ITEM 3. LEGAL PROCEEDINGS

Our net loss was $3,870,387 for the fiscal year ended September 30, 2006 compared to $903,508 for the year ended September 30, 2005.

BENEFICIAL CONVERSION FEATURE - PREFERRED STOCK

During fiscal 2006 and 2005, we recorded a deemed preferred stock dividend of $500,000 and $1,000,000, respectively, which relates to our Series A and B Convertible Preferred Stock. This non-cash expense related to the beneficial conversion features of those securities and is recorded with a corresponding credit to paid in capital.

NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS

We reported a net loss attributable to common shareholders of $4,370,387 for fiscal 2006 as compared to a net loss attributable to common shareholders of $1,903,508 in fiscal 2005. This translates to an overall per-share loss available to shareholders of $.60 for fiscal 2006 compared to per-share loss of $.32 for fiscal 2005.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. The following table provides certain selected balance sheet comparisons between September 30, 2006 and September 30, 2005:

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		September 30,						$ of			% of
		2006			2005			Change			Change
Working capital (deficit)		$	(1,626,966	)	$	319,137		$	(1,946,103	)		-609.8	%
Cash		$	432,885		$	557,175		$	(124,290	)		-22.3	%
Accounts receivable, net		$	1,264,065		$	1,577,460		$	(313,395	)		-19.9	%
Total current assets		$	1,706,621		$	2,221,916		$	(515,295	)		-23.2	%
Property and equipment, net		$	424,559		$	259,852		$	164,707			+63.4	%
Goodwill		$	211,600		$	41,800		$	169,800			+406.2	%
Intangibles, net		$	40,000		$	68,525		$	(28,525	)		-41.6	%
Deferred financing costs, net		$	159,999		$	180,000		$	20,001			-11.1	%
Total assets		$	2,595,875		$	2,788,263		$	(192,388	)		-6.9	%
Notes payable		$	1,200,770		$	0		$	1,200,770			+100.0	%
Equipment financing payable		$	262,296		$	0		$	262,296			+100.0	%
Accounts payable		$	894,390		$	904,910		$	(10,520	)		-1.2	%
Accrued expenses		$	679,544		$	37,488		$	642,056			+1,712.7	%
Advances from related party		$	8,123		$	86,001		$	(77,878	)		-90.6	%
Preferred stock to be issued		$	0		$	408,836		$	(408,836)			-100.0	%
Total current liabilities		$	3,333,587		$	1,902,779		$	1,430,808			+75.2	%
Note payable - related parties		$	328,099		$	215,625		$	112,474			+52.2	%
Total liabilities		$	3,666,556		$	2,118,404		$	1,548,152			+73.1	%
Accumulated (deficit)		$	(10,871,042	)	$	(6,500,655	)	$	4,370,387			+67.2	%
Stockholders' equity (deficit)		$	(1,070,681	)	$	669,859		$	(1,740,540	)		+259.8	%

 

At September 30, 2006, we had a working capital deficit of $(1,626,966) compared to working capital of $319,137 at September 30, 2005, a change of $(1,946,103).  The increase is attributable to an increase in borrowing under a factoring agreement of $1,000,770, an increase in equipment financing payables of $262,296 and an increase in accrued expenses.

Net cash used in operating activities was $1,009,521 for the year ended September 30, 2006 as compared to net cash used in operating activities of $920,515 for the year ended September 30, 2005, an increase of $89,006. The increase in cash used in operations is primarily due to an increase in net loss. For the year ended September 30,2006, our cash used in operations of $1,009,521 consisted of a net loss of $3,870,387 offset by non-cash items such as depreciation and amortization of $227,547, interest expense recorded from stock issued for notes payable of $351,805, the impairment of goodwill of $220,800, stock-based compensation of $734,864 and other non-cash items of $269,307. Additionally, we had an increase in operating liabilities and a decrease in operating assets which offset our net loss. This change in operating assets and liabilities primarily consisted of a decrease in accounts receivable of $299,819 attributable to a decrease in sales, an increase in accounts payable and accrued expenses of $532,925, and an increase of in accrued interest payable of $254,178. For the year ended September 30,2005, our cash used in operations of $920,515 consisted of a net loss of $903,508 offset by non-cash items such as depreciation and amortization of $833,580, interest expense recorded from stock issued for notes payable of $37,500, and other non-cash items of $3,167. Additionally, we had a decrease in operating liabilities and an increase in operating assets. This change in operating assets and liabilities primarily consisted of an increase in accounts receivable of $517,920 and a decrease in accounts payable and accrued expenses of $271,578, and an increase of in accrued interest payable of $254,178.

Net cash used in investing activities for the year ended September 30, 2006 was $539,317 as compared to net cash used in investing activities of $233,224 for fiscal 2005. During fiscal 2006, we acquired a company and in connection therewith used cash of $185,247. Additionally, we used cash of $354,070 for property and equipment purchases and to fund our software development during fiscal 2006. In fiscal 2005, we purchased equipment and software amounting to $224,698 and acquired intangible assets of $8,526 which represented the cash used in investing activities. We did not have any company acquisitions or similar transactions during fiscal 2005.

Net cash provided by financing activities for fiscal 2006 was $1,424,548 as compared to $1,532,133 for fiscal 2005, a decrease of $107,585. The primary reason for the increase was a decrease of $1,377,134 in net proceeds from the sale of equity securities and exercise of warrants and options during fiscal 2006 as compared to fiscal 2005 offset by an increase in borrowings of $1,269,549.

At September 30, 2005 we had an accumulated deficit of $10,871,042 and the report from our independent registered public accounting firm on our audited financial statements at September 30, 2006 contained an explanatory paragraph regarding doubt as to our ability to continue as a going concern as a result of our net losses in operations. Our revenues declined significantly in fiscal 2006 from fiscal 2005, we reported a net loss of $3,870,387 for fiscal 2006 and a net loss attributable to common shareholders of $4,370,387. Subsequent to September 30, 2006 we have sold two subsidiaries which accounted for approximately 10% of our fiscal 2006 revenues. There is no assurance that we will be able to maintain or increase our revenues in fiscal 2007 or that we will report net income in any future periods.

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Historically, our revenues have not been sufficient to fund our operations and we have relied on capital provided through the sale of equity securities, and various financing arrangements and loans from related parties. At September 30, 2006 we had cash on hand of $432,885. In fiscal 2006, we entered into a receivable factoring agreement with Sand Hill Finance, LLC under which we can sell certain accounts receivable to the lender on a full recourse basis at 80% of the face amount of the receivable up to an aggregate of $1.8 million. We agreed to pay Sand Hill Finance, LLC an annual commitment fee of $10,000 and a monthly finance fee of 2% of the average daily balance under the line. We granted Sand Hill Finance, LLC a blanket security interest in our assets and agreed to refrain from certain actions while the line is outstanding. As of September 30, 2006 and as of January 31, 2007, we had approximately $700,000 and $650,000 available under this line of credit.

We do not have any working capital commitments nor do we not presently have any external sources of working capital other than what may be available under the factoring agreement and loans from related parties. Our working capital needs in future periods primarily on the rate at which we can increase our revenues while controlling our expenses and decreasing the use of cash to fund operations. Additional capital may be needed to fund acquisitions of additional companies or assets, although we are not a party to any pending agreements at this time and, accordingly, cannot estimate the amount of capital which may be necessary, if any, for acquisitions.

As long as our cash flow from operations remains insufficient to completely fund operations, we will continue depleting our financial resources and seeking additional capital through equity and/or debt financing. In March 2005 we sold shares of our Series A Convertible Preferred Stock and in December 2005 we sold shares of our Series B Convertible Preferred Stock to the same purchaser. The designations of these shares included a restriction that so long as the shares are outstanding, we cannot sell or issue any common stock, rights to subscribe for shares of common stock or securities which are convertible or exercisable into shares of common stock at an effective purchase price of less than the then conversion value which is presently $0.60 per share for the Series A Convertible Preferred Stock and $0.2727 for the Series B Convertible Preferred Stock. Under the terms of the Series B Convertible Preferred Stock transaction, we also agreed not to issue any convertible debt or preferred stock. The terms of our sales of our Series A Convertible Preferred Stock and Series B Convertible Preferred Stock to Barron Partners contain restrictions on the types of financing transactions we can enter into while those securities are outstanding which may adversely effect our ability to raise capital in equity or debt transactions. In addition, under the terms of the financing agreement with Sand Hill Finance, LLC we agreed not to incur any additional indebtedness other than trade credit in the ordinary course of business. These covenants may also limit our ability to raise capital in future periods. There can be no assurance that acceptable financing can be obtained on suitable terms, if at all. Our ability to continue our existing operations and to fund our working capital needs will suffer if we are unable to raise the additional funds on acceptable terms which will have the effect of adversely affecting our ongoing operations and limiting our ability to increase our revenues and maintain profitable operations in the future. If we are unable to secure the necessary additional working capital as needed, we may be forced to curtail some or all of our operations.

CRITICAL ACCOUNTING POLICIES

Financial Reporting Release No. 60, which was released by the U.S. Securities and Exchange Commission, encourages all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our consolidated financial statements include a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. Management believes the following critical accounting policies affect the significant judgments and estimates used in the preparation of the financial statements.

Use of Estimates - Management's Discussion and Analysis or Plan of Operations is based upon our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates these estimates, including those related to allowances for doubtful accounts receivable, the carrying value of property and equipment and long-lived assets, and the value of stock-option based compensation. Management bases these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition - We follow the guidance of the Securities and Exchange Commission’s Staff Accounting Bulletin 104 for revenue recognition.  In general, we record revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured.  The following policies reflect specific criteria for the various revenues streams of the Company:

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Revenues from sales of products are generally recognized when products are shipped unless we have obligations remaining under sales or licensing agreements, in which case revenue is either deferred until all obligations are satisfied or recognized ratably over the term of the contract.

Revenue from services is recorded as it is earned. Commissions earned on third party sales are recorded in the month in which contracts are awarded. Customers are generally billed every two weeks based on the units of production for the project. Each project has an estimated total which is based on the estimated units of production and agreed upon billing rates. Amounts billed in advance of services being provided are recorded as deferred revenues and recognized in the consolidated statement of operations as services are provided.

Accounting for Stock Based Compensation - Effective October 1, 2005, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share Based Payment ("SFAS No. 123R"). SFAS No. 123R establishes the financial accounting and reporting standards for stock-based compensation plans. As required by SFAS No. 123R, we recognize the cost resulting from all stock-based payment transactions including shares issued under our stock option plans in the financial statements. The adoption of SFAS No. 123R will have a negative impact on our future results of operations.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board has recently issued several new accounting pronouncements:

In February 2006, the FASB issued SFAS 155, which applies to certain "hybrid financial instruments," which are instruments that contain embedded derivatives. The new standard establishes a requirement to evaluate beneficial interests in securitized financial assets to determine if the interests represent freestanding derivatives or are hybrid financial instruments containing embedded derivatives requiring bifurcation. This new standard also permits an election for fair value re-measurement of any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation under SFAS 133. The fair value election can be applied on an instrument-by-instrument basis to existing instruments at the date of adoption and can be applied to new instruments on a prospective basis. The adoption of SFAS No.155 did not have a material impact on the Company's financial position and results of operations.

In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This statement requires all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. SFAS No. 156 is effective for an entity's first fiscal year beginning after September 15, 2006. The adoption of this statement is not expected to have a significant effect on the Company's future reported financial position or results of operations.

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109." This interpretation provides guidance for recognizing and measuring uncertain tax positions, as defined in SFAS No. 109, "Accounting for Income Taxes." FIN No. 48 prescribes a threshold condition that a tax position must meet for any of the benefit of an uncertain tax position to be recognized in the financial statements. Guidance is also provided regarding de-recognition, classification, and disclosure of uncertain tax positions. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect that this interpretation will have a material impact on its financial position, results of operations, or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("FAS 157"). This Statement defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosure related to the use of fair value measures in financial statements. The Statement is to be effective for the Company's financial statements issued in 2008; however, earlier application is encouraged. The Company is currently evaluating the timing of adoption and the impact that adoption might have on its financial position or results of operations

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

ITEM 7. Financial Statements

 

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