**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 March 31, 2007****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.)**149
                  Avenue at the Common, Shrewsbury, New Jersey
                  07702**(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* *o* *No* *ý*
 
 *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* *x*
 
 *The
        number of shares of Common Stock, $.04 par value, outstanding as of May 9,
        2007
        was 67,568,617.*
 
  
  **STRATUS
        SERVICES GROUP, INC.**
 Condensed
        Consolidated Balance Sheets
 (Unaudited)
 
 **March
                  31,**
              
              **September
                  30,**Assets
              
              **2007**
              
              **2006**Current
                  assetsCash
              
              $
              16,412
              
              $
              84,881Accounts
                  receivable-less allowance for doubtful accounts of $75,000and
                  $75,000
              
              
              958,365
              
              
              815,463Unbilled
                  receivables
              
              
              126,552
              
              
              126,191Notes
                  receivable
              
              
              -
              
              
              80,000Due
                  from related party
              
              
              121,764
              
              
              499,264Prepaid
                  insurance
              
              
              35,427
              
              
              12,244Prepaid
                  expenses and other current assets
              
              
              275,852
              
              
              244,6621,534,372
              
              
              1,862,705Property
                  and equipment, net of accumulated depreciation
              
              
              190,099
              
              
              145,727Other
                  assets
              
              
              6,350
              
              
              6,350$
              1,730,821
              
              $
              2,014,782Liabilities
                  and Stockholders’ Equity (Deficiency)Current
                  liabilitiesLoans
                  payable (current portion)
              
              $
              73,464
              
              $
              72,477Loans
                  payable - related parties
              
              
              106,721
              
              
              87,721Notes
                  payable - acquisitions (current portion)
              
              
              237,335
              
              
              203,663Note
                  payable - related party (current portion)
              
              
              423,271
              
              
              265,308Line
                  of credit
              
              
              740,817
              
              
              596,950Insurance
                  obligation payable
              
              
              16,797
              
              
              7,348Accounts
                  payable and accrued expenses
              
              
              3,723,155
              
              
              3,737,712Accrued
                  payroll and taxes
              
              
              155,720
              
              
              107,204Payroll
                  taxes payable
              
              
              3,377,316
              
              
              3,823,710Series
                  A redemption payable
              
              
              300,000
              
              
              300,0009,154,596
              
              
              9,202,093Loans
                  payable (net of current portion)
              
              
              44,124
              
              
              -Notes
                  payable - acquisitions (net of current portion)
              
              
              366,366
              
              
              476,017Note
                  payable - related party (net of current portion)
              
              
              193,579
              
              
              351,542Convertible
                  debt
              
              
              40,000
              
              
              40,0009,798,665
              
              
              10,069,652Commitments
                  and contingenciesStockholders’
                  equity (deficiency)Preferred
                  stock, $.01 par value, 5,000,000 shares authorized
 
 
 
 
 
 See
        notes
        to condensed consolidated financial statements
 
  **1**
  
 Series
                  F voting convertible preferred stock, $.01 par value, 6,000shares
                  issued and outstanding, liquidation preference of $600,000(including
                  unpaid dividends of $112,000 and $91,000)
              
              
              712,000
              
              
              691,000Common
                  stock, $.04 par value, 500,000,000 shares authorized;
                  67,568,617and
                  65,479,756 shares issued and outstanding
              
              
              2,702,745
              
              
              2,619,190Additional
                  paid-in capital
              
              
              9,343,215
              
              
              9,407,238Accumulated
                  deficit
              
              
              (20,825,804
              )
              
              (20,772,298
              )Total
                  stockholders’ equity (deficiency)
              
              
              (8,067,844
              )
              
              (8,054,870
              )$
              1,730,821
              
              $
              2,014,782
 
 
 
 
 See
        notes
        to condensed consolidated financial statements
 
  **2**
  **STRATUS
        SERVICES GROUP, INC.**
 Condensed
        Consolidated Statements of Operations
 (Unaudited)
 
 **Three
                  Months Ended**
              
              **Six
                  Months Ended****March
                  31,**
              
              **March
                  31,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**Revenues
              
              $
              1,810,705
              
              $
              1,190,086
              
              $
              3,673,559
              
              $
              2,423,944Cost
                  of revenues ($-0-, $90,138, $-0-and
                  $90,138 to related parties)
              
              
              1,251,101
              
              
              871,568
              
              
              2,524,904
              
              
              1,693,824Gross
                  profit
              
              
              559,604
              
              
              318,518
              
              
              1,148,655
              
              
              730,120Selling,
                  general and administrative expenses
              
              
              726,358
              
              
              761,471
              
              
              1,374,561
              
              
              2,007,504Operating
                  (loss) from continuing operations
              
              
              (166,754
              )
              
              (442,953
              )
              
              (225,906
              )
              
              (1,277,384
              )Interest
                  expense
              
              
              (56,249
              )
              
              (84,457
              )
              
              (118,672
              )
              
              (383,808
              )Other
                  income (expense)
              
              
              36,386
              
              
              38,572
              
              
              14,578
              
              
              (18,737
              )(Loss)
                  from continuing operations
              
              
              (186,617
              )
              
              (488,838
              )
              
              (330,000
              )
              
              (1,679,929
              )Discontinued
                  operations - (loss)from
                  discontinued operations
              
              
              -
              
              
              (200,000
              )
              
              -
              
              
              (307,044
              )Gain
                  on sale of discontinued operations (net)
              
              
              100,635
              
              
              220,284
              
              
              276,494
              
              
              3,376,726Net
                  earnings (loss)
              
              
              (85,982
              )
              
              (468,554
              )
              
              (53,506
              )
              
              1,389,753Dividends
                  on preferred stock
              
              
              (10,500
              )
              
              (10,500
              )
              
              (21,000
              )
              
              (21,000
              )Net
                  earnings (loss) attributable tocommon
                  stockholders
              
              $
              (96,482
              )
              $
              (479,054
              )
              $
              (74,506
              )
              $
              1,368,753Net
                  earnings (loss) per share attributableto
                  common stockholdersBasic:(Loss)
                  from continuing operations
              
              $
              -
              
              $
              (.01
              )
              $
              -
              
              $
              (.06
              )Earnings
                  (loss) from discontinued operations
              
              
              -
              
              
              -
              
              
              -
              
              
              .11Net
                  earnings (loss)
              
              $
              -
              
              $
              (.01
              )
              $
              -
              
              $
              .05Diluted:(Loss)
                  from continuing operations
              
              $
              -
              
              $
              (.01
              )
              $
              -
              
              $
              (.06
              )Earnings
                  (loss) from discontinued operations
              
              
              -
              
              
              -
              
              
              -
              
              
              .11Net
                  earnings (loss)
              
              $
              -
              
              $
              (.01
              )
              $
              -
              
              $
              .05Weighted
                  average shares outstandingper
                  common shareBasic
              
              
              65,573,033
              
              
              36,055,682
              
              
              65,526,870
              
              
              28,158,364Diluted
              
              
              65,573,033
              
              
              36,055,682
              
              
              65,526,870
              
              
              28,689,714
 
 
 See
        notes
        to condensed consolidated financial statements
 
  **3**
  **STRATUS
        SERVICES GROUP, INC.**
 Condensed
        Consolidated Statements of Cash Flows
 (Unaudited)
  
 **Six
                  Months Ended****March
                  31,****2007**
              
              
              **2006**Cash
                  flows from (used in) operating activitiesNet
                  earnings (loss)
              
              $
              (53,506
              )
              $
              1,389,753Adjustments
                  to reconcile net earnings to net cash used by operating
                  activitiesDepreciation
              
              
              38,799
              
              
              73,340Amortization
              
              
              -
              
              
              41,902Stock
                  compensation
              
              
              -
              
              
              92,000Gain
                  on sale of discontinued operations
              
              
              (276,494
              )
              
              (3,376,726
              )Imputed
                  interest
              
              
              21,654
              
              
              15,254Dividends
                  on preferred stock
              
              
              -
              
              
              163,625Intrinsic
                  value of beneficial conversion feature of convertible preferred
                  stock
              
              
              -
              
              
              1,674Changes
                  in operating assets and liabilitiesAccounts
                  receivable
              
              
              (143,263
              )
              
              10,262,020Prepaid
                  insurance
              
              
              (23,183
              )
              
              185,639Prepaid
                  expenses and other current assets
              
              
              2,303
              
              
              238,930Other
                  assets
              
              
              -
              
              
              23,825Insurance
                  obligation payable
              
              
              9,449
              
              
              (99,903
              )Accrued
                  payroll and taxes
              
              
              48,516
              
              
              (194,962
              )Payroll
                  taxes payable
              
              
              (446,394
              )
              
              (437,725
              )Accounts
                  payable and accrued expenses
              
              
              (46,499
              )
              
              (1,508,853
              )Accrued
                  interest
              
              
              22,099
              
              
              20,578Total
                  adjustments
              
              
              (793,013
              )
              
              5,300,618(846,519
              )
              
              6,890,371Cash
                  flows from investing activitiesPurchase
                  of property and equipment
              
              
              (29,689
              )
              
              (27,582
              )Cash
                  received in connection with sale of discontinued
                  operations(including
                  $377,500 and $460,736 from a related party) (net of
                  $10,000in
                  costs in 2006)
              
              
              650,901
              
              
              702,581Collection
                  of notes receivable
              
              
              -
              
              
              6,609621,212
              
              
              681,608Cash
                  flows from (used in) financing activitiesNet
                  proceeds from (repayments of) line of credit
              
              
              143,867
              
              
              (6,071,490
              )Payments
                  of loans payable
              
              
              (8,371
              )
              
              -Proceeds
                  from loans payable - related parties
              
              
              120,000
              
              
              -Payments
                  of loans payable - related parties
              
              
              (101,000
              )
              
              (9,002
              )Payments
                  of note payable - related party
              
              
              -
              
              
              (1,425,000
              )Payments
                  of notes payable - acquisitions
              
              
              (7,033
              )
              
              (38,999
              )Proceeds
                  from exercise of warrants
              
              
              9,375
              
              
              -Cash
                  overdraft
              
              
              -
              
              
              (14,731
              )156,838
              
              
              (7,559,222
              )Net
                  change in cash
              
              
              (68,469
              )
              
              12,757Cash
                  - beginning
              
              
              84,881
              
              
              40,784Cash
                  - ending
              
              $
              16,412
              
              $
              53,541
 
 
 
 See
        notes
        to condensed consolidated financial statements
 
  **4**
  
 Supplemental
                  disclosure of cash paidInterest
              
              $
              96,573
              
              $
              342,987Schedule
                  of noncash investing and financing activitiesSale
                  of discontinued operations:Gain
                  on sale
              
              $
              276,494
              
              $
              3,156,442Net
                  assets sold
              
              
              -
              
              
              1,683,783Cancellation
                  of accounts payable - related parties (net)
              
              
              -
              
              
              (3,541,364
              )Due
                  from related party
              
              
              377,500
              
              
              (1,250,000
              )Accrued
                  earn-out
              
              
              (3,093
              )
              
              -Accrued
                  expenses
              
              
              -
              
              
              50,000Net
                  cash received
              
              $
              650,901
              
              $
              98,861Issuance
                  of common stock upon conversion of convertible preferred
                  stock
              
              $
              -
              
              $
              24,366Cumulative
                  dividends on preferred stock
              
              $
              21,000
              
              $
              21,000Assignment
                  of note receivable in exchange for notes payable -
                  acquisitions
              
              $
              80,000
              
              $
              -
 
 
 
 
 See
        notes
        to condensed consolidated financial statements
 
 
 
 
 **5**
 
 **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 51%-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 5). Since such time, the Company has been focused on
        expanding its information technology staffing solutions business, which is
        conducted through its 51% owned consolidated joint venture, Stratus Technology
        Services, LLC (“STS”) through offices located in New Jersey and
        Florida (see Note 10).
 
 **NOTE
        2 - LIQUIDITY**
 
 At
        March
        31, 2007, the Company had limited liquid resources. Current liabilities were
        $9,154,596 and current assets were $1,534,372. The difference of $7,620,224
        is a
        working capital deficit, which is primarily the result of losses incurred
        during
        the last several 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 - NEW ACCOUNTING PRONOUNCEMENTS**
 
 In
        July
        2006, the Financial Accounting Standards Board issued FASB Interpretation
        No. 48
        (FIN 48), “Accounting for Uncertainty in Income Taxes - an interpretation of
        FASB Statement No. 109”. FIN 48 provides guidance for the recognition,
        measurement, classification and disclosure of the financial statement effects
        of
        a position taken or expected to be taken in a tax return (“tax position”). The
        financial statement effects of a tax position must be recognized when there
        is a
        likelihood of more than 50 percent that based on the technical merits, the
        position will be sustained upon examination and resolution of the related
        appeals or litigation processes, if any. A tax position that meets the
        recognition threshold must be measured initially and subsequently as the
        largest
        amount of tax benefit that is greater than 50 percent likely of being realized
        upon ultimate settlement with a taxing authority. The interpretation is
        effective for fiscal years beginning after December 15, 2006. The Company does
        not expect its adoption of FIN 48 to have a material impact on its consolidated
        financial portion, results of operations or cash flows.
 
 **6**
  In
        September 2006, the Financial Accounting Standards Board issued Statement
        of
        Financial Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value
        Measurements”. This Statement defines fair value, establishes a framework for
        measuring fair value in generally accepted accounting principles (GAAP),
        and
        expands disclosures about fair value measurements. The Statement applies
        under
        other accounting pronouncements that require or permit fair value measurements.
        SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
        or
        the Company’s fiscal year ending September 30, 2009. The Company does not expect
        the adoption of this new standard to have a material impact on its consolidated
        financial position, results of operations or cash flow.
 
 In
        September 2006, the Financial Accounting Standards Board issued Statement
        of
        Financial Accounting Standards No. 158, “Employers’ Accounting for Defined
        Benefit Pension and Other Postretirement Plans”. This Statement improves
        financial reporting by requiring an employer to recognize the overfunded
        or
        underfunded status of a defined benefit postretirement plan as an asset or
        liability in its statement of financial position and to recognize changes
        in
        that funded status in the year in which the changes occur through comprehensive
        income. This Statement also improves financial reporting by requiring an
        employer to measure the funded status of a plan as of the date of its year-end
        statement of financial position, with limited exceptions. The effective date
        to
        initially recognize the funded status and to provide the required disclosures
        is
        for fiscal years ending after December 15, 2006, or the Company’s fiscal year
        ending September 30, 2007. The requirement to measure plan assets and benefit
        obligations is effective for fiscal years ending after December 15, 2008,
        or the
        Company’s fiscal year ending September 30, 2009. The Company does not expect the
        adoption of this new standard to have a material impact on its consolidated
        financial position, results of operations or cash flows.
 
 In
        February 2007, the Financial Accounting Standards Board issued Statement
        of
        Financial Accounting Standards No. 159, “The Fair Value Option for Financial
        Assets and Financial Liabilities” and is effective for fiscal years beginning
        after November 15, 2007. This Statement permits entities to choose to measure
        many financial instruments and certain other items at fair value. The objective
        is to improve financial reporting by providing entities with the opportunity
        to
        mitigate volatility in reported earnings caused by measuring related assets
        and
        liabilities differently without having to apply complex hedge accounting
        provisions. The Company is currently assessing the impact the adoption of
        this
        pronouncement will have on the financial statements.
 
 **NOTE
        4 - 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 no dilutive
        shares for the three months ended March 31, 2007 and 2006. There were -0-
        and
        531,350 dilutive shares for the six months ended March 31, 2007 and 2006,
        respectively. Outstanding common stock options and warrants not included
        in the
        computation of earnings per share for the three and six months ended March
        31,
        2007 and 2006, totaled 17,221,153 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
        5 - DISCONTINUED OPERATIONS**
 
 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 51% 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 is 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 will be 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.
 
 **7**
 (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 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:
   **8**
 •
              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.
 
 On
        the
        Closing Date, TES made a payment of $1,972,521 to the Company’s lender (see Note
        6) and acquired the lender’s rights to certain of the Company’s accounts
        receivable that collateralize its obligation to the lender. As a result of
        this
        transaction, the Company’s obligations to the lender were reduced by $1,972,521.
 
 The
        operating results of discontinued operations are summarized as
        follows:
 
 **Three
                  Months Ended**
              
              **Six
                  Months Ended****March
                  31,**
              
              **March
                  31,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Revenues
              
              $
              -
              
              $
              
              
              $
              -
              
              $
              18,265,587Cost
                  of revenues
              
              
              -
              
              
              
              
              
              -
              
              
              16,215,630Gross
                  profit
              
              
              -
              
              
              
              
              
              -
              
              
              2,046,957Selling,
                  general and administrative expenses
              
              
              -
              
              
              
              
              
              -
              
              
              1,950,622Operating
                  income
              
              
              -
              
              
              
              
              
              -
              
              
              96,335Interest
                  expense
              
              
              -
              
              
              
              
              
              -
              
              
              (205,056
              )Other
                  income (expense)
              
              
              -
              
              
              (200,000
              )
              
              -
              
              
              (198,323
              )Net
                  income (loss)
              
              $
              -
              
              $
              (200,000
              )
              $
              -
              
              $
              (307,044
              )
 
 The
        gain
        on sale of discontinued operations is summarized as follows:
 
 **Three
                  Months Ended**
              
              **Six
                  Months Ended****March
                  31,**
              
              **March
                  31,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Sold
                  to:ALS
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              4,340,459AI
              
              
              36,041
              
              
              92,836
              
              
              112,614
              
              
              (204,601
              )SOP
              
              
              32,967
              
              
              46,681
              
              
              72,313
              
              
              (284,584
              )TES
              
              
              31,627
              
              
              80,767
              
              
              91,567
              
              
              (414,548
              )100,635
              
              
              220,284
              
              
              276,494
              
              
              3,436,726Other
                  costs of sales
              
              
              -
              
              
              -
              
              
              -
              
              
              (60,000
              )Gain
                  on sale of discontinued operations
              
              $
              100,635
              
              $
              220,284
              
              $
              276,494
              
              $
              3,376,726
 
 The
        above
        gain is comprised of earnout payments in the three and six months ended March
        31, 2007 and three months ended March 31, 2006, and includes earnout payments
        of
        $294,145 in the six months ended March 31, 2006.
 
 **NOTE
        6 - 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. The
        Loan
        Agreement restricted the Company’s ability to incur other indebtedness, pay
        dividends and repurchase stock. Borrowings under the Loan Agreement bore
        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.
  **9**
  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
        10). 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 10), 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 March 31, 2007 was 8.25%.
  **NOTE
        7 - 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 March 31, 2007, there was still an aggregate of $3.4 million
        in delinquent payroll taxes outstanding which are included in “Payroll taxes
        payable” on the balance sheet. Judgment has not been entered against the Company
        in California. While judgment has been entered against the Company in New
        Jersey, no actions have been taken to enforce same.
 
 On
        January 7, 2005, the Company entered into a payment plan agreement 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 $284,046 (as of December 31, 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.
 
 **NOTE
        8 - INCOME TAXES**
 
 No
        income
        tax expense was recorded in the six months ended March 31, 2006, because
        the
        Company recognized a deferred tax benefit resulting from the utilization
        of the
        Company’s net operating loss carryforwards.
  **10**
  **NOTE
        9 - 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 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.
  **11**
  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”) 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. The Convertible Note, which
        is
        secured by substantially all of the Company’s assets, was or 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. During the year ended
        September 30, 2006, the Company issued 5,000,000 shares of its common stock,
        valued at the then market value, to Pinnacle as payment of $45,000 against
        this
        portion of the Convertible Note. At March 31, 2007, $210,000 remains
        unpaid.
 
 •  $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 year
        ended September 30, 2006, $150,000 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
        10 - 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 $-0-
        and
        $44,000 for the six months ended March 31, 2007 and 2006, 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.
 
 ***Joint
        Venture***
 The
        Company provides information technology staffing services through a joint
        venture, STS (see Note 1), in which the Company has a 51% interest. Prior
        to
        February 13, 2007, the Company had a 50% interest. On February 13, 2007,
        the
        Company acquired from Fusion Business Services, LLC (“Fusion”) an additional 1%
        interest in STS in exchange for the issuance to the members of Fusion of
        70,111
        shares of the Company’s common stock. As a result of the transfer, which was
        effective as of January 1, 2007, the Company owns a 51% interest in STS and
        Fusion owns 49% interest. Fusion has a right to re-acquire the 1% interest
        transferred to the Company upon the occurrence of certain events, including
        the
        institution of bankruptcy or insolvency proceedings against the Company,
        a sale
        of all or substantially all of the Company’s assets, a merger or consolidation
        of the Company with another entity, or the liquidation or dissolution of
        the
        Company. The purchase price payable by Fusion in connection with any such
        re-acquisition shall be a return of the shares issued to it for the 1% interest
        or a cash payment of $1,262. A son of the CEO of the Company has a majority
        interest in Fusion.
 
 ***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 $48,245,000 in the six months
        ended March 31, 2006.
 
 The
        Company terminated the Outsourcing Agreement effective February 3,
        2006.
 
 **12**
 ***Due
        from Related Party***
 The
        amount due from related party in the condensed consolidated balance sheet
        is the
        remaining balance due from ALS in connection with the sale of the ALS Purchased
        Assets (see Note 5).
 
 ***Loans
        Payable***
 During
        the six months ended March 31, 2007, the CEO loaned $100,000 to the Company
        which was repaid in January 2007. In addition, during the six months ended
        March
        31, 2007, a significant shareholder loaned $20,000 to the Company, which
        is
        still outstanding at March 31, 2007.
 
 ***Other***
 An
        entity
        through which the son of the CEO is employed is a consultant to AI (see Note
        5).
 
 The
        nephew of the CEO of the Company is affiliated with Pinnacle Investment
        Partners, LP, the holder of the shares of the convertible note issued in
        exchange for shares of the Company’s Series I Preferred Stock (see Note 9). The
        Company believes that PIP Management Inc., which has been designated as the
        advisor to the Series I holders (see Note 9), is also affiliated with Pinnacle
        Investment Partners, LP.
 
 **NOTE
        11 - DERIVATIVE INSTRUMENTS**
 
 The
        Company evaluated the application of SFAS No. 133 and EITF 00-19 for its
        financial instruments and determined that certain warrants to purchase the
        Company’s Common Stock are derivatives that are required to be accounted for as
        free-standing liability instruments in the Company’s financial statement. As a
        result, the Company reports the value of those warrants as current liabilities
        on its balance sheet and reports changes in the value of these warrants as
        non-operating gains or losses on its statements of operations. The value
        of the
        warrants is required to be remeasured on a quarterly basis, and is based
        on the
        Black Scholes Pricing Model.
 
 Variables
        used in the Black Scholes option pricing model include (1) 4% risk-free interest
        rate, (2) expected warrant life is the actual remaining life of the warrants
        as
        of each period end, (3) expected volatility is 100%, and (4) zero expected
        dividends.
 
 Due
        to
        the nature of the required calculations and the large number of shares of
        the
        Company’s common stock involved in such calculations, changes in the Company’s
        common stock price may result in significant changes in the value of the
        warrants and resulting non-cash gains and losses on the Company’s statement of
        operations.
 
  **13**
  **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 the brief operating history of
        our current operations; our ability to raise additional capital; our ability
        to
        achieve and manage growth; our ability to attract and retain qualified
        personnel; the continued cooperation of our creditors; our ability to develop
        new services; 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, 2006.
 
 **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, LLC
        ("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 51% owned joint venture, STS.
  **14**
  **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 paid or is payable as
                  follows:
 
 •  $250,000
        was paid over the 60 days following December 2, 2005, for our documented
        cash
        flow requirements, all of which is payable at a rate no faster than $125,000
        per
        30 days;
 
 •  $1,000,000
        payable by ALS will be paid directly to certain taxing authorities to reduce
        our
        tax obligations; and
 
 •  $3,537,000
        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,
   **15**
  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 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.
   **16**
  In
        connection with the TES transaction, we entered in 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 net gain on sale of discontinued operations
        which is summarized as follows:
  **Three
                  Months Ended**
              
              **Six
                  Months Ended****March
                  31,**
              
              **March
                  31,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Sold
                  to:ALS
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              4,340,459AI
              
              
              36,041
              
              
              92,836
              
              
              112,614
              
              
              (204,601
              )SOP
              
              
              32,967
              
              
              46,681
              
              
              72,313
              
              
              (284,584
              )TES
              
              
              31,627
              
              
              80,767
              
              
              91,567
              
              
              (414,548
              )100,635
              
              
              220,284
              
              
              276,494
              
              
              3,436,726Other
                  costs of sales
              
              
              -
              
              
              -
              
              
              -
              
              
              (60,000
              )Gain
                  on sale of discontinued operations
              
              $
              100,635
              
              $
              220,284
              
              $
              276,494
              
              $
              3,376,726
 
 The
        above
        gain is comprised of earnout payments in the three and six months ended March
        31, 2007 and three months ended March 31, 2006, and includes earnout payments
        of
        $294,145 in the six months ended March 31, 2006.
  **Continuing
        Operations**
 **Three
        Months Ended March 31, 2007 Compared to Three Months Ended March 31,
        2006**
 
 ***Revenues.*** Revenues
        increased 34.3% to $1,810,705 for the three months ended March 31, 2007 from
        $1,190,086 for the three months ended March 31, 2006. This increase was
        primarily a result of an increase in billable hours and permanent placements
        and
        expansion of our customer base.
 
 ***Gross
        Profit.*** Gross
        profit increased 75.7% to $559,604 for the three months ended March 31, 2007
        from $318,518 for the three months ended March 31, 2006, primarily as a result
        of increased revenues. Gross profit as a percentage of revenues increased
        to
        30.9% for the three months ended March 31, 2007 from 26.8% for the three
        months
        ended March 31, 2006. This increase was a result of increased permanent
        placements.
 
 ***Selling,
        General and Administrative Expenses.*** ** Selling,
        general and administrative expenses (“SG&A”) decreased 4.6% to $726,358 for
        the three months ended March 31, 2007 from $761,471 for the three months
        ended
        March 31, 2006. Selling, general and administrative expenses as a percentage
        of
        revenues decreased to 40.1% for the three months ended March 31, 2007 from
        64.0%
        for the three months ended March 31, 2006.
 
 ***Interest
        Expense.*** Interest
        expense decreased 33.4% to $56,249 for the three months ended March 31, 2007
        from ** $84,457
        for the three months ended March 31, 2006. Interest expense as a percentage
        of
        revenues decreased to 3.1% for the three months ended March 31, 2007 from
        7.1%
        for the three months ended March 31. 2006.
  ***Net
        Loss Attributable to Common Stockholders.*** ** As
        a
        result of the foregoing, we had a net loss attributable to common stockholders
        of $197,117, for the three months ended March 31, 2007 compared to a net
        loss
        attributable to common stockholders of $699,338 for the three months ended
        March
        31, 2006.
 
 **Six
        Months Ended March 31, 2007 Compared to Six Months Ended March 31,
        2006**
 
 ***Revenues.*** Revenues
        increased 51.6% to $3,673,559 for the six months ended March 31, 2007 from
        $2,423,944 for the six months ended March 31, 2006. This increase was primarily
        a result of an increase in billable hours and permanent placements and expansion
        of our customer base.
 
 ***Gross
        Profit.*** Gross
        profit increased 57.3% to $1,148,655 for the six months ended March 31, 2007
        from $730,120 for the six months ended March 31, 2006, primarily as a result
        of
        increased revenues. Gross profit as a percentage of revenues increased to
        31.3%
        for the six months ended March 31, 2007 from 30.1% for the six months ended
        March 31, 2006. This increase was a result of increased permanent
        placements.
 
 ***Selling,
        General and Administrative Expenses.*** ** SG&A
        decreased 31.5% to $1,374,561 for the six months ended March 31, 2007 from
        $2,007,504 for the six months ended March 31, 2006. Selling, general and
        administrative expenses as a
  **17**
  percentage
        of revenues decreased to 37.4% for the six months ended March 31, 2007 from
        82.8% for the six months ended March 31, 2006.
 
 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 69.1% to $118,672 for the six months ended March 31, 2007
        from ** $383,808
        for the six months ended March 31, 2006. Interest expense as a percentage
        of
        revenues decreased to 3.2% for the six months ended March 31, 2007 from 15.8%
        for the six months ended March 31, 2006. The decrease was a result of the
        decrease in outstanding debt. Interest expense in the six months ended March
        31,
        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 9 to the Condensed
        Consolidated Financial Statements).
  ***Net
        Loss Attributable to Common Stockholders.*** ** As
        a
        result of the foregoing, we had a net loss attributable to common stockholders
        of $351,000 for the six months ended March 31, 2007 compared to a net loss
        attributable to common stockholders of $1,700,929 for the six months ended
        March
        31, 2006.
 
 **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 six months ended March 31, 2007 and
        2006
        was comprised of the following:
 
 **Six
                  Months Ended****March
                  31,****2007**
              
              **2006**Cash
                  provided by (used in) operating activities
              
              $
              (498,184
              )
              $
              8,280,378Cash
                  provided by investing activities
              
              
              650,901
              
              
              689,535Cash
                  used in financing activities
              
              
              -
              
              
              (7,865,389
              )Net
              
              $
              157,217
              
              $
              1,104,524
 
 Although
        there is no assurance we will continue to receive earnout payments in connection
        with discontinued operations, we estimate that we will receive approximately
        $35,000 per month, through November 2008.
 
 At
        March
        31, 2007, we had limited liquid resources. Current liabilities were $9,154,596
        and current assets were $1,534,372. The difference of $7,620,224 is a working
        capital deficit, which is primarily the result of losses incurred during
        the
        last several 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 the collection of receivables
        that we retained after completion of the asset sale transactions 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 (used in) operating activities was $(846,519) and $6,890,371
        in the
        six months ended March 31, 2007 and 2006, respectively.
  **18**
  Net
        cash
        provided by investing activities was $621,212 and $681,608 in the six months
        ended March 31, 2007 and 2006, respectively. Net cash received in connection
        with the sale of discontinued operations was $650,901 (comprised of earnout
        payments) and $702,581 (including earnout payments of $294,145), in the six
        months ended March 31, 2007 and 2006, respectively. Cash used for capital
        expenditures was $29,689 and $27,582 in the six months ended March 31, 2007
        and
        2006, respectively.
 
 Net
        cash
        provided by (used in) financing activities was $156,838 and $(7,559,222)
        in the
        six months ended March 31, 2007 and 2006, respectively. We had net borrowings
        (repayments) of $143,867 and $(6,071,490) under our line of credit in the
        six
        months ended March 31, 2007 and 2006, respectively. Net short-term borrowings
        (repayments) were $10,629 and $(9,002) in the six months ended March 31,
        2007
        and 2006, respectively. Net short-term borrowings in the six months ended
        March
        31, 2007, includes $100,000 loaned to us by our Chief Executive Officer,
        which
        was repaid in January 2007 and $20,000 which was loaned to us by a significant
        shareholder. Payments of notes payable - acquisitions was $7,033 and $38,999
        in
        the six months ended March 31, 2007 and 2006, respectively. We paid $1,425,000
        in the six months ended March 31, 2006, against a note payable to Pinnacle
        Investment Partners, L.P., a related party.
 
 Our
        principal uses of cash are to fund temporary employee payroll expense and
        employer related payroll taxes, investment in capital equipment, expansion
        of
        services offered, workers’ compensation, general liability and other insurance
        coverages, and debt service.
 
 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 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.
   **19**
  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
        reserves and withholds 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.
  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 March 31, 2007, there was still an aggregate of $3.4 million in delinquent
        payroll taxes outstanding, including interest and penalties, which are included
        in “Payroll taxes payable” on the balance sheet as of March 31, 2007. 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
        July
        2003, we entered into an agreement with the holder of our Series A Preferred
        Stock pursuant to which we agreed to redeem the aggregate 1,458,933 shares
        of
        Series A Preferred Stock then outstanding. The agreement, as amended in March
        2004, provided that our obligation to redeem the Series A Preferred Stock
        was
        contingent upon the sale of not less than $1,000,000 units in our “best efforts”
public offering of units. This condition was satisfied in July 2004. As a
        result, we paid $500,000 and issued 1,750,000 shares of common stock to the
        Series A holder and redeemed all of the Series A Preferred Stock following
        the
        initial closing of the offering. We were obliged to pay the Series A holder
        an
        additional $250,000 by January 31, 2005, at our option, issue to the Series
        A
        holder shares of common stock having an aggregate market value of $250,000,
        based upon the average closing bid prices of the common stock for the 30
        days
        preceding January 31, 2005. We failed to make the $250,000 payment in cash
        or
        stock. Accordingly, we are required to pay $300,000 in cash, plus accrued
        interest at the rate of 18% per year from the date of default until the date
        the
        default is cured, to the former holder of the Series A Preferred Stock. The
        former holder of the Series A Preferred Stock has threatened to institute
        litigation against us related to this matter and the Asset Sales. We are
        currently in discussions with the former holder of the Series A Preferred
        Stock
        to try to resolve all issues.
 
 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 (the
“Convertible Note”) in exchange for all of such shares of Series I Preferred
        Stock. (See Note 9 to the Condensed Consolidated Financial
        Statements).
 
 As
        of
        March 31, 2007, 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
        $8,037,444.
 
 We
        engaged in various transactions with related parties during the six months
        ended
        March 31, 2007 including the following:
 
  **20**
  
 •
              At
                  March 31, 2007, 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,
                  our
                  Chairman, President and CEO; $4,123 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; $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. We borrowed $100,000 from Joseph J. Raymond in
                  December
                  2006 and repaid it in January 2007. We also borrowed $20,000 from
                  a
                  significant shareholder in January 2007, which is still outstanding
                  at
                  March 31, 2007.•
              The
                  nephew of our Chairman, President and CEO is affiliated with Pinnacle
                  Investment Partners, LP (“Pinnacle”), which is the holder of the
                  Convertible Note issued in exchange for our Series I Preferred
                  Stock. As
                  of March 31, 2007, $616,850 was outstanding on the Convertible
                  Note.•
              On
                  February 13, 2007, we acquired from Fusion Business Services, LLC
                  (“Fusion”) an additional 1% interest in STS in exchange for the issuance
                  to the members of Fusion of 70,111 shares of our common stock.
                  As a result
                  of the transfer, which was effective as of January 1, 2007, we
                  own a 51%
                  interest in STS and Fusion owns a 49% interest. Fusion has a right
                  to
                  re-acquire the 1% interest transferred to the Company upon the
                  occurrence
                  of certain events, including the institution of bankruptcy or insolvency
                  proceedings against us, a sale of all or substantially all of our
                  assets,
                  a merger or consolidation of us with another entity, or the liquidation
                  or
                  dissolution of us. The purchase price payable by Fusion in connection
                  with
                  any such re-acquisition shall be a return of the shares issued
                  to it for
                  the 1% interest or a cash payment of $1,262. A son of our CEO has
                  a
                  majority interest in Fusion.
 
 **Contractual
        Obligations**
 
 Our
        aggregate contractual obligations are as follows:
 
 **Payments
                  Due by Fiscal Period (in Thousands)****2009
                  -**
              
              **2011
                  -****Total**
              
              **2008**
              
              **2010**
              
              **2012**
              
              **Thereafter**Contractual
                  Obligations:Long-term
                  debt obligations
              
              $
              1,445
              
              $
              841
              
              $
              445
              
              $
              159
              
              $
              -Operating
                  lease obligations
              
              
              219
              
              
              60
              
              
              119
              
              
              40
              
              
              -Series
                  A redemption payable
              
              
              300
              
              
              300
              
              
              -
              
              
              -
              
              
              -Payroll
                  tax liability (a)
              
              
              122
              
              
              122
              
              
              -
              
              
              -
              
              
              -Workers’
                  compensation insurance liability (b)
              
              
              287
              
              
              41
              
              
              144
              
              
              102
              
              
              -TOTAL
              
              $
              2,373
              
              $
              1,364
              
              $
              708
              
              $
              301
              
              $
              -
 
 (a)
              Exclusive
                  of interest and penalties. Payments may be accelerated based upon
                  future
                  operating result benchmarks.(b)
              In
                  December 2006, we entered into an agreement with the California
                  Compensation Insurance Fund (“the Fund”) whereby the Fund agreed to reduce
                  our then liability of $2,023,000 to $300,000 provided that we make
                  certain
                  monthly payments aggregating $300,000 over 56 months. At March
                  31, 2007,
                  $2,005,000 is included in accounts payable and accrued expenses
                  on the
                  attached condensed consolidated balance sheet. The difference of
                  $1,723,000 has not been recognized in earnings at this time since
                  it is
                  contingent upon our paying the $300,000 in accordance with the
                  terms of
                  the agreement.
 
 **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
        July
        2006, the Financial Accounting Standards Board issued FASB Interpretation
        No. 48
        (FIN 48), “Accounting for Uncertainty in Income Taxes - an interpretation of
        FASB Statement No. 109”. FIN 48 provides guidance for the recognition,
        measurement, classification and disclosure of the financial statement effects
        of
        a position taken or expected to be taken in a tax return (“tax position”). The
        financial statement effects of a tax position must be recognized when there
        is a
        likelihood of more than 50 percent that based on the technical merits, the
        position will be sustained upon examination and resolution of the related
        appeals or litigation processes, if any. A tax position that meets the
        recognition threshold must be measured initially and subsequently as the
        largest
        amount of tax benefit that is greater than 50 percent likely of being
  **21**
  realized
        upon ultimate settlement with a taxing authority. The interpretation is
        effective for fiscal years beginning after December 15, 2006. The Company
        does
        not expect its adoption of FIN 48 to have a material impact on its consolidated
        financial portion, results of operations or cash flows.
 
 In
        September 2006, the Financial Accounting Standards Board issued Statement
        of
        Financial Accounting Standards No. 157 (“SFAS”) No. 157, “Fair Value
        Measurements”. This Statement defines fair value, establishes a framework for
        measuring fair value in generally accepted accounting principles (GAAP),
        and
        expands disclosures about fair value measurements. The Statement applies
        under
        other accounting pronouncements that require or permit fair value measurements.
        SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
        or
        the Company’s fiscal year ending September 30, 2009. The Company does not expect
        the adoption of this new standard to have a material impact on its consolidated
        financial position, results of operations or cash flow.
 
 In
        September 2006, the Financial Accounting Standards Board issued Statement
        of
        Financial Accounting Standards No. 158, “Employers’ Accounting for Defined
        Benefit Pension and Other Postretirement Plans”. This Statement improves
        financial reporting by requiring an employer to recognize the overfunded
        or
        underfunded status of a defined benefit postretirement plan as an asset or
        liability in its statement of financial position and to recognize changes
        in
        that funded status in the year in which the changes occur through comprehensive
        income. This Statement also improves financial reporting by requiring an
        employer to measure the funded status of a plan as of the date of its year-end
        statement of financial position, with limited exceptions. The effective date
        to
        initially recognize the funded status and to provide the required disclosures
        is
        for fiscal years ending after December 15, 2006, or the Company’s fiscal year
        ending September 30, 2007. The requirement to measure plan assets and benefit
        obligations is effective for fiscal years ending after December 15, 2008,
        or the
        Company’s fiscal year ending September 30, 2009. The Company does not expect the
        adoption of this new standard to have a material impact on its consolidated
        financial position, results of operations or cash flows.
 
 In
        February 2007, the Financial Accounting Standards Board issued Statement
        of
        Financial Accounting Standards No. 159, “The Fair Value Option for Financial
        Assets and Financial Liabilities” and is effective for fiscal years beginning
        after November 15, 2007. This Statement permits entities to choose to measure
        many financial instruments and certain other items at fair value. The objective
        is to improve financial reporting by providing entities with the opportunity
        to
        mitigate volatility in reported earnings caused by measuring related assets
        and
        liabilities differently without having to apply complex hedge accounting
        provisions. We are currently assessing the impact the adoption of this
        pronouncement will have on our financial statements.
 
 **Sensitive
        Accounting Estimates**
 
 The
        preparation of financial statements in conformity with generally accepted
        accounting principles requires management to make estimates and assumptions
        that
        affect the amounts reported in the financial statements and notes. Significant
        estimates include management’s estimate of the carrying value of accounts
        receivable, the impairment of goodwill and the establishment of valuation
        reserves offsetting deferred tax assets. Actual results could differ from
        those
        estimates. The Company’s critical accounting policies relating to these items
        are described in the Company’s Annual Report on Form 10-K for the year ended
        September 30, 2006. As of March 31, 2007, there have been no material changes
        to
        any of the critical accounting policies contained therein.
  Item
          3
          -QUANTITATIVE
          AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
 
 We
        are
        subject to the risk of fluctuating interest rates in the ordinary course
        of
        business for borrowings under our Factoring Agreement, which provides for
        the
        sale of up to $1,500,000 of accounts receivable to Action Capital. Advances
        under this agreement bear interest at an annual rate of prime plus 1%, plus
        a
        monthly management fee of.6% on the dail average of unpaid
        balances.
 
 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 our internal control over financial reporting discussed below,
        our disclosure controls and procedures were effective as of the end of the
        period covered by this report.
  **22**
  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, represented a material weakness in our review of
        applicable financial reporting regulatory requirements when preparing our
        financial statements for such period. 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 addressed 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.
 
 In
        addition, 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.
 
 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.
 
 Other
        than the continued implementation of the improvements in our internal controls
        described above, there were no significant changes in our internal controls
        during the quarter ended March 31, 2007, that have materially affected, or
        are
        reasonably likely to have materially affected, our internal controls subsequent
        to the date we carried out our evaluation.
 
 
  **23**
  
 **Part
                  II**
              **Other
                  Information****Item
                  1.**
              **Legal
                  Proceedings**
 
 We
        are
        involved, from time to time, in routine litigation arising in the ordinary
        course of business. We do not believe that any currently pending litigation
        will
        have a material adverse effect on our financial position or results of
        operations.
 
 **Item
                  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, 2006.
 
 **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, $116,718 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 March 31, 2006.
 
 **Item
                  5.**
              **Other
                  Information**
 
 Not
        applicable.
 
 **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
 
  **24**
  **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: May
                10,
                2007
              By:
              /s/ Joseph
                J.
                RaymondChairman
                  of the
                  Board of Directors,
                President and Chief Executive
                  Officer
 
 Date: May
                10,
                2007
              By:
              /s/ Michael
                A. MaltzmanVice
                  President and Chief Financial Officer
                Principal Financial and Accounting
                  Officer
 
 25