**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





**ý**
            **QUARTERLY
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934****For
                the quarterly period ended June 30, 2005****o**
            **TRANSITION
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**





**Commission
      file number 001-15789**





**STRATUS
      SERVICES GROUP, INC.**


(Exact
      name of Registrant as specified in its charter)





Delaware
            
            22-3499261(State
                or 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**(Registrant’s
                telephone number, including area code)Securities
                registered under Section 12(b) of the Exchange Act:**Not
                Applicable**Securities
                registered under Section 12(g) of the Exchange Act:Common
                Stock, $.04 par value(Title
                of class)





*Indicate
      by check mark whether the registrant has (1) filed all reports required to
      be
      filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
      (or for such shorter period that the registrant was required to file such
      reports), and (2) has been subject to such filing requirements for the past
      90
      days. Yes* *ý* *No* *o*





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Act).


Yes o No ý





*The
      number of shares of Common Stock, $.04 par value, outstanding as of August
      12,
      2005 was 17,117,856.*








**STRATUS
      SERVICES GROUP, INC.**


Condensed
      Consolidated Balance Sheets





**June
                30,**
            
            
            **September
                30,**Assets
            
            
            **2005**
            
            
            **2004**(Unaudited)Current
                assetsCash
            
            $
            34,280
            
            $
            735,726Accounts
                receivable-less allowance for doubtful accounts of
                $2,539,000and
                $2,038,000
            
            
            12,940,023
            
            
            14,618,155Unbilled
                receivables
            
            
            1,847,559
            
            
            2,119,836Notes
                receivable (current portion)
            
            
            42,852
            
            
            32,683Prepaid
                insurance
            
            
            1,042,985
            
            
            1,929,056Prepaid
                expenses and other current assets
            
            
            372,841
            
            
            589,42116,280,540
            
            
            20,024,877Notes
                receivable (net of current portion)
            
            
            52,916
            
            
            74,269Note
                receivable - related party
            
            
            3⁄4
            
            
            122,849Property
                and equipment, net of accumulated depreciation
            
            
            497,870
            
            
            597,416Intangible
                assets, net of accumulated amortization
            
            
            752,036
            
            
            1,081,936Goodwill
            
            
            5,816,353
            
            
            5,816,353Other
                assets
            
            
            153,381
            
            
            189,475$
            23,553,096
            
            $
            27,907,175Liabilities
                and Stockholders’ Equity (Deficiency)Current
                liabilitiesLoans
                payable (current portion)
            
            $
            112,090
            
            $
            149,091Loans
                payable - related parties (current portion)
            
            
            111,489
            
            
            196,646Notes
                payable - acquisitions (current portion)
            
            
            559,095
            
            
            955,105Line
                of credit
            
            
            9,929,677
            
            
            11,029,070Cash
                overdraft
            
            
            20,348
            
            
            24,492Insurance
                obligation payable
            
            
            170,704
            
            
            134,975Accounts
                payable and accrued expenses
            
            
            4,827,453
            
            
            5,574,852Accounts
                payable - related parties
            
            
            2,917,133
            
            
            3,512,073Accrued
                payroll and taxes
            
            
            295,913
            
            
            1,155,426Payroll
                taxes payable
            
            
            3,573,399
            
            
            5,153,146Series
                A redemption payable
            
            
            300,000
            
            
            250,000Put
                options liability
            
            
            650,000
            
            
            673,000Series
                I convertible preferred stock (including unpaid dividends
                of$235,468
                and $40,806)
            
            
            2,412,968
            
            
            2,218,30625,880,269
            
            
            31,026,182Loans
                payable - related parties (net of current portion)
            
            
            3⁄4
            
            
            42,929Notes
                payable - acquisitions (net of current portion)
            
            
            1,220,770
            
            
            1,305,285Payroll
                taxes payable
            
            
            661,546
            
            
            3⁄4Convertible
                debt
            
            
            40,000
            
            
            40,00027,802,585
            
            
            32,414,396Commitments
                and contingenciesStockholders’
                equity (deficiency)Preferred
                stock, $.01 par value, 5,000,000 shares authorizedSeries
                E non-voting convertible preferred stock, $.01 par value,247
                and 572 shares issued and outstanding, liquidation
                preferenceof
                $24,700 (including unpaid dividends of $-0- and $1,500)
            
            
            24,700
            
            
            58,700





See
            notes
            to condensed consolidated financial statements
 **2**





Series
                F voting convertible preferred stock, $.01 par value, 6,000shares
                issued and outstanding, liquidation preference of $600,000(including
                unpaid dividends of $83,500 and $72,000)
            
            
            683,500
            
            
            672,000Common
                stock, $.04 par value, 100,000,000 shares authorized; 17,117,854and
                16,822,854 shares issued and outstanding
            
            
            684,714
            
            
            672,914Additional
                paid-in capital
            
            
            16,946,031
            
            
            16,930,831Accumulated
                deficit
            
            
            (22,588,434
            )
            
            (22,841,666
            )Total
                stockholders’ equity (deficiency)
            
            
            (4,249,489
            )
            
            (4,507,221
            )$
            23,553,096
            
            $
            27,907,175








See
            notes
            to condensed consolidated financial statements
 **3**


**STRATUS
      SERVICES GROUP, INC.**


Condensed
      Consolidated Statements of Operations


(Unaudited)








**Three
                Months Ended**
            **Nine
                Months Ended****June
                30,**
            **June
                30,****2005**
            
            
            **2004**
            
            
            **2005**
            
            
            **2004**Revenues
            
            $
            27,257,446
            
            $
            27,637,948
            
            $
            83,270,261
            
            $
            72,063,722Cost
                of revenues
            
            
            23,519,638
            
            
            25,269,607
            
            
            71,676,550
            
            
            63,724,575Gross
                Profit
            
            
            3,737,808
            
            
            2,368,341
            
            
            11,593,711
            
            
            8,339,147Selling,
                general and administrative expenses
            
            
            4,177,662
            
            
            3,579,331
            
            
            12,231,687
            
            
            9,484,996Other
                charges
            
            
            243,084
            
            
            3⁄4
            
            
            416,345
            
            
            3⁄4Operating
                loss from continuing operations
            
            
            (682,938
            )
            
            (1,210,990
            )
            
            (1,054,321
            )
            
            (1,145,849
            )Interest
                expense
            
            
            (404,469
            )
            
            (1,160,740
            )
            
            (1,262,503
            )
            
            (2,153,622
            )Other
                income (expense) (net)
            
            
            (23,983
            )
            
            30,849
            
            
            (46,810
            )
            
            19,265Loss
                from continuing operations
            
            
            (1,111,390
            )
            
            (2,340,881
            )
            
            (2,363,634
            )
            
            (3,280,206
            )Discontinued
                operations - earnings fromdiscontinued
                operations
            
            
            81,170
            
            
            25,883
            
            
            377,758
            
            
            60,117Gain
                on sale of discontinued operations to related party
            
            
            2,239,108
            
            
            3⁄4
            
            
            2,239,108
            
            
            3⁄4Net
                earnings (loss)
            
            
            1,208,888
            
            
            (2,314,998
            )
            
            253,232
            
            
            (3,220,089
            )Dividends
                on preferred stock
            
            
            (10,500
            )
            
            (81,898
            )
            
            (31,500
            )
            
            (1,330,655
            )Net
                earnings (loss) attributable to common stockholders
            
            $
            1,198,388
            
            $
            (2,396,896
            )
            $
            221,732
            
            $
            (4,550,744
            )Net
                earnings (loss) per share attributableto
                common stockholdersBasic:(Loss)
                from continuing operations
            
            $
            (.07
            )
            $
            (.39
            )
            $
            (.14
            )
            $
            (.79
            )Earnings
                from discontinued operations
            
            
            .14
            
            
            .01
            
            
            .15
            
            
            .01Net
                earnings (loss)
            
            $
            .07
            
            $
            (.38
            )
            $
            .01
            
            $
            (.78
            )Diluted:(Loss)
                from continuing operations
            
            $
            (.05
            )
            $
            (.39
            )
            $
            (.13
            )
            $
            (.79
            )Earnings
                from discontinued operations
            
            
            .11
            
            
            .01
            
            
            .14
            
            
            .01Net
                earnings (loss)
            
            $
            .06
            
            $
            (.38
            )
            $
            .01
            
            $
            (.78
            )Weighted
                average shares outstanding per common shareBasic
            
            
            17,062,909
            
            
            6,237,144
            
            
            16,905,693
            
            
            5,845,026Diluted
            
            
            20,874,831
            
            
            6,237,144
            
            
            18,287,060
            
            
            5,845,026








See
            notes
            to condensed consolidated financial statements
 **4**


**STRATUS
      SERVICES GROUP, INC.**


Condensed
      Consolidated Statements of Cash Flows


(Unaudited)





**Nine
                Months Ended****June
                30, 2005**
            
            
            **June
                30, 2004**Cash
                flows from (used in) operating activitiesNet
                (loss) from continuing operations
            
            $
            (2,363,634
            )
            $
            (3,280,206
            )Net
                earnings from discontinued operations
            
            
            2,616,866
            
            
            60,117Adjustments
                to reconcile net loss to net cash used by operating activitiesDepreciation
            
            
            251,399
            
            
            300,222Amortization
            
            
            319,988
            
            
            317,021Provision
                for doubtful accounts
            
            
            500,000
            
            
            525,000Deferred
                financing costs amortization
            
            
            1,748
            
            
            804Gain
                on sale of discontinued operations
            
            
            (2,239,108
            )
            
            3⁄4Restricted
                stock award expense
            
            
            42,000
            
            
            3⁄4Accrued
                interest
            
            
            (36,695
            )
            
            839,615Imputed
                interest
            
            
            55,920
            
            
            62,411Dividends
                on preferred stock
            
            
            194,662
            
            
            396,789Changes
                in operating assets and liabilitiesAccounts
                receivable
            
            
            1,400,409
            
            
            (2,645,085
            )Prepaid
                insurance
            
            
            886,071
            
            
            12,272Prepaid
                expenses and other current assets
            
            
            8,035
            
            
            76,109Other
                assets
            
            
            34,346
            
            
            (43,295
            )Insurance
                obligation payable
            
            
            35,729
            
            
            136,384Accrued
                payroll and taxes
            
            
            (859,513
            )
            
            264,545Payroll
                taxes payable
            
            
            (918,201
            )
            
            372,263Accounts
                payable and accrued expenses
            
            
            2,057,675
            
            
            2,591,722Total
                adjustments
            
            
            1,734,465
            
            
            3,206,7771,987,697
            
            
            (13,312
            )Cash
                flows from (used in) investing activitiesPurchase
                of property and equipment
            
            
            (182,706
            )
            
            (52,954
            )Payments
                for business acquisitions
            
            
            (136,000
            )
            
            3⁄4Collection
                of notes receivable
            
            
            11,184
            
            
            16,748Payments
                in connection with sale of discontinued operations
            
            
            (322,952
            )
            
            3⁄4(630,474
            )
            
            (36,206
            )Cash
                flows from financing activitiesPayments
                of registration costs
            
            
            3⁄4
            
            
            (479,189
            )Proceeds
                from loans payable
            
            
            3⁄4
            
            
            12,337Payments
                of loans payable
            
            
            (76,600
            )
            
            (223,357
            )Proceeds
                from loans payable - related parties
            
            
            650,000
            
            
            3⁄4Payments
                of loans payable - related parties
            
            
            (778,087
            )
            
            (202,583
            )Payments
                of notes payable - acquisitions
            
            
            (696,445
            )
            
            (465,844
            )Net
                proceeds from (repayment of) line of credit
            
            
            (1,099,393
            )
            
            2,154,806Redemption
                of preferred stock
            
            
            (34,000
            )
            
            3⁄4Cash
                overdraft
            
            
            (4,144
            )
            
            (683,078
            )Dividends
                paid
            
            
            (20,000
            )
            
            3⁄4(2,058,669
            )
            
            113,092Net
                change in cash
            
            
            (701,446
            )
            
            63,574Cash
                - beginning
            
            
            735,726
            
            
            53,753Cash
                - ending
            
            $
            34,280
            
            $
            117,327





See
            notes
            to condensed consolidated financial statements
 **5**


**STRATUS
      SERVICES GROUP, INC.**


Condensed
      Consolidated Statements of Cash Flows


(Unaudited)











**Nine
                Months Ended****June
                30, 2005**
            
            
            **June
                30, 2004**Supplemental
                disclosure of cash paid:Interest
            
            $
            1,014,536
            
            $
            958,893Schedule
                of noncash investing and financing activities:Business
                acquired:Fair
                value of net assets acquired
            
            $
            358,500
            
            $
            3⁄4Less:
                cash paid
            
            
            (136,000
            )
            
            3⁄4Less:
                common stock issued
            
            
            (16,500
            )
            
            3⁄4Liabilities
                assumed
            
            $
            206,000
            
            $
            3⁄4Sale
                of discontinued operations:Gain
                on sale
            
            $
            (2,239,108
            )
            $
            3⁄4Net
                assets sold
            
            
            (377,265
            )
            
            3⁄4Cancellation
                of accounts payable - related parties
            
            
            3,315,719
            
            
            3⁄4Cancellation
                of amounts due from related party
            
            
            (376,394
            )
            
            3⁄4Cash
                paid
            
            $
            322,952
            
            $
            3⁄4Issuance
                of common stock upon conversion of convertible preferred
                stock
            
            $
            3⁄4
            
            $
            572,500Issuance
                of common stock to a related party in exchange for accounts payableand
                accrued expenses
            
            $
            3⁄4
            
            $
            57,000Cumulative
                dividends on preferred stock
            
            $
            31,500
            
            $
            1,330,665Accrued
                interest converted to loan payable
            
            $
            21,600
            
            $
            3⁄4Put
                option liability converted to loan payable
            
            $
            18,000
            
            $
            3⁄4








See
          notes
          to condensed consolidated financial statements
 **6**


**STRATUS
      SERVICES GROUP, INC.**


Notes
      to
      Condensed Consolidated Financial Statements


(Unaudited)





**NOTE
      1 - BASIS OF PRESENTATION**





The
      accompanying condensed consolidated financial statements have been prepared
      by
      the Company, without audit, pursuant to the rules and regulations of the
      Securities and Exchange Commission. Certain information and disclosures normally
      included in financial statements prepared in accordance with accounting
      principles generally accepted in the United States have been condensed or
      omitted pursuant to such rules and regulations. These condensed financial
      statements reflect all adjustments (consisting only of normal recurring
      adjustments) that, in the opinion of management, are necessary to present fairly
      the financial position, the results of operations and cash flows of the Company
      for the periods presented. It is suggested that these condensed consolidated
      financial statements be read in conjunction with the consolidated financial
      statements and the notes thereto included in the Company’s Annual Report on Form
      10-K.





The
      results of operations for the interim periods presented are not necessarily
      indicative of the results to be expected for the full year.





The
      following summarizes revenues:





**Three
                Months Ended**
            **Nine
                Months Ended****June
                30,**
            **June
                30,****2005**
            
            
            **2004**
            
            
            **2005**
            
            
            **2004**Staffing
            
            $
            27,244,903
            
            $
            27,610,858
            
            $
            83,235,754
            
            $
            71,998,098Payrolling
            
            
            12,543
            
            
            27,090
            
            
            34,507
            
            
            65,624$
            27,257,446
            
            $
            27,637,948
            
            $
            83,270,261
            
            $
            72,063,722





Unlike
      traditional staffing services, under a payrolling arrangement, the Company’s
      customer recruits and identifies individuals for the Company (or a third party
      to the extent that the Company outsources its payroll functions) to hire to
      provide services to the customer. The Company (or a third party to the extent
      that the Company outsources its payroll functions) becomes the statutory
      employer although the customer maintains substantially all control over those
      employees. Accordingly, Emerging Issues Task Force (“EITF”) 99-19, “Reporting
      Revenue Gross as a Principal versus Net as an Agent” requires that the Company
      does not reflect the direct payroll costs paid to such employees in revenues
      and
      cost of revenue.





**NOTE
      2 - LIQUIDITY**





At
      June
      30, 2005, the Company had limited liquid resources. Current liabilities were
      $25,880,269 and current assets were $16,380,540. The difference of $9,499,729
      is
      a working capital deficit, which is primarily the result of losses incurred
      from
      the year ended September 30, 2002 through March 31, 2005. The Company entered
      into an Amended and Restated Forbearance Agreement with its lender on August
      11,
      2005 (see Note 9). If the Company cannot obtain an alternate source of funding
      by the expiration of the forbearance period, i.e. by August 26, 2005, if not
      further extended, it may adversely affect the Company’s cash flow and there can
      be no assurance that the Company’s lender will not pursue all remedies available
      to it, which could include the imposition of insolvency proceedings.
      Additionally, if the Company cannot obtain an extension of the forbearance
      agreement for payment defaults under its outsourcing agreement with a related
      party (see Notes 10 and 14), or is unable to cure the payment defaults under
      the
      outsourcing agreement, going forward, there can be no assurance that the Company
      will be able to obtain an alternative outsourcing provider. These conditions
      raise substantial doubts about the Company’s ability to continue as a going
      concern. The financial statements do not include any adjustments to reflect
      the
      possible future effect on the recoverability and classification of assets or
      the
      amounts and classification of liabilities that may result from the outcome
      of
      this uncertainty.





The
      Company’s continuation of existence is dependent upon the continued cooperation
      of its creditors, its ability to generate sufficient cash flow to meet its
      continuing obligations on a timely basis, to fund the operating and capital
      needs, and to obtain additional financing as may be necessary.





Management
      of the Company has taken steps to revise and reduce its operating requirements,
      which it believes will be sufficient to assure continued operations and
      implementation of the Company’s plans. The steps include closing and selling
      branches that are not profitable, consolidating branches and reductions in
      staffing, cost of revenues and other selling,


**7**


general
      and administrative expenses. The Company also entered into a Second Addendum
      to
      Outsourcing Agreement with a related party (see Note 13) which reduced certain
      rates charged by the related party to the Company.





The
      Company continues to pursue other sources of equity or long-term debt
      financings. The Company also continues to negotiate payment plans and other
      accommodations with its creditors. There can be no assurance that these plans
      will be successfully consummated.





The
      Company entered into a Letter of Intent with Humana Trans Services Holding
      Corp.
      (“Humana”)(see Notes 14 and 15), which contemplates, among other things, that
      Humana will provide a $500,000 bridge loan to the Company and provide new
      receivable financing or arrange a line of credit to replace the Company’s line
      of credit with Capital. No assurance can be given that any of such financing
      will be obtained.





**NOTE
      3 - REVERSE STOCK SPLIT**





On
      July
      14, 2004, the Company effected a one-for-four reverse stock split of the
      Company’s common stock. All references to per share information and the number
      of shares issued and outstanding for prior periods have been adjusted to reflect
      the reverse stock split on a retroactive basis.





**NOTE
      4 - NEW ACCOUNTING PRONOUNCEMENT**





In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based
      Payment” (“SFAS 123R”). SFAS 123R replaces SFAS 123 “Accounting for Stock-Based
      Compensation”, and supercedes Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (APB No. 25). SFAS 123R requires that
      the cost of all forms of equity-based compensation granted to employees,
      excluding employee stock ownership plans, be recognized in a company’s income
      statement and that such cost be measured at the fair value of the stock options.
      This statement is effective for financial statements relating to fiscal years
      beginning after June 15, 2005. The Company expects to adopt SFAS 123R on October
      1, 2005, on a prospective basis, which will require recognition of compensation
      expense for all stock option or other equity - based awards that vest or become
      exercisable after the effective date. The Company does not expect that the
      adoption of SFAS 123R will have a material impact on the Company’s financial
      position and results of operations as it relates to employee stock options
      granted at June 30, 2005.





In
      May
      2005, FASB issued Statement of Financial Accounting Standards No. 154,
“Accounting Changes and Error Corrections” (SFAS 154”). SFAS 154 requires
      retroactive application of a voluntary change in accounting principle to prior
      period financial statements unless it is impracticable. SFAS 154 also requires
      that a change in method of depreciation, amortization, or depletion for
      long-lived, non-financial assets be accounted for as a change in accounting
      estimate that is affected by a change in accounting principle. SFAS 154 replaces
      APB Opinion 20, “Accounting Changes”, and SFAS 3, “Reporting Accounting Changes
      in Interim Financial Statements”. The Company believes that adoption of the
      provisions of SFAS 154 will not have a material impact on the Company’s
      consolidated financial statements.





**NOTE
      5 - EARNINGS/LOSS PER SHARE**





Basic
      “Earnings Per Share” (“EPS”) excludes dilution and is computed by dividing
      earnings available to common stockholders by the weighted-average number of
      common shares outstanding during the period. Diluted EPS assumes conversion
      of
      dilutive options and warrants, and the issuance of common stock for all other
      potentially dilutive equivalent shares outstanding. There were 3,811,922 and
      1,381,367 dilutive shares for the three and nine months ended June 30, 2005,
      respectively. There were no dilutive shares for the three and nine months ended
      June 30, 2004. Outstanding common stock options and warrants not included in
      the
      computation of earnings per share for the three and nine months ended June
      30,
      2005 totaled 18,611,403. These options and warrants were excluded because their
      inclusion would have an anti dilutive effect on earnings per share.





**NOTE
      6 - INCOME TAXES**





Based
      upon management’s estimate of the operating results for the year ended September
      30, 2005, no provision for income taxes was provided for the three and nine
      months ended June 30, 2005.





**NOTE
      7 - DISCONTINUED OPERATIONS**





Effective
      as of June 5, 2005 (the “Effective Date”), the Company sold substantially all of
      the assets, excluding accounts receivable of its six Northern California offices
      to ALS, LLC (“ALS”), a related party (see Note 14).


**8**


The
      purchase price was $3,315,719, which represented the balance due by the Company
      to ALS as of the close of business on May 3, 2005, less $600,000. Accordingly,
      on the Effective Date, $3,315,719 due to ALS was deemed paid and cancelled.
      In
      addition, all amounts due to the Company from ALS as of the Effective Date
      were
      deemed paid in full. Such amounts aggregating $376,394 were comprised of a
      note
      receivable ($122,849) (see Note 14), accounts receivable ($50,000) and other
      receivables ($203,545). ALS and the Company’s lender (see Note 10) also entered
      into a transaction pursuant to which ALS contributed $600,000 in exchange for
      a
      junior participation interest (see Note 9) in amounts borrowed under the line
      of
      credit. ALS will pay to the Company $600,000 as contingent purchase price,
      which
      will be paid to the Company or offset against balances due by the Company to
      ALS, when ALS has been repaid the junior participation interest and all other
      amounts due by the Company to ALS are current and paid in full.





In
      connection with the transaction, the Company and ALS entered into a non-compete
      and non-solicitation agreement pursuant to which the Company agreed not to
      compete with ALS with the customers of and in the geographic area of the
      Northern California offices, and ALS agreed not to compete with the Company
      with
      respect to certain customers and accounts, including, accounts serviced by
      the
      Company’s remaining offices, for a period of two years.





The
      sale
      resulted in a gain of $2,239,108, computed as follows:





Sales
                price - cancellation of accounts payable - related parties
            
            $
            3,315,719Less
                costs of sale:Cancellation
                of amounts due from ALS
            
            
            (376,394
            )Other
                costs (including $75,000 to a related party (see Note 14))
            
            
            (322,952
            )Balance
            
            
            2,616,373Net
                assets sold
            
            
            377,265Gain
            
            $
            2,239,108





Revenues
      from the sold branches were $10,087,390 and $5,209,445 for the nine months
      ended
      June 30, 2005 and 2004, respectively.





Assets
      of
      the discontinued operations are not shown separately on the balance sheet as
      of
      September 30, 2004, since they are not material.





The
      consolidated statements of operations for all periods presented have been
      reclassified to reflect the operating results of the sold branches as
      discontinued operations.





**NOTE
      8 - ACQUISITION**





Effective
      as of March 7, 2005, the Company purchased substantially all of the tangible
      and
      intangible assets excluding accounts receivable, of Team One Personnel
      Solutions, LLC (“Team One”), which is comprised of three branch offices in
      Northern California. These offices provide temporary light industrial and
      clerical staffing and had strengthened the Company’s presence in the Northern
      California region. The purchase price was $242,500 of which $20,000 was paid
      in
      cash. The balance was comprised of a promissory note for $160,000, payable
      $7,091 a month, including interest at 6% a year, over 24 months, 50,000 shares
      of the Company’s Common Stock, and a net liability for unpaid workers’
      compensation premium of $46,000. In addition, there was $116,000 of costs to
      a
      related party (see Note 14) in connection with the acquisition.





The
      aggregate cost of $358,500 was allocated $338,500 to intangible assets and
      $20,000 to property and equipment. The results of operations of the acquisition,
      which are immaterial to the consolidated operations, are included with that
      of
      the Company from the effective date.





These
      branches were included in the branches sold June 5, 2005 (see Note
      7).





**9**


**NOTE
      9 - INTANGIBLE ASSETS**





As
      of
      June 30, 2005 and September 30, 2004, intangible assets consisted of the
      following:





**June
                30, 2005**
            
            
            **September
                30, 2004**Covenant-not-to-compete
            
            $
            17,300
            
            $
            144,600Customer
                list
            
            
            1,426,709
            
            
            1,957,7091,444,009
            
            
            2,102,309Less:
                accumulated amortization
            
            
            (691,973
            )
            
            (1,020,393
            )$
            752,036
            
            $
            1,081,936





Estimated
      amortization expense for each of the next five years is as follows:





**For
                the Twelve Months Ending June 30,**2006
            
            $
            202,0002007
            
            
            156,0002008
            
            
            154,0002009
            
            
            153,0002010
            
            
            88,000





**NOTE
      10 - LINE OF CREDIT**





The
      Company has a loan and security agreement (the “Loan Agreement”) with a lending
      institution whereby the Company can borrow up to 85% of eligible accounts
      receivable, as defined, not to exceed the lesser of $12 million or six times
      the
      Company’s tangible net worth (as defined). Borrowings under the Loan Agreement
      bear interest at 3% above the prime rate and are collateralized by substantially
      all of the Company’s assets. The prime rate at June 30, 2005 was 6.25%. The Loan
      Agreement expires on August 12, 2005.





At
      June
      30, 2005, the Company was in violation of the following covenants under the
      Loan
      Agreement:





(i)
            Failing
                to meet the tangible net worth requirement,(ii)
            The
                Company’s Common Stock being delisted from the Nasdaq SmallCap Market,
                and;(iii)
            The
                Company having delinquent state, local or federal
                taxes.





On
      January 15, 2005, the Company entered into a Forbearance Agreement (the
“Forbearance Agreement”) with its lender (the “Lender”), whereby the Lender has
      agreed to forebear from accelerating obligations and/or enforcing existing
      defaults.





The
      Forbearance Agreement amended the Loan Agreement to reduce the maximum credit
      line to $12,000,000, which was further reduced by $250,000 per month commencing
      March 1, 2005; provided, however, that in the event that the amounts of the
      obligation owing to the Lender were reduced below $7,500,000, then the monthly
      reduction would be suspended unless and until the obligations again exceed
      $7,500,000, in which case the monthly reduction would be subject to certain
      further adjustments.





Provided
      the Company was in compliance with all of the terms and conditions of the
      Forbearance Agreement, the Lender agreed that it would refrain from exercising
      its rights and remedies under the Loan Agreement and applicable law until August
      12, 2005.





On
      August
      11, 2005, the Company and the Lender entered into an Amended and Restated
      Forbearance Agreement (the “Amended Forbearance Agreement”) whereby the Lender
      has again agreed to forbear from accelerating obligations and/or enforcing
      existing defaults.





**10**


The
      Amended Forbearance Agreement provides for the following:





1.
            The
                Lender will forbear from exercising its rights and remedies under
                the Loan
                Documents, solely with respect to certain Designated Defaults during
                the
                period commencing on August 11, 2005, or such other date as may be
                mutually agreed upon in writing by the Parties, and ending on the
                earlier
                to occur of (a) August 26, 2005 or (b) the date of any Forbearance
                Default
                (the “Forbearance Period”).2.
            During
                the Forbearance Period, the maximum credit line shall continue at
                $10,500,000.3.
            In
                consideration for the Lender’s extension of forbearance, Lender will
                charge the Company a forbearance fee in the amount of $300,000 (the
                “Forbearance Fee”). However, if the Forbearance Fee is paid in full within
                60 days from August 11, 2005, the Lender will rebate $50,000 to the
                Company. Additionally, provided there are no additional events of
                default
                under the Loan Agreement, there will be no additional Forbearance
                Fee due
                through October 31, 2005.4.
            During
                the Forbearance Period, the Lender shall maintain a representative
                at the
                Company’s premises, at the Company’s cost, to monitor collateral
                performance and the adherence by the Company to the terms and provisions
                of the Loan Documents.5.
            No
                later than August 31, 2005, the Company shall have received at least
                $500,000 in capital or subordinated loans from a third party.6.
            Failure
                of the Company or ALS, after the Forbearance Period, to comply in
                any
                material respect with any of the terms and conditions of the Outsourcing
                Agreement or modification of the Outsourcing Agreement without the
                Lender’s consent, shall constitute a Forbearance Default.7.
            Failure
                of the Company to comply with the Forbearance Agreement between the
                Company and ALS (the “ALS Forbearance”), shall constitute a Forbearance
                Default.


Thus,
      provided the Company is in compliance with all of the terms and conditions
      of
      the Amended Forbearance Agreement, the Lender agrees that it will refrain from
      exercising its rights and remedies under the Loan Agreement and applicable
      law
      until no earlier than August 26, 2005.





In
      connection with the Company and the Lender entering into the Amended Forbearance
      Agreement, the Company, the Lender and ALS also entered into the ALS
      Forbearance, whereby ALS agreed to forbear, through August 25, 2005, from
      enforcing payment defaults under the Outsourcing Agreement subject to certain
      conditions.





Pursuant
      to the ALS Forbearance, the Company paid to ALS, on August 11, 2005, the sum
      of
      $1,112,000 to cure defaults under the Outsourcing Agreement through that date.
      During the term of the ALS Forbearance:





1.
            After
                the August 11, 2005 payment, invoices totaling the amount of $1,100,000
                shall be due and payable on or before August 18, 2005 (the “Deferred
                Amount”), and the remaining amount due under invoices after deducting
                $1,100,000 shall be due and payable immediately (the “Immediately Payable
                Amount”).2.
            The
                Company shall repay the Immediately Payable Amount by directing the
                Lender, on a daily basis starting Friday, August 12, 2005, to advance
                and
                wire transfer to ALS from available funds under the Loan Agreement
                with
                the Lender. The Company shall provide ALS with an exact copy of the
                loan
                status provided by the Lender. In the event that the Lender lowers
                the
                advance rate under the Loan Agreement, the Lender shall immediately
                notify
                ALS thereof and ALS may elect, prior to the Lender making any additional
                advances, to cease to forbear under the ALS Forbearance.3.
            The
                Company shall be in default of the ALS Forbearance unless the Immediately
                Due Amount is paid in full by August 17, 2005. The Deferred Amount
                shall
                be due in full without further notice or demand at 12:00 p.m. Eastern
                Time
                on August 18, 2005.4.
            If
                the Immediately Due Amount and the Deferred Amount are paid in full
                by
                noon on August 18, 2005, and no other defaults exist under the ALS
                Forbearance, ALS will forbear for one more week, but all terms of
                the
                Outsourcing Agreement, as amended, including, but not limited to,
                payment
                terms shall govern.





**11**





5.
            Any
                further default under the ALS Forbearance or the Amended Forbearance
                Agreement shall be a default. A default under the Amended Forbearance
                Agreement or the ALS Forbearance shall entitle ALS to immediately
                terminate the ALS Forbearance and immediately seek all available
                remedies.6.
            The
                Lender will forbear from exercising its rights under the Loan Agreement
                during the Forbearance Period pursuant to the Amended Forbearance
                Agreement. ALS’ obligation to forbear shall cease if the Lender ceases to
                forbear under the Amended Forbearance Agreement and such ALS right
                to
                cease forbearance shall constitute ALS’ sole remedy against
                Lender.


In
      consideration for the ALS Forbearance, ALS shall receive a $50,000 Forbearance
      Fee (net of any other default penalties or interest), payable on the earlier
      of
      the termination of the agreement or an additional default.





ALS
      and
      the Lender also entered into a transaction, on June 10, 2005, pursuant to which
      ALS contributed $600,000 in exchange for a junior participation interest in
      the
      Lender’s loan to the Company. ALS is required to pay to the Company $600,000 as
      contingent purchase price for the sale of the Company’s Northern California
      Offices (see Note 7), which shall be paid to the Company, or offset against
      the
      balance remaining of the $600,000 receivable due from the Company to ALS, when
      ALS has been repaid the junior participation interest and all other monies
      due
      from the Company to ALS are current and paid in full.





While
      the
      Company has identified and is currently aggressively exploring other funding
      alternatives, the Company can provide no guarantee that it will be able to
      obtain such alternate sources of funding. If the Company cannot obtain an
      alternate source of funding before the expiration of the Forbearance Period,
      i.e. August 26, 2005, if not further extended with respect to both Capital
      and
      ALS, it may adversely affect the Company’s cash flow and there can be no
      assurance that the Company’s existing lender will not pursue all remedies
      available to it, which could include the imposition of insolvency
      proceedings.





**NOTE
      11 - PAYROLL TAX LIABILITIES**





During
      fiscal 2003, the Company was notified by both the New Jersey Department of
      Labor
      and the California Employment Development Department (the “EDD”) that, if
      certain payroll delinquencies were not cured, judgment would be entered against
      the Company. As of June 30, 2005, there was still an aggregate of $4.3 million
      in delinquent payroll taxes outstanding, which are included in “Payroll taxes
      payable” on the balance sheet. Judgment has not been entered against the Company
      in California. While Judgment has been entered against the Company in New
      Jersey, no actions have been taken to enforce same.





On
      January 7, 2005, the Company entered into a payment plan agreement (the “Plan”)
      with the EDD with regard to the Company’s past due and unpaid unemployment
      taxes.





The
      Company is to continue to pay $12,500 per week to be first applied to its unpaid
      employment tax liability of $1,291,546 (as of June 30, 2005) for periods prior
      to the second quarter 2004; then to second quarter 2004 and third quarter 2004
      employment taxes to the extent not already paid, then to interest and then
      to
      penalties.





The
      weekly payment of $12,500 is to increase for a three month period following
      any
      quarter in which the Company’s reported income is above $200,000 based on a
      percentage increase tied to the amount in excess of $200,000. The Company
      believes that consistent with the parties’ intentions when entering into the
      Plan, the gain on sale of discontinued operations, which resulted in no cash
      to
      the Company, would be excluded from reported income.





The
      Company is to pay the remaining tax liability for its second quarter 2004,
      and
      third quarter 2004 of $110,736 at the rate of $20,000 a month with the balance
      due in full by no later than November 30, 2005.





**NOTE
      12 - PREFERRED STOCK**





***a.***  ***Series
      E***





The
      shares of Series E Preferred Stock have a stated value of $100 per share. The
      holders of the Series E Preferred stock are entitled to cumulative dividends
      at
      a rate of 6% of the stated value per year, payable every 120 days, in preference
      and priority to any payment of any dividend on the Company’s Common Stock.
      Dividends may be paid, at the Company’s option, either in cash or in shares of
      Common Stock, valued at the Series E Conversion Price (as defined below).
      Holders of Series E Preferred Stock are entitled to a liquidation preference
      of
      $100 per share, plus accrued and unpaid dividends.


**12**


The
      Series E Preferred Stock is convertible into Common Stock at a conversion price
      equal to 75% of the average of the closing bid prices, for the five trading
      days
      preceding the conversion date, for the Common Stock. The number of shares
      issuable upon conversion is determined by multiplying 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 have any voting rights, except as required
      by
      law.





The
      Company may redeem the shares of the Series E 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 accrued but unpaid dividends.





During
      the nine months ended June 30, 2005, the Company redeemed 325 shares of Series
      E
      Preferred Stock, plus accrued dividends for an aggregate of
      $34,000.





During
      the nine months ended June 30, 2004, holders of Series E Preferred Stock
      converted 3,275 shares into 713,384 shares of common stock at conversion prices
      between $.464 and $.63 per share.





During
      the nine months ended June 30, 2004, the Company issued 11,196 shares of Series
      E Preferred Stock to the Series E shareholders in respect of penalties arising
      out of the Company’s failure to timely register the shares issuable upon
      conversion of the Series E Preferred Stock for public re-sale.





***b.***  ***Series
      F***





In
      July
      2002, the Company’s Chief Executive Officer invested $1,000,000 in the Company
      in exchange for 10,000 shares of newly created Series F Convertible Preferred
      Stock (the “Series F Preferred Stock”), which has a stated value of $100 per
      share.





The
      holder of the Series F Preferred Stock is entitled to receive, from assets
      legally available therefore, cumulative dividends at a rate of 7% per year,
      accrued daily, payable monthly, in preference and priority to any payment of
      any
      dividend on the Common Stock and on the Series F Preferred Stock. Dividends
      may
      be 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). Holders of Series
      F
      Preferred Stock are entitled to a liquidation preference of $100 per share,
      plus
      accrued and unpaid dividends.





The
      Series F Preferred Stock is convertible into Common Stock at a conversion price
      equal to $.40 per share. The number of shares issuable upon conversion is
      determined by multiplying the number of shares of Series F Preferred Stock
      to be
      converted by $100, and dividing the result by the Series F Conversion
      Price.





Except
      as
      otherwise required by law, holders of Series F Preferred Stock and holders
      of
      Common Stock shall vote together as a single class on each matter submitted
      to a
      vote of stockholders. Each outstanding share of Series F Preferred Stock shall
      be entitled to the number of votes equal to the number of full shares of Common
      Stock into which each such share of Series F Preferred Stock is then convertible
      on the date for determination of stockholders entitled to vote at the meeting.
      Holders of the Series F Preferred Stock are entitled to vote at the meeting.
      Holders of the Series F Preferred Stock are entitled to vote as a separate
      class
      on any proposed amendment to the terms of the Series F Preferred Stock which
      would increase or decrease the number of authorized shares of Series F Preferred
      Stock or have an adverse impact on the Series F Preferred Stock and on any
      proposal to create a new class of shares having rights or preferences equal
      to
      or having priority to the Series F Preferred Stock.





The
      Company may redeem the shares of the Series F 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 accrued but unpaid dividends.





During
      the nine months ended June 30, 2004, the Company’s Chief Executive Officer
      converted 2,000 shares of the Series F Preferred Stock into 500,000 shares
      of
      common stock.





***c.***  ***Series
      I***





The
      holders of the Series I Preferred Stock are entitled to dividends at a rate
      of
      12% of the stated value per year. The Company is required to redeem each share
      of the Series I Preferred Stock for an amount equal to the stated value of
      $100
      per share plus all accrued and unpaid dividends on August 5, 2005, to the extent
      permitted by applicable law; provided, however, that the Company has the right
      to extend the required redemption date for an additional one year, in which
      case
      the Company will be required to pay all dividends accrued through the first
      year
      of issuance in cash and issue to each holder of Series I Preferred Stock a
      number of shares of its common stock which then have a value equal to 10% of
      the
      stated value of the Series I Preferred Stock held (see Note 15). In addition,
      if
      the Company extends the redemption date, it


**13**


will
      be
      required to pay dividends quarterly and pay an advisory fee to an advisor
      designated by the holders of the Series I Preferred Stock in an amount equal
      to
      10% of the aggregate stated value of the outstanding shares of Series I
      Preferred Stock, 80% of which will be payable in cash and 20% of which will
      be
      paid in shares of the Company’s common stock, valued at the then current market
      value.





If
      the
      Company does not redeem the Series I Preferred Stock by the extended redemption
      date, the dividend rate of the Series I Preferred Stock will increase to 24%
      per
      year and the Series I Preferred Stock will be convertible, at the option of
      the
      holder, into either common stock at a conversion price equal to 80% of the
      average closing bid price of the common stock during the five trading days
      preceding the conversion or common stock and warrants at a rate of 125 shares
      of
      common stock and 250 warrants for each $100 of stated value and accrued and
      unpaid dividends represented by the Series I Preferred Stock.





The
      Company has the right at any time through August 5, 2005, to cause all of the
      outstanding shares of the Series I Preferred Stock to be converted into, at
      the
      election of the holder, either common stock at a conversion price equal to
      80%
      of the average closing bid price of the common stock during the five trading
      days preceding the conversion, or common stock and warrants at a rate of 125
      shares of common stock and 250 warrants for each $100 of stated value and
      accrued and unpaid dividends represented by the Series I Preferred Stock. The
      discount associated with the conversion feature of the Series I Preferred Stock
      could result in charges to the Company’s earnings in future periods. Holders of
      Series I Preferred Stock have no voting rights, except as provided by law and
      with respect to certain limited matters.





Pinnacle
      Investment Partners, LP, a related party (see Note 14), is a majority holder
      of
      the Series I Preferred Stock.





**NOTE
      13 - STOCK - BASED COMPENSATION**





The
      Company accounts for its stock-based compensation plans using the intrinsic
      value method in accordance with APB No. 25. Accordingly, no stock-based employee
      compensation cost has been recognized in the financial statements as all options
      granted under the Company’s stock option plan, had an exercise price at least
      equal to the market value of the underlying common stock on the date of grant.
      The pro forma information below is based on provisions of SFAS No. 123, as
      amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and
      Disclosure”, issued in December 2002.





**Three
                Months Ended**
            **Nine
                Months Ended****June
                30,**
            **June
                30,****2005**
            
            
            **2004**
            
            
            **2005**
            
            
            **2004**Net
                loss from continuing operationsattributable
                to common stockholders,as
                reported
            
            $
            (1,121,890
            )
            $
            (2,422,779
            )
            $
            (2,395,134
            )
            $
            (4,610,861
            )Deduct:Total
                stock-based employee compensationexpense
                determined under fair value basedmethod
                for all awards, net of related taxeffects
            
            
            (242,400
            )
            
            (213,300
            )
            
            (617,288
            )
            
            (630,700
            )Proforma
                net loss from continuingoperations
                attributable to commonstockholders
            
            $
            (1,364,290
            )
            $
            (2,636,079
            )
            $
            (3,012,422
            )
            $
            (5,241,561
            )Net
                loss from continuing operationsper
                common share attributableto
                common stockholders:Basic
                - as reported
            
            $
            (.07
            )
            $
            (.39
            )
            $
            (.14
            )
            $
            (.79
            )Basic
                - pro forma
            
            $
            (.08
            )
            $
            (.42
            )
            $
            (.18
            )
            $
            (.90
            )Diluted
                - as reported
            
            $
            (.05
            )
            $
            (.39
            )
            $
            (.13
            )
            $
            (.79
            )Diluted
                - pro forma
            
            $
            (.07
            )
            $
            (.42
            )
            $
            (.16
            )
            $
            (.90
            )





**14**


**NOTE
      14 - RELATED PARTY TRANSACTIONS**





***Consulting
      Fees***


An
      entity
      which employs the son of the Chief Executive Officer of the Company (the “CEO”)
      provides consulting services to the Company. Consulting expense was $139,151
      and
      $46,500 for the nine months ended June 30, 2005 and 2004, respectively. The
      Company has paid consulting fees to an entity whose stockholder is another
      son
      of the CEO of the Company. Consulting fees amounted to $50,000 and $76,000
      for
      the nine months ended June 30, 2005 and 2004, respectively.





***Joint
      Venture***


The
      Company provides information technology staffing services through a joint
      venture, Stratus Technology Services, LLC (“STS”), in which the Company has a
      50% interest. A son of the CEO of the Company has a majority interest in the
      other 50% venturer. The Company’s (loss) from operations of STS of $(19,280) for
      the six months ended March 31, 2004, is included in other income (expense)
      in
      the consolidated statements of operations and is not material to the overall
      operations of the Company.





Effective
      March 31, 2004, the Company adopted the provisions of FASB Interpretation No.
      46R, “Consolidation of Variable Interest Entities” (“FIN 46R”). As a result of
      adopting FIN 46R, the Company consolidates the accounts of STS.





***Note
      Receivable***


The
“Note
      Receivable - related party” as of September 30, 2004, was the amount due from
      ALS in connection with the sale of the Company’s Miami Springs, Florida office
      in August, 2003. ALS is the holding company for Advantage Services Group, LLC
      (“Advantage”). The son of the Company’s CEO is a 50% member in ALS. The amount
      due under the note was deemed paid in connection with the sale of the Company’s
      Northern California offices to ALS, effective June 5, 2005 (see Note
      6).





***Payroll
      Outsourcing***


The
      Company is a party to an Outsourcing Agreement with ALS pursuant to which ALS
      and Advantage are to provide payroll outsourcing services for all of the
      Company’s in-house staff, except for its corporate employees, and customer
      staffing requirements (see Note 10). As a result of this arrangement, all of
      the
      Company’s field personnel are employees of ALS. The Company pays agreed upon pay
      rates, plus burden (payroll taxes and workers’ compensation insurance) plus a
      fee ranging between 2% and 3% (0% - 1 1⁄2% effective June 10, 2005) of pay rates.
      On June 10, 2006, the Company entered into a Second Addendum to Outsourcing
      Agreement with ALS, which, among other things, reduced certain rates charged
      by
      ALS to the Company. The total amount charged by ALS under this agreement and
      similar agreements previously in effect between the parties was $76,265,000
      and
      $8,062,000 in the nine months ended June 30, 2005 and 2004, respectively.
      Accounts payable - related parties in the attached condensed consolidated
      balance sheets at June 30, 2005 and September 30, 2004, represents amounts
      due
      to ALS and Advantage.





***Loans
      Payable***


During
      the nine months ended June 30, 2005, the CEO of the Company loaned an aggregate
      of $650,000 to the Company, all of which was repaid during the nine months
      ended
      June 30, 2005. Of this amount $250,000 bore interest at 12% a year and the
      balance was non-interest bearing.





***Other***


The
      Company incurred fees to an entity with whom the son of the CEO is affiliated.
      Such amounts in the nine months ended June 30, 2005, aggregated $75,000 in
      connection with the sale of the Company’s Northern California offices (see Note
      7) and $116,000 in connection with an acquisition (see Note 8). During the
      nine
      months ended June 30, 2004, the Company repaid $151,583 against loans previously
      made by the entity to the Company. Also, during the nine months ended June
      30,
      2004, the Company issued 300,000 shares of its common stock to the entity in
      exchange for $57,000 owed to the entity in connection with a prior year’s
      transaction.





An
      entity
      through which the son of the CEO is employed is a consultant to Humana Trans
      Services Holding Corp. (see Note 15).





The
      nephew of the CEO of the Company is affiliated with Pinnacle Investment
      Partners, LP, the holder of a majority of the shares of the Company’s Series I
      Preferred Stock (see Notes 12 and 15). The Company believes that PIP Management
      Inc., which has been designated as the advisor to the Series I holders (see
      Note
      15), is also affiliated with Pinnacle Investment Partners, LP.





**15**


**NOTE
      15 - SUBSEQUENT EVENTS**





***Series
      I Preferred Stock***


In
      connection with the Company’s election to extend the redemption date of its
      Series I Preferred Stock by one year (see Note 12), on August 5, 2005, the
      Company paid $261,239 representing all accrued dividends on the Series I
      Preferred Stock as of that date. The Company is also required to issue $217,750
      worth of Common Stock to the holders of the Series I Preferred Stock by
      September 4, 2005. In addition, the Company is required to pay, by September
      4,
      2005, an advisory fee to an advisor, PIP Management Inc. (see Note 14), in
      the
      amount of $217,750, $174,200 of which is to be paid in cash and the balance
      of
      $43,550 in shares of the Company’s Common Stock. The Company will be required to
      issue an aggregate of 2,488,569 shares of Common Stock as a result of the
      extension.





***Letter
      of Intent***


On
      August
      15, 2005, the Company entered into a Letter of Intent (the “LOI”) with Humana
      Trans Service Holding Corp. (“Humana”)(see Note 14) relative to Humana and the
      Company entering into a Management Agreement whereby Humana will provide certain
      management, financial, strategic and marketing advisory services to the Company,
      along with, inter alia, a bridge financing of $500,000, and the Company will
      employ Ron Shapss as CEO and Jim Zimbler as Executive Vice President for
      Business Development (the “Management Transaction”).





The
      entering into of the Management Transaction is subject to the following
      conditions:





1.
            Humana
                will provide a Bridge Loan in the amount of $500,000 to the Company,
                prior
                to September 2, 2005;2.
            Humana
                will, by August 26, 2005, provide new receivable financing or some
                other
                line of credit for the Company to replace the Company’s current line of
                credit, or work out satisfactory forbearance or other accommodation
                with
                the Company’s current lender, Capital Temp Funds, Inc. until such time as
                Humana completes the receivables financing, for which Humana will
                have
                received a binding commitment.


No
      assurance can be given that the transactions with Humana will be
      completed.








**16**


**Item
      2 -**  **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**


**AND
      RESULTS OF OPERATIONS**





This
      Form
      10-Q contains “forward-looking statements” within the meaning of Section 27A of
      the Securities Act of 1933, as amended and Section 21E of the Securities
      Exchange Act of 1934, as amended. These statements relate to future economic
      performance, plans and objectives of management for future operations and
      projections of revenue and other financial items that are based on the beliefs
      of our management, as well as assumptions made by, and information currently
      available to, our management. The words “expect”, “estimate”, “anticipate”,
“believe”, “intend”, and similar expressions are intended to identify
      forward-looking statements. Such statements involve assumptions, uncertainties
      and risks. If one or more of these risks or uncertainties materialize or
      underlying assumptions prove incorrect, actual outcomes may vary materially
      from
      those anticipated, estimated or expected. Among the key factors that may have
      a
      direct bearing on our expected operating results, performance or financial
      condition are economic conditions facing the staffing industry generally;
      uncertainties related to the job market and our ability to attract qualified
      candidates; uncertainties associated with our brief operating history; our
      ability to raise additional capital; our ability to obtain a line of credit
      to
      replace our existing credit facility; our ability to maintain reasonably priced
      workers’ compensation insurance; our ability to achieve and manage growth; our
      ability to successfully identify suitable acquisition candidates, complete
      acquisitions or integrate the acquired business into our operations; our ability
      to attract and retain qualified personnel; our ability to develop new services;
      our ability to cross-sell our services to existing clients; our ability to
      enhance and expand existing offices; our ability to open new offices; general
      economic conditions; and other factors discussed from time to time in our
      filings with the Securities and Exchange Commission. These factors are not
      intended to represent a complete list of all risks and uncertainties inherent
      in
      our business. The following discussion and analysis should be read in
      conjunction with the Condensed Consolidated Financial Statements and notes
      appearing elsewhere in this report.





Our
      critical accounting policies and estimates are described in our Annual Report
      on
      Form 10-K for the fiscal year ended September 30, 2004.





**Introduction**





We
      provide a wide range of staffing and productivity consulting services nationally
      through a network of offices located throughout the United States. Regardless
      of
      the type of temporary service offering we provide, we recognize revenues based
      on hours worked by assigned personnel. Generally, we bill our customers a
      pre-negotiated, fixed rate per hour for the hours worked by the temporary
      employees placed by us. Therefore, we do not separate our various service
      offerings into separate offering segments. We do not routinely provide discrete
      financial information about any particular service offering to assess its
      performance. As set forth below, certain of our service offerings target
      specific markets, but we do not necessarily conduct separate marketing campaigns
      for such services. Pursuant to the outsourcing agreement currently in place
      with
      ALS, LLC (“ALS”), ALS is responsible for paying wages, workers’ compensation,
      unemployment compensation insurance, Medicare and Social Security taxes and
      other general payroll related expenses for all of the temporary employees we
      place, and we are billed for such expenses plus a fee from ALS. These expenses
      are included in the cost of revenue. Because we pay the temporary employees
      that
      we place only for the hours they actually work, wages for temporary personnel
      are a variable cost that increases or decreases in proportion to revenues.
      Gross
      profit margin varies depending on the type of services offered. In some
      instances, temporary employees placed by us may decide to accept an offer of
      permanent employment from the customer and thereby “convert” the temporary
      position to a permanent position. Fees received from such conversions are
      included in our revenues. Selling, general and administrative expenses include
      payroll for management and administrative employees, office occupancy costs,
      sales and marketing expenses and other general and administrative
      costs.


**17**


**Results
      of Operations**


**Discontinued
      Operations**





Effective
      as of June 5, 2005 (the “Effective Date”), we sold substantially all of the
      tangible and intangible assets, excluding accounts receivable of our six
      Northern California offices to ALS, a related party (see Note 14 to the
      Condensed Consolidated Financial Statements).





The
      purchase price was $3,315,719, which represented the balance due by us to ALS
      as
      of the close of business on May 3, 2005, less $600,000. Accordingly, on the
      Effective Date, $3,315,719 due to ALS was deemed paid and cancelled. In
      addition, all amounts due to us from ALS as of the Effective Date were deemed
      paid in full. Such amounts aggregating $376,394 were comprised of a note
      receivable ($122,849), accounts receivable ($50,000) and other receivables
      ($203,545). ALS and our lender also entered into a transaction pursuant to
      which
      ALS contributed $600,000 in exchange for a junior participation interest in
      amounts borrowed under our line of credit. ALS will pay to us $600,000 as
      contingent purchase price, which will be paid to us or offset against balances
      due by us to ALS, when ALS has been repaid the junior participation interest
      and
      all other amounts due by us to ALS are current and paid in full.





In
      connection with the transaction, we and ALS entered into a non-compete and
      non-solicitation agreement pursuant to which we agreed not to compete with
      ALS
      with the customers of and in the geographic area of the Northern California
      offices, and ALS agreed not to compete with us with respect to certain customers
      and accounts, including, accounts serviced by our remaining offices, for a
      period of two years.





The
      sale
      resulted in a gain of $2,239,108, computed as follows:





Sales
                price - cancellation of accounts payable - related parties
            
            $
            3,315,719Less
                costs of sale:Write-off
                of amounts due from ALS
            
            
            (376,394
            )Other
                costs (including $75,000 to a related party)
            
            
            (322,952
            )Balance
            
            
            2,616,373Net
                assets sold
            
            
            377,265Gain
            
            $
            2,239,108





Revenues
      from the sold branches were $10,087,390 and $5,209,445 for the nine months
      ended
      June 30, 2005 and 2004, respectively.





**Continuing
      Operations**





**Three
      Months Ended June 30, 2005 Compared to Three Months Ended June 30,
      2004**





***Revenues.*** Revenues
      decreased 1.4% to $27,257,446 for the three months ended June 30, 2005 from
      $27,637,948 for the three months ended June 30, 2004. The significant revenue
      increases we had realized in the first two quarters of fiscal 2005 leveled
      off
      during the three months ended June 30, 2005. This, along with the loss of a
      large customer accounted for the decrease in revenues.





***Gross
      Profit.*** Gross
      profit increased 36.6% to $3,737,808 for the three months ended June 30, 2005
      from $2,368,341 for the three months ended June 30, 2004. Gross profit as a
      percentage of revenues increased to 13.8% for the three months ended June 30,
      2005 from 8.6% for the three months ended June 30, 2004. Effective May 2004,
      the
      California State Compensation Insurance Fund increased our effective workers’
      compensation rates by approximately 238%. This increase reduced our gross profit
      by approximately $800,000 or 2.9% of revenues during the three months ended
      June
      30, 2004. The increase in gross profit and gross profit as a percentage of
      revenues was a result of outsourcing our payroll under various agreements with
      related parties, which enabled us to significantly reduce our workers’
      compensation costs (see Note 14 to the Condensed Consolidated Financial
      Statements).





***Selling,
      General and Administrative Expenses.*** ** Selling,
      general and administrative expenses (“SG&A”) increased 13.9% to $4,077,662
      for the three months ended June 30, 2005 from $3,579,331 for the three months
      ended June 30, 2004. SG&A expenses as a percentage of revenues increased to
      15.0% for the three months ended June 30, 2005 from 13.0% for the three months
      ended June 30, 2004. The Company incurred fees of $380,985 (1.4% of revenues)
      and $5,665 in the three months ended June 30, 2005 and 2004, respectively,
      in
      connection with its Outsourcing Agreement with a related party (see


**18**


Note
      13
      to the Condensed Consolidated Financial Statements). We increased our allowance
      for doubtful accounts in the three months ended June 30, 2005 and 2004 and
      took
      a charge against operations of $200,000 and $450,000, respectively.





***Other
      Charges.*** Other
      charges in the three months ended June 30, 2005, represent adjustments to
      reserves and premiums in connection with prior years’ workers’ compensation
      insurance policies.





***Interest
      Expense.*** Interest
      expense decreased 65.2% to $404,469 for the three months ended June 30, 2005
      from ** $1,160,740
      for the three months ended June 30, 2004. Included in the three months ended
      June 30, 2004, were dividends and accretion relating to the Series A Preferred
      Stock and additional interest on unpaid taxes.





***Net
      (Loss) Attributable to Common Stockholders.*** ** As
      a
      result of the foregoing, we had a net (loss) and net (loss) attributable to
      common stockholders of $(1,011,390) and $(1,021,890), respectively, for the
      three months ended June 30, 2005 compared to a net (loss) and net (loss)
      attributable to common stockholders of $(2,340,881) and $(2,422,779) for the
      three months ended June 30, 2004, respectively.





**Nine
      Months Ended June 30, 2005 Compared to Nine Months Ended June 30,
      2004**





***Revenues.*** Revenues
      increased 15.6% to $83,270,261 for the nine months ended June 30, 2005 from
      $72,063,722 for the nine months ended June 30, 2004. This increase was a result
      of a net increase in billable hours. The net increase in billable hours is
      primarily from (i) expanding into other departments of existing customers,
      (ii)
      successful implementation of “Vendor on Premise” accounts, (iii) becoming the
      primary provider on accounts in which we were not the sole vendor, and (iv)
      new
      customers.





***Gross
      Profit.*** Gross
      profit increased 39.0% to $11,593,711 for the nine months ended June 30, 2005
      from $8,339,147 for the nine months ended June 30, 2004. Gross profit as a
      percentage of revenues increased to 13.9% for the nine months ended June 30,
      2005 from 11.6% for the nine months ended June 30, 2004. The increase in gross
      profit and gross profit as a percentage of revenues was a result of increased
      revenues and the outsourcing of our payroll under various agreements with
      related parties (see Note 14 to the Condensed Consolidated Financial
      Statements).





***Selling,
      General and Administrative Expenses.*** SG&A
      increased 27.9% to $12,131,687 for the nine months ended June 30, 2005 from
      $9,484,996 for the nine months ended June 30, 2004. SG&A expenses as a
      percentage of revenues increased to 14.6% for the nine months ended June 30,
      2005 from 13.2% for the nine months ended June 30, 2004. The Company incurred
      fees of $1,247,738 (1.5% of revenues) and $5,665 in the nine months ended June
      30, 2005 and 2004, respectively, in connection with its Outsourcing Agreement
      with a related party (see Note 13 to the Condensed Consolidated Financial
      Statements). Included in SG&A in the nine months ended June 30, 2005 is
      $499,000 from our 50% - owned joint venture which, prior to March 31, 2004,
      was
      not consolidated (see Note 13 to the Condensed Consolidated Financial
      Statements). We increased our allowance for doubtful accounts in the nine months
      ended June 30, 2005 and 2004 and took a charge against operations of $500,000
      and $525,000, respectively. We also incurred approximately $110,000 of
      nonrecurring legal fees in connection with negotiating our payment plan
      agreement with the California Employment Development Department and collections
      of certain of our accounts receivable.





***Interest
      Expense.*** Interest
      expense decreased 41.4% to $1,262,503 for the nine months ended June 30, 2005
      from $2,153,622 for the nine months ended June 30, 2004. Included in the nine
      months ended June 30, 2004, were dividends and accretion related to the Series
      A
      Preferred Stock and additional interest on unpaid taxes.





***Other
      Charges.*** Other
      charges in the nine months ended June 30, 2005 represent adjustments to reserves
      and premiums in connection with prior years’ workers’ compensation insurance
      policies.





***Net
      (Loss) Attributable to Common Stockholders.*** As a
      result of the foregoing, we had a net (loss) and net (loss) attributable to
      common stockholders of $(2,263,634) and $(2,295,134), respectively, for the
      nine
      months ended June 30, 2005 compared to a net (loss) and (loss) attributable
      to
      common stockholders of $(3,280,206) and $(4,610,861) for the nine months ended
      June 30, 2004, respectively.





**Liquidity
      and Capital Resources**





At
      June
      30, 2005, we had limited liquid resources. Current liabilities were $25,880,269
      and current assets were $16,380,540. The difference of $9,499,729 is a working
      capital deficit, which is primarily the result of losses incurred from the
      year
      ended September 30, 2002 through March 31, 2005. We have entered into an Amended
      and Restated Forbearance Agreement with our lender on August 11, 2005, (see
      Part
      II - Other Information, Item 5, Other Information). If we cannot obtain an
      alternate source of funding by the expiration of the Forbearance Period, i.e.
      August 26, 2005, if not further extended, it may adversely affect our cash
      flows
      and there can be no assurance that our lender will not pursue all remedies


**19**


available
      to it. Additionally, we have entered into a forbearance agreement with ALS
      as a
      result of certain defaults under our Outsourcing Agreement. If we cannot obtain
      an extension of the ALS forbearance, or are unable to cure defaults under the
      ALS Outsourcing Agreement, as amended, going forward, there can be no assurance
      that we will be able to obtain an alternative outsourcing provider. These
      conditions raise substantial doubts about our ability to continue as a going
      concern. The financial statements do not include any adjustments to reflect
      the
      possible future effect on the recoverability and classification of assets or
      the
      amounts and classification of liabilities that may result from the outcome
      of
      this uncertainty.





Our
      continuation of existence is dependent upon the continued cooperation of our
      creditors, our ability to generate sufficient cash flow to meet our continuing
      obligations on a timely basis, to fund the operating and capital needs, and
      to
      obtain additional financing, including a new line of credit, as may be
      necessary.





We
      have
      taken steps to revise and reduce our operating requirements, which we believe
      will be sufficient to assure continued operations and implementation of our
      plans. The steps include closing and selling branches that are not profitable,
      consolidating branches and reductions in staffing, cost of revenues, and other
      selling, general and administrative expenses. We also entered into a Second
      Addendum to Outsourcing Agreement with a related party, which reduced certain
      rates charged by the related party to us. We continue to pursue other sources
      of
      equity or long-term debt financings. We also continue to negotiate payments
      plans and other accommodations with our creditors.





Net
      cash
      provided by (used in) operating activities was $1,987,697 and $(13,312) in
      the
      nine months ended June 30, 2005 and 2004, respectively.





Net
      cash
      used in investing activities was $630,474 and $36,206 in the nine months ended
      June 30, 2005 and 2004, respectively. We used $136,000 in connection with an
      acquisition in March 2005. Payments in connection with the sale of discontinued
      operations aggregated $322,952 in the nine months ended June 30, 2005. The
      balance of cash used in both periods was primarily for capital
      expenditures.





Net
      cash
      provided by (used in) used in financing activities was $(2,058,669) and $113,092
      in the nine months ended June 30, 2005 and 2004, respectively. We had net
      borrowings (repayments) of $(1,099,393) and $2,154,806 under our line of credit
      in the nine months ended June 30, 2005 and 2004, respectively. Net short-term
      loan repayments were $204,687 and $413,603 in the nine months ended June 30,
      2005 and 2004, respectively. During the nine months ended June 30, 2005, our
      Chief Executive Officer loaned an aggregate of $650,000 to us, all of which
      was
      repaid during the nine months ended June 30, 2005. Payments of notes payable
      -
      acquisitions was $696,445 and $465,844 in the nine months ended June 30, 2005
      and 2004, respectively.





Our
      principal uses of cash are to fund temporary employee payroll expense and
      employer related payroll taxes or the similar costs charged to us under our
      payroll outsourcing agreement,, investment in capital equipment, start-up
      expenses of new offices, expansion of services offered, workers’ compensation,
      general liability and other insurance coverages, debt service and costs relating
      to other transactions such as acquisitions. Temporary employees are paid weekly,
      as are payments under our payroll outsourcing agreements with related parties
      (see Note 13 to Condensed Consolidated Financial Statements).





We
      have a
      loan and security agreement (the “Loan Agreement”) with Capital Temp Funds, Inc.
      (“Capital” or the “Lender”), which provides for a line of credit up to 85% of
      eligible accounts receivable, as defined, not to exceed $12,000,000. The Loan
      Agreement restricts our ability to incur other indebtedness, pay dividends
      and
      repurchase stock. Borrowings under the Loan Agreement bear interest at 3% above
      the prime rate and are collateralized by substantially all of our assets. As
      of
      June 30, 2005, $9,929,677 was outstanding under the credit
      agreement.





At
      June
      30, 2005, we were in violation of the following covenants under the Loan
      Agreement:





(i)
            Failing
                to meet the tangible net worth requirements;(ii)
            Our
                common stock being delisted from the Nasdaq SmallCap Market,
                and;(iii)
            Our
                having delinquent state, local or federal
                taxes.





On
      January 15, 2005, we entered into a Forbearance Agreement (the “Forbearance
      Agreement”) pursuant to which Capital has agreed to forebear from accelerating
      obligations and/or enforcing existing defaults.





**20**


The
      Forbearance Agreement amended the Loan Agreement to reduce the maximum credit
      line to $12,000,000, which, since March 1, 2005 has been further reduced by
      $250,000 per month provided, however, that in the event that the amounts of
      the
      obligation owing to Capital were reduced below $7,500,000, then the monthly
      reduction would be suspended unless and until the obligations again exceed
      $7,500,000, subject to certain further adjustments.





Provided
      we were in compliance with all of the terms and conditions of the Forbearance
      Agreement, which was amended in April 2005, Capital agreed that it would refrain
      from exercising its rights and remedies under the Loan Agreement and applicable
      law until August 26, 2005.





On
      August
      11, 2005, we and the Lender entered into an Amended and Restated Forbearance
      Agreement (the “Amended Forbearance Agreement”) whereby the Lender has again
      agreed to forbear from accelerating obligations and/or enforcing existing
      defaults.





The
      Amended Forbearance Agreement provides for the following:





1.
            The
                Lender will forbear from exercising its rights and remedies under
                the Loan
                Documents, solely with respect to certain Designated Defaults during
                the
                period commencing on August 11, 2005, or such other date as may be
                mutually agreed upon in writing by the Parties, and ending on the
                earlier
                to occur of (a) August 26, 2005 or (b) the date of any Forbearance
                Default
                (the “Forbearance Period”).2.
            During
                the Forbearance Period, the maximum credit line shall continue at
                $10,500,000.3.
            In
                consideration for the Lender’s extension of forbearance, Lender will
                charge us a forbearance fee in the amount of $300,000 (the “Forbearance
                Fee”). However, if the Forbearance Fee is paid in full within sixty (60)
                days from August 11, 2005, the Lender will rebate $50,000 to us.
                Additionally, provided there are no additional events of default
                under the
                Loan Agreement, there will be no additional Forbearance Fee due through
                October 31, 2005.4.
            During
                the Forbearance Period, the Lender shall maintain a representative
                at our
                premises, at our cost, to monitor collateral performance and the
                adherence
                by us to the terms and provisions of the Loan Documents.5.
            No
                later than August 31, 2005, we shall have received at least $500,000
                in
                capital or subordinated loans from a third party.6.
            Failure
                by us or ALS, after the Forbearance Period, to comply in any material
                respect with any of the terms and conditions of the Outsourcing Agreement
                or modification of the Outsourcing Agreement without the Lender’s consent,
                shall constitute a Forbearance Default.7.
            Failure
                by us to comply with the Forbearance Agreement between ourselves
                and ALS
                (the “ALS Forbearance”), shall constitute a Forbearance
                Default.





Thus,
      provided we are in compliance with all of the terms and conditions of the
      Amended Forbearance Agreement, the Lender agrees that it will refrain from
      exercising its rights and remedies under the Loan Agreement and applicable
      law
      until no earlier than August 26, 2005.





In
      connection with us and the Lender entering into the Amended Forbearance
      Agreement, we, the Lender and ALS also entered into the ALS Forbearance, whereby
      ALS agreed to forbear, through August 25, 2005, from enforcing payment defaults
      under the Outsourcing Agreement subject to certain conditions.





Pursuant
      to the ALS Forbearance, we paid to ALS, on August 11, 2005, the sum of
      $1,112,000 to cure defaults under the Outsourcing Agreement through that date.
      During the term of the ALS Forbearance:





1.
            After
                the August 11, 2005 payment, invoices totaling the amount of $1,100,000
                shall be due and payable on or before August 18, 2005 (the “Deferred
                Amount”), and the remaining amount due under invoices after deducting
                $1,100,000 shall be due and payable immediately (the “Immediately Payable
                Amount”).2.
            We
                shall repay the Immediately Payable Amount by directing the Lender,
                on a
                daily basis starting Friday, August 12, 2005, to advance and wire
                transfer
                to ALS from available funds under the Loan Agreement with the Lender.
                We
                shall provide ALS with an exact copy of the loan status provided
                by the
                Lender. In the event that the Lender lowers the advance rate under
                the
                Loan Agreement, the Lender shall immediately notify ALS thereof and
                ALS
                may elect, prior to the Lender making any additional advances, to
                cease to
                forbear under the ALS Forbearance.3.
            We
                shall be in default of the ALS Forbearance unless the Immediately
                Due
                Amount is paid in full by August 17, 2005. The Deferred Amount shall
                be
                due in full without further notice or demand at 12:00 p.m. Eastern
                Time on
                August 18, 2005.4.
            If
                the Immediately Due Amount and the Deferred Amount are paid in full
                by
                noon on August 18, 2005, and no other defaults exist under the ALS
                Forbearance, ALS will forbear for one more week, but all terms of
                the
                Outsourcing Agreement, as amended, including, but not limited to,
                payment
                terms shall govern.5.
            Any
                further default under the ALS Forbearance or the Amended Forbearance
                Agreement shall be a default. A default under the Amended Forbearance
                Agreement or the ALS Forbearance shall entitle ALS to immediately
                terminate the ALS Forbearance and immediately seek all available
                remedies.6.
            The
                Lender will forbear from exercising its rights under the Loan Agreement
                during the Forbearance Period pursuant to the Amended Forbearance
                Agreement. ALS’ obligation to forbear shall cease if the Lender ceases to
                forbear under the Amended Forbearance Agreement and such ALS right
                to
                cease forbearance shall constitute ALS’ sole remedy against
                Lender.


In
      consideration for the ALS Forbearance, ALS shall receive a $50,000 Forbearance
      Fee, (net of any other default penalties or interest), payable on the earlier
      of
      the termination of the agreement or an additional default.





While
      we
      have identified and are currently aggressively exploring other funding
      alternatives, we can provide no guarantee that we will be able to obtain such
      alternate sources of funding before the expiration of the Forbearance Period,
      i.e. August 26, 2005, if not further extended. If we cannot obtain an alternate
      source of funding, it may adversely affect our cash flow and there can be no
      assurance that Capital will not pursue all remedies available to it, which
      could
      include the imposition of insolvency proceedings.





We
      have
      entered into a Letter of Intent with Humana Trans Services Holding Corp.
      (“Humana”) which contemplates, among other things, that Humana will provide a
      $500,000 bridge loan to us and provide new receivable financing or arrange
      a
      line of credit to replace our line of credit with Capital. No assurance can
      be
      given that any of such financing will be obtained. See Part II - Item 5 of
      this
      Report.





We
      may be
      required to make certain “earnout” payments to sellers of businesses that we
      have acquired in recent years. The amount of these payments, if any, will depend
      upon the results of the acquired businesses. There is $138,000 included in
      “Accounts payable and accrued expenses” on the balance sheet as of June 30, 2005
      for earnout payments that we recorded as part of one of our acquisitions. The
      original amount recorded at the time of the acquisition was $244,000. The final
      computation of the earnout was based upon the operations of the acquired
      business through November 30, 2004. Accordingly, we reduced the earnout
      liability to $222,000 and reduced intangible assets by the $22,000
      difference.


We
      have
      entered into an agreement with the Seller to pay $14,000 a month for twelve
      months beginning January 2005 and $9,000 a month for six months beginning
      January 2006.





Source
      One Personnel, Inc. (“Source One”) had the right to require us to repurchase
      100,000 shares of our common stock at a price of $8.00 per share at any time
      after July 27, 2003 and before the later of July 27, 2005 and the full payment
      of the outstanding note that we issued to it in connection with the acquisition
      transaction completed with Source One in July 2001. Source One exercised this
      right on July 29, 2003. We are attempting to negotiate an arrangement, which
      would permit us to pay this amount over an extended period of time or upon
      receipt of financing. No assurance can be given that Source One will agree
      to
      such an arrangement. During the year ended September 30, 2004, we paid $150,000
      against this liability, which is reflected as “put options liability” on the
      condensed consolidated balance sheet.





During
      fiscal 2003, we were notified by both the New Jersey Department of Labor and
      the
      California Employment Development Department (the “EDD”) that, if certain
      payroll delinquencies were not cured, judgment would be entered against us.
      As
      of June 30, 2005, there was still an aggregate of $4.3 million in delinquent
      payroll taxes outstanding, which are included in “Payroll taxes payable” on the
      balance sheet as of June 30, 2005. Judgment has not been entered against us
      in
      California. While judgment has been entered against us in New Jersey, no actions
      have been taken to enforce same. On January 7, 2005, we entered into a payment
      plan agreement with the EDD, which requires us to pay $12,500 per week to the
      EDD. The $12,500 weekly payment is subject to increase for a three month period
      following any quarter in which our reported income exceeds $200,000, based
      upon
      a percentage related to the amount of increase above $200,000.


**21**


As
      of
      June 30, 2005, there were no off-balance sheet arrangements, unconsolidated
      subsidiaries, commitments or guarantees of other parties, except as disclosed
      in
      the notes to financial statements. Stockholders’ deficiency at that date was
      $4,249,489.





In
      July
      2003, we entered into an agreement with Artisan (UK) plc (“Artisan”) pursuant to
      which we agreed to redeem the aggregate 1,458,933 shares of its Series A
      Preferred Stock owned by Artisan.com and Cater Barnard (USA) plc, an affiliate
      of Artisan. These shares represented all of the shares of Series A Preferred
      Stock then outstanding. The agreement, as amended in March 2004, provided that
      our obligation to redeem the Series A Preferred Stock was contingent upon our
      sale of not less than $1,000,000 of units in a proposed “best-efforts” public
      offering of the units (the “Offering”). This condition was satisfied in July
      2004. As a result, we paid $500,000 and issued 1,750,000 shares of common stock
      to an assignee of Artisan and redeemed all of the Series A Preferred Stock
      following the initial closing of the Offering. We were obligated to pay the
      assignee an additional $250,000 by January 31, 2005, or at our option, issue
      to
      the assignee shares of our common stock having an aggregate market value of
      $250,000, based upon the average closing bid prices of the common stock for
      30
      days preceding January 31, 2005. As we failed to make the $250,000 payment
      in
      cash or stock, we will be required to pay the assignee $300,000 in cash, plus
      accrued interest at the rate of 18% per year from January 31, 2005, until the
      date the default is cured.





We
      engaged in various transactions with related parties during the nine months
      ended June 30, 2005 including the following:





•
            We
                paid $139,151 to an entity, which employs Jeffrey J. Raymond, the
                son of
                Joseph J. Raymond, our Chairman, President and Chief Executive Officer,
                for consulting services. We also paid $50,000 to an entity owned
                by Joseph
                J. Raymond, Jr., who also is the son of Joseph J. Raymond, for consulting
                services. These amounts were included in selling, general and
                administrative expense. The services provided included the identification
                of acquisition candidates, acquisition advisory services, due diligence,
                post-acquisition transition services, customer relations, accounts
                receivable collection and strategic planning advice.•
            We
                paid fees of $75,000 and $116,000 in connection with the sale of
                our
                Northern California offices and an acquisition, respectively, to
                an entity
                with whom Jeffrey J. Raymond is affiliated.•
            Jeffrey
                J. Raymond, is employed by an entity which serves as a consultant
                to
                Humana Trans Services Holding Corp. (see Note 15 to the condensed
                consolidated financial statements).•
            Joseph
                J. Raymond, Jr. is a 50% member in ALS, LLC, which is the holding
                company
                for Advantage Services Group, LLC (“Advantage”). We are a party to an
                Outsourcing Agreement with ALS and pursuant to which ALS provides
                payroll
                outsourcing services for all of the Company’s in-house staff, except for
                its corporate employees, and customer staffing requirements (see
                Part II -
                Other Information, Item 5. Other Information). As a result of this
                arrangement, all of our field personnel are employed by ALS. We pay
                agreed
                upon pay rates, plus burden (payroll taxes and workers’ compensation
                insurance) plus a fee ranging between 2% and 3% (0% - 1 1⁄2% effective June
                10, 2005) of pay rates. The total amount charged by ALS under this
                agreement was $76,265,000 during the nine months ended June 30,
                2005.•
            At
                June 30, 2005, we owed: $41,000 under a demand note bearing interest
                at
                10% a year to a corporation owned by the son of Joseph J. Raymond;
                $14,125
                to a trust formed for the benefit of a family member of a former
                member of
                our Board of Directors under a promissory note bearing interest at
                12% a
                year which will become due in full in August 2005 and $56,364 to
                a member
                of our Board of Directors under a promissory note bearing interest
                at 12%
                a year which becomes due in full in May 2006.•
            Accounts
                payable and accrued expenses - related parties in the attached condensed
                consolidated balance sheets at June 30, 2005 and September 30, 2004,
                represents amounts due to ALS and Advantage.•
            The
                nephew of the CEO of the Company is affiliated with Pinnacle Investment
                Partners, LP. The Company also believes that PIP Management Inc.,
                which
                has been designated as the advisor to the Series I holders, is also
                affiliated with Pinnacle Investment Partners, LP.•
            During
                the nine months ended June 30, 2005, Joseph J. Raymond loaned an
                aggregate
                of $650,000 to us, all of which was repaid during the nine months
                ended
                June 30, 2005. Of this amount, $250,000 bore interest at 12% a year
                and
                the balance was non-interest bearing.





**22**


**Contractual
      Obligations**





Our
      aggregate contractual obligations are as follows:





**Payments
                Due by Fiscal Period (in Thousands)****2007
                -**
            
            
            **2009
                -****Total**
            
            
            **2006**
            
            
            **2008**
            
            
            **2010**
            
            
            **Thereafter**Contractual
                Obligations:Long-term
                debt obligations
            
            $
            2003
            
            $
            783
            
            $
            521
            
            $
            490
            
            $
            209Operating
                lease obligations
            
            
            978
            
            
            496
            
            
            444
            
            
            38
            
            
            3⁄4Put
                options liability
            
            
            650
            
            
            650
            
            
            3⁄4
            
            
            3⁄4
            
            
            3⁄4Series
                A redemption payable
            
            
            300
            
            
            300
            
            
            3⁄4
            
            
            3⁄4
            
            
            3⁄4Series
                I Preferred Stock
            
            
            2,178
            
            
            3⁄4
            
            
            2,178
            
            
            3⁄4
            
            
            3⁄4Earnout
                liability
            
            
            138
            
            
            138
            
            
            3⁄4
            
            
            3⁄4
            
            
            3⁄4Payroll
                tax liability (a)
            
            
            1,402
            
            
            741
            
            
            661
            
            
            3⁄4
            
            
            3⁄4TOTAL
            
            $
            7,649
            
            $
            3,108
            
            $
            3,804
            
            $
            528
            
            $
            209





(a)
            Exclusive
                of interest and penalties. Payments may be accelerated based upon
                future
                operating result benchmarks.





**Seasonality**





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





**Impact
      of Inflation**





We
      believe that since our inception, inflation has not had a significant impact
      on
      our results of operations.





**Impact
      of Recent Accounting Pronouncements**





In
      December 2004, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”
      (“SFAS NO. 123R”). SFAS No. 123R replaces SFAS No. 123 “Accounting for
      Stock-Based Compensation”, and supercedes Accounting Principles Board Opinion
      No. 25, “Accounting for Stock Issued to Employees” (APB No. 25). SFAS No. 123R
      requires that the cost of all forms of equity-based compensation granted to
      employees, excluding employee stock ownership plans, be recognized in a
      company’s income statement and that such cost be measured at the fair value of
      the stock options. This statement is effective for financial statements relating
      to fiscal periods beginning after June 15, 2005. We expect to adopt SFAS No.
      123R on October 1, 2005 on a prospective basis, which will require recognition
      of compensation expense for all stock option or other equity - based awards
      that
      vest or become exercisable after the effective date. We do not expect that
      the
      adoption of SFAS No. 123R will have a material impact on our financial position
      and results of operations as it relates to employee stock options granted at
      June 30, 2005.





In
      May
      2005, FASB issued Statement of Financial Accounting Standards No. 154,
“Accounting Changes and Error Corrections”) (SFAS 154”). SFAS 154 requires
      retroactive application of a voluntary change in accounting principle to prior
      period financial statements unless it is impracticable. SFAS 154 also requires
      that a change in method of depreciation, amortization, or depletion for
      long-lived, non-financial assets be accounted for as a change in accounting
      estimate that is affected by a change in accounting principle. SFAS 154 replaces
      APB Opinion 20, “Accounting Changes”, and SFAS 3, “Reporting Accounting Changes
      in Interim Financial Statements”. We believe that adoption of the provisions of
      SFAS 154 will not have a material impact on our consolidated financial
      statements.





**Sensitive
      Accounting Estimates**





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the amounts reported in the financial statements and notes. Significant
      estimates include management’s estimate of the carrying value of accounts
      receivable, the impairment of goodwill and the establishment of valuation
      reserves offsetting deferred tax assets. Actual results could differ from those
      estimates. The Company’s critical accounting policies relating to these items
      are described in the Company’s Annual Report on Form 10-K for the year ended
      September 30, 2004. As of June 30, 2005, there have been no material changes
      to
      any of the critical accounting policies contained therein.


**23**





**Item
                3.**
            **QUANTITATIVE
                AND QUALITATIVE DISCLOSURE ABOUT MARKET
                RISKS**





We
      are
      subject to the risk of fluctuating interest rates in the ordinary course of
      business for borrowings under our Loan and Security Agreement, as modified
      by
      the Forbearance Agreement with Capital Tempfunds, Inc. This credit agreement
      provides for a line of credit up to 85% of eligible accounts receivable, not
      to
      exceed $12,000,000. Advances under this credit agreement bear interest at a
      rate
      of prime plus 3%. A significant increase in the underlying interest rate could
      have a material adverse effect on our cash flow.





Further,
      the maximum credit line of $12,000,000 has been reduced by $250,000 per month
      since March 1, 2005. The continued reduction in our Maximum Credit Line has
      affected our ability to borrow against all of our eligible accounts receivable
      and thus has also adversely affected our cash flow.





If
      we
      cannot obtain an alternate source of funding by the expiration of the
      forbearance period, i.e. by August 26, 2005, if not further extended with
      respect to both Capital and ALS, it may adversely affect our cash flow and
      there
      can be no assurance that our Lender will not pursue all remedies available
      to
      it, which could include the imposition of insolvency proceedings. Additionally,
      if we cannot obtain an extension of the ALS Forbearance, or are unable to cure
      defaults under the ALS Outsourcing Agreement, as amended, going forward, there
      can be no assurance that we will be able to obtain an alternative outsourcing
      provider. These conditions raise substantial doubts about the Company’s ability
      to continue as a going concern.





We
      believe that our business operations are not exposed to market risk relating
      to
      foreign currency exchange risk or commodity price risk.





**Item
                4.**
            **CONTROLS
                AND PROCEDURES**





At
      the
      end of the period covered by this report, we carried out an evaluation of the
      effectiveness of the design and operations of our disclosure controls and
      procedures. This evaluation was carried out under the supervision and with
      the
      participation of our management, including our Chairman and Chief Executive
      Officer along with our Chief Financial Officer, who concluded that our
      disclosure controls and procedures were generally effective as of the date
      of
      the evaluation, but there continue to be several material weaknesses that
      require further correction.





As
      disclosed in Item 9A of our Form 10-K filed with the SEC on December 23, 2004,
      in connection with its audit of, and in the issuance of its report on our
      financial statements for the year ended September 30, 2004, our auditors
      delivered a letter that identified certain items that it considers to be
      material weaknesses in the effectiveness of our internal controls. These
      material weaknesses were: (1) limited resources and manpower in the finance
      department; (2) inadequacy of the financial review process as it pertains to
      various account analyses; and (3) inadequate documentation of financial
      procedures as it relates to certain accounting estimates and
      accruals.





While
      we
      believe these weaknesses continue, we also are continuing to implement
      additional procedures to alleviate these weaknesses. In particular, there has
      been improvement in our financial review process.





Except
      for our improvement in our financial review process, there were no significant
      changes in our internal controls during the quarter ended June 30, 2005 that
      have materially affected, or are reasonably likely to have materially affected,
      our internal controls subsequent to the date we carried out our
      evaluation.


**24**





**Part
                II**
            **Other
                Information****Item
                1.**
            **Legal
                Proceedings**





We
      are
      involved, from time to time, in routine litigation arising in the ordinary
      course of business. We do not believe that any currently pending litigation
      will
      have a material adverse effect on our financial position or results of
      operations.





**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**





Not
      applicable.





**Item
                3.**
            **Defaults
                Upon Senior Securities**





Dividends
      on our Series F Preferred Stock accrue at a rate of 7% per annum, payable
      monthly. As of the date of the filing of this report, $88,500 is in arrears
      on
      the Series F Preferred Stock.





**Item
                4.**
            **Submission
                of Matters to a Vote of Security
                Holders**





There
      were no matters submitted to a vote of our security holders during the three
      months ended June 30, 2005.





**Item
                5.**
            **Other
                Information**





a.
            On
                June 29, 2005, we notified the holders of the Series I Preferred
                Stock,
                pursuant to Paragraph 4(a) of the Series I Certificate of Designation
                (the
                “Certificate”), of our election to extend (the “Extension”) the date by
                which we were required to redeem the Series I Preferred Stock to
                the 2
                year anniversary date (i.e. August 5, 2006) of its original issuance
                (i.e.
                August 5, 2004).





In
      connection with the Extension, we paid all dividends accrued on the Series
      I
      through the one year anniversary of the date of issuance (the “Initial
      Redemption Date”), which equaled, in the aggregate, $261,239 as of August 5,
      2005. As a result of the Extension, we will also be required to
      pay:





1.  All
      dividends accruing on the Series I Preferred Stock after the Initial Redemption
      Date in cash on the last date of each calendar quarter (March 31, June 30,
      September 30 and December 31);





2.  An
      additional $217,750 to the holders of the Series I Preferred Stock in the form
      of Common Stock, within 30 days after the Initial Redemption Date, i.e. by
      September 4, 2005; such shares to be valued at the Market Price (as defined
      in
      the Certificate) of our Common Stock on the Initial Redemption Date;
      and





3.  An
      advisory fee to an advisor of the holders of the Series I Preferred Stock,
      PIP
      Management Inc., in an amount equal to $217,750, $174,200 of such amount to
      be
      paid in cash and the remaining $43,550 to be paid in shares of our Common Stock
      valued at the Market Price of the Common Stock on the Initial Redemption Date
      by
      no later than September 4, 2005. The nephew of the CEO of the Company is
      affiliated with Pinnacle Investment Partners, LP., the holder of a majority
      of
      the outstanding shares of Series I Preferred Stock. The Company also believes
      that PIP Management Inc., which has been designated as the advisor to the Series
      I holders, is also affiliated with Pinnacle Investment Partners,
      LP.





b.
            As
                reported in our Report on Form 10-Q for the quarter ended June 30,
                2005,
                Essex & York, Inc., the Underwriter of our public offering of Common
                Stock and Warrants that was completed in August 2004, and Pinnacle
                Investment Partners, LP, a holder of our Common Stock and Series
                I
                Preferred Stock, expressed disappointment with our fundamental performance
                and management issues. While we have had continuing discussions with
                these
                parties over the last several months in an attempt to avoid any potential
                litigation, we have not yet been able to reach a final resolution
                of our
                differences, and there can be no assurance that we will be able to
                do so.





c.
            On
                August 15, 2005, the Company entered into a Letter of Intent (the
“LOI”)
                with Humana Trans Service Holding Corp. (“Humana”) relative to Humana and
                the Company entering into a Management Agreement whereby Humana will
                provide certain management, financial, strategic and marketing advisory
                services to the Company, along with, inter alia, a bridge financing
                of
                $500,000, and the Company will employ Ron Shapss as CEO and Jim Zimbler
                as
                Executive Vice President for Business Development (the “Management
                Transaction”).





The
      entering into of the Management Transaction is subject to the following
      conditions:





1.
            Humana
                will provide a Bridge Loan in the amount of $500,000 to the Company,
                prior
                to September 2, 2005;2.
            Humana
                will, by August 26, 2005, provide new receivable financing or some
                other
                line of credit for the Company to replace the Company’s current line of
                credit, or work out satisfactory forbearance or other accommodation
                with
                the Company’s current lender, Capital Temp Funds, Inc. until such time as
                Humana completes the receivables financing, for which Humana will
                have
                received a binding commitment.


No
      assurance can be given that the transactions with Humana will be
      completed.





An
      entity
      through which Jeffrey J. Raymond, the son of the CEO, is employed is a
      consultant to Humana.








**25**





**Item
                6**
            **Exhibits**





**Number**
            **Description**10.35
            Amended
                and Restated Forbearance Agreement between the Company and Capital
                Temp
                Funds, Inc. dated August 11, 200510.36
            Forbearance
                Letter Agreement by and among the Company, ALS, LLC and Capital Temp
                Funds, Inc. dated August 11, 2005.10.37
            Letter
                of Intent between the Company and Humana Trans Services Holding Corp.
                dated August 15, 2005.31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley
                Act
                of 200231.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley
                Act
                of 200232.1
            Certification
                of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley
                Act
                of 200232.2
            Certification
                of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley
                Act
                of 2002





**26**


**SIGNATURES**





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








STRATUS
                SERVICES GROUP, INC.Date:
                August 17, 2005
            By:
                /s/ Joseph J. Raymond---------------------------------------Joseph
                J. RaymondChairman
                of the Board of Directors,President
                and Chief Executive Officer














Date:
                August 17, 2005
            By:
                /s/ Michael A. Maltzman------------------------------------------Michael
                A. MaltzmanVice
                President and Chief Financial OfficerPrincipal
                Financial and Accounting Officer




**27**