** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

# ** **

**FORM 10-Q**

 

**(MarkOne)**

 

| **ý** |   | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------|

 

**                                                                            For the quarterly period ended June 30, 2002      **

** **

| **o** |   | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT** |
|-------|--------|----------------------------------------------------------------------|

 

**                                                                            For the transition period from                 to                         **

** **

**                                                                            Commission file number 001-15789**

 

**STRATUS SERVICES GROUP, INC.**

(Exact name of Registrant as specified in itscharter)

 

| **Delaware**                                                                        |   | **22-3499261**                       |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State of other jurisdiction of incorporation or organization)                      |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |                                 |
| **500 Craig Road, Suite 201, Manalapan, New  Jersey 07726**                         |
| (Address of principal executive offices)                                            |
|                                                                                |   |                                 |
| **(732) 866-0300**                                                                  |
| (Issuer’s telephone number)                                                    |
|                                                                                |   |                                 |
|                                                                                |   |                                 |
| (Former name, former address and former fiscal  year, if changed since last report) |

 

Indicate by check mark whether the registrant(1) has filed 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 filing requirements for the past 90 days.

 

Yes   ý  No   o

 

As of August 14, 2002, 11,522,567 shares of the Registrant’s commonstock were outstanding.

 

 

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**STRATUSSERVICES GROUP, INC.**

Condensed Balance Sheets

 
|                                                                                                                                                                                                                     |   | **June 30,  2002** |       | **September 30,  2001** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|------------|
|                                                                                                                                                                                                                     |   |               |       |
|                                                                                                                                                                                                                     |   | **(Unaudited)**    |       |                    |       |
| Assets                                                                                                                                                                                                                   |   |               | ** ** |                    | ** ** |
| Current assets                                                                                                                                                                                                           |   |               |       |                    |       |
| Cash and cash equivalents                                                                                                                                                                                                |   | $                  | 42,285     |                    | $          | 171,822 |   |
| Accounts receivable – less allowance for  doubtful accounts of $1,292,000 and $551,000                                                                                                                              |   | 8,994,621          |       | 8,540,112               |       |
| Unbilled receivables                                                                                                                                                                                                     |   | 1,606,255          |       | 1,566,417               |       |
| Other receivables                                                                                                                                                                                                        |   | 250,000            |       | 3⁄4                  |       |
| Prepaid insurance                                                                                                                                                                                                        |   | 2,744,049          |       | 1,436,278               |       |
| Investment                                                                                                                                                                                                               |   | 3⁄4             |       | 1,166,046               |       |
| Prepaid expenses and other current assets                                                                                                                                                                                |   | 94,739             |       | 77,146                  |       |
| Net assets of discontinued Engineering  Division                                                                                                                                                                         |   | 3⁄4             |       | 199,610                 |       |
|                                                                                                                                                                                                                     |   | 13,731,949         |       | 13,157,431              |       |
|                                                                                                                                                                                                                     |   |               |       |                    |       |
| Property and equipment, net of accumulated  depreciation                                                                                                                                                                 |   | 1,364,670          |       | 1,427,216               |       |
| Intangible assets, net of accumulated  amortization                                                                                                                                                                      |   | 8,334,434          |       | 7,078,428               |       |
| Deferred financing costs, net of  accumulated amortization                                                                                                                                                               |   | 6,170              |       | 454,878                 |       |
| Other assets                                                                                                                                                                                                             |   | 129,646            |       | 150,205                 |       |
|                                                                                                                                                                                                                     |   | $                  | 23,566,869 |                    | $          | 22,268,158 |   |
| Liabilities  and Stockholders’ Equity                                                                                                                                                                               |   |               |       |                    |       |
| Current liabilities                                                                                                                                                                                                      |   |               |       |                    |       |
| Loans payable (current portion)                                                                                                                                                                                          |   | $                  | 481,565    |                    | $          | 347,289 |   |
| Notes payable – acquisitions (current  portion)                                                                                                                                                                     |   | 1,083,209          |       | 1,110,726               |       |
| Line of credit                                                                                                                                                                                                           |   | 7,243,129          |       | 7,306,581               |       |
| Cash overdraft                                                                                                                                                                                                           |   | 872,234            |       | 3⁄4                  |       |
| Insurance obligation payable                                                                                                                                                                                             |   | 220,791            |       | 549,460                 |       |
| Accounts payable and accrued expenses                                                                                                                                                                                    |   | 5,103,691          |       | 3,421,796               |       |
| Accrued payroll and taxes                                                                                                                                                                                                |   | 1,542,221          |       | 1,461,738               |       |
| Payroll taxes payable                                                                                                                                                                                                    |   | 958,186            |       | 306,230                 |       |
|                                                                                                                                                                                                                     |   | 17,505,126         |       | 14,503,820              |       |
|                                                                                                                                                                                                                     |   |               |       |                    |       |
| Loans payable (net of current portion)                                                                                                                                                                                   |   | 253,371            |       | 291,243                 |       |
| Notes payable – acquisition (net of current  portion)                                                                                                                                                               |   | 2,043,021          |       | 1,403,847               |       |
| Convertible debt                                                                                                                                                                                                         |   | 40,000             |       | 1,125,399               |       |
|                                                                                                                                                                                                                     |   | 19,841,518         |       | 17,324,309              |       |
| Series A voting redeemable convertible  stock, $.01 par value, 1,458,933 shares issued and outstanding, liquidation  preference of $4,376,799 (including unpaid dividends of $39,000)                                    |   | 3⁄4             |       | 2,792,000               |       |
| Temporary equity – put options                                                                                                                                                                                      |   | 823,000            |       | 869,000                 |       |
| Commitments and contingencies                                                                                                                                                                                            |   |               |       |                    |       |
| Stockholders’ equity                                                                                                                                                                                                |   |               |       |                    |       |
| Preferred stock, $.01 par value, 5,000,000  shares authorized                                                                                                                                                            |   |               |       |                    |       |
| Series A voting redeemable convertible  preferred stock, $.01 par value,1,458,933 shares issued and outstanding,  liquidation preference of $4,376,799 (including unpaid dividends of $270,000)                          |   | 3,168,000          |       | 3⁄4                  |       |
| Series B non-voting convertible preferred  stock, $.01 par value, 500,000 shares authorized, 172,300 and -0- shares  issued and outstanding, liquidation preference of $861,500 (including unpaid  dividends of $16,110) |   | 823,609            |       | 3⁄4                  |       |
| Common stock, $.01 par value, 25,000,000  shares authorized, 11,522,567 and 8,217,764 shares issued and outstanding                                                                                                      |   | 115,226            |       | 82,178                  |       |
| Additional paid-in capital                                                                                                                                                                                               |   | 13,018,403         |       | 11,992,685              |       |
| Accumulated deficit                                                                                                                                                                                                      |   | (14,222,887        | )          | (9,592,014              | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                     |   | 3⁄4             |       | (1,200,000              | )          |
| Total Stockholders’ equity                                                                                                                                                                                          |   | 2,902,351          |       | 1,282,849               |       |
|                                                                                                                                                                                                                     |   | $                  | 23,566,869 |                    | $          | 22,268,158 |   |

 

See notes to condensed financial statements.

 

2

----

 

**STRATUSSERVICES GROUP, INC.**

Condensed Statements of Operations

(Unaudited)

 
|                                                                                   |   | **Three  Months Ended  June 30,** |       | **Nine  Months Ended  June 30,** |       |
|----------------------------------------------------------------------------------------|--------|-----------------------------------|------------|----------------------------------|------------|
|                                                                                   |   | **2002**                          | ** ** | **2001**                         | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Revenues                                                                               |   | $                                 | 19,269,395 |                             | $          | 12,692,761 |   | $ | 51,568,047 |   | $ | 42,491,647 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Cost of revenues                                                                       |   | 16,387,222                        |       | 10,494,834                       |       | 43,343,294 |   | 34,007,322 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Gross profit                                                                           |   | 2,882,173                         |       | 2,197,927                        |       | 8,224,753 |   | 8,484,325 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Selling, general and administrative  expenses                                          |   | 4,337,929                         |       | 2,920,765                        |       | 10,535,246 |   | 10,180,337 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Loss on impairment of goodwill                                                         |   | 100,000                           |       | 3⁄4                           |       | 100,000 |   | 3⁄4 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Other charges                                                                          |   | 103,226                           |       | 144,417                          |       | 103,226 |   | 144,417 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| (Loss) from continuing operations                                                      |   | (1,658,982                        | )          | (867,255                         | )          | (2,513,719 | ) | (1,840,429 | ) |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Other income (expenses)                                                                |   |                              |       |                             |       |   |   |   |   |
| Finance charges                                                                        |   | 3⁄4                            |       | 3⁄4                           |       | 3⁄4 |   | (61,291 | ) |
| Interest and financing costs                                                           |   | (573,799                          | )          | (535,215                         | )          | (1,537,406 | ) | (1,510,721 | ) |
| (Loss) on sale of investment                                                           |   | (2,149,865                        | )          | 3⁄4                           |       | (2,159,415 | ) | 3⁄4 |   |
| Other income (expense)                                                                 |   | 25,260                            |       | (23,812                          | )          | 66,770 |   | (20,641 | ) |
|                                                                                   |   | (2,698,404                        | )          | (559,027                         | )          | (3,630,051 | ) | (1,592,653 | ) |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Earnings (loss) from continuing operations  before income taxes                        |   | (4,357,386                        | )          | (1,426,282                       | )          | (6,143,770 | ) | (3,433,082 | ) |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Income taxes                                                                           |   | 3⁄4                            |       | 88,000                           |       | 3⁄4 |   | 3⁄4 |   |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Earnings (loss) from continuing operations                                             |   | (4,357,386                        | )          | (1,514,282                       | )          | (6,143,770 | ) | (3,433,082 | ) |
| Discontinued operations – earnings (loss)  from discontinued Engineering Division |   | (7,366                            | )          | (10,226                          | )          | (246,159 | ) | 69,425 |   |
| Gain on sale of Engineering Division                                                   |   | 3⁄4                            |       | 3⁄4                           |       | 1,759,056 |   | 3⁄4 |   |
| Net earnings (loss)                                                                    |   | (4,364,752                        | )          | (1,524,508                       | )          | (4,630,873 | ) | (3,363,657 | ) |
| Dividends and accretion on preferred stock                                             |   | (288,110                          | )          | 3⁄4                           |       | (578,110 | ) | 3⁄4 |   |
| Net earnings (loss) attributable to common  stockholders                               |   | $                                 | (4,652,862 | )                                | $          | (1,524,508 | ) | $ | (5,208,983 | ) | $ | (3,363,657 | ) |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Basic:                                                                                 |   |                              |       |                             |       |   |   |   |   |
| (Loss) from continuing operations                                                      |   | $                                 | (.40       | )                                | $          | (.26 | ) | $ | (.66 | ) | $ | (.60 | ) |
| Earnings from discontinued operations                                                  |   | 3⁄4                            |       | 3⁄4                           |       | .15 |   | .01 |   |
| Net earnings (loss)                                                                    |   | $                                 | (.40       | )                                | $          | (.26 | ) | $ | (.51 | ) | $ | (.59 | ) |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Diluted:                                                                               |   |                              |       |                             |       |   |   |   |   |
| (Loss) from continuing operations                                                      |   | $                                 | (.40       | )                                | $          | (.26 | ) | $ | (.66 | ) | $ | (.60 | ) |
| Earnings from discontinued operations                                                  |   | 3⁄4                            |       | 3⁄4                           |       | .15 |   | .01 |   |
| Net earnings (loss)                                                                    |   | $                                 | (.40       | )                                | $          | (.26 | ) | $ | (.51 | ) | $ | (.59 | ) |
|                                                                                   |   |                              |       |                             |       |   |   |   |   |
| Weighted average shares, outstanding per  common share                                 |   |                              |       |                             |       |   |   |   |   |
| Basic                                                                                  |   | 11,522,567                        |       | 5,700,027                        |       | 10,230,023 |   | 5,674,781 |   |
| Diluted                                                                                |   | 11,522,567                        |       | 5,700,027                        |       | 10,230,023 |   | 5,674,781 |   |

 

See notes to condensed financial statements.

 

3

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**STRATUSSERVICES GROUP, INC.**

Condensed Statements of Cash Flows

(Unaudited)

 
|                                                                                                     |   | **Nine Months Ended** |       |
|----------------------------------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                                                     |   | **June 30, 2002**     |       | **June 30, 2001** |   |   |
| Cash flows from operating activities                                                                     |   |                  |       |   |   |   |
| Net earnings (loss) from continuing operations                                                           |   | $                     | (6,143,770 | ) | $ | (3,433,082 | ) |   |
| Net earnings (loss) from discontinued  operations                                                        |   | 1,512,897             |       | 69,425 |   |   |
| Adjustments to reconcile net earnings to  net cash used by operating activities                          |   |                  |       |   |   |   |
| Depreciation                                                                                             |   | 388,274               |       | 286,263 |   |   |
| Amortization                                                                                             |   | 418,720               |       | 247,418 |   |   |
| Provision for doubtful accounts                                                                          |   | 958,000               |       | 459,000 |   |   |
| Loss on impairment of goodwill                                                                           |   | 100,000               |       | 3⁄4 |   |   |
| Deferred financing costs amortization                                                                    |   | 405,069               |       | 100,650 |   |   |
| Loss on sale of investment                                                                               |   | 2,159,415             |       | 3⁄4 |   |   |
| (Gain) loss on extinguishment of convertible  debt                                                       |   | (3,277                | )          | 34,756 |   |   |
| Gain on sale of Engineering Division                                                                     |   | (1,759,056            | )          | 3⁄4 |   |   |
| Interest expense amortization for the  intrinsic beneficial conversion feature of convertible debentures |   | 104,535               |       | 979,129 |   |   |
| Accrued interest                                                                                         |   | 206,856               |       | 51,534 |   |   |
| Compensation – stock options                                                                        |   | 3⁄4                |       | 47,370 |   |   |
| Changes in operating assets and liabilities                                                              |   |                  |       |   |   |   |
| Due from factor/Accounts receivable                                                                      |   | (1,452,347            | )          | (865,575 | ) |   |
| Prepaid insurance                                                                                        |   | (1,307,771            | )          | (969,244 | ) |   |
| Prepaid expenses and other current assets                                                                |   | (17,593               | )          | 106,372 |   |   |
| Other assets                                                                                             |   | 20,234                |       | (50,040 | ) |   |
| Insurance obligation payable                                                                             |   | (328,669              | )          | 361,300 |   |   |
| Accrued payroll and taxes                                                                                |   | 80,483                |       | 165,160 |   |   |
| Payroll taxes payable                                                                                    |   | 651,956               |       | (144,733 | ) |   |
| Accounts payable and accrued expenses                                                                    |   | 1,595,740             |       | 1,452,233 |   |   |
| Total adjustments                                                                                        |   | 2,220,569             |       | 2,261,593 |   |   |
|                                                                                                     |   | $                     | (2,410,304 | ) | $ | (1,102,064 | ) |   |
| Cash flows (used in) investing activities                                                                |   |                  |       |   |   |   |
| Purchase of property and equipment                                                                       |   | (283,816              | )          | (674,317 | ) |   |
| Proceeds from sale of investment                                                                         |   | 206,631               |       | 3⁄4 |   |   |
| Payments for business acquisitions                                                                       |   | (336,727              | )          | (976,512 | ) |   |
| Net proceeds from sale of Engineering  Division                                                          |   | 1,709,079             |       | 3⁄4 |   |   |
| Loans receivable                                                                                         |   | 3⁄4                |       | (105,000 | ) |   |
|                                                                                                     |   | 1,295,167             |       | (1,755,829 | ) |   |
| Cash flows from financing activities                                                                     |   |                  |       |   |   |   |
| Proceeds from issuance of common stock                                                                   |   | 222,083               |       | 98,000 |   |   |
| Proceeds from issuance of Series B  Preferred Stock                                                      |   | 282,500               |       | 3⁄4 |   |   |
| Proceeds from loans payable                                                                              |   | 878,195               |       | 240,000 |   |   |
| Payments of loans payable                                                                                |   | (285,596              | )          | (48,958 | ) |   |
| Proceeds from temporary equity put options                                                               |   | 3⁄4                |       | 60,000 |   |   |
| Payments of notes payable – acquisitions                                                            |   | (488,343              | )          | (320,395 | ) |   |
| Net proceeds from line of credit                                                                         |   | (63,452               | )          | 865,104 |   |   |
| Cash overdraft                                                                                           |   | 872,334               |       | 3⁄4 |   |   |
| Cost in connection with common stock issued  for acquisition                                             |   | (2,000                | )          | 3⁄4 |   |   |
| Net proceeds from convertible debt                                                                       |   | 326,871               |       | 2,682,908 |   |   |
| Purchase of treasury stock                                                                               |   | 3⁄4                |       | (265,125 | ) |   |
| Redemption of convertible debt                                                                           |   | (301,992              | )          | (1,400,510 | ) |   |
| Redemption of Series B Preferred Stock                                                                   |   | (455,000              | )          | 3⁄4 |   |   |
|                                                                                                     |   | 985,600               |       | 1,911,024 |   |   |
| Net change in cash and cash equivalents                                                                  |   | (129,537              | )          | (946,869 | ) |   |
| Cash and cash equivalents – beginning                                                               |   | 171,822               |       | 1,030,722 |   |   |
| Cash and cash equivalents – ending                                                                  |   | $                     | 42,285     |   | $ | 83,853 |   |   |
| Supplemental disclosure of cash  paid                                                                    |   |                  |       |   |   |   |
| Interest                                                                                                 |   | $                     | 881,100    |   | $ | 499,648 |   |   |
| Schedule of Noncash Investing and Financing  Activities                                                  |   |                  |       |   |   |   |
| Fair value of assets acquired                                                                            |   | $                     | 1,816,727  |   | $ | 1,126,512 |   |   |
| Less: cash paid                                                                                          |   | (336,727              | )          | 976,512 |   |   |
| Less: common stock and put options issued                                                                |   | (380,000              | )          | 3⁄4 |   |   |
| Liabilities assumed                                                                                      |   | $                     | 1,100,000  |   | $ | 150,000 |   |   |
| Issuance of Series B preferred stock in  exchange for convertible and other debt                         |   | $                     | 1,106,499  |   | $ | — |   |   |
| Purchase of treasury stock in exchange for  loans                                                        |   | $                     | —     |   | $ | 402,000 |   |   |
| Issuance of common stock in exchange for  accounts payable and accrued expenses                          |   | $                     | 59,000     |   | $ | — |   |   |
| Issuance of common stock in exchange for investment                                                      |   | $                     | —     |   | $ | 61,000 |   |   |
| Issuance of common stock upon conversion of  convertible debt                                            |   | $                     | 736,003    |   | $ | 50,000 |   |   |
| Issuance of warrants for fees                                                                            |   | $                     | 55,000     |   | $ | — |   |   |
| Cumulative dividends and accretion in  preferred stock                                                   |   | $                     | 578,110    |   | $ | — |   |   |
|                                                                                                          |        |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to condensed financial statements.

 

4

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### **NOTE1 – BASIS OF PRESENTATION**

 

Theaccompanying condensed financial statements have been prepared by the Company,without audit, pursuant to the rules and regulations of the Securities andExchange Commission.  Certaininformation and disclosures normally included in financial statements preparedin accordance with accounting principles generally accepted in the UnitedStates have been condensed or omitted pursuant to such rules andregulations.  These condensed financialstatements reflect all adjustments (consisting only of normal recurringadjustments) that, in the opinion of management, are necessary to presentfairly the financial position, the results of operations and cash flows of theCompany for the periods presented.  Itis suggested that these condensed financial statements be read in conjunctionwith the consolidated financial statements and the notes thereto included inthe Company’s Annual Report on Form 10-K.

 

Theresults of operations for the interim periods presented are not necessarilyindicative of the results to be expected for the full year.

 

Certainreclassifications have been made to prior year’s financial statements toconform with current year presentation.

 

**NOTE 2**–**LIQUIDITY**

 

AtJune 30, 2002, the Company had limited liquid resources.  Current liabilities were $17,505,126 andcurrent assets were $13,731,949.  Thedifference of $3,773,177 is a working capital deficit, which is primarily theresult of losses incurred during each of the five quarters ended June 30,2002.  Current liabilities include acash overdraft of $872,234, which is represented by outstanding checks.  These conditions raise substantial doubtsabout the Company’s ability to continue as a going concern.  The financial statements do not include anyadjustments to reflect the possible future effect on the recoverability andclassification of assets or the amounts and classification of liabilities thatmay result from the outcome of this uncertainty.

 

TheCompany’s continuation of existence is dependent upon its ability to generatesufficient cash flow to meet its continuing obligations on a timely basis, tofund the operating and capital needs, and to obtain additional financing as maybe necessary.

 

Managementof the Company has taken steps to revise and reduce its operating requirement,which it believes will be sufficient to assure continued operations andimplementation of the Company’s plans. The steps include closing branches that are not profitable,consolidating branches and reductions in staffing and other selling, generaland administrative expenses.

 

**NOTE3**–**GOODWILL**

 

Goodwillis amortized on a straight-line basis over fifteen years except foracquisitions after June 30, 2001, where goodwill is not being amortized.

 

Periodically,the Company will determine if there has been a permanent impairment of goodwillby comparing undiscounted cash flows for operating activities of acquiredbusinesses with the carrying value of the related goodwill.  In this connection, the Company charged$100,000 to operations in the three and nine months ended June 30, 2002.

 

5

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**NOTE4 – EARNINGS/LOSS PER SHARE**

 

Basic“Earnings Per Share” (“EPS”) excludes dilution and is computed by dividingearnings available to common stockholders by the weighted-average number ofcommon shares outstanding during the period. Diluted EPS assumes conversion of dilutive options and warrants, and theissuance of common stock for all other potentially dilutive equivalent sharesoutstanding.  There were no dilutiveshares for the three and nine months ended June 30, 2002 and 2001.

 

### **NOTE5**– FACTORING AGREEMENT

 

TheCompany had a factoring agreement under which it was able to sell qualifiedtrade accounts receivable, with limited recourse provisions.  The Company was required to repurchase orreplace any receivable remaining uncollected for more than 90 days.

 

On December 12, 2000, theCompany terminated its agreement with the factor.  As part of the termination agreement, the Company repurchased allaccounts receivable from the factor with proceeds from a new line of credit(see Note 6).

 

### **NOTE6**– LINE OF CREDIT

 

OnDecember 12, 2000, the Company entered into a loan and security agreement witha lending institution whereby the Company can borrow up to 85% to 90% ofeligible accounts receivable, as defined, not to exceed the lesser of $12million or six times the Company’s tangible net worth (as defined).  Borrowings under the agreement bear interestat 1 1⁄2 % above the prime rate and are collateralized by substantially all ofthe Company’s assets.  The agreementexpires on June 12, 2003.  Approximately$5,100,000 of the initial borrowing under this agreement was used to repurchaseaccounts receivable from the factor (see Note 5).

 

AtJune 30, 2002, the Company was in violation of the following covenants underthe loan and security agreement:

 

(i)                         Failing to meet the tangible net worthrequirement;

(ii)                      Exceeding the $250,000 limit on redeemingthe Company’s common stock, as a result of the redemption of Series B PreferredStock, and;

(iii)                   The Company’s common stock being delistedfrom the Nasdaq SmallCap Market

 

The Company hasreceived a waiver from the lender on all of the above violations.

 

### **NOTE7 – CONVERTIBLE DEBT**

 

At various times during the year ended September 30, 2001 and the ninemonths ended June 30, 2002, the Company issued convertible debentures throughprivate placements.  The debentures boreinterest at 6% a year, payable quarterly and had a maturity date of five yearsfrom issuance.  Each debenture wasconvertible after 120 days from issuance into the number of shares of theCompany’s common stock determined by dividing the principal amount of thedebenture by the lesser of (a) 120% of the closing bid price of the commonstock on the trading day immediately preceding the issuance date or (b) 75% ofthe average closing bid price of the common stock for the five trading daysimmediately preceding the date of the conversion.  The Company had the right to prepay any of the debentures at anytime at a prepayment rate that varied from 115% to 125% of the amount of thedebenture depending on when the prepayment was made.

 

The discount arising from the75% beneficial conversion feature is charged to interest expense during theperiod from the issuance of the debenture to the earliest time at which thedebenture becomes convertible.

 

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During the nine months endedJune 30, 2002, the Company redeemed $258,394 of debentures resulting in a gainof approximately $3,000, which is included in “Other income (expense)” in thecondensed statement of operations.

 

InMarch 2002, the Company entered into an agreement with the holder (the“Debenture Holder”) of all but $40,000 of the outstanding debentures pursuantto which it issued to the Debenture Holder 231,300 shares of Series BConvertible Preferred Stock (see Note 8) in exchange for (i) $456,499 aggregateprincipal amount of Debentures, (ii) the cancellation of a $400,000 promissorynote previously issued by the Company to the Debenture Holder and (iii)$300,000 in cash.  As a result, only$40,000 of Debentures remains outstanding.

 

**NOTE8 – PREFERRED STOCK**

 

**a**.               ***Series A***

 

The shares of Series A ConvertiblePreferred Stock (the “Series A Preferred Stock”) have a stated value of $3.00per share.  The difference between thecarrying value and redemption value of the Series A Preferred Stock is beingaccreted through a charge to additional paid-in-capital through the June 30,2008 redemption date.

 

The Series A Preferred Stockpays cumulative dividends at $.21 per share per year, payable semi-annually,commencing on December 31, 2001, when and if declared by the Board ofDirectors.  The shares of Series APreferred Stock are convertible at the option of the holder into shares of theCompany’s Common Stock on a one-for-one basis. On June 30, 2008, the Company will be required to redeem any shares ofSeries A Preferred Stock outstanding at a redemption price of $3.00 per sharetogether with accrued and unpaid dividends, payable, at the Company’s option,either in cash or in shares of common stock. For purposes of determining the number of shares which the Company willbe required to issue if it chooses to pay the redemption price in shares ofCommon Stock, the Common Stock will have a value equal to the average closingprice of the Common Stock during the five trading days immediately precedingthe date of redemption.

 

At the Company’s Annual Meetingof Stockholders held on March 28, 2002, the stockholders approved the issuanceby the Company of the full number of shares of Common Stock which may be issuedby the Company in connection with the conversion of the Series A PreferredStock.  Accordingly, the Company’sobligation to redeem a portion of the outstanding shares of Series A PreferredStock, if such approval was not obtained, was terminated and the Series APreferred Stock was reclassified to permanent equity.

 

**b**.               ***Series B***

 

The shares of Series B Convertible Preferred Stock (the “Series BPreferred Stock”) have a stated value of $5 per share.  Holders of the Series B Preferred Stock areentitled to cumulative dividends at a rate of 6% of the stated value per annum,payable when and as declared by the Board of Directors.  Dividends may be paid in cash or, at theoption of the Company, in shares of Common Stock, under certaincircumstances.  Holders of Series BPreferred Stock are entitled to a liquidation preference of $5.00 per shareplus accrued dividends.  The Series BPreferred Stock is convertible into shares of Common Stock at the option of theholder at any time.  The number ofshares of Common Stock into which each share of Series B Preferred Stock isconvertible is determined by dividing the aggregate liquidation preference ofthe shares being converted by the lesser of (i) $4.65 or (ii) 75% of theaverage closing price of the Common Stock during the trading day preceding thedate of conversion.  The discountarising from the beneficial conversion feature is being treated as a dividendfrom the date of issuance to the earliest conversion date.

 

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In June 2002, the Company, at its option, redeemed for cash, 91,000shares of Series B Preferred Stock at $5.00 per share, totaling $455,000.

 

At a Special Meeting of Stockholders held on July 26, 2002, the Companyreceived approval from its stockholders of a proposal to approve the issuanceof shares of Common Stock upon conversion of the Series B Preferred Stock inexcess of the limits imposed by the rules of the Nasdaq Stock Market, in theevent that the Company’s Common Stock is reinstated for trading on the NasdaqStock Market.

 

**NOTE 9 – ACQUISITION**

 

Effective January 1, 2002, the Company purchased substantially all ofthe tangible and intangible assets, excluding accounts receivable, of sevenoffices of Provisional Employment Solutions, Inc. (“PES”).  The initial purchase price was $1,480,000,represented by a $1,100,000 promissory note and 400,000 shares of the Company’scommon stock.  There was an additional$336,727 of costs incurred in connection with the acquisitions.  In addition, PES is entitled to earnoutpayments of 15% of pretax profit of the acquired business up to a total of$1.25 million or the expiration of ten years, whichever occurs first.  The note bears interest at 6% a year and ispayable over a ten-year period in equal quarterly payments.

 

The following table summarizes the fair value of the assets acquired atthe date of acquisition based upon a third-party valuation of certainintangible assets:

 

| Property and  equipment |   | $         | 42,000    |   |
|-------------------------|--------|-----------|-----------|--------|
| Intangible assets       |   | 468,596   |      |
| Goodwill                |   | 1,306,131 |      |
|                    |   | $         | 1,816,727 |   |

 

Of the $468,596 of intangibleassets, $85,880 was assigned to a covenant-not-to-compete and $382,716 wasassigned to the customer list.  Theintangible assets are being amortized over their estimated useful life of twoto four years.  Goodwill is not beingamortized under the provision of Statement of Financial Accounting StandardsNo. 142, “Goodwill and Other Intangible Assets”.  All of the goodwill is expected to be deductible for taxpurposes.

 

**NOTE10 – INVESTMENT**

 

InNovember 2001 and June 2002, the Company sold 400,000 shares and 62,625,000shares, respectively, representing its entire 26.3% investment inenterpriseAsia.com, a publicly-traded foreign company.  The Company received net proceeds of$206,631 and recorded a loss on the sales of $2,159,415.

** **

**NOTE11 – DISCONTINUED OPERATIONS – SALE OF ENGINEERING DIVISION**

 

On January 24, 2002 the Companyentered into an agreement to sell the assets of its Engineering ServicesDivision (the “Division”) to SEA Consulting Services Corporation (“SEA”).  Closing of the sale was contingent uponshareholder approval and receipt of a fairness opinion by the Company.

 

OnMarch 28, 2002, the Company completed the sale of the assets of the Division toSEA pursuant to the Asset Purchase Agreement dated as of January 24, 2002 amongthe Company, SEP, LLC (“SEP”), Charles Sahyoun, Sahyoun Holdings LLC and SEA.  The transaction was approved by a vote ofthe Company’s stockholders at the Company’s annual meeting of stockholders heldon March 28, 2002.

 

Theassets of the Division had been transferred to SEP, a limited liability companyin which the Company owns a 70% interest, at the time of the execution of theAsset Purchase Agreement.  SahyounHoldings, LLC, a company wholly owned by Charles Sahyoun, the President of theDivision, owns the remaining 30% interest in SEP.

 

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Underthe terms of the Asset Purchase Agreement, the Company received an initial cashpayment of $1,560,000, which represented 80% of the initial $2,200,000installment of the purchase price payable to SEP after the satisfaction ofcertain liabilities and expenses of SEP. Sahyoun Holdings, LLC received the other 20% of the initial netinstallment of the purchase price, or $440,000.

 

TheAsset Purchase Agreement requires SEA to make the following additional paymentsto SEP:

 

(a)               A payment of $1 million, plus or minusthe amount by which SEA’s profit for the six months ending June 30, 2002, asdetermined pursuant to the Asset Purchase Agreement, is greater or less than$600,000 (the “Second Payment”);

 

(b)              A payment of $1 million, plus or minus theamount by which SEA’s profit for the six months ending December 31, 2002, asdetermined pursuant to the Asset Purchase Agreement, is greater or less than$600,000 (the “Third Payment”);

 

(c)               Five subsequent annual payments (the“Subsequent Payments”) which will be based upon a multiple of the annualsuccessive increases, if any, in SEA’s profit during the five year periodbeginning on January 1, 2003 and ending December 31, 2007.

### ** **

### **Pursuant to an allocation and indemnity agreement enteredinto by the Company, Sahyoun Holdings, LLC and Charles Sahyoun (the “Allocationand Indemnity Agreement”), the Company was entitled to $250,000 of the SecondPayment and $250,000 of the Third Payment. On April 15, 2002, by letter agreement between the Company, Sahyoun Holdings,LLC and Joseph J. Raymond, Sr., the Chairman and Chief Executive Officer of theCompany, the parties agreed to a modification of the Allocation and IndemnityAgreement.  Per that letter agreement,Sahyoun Holdings, LLC provided the Company with $200,000 cash in exchange forthe Company’s short-term, 90-day demand note, due and payable by August 1, 2002in the amount of $250,000.  Such$250,000 was repaid by the Company from its $250,000 share of the Second Paymentwhich was received in June 2002.  SahyounHoldings LLC and Charles Sahyoun have guaranteed the $250,000 payment to bemade to the Company from the Third Payment, regardless of the operating resultsof SEA.  Upon its receipt of all of thepayments required under the Allocation and Indemnity Agreement, the Company’sinterest in SEP will terminate and the Company will not be entitled to anyadditional payments under the Asset Purchase Agreement, including theSubsequent Payments.  Sahyoun HoldingsLLC is entitled to all amounts paid to SEP under the Asset Purchase Agreementother than $500,000 of payments made or payable to the Company pursuant to theAllocation and Indemnity Agreement and guaranteed by Charles Sahyoun andSahyoun Holdings, LLC as described above.**

 

### **The balance sheet as at September 30, 2001 and thestatements of operations have been reclassified to reflect discontinuedoperations.**

 

### **NOTE12 – OTHER CHARGES**

 

Duringthe three months ended June 30, 2002, the Company incurred costs associatedwith financing not obtained, settlement costs in connection with a prior year’sacquisition and penalties associated with not registering the Series BPreferred Stock.  During the threemonths ended June 30, 2001, the Company discontinued negotiations to sell theEngineering Division and discontinued efforts to make certainacquisitions.  Accordingly, the Companycharged operations with costs associated with these activities.  The Company also charged operations for costsincurred with various financing not obtained.

### ** **

### **NOTE13 – INCOME TAXES**

 

There was no provision forincome taxes for the three months ended June 30, 2002 and the nine months endedJune 30, 2002 and 2001, because the Company has net operating losscarryforwards with a

 

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corresponding valuationallowance against them.  The income taxexpense for the three months ended June 30, 2001, is the result of an increasein the valuation allowance.

 

### **NOTE14 – SUBSEQUENT EVENTS**

 

(a)          In July 2002, the Company sold 7,650shares of newly created Series E Preferred Stock in a private placement for$765,000 in cash and issued an additional 8,615 shares of Series E PreferredStock in exchange for all of the outstanding shares of Series B Preferred Stockwhich had an aggregate stated value of $861,500.  In addition, $41,790 of dividends and penalties had accrued onthe Series B Preferred Stock prior to the exchange.  Of the 172,300 shares of Series B Preferred Stock surrendered inthe exchange, 32,000 shares were held by a corporation of which the Company’sPresident and Chief Executive Officer, is the sole owner.

 

The shares of Series E Preferred Stock have astated value of $100 per share.  Theholders of the Series E Preferred Stock are entitled to cumulative dividends ata rate of 6% per annum of the stated value, payable every 120 days, inpreference and priority to any payment of any dividend on the Company’s CommonStock.  Dividends may be paid, at theCompany’s option, either in cash or in shares of Common Stock, valued at theSeries E Conversion Price (as defined below), if the Common Stock issuable uponconversion of such Series E Preferred Stock has been registered for resaleunder the Securities Act of 1933. Holders of Series E Preferred shares are entitled to a liquidationpreference of $100 per share, plus accrued and unpaid dividends.

 

The Series E Preferred Stock is convertible intoCommon Stock at a conversion price (the “Series E Conversion Price”) equal to75% of the average of the closing bid prices, for the five trading dayspreceding the conversion date, for the Common Stock.  The number of shares issuable upon conversion is determined bymultiplying the number of shares of Series E Preferred Stock to be converted by$100, and dividing the result by the Series E Conversion Price then in effect.

 

Holders of Series E Preferred Stock do not haveany voting rights, except as required by law.

 

The Company may redeem the shares of the SeriesE Preferred Stock at any time prior to conversion at a redemption price of 115%of the purchase price paid for the Series E Preferred Shares plus any accruedbut unpaid dividends.

 

(b)         In July 2002, Joseph J. Raymond, theCompany’s President and Chief Executive Officer invested $1,000,000 in theCompany in exchange for 10,000 shares of newly created Series F PreferredStock, which has a stated value of $100 per share.

 

The holders of the Series F Preferred Stock areentitled to receive, from assets legally available therefore, cumulativedividends at a rate of 7% per annum, accrued daily, payable monthly, in preferenceand priority to any payment of any dividend on the Common Stock and on theSeries E Preferred Stock.  Dividends maybe paid, at the Company’s option, either in cash or in shares of Common Stock,valued at the Series F Conversion Price (as defined below), if the Common Stockissuable upon conversion of such Series F Preferred Stock has been registeredfor resale under the Securities Act of 1933. Holders of Series F Preferred shares are entitled to a liquidationpreference of $100 per share, plus accrued and unpaid dividends.

 

The Series F Preferred Stock is convertible intoCommon Stock at a conversion price (the “Series F Conversion Price”) equal to$.10 per share, the market price at the date of issuance of the Series FPreferred Stock.  The number of sharesissuable upon conversion is determined by multiplying the number of shares ofSeries F Preferred Stock to be converted by $100 and dividing the result by theSeries F Conversion Price then in effect.

 

Except as otherwise required by law, holders ofSeries F Preferred Stock and holders of Common Stock shall vote together as asingle class on each matter submitted to a vote of stockholders.  Each

 

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outstanding share of Series F Preferred Stock shallbe entitled to the number of votes equal to the number of full shares of CommonStock into which each such share of Series F Preferred Stock is thenconvertible on the date for determination of stockholders entitled to vote atthe meeting.  Holders of the Series FPreferred Stock are entitled to vote as a separate class on any proposedamendment to the terms of the Series F Preferred Stock which would increase ordecrease the number of authorized shares of Series F Preferred Stock or have anadverse impact on the Series F Preferred Stock and on any proposal to create anew class of shares having rights or preferences equal to or having priority tothe Series F Preferred Stock.

 

The Company may redeem the shares of the SeriesF Preferred Stock at any time prior to conversion at a redemption price of 115%of the purchase price paid for the Series F Preferred Shares plus any accruedbut unpaid dividends.

 

(c)          On July 2, 2002, the Company received thedecision of the Nasdaq Listing and Hearing Review council (the “ReviewCouncil”), which reversed the February 26, 2002 decision of the Nasdaq ListingQualifications Panel (the “Panel”), to de-list the Company’s securities fromthe Nasdaq Small Cap Market.

 

TheReview Council reversed and remanded the Panel’s decision to the Panel, subjectto certain conditions.  These conditionsare further subject to the Panel’s discretion to impose additional monitoringrestrictions.  By September 30, 2002,the Company must demonstrate a closing price of at least $1.00 per share andimmediately thereafter maintain a closing bid price of at least $1.00 per sharefor a minimum of ten consecutive trading days. Upon fulfilling this requirement, and the June 30, 2002 equityrequirement set forth below, the Panel is to re-list our securities on theNasdaq Small Cap Market provided there are no adverse developments justifyingdenial of the listing.

 

Inaddition, prior to re-listing, the Company must report a $4,500,000shareholder’s equity requirement as of June 30, 2002, and must, going forward,maintain certain other additional shareholder’s equity requirements for theSeptember 30, 2002 year-end ($3,750,000) and December 31, 2002 quarter($3,500,000) and demonstrate compliance with all requirements for continuedlisting.

 

TheCompany has been informed that the Panel will not render a formal decisionuntil the Company has notified the Panel that it met both the June 30, 2002shareholder’s equity requirement and the minimum bid price requirement.  The Company has not met the June 30, 2002shareholder’s equity requirement.

 

(d)         The Companyissued promissory notes to Source One in the principal amounts of $600,000(“Note 1”) and $1,800,000 (“Note 2”), respectively, on July 27, 2001 inconnection with an acquisition transaction. As a result of our working capital deficit, the Company was unable tomake the following payments when due:

 

(i)                                     a payment of $600,000 of principal and $21,000 of accrued interest due on January 28, 2002 under Note 1;

(ii)                                  a payment of $100,766 of principal and $29,951 of accrued interest due onFebruary 27, 2002 under Note 2; and

(iii)                               a payment of $102,530 of principal and $28,187 of accrued interest due onMay 27, 2002 under Note 2.

 

Pursuant to a Forbearance Agreement executed in January 2002 andamended in June 2002, Source One agreed to forbear from exercising remediesagainst the Company until June 30, 2002. On July 31, 2002, the Company cured all payment defaults under Note 1and Note 2 and repaid $200,000 loaned to the Company by Source One on June 4,2002 which was due June 30, 2002 and bore interest at a rate of 7% per annum.

 

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**Item2 -****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**

### **AND RESULTS OF OPERATIONS**

 

This Form 10-Q contains“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended and Section 21E of the Securities ExchangeAct of 1934, as amended.  Thesestatements relate to future economic performance, plans and objectives ofmanagement for future operations and projections of revenue and other financialitems that are based on the beliefs of our management, as well as assumptionsmade by, and information currently available to, our management.  The words “expect”, “estimate”, “anticipate”,“believe”, “intend”, and similar expressions are intended to identifyforward-looking statements.  Suchstatements involve assumptions, uncertainties and risks.  If one or more of these risks oruncertainties materialize or underlying assumptions prove incorrect, actualoutcomes may vary materially from those anticipated, estimated orexpected.  Among the key factors thatmay have a direct bearing on our expected operating results, performance orfinancial condition are economic conditions facing the staffing industrygenerally; uncertainties related to the job market and our ability to attractqualified candidates; uncertainties associated with our brief operatinghistory; our ability to raise additional capital; our ability to achieve andmanage growth; our ability to successfully identify suitable acquisitioncandidates, complete acquisitions or integrate the acquired business into ouroperations; our ability to attract and retain qualified personnel; our abilityto develop new services; our ability to cross-sell our services to existingclients; our ability to enhance and expand existing offices; our ability toopen new offices; general economic conditions; our ability to continue tomaintain workers’ compensation, general liability, and other insurancecoverages; the continued cooperation of our creditors; and other factorsdiscussed from time to time in our filings with the Securities and ExchangeCommission.  These factors are notintended to represent a complete list of all risks and uncertainties inherentin our business.  The followingdiscussion and analysis should be read in conjunction with the CondensedFinancial Statements and notes appearing elsewhere in this report.

 

### **Introduction**

 

We provide a wide range ofstaffing and productivity consulting services nationally through a network ofoffices located throughout the United States. We recognize revenues based on hours worked by assigned personnel.  Generally, we bill our customers apre-negotiated, fixed rate per hour for the hours worked by our temporaryemployees.  We are responsible forworkers’ compensation, unemployment compensation insurance, Medicare and SocialSecurity taxes and other general payroll related expenses for all of thetemporary employees we place.  Theseexpenses are included in the cost of revenue. Because we pay our temporary employees only for the hours they actuallywork, wages for our temporary personnel are a variable cost that increases ordecreases in proportion to revenues. Gross profit margin varies depending on the type of servicesoffered.  In some instances, temporaryemployees placed by us may decide to accept an offer of permanent employmentfrom the customer and thereby “convert” the temporary position to a permanent position.  Fees received from such conversions areincluded in our revenues.  Selling,general and administrative expenses include payroll for management andadministrative employees, office occupancy costs, sales and marketing expensesand other general and administrative costs.

 

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**Resultsof Operations**

 

**DiscontinuedOperations/Acquisition or Disposition of Assets**

 

On January 24, 2002 we enteredinto an agreement to sell the assets our Engineering Services Division (the“Division”) to SEA Consulting Services Corporation (“SEA”).  Closing of the sale was contingent uponshareholder approval and receipt of a fairness opinion by the Company.

 

OnMarch 28, 2002, we completed the sale of the assets of the Division to SEApursuant to the Asset Purchase Agreement dated as of January 24, 2002 among us,SEP, LLC (“SEP”), Charles Sahyoun, Sahyoun Holdings LLC and SEA.  The transaction was approved by a vote ofour stockholders at the annual meeting of stockholders held on March 28, 2002.

 

Theassets of the Division had been transferred to SEP, a limited liability companyin which the Company owns a 70% interest, at the time of the execution of theAsset Purchase Agreement.  SahyounHoldings, LLC, a company wholly owned by Charles Sahyoun, the President of the Division,owns the remaining 30% interest in SEP.

 

Underthe terms of the Asset Purchase Agreement, we received an initial cash paymentof $1,560,000, which represented 80% of the initial $2,200,000 installment ofthe purchase price payable to SEP after the satisfaction of certain liabilitiesand expenses of SEP.  Sahyoun Holdings,LLC received the other 20% of the initial net installment of the purchaseprice, or $440,000.

 

TheAsset Purchase Agreement requires the Purchaser to make the following additionalpayments to SEP:

 

(a)          A payment of $1 million, plus or minusthe amount by which SEA’s profit for the six months ending June 30, 2002, asdetermined pursuant to the Asset Purchase Agreement, is greater or less than$600,000 (the “Second Payment”);

 

(b)         A payment of $1 million, plus or minusthe amount by which the SEA’s profit for the six months ending December 31,2002, as determined pursuant to the Asset Purchase Agreement, is greater orless than $600,000 (the “Third Payment”);

 

(c)          Five subsequent annual payments (the“Subsequent Payments”) which will be based upon a multiple of the annualsuccessive increases, if any, in the SEA’s profit during the five year periodbeginning on January 1, 2003 and ending December 31, 2007.

 

Pursuant to an allocation andindemnity agreement entered into by us, Sahyoun Holdings, LLC and Mr. Sahyoun(the “Allocation and Indemnity Agreement”), we were entitled to $250,000 of theSecond Payment and $250,000 of the Third Payment.  On April 15, 2002, by letter agreement between us, SahyounHoldings, LLC and Joseph J. Raymond, Sr., the Chairman and Chief ExecutiveOfficer of the Company, the parties agreed to a modification of the Allocationand Indemnity Agreement.  Per thatletter agreement, Sahyoun Holdings, LLC provided us with $200,000 cash inexchange for our short-term, 90-day demand note, due and payable by August 1,2002 in the amount of $250,000.  The$250,000 was paid by us from our share of the Second Payment which was receivedby us in June 2002.  Sahyoun Holdings LLCand Mr. Sahyoun have guaranteed the $250,000 payment to be made to us from theThird Payment, regardless of the operating results of SEA.  Upon its receipt of the payments requiredunder the Allocation and Indemnity Agreement, our interest in SEP will terminateand we will not be entitled to any additional payments under the Asset PurchaseAgreement, including the Subsequent Payments. Sahyoun Holdings LLC is entitled to all amounts paid to SEP under theAsset Purchase Agreement other than $500,000 of payments made or payable to uspursuant to the Allocation and Indemnity Agreement and guaranteed by CharlesSahyoun and Sahyoun Holdings, LLC as described above.  Under the terms of the Asset Purchase Agreement, Sahyoun HoldingsLLC will not be entitled to any Subsequent Payments or its allocable share ofthe Second and Third Payments if Mr. Sahyoun’s 

 

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employment with SEA ceases forany reason other than death or permanent disability prior to December 31, 2003.

 

**ContinuingOperations**

 

**ThreeMonths Ended June 30, 2002 Compared to the Three Months Ended June 30, 2001**

 

***Revenues.***  Revenues increased 51.8% to $19,269,395 forthe three months ended June 30, 2002 from $12,692,761 for the three monthsended June 30, 2001.  A substantialportion of the increase was a result of the acquisition of seven offices ofProvisional Employment Solutions, Inc. (“PES”) on January 1, 2002.

 

***Gross Profit.***  Gross profit increased 31.1% to $2,882,173for the three months June 30, 2002 from $2,197,927 for the three months endedJune 30, 2001.  Gross profit as apercentage of revenues decreased to 15.0% for the three months ended June 30,2002 from 17.3% for the three months ended June 30, 2001.  The increased dollar amount was a result ofthe acquisition on January 1, 2002.  Thedecrease in the percentage was a result of increased pricing competition ofstaffing services.  We also sawdeterioration in margins as a result of the downturn in the economy.

*** ***

***Selling, General and Administrative Expenses.**** *Selling,general and administrative expenses, not including depreciation andamortization and provision for doubtful accounts, increased 25.7% to $3,318,929for the three months ended June 30, 2002 from $2,641,083 for the three monthsended June 30, 2001 primarily as a result of the acquisition on January 1,2002.  Selling, general andadministrative expenses, not including depreciation and amortization andprovision for doubtful accounts, as a percentage of revenues decreased to 17.2%for the three months ended June 30, 2002 from 20.8% for the three months endedJune 30, 2001.  The decrease isattributable to significant cost reductions implemented by us.

 

***Losson Impairment of Goodwill.***  We periodically determine if there has beena permanent impairment of goodwill.  Inthis connection, we recorded an impairment loss of $100,000 in the three monthsended June 30, 2002.

 

***Depreciation and Amortization.***  Depreciation and amortization expensesincreased 73.9% to $269,000 for the three months ended June 30, 2002 from$154,682 for the three months ended June 30, 2001.  Depreciation and amortization as a percentage of revenuesincreased to 1.4% for the three months ended June 30, 2002 from 1.2% for thethree months ended June 30, 2001.  Theincrease was primarily due to the amortization of goodwill and otherintangibles associated with acquisitions and the impact of increased capitalexpenditures.

 

***Provision for Doubtful Accounts.***  Provision for doubtful accounts increased500.0% to $750,000 for the three months ended June 30, 2002 from $125,000 forthe three months ended June 30, 2001. Provision for doubtful accounts as a percentage of revenue, increased to3.9% for the three months ended June 30, 2002 from 1.0% for the three monthsended June 30, 2001.  The increase wasdue to a change in estimate in light of the downturn in the economy and ourevaluation of the recoverability of certain of our accounts.

 

***Interest and Financing Costs.***  Interest and financing costs increased to$573,799 for the three months ended June 30, 2002 from**$535,215 for the three months ended June30, 2001.  The increase is the result ofdebt incurred by us in connection with acquisitions.

 

***Net (Loss) Attributable to CommonStockholders.**** *As a result of the foregoing, wehad a net loss attributable to common stockholders of ($4,652,862) for thethree months ended June 30, 2002 compared to net loss attributable to commonstockholders of ($1,524,508) for the three months ended June 30, 2001.

 

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### **NineMonths Ended June 30, 2002 Compared to the Nine Months Ended June 30, 2001**

 

***Revenues.***  Revenues increased 21.4% to $51,568,047 forthe nine months ended June 30, 2002 from $42,491,647 for the nine months endedJune 30, 2001.  A substantial portion ofthe increase was a result of the acquisition on January 1, 2002.

 

***Gross Profit.***  Gross profit decreased 3.1% to $8,224,753for the nine months ended June 30, 2002 from $8,484,325 for the nine monthsended June 30, 2001.  Gross profit as apercentage of revenues decreased to 15.9% for the nine months ended June 30,2002 from 20.0% for the nine months ended June 30, 2001.  This decrease was a result of increasedpricing competition of staffing services. We also saw a deterioration in margins as a result of the downturn inthe economy.

 

***Selling, General and Administrative Expenses.**** *Selling,general and administrative expenses, not including depreciation andamortization and provision for doubtful accounts, decreased 4.3% to $8,828,252for the nine months ended June 30, 2002 from $9,221,656 for the nine monthsended June 30, 2001.  Selling, generaland administrative expenses, not including depreciation and amortization andprovision for doubtful accounts, as a percentage of revenues decreased to 17.1%for the nine months ended June 30, 2002 from 21.7% for the nine months endedJune 30, 2001.  The decrease isattributable to significant cost reductions implemented by us.

 

***Losson Impairment of Goodwill.***  We periodically determine if there has beena permanent impairment of goodwill.  Inthis connection, we recorded an impairment loss of $100,000 in the nine monthsended June 30, 2002.

 

***Depreciation and Amortization.***  Depreciation and amortization expensesincreased 51.2% to $806,994 for the nine months ended June 30, 2002 from$533,681 for the nine months ended June 30, 2001.  Depreciation and amortization as a percentage of revenuesincreased to 1.6% for the nine months ended June 30, 2002 from 1.3% for thenine months ended June 30, 2001.  The increasewas primarily due to the amortization of goodwill and other intangiblesassociated with acquisitions and the impact of increased capital expenditures.

 

***Provision for Doubtful Accounts.***  Provision for doubtful accounts increased111.8% to $900,000 for the nine months ended June 30, 2002 from $425,000 forthe nine months ended June 30, 2001. Provision for doubtful accounts as a percentage of revenues increased to1.7% for the nine months ended June 30, 2002 from 1.0% for the nine monthsended June 30, 2001.  The increase wasdue to a change in estimate in light of the downturn in the economy and ourevaluation of the recoverability of certain of our accounts.

 

***Finance Charges.***  Finance charges for the nine months endedJune 30, 2001 were the amounts charged under an agreement with a factor, whichwas terminated on December 12, 2000.

*** ***

***Losson Sale of Investment.***  In the nine months ended June 30, 2002, we sold 63,025,000shares, representing our entire 26.3% investment in a publicly-traded foreigncompany for net proceeds of $206,631 and realized a loss of $2,159,415.

 

***Interest and Financing Costs.***  Interest and financing costs increased to$1,537,406 for the nine months ended June 30, 2002 from**$1,510,721 for the nine months ended June30, 2001.  The increase is the result ofdebt incurred by us in connection with acquisitions.

 

***Net (Loss****) **Attributable toCommon Stockholders**. *Asa result of the foregoing, we had a net loss of ($5,208,983) for the ninemonths ended June 30, 2002 compared to a net loss of ($3,363,657) for the ninemonths ended June 30, 2001.

 

15

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**Liquidityand Capital Resources**

 

AtJune 30, 2002, we had limited liquid resources.  Current liabilities were $17,505,126 and current assets were $13,731,949.  The difference of $3,773,177 is a workingcapital deficit, which is primarily the result of losses incurred during eachof the five quarters ended June 30, 2002. Current liabilities include a cash overdraft of $872,234 which isrepresented by outstanding checks. These conditions raise substantial doubts about our ability to continueas a going concern.  The financialstatements do not include any adjustments to reflect the possible future effecton the recoverability and classification of assets or the amounts andclassification of liabilities that may result from the outcome of thisuncertainty.

 

Ourcontinuation of existence is dependent upon our ability to generate sufficientcash flow to meet our continuing obligations on a timely basis, to fund theoperating and capital needs, and to obtain additional financing as may benecessary.

 

Wehave taken steps to revise and reduce our operating requirements, which webelieve will be sufficient to assure continued operations and implementation ofour plans.  The steps include closingbranches that are not profitable, consolidating branches and reduction instaffing and other selling, general and administrative expenses.

 

InJuly 2002, we sold 7,650 shares of a newly created Series E Preferred Stock ina private placement for $765,000 in cash. In addition, on July 30, 2002, Joseph J. Raymond invested $1,000,000 ofhis personal funds in the Company in exchange for 10,000 shares of newlycreated Series F Preferred Stock.  SeePart II — Item 2 of this report for a description of the terms of the Series EPreferred Stock and the Series F Preferred Stock.  The proceeds from the issuance reduced our working capitaldeficit by approximately $1.5 million and were used to reduce outstanding debtand for general working capital purposes.

 

Netcash used in operating activities was $2,562,739 and $1,102,064 in the ninemonths ended June 30, 2002 and 2001, respectively.

 

Netcash provided by (used in) investing activities was $1,447,602 and ($1,755,829)in the nine months ended June 30, 2002 and 2001, respectively.  The sale of our Engineering Division andsale of an investment generated net cash proceeds of $1,709,079 and $206,631,respectively, which was used to fund operating activities.  Cash used for acquisitions for the ninemonths ended June 30, 2002 and 2001 was $184,292, and $976,512,respectively.  The balance in bothperiods was primarily for capital expenditures.

 

Netcash provided by financing activities was $985,600 and $1,911,024 in the ninemonths ended June 30, 2002 and 2001, respectively.  We had net borrowings (reductions in borrowings) of ($63,452) and$865,104 under our line of credit in the nine months ended June 30, 2002 and2001, respectively.  We also receivednet proceeds, less redemptions, of $24,879 and $1,282,398 from the issuance ofconvertible debt in the nine months ended June 30, 2002 and 2001,respectively.  During the nine monthsended June 30, 2002, we received $504,583 in proceeds from the issuance of ourCommon Stock and Series B Preferred Stock and redeemed $455,000 of Series BPreferred Stock.  Net borrowings duringthe nine months ended June 30, 2002 include $200,000 advanced to us by SourceOne Personnel, Inc. (“Source One”). This loan was represented by a promissory note bearing interest at arate of 7% per annum and was made in connection with a modification of SourceOne’s agreement to forbear from exercising remedies under promissory notes weissued to it in connection with an acquisition transaction completed in July2001 in the principal amounts of $600,000 and $1,800,000, respectively.  The $200,000 note and the $600,000 note wererepaid in full on July 31, 2002 from the proceeds we received from the issuanceof the Series E Preferred Stock and the Series F Preferred Stock.  The $1,800,000 note is payable quarterlyover a four year period which commenced in November 2001.

 

Ourprincipal uses of cash are to fund temporary employee payroll expense andemployer related payroll taxes; investment in capital equipment; start-up expensesof new offices; expansion of services offered;

 

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workers’compensation, general liability and other insurance coverages; and costsrelating to other transactions such as acquisitions.  Temporary employees are paid weekly.

 

At various times during the year ended September 30, 2001 and the ninemonths ended June 30, 2002, we issued convertible debentures through privateplacements.  The debentures boreinterest at 6% a year, payable quarterly and had a maturity date of five yearsfrom issuance.  Each debenture wasconvertible after 120 days from issuance into the number of shares of ourcommon stock determined by dividing the principal amount of the debenture bythe lesser of (a) 120% of the closing bid price of the common stock on thetrading day immediately preceding the issuance date or (b) 75% of the averageclosing bid price of the common stock for the five trading days immediatelypreceding the date of the conversion. We had the right to prepay any of the debentures at any time at aprepayment rate that varied from 115% to 125% of the amount of the debenturedepending on when the prepayment was made.

 

The discount arising from the 75% beneficial conversion feature wascharged to interest expense during the period from the issuance of thedebenture to the earliest time at which the debenture became convertible.

 

As a result of conversions of the debentures and certain transactionswith the debenture holders, only $40,000 of debentures remains outstanding.

 

On December 12, 2000, weentered into a loan and security agreement with a lending institution whichreplaced our prior factoring arrangement and provides for a line of credit upto 85% to 90% of eligible accounts receivable, as defined, not to exceed$12,000,000.  Advances under the creditagreement bear interest at a rate of prime plus one and one-half percent (11⁄2%).  The credit agreement restricts ourability to incur other indebtedness, pay dividends and repurchase stock.  Borrowings under the agreement arecollateralized by substantially all of our assets.  As of June 30, 2002, $7,243,129 was outstanding under the creditagreement.

 

AtJune 30, 2002, we were in violation of the following covenants under the loanand security agreement:

 

(i)                       Failing to meet the tangible net worthrequirement;

(ii)                    Exceeding the $250,000 limit on redeemingour common stock, as a result of the redemption of Series B Preferred Stock,and;

(iii)                 Our common stock being delisted from theNasdaq SmallCap Market

 

We have received awaiver from the lender on all of the above violations.

 

Effective January 1, 2002, we purchased substantially all of thetangible and intangible assets, excluding accounts receivable, of seven officesof Provisional Employment Solutions, Inc. (“PES”).  The initial purchase price was $1,480,000, represented by a$1,100,000 promissory note and 400,000 shares of our common stock.  There was an additional $336,727 of costsincurred in connection with the acquisitions. In addition, PES is entitled to earnout payments of 15% of pretax profitof the acquired business up to a total of $1.25 million or the expiration often years, whichever occurs first.  Thenote bears interest at 6% a year and is payable over a ten-year period in equalquarterly payments.

 

The following table summarizes the fair value of the assets acquired atthe date of acquisition based upon a third-party valuation of certainintangible assets:

 

| Property and  equipment |   | $         | 42,000    |   |
|-------------------------|--------|-----------|-----------|--------|
| Intangible  assets      |   | 468,596   |      |
| Goodwill                |   | 1,306,131 |      |
|                    |   | $         | 1,816,727 |   |

 

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Of the $468,596 of intangibleassets, $85,880 was assigned to a covenant-not-to-compete and $382,716 wasassigned to the customer list.  Theintangible assets are being amortized over their estimated useful life of twoto four years.  Goodwill is not beingamortized under the provision of Statement of Financial Accounting StandardsNo. 142, “Goodwill and Other Intangible Assets”.  All of the goodwill is expected to be deductible for tax purposes.

 

###### **Seasonality**

 

Our business follows theseasonal trends of our customer’s business. Historically, we have experienced lower revenues in the first calendarquarter with revenues accelerating during the second and third calendar quartersand then starting to slow again during the fourth calendar quarter.

 

###### **Impact of Inflation**

 

We believe that since ourinception, inflation has not had a significant impact on our results ofoperations.

 

**Impactof Recent Accounting Pronouncements**

 

InJune 2001, the Financial Accounting Standards Board (FASB) issued Statement ofFinancial Accounting Standard (SFAS) No. 141, “Business Combinations”.  SFAS No. 141 establishes new standards foraccounting and reporting requirements for business combinations and requiresthat the purchase method of accounting be used for all business combinationsinitiated after June 30, 2001.  SFAS No.141 also requires that acquired intangible assets be recognized as assets apartfrom goodwill if they meet one of the two specified criteria.  Additionally, the statement adds certaindisclosure requirements to those required by APB 16, including disclosure ofthe primary reasons for the business combination and the allocation of thepurchase price paid to the assets acquired and liabilities assumed by majorbalance sheet caption.  This statementis required to be applied to all business combinations initiated after June 30,2001 and to all business combinations accounted for using the purchase methodfor which the date of acquisition is July 1, 2001 or later.  Use of the pooling-of-interests method isprohibited.  The adoption of SFAS No.141 did not have an impact on our financial condition or results of operations.

 

InJune 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets”.  SFAS No. 142, which must be applied tofiscal years beginning after December 15, 2001, modifies the accounting andreporting of goodwill and intangible assets. The pronouncement requires entities to discontinue the amortization ofgoodwill, reallocate all existing goodwill among its reporting segments basedon criteria set by SFAS No. 142 and perform initial impairment tests byapplying a fair-value-based analysis on the goodwill in each reportingsegment.  Any impairment at the initialadoption date shall be recognized as the effect of a change in accountingprinciple.  Subsequent to the initialadoption, goodwill shall be tested for impairment annually or more frequentlyif circumstances indicate a possible impairment.

 

UnderSFAS No. 142, entities are required to determine the useful life of otherintangible assets and amortize the value over the useful life.  If the useful life is determined to beindefinite, no amortization will be recorded. For intangible assets recognized prior to the adoption of SFAS No. 142,the useful life should be reassessed. Other intangible assets are required to be tested for impairment in amanner similar to goodwill.  At June 30,2002, our goodwill subject to amortization was approximately $3,451,000, andannual amortization of such goodwill was approximately $289,000.  We expect to adopt SFAS No. 142 during ourfirst fiscal quarter of fiscal 2003. Because of the extensive effort required to comply with the remainingprovisions of SFAS Nos. 141 and 142, we cannot reasonably estimate the impacton its financial statements of these provisions beyond discontinuingamortization.

 

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**Item3 - Quantitative and Qualitative Disclosure About Market Risks**

 

Weare subject to the risk of fluctuating interest rates in the ordinary course ofbusiness for borrowings under our Loan and Security Agreement with CapitalTempfunds, Inc.  This credit agreementprovides for a line of credit up to 85% to 90% of eligible accounts receivable,not to exceed $12,000,000.  Advancesunder this credit agreement bear interest at a rate of prime plus one andone-half percent (1-1/2%).

 

Asa result of the disposition of our interest in enterpriseAsia.com, apublicly-traded foreign company, we are no longer exposed to equity price risk.

 

Webelieve that our business operations are not exposed to market risk relating toforeign currency exchange risk or commodity price risk.

 

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**Part II – Other Information**

**Item 2 – Changes in Securities and Use of Proceeds**

 

***Private Placement of Series E ConvertiblePreferred Stock; Exchange of Series B Convertible Preferred Stock***

 

InJuly 2002, we conducted, through Hornblower & Weeks, Inc. as PlacementAgent, a private placement of our Series E Convertible Preferred Stock (“theSeries E Preferred”), to accredited investors. The offering’s closing date was July 19, 2002, and the gross proceeds ofthe offering were $765,000.  Theoffering proceeds have been and will be used for the reduction of debt andother working capital purposes.

 

OnJune 18, 2002, we, at our option, redeemed 91,000 shares of Series B PreferredStock at the current redemption price of $5.00 per share, totaling $455,000 inthe aggregate from Pinnacle Investment Partners, LLP (“Pinnacle”).

 

Additionally,on July 19, 2002, we entered into an Exchange Agreement with Pinnacle pursuantto which, Pinnacle exchanged its remaining 140,300 shares of Series B PreferredStock and its right to receive $41,790 in accrued dividends and penalties for7,433 shares of the Series E Preferred Stock.

 

TheCompany also entered, on July 19, 2002, into an Exchange Agreement withTransworld Management Services, Inc. (“Transworld”), pursuant to whichTransworld exchanged its remaining 32,000 shares of Series B Preferred Stockfor 1,600 shares of Series E Preferred Stock and waived all accrued dividendsand penalties.  Thus, as of July 19,2002, no shares of Series B Preferred Stock remain outstanding.  Joseph J. Raymond, our President and ChiefExecutive Officer, is the sole shareholder of Transworld.

 

Theholders of the Series E Preferred Stock are entitled to cumulative dividends ata rate of six percent (6%) per annum, accrued daily, on a quarterly basis andpayable every 120 days, in preference and priority to any payment of anydividend on our Common Stock.  Dividendsmay be paid, at our option, either in cash or in shares of Common Stock, valuedat the Series E Conversion Price (as defined below), if the Common Stockissuable upon conversion of such Series E Preferred Stock has been registeredfor resale under the Securities Act of 1933. Holders of Series E Preferred shares are entitled to a liquidationpreference of $100 per share, plus accrued and unpaid dividends.

 

TheSeries E Preferred Stock is convertible into Common Stock at a conversion price(the “Series E Conversion Price”) equal to 75% of the average of the closingbid prices, for the five days preceding the conversion date, for the CommonStock.  The number of shares issuableupon conversion is determined by multiplying the number of shares of Series EPreferred Stock to be converted by $100 and dividing the result by theConversion Price then in effect.

 

Holdersof Series E Preferred Stock do not have any voting rights, except as requiredby law.

 

Weare obligated to file a registration statement with the Securities and ExchangeCommission to register the shares of Common Stock issuable upon conversion ofthe Series E Preferred Stock for public resale and use our best efforts tocause such registration statement to become effective within 120 days after theClosing Date of the offering, i.e., 120 days after July 19, 2002 (the “Series ETarget Date”).  If such registrationstatement is not effective before the Series E Target Date, we are obligated topay a penalty equal to fifteen percent (15%) of the purchase price of theSeries E Preferred Shares.  Thereafter,for every additional 120 day period beyond the date for which a registrationstatement has not been declared effective, an additional fifteen percent (15%)penalty shall accrue.

 

Wehave the right, but not the obligation, to redeem the shares of the Series EPreferred Stock at any time prior to conversion at a redemption price of 115%of the purchase price paid for the Series E Preferred Shares plus any accruedbut unpaid dividends.

 

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Werelied upon the exemption provided by Rule 506 promulgated under the SecuritiesAct of 1933 in connection with the issuance of the Series E Preferred Stock inthe private placement and exchange transactions described above.

 

***Private Placement of Series F ConvertiblePreferred Stock***

 

OnJuly 30, 2002, our President and CEO, Joseph J. Raymond, Sr., invested$1,000,000 of his personal funds in the Company in exchange for 10,000 sharesof newly created Series F Preferred Stock with a stated value of $100 pershare.

 

Theholders of the Series F Preferred Stock are entitled to receive from assetslegally available thereafter, cumulative dividends at a rate of seven (7%)percent per annum, accrued daily and payable monthly, in preference andpriority to any payment of any dividend on the Common Stock and on the Series EPreferred Stock.  Dividends may be paid,at our option, either in cash or in shares of Common Stock, valued at theSeries F Conversion Price (as defined below), if the Common Stock issuable uponconversion of such Series F Preferred Stock has been registered for resaleunder the Securities Act of 1933. Holders of Series F Preferred shares are entitled to a liquidationpreference of $100.00 per share, plus accrued and unpaid dividends.

 

TheSeries F Preferred Stock is convertible into Common Stock at a conversion price(the “Series F Conversion Price”) equal to $.10 per share.  The number of shares issuable uponconversion is determined by multiplying the number of shares of Series FPreferred Stock to be converted by $100 and dividing the result by theconversion price then in effect.

 

Exceptas otherwise required by law, holders of Series F Preferred Stock and holdersof Common Stock shall vote together as a single class on each matter submittedto a vote of stockholders.  Eachoutstanding share of Series F Preferred Stock shall be entitled to the numberof votes equal to the number of full shares of Common Stock into which suchshares of Series F Preferred Stock is then convertible on the date fordetermination of stockholders entitled to vote at the meeting.  Holders of the Series F Preferred Stock areentitled to vote as a separate class on any proposed amendment to the Series FPreferred Stock which would increase or decrease the number of authorizedshares of Series F Preferred Stock or have an adverse impact on the Series FPreferred Stock, and on any proposal to create a new class of shares havingrights or preferences equal to or having priority to the Series F PreferredStock.

 

Weare obligated to file a registration statement with the Securities and ExchangeCommission to register the shares of Common Stock issuable upon conversion ofthe Series F Preferred Stock and use its best efforts to cause suchregistration statement to become effective within 120 days after the ClosingDate of the offering, i.e., 120 days after July 30, 2002 (the “Series F TargetDate”).  If such registration statementis not effective before the Series F Target Date, we are obligated to pay apenalty equal to fifteen percent (15%) of the purchase price of the Series FPreferred Shares.  Thereafter, for everyadditional 120 day period beyond the date for which a registration statementhas not been declared effective, an additional fifteen percent (15%) penaltyshall accrue.

 

Wehave the right, but not the obligation to redeem the shares of the Series FPreferred Stock at any time prior to conversion at a redemption price of 115%of the purchase price paid for the Series F Preferred shares plus any accruedbut unpaid dividends.

 

Werelied upon the exemption provided by Rule 506 promulgated under the SecuritiesAct of 1933 in connection with the issuance of the Series F Preferred Stock.

 

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**Item 3 – Defaults Upon Senior Securities**

 

We issued promissory notes to Source One in theprincipal amounts of $600,000 (“Note 1”) and $1,800,000 (“Note 2”), respectively,on July 27, 2001 in connection with an acquisition transaction.  As a result of our working capital deficit,we were unable to make the following payments when due:

 

(i)                                     a payment of $600,000 of principal and $21,000 of accrued interest due onJanuary 28, 2002 under Note 1;

 

(ii)                                  a payment of $100,766 of principal and $29,951 of accrued interest due onFebruary 27, 2002 under Note 2; and

 

(iii)                               a payment of $102,530 of principal and $28,187 of accrued interest due onMay 27, 2002 under Note 2.

 

Pursuant to a Forbearance Agreement executedin January 2002 and amended in June 2002, Source One agreed to forbear fromexercising remedies against us until June 30, 2002.  On July 31, 2002 we cured all payment defaults under Note 1 andNote 2 and repaid $200,000 loaned to us by Source One on June 4, 2002 which wasdue June 30, 2002 and bore interest at a rate of 7% per annum.

 

Dividends on our Series A Preferred Stockaccrue at a rate of 7% per annum and are payable semi-annually when and ifdeclared by our Board of Directors.  Nosuch dividends have been declared and, as of the date of the filing of thisreport, $270,000 of dividends are in arrears on the Series A Preferred Stock.

 

**Item 4 – Submission of Matters to a Vote of SecurityHolders**

 

ASpecial Meeting of Stockholders was held at our corporate offices at 500 CraigRoad, Suite 201, Manalapan, New Jersey 07726 on July 26, 2002.  The Special Meeting was previously scheduledfor July 17, 2002, but was adjourned to allow us sufficient time to obtain thevotes necessary to approve those proposals recommended by the Board forapproval and presented to the stockholders.

 

Thefour matters to be considered and acted upon at the meeting were (i) a proposalto amend our Certificate of Incorporation to increase the number of theauthorized shares of our Common Stock from 25,000,000 to 100,000,000; (ii) aproposal to approve the issuance of 47,000 shares of the Series C ConvertiblePreferred Stock (the “Series C Preferred Stock”) to Artisan (UK) plc(“Artisan”) and the issuance of shares of Common Stock upon the conversion ofsuch Series C Preferred Stock (the “Series C Proposal”); (iii) a proposal toapprove the issuance of the full number of Common Stock to which the holders ofour Series B Preferred Stock (the “Series B Preferred Stock”) are entitled uponthe Conversion of the Series B Preferred Stock; and a proposal to approve theissuance of into up to 50,000,000 shares of Common Stock, or securitiesconvertible into up to 50,000,000 shares of Common Stock at prices which may bebelow the book and market value of the Common Stock.

 

Thematters voted upon at the meeting, and the number of votes cast for, against orwithheld, as well as the number of abstentions, as to each such matter, is setforth below.  Each of the proposals tobe voted upon at the Special Meeting were approved by the Stockholders, exceptthe Series C Proposal.

 

Withregard to the proposal to approve the amendment of our Certificate ofIncorporation to increase the number of authorized shares of our Common Stockfrom 25,000,000 to 100,000,000, 50.8% of the Common Stock, voting as a separateclass and 56.3% of the Common Stock and Series A Preferred Stock, voting as asingle class, were voted in favor of this proposal.  Of the votes cast, 7,329,632 shares of our Common Stock andSeries A Preferred Stock, voting as a single class, were voted in favor of theapproval of the amendment, 560,406 shares of our Common Stock and Series APreferred Stock, voting as a single 

 

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class,were voted against the approval of the amendment and 11,580 shares of ourCommon Stock and Series A Preferred Stock, voting as a single class, abstainedfrom voting.

 

Additionally,of the votes cast, 5,870,699 shares of our Common Stock, voting as a separateclass, were voted in favor of the approval of the amendment, 560,406 shares ofour Common Stock, voting as a separate class, were voted against the approvalof the amendment and 11,580 shares of our Common Stock, voting as a separateclass, abstained from voting.

 

Withregard to the proposal to approve the issuance of 47,000 shares of the Series CConvertible Preferred Stock to Artisan (UK) plc and the issuance of shares ofCommon Stock upon the conversion of such Series C Preferred Stock, 4.8% of thevotes of Common Stock were cast in favor of this proposal.  Of the votes cast, 0 shares of our Series APreferred Stock, voting as a separate class, were voted in favor of theproposal, 1,458,933 shares of our Series A Preferred Stock, voting as aseparate class, were voted against the adoption and 0 shares of our Series APreferred Stock, voting as a separate class, abstained from voting.

 

Ofthe votes cast, 0 shares of our Series B Preferred Stock, voting as a separateclass, were voted in favor of the proposal, 263,300 shares of our Series BPreferred Stock, voting as a separate class were voted against the adoption and0 shares of our Series B Preferred Stock, voting as a separate class, abstainedfrom voting.

 

Ofthe votes cast, 638,941 shares of our Common Stock and Series A PreferredStock, voting together as a single class, were voted in favor of the proposal,7,224,097 shares of our Common Stock and Series A Preferred Stock, votingtogether as a single class were voted against the adoption and 38,580 shares ofour Common Stock and Series A Preferred Stock, voting as a single class,abstained from voting.

 

Withregard to the proposal to approve the issuance to the holders of our Series BPreferred Stock of the full number of shares of our Common Stock to which suchholders are entitled upon conversion of the Series B Preferred Stock, 90% ofthe votes were cast in favor of the proposal. Of the votes cast 7,184,081 shares of our Common Stock and Series APreferred Stock voting as a single class, voted in favor of approval of ourissuance to holders of our Series B Preferred Stock upon conversion of thePreferred Stock, 689,957 shares of our Common Stock and Series A PreferredStock, voting as a single class, voted against the approval of issuance and27,580 shares of our Common Stock and Series A Preferred Stock, voting as asingle class, abstained from voting.

 

Withregard to the proposal to approve the issuance of up to 50,000,000 shares ofCommon Stock, or securities convertible into up to 50,000,000 shares of CommonStock, at prices which may be below book and market value of the Common Stock,90% of the votes were cast in favor of this proposal.  Of the votes cast 7,186,423 shares of our Common Stock and SeriesA Preferred Stock, voting as a single class, were voted in favor of approval ofour issuance of up to 50,000,000 shares of Common Stock, or securitiesconvertible into up to 50,000,000 shares of Common Stock, at prices which maybe below book and market value of the Common Stock, 673,865 shares of ourCommon Stock and Series A Preferred Stock, voting as a single class, were votedagainst the approval of issuance and 41,330 shares of our Common Stock andSeries A Preferred Stock, voting as a single class, abstained from voting.

 

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**Item 5 – Other Information**

 

***Termination of Placement Agent Agreement***

 

OnJune 14, 2002, we notified Kirlin Securities, Inc. (“Kirlin”) that we wereimmediately terminating the Placement Agent Agreement and Investment BankingAgreement we had previously entered into with Kirlin for the purposes of ouroffering up to $2,000,000 of Series D Preferred Stock and correspondingwarrants.  Our decision to terminate theagreement was in large part, to recent trends in the marketplace in general andalso with respect to our stock prices. In addition, Kirlin had made no efforts to place our shares pursuant tothe Placement Agent Agreement, nor had it provided any investment bankingadvice to the Company.

 

***Nasdaq Listing***

 

OnJuly 2, 2002, we received the decision of the Nasdaq Listing and Hearing ReviewCouncil (the “Review Council”), which reversed the February 26, 2002 decisionof the Nasdaq Listing Qualifications Panel (the “Panel”), to de-list oursecurities from the Nasdaq Small Cap Market.

 

TheReview Council reversed and remanded the Panel’s decision to the Panel, subjectto certain conditions.  These conditionsare further subject to the Panel’s discretion to impose additional monitoringrestrictions.  By September 30, 2002, wemust demonstrate a closing price of at least $1.00 per share and immediatelythereafter maintain a closing bid price of at least $1.00 per share for aminimum of ten consecutive trading days. Upon us fulfilling this requirement, and the June 30, 2002 shareholder’sequity requirement set forth below, the Panel is to re-list our securities onthe Nasdaq Small Cap Market provided there are no adverse developmentsjustifying denial of the listing.

 

Inaddition, prior to re-listing, we must report a $4,500,000 shareholders’ equityrequirement as of June 30, 2002, and must, going forward, maintain certainother additional shareholder’s equity requirements for the September 30, 2002year-end ($3,750,000) and December 31, 2002 quarter ($3,500,000) anddemonstrate compliance with all requirements for continued listing.

 

Wehave been informed that the Panel will not render a formal decision until wehave notified the Panel that we have met both the June 30, 2002 shareholders’equity requirement and the minimum bid price requirement.  We have not met the June 30, 2002shareholders’ equity requirement.

 

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**Item 6 - Exhibits and Reports on Form 8-K**

 

(a)                                                     Exhibits

 
| **Number** |   | **Description**                                                                                                                                                                                                                                                                                                                                                  |   |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 3.4        |   | Certificate  of Designations, Preferences and Rights of Series E Preferred Stock                                                                                                                                                                                                                                                                                 |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 3.5        |   | Certificate  of Amendment to Certificate of Designations, Preferences and Rights of Series  E Preferred Stock                                                                                                                                                                                                                                                    |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 3.6        |   | Certificate  of Designations, Preferences and Rights of Series F Preferred Stock                                                                                                                                                                                                                                                                                 |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 4.1.8      |   | Specimen  Series E Stock Certificate of the Registrant                                                                                                                                                                                                                                                                                                           |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 4.1.9      |   | Specimen  Series F Stock Certificate of the Registrant                                                                                                                                                                                                                                                                                                           |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 4.1.10     |   | Exchange  Agreement between Pinnacle Investment Partners, LP and the Registrant                                                                                                                                                                                                                                                                                  |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 4.1.11     |   | Exchange  Agreement between Transworld Management Services, Inc. and the Registrant                                                                                                                                                                                                                                                                              |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 4.1.12     |   | Securities  Purchase Agreement between Joseph J. Raymond, Sr. and the Registrant  regarding Series F Preferred Stock                                                                                                                                                                                                                                             |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 10.8.3     |   | Modification  of Forbearance Agreement dated June 4, 2002 between the Registrant and Source  One Personnel together with Exhibits thereto                                                                                                                                                                                                                        |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 99.1       |   | Certification  of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                 |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| 99.2       |   | Certification  of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                 |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
| (b)        |   | Reports on  Form 8-K                                                                                                                                                                                                                                                                                                                                             |   |
|       |   |                                                                                                                                                                                                                                                                                                                                                             |   |
|       |   | One April 4,  2002, we filed a Report on Form 8-K to report (a) the completion of the sale  of the assets of our Engineering Services Division, (ii) the issuance of  Series B Preferred Stock in exchange for 6% convertible debentures, the  cancellation of other indebtedness and cash and (iii) an amendment of the  terms of the Series A Preferred Stock. |   |

 

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SIGNATURES

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

STRATUSSERVICES GROUP, INC.

 
| Date:  August 14, 2002 | By:    | /s/ Joseph  J. Raymond   |                                          |
|-----------------------------|--------|--------------------------|-----------------------------------------------|
|                        |   |                     | Joseph J.  Raymond                            |
|                        |   |                     | Chairman of  the Board of Directors,          |
|                        |   |                     | President  and Chief Executive Officer        |
|                        |   |                     |                                          |
| Date:  August 14, 2002 | By:    | /s/ Michael  A. Maltzman |                                          |
|                        |   |                     | Michael A.  Maltzman                          |
|                        |   |                     | Chief Financial  Officer                      |
|                        |   |                     | (Principal  Financial and Accounting Officer) |

 

 

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