**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, 2006****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 a large accelerated filer, an
      accelerated filer or a non-accelerated filer. See definition of “accelerated
      filer” and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
      One)*





Large
                Accelerated Filero
            Accelerated
                Filero
            Non-Accelerated
                FilerT





*Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes* *o* *No* *S*





*The
      number of shares of Common Stock, $.04 par value, outstanding as of August
      11,
      2006 was 65,479,756.*





**1**


**STRATUS
      SERVICES GROUP, INC.**


Condensed
      Consolidated Balance Sheets


(Unaudited)





**June
                30,**
            
            
            **September
                30,**Assets
            
            
            **2006**
            
            
            **2005****(Restated)**Current
                assetsCash
            
            $
            103,866
            
            $
            40,784Accounts
                receivable-less allowance for doubtful accounts of
                $697,000and
                $3,039,000
            
            
            929,227
            
            
            11,591,026Unbilled
                receivables
            
            
            196,315
            
            
            2,484,799Notes
                receivable (current portion)
            
            
            80,000
            
            
            39,016Due
                from related party
            
            
            621,764
            
            
            -Prepaid
                insurance
            
            
            230,058
            
            
            455,881Prepaid
                expenses and other current assets
            
            
            214,121
            
            
            264,485Assets
                held for sale
            
            
            -
            
            
            3,656,5392,375,351
            
            
            18,532,530Notes
                receivable (net of current portion)
            
            
            -
            
            
            47,593Property
                and equipment, net of accumulated depreciation
            
            
            160,239
            
            
            182,606Other
                assets
            
            
            12,020
            
            
            34,906$
            2,547,610
            
            $
            18,797,635Liabilities
                and Stockholders’ Equity (Deficiency)Current
                liabilitiesLoans
                payable
            
            $
            78,450
            
            $
            73,450Loans
                payable - related parties
            
            
            87,721
            
            
            111,723Notes
                payable - acquisitions (current portion)
            
            
            152,669
            
            
            182,439Note
                payable - related party (current portion)
            
            
            248,827
            
            
            -Line
                of credit
            
            
            477,557
            
            
            8,931,689Cash
                overdraft
            
            
            -
            
            
            14,731Insurance
                obligation payable
            
            
            10,448
            
            
            113,373Accounts
                payable and accrued expenses
            
            
            4,188,472
            
            
            4,574,587Accounts
                payable - related parties
            
            
            -
            
            
            1,232,342Accrued
                payroll and taxes
            
            
            181,943
            
            
            284,834Payroll
                taxes payable
            
            
            3,916,235
            
            
            4,160,539Series
                A redemption payable
            
            
            300,000
            
            
            300,000Warrant
                liability
            
            
            -
            
            
            2,135Series
                I convertible preferred stock (including unpaid dividends
                of$40,091)
            
            
            -
            
            
            2,217,591Liabilities
                held for sale
            
            
            -
            
            
            5,494,2799,642,322
            
            
            27,693,712Notes
                payable - acquisitions (net of current portion)
            
            
            525,875
            
            
            490,848Note
                payable - related party (net of current portion)
            
            
            393,023
            
            
            -Payroll
                taxes payable
            
            
            31,546
            
            
            449,046Convertible
                debt
            
            
            40,000
            
            
            40,00010,632,766
            
            
            28,673,606Commitments
                and contingenciesStockholders’
                equity (deficiency)Preferred
                stock, $.01 par value, 5,000,000 shares authorizedSeries
                E non-voting convertible preferred stock, $.01 par value,247
                shares issued and outstanding, liquidation preference of
                $24,700
            
            
            -
            
            
            24,700





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 $80,500 and $94,000)
            
            
            680,500
            
            
            694,000Common
                stock, $.04 par value, 100,000,000 shares authorized;
                65,479,754and
                19,606,423 shares issued and outstanding
            
            
            2,619,190
            
            
            784,257Additional
                paid-in capital
            
            
            9,417,738
            
            
            10,835,031Accumulated
                deficit
            
            
            (20,802,584
            )
            
            (22,213,959
            )Total
                stockholders’ equity (deficiency)
            
            
            (8,085,156
            )
            
            (9,875,971
            )$
            2,547,610
            
            $
            18,797,635








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,****2006**
            
            
            **2005**
            
            
            **2006**
            
            
            **2005****(Restated)**
            
            
            
            
            
            **(Restated)**Revenues
            
            $
            1,282,074
            
            $
            1,180,222
            
            $
            3,706,018
            
            $
            3,414,949Cost
                of revenues ($-0-, $222,191, $479,873and
                $319,756 to related parties)
            
            
            910,576
            
            
            839,557
            
            
            2,604,400
            
            
            2,435,317Gross
                profit
            
            
            371,498
            
            
            340,665
            
            
            1,101,618
            
            
            979,632Selling,
                general and administrative expenses
            
            
            527,365
            
            
            1,384,590
            
            
            2,534,869
            
            
            3,736,838Operating
                loss from continuing operations
            
            
            (155,867
            )
            
            (1,043,925
            )
            
            (1,433,251
            )
            
            (2,757,206
            )Interest
                expense
            
            
            (47,179
            )
            
            (187,433
            )
            
            (430,987
            )
            
            (654,427
            )Other
                income (expense)
            
            
            7,108
            
            
            (24,049
            )
            
            (11,629
            )
            
            (43,322
            )Gain
                on change in fair value of warrants
            
            
            -
            
            
            882,409
            
            
            2,135
            
            
            5,152,130Earnings
                (loss) from continuing operations
            
            
            (195,938
            )
            
            (372,998
            )
            
            (1,873,732
            )
            
            1,697,175Discontinued
                operations - income (loss)
              from
                discontinued operations
            
            
            -
            
            
            225,187
            
            
            (307,044
            )
            
            1,469,079Gain
                on sale of discontinued operations (net)
            
            
            215,425
            
            
            2,239,108
            
            
            3,592,151
            
            
            2,239,108Net
                earnings
            
            
            19,487
            
            
            2,091,297
            
            
            1,411,375
            
            
            5,405,362Dividends
                on preferred stock
            
            
            (10,500
            )
            
            (10,500
            )
            
            (31,500
            )
            
            (31,500
            )Net
                earnings (loss) attributable to
              common
                stockholders
            
            $
            8,987
            
            $
            2,080,797
            
            $
            1,379,875
            
            $
            5,373,862Net
                earnings (loss) per share attributable
              to
                common stockholdersBasic:(Loss)
                from continuing operations
            
            $
            -
            
            $
            (.02
            )
            $
            (.05
            )
            $
            .10Earnings
                from discontinued operations
            
            
            -
            
            
            .14
            
            
            .09
            
            
            .22Net
                earnings (loss)
            
            $
            -
            
            $
            .12
            
            $
            .04
            
            $
            .32Diluted:(Loss)
                from continuing operations
            
            $
            -
            
            $
            (.02
            )
            $
            (.05
            )
            $
            .08Earnings
                from discontinued operations
            
            
            -
            
            
            .12
            
            
            .08
            
            
            .20Net
                earnings (loss)
            
            $
            -
            
            $
            .10
            
            
            .03
            
            $
            .28Weighted
                average shares outstanding
              per
                common shareBasic
            
            
            52,849,291
            
            
            17,062,909
            
            
            36,388,673
            
            
            16,905,693Diluted
            
            
            71,933,849
            
            
            20,874,831
            
            
            43,104,426
            
            
            19,446,974








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


**STRATUS
      SERVICES GROUP, INC.**


Condensed
      Consolidated Statements of Cash Flows


(Unaudited)




**Nine
                Months Ended****June
                30,****2006**
            
            
            **2005****(Restated)**Cash
                flows from (used in) operating activitiesNet
                earnings
            
            $
            1,411,375
            
            $
            5,405,362Adjustments
                to reconcile net loss to net cash used by operating
                activitiesDepreciation
            
            
            93,302
            
            
            251,399Amortization
            
            
            41,902
            
            
            319,988Provision
                for doubtful accounts
            
            
            -
            
            
            500,000Deferred
                financing costs amortization
            
            
            -
            
            
            1,748Gain
                on sale of discontinued operations
            
            
            (3,592,151
            )
            
            (2,239,108
            )Stock
                compensation
            
            
            100,400
            
            
            42,000Warrants
                issued for fees
            
            
            -
            
            
            13,000Accrued
                interest
            
            
            29,326
            
            
            (36,695
            )Imputed
                interest
            
            
            26,782
            
            
            55,920Dividends
                on preferred stock
            
            
            163,625
            
            
            194,662Intrinsic
                value of beneficial conversion feature of convertible preferred
                stock
            
            
            -
            
            
            1,674Gain
                on change in fair value of warrants
            
            
            (2,135
            )
            
            (5,152,130
            )Changes
                in operating assets and liabilitiesAccounts
                receivable
            
            
            10,920,387
            
            
            1,400,409Prepaid
                insurance
            
            
            225,823
            
            
            886,071Prepaid
                expenses and other current assets
            
            
            182,935
            
            
            8,035Other
                assets
            
            
            21,886
            
            
            34,346Insurance
                obligation payable
            
            
            (102,925
            )
            
            35,729Accrued
                payroll and taxes
            
            
            (102,891
            )
            
            (859,513
            )Payroll
                taxes payable
            
            
            (661,804
            )
            
            (918,201
            )Accounts
                payable and accrued expenses
            
            
            (1,631,500
            )
            
            2,057,675Total
                adjustments
            
            
            5,727,636
            
            
            (3,417,665
            )7,139,011
            
            
            1,987,697Cash
                flows from (used in) investing activitiesPurchase
                of property and equipment
            
            
            (32,782
            )
            
            (182,706
            )Cash
                received in connection with sale of discontinued
                operations
            
            
            
            
            
            (136,000
            )(net
                of $10,000 in costs) - (including $628,236 from a related
                party)
            
            
            -
            
            
            1,024,587Payments
                for business acquisitions
            
            
            -
            
            
            11,184Collection
                of notes receivable
            
            
            6,609
            
            
            (322,952
            )Payments
                in connection with sale of discontinued operations
            
            
            998,414
            
            
            (630,474
            )Cash
                flows (used in) financing activitiesPayments
                of loans payable
            
            
            -
            
            
            (76,600
            )Proceeds
                from loans payable - related parties
            
            
            -
            
            
            650,000Payments
                of loans payable - related parties
            
            
            (24,002
            )
            
            (778,087
            )Payments
                of note payable - related party
            
            
            -
            
            
            (1,490,000
            )Payments
                of notes payable - acquisitions
            
            
            (63,999
            )
            
            (696,445
            )Net
                repayment of line of credit
            
            
            (6,481,611
            )
            
            (1,099,393
            )Redemption
                of preferred stock
            
            
            -
            
            
            (34,000
            )Cash
                overdraft
            
            
            (14,731
            )
            
            (4,144
            )Dividends
                paid
            
            
            -
            
            
            (20,000
            )(8,074,343
            )
            
            (2,058,669
            )Net
                change in cash
            
            
            63,082
            
            
            (701,446
            )Cash
                - beginning
            
            
            40,784
            
            
            735,726Cash
                - ending
            
            $
            103,866
            
            $
            34,280





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





Supplemental
                disclosure of cash paidInterest
            
            $
            381,418
            
            $
            1,014,536Schedule
                of noncash investing and financing activitiesBusiness
                acquired:Fair
                value of net assets acquired
            
            $
            -
            
            $
            358,500Less:
                cash paid
            
            
            -
            
            
            (136,000
            )Less:
                common stock issued
            
            
            -
            
            
            (16,500
            )Liabilities
                assumed
            
            $
            -
            
            $
            206,000Sale
                of discontinued operations:Gain
                on sale
            
            $
            3,592,151
            
            $
            2,239,108Net
                assets sold
            
            
            1,683,783
            
            
            377,265Due
                from related party
            
            
            (621,764
            )
            
            -Accrued
                earn-out
            
            
            (138,219
            )
            
            -Cancellation
                of accounts payable - related parties (net)
            
            
            (3,541,364
            )
            
            (3,315,719
            )Cancellation
                of amounts due from related party
            
            
            -
            
            
            376,394Accrued
                expenses
            
            
            50,000
            
            
            -Net
                cash received (paid)
            
            $
            1,024,587
            
            $
            (322,952
            )Issuance
                of common stock upon conversion of convertible preferred
                stock
            
            $
            24,366
            
            $
            -Cumulative
                dividends on preferred stock
            
            $
            31,500
            
            $
            31,500Accrued
                interest converted to loan payable
            
            $
            -
            
            $
            21,600Put
                option liability converted to loan payable
            
            $
            -
            
            $
            18,000





**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 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.





Until
      December 2005, Stratus Services Group, Inc. together with its 50%-owned
      consolidated joint venture, (the “Company”) was a national provider of staffing
      and productivity consulting services. Prior to December 2005, the Company
      operated a network of 29 offices in 7 states. In December 2005, the Company
      completed a series of asset sales transactions pursuant to which it sold
      substantially all of the assets that it used to conduct its staffing services
      business (see Note 6). As a result, the Company is no longer conducting active
      staffing services for any clients and is not operating any branch offices.
      The
      Company plans to focus on expanding its information technology staffing
      solutions business, which is conducted through its 50% owned consolidated joint
      venture, Stratus Technology Services, LLC (“STS”) (see Notes 1 and
      11).





**NOTE
                2 -**
            **LIQUIDITY**





At
      June
      30, 2006, the Company had limited liquid resources. Current liabilities were
      $9,642,322 and current assets were $2,375,351. The difference of $7,266,971
      is a
      working capital deficit, which is primarily the result of losses incurred during
      the last four years. These factors, among others, indicate that the Company
      may
      be unable to continue as a going concern. The financial statements do not
      include any adjustments relating to the recoverability and classification of
      liabilities that might be necessary should the Company be unable to continue
      as
      a going concern.





Management
      recognizes that the Company’s continuation as a going concern is dependent upon
      its ability to generate sufficient cash flow to allow it to satisfy its
      obligations on a timely basis, to fund the operation 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 included closing branches that
      were not profitable, consolidating branches and reductions in staffing and
      other
      selling, general and administrative expense, and most significantly, the asset
      sales transactions that were completed in December 2005 (see Note
      5).





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.





**NOTE
                3 -**
            **ACCOUNTING
                FOR STOCK-BASED
                COMPENSATION**





Effective
      October 1, 2005, the Company adopted Statement of Financial Accounting Standard
      (“SFAS”) No. 123(R) (revised 2004), *Share-Based
      Payment* ,
      using
      the modified prospective application transition method. All outstanding stock
      options at September 30, 2005, were fully-vested. Accordingly, the adoption
      of
      SFAS No. 123(R) did not have a significant impact on our financial position,
      results of operations or cash flows.





**7**


The
      following table illustrates, for the three and six months ended March 31, 2005,
      the effect on net (loss) and net (loss) per share had compensation expense
      for
      the employee stock-based plans been recorded based on the fair value method
      using the Black-Scholes option pricing model under SFAS No. 123, as
      amended:





**Three
                Months**
            
            
            **Nine
                Months****Ended**
            
            
            **Ended****June
                30, 2005**
            
            
            **June
                30, 2005**Net
                earnings, as reported
            
            $
            2,080,797
            
            $
            5,373,862Deduct:
                total stock-based compensation expense determined
              under
                fair value method
            
            
            (242,400
            )
            
            (617,288
            )Net
                earnings, as adjusted
            
            $
            1,838,397
            
            $
            4,756,574Basic
                net earnings per share:As
                reported
            
            $
            .12
            
            $
            .32As
                adjusted
            
            $
            .11
            
            $
            .28Diluted
                net earnings per share:As
                reported
            
            $
            .10
            
            $
            .28As
                adjusted
            
            $
            .09
            
            $
            .24





During
      the nine months ended June 30, 2006, the Company issued an aggregate of
      12,200,000 shares of its common stock to five employees, a director, three
      former directors and a consultant. In connection therewith, the value of the
      shares was based on the market price at date of issuance and accordingly,
      $100,400 was charged to operations.





**NOTE
                4 -**
            **NEW
                ACCOUNTING PRONOUNCEMENTS**





In
      February 2006, the Financial Accounting Standards Board (the “FASB”) issued
      Statement of Financial Accounting Standards No. 155, “Accounting for Certain
      Hybrid Instruments,” (SFAS 155), which amends SFAS 133, “Accounting for
      Derivative Instruments and Hedging Activities,” and SFAS 140, “Accounting for
      Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”.
      SFAS 155 allows financial instruments that have embedded derivatives to be
      accounted for as a whole (eliminating the need to bifurcate the derivative
      from
      its host) if the holder elects to account for the whole instrument on a fair
      value basis. SFAS 155 also clarifies and amends certain other provisions of
      SFAS
      133 and SFAS 140. This statement is effective for all financial instruments
      acquired or issued in fiscal years beginning after September 15, 2006. The
      Company does not expect its adoption of this new standard to have a material
      impact on the Company’s financial position, results of operations or cash
      flows.





In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets - an amendment of FASB Statement No. 140” (SFAS 156”). This statement was
      issued to simplify the accounting for servicing assets and liabilities, such
      as
      those common with mortgage securitization activities. This statement addresses
      the recognition and measurement of separately recognized servicing assets and
      liabilities and provides an approach to simplify hedge-like (offset) accounting.
      SFAS 156 clarifies when an obligation to service financial assets should be
      separately recognized (as a servicing asset or liability), requires initial
      measurement at fair value and permits an entity to select either the
      Amortization Method of the Fair Value Method. This statement is effective for
      fiscal years beginning after September 15, 2006. The Company does not expect
      its
      adoption of this new standard to have a material impact on the Company’s
      financial position, results of operations or cash flows.





On
      July
      13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
      Income Taxes” (“FIN 48”), which is effective for fiscal years beginning after
      December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income
      taxes recognized in the financial statements in accordance with FASB Statement
      No. 109, “Accounting for Income Taxes”. This interpretation prescribes a
      comprehensive model for how a company should recognize, measure, present, and
      disclose in its financial statements uncertain tax positions that the company
      has taken or expects to take on a tax return. The Company does not expect that
      the implementation of FIN 48 will have a material impact on its financial
      position, results of operations or cash flows.





**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 19,084,558 and
      3,811,922 dilutive shares for the three months ended June 30, 2006 and 2005,
      respectively. There were 6,715,753 and 1,381,367 dilutive shares for the nine
      months ended June 30, 2006 and 2005,


**8**


respectively.
      Outstanding common stock options and warrants not included in the computation
      of
      earnings per share for the three and nine months ended June 30, 2006 and 2005,
      totaled 20,326,787 and 18,611,403, respectively. These options and warrants
      were
      excluded because their inclusion would have an anti-dilutive effect on earnings
      per share.





**NOTE
                6 -**
            **DISCONTINUED
                OPERATIONS**





(a)
            In
                December 2005, the Company completed the following series of transactions
                pursuant to which it sold substantially all of the assets used to
                conduct
                its staffing services business, other then the IT staffing solutions
                business that is conducted through the Company’s 50% owned joint venture,
                STS.





(i)
            On
                December 2, 2005, the Company completed the sale, effective as of
                November
                21, 2005, of substantially all of the tangible and intangible assets,
                excluding accounts receivable, of several of its offices located
                in the
                Western half of the United States (the “ALS Purchased Assets”) to ALS, LLC
                (“ALS”), a related party (see Note 11). The offices sold were the
                following: Chino, California; Colton, California; Los Nietos, California;
                Ontario, California; Santa Fe Springs, California and the Phoenix,
                Arizona
                branches and the Dallas Morning News Account (the “Western Offices”).
                Pursuant to the terms of an Asset Purchase Agreement between the
                Company
                and ALS dated December 2, 2005 (the “ALS Asset Purchase Agreement”), the
                purchase price for the ALS Purchased Assets was payable as
                follows:





•
            $250,000
                was payable over the 60 days following December 2, 2005, at a rate
                no
                faster than $125,000 per 30 days;




•
            $1,000,000
                payable by ALS is being paid directly to certain taxing authorities
                to
                reduce the Company’s tax obligations;
                and




•
            $3,537,000
                which was paid by means of the cancellation of all net indebtedness
                owed
                by the Company to ALS outstanding as of the close of business on
                December
                2, 2005.




In
      addition to the foregoing amounts, ALS also assumed the Company’s obligation to
      pay $798,626 due under a certain promissory note issued by the Company in
      connection with an acquisition to Provisional Employment Solutions, Inc. As
      a
      result of the sale of the ALS Purchased Assets to ALS, all sums due and owing
      to
      ALS by the Company were deemed paid in full and no further obligations
      remain.





(ii) On
      December 5, 2005, the Company completed the sale, effective as of November
      28,
      2005 (the “AI Effective Date”), of substantially all of the tangible and
      intangible assets, excluding accounts receivable and other certain items, as
      described below, of three of its California offices (the “AI Purchased Assets”)
      to Accountabilities, Inc. (AI”). The offices sold were the following: Culver
      City, California; Lawndale, California and Orange, California (the “Other
      California Offices”). Pursuant to the terms of an Asset Purchase Agreement
      between the Company and AI dated December 5, 2005 (the “AI Asset Purchase
      Agreement”), AI has agreed to pay to the Company an earnout amount equal to two
      percent of the sales of the Other California Offices for the first twelve month
      period after the AI Effective Date; one percent of the sales of the Other
      California Offices for the second twelve month period after the AI Effective
      Date; and one percent of the sales of the Other California Offices for the
      third
      twelve month period from the AI Effective Date. In addition, a Demand
      Subordinated Promissory Note between the Company and AI dated September 15,
      2005, which had an outstanding principal balance of $125,000 at the time of
      closing was deemed paid and marked canceled.





Certain
      assets held by the other California Offices were excluded from the sale,
      including cash and cash equivalents, accounts receivable and the Company’s
      rights to receive payments from any source.





(iii) On
      December 7, 2005, the Company completed the sale, effective as of November
      28,
      2005 (the “SOP Effective Date”), of substantially all of the tangible and
      intangible assets, excluding accounts receivable and other assets as described
      below, of several of its Northeastern offices (the “SOP Purchased Assets”) to
      Source One Personnel, Inc. (“SOP”). The offices sold were the following: Cherry
      Hill, New Jersey; New Brunswick, New Jersey; Mount Royal/Paulsboro, New Jersey
      (soon to be Woodbury Heights, New Jersey); Pennsauken, New Jersey; Norristown,
      Pennsylvania; Fairless Hills, Pennsylvania; New Castle, Delaware and the former
      Freehold, New Jersey profit center (the “NJ/PA/DE Offices”). The assets of Deer
      Park, New York, Leominster, Massachusetts, Lowell, Massachusetts and Athol,
      Massachusetts (the “Earn Out Offices”) were also purchased (collectively the
“NJ/PA/DE Offices” and the “Earn Out Offices” shall be referred to as the
“Purchased Offices”). In addition to the foregoing, the SOP Purchased Assets
      also included substantially all of the tangible and intangible assets, excluding
      accounts receivable and other assets as described below, used by the Company
      in
      the operation of its business at certain facilities of certain customers
      including the following: the Setco facility in Cranbury, New Jersey, the


**9**


Record
      facility in Hackensack, New Jersey, the UPS-MI (formerly RMX) facility in Long
      Island, New York, the UPS-MI (formerly RMX) facility in the State of
      Connecticut, the UPS-MI (formerly RMX) facility in the State of Ohio, the APX
      facility in Clifton, New Jersey (the “Earn Out On-Site Business”) and the
      Burlington Coat Factory in Burlington, New Jersey, the Burlington Coat Factory
      facility in Edgewater Park, New Jersey and the UPS-MI (formerly RMX) facility
      in
      Paulsboro, New Jersey (the foregoing business and the “Earn Out On-Site
      Businesses” shall be referred to herein collectively as the “On-Site
      Businesses”). Pursuant to the SOP Asset Purchase Agreement between the Company
      and SOP dated December 7, 2005 (the “SOP Asset Purchase Agreement:), the
      purchase price for the SOP Purchased Assets was payable as follows (the “SOP
      Purchase Price”):





•
            An
                aggregate of $974,031 of indebtedness owed by the Company to SOP
                (i) under
                certain promissory notes previously issued by the Company to SOP
                and (ii)
                in connection with a put right previously exercised by SOP with respect
                to
                400,000 shares of our common stock was
                cancelled.




•
            SOP
                is required to make the following earn out payments to the Company
                during
                the three year period commencing on the SOP Effective Date (the “Earn Out
                Period”):




•
            Two
                percent of sales (excluding taxes on sales) from the Earn Out Offices
                and
                the Earn Out On-Site Businesses for the initial twelve months of
                the Earn
                Out Period.




•
            One
                percent of sales (excluding taxes on sales) from the Earn Out Offices
                and
                the Earn Out On-Site Businesses for the second twelve months of the
                Earn
                Out Period.




•
            One
                percent of sales (excluding taxes on sales) from the Earn Out Offices
                and
                the Earn Out On-Site Businesses for the third twelve months of the
                Earn
                Out Period.




Certain
      assets held by the Purchased Businesses were excluded from the sale, including
      cash and cash equivalents, accounts receivable, and the Company’s rights to
      receive payments from any source.





(iv)
            On
                December 7, 2005 (the “Closing Date”), the Company completed the sale of
                substantially all of the tangible and intangible assets, excluding
                cash
                and cash equivalents, of two of its California branch offices (the
“TES
                Purchased Assets”) to Tri-State Employment Service, Inc. (“TES”). The
                offices sold were the following: Bellflower, California and West
                Covina,
                California (the “California Branch Offices”). Pursuant to the terms of an
                Asset Purchase Agreement between the Company and TES dated December
                7,
                2005 (the “TES Asset Purchase Agreement”), TES has agreed to pay to the
                Company an earnout amount as
                follows:





•
            two
                percent of sales of the California Branch Offices to existing clients
                for
                the first twelve month period after the Closing
                Date;




•
            one
                percent of sales of the California Branch Offices to existing clients
                for
                the second twelve month period after the Closing Date;
                and




•
            one
                percent of sales of the California Branch Offices to existing clients
                for
                the third twelve month period after the Closing
                Date.




For
      purposes of calculating the amount owed by TES to the Company, in no event
      shall
      the aggregate annual sales to such clients exceed $25,000,000.





(b)
            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 (see Note
                11).





**10**


The
      consolidated financial statements for all periods presented have been restated
      to reflect discontinued operations of the aforementioned asset sales. The
      operating results of discontinued operations are summarized as
      follows:





**Three
                Months Ended**
            **Nine
                Months Ended****June
                30,**
            **June
                30,****2006**
            
            
            **2005**
            
            
            **2006**
            
            
            **2005**Revenues
            
            $
            -
            
            $
            29,263,653
            
            $
            18,265,587
            
            $
            89,942,702Cost
                of revenues
            
            
            -
            
            
            25,352,961
            
            
            16,215,630
            
            
            77,759,463Gross
                profit
            
            
            -
            
            
            3,910,692
            
            
            2,046,957
            
            
            12,183,239Selling,
                general and administrative expenses
            
            
            -
            
            
            3,199,959
            
            
            1,950,622
            
            
            9,605,552Other
                charges
            
            
            -
            
            
            243,084
            
            
            -
            
            
            416,345Operating
                income
            
            
            -
            
            
            467,640
            
            
            96,335
            
            
            2,161,342Interest
                expense
            
            
            -
            
            
            (242,528
            )
            
            (205,056
            )
            
            (688,775
            )Other
                income (expense)
            
            
            -
            
            
            66
            
            
            (198,323
            )
            
            (3,488
            )Net
                income (loss)
            
            $
            -
            
            $
            225,187
            
            $
            (307,044
            )
            $
            1,469,079





Assets
      of
      the discontinued operations have been reflected in the condensed consolidated
      balance sheet as current assets held for sale. The liabilities that were assumed
      or cancelled by the purchasers are reflected as current liabilities held for
      sale. The following is a summary of assets and liabilities of discontinued
      operations at September 30, 2005:





**September
                30,****2005**Pre-paid
                expenses and other current assets
            
            $
            61,781Property
                and equipment, net
            
            
            291,552Goodwill
            
            
            2,553,081Intangible
                assets, net
            
            
            689,182Other
                assets
            
            
            60,943Total
                assets of discontinued operations
            
            $
            3,656,539Loans
                payable
            
            
            125,000Notes
                payable - acquisitions
            
            
            936,820Accounts
                payable and accrued expenses
            
            
            185,037Accounts
                payable - related parties
            
            
            3,597,422Put
                options liability
            
            
            650,000Total
                liabilities of discontinued operations
            
            $
            5,494,279





The
      gain
      (loss) on sale of discontinued operations for the three months and nine months
      ended June 30, 2006 is summarized as follows:





**Three
                Months**
            
            
            **Nine
                Months****Ended**
            
            
            **Ended****June
                30, 2006**
            
            
            **June
                30, 2006**Sold
                to:ALS
            
            $
            -
            
            $
            4,340,459AI
            
            
            99,704
            
            
            (104,897
            )SOP
            
            
            50,594
            
            
            (233,990
            )TES
            
            
            65,127
            
            
            (349,421
            )215,425
            
            
            3,652,151Other
                costs of sales
            
            
            -
            
            
            (60,000
            )Gain
                on sale of discontinued operations
            
            $
            215,425
            
            $
            3,592,151





The
      above
      gain includes earnout payments of $215,425 and $509,570 in the three and nine
      months ended June 30, 2006, respectively.


**11**





**NOTE
                7 -**
            **LINE
                OF CREDIT**





The
      Company had a loan and security agreement (the “Loan Agreement”) with Capital
      Temp Funds, Inc. (the “Lender”) which provided for a line of credit up to 85% of
      eligible accounts receivable, as defined, not to exceed $12,000,000. Until
      April
      10, 2003, advances under the Loan Agreement bore interest at a rate of prime
      plus 1-3/4%. The Loan Agreement restricted the Company’s ability to incur other
      indebtedness, pay dividends and repurchase stock. Effective April 10, 2003,
      the
      Company entered into a modification of the Loan Agreement which provided that
      borrowings under the Loan Agreement would bear interest at 3% above the prime
      rate. Borrowings under the Loan Agreement were collateralized by substantially
      all of the Company’s assets.





On
      January 15, 2005, the Company entered into a Forbearance Agreement (the
“Forbearance Agreement”) pursuant to which Lender 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, after March 1, 2005 was further reduced by $250,000
      per month.




On
      August
      11, 2005, the Company and the Lender entered into an Amended and Restated
      Forbearance Agreement (the “Amended Forbearance Agreement”) whereby the Lender
      had again agreed to forbear from accelerating obligations and/or enforcing
      existing defaults until the earlier to occur of (a) August 26, 2005 or (b)
      the
      date of any Forbearance Default, as defined (the “Forbearance
      Period”).




The
      Amended Forbearance Agreement provided that during the Forbearance Period,
      the
      maximum credit line would be $10,500,000.




Between
      August 25, 2005 and December 21, 2005, the Lender granted the Company a series
      of extensions of the Amended Forbearance Agreement. An extension granted in
      November 2005 was conditioned upon, among other things, the Company and ALS
      entering into a binding agreement providing for a sale to ALS of certain assets
      of the Company. The Company and ALS entered into such an agreement on November
      3, 2005. As a condition to obtaining an extension granted in December 2005,
      the
      Company was required to represent that it had closed the sale of assets to
      ALS
      and to acknowledge and agree that any loans and advances made by the Lender
      during the extension period would be the last requested advances under the
      Loan
      Agreement. The final extension of the Amended Forbearance Agreement expired
      on
      December 21, 2005. As of January 31, 2006, the Company repaid all of the
      indebtedness under the Loan Agreement.




The
      Lender charged the Company $350,000 of fees in connection with the Forbearance
      Agreement, the Amended Forbearance Agreement and the various extensions thereof
      during the three months ended December 31, 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 Company’s Outsourcing Agreement (see Note
      11). All of the Company’s obligations under the Company’s Outsourcing Agreement
      with ALS were satisfied in connection with the sale of assets to ALS which
      occurred in December 2005 (see Note 5).




On
      January 3, 2006, the Company’s consolidated 50% owned joint venture, STS (see
      Notes 1 and 11), entered into a factoring and security agreement (the “Factoring
      Agreement”) with Action Capital Corporation (“Action”). The Factoring Agreement
      provides for the sale of up to $1,500,000 of acceptable accounts receivable
      of
      STS to Action. Action reserves and withholds an amount in a reserve account
      equal to 10% of the face amount of accounts receivable purchased under the
      Factoring Agreement. Action has full recourse against STS including, without
      limitation, the right to charge-back or sell back any accounts receivable,
      if
      not paid within 90 days of the date of purchase. The Factoring Agreement
      provides for STS to pay interest of prime plus 1% plus a monthly fee of .6%
      on
      the daily average of unpaid advances.




The
      prime
      rate at June 30, 2006 was 8.25%.




**NOTE
                8 -**
            **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, 2006, there was still an aggregate of $3.9 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.


**12**


On
      January 7, 2005, the Company entered into a payment plan agreement 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 $621,546 (as of June 30, 2006) 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 for purposes of the
      Plan.





**NOTE
                9 -**
            **INCOME
                TAXES**





No
      income
      tax expense was recorded in the three and nine months ended June 30, 2006,
      because the Company recognized a deferred tax benefit resulting from the
      utilization of the Company’s net operating loss carryforwards.





**NOTE
                10 -**
            **PREFERRED
                STOCK**





**a.**  **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 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.





**b.**  **Series
      I**





The
      Company was 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, the one year anniversary date of the issuance
      of
      the Series I Preferred Stock to the extent permitted by applicable law;
      provided, however, that the Company had the right to extend the required
      redemption date for an additional one year, in which case the Company was
      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. In addition, because the Company extended the
      redemption date, it was 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 was 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 did not redeem the Series I Preferred Stock by
      the
      extended redemption date, the dividend rate of the Series I Preferred Stock
      would have increased to 24% per year and the Series I Preferred Stock would
      have
      been convertible, at the option of the


**13**


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. Holders of Series I Preferred
      Stock
      had no voting rights, except as provided by law and with respect to certain
      limited matters.





Pinnacle
      Investment Partners, LP (“Pinnacle”), the holder of the shares of the Company’s
      Series I Preferred Stock (see Note 11) notified the Company that the Company
      was
      in default of its obligations to pay $30,000 of the $174,200 cash portion of
      the
      advisory fee which was required to be paid in connection with the Company’s
      election to extend the date by which it was required to redeem the Series I
      Preferred Stock to August 5, 2006. The Company was also in default for
      non-payment of $40,091 of dividends on the Series I Preferred Stock that were
      due on September 30, 2005.





The
      Company permitted Pinnacle to convert 41 shares of Series I Preferred Stock
      into
      840,000 shares of common stock in October 2005 as a result of the payment
      defaults.





In
      December 2005, the Company permitted Pinnacle to convert an aggregate of 203
      shares of Series I Preferred Stock into 3,000,000 shares of Common Stock and
      agreed to pay to Pinnacle a default fee of $100,000.





On
      January 13, 2006, the Company entered into an agreement with Pinnacle, pursuant
      to which the Company issued to Pinnacle, effective December 28, 2005, a secured
      convertible promissory note (the “Convertible Note”) (see Note 10) in the
      aggregate principal amount of $2,356,850 in exchange for 21,531 shares of the
      Company’s Series I Preferred Stock held by Pinnacle. As a result of the
      exchange, there are no longer any shares of Series I Preferred Stock
      outstanding, and the Company no longer has any obligation to pay to Pinnacle
      any
      amounts owed to it under the terms of the Series I Preferred Stock, including
      $103,716 of unpaid dividends which had accrued through December 28,
      2005.





**NOTE
                11 -**
            **NOTE
                PAYABLE - RELATED PARTY**





The
      Convertible Note, payable to Pinnacle (see Notes 9 and 11), which is secured
      by
      substantially all of the Company’s assets, becomes due as follows:





•  $1,800,000
      was due and payable in cash upon the earlier of the Company’s receipt of
      $1,800,000 of accounts receivable or March 15, 2006. At June 30, 2006, $235,000
      of this has not been paid.




•  $331,850
      and accrued interest at a rate of 12% per annum is payable in 24 equal
      installments of principal and interest during the period commencing June 28,
      2007 and ending on May 28, 2009.




•  $225,000
      and accrued interest thereon at the rate of 6% per annum becomes due and payable
      on December 28, 2007; provided, however, that the Company has the right to
      pay
      such amount in cash or shares of its common stock (valued at $0.0072 per
      share).




Pinnacle
      has the right to convert the principal amount of and interest accrued under
      the
      Convertible Note at any time as follows:




•  $331,850
      of the principal amount and unpaid interest accrued thereon is convertible
      into
      the Company’s common stock at a conversion price of $.06 per share.




•  $225,000
      of the principal amount and unpaid accrued interest thereon is convertible
      into
      the Company’s common stock at a conversion price of $0.0072. During the nine
      months ended June 30, 2006, $150,000 of principal was converted into 20,833,331
      shares of the Company’s common stock.





Pinnacle
      may not convert the Convertible Note to the extent that the conversion would
      result in Pinnacle owning in excess of 9.999% of the then issued and outstanding
      shares of common stock of the Company. Pinnacle may waive this conversion
      restriction upon not less than 60 days prior notice to the Company.





**NOTE
                12 -**
            **RELATED
                PARTY TRANSACTIONS**





***Consulting
      Fees***


An
      entity
      which employs the son of the Chief Executive Officer of the Company (the “CEO”)
      provided consulting services to the Company. Consulting expense was $44,000
      and
      $139,151 for the nine months ended June 30, 2006 and 2005, respectively.
      Included in the $44,000 is a charge of $16,000 in connection with the issuance
      of 2,000,000 shares of the Company’s common stock to the entity. The Company has
      paid consulting fees to an entity whose stockholder is another son of the CEO
      of
      the Company. Consulting fees amounted to $-0- and $76,000 for the nine months
      ended June 30, 2006 and 2005, respectively.


**14**


***Joint
      Venture***


The
      Company provides information technology staffing services through a joint
      venture, STS (see Note 1), 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.





***Payroll
      Outsourcing***


The
      Company was a party to an Outsourcing Agreement with ALS pursuant to which
      ALS
      and its affiliate, Advantage Services Group, LLC (“Advantage”), were to provide
      payroll outsourcing services for all of the Company’s in-house staff, except for
      its corporate employees, and customer staffing requirements. As a result of
      this
      arrangement, all of the Company’s field personnel were employees of ALS. The
      Company paid 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, 2005, 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 $17,326,000 and $76,265,000 in the nine months ended
      June 30, 2006 and 2005, respectively. Accounts payable - related parties in
      the
      attached condensed consolidated balance sheets at September 30, 2005, represents
      amounts due to ALS and Advantage.





The
      Company terminated the Outsourcing Agreement effective February 3,
      2006.





***Loan
      Payable***


During
      the nine months ended June 30, 2006, the Company repaid the $15,000 balance
      of a
      loan made to the Company by the CEO.





***Other***


An
      entity
      through which the son of the CEO is employed is a consultant to AI (see Note
      6).





The
      nephew of the CEO of the Company is affiliated with Pinnacle Investment
      Partners, LP, the holder of the shares of the Company’s Series I Preferred Stock
      (see Notes 9 and 10). The Company believes that PIP Management Inc., which
      was
      designated as the advisor to the Series I holders (see Notes 9 and 10), is
      also
      affiliated with Pinnacle Investment Partners, LP.





**NOTE
                13 -**
            **DERIVATIVE
                INSTRUMENTS AND
                RESTATEMENT**





In
      accordance with SFAS No. 133 and EITF 00-19, in August 2006, the Company
      determined that certain warrants to purchase the Company’s common stock should
      be separately accounted for as liabilities. The Company had not classified
      those
      derivative liabilities as such in its previously issued financial statements.
      In
      order to reflect these changes, the Company restated its financial statements
      for the years ended September 30, 2005 and 2004, and the quarterly periods
      therein, to record the fair value of these warrants on the Company’s balance
      sheet as a liability and record changes in the values of these derivatives
      in
      the Company’s consolidated statements of operations as “Gain on Change in Fair
      Value of Warrants”. This resulted in total liabilities being understated by
      $113,859 at June 30, 2005.





The
      aggregate balance sheet amount shown for the warrant liability decreased from
      $5,265,989 at September 30, 2004 to $113,859 at June 30, 2005 and to $-0- at
      June 30, 2006. As a result, we recognized a gain of $-0- and $982,401 in the
      three months ended June 30, 2006 and 2005, respectively, and $2,135 and
      $5,152,130 in the nine months ended June 30, 2006 and 2005, respectively.


**15**





**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 achieve and manage growth;
      our ability to attract and retain qualified personnel; our ability to develop
      new services; the continued cooperation of our creditors; 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, 2005.





**Introduction**





Through
      December 2005, we provided a wide range of staffing services and productivity
      consulting services associated with such staffing services nationally through
      a
      network of offices located throughout the United States. Regardless of the
      type
      of temporary service offering we provided, we recognized revenues based on
      hours
      worked by assigned personnel. Generally, we billed our customers a
      pre-negotiated, fixed rate per hour for the hours worked by our temporary
      employees. Therefore, we did not separate our various service offerings into
      separate offering segments. We did not routinely provide discrete financial
      information about any particular service offering. We also did not conduct
      any
      regular reviews of, nor make decisions about, allocating any particular
      resources to a particular service offering to assess its performance. As set
      forth below, certain of our service offerings targeted specific markets, but
      we
      did not necessarily conduct separate marketing campaigns for such services.
      Pursuant to the Outsourcing Agreement that was in place with ALS, ALS was
      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 placed, and we were billed for
      such expenses plus a fee by ALS. These expenses are included in the cost of
      revenue. Because we paid our temporary employees only for the hours they
      actually worked, wages for our temporary personnel were a variable cost that
      increased or decreased in proportion to revenues. Gross profit margin varied
      depending on the type of services offered. In some instances, temporary
      employees placed by us may have decided 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 were 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.





In
      December 2005, we completed a series of asset sale transactions pursuant to
      which we sold our staffing operations. As a result of such sales, we no longer
      actively conduct any staffing services business, other than IT staffing
      solutions services conducted through our 50% owned joint venture, STS. As a
      result of these asset sale transactions, we expect that our revenues in fiscal
      2006 will be substantially less than revenues achieved in fiscal 2005. During
      fiscal 2006, we plan to expand the IT staffing solutions business we conduct
      through STS; however, we can give no assurance that such efforts will be
      successful.


**16**


**Results
      of Operations**


**Discontinued
      Operations/Acquisition on Disposition of Assets**





In
      December 2005, we completed the following series of transactions pursuant to
      which we sold substantially all of our assets used to conduct our staffing
      services business, other than the IT staffing solutions business that is
      conducted through our 50% owned joint venture, Stratus Technology Services,
      LLC:





(a)
            On
                December 2, 2005, we completed the sale, effective as of November
                21,
                2005, of substantially all of the tangible and intangible assets,
                excluding accounts receivable, of several of our offices located
                in the
                Western half of the United States (the “ALS Purchased Assets”) to ALS, LLC
                (“ALS”). The offices sold were the following: Chino, California; Colton,
                California; Los Angeles, California; Los Nietos, California; Ontario,
                California; Santa Fe Springs, California and the Phoenix, Arizona
                branches
                and the Dallas Morning News Account (the “Western Offices”). Pursuant to
                the terms of an Asset Purchase Agreement between us and ALS dated
                December
                2, 2005 (the “ALS Asset Purchase Agreement”), the purchase price for the
                ALS Purchased Assets was payable as
                follows:





•
            $250,000
                was payable over the 60 days following December 2, 2005, for our
                documented cash flow requirements, all of which is payable at a rte
                no
                faster than $125,000 per 30 days;





•
            $1,000,000
                payable by ALS is being paid directly to certain taxing authorities
                to
                reduce our tax obligations; and





•
            $3,537,000
                which was paid by means of the cancellation of all net indebtedness
                owed
                by us to ALS outstanding as of the close of business on December
                2,
                2005.





In
                addition to the foregoing amounts, ALS also assumed our obligation
                to pay
                $798,626 due under a certain promissory note issued by us to Provisional
                Employment Solutions, Inc. As a result of the sale of the ALS Purchased
                Assets to ALS, all sums due and owing to ALS by Stratus were deemed
                paid
                in full and no further obligations
                remain.





In
      connection with the transaction, we entered into Non-Compete and
      Non-Solicitation Agreements with ALS pursuant to which we agreed not to compete
      with ALS with the customers of and in the geographic area of the Western
      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.




(b)
            On
                December 5, 2005, we completed the sale, effective as of November
                28, 2005
                (the “AI Effective Date”), of substantially all of the tangible and
                intangible assets, excluding accounts receivable and other certain
                items,
                as described below, of three of our California offices (the “AI Purchased
                Assets”) to Accountabilities, Inc. (“AI”) The offices sold were the
                following: Culver City, California; Lawndale, California and Orange,
                California (the “Other California Offices”). Pursuant to the terms of an
                Asset Purchase Agreement between the Company and AI dated December
                5, 2005
                (the “AI Asset Purchase Agreement”), AI has agreed to pay to us an earnout
                amount equal to two percent of the sales of the Other California
                Offices
                for the first twelve month period after the AI Effective Date; one
                percent
                of the sales of the Other California Offices for the second twelve
                month
                period after the AI Effective Date; and one percent of the sales
                of the
                Other California Offices for the third twelve month period from the
                AI
                Effective Date. In addition, a Demand Subordinated Promissory Note
                between
                us and AI dated September 15, 2005 which had an outstanding principal
                balance of $125,000 at the time of closing was deemed paid and marked
                canceled.




Certain
      assets held by the Other California Offices were excluded from the sale,
      including cash and cash equivalents, accounts receivable, and our rights to
      receive payments from any source.




In
      connection with the AI transaction, we entered into Non-Compete and
      Non-Solicitation Agreements with AI pursuant to which we agreed not to compete
      with AI with the customers of and in the geographic area of the Other California
      Offices, and AI agreed not to compete with us with respect to certain customers
      and accounts, including, accounts serviced by our remaining offices, for a
      period of three years.




(c)
            On
                December 7, 2005, we completed the sale, effective as of November
                28, 2005
                (the “SOP Effective Date”), of substantially all of the tangible and
                intangible assets, excluding accounts receivable and other assets
                as
                described below, of several of our Northeastern offices (the “SOP
                Purchased Assets”) to Source One Personnel, Inc. (“SOP”). The offices sold
                were the following: Cherry Hill, New Jersey; New Brunswick, New Jersey;
                Mount Royal/Paulsboro, New Jersey (soon to be Woodbury Heights, New
                Jersey); Pennsauken, New Jersey; Norristown, Pennsylvania; Fairless
                Hills,
                Pennsylvania; New Castle Delaware and the former Freehold, New Jersey
                profit




**17**


center
      (the “NJ/PA/DE Offices”). The assets of Deer Park, New York, Leominster,
      Massachusetts, Lowell, Massachusetts and Athol, Massachusetts (the “Earn Out
      Offices”) were also purchased (collectively the “NJ/PA/DE Offices” and the “Earn
      Out Offices” shall be referred to as the “Purchased Offices”). In addition to
      the foregoing, the SOP Purchased Assets also included substantially all of
      the
      tangible and intangible assets, excluding accounts receivable and other assets
      as described below, used by us in the operation of our business at certain
      facilities of certain customers including the following: the Setco facility
      in
      Cranbury New Jersey, the Record facility in Hackensack, New Jersey, the UPS-MI
      (formerly RMX) facility in Long Island, New York, the UPS-MI (formerly RMX)
      facility in the State of Connecticut, the UPS-MI (formerly RMX) facility in
      the
      State of Ohio, the APX facility in Clifton, New Jersey (the “Earn Out On-Site
      Business”) and the Burlington Coat Factory in Burlington, New Jersey, the
      Burlington Coat Factory facility in Edgewater Park, New Jersey and the UPS-MI
      (formerly RMX) facility in Paulsboro, New Jersey (the foregoing business and
      the
“Earn-Out On-Site Businesses” shall be referred to herein collectively as the
“On-Site Businesses”). Pursuant to the SOP Asset Purchase Agreement between us
      and SOP dated December 7, 2005 (the “SOP Asset Purchase Agreement”), the
      purchase price for the SOP Purchased Assets was payable as follows (the “SOP
      Purchase Price”):




·
            An
                aggregate of $974,031 of indebtedness owed by us to SOP (i) under
                certain
                promissory notes previously issued by us to SOP and (ii) in connection
                with a put right previously exercised by SOP with respect to 400,000
                shares of our common stock was
                cancelled.




·
            SOP
                is required to make the following earn out payments to us during
                the three
                year period commencing on the SOP Effective Date (the “Earn Out
                Period”):




·
            Two
                percent of sales (excluding taxes on sales) from the Earn Out Offices
                and
                the Earn Out On-Site Businesses for the initial twelve months of
                the Earn
                Out Period.




·
            One
                percent of sales (excluding taxes on sales) from the Earn Out Offices
                and
                the Earn Out On-Site Businesses for the second twelve months of the
                Earn
                Out Period.




·
            One
                percent of sales (excluding taxes on sales) from the Earn Out Offices
                and
                the Earn Out On-Site Businesses for the third twelve months of the
                Earn
                Out Period.




Certain
      assets held by the Purchased Offices were excluded from the sale, including
      cash
      and cash equivalents, accounts receivable, our rights to receive payments from
      any source.




In
      connection with the SOP transaction, we entered into Non-Compete and
      Non-Solicitation Agreements with SOP pursuant to which we agreed not to compete
      with SOP with respect to the business acquired from us by SOP for a period
      of
      two years.




(d)
            On
                December 7, 2005 (the “Closing Date”), we completed the sale of
                substantially all of the tangible and intangible assets, excluding
                cash
                and cash equivalents, of two of our California branch offices (the
“TES
                Purchased Assets”) to Tri-State Employment Service, Inc. (“TES”). The
                offices sold were the following: Bellflower, California and West
                Covina,
                California (the “California Branch Offices”). Pursuant to the terms of an
                Asset Purchase Agreement between the Registrant and TES dated December
                7,
                2005 (the “TES Asset Purchase Agreement”), TES has agreed to pay to us as
                follows:




·
            two
                percent of sales of the California Branch Offices to existing clients
                for
                the first twelve month period after the Closing
                Date;




·
            one
                percent of sales of the California Branch Offices to existing clients
                for
                the second twelve month period after the Closing Date; and




·
            one
                percent of sales of the California Branch Offices to existing clients
                for
                the third twelve month period after the Closing Date.




For
      purposes of calculating the amount owed by TES to us, in no event shall the
      aggregate annual sales to such clients exceed $25,000,000.




On
      the
      Closing Date, TES made a payment of $1,972,521 to our lender and acquired the
      lender’s rights to certain of our accounts receivable that collateralize our
      obligation to the lender. As a result of this transaction, our obligations
      to
      the lender were reduced by $1,972,521.




**18**


In
      connection with the TES transaction, we entered into Non-Compete and
      Non-Solicitation Agreements pursuant to which we agreed not to compete with
      TES
      with the customers of and in the geographic area of the California Branch
      Offices, and TES agreed not to compete with Stratus with respect to certain
      customers and accounts, including, accounts serviced by Stratus’ remaining
      offices, for a period of three years.




The
      foregoing transactions resulted in a $3,592,151 net gain on sale of discontinued
      operations which is summarized as follows:




Sold
                to:ALS
            
            $
            4,340,459AI
            
            
            (104,897
            )SOP
            
            
            (233,990
            )TES
            
            
            (349,421
            )3,652,151Other
                costs of sales
            
            
            (60,000
            )Gain
                on sale of discontinued operations
            
            $
            3,592,151





The
      above
      gain includes earnout payments of $509,570.




**Continuing
      Operations**


**Three
      Months Ended June 30, 2006 Compared to Three Months Ended June 30,
      2005**





***Revenues.*** Revenues
      increased 8.6% to $1,282,074 for the three months ended June 30, 2006 from
      $1,180,222 for the three months ended June 30, 2005. This increase was primarily
      a result of an increase in billable hours.





***Gross
      Profit.*** Gross
      profit increased 9.1% to $371,498 for the three months ended June 30, 2006
      from
      $340,665 for the three months ended June 30, 2005, primarily as a result of
      increased revenues. Gross profit as a percentage of revenues increased slightly
      to 29.0% for the three months ended June 30, 2006 from 28.9% for the three
      months ended June 30, 2005.





***Selling,
      General and Administrative Expenses.*** ** Selling,
      general and administrative expenses (“SG&A”) decreased 61.9% to $527,365 for
      the three months ended June 30, 2006 from $1,384,590 for the three months ended
      June 30, 2005. Selling, general and administrative expenses as a percentage
      of
      revenues decreased to 41.1% for the three months ended June 30, 2006 from 117.3%
      for the three months ended June 30, 2005.





As
      a
      result of the asset sales transactions completed in December 2005, the Company
      began reducing its corporate overhead structure to be more in line with the
      remaining revenues. These reductions were completed in February
      2006.





***Interest
      Expense.*** Interest
      expense decreased 74.8% to $47,179 for the three months ended June 30, 2006
      from ** $187,433
      for the three months ended June 30, 2005. Interest expense as a percentage
      of
      revenues decreased to 3.7% for the three months ended June 30, 2006 from 15.9%
      for the three months ended June 30, 2005. The decrease was a result of the
      decrease in outstanding debt.





***Gain
      on Change in Fair Value of Warrants*** **.** We
      recognized a non-cash gain as a result of the decrease in the fair value of
      certain warrants accounted for as a derivative liability of $882,409 in the
      three months ended June 30, 2005.




***Net
      Earnings Attributable to Common Stockholders.*** ** As
      a
      result of the foregoing, we had net earnings attributable to common stockholders
      of $8,987, for the three months ended June 30, 2006 compared to net earnings
      attributable to common stockholders of $2,080,797 for the three months ended
      June 30, 2005.





**Nine
      Months Ended June 30, 2006 Compared to Nine Months Ended June 30,
      2005**





***Revenues.*** Revenues
      increased 8.5% to $3,706,018 for the nine months ended June 30, 2006 from
      $3,414,949 for the nine months ended June 30, 2005. This increase was primarily
      a result of an increase in billable hours.





***Gross
      Profit.*** Gross
      profit increased 12.5% to $1,101,618 for the nine months ended June 30, 2006
      from $979,632 for the nine months ended June 30, 2005, primarily as a result
      of
      increased revenues. Gross profit as a percentage of revenues increased to 29.7%
      for the nine months ended June 30, 2006 from 28.7% for the nine months ended
      June 30, 2005. This increase was a result of increased permanent
      placements.


**19**


***Selling,
      General and Administrative Expenses.*** ** SG&A
      decreased 32.2% to $2,534,869 for the nine months ended June 30, 2006 from
      $3,736,838 for the nine months ended June 30, 2005. Selling, general and
      administrative expenses as a percentage of revenues decreased to 68.4% for
      the
      nine months ended June 30, 2006 from 109.4% for the nine months ended June
      30,
      2005. SG&A in the nine months ended June 30, 2006, includes $350,000 of fees
      charged to us by our former lender in connection with the Forbearance Agreement,
      the Amended Forbearance Agreement and the various extensions thereof (see Note
      7
      to the Condensed Consolidated Financial Statements).





As
      a
      result of the asset sales transactions completed in December 2005, the Company
      began reducing its corporate overhead structure to be more in line with the
      remaining revenues. These reductions were completed in February 2006.





***Interest
      Expense.*** Interest
      expense decreased 34.1% to $430,987 for the nine months ended June 30, 2006
      from ** $654,427
      for the nine months ended June 30, 2005. Interest expense in the nine months
      ended June 30, 2006, includes $100,000 of the principal amount of the
      Convertible Note issued in exchange for our Series I Preferred Stock that was
      attributable to the settlement of our obligation to pay certain advisory fees
      and dividend payments under the terms of the Series I Preferred Stock. (see
      Note
      10 to the Condensed Consolidated Financial Statements). Interest expense as
      a
      percentage of revenues decreased to 11.6% for the nine months ended June 30,
      2006 from 19.2% for the nine months ended June 30, 2005. The decrease was a
      result of the decrease in outstanding debt.




***Gain
      on Change in Fair Value of Warrants.*** We
      recognized a non-cash gain as a result of the decrease to the fair value of
      certain warrants accounted for as a derivative liability of $2,135 and
      $5,152,130 in the nine months ended June 30, 2006 and 2005,
      respectively.





***Net
      Earnings Attributable to Common Stockholders.*** ** As
      a
      result of the foregoing, we had net earnings attributable to common stockholders
      of $1,379,875 for the nine months ended June 30, 2006 compared to net earnings
      attributable to common stockholders of $5,373,862 for the nine months ended
      June
      30, 2005.





**Liquidity
      and Capital Resources**





Cash
      flows have not been segregated between continuing operations and discontinued
      operations in the accompanying condensed consolidated statements of cash flows.
      Cash provided to us from discontinued operations (included in the consolidated
      cash flow discussions below) during the nine months ended June 30, 2006 and
      2005
      was comprised of the following:





**Nine
                Months Ended June 30,****2006**
            
            
            **2005**Cash
                provided by operating activities
            
            $
            8,400,417
            
            $
            3,883,929Cash
                provided by (used in) investing activities
            
            
            1,011,541
            
            
            (252,297
            )Cash
                used in financing activities
            
            
            (7,930,389
            )
            
            (1,992,635
            )Net
            
            $
            1,481,569
            
            $
            1,638,997





Although
      there is no assurance we will continue to receive earnout payments in connection
      with discontinued operations, we estimate that we will receive approximately
      $80,000 per month, through November 2006 and $40,000 per month thereafter,
      through November 2008.





At
      June
      30, 2006, we had limited liquid resources. Current liabilities were $9,642,322
      and current assets were $2,375,351. The difference of $7,266,971 is a working
      capital deficit, which is primarily the result of losses incurred during the
      last four years. This condition raises 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 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 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 included closing branches that are not profitable, reductions
      in staffing, and other selling, general and administrative expenses, and most
      significantly, the asset sales transactions that were completed in December
      2005. 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. We believe that


**20**


the
      cash
      flow from operations and earnout payments to which we are entitled in connection
      with the Asset Sales will provide us with sufficient cash flow to support our
      operations in the next twelve months.





Net
      cash
      provided by operating activities was $7,139,011 and $1,987,697 in the nine
      months ended June 30, 2006 and 2005, respectively.





Net
      cash
      provided by (used in) investing activities was $998,414 and $(630,474) in the
      nine months ended June 30, 2006 and 2005, respectively. Net cash received in
      connection with the sale of discontinued operations was $1,024,587, including
      earnout payments of $371,351, in the nine months ended June 30, 2006. Cash
      used
      for capital expenditures was $32,782 and $182,706 in the nine months ended
      June
      30, 2006 and 2005, 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.





Net
      cash
      used in financing activities was $8,074,343 and $2,058,669 in the nine months
      ended June 30, 2006 and 2005, respectively. We had net repayments of $6,481,611
      and $1,099,393 under our line of credit in the nine months ended June 30, 2006
      and 2005, respectively. Net short-term loan repayments were $24,002 and $204,687
      in the nine months ended June 30, 2006 and 2005, 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 $63,999 and $696,445 in
      the
      nine months ended June 30, 2006 and 2005, respectively. We paid $1,490,000
      in
      the nine months ended June 30, 2006, against a note payable to Pinnacle
      Investment Partners, LP, a related party.





Our
      principal uses of cash through December 2005 were to fund temporary employee
      payroll expense and employer related payroll taxes, 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 were paid weekly, as were payments under our payroll outsourcing
      agreements with related parties (see Note 11 to the Condensed Consolidated
      Financial Statements).





Through
      December 2005, we had a loan and security agreement (the “Loan Agreement”) with
      Capital Temp Funds, Inc. (the “Lender”) which provided for a line of credit up
      to 85% of eligible accounts receivable, as defined, not to exceed $12,000,000.
      Until April 10, 2003, advances under the Loan Agreement bore interest at a
      rate
      of prime plus 1 1/2%. The Loan Agreement restricted our ability to incur other
      indebtedness, pay dividends and repurchase stock. Effective April 10, 2003,
      we
      entered into a modification of the Loan Agreement which provided that borrowings
      under the Loan Agreement would bear interest at 3% above the prime rate.
      Borrowings under the Loan Agreement were collateralized by substantially all
      of
      our assets. As of September 30, 2005, $8,931,689 was outstanding under the
      credit agreement.





During
      the year ended September 30, 2005, we were in violation of the following
      covenants under the Loan Agreement:





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





We
      had
      received a waiver from the lender on all of the above violations.





On
      January 15, 2005, we entered into a Forbearance Agreement (the “Forbearance
      Agreement”) pursuant to which the Lender 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, after March 1, 2005 was further reduced by $250,000 per
      month.




On
      August
      11, 2005, we entered into an Amended and Restated Forbearance Agreement (the
      “Amended Forbearance Agreement”) whereby the Lender had again agreed to forbear
      from accelerating obligations and/or enforcing existing defaults until the
      earlier to occur of (a) August 26, 2005 or (b) the date of any Forbearance
      Default, as defined (the “Forbearance Period”).




The
      Amended Forbearance Agreement provided that during the Forbearance Period,
      the
      maximum credit line would be $10,500,000.




Between
      August 25, 2005 and December 21, 2005, the Lender granted us a series of
      extensions of the Amended Forbearance Agreement. An extension granted in
      November 2005 was conditioned upon, among other things, our entry




**21**


into
      a
      binding agreement providing for a sale to ALS of the assets of our offices
      in
      Southern California, the Phoenix region and its Dallas Morning News account.
      We
      entered into such an agreement with ALS on November 3, 2005. As a condition
      to
      obtaining an extension granted in December 2005, we were required to represent
      that we had closed the sale of assets to ALS and to acknowledge and agree that
      any loans and advances made by the Lender during the extension period would
      be
      the last requested advances under the Loan Agreement. The final extension of
      the
      Amended Forbearance Agreement expired on December 21, 2005. At such time,
      $2,431,808 of indebtedness remained outstanding under the Loan Agreement. As
      of
      January 31, 2006, we had repaid all of the indebtedness.




The
      Lender charged us $412,500 of fees in connection with the Forbearance Agreement,
      the Amended Forbearance Agreement and the various extensions thereof during
      the
      fiscal year ended September 30, 2005 and $350,000 during the three months ended
      December 31, 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 our Outsourcing Agreement with ALS subject to certain conditions. All
      of
      our obligations under our Outsourcing Agreement with ALS were satisfied in
      connection with the sale of assets to ALS which occurred in December
      2005.




In
      January 2006, STS entered into a Factoring and Security Agreement (the
“Factoring Agreement”) with Action Capital Corporation (“Action”) which provides
      for the sale of up to $1,500,000 of accounts receivable of STS to Action. Action
      will reserve and withhold in a reserve account, an amount equal to 10% of the
      face amount of accounts receivable purchased under the Factoring Agreement.
      Action has full recourse against STS, including the right to charge-back or
      sell
      back any accounts receivable if not paid within 90 days of the date of purchase.
      The Factoring Agreement provides for interest at an annual rate of prime plus
      1%
      plus a monthly fee of .6% on the daily average of unpaid balances. The prime
      rate at June 30, 2006 was 8.25%.




SOP
      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 SOP in July 2001.
      SOP exercised this right on July 29, 2003. 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. Our remaining
      repurchase obligation was cancelled in connection with the closing of the asset
      sale transaction that we completed with SOP in December 2005.




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, 2006, there was still an aggregate of $3.9 million in delinquent
      payroll taxes outstanding, including interest and penalties, which are included
      in “Payroll taxes payable” on the balance sheet as of June 30, 2006. 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.




In
      January 2006 we entered into an agreement with the holder of all of the
      outstanding shares of our Series I Preferred Stock pursuant to which we issued
      to the holder, effective as of December 28, 2005, a secured convertible
      promissory note in the aggregate principal amount of $2,356,750 in exchange
      for
      all of such shares of Series I Preferred Stock. (See Notes 9 and 10 to the
      Condensed Consolidated Financial Statements).





As
      of
      March 31, 2006, 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
      $(8,085,156).


**22**


We
      engaged in various transactions with related parties during the nine months
      ended June 30, 2006 including the following:





•
            We
                paid $44,000 to an entity which employs Jeffrey J. Raymond, the son
                of
                Joseph J. Raymond, our Chairman, President and Chief Executive Officer,
                for consulting services. This amount was included in selling, general
                and
                administrative expense and includes a charge of $16,000 in connection
                with
                the issuance of 2,000,000 shares of our Common Stock to the entity.
                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.•
            Joseph
                J. Raymond, Jr., the son of Joseph J. Raymond, our Chairman, President
                and
                Chief Executive Officer, is a 50% member in ALS, LLC, which is the
                holding
                company for Advantage. We were a party to an Outsourcing Agreement
                with
                ALS and pursuant to which ALS provided payroll outsourcing services
                for
                all our in-house staff, except for our corporate employees, and customer
                staffing requirements. As a result of this arrangement, all of our
                field
                personnel were employed by ALS until December 2005. We paid 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 to ALS. The total amount charged by ALS under this agreement
                was $17,326,000 in the nine months ended June 30, 2006.•
            We
                repaid a $15,000 non-interest bearing loan made to us by Joseph J.
                Raymond.•
            At
                June 30, 2006, we owed: $41,000 under a demand note bearing interest
                at
                10% per annum to a corporation owned by the son of Joseph J. Raymond;
                $5,123 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% per annum which became due in full in August 2005 and $41,598
                to a
                former member of our Board of Directors under a promissory note bearing
                interest at 12% per annum which becomes due in full in May
                2006.•
            Accounts
                payable and accrued expenses - related parties in the attached condensed
                consolidated balance sheets at September 30, 2005, represents amounts
                due
                to ALS and Advantage.•
            The
                nephew of our Chairman, President and CEO is affiliated with Pinnacle
                Investment Partners, LP (“Pinnacle”), which held 21,163 shares of our
                Series I Preferred Stock as of September 30, 2005. The Company also
                believes that PIP Management, Inc., which was designated as the advisor
                to
                the Series I holders, is also affiliated with Pinnacle Investment
                Partners, LP. In January 2006, we entered into an agreement with
                Pinnacle
                pursuant to which we issued to Pinnacle, effective as of December
                28,
                2005, a secured convertible promissory note in the aggregate principal
                amount of $2,356,750 in exchange for all the outstanding shares of
                Series
                I Preferred Stock (see Notes 9 and 10 to the Condensed Consolidated
                Financial Statements). During the nine months ended June 30, 2006,
                we paid
                $1,490,000 against the note. In addition, $225,000 of principal was
                converted into 25,833,331 shares of our common stock.•
            In
                December 2005, we sold substantially all of the assets, excluding
                accounts
                receivable, of certain other offices located in California and Arizona
                to
                ALS. See “Management’s Discussion and Analysis of Financial Condition and
                Results of Operations-Discontinued Operations/Acquisition or Disposition
                of Assets” and Note 5 to the Condensed Consolidated Financial
                Statements.•
            In
                December 2005, we sold substantially all of the assets, excluding
                accounts
                receivable and certain other items of three of our California offices
                to
                AI. The son of Joseph J. Raymond, our Chairman, President and Chief
                Executive Officer, is employed by an entity which serves as a consultant
                to AI. See “Management’s Discussion and Analysis of Financial Condition
                and Results of Operations/Acquisition or Disposition of Assets” and Note 5
                to the Condensed Consolidated Financial Statements.





**23**


**Contractual
      Obligations**





Our
      aggregate contractual obligations are as follows:





**Payments
                Due by Fiscal Period (in Thousands)****2008
                -**
            
            
            **2010
                -****Total**
            
            
            **2007**
            
            
            **2009**
            
            
            **2011**
            
            
            **Thereafter**Contractual
                Obligations:Long-term
                debt obligations
            
            $
            1,487
            
            $
            568
            
            $
            704
            
            $
            215
            
            $
            -Operating
                lease obligations
            
            
            134
            
            
            76
            
            
            58
            
            
            -
            
            
            -Series
                A redemption payable
            
            
            300
            
            
            300
            
            
            -
            
            
            -
            
            
            -Earnout
                liability
            
            
            45
            
            
            45
            
            
            -
            
            
            -
            
            
            -Payroll
                tax liability (a)
            
            
            682
            
            
            650
            
            
            32
            
            
            -
            
            
            -TOTAL
            
            $
            2,648
            
            $
            1,639
            
            $
            794
            
            $
            215
            
            $
            -





(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
      February 2006, the financial Accounting Standards Board (the “FASB”) issued
      Statement of Financial Accounting Standards No. 155, “Accounting for Certain
      Hybrid Instruments,” (SFAS 155), which amends SFAS 133, “Accounting for
      Derivative Instruments and Hedging Activities,” and SFAS 140, “Accounting for
      Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”.
      SFAS 155 allows financial instruments that have embedded derivatives to be
      accounted for as a whole (eliminating the need to bifurcate the derivative
      from
      its host) if the holder elects to account for the whole instrument on a fair
      value basis. SFAS 155 also clarifies and amends certain other provisions of
      SFAS
      133 and SFAS 140. This statement is effective for all financial instruments
      acquired or issued in fiscal years beginning after September 15, 2006. We do
      not
      expect our adoption of this new standard to have a material impact on our
      financial position, results of operations or cash flows.





In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets - an amendment of FASB Statement No. 140” (“SFAS 156”). This statement
      was issued to simplify the accounting for servicing assets and liabilities,
      such
      as those common with mortgage securitization activities. This statement
      addresses the recognition and measurement of separately recognized servicing
      assets and liabilities and provides an approach to simplify hedge-like (offset)
      accounting. SFAS 156 clarifies when an obligation to service financial assets
      should be separately recognized (as a servicing asset or liability), requires
      initial measurement at fair value and permits an entity to select either the
      Amortization Method of the Fair Value Method. This statement is effective for
      fiscal years beginning after September 15, 2006. We do not expect our adoption
      of this new standard to have a material impact on our financial position,
      results of operations or cash flows.





On
      July
      13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
      Income Taxes” (“FIN 48”), which is effective for fiscal years beginning after
      December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income
      taxes recognized in the financial statements in accordance with FASB Statement
      No. 109, “Accounting for Income Taxes”. This Interpretation prescribes a
      comprehensive model for how a company should recognize, measure, present, and
      disclose in its financial statements uncertain tax positions that the company
      has taken or expects to take on a tax return. We do not expect that the
      implementation of FIN 48 will have a material impact on our financial position,
      results of operations or cash flows.


**24**


**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, 2005. As of June 30, 2006, there have been no material changes
      to
      any of the critical accounting policies contained therein.





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





During
      fiscal 2005, we were 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 provided for a line of credit up to 85% of eligible
      accounts receivable, not to exceed $12,000,000. Advances under this credit
      agreement bore interest at a rate of prime plus 3%. The line or credit was
      terminated in December 2005 and no additional borrowings are permitted under
      the
      line of credit. In January 2006, STS entered into a Factoring Agreement, which
      provides for the sale of up to $1,500,000 of accounts receivable to Action.
      STS
      is charged interest at an annual rate of prime plus 1%, plus a monthly
      management fee of .6% on the daily average of unpaid balances. As a result,
      we
      continue to be subject to the risk of fluctuating interest rates.





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**





Under
      the
      supervision and with the participation of management, including our Chief
      Executive Officer and our Chief Financial Officer, we have evaluated the
      effectiveness of the design and operation of our disclosure controls and
      procedures. Disclosure controls and procedures are controls and procedures
      that
      are designed to ensure that information required to be disclosed in our reports
      filed or submitted under the 1934 Act is recorded, processed, summarized and
      reported within the time periods specified in the SEC’s rules and forms. Based
      on this evaluation, our Chief Executive Officer and Chief Financial Officer
      have
      concluded that, as a result of a material weakness in our internal control
      over
      financial reporting discussed below, our disclosure controls and procedures
      were
      not effective as of the end of the period covered by this report.





In
      March
      2006, the Securities and Exchange Commission requested that we amend our Annual
      Report on Form 10-K for the fiscal year ended September 30, 2005 to remove
      the
      audit report issued by Amper Politziner & Mattia, P.C., our predecessor
      auditor, on our financial statements as of and for the years ended September
      30,
      2004 and 2003, inasmuch as we had not obtained permission from the predecessor
      auditor to include such report in the filing as contemplated by Public Company
      Accounting Oversight Board Statements of Auditing Standards Section 508. Our
      Chief Executive Officer and Chief Financial Officer have concluded that the
      inclusion of the predecessor auditor report in our Form 10-K for the fiscal
      year
      ended September 30, 2005 represents a material weakness in our review of
      applicable financial reporting regulatory requirements when preparing our
      financial statements. A “material weakness” is a reportable condition in which
      the design or operation of one or more of the specific control components has
      a
      defect or defects that could have a material adverse effect on our ability
      to
      record, process, summarize and report financial data in the financial statements
      in a timely manner. We are addressing the weakness in our review of the
      application of applicable financial reporting regulatory requirements by
      improving the training of our personnel and researching, identifying, analyzing,
      documenting and reviewing applicable regulatory requirements.





In
      connection with its audit of, and in the issuance of its report on our financial
      statements for the year ended September 30, 2004, Amper Politziner & Mattia,
      P.C. delivered a letter to the Audit Committee of our Board of Directors and
      our
      management that identified three items that it considered to be material
      weaknesses in the effectiveness of our internal controls pursuant to standards
      established by the American Institute of Certified Public Accountants. Those
      material weaknesses arose due to (1) limited resources and manpower in the
      finance department; (2) inadequacy of the financial review process; and (3)
      inadequate documentation of certain financial procedures. While we believe
      that
      we have adequate policies, we agreed with our independent auditors that our
      implementation of those policies should be improved. As a result, although
      we
      were unable to expand the number of personnel in the accounting function due
      to
      financial constraints, we did provide additional training to existing staff
      which allowed us to increase redundancies in our system and improve our
      segregation of duties.


**25**


In
      addition, in August 2006, we identified deficiencies in our internal controls
      and disclosure controls related to the accounting for certain warrants,
      primarily with respect to accounting for derivative liabilities in accordance
      with EITF 00-19 and SFAS 133. We restated our consolidated financial statements
      for the years ended September 30, 2004 and 2005, in order to correct the
      accounting in such financial statements with respect to derivative liabilities
      in accordance with EITF 00-19 and SFAS 133. Since July 2006, we have undertaken
      improvements to our internal controls in an effort to remediate those
      deficiencies by training our accounting staff to understand and implement the
      requirements of EITF 00-19 and SFAS 133.





Notwithstanding
      the material weaknesses and deficiencies described above, our management,
      including our Chief Executive Officer and Chief Financial Officer believes
      that
      the consolidated financial statements, as restated, included in the 2005 Form
      10-K/A and this report on Form 10-Q fairly present in all material respects
      our
      financial condition, results of operations and cash flows for the periods
      presented.





Our
      management, including the Chief Executive Officer and Chief Financial Officer
      does not expect that our disclosure controls and procedures or our internal
      control over financial reporting will prevent all error and all fraud. A control
      system, no matter how well designed and operated, can provide only reasonable,
      not absolute, assurance that the objectives of the control system are met.
      Because of the inherent limitations in all control systems, no evaluation of
      controls can provide absolute assurance that all control issues and instances
      of
      fraud, if any, within the company have been detected.





There
      were no significant changes in our internal controls during the quarter ended
      March 31, 2006 that have materially affected, or are reasonably likely to have
      materially affected, our internal controls subsequent to the date we carried
      out
      our evaluation.








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





As
      referenced in our Form 8-K filed with the Commission on June 8, 2006, the
      California State Compensation Insurance Fund instituted an action on May 17,
      2006 in the U.S. District Court, Control District of California, to collect
      $2.3
      million allegedly owed by the Company with respect to workers’ compensation
      insurance premiums.  In addition, on May 24, 2006 Liberty Mutual Insurance
      filed suit in the Superior Court of New Jersey, Law Division, Somerset County,
      seeking $250,000 allegedly owed for workers’ compensation insurance premiums.
      These amounts have been provided for in the Company’s consolidated financial
      statements.





**Item
                1A.**
            **Risk
                Factors**





There
      have been no material changes with respect to the risk factors disclosed in
      our
      Report on Form 10-K for the fiscal year ended September 30, 2005.





**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, $85,678 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, 2006.





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





Not
      applicable.


**26**





**Item
                6.**
            **Exhibits**





**Number**
            **Description**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





**27**


**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
              16, 2006
            By:
            /s/ Joseph
              J.
              RaymondChairman
              of the Board of Directors, President and Chief Executive
              OfficerPresident
              and Chief Executive Officer




Date: August
              16, 2006
            By:
            /s/ Michael
              A. MaltzmanVice
              President and Chief Financial OfficerPrincipal
              Financial and Accounting Officer




28