financial Officer Pursuantto Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of1934 and 18 U.S.C. Section 1350.

SIGNATURE

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|                         | DYNTEK, INC. |
|-------------------------|--------------|
|                    |         |   |
|                    |         |   |
| Date: February 20, 2007 | By:          | /s/ Casper Zublin, Jr. |
|                    |         | Casper Zublin, Jr. |
|                    |         | Chief Executive Officer  (principal executive officer) |
|                    |         |   |
| Date: February 20, 2007 | By:          | /s/ Mark E. Ashdown |
|                    |         | Mark E. Ashdown |
|                    |         | Chief Financial Officer  (principal financial and accounting officer) |
|                    |         |   |

 

**INDEX TO EXHIBITS**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                          |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1            |       | Certification of Chief Executive Officer Pursuant to  Rule 13a-14(d) / 15d-14(a) of the Securities Exchange Act of  1934.                                 |
|            |       |                                                                                                                                                                     |
| 31.2            |       | Certification of Chief Financial Officer Pursuant to  Rule 13a-14(d) / 15d-14(a) of the Securities Exchange Act of  1934.                                 |
|            |       |                                                                                                                                                                     |
| 32.1            |       | Certification of Chief Executive Officer Pursuant to  Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of  1934 and 18 U.S.C. Section 1350. |
|            |       |                                                                                                                                                                     |
| 32.2            |       | Certification of Chief Financial Officer Pursuant to  Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of  1934 and 18 U.S.C. Section 1350. |

 

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