~~Number~~UNITED ofSTATES SECURITIES ~~securities~~AND ~~remaining~~EXCHANGE available for Number of securities future issuance under to be issued upon Weighted-average equity compensation exercise of exercise price of plans (excluding outstanding options, outstanding options, securities reflected in Plan category warrants and rights warrants and rights column (a) ------------- --------------------- -------------------- ----------------------- (a) (b) (c) Equity compensation plans approved by security holders ............. 2,462,343 $1.57 3,665,500 Equity compensation plans not approved by security holders ............. -- -- -- Total ............. 2,462,343 $1.57 3,665,500COMMISSION

~~2004 2003 2002 2001 2000 ---- ---- ---- ---- ---- Operating revenues $ 49~~Washington,~~947 $ 52,647 $ 60,077 $ 44,910 $ 1,962 Loss from continuing operations (18,935) (4,203) (12,379) (10,822) (3,947) Loss from continuing operations - per share (~~ D.~~40)~~ (C.~~12)~~ ~~(.43) (.63) (.25) Loss from discontinued operations - per share -- (.26) (.24) -- -- Total assets 45,649 53,127 80,519 33,997 12,525 Long term debt 3,505 5,000 -- -- --~~20549

~~Payments due by period (in thousands) Less than More than Total 1 year 1~~FORM 10-3 years 3-5 years 5 years Contractual Obligations Long-Term Debt Obligations 5,775 1,891 3,884 -- -- Operating Lease Obligations 1,720 874 529 317 -- ------ ------ ------ ------ ---- Total $7,495 $2,765 $4,413 $ 317 -- ====== ====== ====== ====== ====K

~~------------------------------~~x ANNUAL REPORT ~~ASSETS~~PURSUANT ~~June~~TO ~~30,~~SECTION 13 ~~2004~~OR June 30, 2003 ------ ------------- ------------- CURRENT ASSETS: Cash $ 2,810 $ -- Cash - Restricted 479 920 Accounts receivable, net of allowance for doubtful accounts of $240 and $463 12,045 9,370 Inventory 1,399 351 Prepaid expenses and other assets 54 151 Other receivables 88 122 --------- --------- TOTAL CURRENT ASSETS 16,875 10,914 RESTRICTED CASH - over one year 91 317 INVESTMENTS - Marketable Securities 78 282 INVESTMENTS - Preferred Stock 1,104 -- PROPERTY AND EQUIPMENT, net of accumulated depreciation of $3,035 and $2,904 519 624 GOODWILL 19,869 31,214 CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $809 and $594 163 483 ACQUIRED CUSTOMER LISTS, net of accumulated amortization of $7,136 and $4,955 5,542 7,602 PURCHASED SOFTWARE, net of accumulated amortization of $671 and $498 19 192 DEFERRED FINANCING COSTS, net of accumulated amortization of $77 655 -- NOTES RECEIVABLE, long term, including receivable from officer of $100 548 1,204 DEPOSITS AND OTHER ASSETS 186 295 --------- --------- $ 45,649 $ 53,127 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable $ 5,897 $ 11,714 Line of credit 2,454 708 Accrued expenses 1,468 2,271 Deferred revenue 559 981 Notes payable accrued interest 79 625 Notes payable-current portion 1,812 -- Current liabilities of discontinued operations 4,181 5,888 --------- --------- TOTAL CURRENT LIABILITIES 16,450 22,187 DEFERRED REVENUE - long term 91 317 LONG TERM NOTE PAYABLE 3,505 5,000 --------- --------- TOTAL LIABILITIES 20,046 27,504 --------- --------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.0001 par value, 10,000,000 shares authorized; 683,317 and 1,490,437 shares issued and outstanding as of June 30, 2004 and June 30, 2003, respectively 1 1 Class A Common stock, $.0001 par value, 150,000,000 shares authorized; 58,430,597 and 38,382,705 shares issued and outstanding as of June 30, 2004 and June 30, 2003, respectively 5 4 Additional paid-in capital 100,822 81,918 Accumulated other comprehensive loss 15(~~170~~d) OF ~~(244)~~THE ~~Accumulated~~SECURITIES ~~deficit~~EXCHANGE ~~(75,055)~~ACT OF ~~(56,056) --------- --------- TOTAL STOCKHOLDERS' EQUITY 25,603 25,623 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 45,649 $ 53,127 ========= =========~~1934

~~Years~~For the ~~Ended~~year ~~June~~ended June 30, ----------------------------------------------- 2004 2003 2002 ------------ ------------ ------------ REVENUES Product Revenues $ 22,782 $ 21,882 $ 31,055 Service Revenues 27,165 30,765 29,022 ------------ ------------ ------------ TOTAL REVENUES 49,947 52,647 60,077 ------------ ------------ ------------ COST OF REVENUES Cost of Products 19,031 18,540 26,392 Cost of Services (net of $5 million reimbursement in 2002) 21,980 24,548 22,197 ------------ ------------ ------------ TOTAL COST OF REVENUES 41,011 43,088 48,589 ------------ ------------ ------------ GROSS PROFIT 8,936 9,559 11,488 ------------ ------------ ------------ OPERATING EXPENSES: Selling costs 7,125 7,443 10,507 General and administrative expenses 5,050 3,759 5,279 Non Cash Charge Options and Warrants-General and administrative -- -- 325 Application development -- -- 492 Depreciation and amortization 2,985 2,729 2,720 Impairment of goodwill 11,600 600 1,135 ------------ ------------ ------------ TOTAL OPERATING EXPENSES 26,760 14,531 20,458 ------------ ------------ ------------ LOSS FROM OPERATIONS (17,824) (4,972) (8,970) ------------ ------------ ------------ OTHER INCOME (EXPENSE) Loss on marketable securities (207) -- (1,241) Equity interest in loss of investee (64) (72) (220) Interest expense (942) (1,175) (2,582) Interest income 102 69 294 Other income (expense), net -- 1,947 142 ------------ ------------ ------------ TOTAL OTHER INCOME ( EXPENSE) (1,111) 769 (3,607) ------------ ------------ ------------ LOSS FROM CONTINUING OPERATIONS BEFORE (18,935) (4,203) (12,577) INCOME TAXES INCOME TAX BENEFIT -- -- (198) ------------ ------------ ------------ LOSS FROM CONTINUING OPERATIONS (18,935) (4,203) (12,379) ------------ ------------ ------------ DISCONTINUED OPERATIONS Gain (Loss) on disposal of discontinued operations 392 (6,309) -- Loss on discontinued operations (456) (3,257) (7,034) ------------ ------------ ------------ TOTAL LOSS FROM DISCONTINUED OPERATIONS (64) (9,566) (7,034) ------------ ------------ ------------ ------------ ------------ ------------ NET LOSS $ (18,999) $ (13,769) $ (19,413) ------------ ------------ ------------ NET LOSS PER SHARE: Continued $ (0.40) $ (0.12) $ (0.43) Discontinued -- (0.26) (0.24) ------------ ------------ ------------ NET LOSS PER SHARE - basic and diluted $ (0.40) $ (0.38) $ (0.67) ============ ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION-BASIC AND DILUTED 47,301,707 36,639,261 29,103,092 ============ ============ ============ NET LOSS $ (18,999) $ (13,769) $ (19,413) OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX Unrealized gain (loss) on available-for-sale securities 74 (113) 823 ------------ ------------ ------------ COMPREHENSIVE LOSS $ (18,925) $ (13,882) $ (18,590) ============ ============ ============2006

Class A Class B Unrealized Preferred Stock Common Stock Common Stock Additional Gain Total ------------------- ------------------- ------------------- Paid-In (Loss) on Accumulated Stockholders' Shares Amount Shares Amount Shares Amount Capital Securities Deficit Equity --------- --------- -------- -------- -------- -------- ---------- ----------- ----------- ------------- Balance - June 30, 2001 2,190 1 19,470 2 40,060 (954) (22,874) 16,235 Shares issued in connection with the acquisition of DMR 18,337 2 40,339 40,341 Shares issued in connection with the exercise of employee stock options 184 131 131 Conversion of short-term notes to subscriptions due 316 473 473 Shares issued in connection with private offering 625 938 938 Subscriptions due in connection with private offering 1,962 1,962 Shares due for services rendered 58 58 Discount on short-term notes payable 591 591 Deferred finance costs 115 115 Beneficial conversion feature 763 763 Convert preferred stock to common (574) 1,433 -- -- Convert shares issued in connection with BugSolver, Inc. private offering 1,500 222 222 Shares issued in connection with the acquisition of Big Technologies 78 216 216 Options issued for services 325 325 Retirement of shares (72) -- -- Changes in unrealized gain (loss) on securities available for sale 823 823 Net loss (19,413) (19,413) -------- ------- -------- ------- -------- -------- ---------- --------- ---------- --------- Balance - June 30, 2002 1,616 $ 1 23,534 $ 2 18,337 $ 2 $ 86,193 $ (131) $ (42,287) $ 43,780 Conversion of short-term notes to private offering 776 1 -- Shares issued in connection with private offering 726 12 12 Shares issued for services rendered 25 50 50 Convert preferred stock to common (126) 314 -- -- Buyback of Class B shares (8,000) (1) (4,999) (5,000) Convert Class B shares to Class A 10,337 1 (10,337) (1) -- 1 Shares issued in connection with private offering 2,889 1,111 1,111 Options issued for services -- 16 16 Stock option exercise 10 10 10 Retirement of shares (300) (435) (435) Reverse Retirement of shares 72 (7) (7) Stock Fees (33) (33) Changes in unrealized gain (loss) on securities available for sale (113) (113) Net loss (13,769) (13,769) -------- ------- -------- ------- -------- -------- ---------- --------- ---------- --------- Balance - June 30, 2003 1,490 $ 1 38,383 $ 4 -- $ -- $ 81,918 $ (244) $ (56,056) $ 25,623 Convert preferred stock to common (807) 2,018 -- Shares issued in connection with private offering 15,811 1 11,000 11,001 Warrant exercise 1,383 1,041 1,041 Options exercise 4 4 4 Shares issued in connection with the acquisition of Woda & Associates 263 200 200 Shares issued in connection with the acquisition of Entellus 108 90 90 Cancellation of Note Payable 5,625 5,625 Shares issued in connection with convertible debt repayment 250 225 225 Convertible debt warrant discount 499 499 Shares issued in connection with convertible debt to placement agent 161 170 170 Shares issued for services 50 50 50 Changes in unrealized gain (loss) on securities available for sales 74 74 Net loss (18,999) (18,999) -------- ------- -------- -------- -------- -------- ---------- --------- ---------- --------- Balance - June 30, 2004 683 $ 1 58,431 $ 5 -- $ -- $ 100,822 $ (170) $ (75,055) $ 25,603 ======== ======= ======== ======== ======== ======== ========== ========= ========== =========OR

~~Years~~o TRANSITION REPORT ~~Ended~~PURSUANT ~~June~~TO 30, --------------------------------- 2004 2003 2002 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss-Continuing operations $(18,935) $ (4,203) (12,379) -------- -------- -------- Adjustments to reconcile net loss, excluding discontinued operations, to net cash used in operating activities: Depreciation and amortization 2,665 2,729 2,720 Amortization of debt discount on short-term notes 41 -- 591 Amortization of deferred financing costs 79 -- -- Amortization of capitalized software costs 215 215 216 Write-down of capitalized software costs 105 -- -- Equity interest in loss of investee 64 72 220 Beneficial conversion feature of short-term notes -- -- 763 Loss (gain) on marketable securities 207 -- 1,241 Options and shares issued for services -- 16 370 Impairment of goodwill 11,600 600 1,135 Forgiveness of loan receivable from officer -- -- 70 Settlement of royalties, net -- (425) -- State audit assessment -- (1,861) 69 Changes in operating assets and liabilities: Accounts receivable (3,221) 642 4,431 Refund receivable -- 245 (245) Inventory (1,048) 657 609 Accrued interest income on note -- -- (392) Prepaid expenses 97 (23) 331 Deposits and other assets 89 95 (132) Accounts payable (5,775) (546) (2,284) Deferred revenue (648) (1,307) 76 Accrued expenses (810) (2,152) 749 Note Payable-accrued interest 79 625 -- Restricted cash 685 744 (1,177) -------- -------- -------- Total adjustments 4,424 326 9,361 -------- -------- -------- NET CASH USED IN CONTINUING OPERATIONS (14,511) (3,877) (3,018) NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES OF DISCONTINUED OPERATIONS (2,163) 1,655 (5,289) -------- -------- -------- NET CASH USED IN OPERATING ACTIVITIES (16,674) (2,222) (8,307) -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash proceeds from sale of discontinued operations 392 6,450 -- Cash received from purchase of subsidiary -- -- SECTION 13 ~~Cash~~OR ~~received from the sale of securities 71 -- -- Other notes receivable~~ 15(12d) 195 109 Capital expenditures (195) (109) (131) Net cash paid for acquisition -- -- -- Collection on note receivable -- 188 600 -------- -------- -------- NET CASH PROVIDED BY INVESTING ACTIVITIES 256 6,724 591 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from debt financing 6,000 -- 1,508 Deferred financing costs (564) Net proceeds (repayments) under line of credit 1,746 (5,639) 3,844 Issuance of subsidiary securities, net of expenses -- -- 62 Exercise of options and warrants 1,045 10 131 Issuance of Common Stock, net of expenses 11,001 1,101 1,692 -------- -------- -------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 19,228 (4,528) 7,237 NET INCREASE (DECREASE) IN CASH 2,810 (26) (479) CASH AT BEGINNING OF ~~YEAR~~THE --SECURITIES 26EXCHANGE ~~505 -------- -------- -------- CASH AT END~~ ACT OF ~~YEAR $ 2,810 $ -- $ 26 ======== ======== ========~~1934

~~Years~~For the ~~Ended~~transition ~~June~~period 30, ----------------------------- 2004 2003 2002 ---- ---- ---- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 681 $ 1,175 $ 690 Cash paid for income taxes $ 33 $ -- $ 47 SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES: Convertible notes converted from to common stock $ 225 $ -- $ 1,563 Note Receivable converted to preferred stock $ 1,104 $ -- $ -- Issuance of common stock in connection with convertible debt $ 170 $ -- $ -- Issuance of common stock in conjunction with acquisition of businesses $ 290 $ -- $40,341 Buyback of common stock in conjunction with note payable $ -- $ 5,000 $ -- Issuance of common stock for services rendered $ 50 $ 50 $ -- Reclassification of LaborSoft accounts receivable to notes receivable, net of reserve $ 436 $ -- $ -- Debt discount issued in connection with convertible debt $ 499 $ -- $ -- Cancellation of note payable and accrued interest by investors $ 5,625 $ -- $ --

~~(in~~COMMISSION FILE ~~thousands~~NUMBER ~~except per share data) Year Ended June 30,~~ 1----------------------------------------------- 2004 2003 2002 ---------- ---------- ---------- Net Loss $ (18,999) $ (13,769) $ (19,413) Stock-based employee compensation cost, net of tax effect, under fair value accounting (151) (399) (433) ---------- ---------- ---------- Pro-forma net loss under Fair Value Method $ (19,150) $ (14,168) $ (19,846) ---------- ---------- ---------- Loss per share Basic $ (0.40) $ (0.37) $ (0.67) Diluted $ (0.40) $ (0.37) $ (0.67) Per share stock-based employee compensation cost, net of tax effect, under fair value accounting: Pro-forma loss share basic $ (0.41) $ (0.38) $ (0.68) ========== =========== =========== Pro-forma loss share diluted $ (0.41) $ (0.38) $ (0.68) ========== =========== ===========11568

~~(in thousands of dollars) Balance at Charged to Charged to Balance Accounts Receivable Reserve beginning cost and Other Deduc- at end Activity for the year ended June 30~~DYNTEK,: of year expenses Accounts tions of year ------------------------------------- ------- -------- -------- ----- ------- 2004 $463 $ -- $ 200 $ (23) $ 240 2003 $609 $ -- $ -- $ (146) $ 463 2002 $205 $ 366 $ 38 $ (--) $ 609INC.

Stock options under Plans Other Options and Warrants ------------------------------------------------ ------------------------------------------------- Weighted Weighted Weighted Average Average Average Remaining Remaining Exercise Contractual Contractual Shares Price Life (~~years)~~Exact ~~Exerciseable~~Name ~~Shares~~of ~~Price~~Registrant as ~~Life~~Specified ~~(years)~~in ~~Exerciseable~~its --------- -------- ------------ ------------ ----------- ----- ------------ ------------ Outstanding at June 30, 2001 2,635,251 1.60 7.7 1,510,522 3,931,875 2.12 3.9 3,909,375 Granted 963,000 2.06 === ========= 1,259,255 1.61 === ========== Canceled (67,116Charter) 1.77 (839,389) 2.27 Exercised (109,139) 0.97 (74,711) 0.94 --------- ---------- Outstanding at June 30, 2002 3,421,996 1.81 5.6 2,221,377 4,277,000 1.96 3.5 4,072,000 ========= === ========= ========== === ========== Granted 160,000 1.81 9,389,388 3.49 Canceled (459,723) 1.92 (35,000) 2.06 Exercised 0 -- (10,000) 1.21 --------- ---------- Outstanding at June 30, 2003 3,122,273 1.77 4.9 2,766,937 13,621,388 3.02 3.2 13,621,388 ========= === ========= ========== === ========== Granted 50,000 .80 12,119,472 .93 Canceled (705,930) 2.37 (7,790,000) 1.34 Exercised (4,000) 1.09 (1,382,577) .75 --------- ---------- Outstanding at June 30, 2004 2,462,343 1.57 4.7 2,462,343 16,568,283 1.26 3.5 14,754,722 ========= === ========= ========== === ==========

Sep.30 Dec.31 Mar.31 Jun.30 Sep.30 Dec.31 Mar.31 Jun.30 2002 2002 2003 2003 2003 2003 2004 2004 -------- -------- -------- -------- -------- -------- -------- -------- Revenue $ 14,148 $ 11,840 $ 12,012 $ 14,647 $ 12,925 $ 9,801 $ 12,096 $ 15,125 Gross Profit $ 2,818 $ 1,989 $ 2,507 $ 2,245 $ 2,284 $ 1,353 $ 2,483 $ 2,816 Net Income (loss) Continuing Operations $ (1,185) $ (1,208) $ 848 $ (2,658) $ (1,522) $ (5,450) $ (984) $(10,979) Net Income (loss) Discontinued operations $ 84 $ 178 $ (342) $ (9,486) $ (175) $ (30) $ (23) $ 164 Basic and diluted income (loss) per share-Continuing Operations $ (.03) $ (.03) $ .03 $ (.08) $ (.04) $ (.12) $ (.02) $ (.23) Basic and diluted income (loss) per share-Discontinued Operations $ -- $ .01 $ (.01) $ (.26) $ -- $ -- $ -- $ --

DELAWARE		95-4228470
(State or other jurisdiction of incorporation or organization)		(I.R.S Employer Identification No.)

~~Annual~~19700 ~~Compensation~~Fairchild Long Term Compensation ------------ ---------------------- Other Annual Restricted All Other Fiscal Compen- Stock Options/ LTIP Compen- Name and Position Year Salary($) Bonus($) sation Awards SARs (#) Payouts sation ----------------- ------ --------- --------- ------------ ----------- -------- ------- --------- Steven J. Ross 2004 $430Road,~~000~~ ~~$125~~Suite 230 Irvine,~~000~~ ~~$100,000(1)~~CA -- 10,000 -- $12,669 President, Chief 2003 $400,000 $100,000 $ 25,000 -- -- -- -- Executive Officer 2002 $376,000 $205,000 $ 70,000 -- 75,000 -- $40,431 and Chairman of the Board James Linesch 2004 $179,200 -- $ 25,000 -- 10,000 -- $ 9,292 Chief Financial 2003 $200,000 $ 25,000 $ 25,000 -- -- -- $ 6,000 Officer, Executive 2002 $179,000 $ 75,000 $ 25,000 -- 45,000 -- $ 6,321 Vice President and Director Wade Stevenson 2004 $155,000 $ 10,000 -- -- -- $ 6,065 Vice President 2003 $140,000 $ 10,000 -- -- -- -- -- Finance 2002 $129,000 $ 20,000 -- -- -- -- -- Arion Kalpaxis 2004 $176,000 -- -- -- -- -- $12,307 Chief Technology 2003 $176,000 -- -- -- -- -- -- Officer 2002 $176,000 -- -- -- -- -- --92612

~~Number~~(Address of ~~Potential~~principal executive ~~Realizable Value at Securities Percent of Total Assumed Annual Rates Underlying Options/SARs Exercise or of Stock Price Options/SARs Granted in Base Price Appreciation Name Granted Fiscal Year ($/Sh~~offices) ~~for Option Term ---- ------------ ---------------- ----------- -----------------------------~~ (a)Zip (bcode) ~~(c) (d) 5% 10% Steven J. Ross 10,000 20% $.80 $400 $800 James Linesch 10,000 20% $.80 $400 $800 Wade Stevenson -- -- -- -- -- Arion Kalpaxis -- -- -- -- --~~

~~Number~~REGISTRANT’S ofTELEPHONE NUMBER, ~~Securities~~INCLUDING ~~Value~~AREA ofCODE: ~~Unexercised Underlying Unexercised In-The-Money Shares Options/SARs At Fiscal Options/SARs At Acquired on Value Year-End~~ (#949) ~~Fiscal Year~~271-end ($) Name Exercise (#) Realized ($) Exercisable/Unexercisable Exercisable/Unexercisable(1) ---- ------------ ------------ ------------------------- ---------------------------- (a) (b) (c) (d) (e) Steven J. Ross -- 0 954,000/0 $8,330/$0 James Linesch -- 0 410,000/0 $0/$0 Wade Stevenson -- 0 62,250/0 $0/$0 Arion Kalpaxis -- 0 15,000/0 $0/$06700

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.0001 par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 filings requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the issuer as of December 31, 2005 was approximately $4,217,912.

As of October 9, 2006, there were 56,054,526 shares of our common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on December 14, 2006 are incorporated by reference into Part III of this Annual Report on Form 10-K.

PART I

This Annual Report on Form 10-K contains forward-looking statements that have been made pursuant to the provisions of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995 and concern matters that involve risks and uncertainties that could cause actual results to differ materially from historical results or from those projected in the forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this Form 10-K. Words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable as of the date of this Report, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this Annual Report on Form 10-K. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations.

Readers should carefully review and consider the various disclosures made by us in this Report, set forth in detail in Item 1A of Part I, under the heading “Risk Factors,” as well as those additional risks described in other documents we file from time to time with the Securities and Exchange Commission, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business. We undertake no obligation to publicly release the results of any revisions to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.

ITEM 1. BUSINESS

GENERAL

We provide professional information technology (“IT”) services and sales of related products to mid-market commercial businesses, state and local government agencies, and educational institutions. We operate our business primarily through our subsidiary, DynTek Services, Inc.

Depending upon the context, the terms “DynTek,” “Company,” “we,” “our,” and “us,” refers to either DynTek, Inc. alone, or DynTek, Inc. and its subsidiaries collectively.

We provide a broad range of multi-disciplinary IT solutions that address the critical business needs of our clients, including IT security, converged networking (including voice-over-internet-protocol “VOIP”), application infrastructure, and access infrastructure. Our primary operations are located in four of the top ten largest IT spending states: California, New York, Florida, and Michigan. We deliver complex infrastructure technology solutions through teams of professional consultants in close geographic proximity to our clients. Members of our technical and consulting services team have advanced certifications with leading vendor-manufacturers, including Microsoft, Cisco, McAfee and Citrix. As a professional services firm and value-added reseller of hardware and software from leading manufacturers, we help organizations assess, design, build, implement, manage and support their technology infrastructure.

We believe that our services-led approach, combined with expertise in multi-disciplinary practice areas such as IT security, converged networking (VOIP), application and access infrastructure, will continue to provide the platform we need to capture an increasing share of our target markets. Our strategy allows our clients to rely on DynTek as their primary IT vendor. Additionally, we believe that our multi-disciplinary capabilities help differentiate us from our competitors in the markets in which we compete.

In September 2004 and October 2004, we closed the acquisitions of Redrock Communications Solutions, Inc. (“Redrock”), and Integration Technologies, Inc. (“ITI”), respectively. Both businesses were located in Southern California. In February 2005, we consolidated the operations of Redrock and ITI into one integrated region (the “Southwest Region”), with offices in Irvine, California and Las Vegas, Nevada. During the year ended June 30, 2006, the Southwest Region contributed approximately $26,629,000, or 33%, of our aggregate revenue of $80,831,000 and approximately $27,861,000, or 36%, of our aggregate revenue of $76,559,000 for the year ended June 30, 2005, which included 11 months of operations from Redrock and 9 months of operations from ITI. Our acquisitions of Redrock and ITI led us to increase our emphasis in obtaining commercial business. As a result, our customer mix changed from 68% government, 11% education, and 21% commercial during the year ended June 30, 2004 to 38% government, 9% education, and 53% commercial during the year ended June 30, 2005. Our customer mix for the year ended June 30, 2006 was 38% government, 11% education, and 51% commercial.

In June 2006 we purchased the customer list of the Long Island Division of TekConnect Corporation, a privately-held educational technology integration and consulting firm, comprised of specific IT services contracts and related assets. This acquisition contributed approximately $47,000 in revenue during the year ended June 30, 2006.

BUSINESS SEGMENTS

We report in two segments: Information Technology Solutions and Business Process Outsourcing.

Information Technology Solutions (“IT Solutions”)

We provide professional information technology services and sales of related products. Our information technology services include:

· information technology security solutions, which include vulnerability assessments, risk assessments, enterprise security assessments and similar services;

· converged networking solutions (design through implementation);

· application infrastructure solutions (active directory design, Microsoft Exchange migrations and similar solutions);

· access infrastructure solutions including server based computing, remote access and similar services; and

· general infrastructure support.

In connection with these service offerings, we sell hardware and software to our clients. We purchase products for re-sale from distributors or directly from manufacturers of hardware and software. The scope of services and product sales that we provide to any given client can vary according to the client’s need, project size, and internal client IT resources available. The majority of our IT service revenues and related product sales are derived from specific projects, as contracted.

We provide services to our clients through a combination of approximately 72 in-house engineers and consultants, and approximately 13 subcontracted third-party suppliers during the year ended June 30, 2006.

With increasing convergence and connectivity driving infrastructure complexity, IT clients are seeking solutions that provide secure and ubiquitous access to their applications and data. According to a Gartner, Inc. report published in June 2005, the IT services market in the United States is projected to grow from $241.9 billion in 2004 to $326.4 billion in 2009. While our target markets only represent a portion of the overall IT services market, these target markets are expected to grow at a compound annual growth rate of 6.2 percent. It is anticipated that this growth will be driven in part by pent-up demand for

technology upgrades, data security concerns, regulatory and compliance initiatives, such as the Sarbanes-Oxley Act, and the convergence of voice and data.

The following table sets forth our aggregate IT product sales, IT service sales and IT Solutions revenue, as well as the relative approximate percentages thereof in relation to our total revenue, for each of the last three fiscal years:

	Year ended June 30,
	2006					2005					2004
IT Product Sales		$	56,458,000	(70	)%		$	45,490,000	(59	)%		$	22,884,000	(46	)%
IT Service Sales		$	21,215,000	(26	)%		$	24,212,000	(32	)%		$	19,333,000	(39	)%
Aggregate IT Solutions Revenue		$	77,673,000	(96	)%		$	69,702,000	(91	)%*		$	42,217,000	(85	)%
Total Revenue		$	80,831,000				$	76,559,000				$	49,947,000

Business Process Outsourcing (“BPO”)

As part of a previous strategic direction, we provided child support enforcement services under contracts with state or county agencies, including the State of Kansas Department of Social and Rehabilitation Services, State of Nebraska Department of Health and Human Services, New Hanover County Department of Social Services in North Carolina, Beaufort County Department of Social Services in North Carolina and 3rd Judicial Court of Shawnee County, Kansas. Services under these contracts included determining legally established paternity and support obligations, enforcing court or administrative orders for such obligations, locating absent responsible parents or other persons obligated for such payments and relevant assets that may be used to satisfy such obligations, and providing help desk customer service support. We provided these services through in-house customer service representatives and attorneys, and third-party attorneys. A portion of the BPO segment included various contracts with the Commonwealth of Virginia for information technology services and related products. Typically, our BPO contracts spanned multiple periods, and may have included options to renew for additional periods. Payment terms were either fixed-price, fixed-unit-price, revenue sharing, or a combination of the above.

The following table sets forth our aggregate BPO revenue, as well as the relative approximate percentage thereof in relation to our total revenue, for each of the last three fiscal years:

	Year ended June 30,
	2006					2005					2004
BPO revenue		$	3,158,000	(4	)%		$	6,857,000	(9	)%		$	7,730,000	(15	)%
Total Revenue		$	80,831,000				$	76,559,000				$	49,947,000

In March 2004, we outsourced the management of our BPO segment to Young Williams, P.C., a law firm based in Mississippi that specializes in child support enforcement services. During the quarter ended December 31, 2004, certain of our customers notified us of their intention not to renew existing contracts. These circumstances caused us to lower our expectations with respect to future BPO revenues and curtail our related activities in this segment. During the quarter ended June 30, 2005, we re-focused our business strategy to neither seek new opportunities nor actively seek renewals of our existing contracts with respect to BPO services related to the child support enforcement services.

On June 30, 2006, the Company completed the transition and sale of all outstanding BPO operations related to the child support enforcement services to Young Williams, P.C. concluding our involvement in this non-core business segment. The contracts for information technology services and related products with the Commonwealth of Virginia were retained as part of the IT Solutions segment.

CUSTOMERS

Our customers are primarily (i) mid-market commercial businesses, (ii) agencies of state governments and municipalities, and (iii) educational institutions. These mid-market to small enterprise customers generally have between approximately 200 and 5,000 employee-computer users. For the year ended June 30, 2006, our mix of revenues was approximately 38% state and local government, 11% education, and 51% commercial.

In the state of New York, we are listed as a procurement vendor on many different contracts that are used by the various state and local entities to procure product and services. Generally, our products and services are purchased by state, city and other local agencies issuing their own purchase orders under master contract agreements between us and the related state government through which the agency is authorized to issue a valid purchase order. As a result, revenue generated from the state of New York (including from city and other local agencies) comprised approximately 25% of our total revenues and 26% of our IT Solutions revenues for the fiscal year ended June 30, 2006. Approximately 78% of such New York state revenues were from product sales and 22% were from sales of services during the fiscal year ended June 30, 2006.

For the fiscal year ended June 30, 2006, the state of New York as a consolidated purchasing entity was the only customer that accounted for more than 10% of our total revenue.

VENDORS

In connection with sales of our IT services and products, we purchase technology equipment directly from manufacturers such as Cisco, McAfee, Citrix, Hewlett Packard and Novell, and indirectly through distributors such as Ingram Micro Corporation, Tech Data, and Alternative Technologies. In general, we are authorized by a manufacturer to sell its products, whether the products are purchased from a distributor or directly from the manufacturer. Typically, vendor agreements provide that we have been appointed, on a non-exclusive basis, as an authorized reseller of specified products at specified locations. The agreements generally are terminable on 30 to 90 days’ notice or immediately upon the occurrence of certain events, and are subject to periodic renewal. The loss of a major manufacturer or the deterioration of our relationship with a major manufacturer could have a material adverse effect on our business as certain product offerings that are requested by customers may not be available to us.

We are an authorized reseller of computers, workstations, networking equipment, software, and related products for over 50 manufacturers. Our sales of products manufactured by Cisco and McAfee accounted for approximately 44% of our product revenues during the last fiscal year (or 31% of our total revenue during the fiscal year ended June 30, 2006). Based on product sales and certifications, we have obtained preferred status with several vendors, including Microsoft, Cisco, McAfee, Novell and Citrix. This status allows us to participate in rebate and co-marketing programs.

SALES AND MARKETING

Our sales and marketing objective in our IT Solutions sector is to develop lasting relationships with clients that result in both repeat and long-term engagements. We use an internal sales force in conjunction with partnership alliances with our vendors. Our sales team derives leads through industry networking, referrals from existing clients, government agencies’ requests for proposals (“RFP”), open competitions conducted by states and municipalities, strategic partnerships with third party vendors under which we jointly bid and perform certain engagements, and sales and marketing activities directed to specific customers.

For governmental entities, we receive and review numerous RFPs, and evaluate competitive bidding opportunities for the provision of products and services and identify those that are suitable for our

responsive bid. In government contract award procedures, following proposal submission, contracts are often awarded based on subsequent negotiations with the bidder offering the most attractive proposal, price and other contracting factors. In certain cases low price may be the determining factor, while in others price may be secondary when compared with the quality of technical skills or management approach.

We employ a team selling approach for marketing our offerings. Our practice subject matter experts collaborate with our service delivery professionals to identify a comprehensive service and product offering mix that will meet customer needs. As a result of our particular mix of service offerings and multi-disciplinary practices, we believe that we have the ability to allow our clients to rely on us as their primary IT vendor.

COMPETITION

The IT solutions industry is highly competitive and is served by numerous national and local firms. Market participants include global consulting and integration firms, such as IBM Global Services, international accounting firms and related entities, internal information systems and service groups of clients and prospective clients, professional services companies, small, medium and large hardware and application software re-sellers, and divisions of both integrated technology companies and outsourcing companies. Our markets are highly competitive and very fragmented, with relatively low barriers to entry.

We believe that the principal competitive factors for IT services include reputation, customer service levels, project management expertise, technical expertise, competitive pricing, the ability to deliver results in a timely manner, vendor-partner relations, and overall breadth and depth of solutions. We believe that our multi-disciplinary approach, and our ability to deliver complex infrastructure technology solutions, allows us to be competitive in the regions where we operate. Our ability to successfully compete, however, also depends on a number of competitive factors outside our control, including the ability of our clients or competitors to hire, retain and motivate project managers and other senior technical staff, the price at which competitors offer comparable services, the ability of our clients to perform the services themselves, and the extent of our competitors’ responsiveness to client needs. Moreover, although our primary, current competition in the mid-market commercial and state and local government segments is generally localized and comprised of many small entities, there are many larger and better-capitalized companies that could employ significant resources should they chose to compete for our mid-market customers.

BACKLOG

Our IT Solutions contracts typically are funded incrementally and are specific-task driven, with the exception of annual maintenance and support contracts. Our backlog only becomes firm as work progresses, and as specific orders under the contract are placed for services and related products. In our estimation, our contractual backlog at any point in time does not represent the aggregate projected value of our related contracts and customer relationships. Moreover, our backlog can be subject to variations from quarter to quarter based on fluctuations from period to period based on usage criteria and the length of particular contracts. As a result, we do not consider our backlog from IT Solutions contracts to be a significant indicator of our future IT Solutions revenue. Any backlog represents an estimate of the remaining future revenues from existing firm contracts, and does not assume any contract renewals or extensions. Our backlog at any date may not indicate demand for our products and services, and may not reflect actual revenue for any period in the future.

INTELLECTUAL PROPERTY RIGHTS

We rely on a combination of trade secret, nondisclosure and other contractual agreements to protect our proprietary rights. Existing trade secret and copyright laws afford us only limited protection. We enter

into confidentiality agreements with our employees and our contractors to restrict access to and limit the distribution of our proprietary information. There can be no assurance that the steps we have taken to protect our intellectual property will be adequate to deter its misappropriation, detect unauthorized use, or enforce our intellectual property rights.

HUMAN RESOURCES

As of October 6, 2006, we had 155 employees. We also sub-contract with approximately 13 third party subcontractors for technical support. Our employees are not subject to any collective bargaining agreements, and we believe that our relationships with our employees are good.

INSURANCE COVERAGE

We maintain general liability insurance, which includes directors and officers’ liability coverage, workers compensation and professional liability insurance in amounts deemed adequate by our Board of Directors.

ADDITIONAL INFORMATION

We were incorporated in Delaware in May 1989 and changed our name to DynTek, Inc. in December 2001. Our principal executive offices are located at 19700 Fairchild Road, Suite 230, Irvine, California 92612, and our telephone number is (949) 271-6700. Our annual reports filed on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports are available on our website at www.dyntek.com free of charge as soon as practicable after filing with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW Washington, DC 20549 or view our electronic filings with the Securities and Exchange Commission at www.sec.gov. Information regarding operation of the SEC’s Public Reference Room can be obtained by calling 1-800-SEC-0330.

ITEM 1A. RISK FACTORS

In addition to other information included in this report, the following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements contained in this Annual Report on Form 10-K, and thus should be considered carefully in evaluating our business and future prospects.

Risks Related to Our Business

We will need additional capital in the future, or we will need to scale back operations.

We will need capital in the future, and if it is not available on terms acceptable to us, or at all, and we cannot generate enough cash through existing operations, we may have to scale back operations and/or curtail expansion plans. As of June 30, 2006, we had cash and cash equivalents of approximately $1,190,000. We have taken steps during the fiscal year ended June 30, 2006 to conserve our capital resources including a reduction of our selling, general and administrative expenses by approximately $2,400,000 annually. We have also reduced the current portion of our debt burden by completing our recapitalization in March 2006, including canceling certain debt obligations through equity conversion and debt settlement agreements. Additional financing transactions may be necessary if we are not able to generate sufficient cash flow from operations through revenue growth and overhead reduction to meet our requirements.

have a material affect on the business that could require it to raise addition capital or take other measures to sustain operations in the event outside sources of capital are not available. The Company has not secured any commitments for new financing at this time nor can it provide any assurance that new capital (if needed) will be available to it on acceptable terms, if at all.

We have a history of operating losses and may not be able to achieve long-term profitability.

Since our inception in May 1989, we have incurred substantial operating losses. During the year ended June 30, 2006, we generated a net loss of $28,262,000, which included a charge on the extinguishment of debt of approximately $13,720,000. At June 30, 2006, we had an accumulated deficit of $125,908,000. There can be no assurance that our revenues will exceed our operating expenses and cost of revenues in the future.

We may not be able to compete successfully in the information technology and services markets.

The information technology products and related services markets are highly competitive and are served by numerous international, national and local firms. There can be no assurance that we will be able to compete effectively in these markets. Market participants include systems consulting and integration firms, including national accounting firms and related entities, the internal information systems groups of our prospective clients, professional services companies, hardware and application software vendors, and divisions of both large integrated technology companies and outsourcing companies. Many of these competitors have significantly greater financial, technical and marketing resources, generate greater revenues and have greater name recognition than we do. In addition, there are relatively low barriers to entry into the IT products and related services markets, and we have faced, and expect to continue to face, additional competition from new entrants into the IT products and related services markets.

We may not be able to identify, acquire or integrate new businesses, which could adversely impact our business.

A component of our business strategy is to expand our presence in new or existing markets by acquiring additional businesses. There can be no assurance that we will be able to identify, acquire or profitably manage additional businesses or integrate successfully any acquired businesses without substantial expense, delay or other operational or financial problems. Acquisitions involve a number of special risks, including the diversion of management’s attention, failure to retain key personnel, increased general and administrative expenses, client dissatisfaction or performance problems with an acquired firm, assumption of unknown liabilities, and other unanticipated events or circumstances. Acquisitions may require large one-time charges and can result in increased debt or contingent liabilities, adverse tax consequences, substantial depreciation and deferred compensation charges, and the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, any of which items could negatively impact out results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline. Acquisitions or asset purchases made entirely or partially for cash may reduce our cash reserves. Alternatively, we may issue equity or convertible debt securities in connection with an acquisition. Any of these risks could have a material adverse effect on our business, financial condition and results of operations.

Our product margins are subject to competitive pricing pressures.

Our product margins are subject to competitive pricing pressures and fluctuate from quarter to quarter depending on the mix of products we provide. We believe that current product margins are more reflective of the present marketplace and likely to continue at or near present levels into the foreseeable future. We intend to meet the challenges of aggressive price reductions and discount pricing by certain product suppliers by focusing our offerings around relatively higher margin practice areas, including security solutions, VOIP, and access infrastructure. There can be no assurance, however, that we will be able to improve profit margins and compete profitably in all areas, given the intense competition that exists in the IT industry.

We depend on a small number of vendors to supply the IT products that we sell and the loss of, or a material change in, our business relationship with a major supplier could adversely affect our business, financial condition and results of operation.

Product sales depend on our ability to maintain reseller status with several major technology manufacturers including Hewlett Packard, Citrix, McAfee, Cisco, Microsoft and Novell. We are also highly dependant on distributors such as Ingram Micro, GE Access, and Tech Data for manufactured products. Although, we are currently an authorized reseller of various products, the loss of authorization could have an adverse material effect on our product sales and results of operations. Our vendor agreements are generally terminable on 30 to 90 days notice, or immediately upon the occurrence of certain events, and are subject to periodic renewal. We rely upon the manufacturers and distributors supply of products to fulfill customer orders on a timely basis, and any supply shortages or delays could cause us to be unable to fulfill orders on a timely basis, which, in turn could harm our business, financial position and operating results. Our ability to obtain particular products in the required quantities and to fulfill customer orders on a timely basis is critical to our success. In most cases, we have no guaranteed price or delivery agreements with our third-party suppliers. We occasionally experience a supply shortage of certain products as a result of strong demand or problems experienced by our third-party suppliers. If shortages or delays persist, the price of those products may increase, or the products may not be available at all. In addition, our third-party suppliers may decide to distribute, or to substantially increase their existing distribution business, through other distributors, their own dealer networks, or directly to our customers. Accordingly, if we are not able to secure and maintain an adequate supply of products to fulfill our customer orders on a timely basis, our business, financial position and operating results may be materially adversely affected.

We may not be able to attract and retain professional staff necessary for existing and future projects.

Our success depends in large part upon our ability to attract, retain, train, manage and motivate skilled employees, particularly senior technical personnel. There is significant competition for employees with the skills required to perform the services we offer. In particular, qualified senior technical and professional staff are in great demand and competition for such persons is likely to increase. If we are unable to attract, retain and train skilled employees, it could impair our ability to adequately manage and staff our existing projects and to bid for or obtain new projects, which would have a material adverse effect on our business, financial condition and results of operations. In addition, the failure of our employees to achieve expected levels of performance could adversely affect our business. There can be no assurance that a sufficient number of skilled employees will continue to be available, or that we will be successful in training, retaining and motivating current or future employees.

Our success depends in large part upon the continued services of a number of significant employees, the loss of which could adversely affect our business, financial condition and results of operation.

Our success depends in large part upon the continued services of our senior executives and other key employees, including certain sales, consulting and technical personnel. Although we have entered into an

employment agreement with Casper Zublin, Jr., our Chief Executive Officer, Mr. Zublin and other significant employees who have not entered into employment agreements may terminate their employment at any time. The loss of the services of any significant employee could have a material adverse effect on our business. In addition, if one or more of our significant employees resigns to join a competitor or to form a competing company, the loss of such personnel and any resulting loss of existing or potential clients to any such competitor could have a material adverse effect on our business, financial condition and results of operations.

We depend on contracts with government agencies, which, if terminated or reduced, would have a material adverse effect on our business.

A large percentage of our revenues are derived from sales to government agencies. Such government agencies may be subject to budget cuts or budgetary constraints or a reduction or discontinuation of funding. A significant reduction in funds available for government agencies to purchase professional services and related products would have a material adverse effect on our business, financial condition and results of operations.

Our revenue and operating results may fluctuate in the future.

Our operating results have fluctuated and will fluctuate in the future as a result of many factors, including:

· general economic conditions and weakness in information technology spending;

· the loss or consolidation of one or more of our significant suppliers or customers;

· market acceptance and product life of the products we distribute;

· competitive conditions in our industry which may impact our pricing, margins and terms with our suppliers; and

· changes in our costs and operating expenses.

Although we attempt to control our expense levels, these levels are based in part, on anticipated revenue. Therefore, we may not be able to control spending in a timely manner to compensate for any unexpected revenue shortfall. In addition, we have at times experienced quarter-to-quarter declines in revenue, particularly in the quarters ending in December. We believe these fluctuations in revenue result primarily from the budgeting and purchasing cycles of our customers. As a result, period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance.

We may face litigation in the ordinary course of business, which could result in substantial expenses.

We are from time to time involved in litigation in the ordinary course of business. We may not be successful in defending these or other claims. Regardless of the outcome, litigation can result in substantial expenses and could divert the efforts of our management.

War and terrorist activities could adversely affect our business.

The continued threat of terrorism within the United States and acts of war may cause significant disruption to commerce throughout the world. Our business and results of operations could be materially and adversely affected to the extent that such disruptions result in delays or cancellations of customer orders, delays in collecting cash, a general decrease in corporate spending on information technology, or our inability to effectively market, manufacture or ship our products. We are unable to predict whether war and the threat of terrorism or the responses thereto will result in any long-term commercial

disruptions or if such activities or responses will have any long-term material adverse effect on our business, results of operations or financial condition.

The level of our indebtedness could adversely affect our financial condition.

We have significant debt service obligations. As of October 9, 2006, the aggregate principal amount owed under our debt instruments is $14.4 million.

The level of our indebtedness could have important consequences. For example, it could:

· increase our vulnerability to adverse economic and industry conditions;

· require us to dedicate a substantial portion of our cash flow from operations to the payment of our indebtedness, thereby reducing the availability of cash to fund working capital and capital expenditures and for other general corporate purposes;

· restrict us from making strategic acquisitions, acquiring new content or exploring other business opportunities;

· limit our ability to obtain financing for working capital, capital expenditures, general corporate purposes or acquisitions;

· place us at a disadvantage compared to our competitors that have less indebtedness; and

· limit our flexibility in planning for, or reacting to, changes in our business and industry.

We may be unable to generate sufficient cash flow to service our debt obligations.

Our ability to make payments on our indebtedness and to fund our operations, working capital and capital expenditures, depends on our ability to generate cash in the future, which is subject to general economic, industry, financial, competitive, operating, and other factors that are beyond our control.

We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to pay amounts due on our indebtedness or to fund our other liquidity needs.

We may need to refinance all or a portion of our indebtedness on or before maturity. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:

· our financial condition at the time;

· restrictions in our outstanding debt instruments; and

· other factors, including the condition of the financial markets.

As a result, we may not be able to refinance any of our indebtedness on commercially reasonable terms, or at all. If we do not generate sufficient cash flow from operations, and additional borrowings or refinancings or other proceeds are not available to us, we may not have sufficient cash to enable us to meet all of our obligations.

Risks Related to our Stock

A volatile public market for our common stock may impair liquidity and/or return on investment.

Any market price for shares of our common stock is likely to be very volatile, and numerous factors beyond our control may have a significant adverse effect. In addition, the stock markets generally have experienced, and continue to experience, extreme price and volume fluctuations which have affected the market price of many small capital companies and which have often been unrelated to the operating performance of these companies. The price for our common stock and the volume of shares traded fluctuate. Consequently, persons who invest in our common stock may not be able to use their shares as

collateral for loans and may not be able to liquidate at a suitable price in the event of an emergency. In addition, holders may not be able to resell their shares, or may not be able to sell their shares at or above the price they paid for them. Moreover, our common stock is currently traded on the National Association of Securities Dealer’s “Electronic Bulletin Board.” Consequently, broker-dealers may be less willing or able to sell and/or make a market in our common stock. Additionally, an investor may find it more difficult to dispose of, or to obtain accurate quotations for the price of, our common stock.

Trading in our stock over the last 12 months has been limited, so investors may not be able to sell as much stock as they want at prevailing prices.

The average daily trading volume in our common stock for the twelve-month period ended June 30, 2006 was approximately 47,000. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices.

Dilution in ownership of our shares from the exercise or conversion of options, warrants and convertible securities.

There are a significant number of outstanding options, warrants, and convertible securities to acquire shares of our common stock and we may grant additional rights in the future. The holders of such options, warrants, and convertible securities can be expected to exercise them at a time when our common stock is trading at a price higher than the exercise price of these outstanding options, warrants, and convertible securities. If these options or warrants to purchase our common stock are exercised, convertible debt is converted or other equity interests are granted under our 2001, 2005 or 2006 stock option plans, or under other plans or agreements adopted in the future, such equity interests will have a dilutive effect on your ownership of common stock. The existence of such options, warrants, and convertible securities may also adversely affect the terms on which we can obtain additional financing.

As of October 9, 2006, we had 56,054,526 shares issued and outstanding. As of such date, we had outstanding options to purchase 2,330,166 shares of our common stock, warrants to purchase approximately 31,599,438 shares of common stock, and $7,287,314 of convertible debt, convertible into 36,437,585 shares of common stock. The principal amount of the convertible debt will continue to increase to the extent we elect not to pay interest as it accrues during the first three years, in which case the principal would increase to approximately $10,281,663, and the number of shares issuable upon conversion would be 51,408,315. We intend to raise capital through offerings of our common stock, securities convertible into our common stock, or rights to acquire such securities or our common stock. Such other rights to acquire our common stock may be issued at exercise prices or conversion rates that are significantly lower than the price at which you may have paid for our shares. In addition, the shares issuable upon exercise of certain of the warrants and upon conversion of convertible debt may increase subject to anti-dilutive rights, which we granted to certain warrant and debt holders.

Lloyd I. Miller, III beneficially owns a majority of our outstanding common stock, which may enable him to control many significant stockholder matters and corporate actions and may prevent a change in control that would otherwise be beneficial to other stockholders.

Lloyd I. Miller may be deemed to beneficially own a total of 62,321,743 shares of our common stock, or 56.1%, as of October 9, 2006, including shares issuable to upon exercise of warrants held by Mr. Miller and his affiliates. The foregoing does not take into account the exercise or conversion of other outstanding convertible or exercisable securities of the Company, which would have the effect of reducing the percentage beneficial ownership of Mr. Miller. Because of his high percentage of beneficial ownership, Mr. Miller may be able to control matters requiring the vote of stockholders, including the election of our board of directors and certain other significant corporate actions. This control could delay, defer or prevent others from initiating a potential merger, takeover or other change in our control, even if these

actions would benefit our other stockholders and us. This control could adversely affect the voting and other rights of our stockholders and could depress the market price of our common stock.

We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

We currently do not plan to declare dividends on shares of our common stock in the foreseeable future. Further, the payment of dividends by us is restricted by our credit facility. Consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates and you sell your shares at a profit.

ITEM 1B: UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES

Our corporate headquarters and Southwest Regional Offices are in a leased facility in Irvine, California, consisting of approximately 12,500 square feet of office space rented under a lease expiring in January 2009.

Additionally, we currently lease 9 other separate sales offices and commercial facilities, comprising an aggregate of approximately 39,141 square feet, for our IT services business in New York, Michigan, California, Massachusetts, Nevada, Virginia, and Florida. The lease terms for our IT solutions business facilities range from month-to-month to five years. We terminated operations in our Massachusetts facility in August 2005, and we have entered into an agreement to sublet the premises through the remainder of the lease obligation, which ends in October 2007.

During the fiscal year ended June 30, 2006, we also leased 5 other separate facilities for our BPO business in Kansas, North Carolina and Nebraska. These five facilities and related lease obligations were transferred to Young Williams, P.C. as part of the transition and sale of our BPO business, which was completed on June 30, 2006.

Other than our Massachusetts facility, all other facilities are expected to continue to be utilized in the operation of our business.

None of these properties is unique and our properties are believed to be adequate for the present needs of our business.

ITEM 3. LEGAL PROCEEDINGS

On or about July 19, 2006, Pangaea Education Systems, LLC (“Pangaea”) filed a lawsuit against the Company alleging unfair competition, reverse passing off, misappropriation of trade secrets, copyright infringement and breach of contract arising out of services performed in 2003 (the “Action”). Pangaea’s complaint does not specify the amount of damages sought, but Pangaea has demanded in excess of $2,500,000 in preliminary communications with the Company’s counsel. The Company contends that this demand is without factual or legal basis and that the Action has no merit. A response to the complaint is due November 28, 2006. The Company intends to continue discussing an informal resolution. While the Company believes it has a strong position, it is not possible at this time to state the likelihood of an unfavorable outcome based on the early stage of the dispute, the positions taken by Pangaea and the inherent uncertainties of litigation

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 2006.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock traded on The Nasdaq Small Cap Market under the symbol “DYTK” from December 18, 1992 through the time of its voluntary delisting by us from that market on December 16, 2004. On December 16, 2004, our common stock began trading over-the-counter on the OTC Bulletin Board under the symbol “DYTK”. Following the 1-for-10 reverse split of our common stock on June 5, 2006, our common stock began trading on the OTC Bulletin Board under the symbol “DYNK”.

PRICE RANGE OF OUTSTANDING COMMON STOCK

The following table presents, for the periods indicated, the high and low closing sale price of our common stock as reported by the Nasdaq Small Cap Market through December 16, 2004 and the high and low last sale price of our common stock as reported by the OTC Bulletin Board for periods since December 16, 2004.

	HIGH		LOW
YEAR ENDING JUNE 30, 2007
First Quarter	$	0.19	$	0.13
YEAR ENDED JUNE 30, 2006
Fourth Quarter	$	0.50	$	0.17
Third Quarter	$	1.20	$	0.40
Second Quarter	$	2.65	$	0.91
First Quarter	$	3.10	$	2.30

	HIGH		LOW
YEAR ENDED JUNE 30, 2005
Fourth Quarter	$	4.90	$	2.90
Third Quarter	$	6.10	$	4.90
Second Quarter	$	7.60	$	5.20
First Quarter	$	8.00	$	6.00

HOLDERS

As of October 9, 2006, there were approximately 193 holders of record of our common stock. We estimate that there are approximately 6,000 stockholders of our common stock held in street name.

DIVIDEND POLICY

We have never paid or declared any cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future but rather intend to retain future earnings, if any, for reinvestment in our future business. Any future determination to pay cash dividends will be in compliance with our contractual obligations and otherwise at the discretion of the board of directors and based upon our financial condition, results of operations, capital requirements and such other factors as the board of directors deems relevant.

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information, as of June 30, 2006, relating to our equity compensation plans:

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)			(c)
Equity compensation plans approved by security holders(1)		230,166		$	5.33		3,175,775
Equity compensation plans not approved by security holders(2)		—		—			11,790,672
Total		230,166		$	5.33		14,966,447

(1) Options to purchase 66,000 shares of common stock held by Mr. Robert Webber, our former Chief Financial Officer, and options to purchase 8,000 shares of common stock held by Mr. Casper Zublin, Jr. were cancelled on September 30, 2005. The cancellation of such options reduced the number of securities to be issued upon exercise of outstanding options and increase the number of securities available by 74,000 shares.

(2) Although we intend to submit the 2006 Nonqualified Stock Option Plan (the “2006 Plan”) to a vote of our stockholders within twelve (12) months of our adoption of the 2006 Plan, the 2006 Plan has not yet been submitted to such a vote. All stock options granted under the 2006 Plan remain subject to the Company obtaining such a vote.

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data has been derived from our audited consolidated financial statements and should be read in conjunction with the full consolidated financial statements included herein.

	Years ended June 30,
	2006			2005			2004			2003			2002
	(in thousands, except per share amounts)
Consolidated statement of operations data:
Operating revenues	$	80,831		$	76,559		$	49,947		$	52,647		$	60,077
Loss from continuing operations	(28,775		)	(24,437		)	(18,935		)	(4,203		)	(12,379		)
Gain (loss) from discontinued operations	513			1,846			(64		)	(9,566		)	(7,034		)
Loss from continuing operations—per share	(1.33		)	(3.78		)	(4.00		)	(1.15		)	(4.25		)
Gain (loss) from discontinued operations—per share	.02			.29			(0.01		)	(2.61		)	(2.42		)

	Years ended June 30,
	2006	2005	2004	2003	2002
	(in thousands)
Consolidated balance sheet data:
Total assets	30,106	47,336	45,649	53,127	80,519
Long term debt	2,550	7,603	3,596	5,317	—

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations

The following table sets forth, for the periods indicated, the relative percentages that certain income and expense items bear to net sales.

	Year Ended June 30,
	2006			2005			2004
Product Revenue		70	%		59	%		46	%
Service Revenue-Information Technology		26	%		29	%		35	%
Service Revenue-Business Process Outsourcing		4	%		12	%		19	%
Cost of Products		89	%		85	%		84	%
Cost of Service-Information Technology		74	%		76	%		81	%
Cost of Service-Business Process Outsourcing		79	%		92	%		82	%
Gross profit		16	%		18	%		18	%
SG & A		25	%		24	%		24	%
Loss from continuing operations		(36	)%		(32	)%		(38	)%
Gain (loss) from discontinued operations		1	%		2	%		—
Net income (loss)		(35	)%		(30	)%		(38	)%

Fiscal years ended June 30, 2006 and June 30, 2005—Continuing Operations

Revenues. For the year ended June 30, 2006, revenues increased to approximately $80,831,000 from approximately $76,559,000 during the prior year, or a 6% increase from the year ended June 30, 2005. Product sales increased by 24% from $45,490,000 in fiscal 2005 to $56,459,000 in fiscal 2006 primarily related to increased purchases under our New York contracts and educational contracts. Product sales related to our Redrock and ITI acquisitions in the Southwest Region increased by 4% for the full year 2006 compared to 2005. Our services revenue decreased 22% from $31,069,000 in fiscal 2005 to $24,372,000 in fiscal 2006, primarily due to the de-emphasis of the BPO segment. The BPO segment revenue declined from $6,785,000 in fiscal year 2005 to $3,158,000 in the fiscal year 2006. Service revenues for the Southwest region decreased by $2,054,000, or 24% from $8,684,000 in fiscal year 2005 to $6,630,000 in fiscal year 2006, primarily as a result of the under utilization of internal service resources and the subsequent restructuring and reorganization of the Southwest region to improve future performance. Services within the other regions declined approximately $1,016,000 from $15,600,000 in fiscal year 2005 to $14,584,000 in fiscal year 2006 due to lower utilization of service personnel primarily during the third quarter. The revenue mix from product and services sales was 70% and 30%, respectively, for the 2006 fiscal year, as compared to 59% and 41%, respectively, for the 2005 fiscal year.

The following table sets forth for the periods presented from information derived from our consolidated statements of operations (in thousands):

		For the Twelve Months
		ended June 30,					Percentage
REVENUES		2006			2005		change			Amount
*DynTek, excluding*	*Product*		$	36,460	$	26,313		39	%	$	10,147
*Redrock and ITI(1)*	*Service*		17,742		22,385			(21	)%	(4,643		)
	*Total*		54,202		48,698			11	%	5,504
*Redrock and ITI(2)*	*Product*		19,999		19,177			4	%	822
	*Service*		6,630		8,684			(24	)%	(2,054		)
	*Total*		26,629		27,861			(4	)%	(1,232		)
	*Totals*		$	80,831	$	76,559		6	%	$	4,272

(1) Revenues from Redrock, ITI, and TekConnect are excluded for comparative purposes

(2) Represents revenues generated by Redrock following its acquisition on August 1, 2004 and ITI following its acquisition on October 1, 2004. Redrock and ITI operations were combined on February 11, 2005. Therefore, revenues are combined.

Our customers are primarily state and local government entities and mid-sized corporations in diversified industries. For our year ended June 30, 2006, 51% of our revenues were derived from commercial clients, compared to 49% from government agencies and educational institutions. This represents a comparable customer mix from fiscal 2005 when 53% of our customers were commercial clients and 47% of our customers were government agencies and educational institutions. The acquisition of Redrock and ITI during fiscal year 2005 reduced our dependence overall on state and local government agencies and reflected our decision to grow our commercial business. The State of New York and the City of New York with their agencies accounted for 25% of our total revenues in fiscal 2006.

Gross profit. Gross profit decreased from $13,893,000 in fiscal 2005 to $12,588,000 in fiscal 2006, a decrease of 9%. Gross margin also decreased from 18.1% in fiscal 2005 to 15.6% during fiscal 2006. Service gross margins improved to 25.0% in fiscal year 2006 from 22.2% in fiscal year 2005. However, the decline in services revenue and the under utilization of resources caused service gross profit to decline from $6,902,000 in fiscal year 2005 to $6,101,000 in fiscal year 2006. Product gross profit declined from $6,991,000 in fiscal 2005 to $6,487,000 fiscal 2006. Product gross margin declined from 15.4% in fiscal year 2005 to 11.5% in fiscal year 2006. The decrease in overall product gross margin is primarily the result of the competitive marketplace in commercial accounts as well as having consummated several large, lower-margin product sales under contracts with certain state and local government clients, and fewer vendor rebates that were received during the fiscal year ended June 30, 2006. Although we have improved our service margins, and will seek opportunities to make further improvements, our product margins in particular are subject to competitive pricing pressures and fluctuate from period to period depending on the mix of products we provide. We believe that current product margins are more reflective of the present marketplace and likely to continue at or near present levels into the foreseeable future. We intend to meet the challenges of aggressive price reductions and discount pricing by certain product suppliers by focusing our offerings around relatively higher margin practice areas, including security solutions, VOIP, and access infrastructure. There can be no assurance, however, that we will be able to improve profit margins, especially for our sale of products, and compete profitably in all areas, given the intense competition that exists in the IT industry.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased to approximately $17,569,000 for the year ended June 30, 2006, from approximately $18,738,000

for the year ended June 30, 2005. As a percentage of total revenues, the aggregate selling, general and administrative expenses were 24.5% during fiscal 2005 compared to 21.7% during fiscal year 2006.

In the last fiscal year, selling costs increased by approximately $733,000, from $11,693,000 in year ended June 2005 compared to $12,426,000 in year ended June 2006, primarily as a result of increased variable selling costs on a higher revenue base. As a percentage of sales, selling costs were 15.2% of sales in fiscal year 2005 and 15.4% in fiscal year 2006. The increase in selling costs during fiscal year 2006 included a $205,000 expense for employee stock options that vested during the first quarter of fiscal year 2006 and one-time severance and restructuring costs of $306,000 during the third quarter.

General and administrative expenses decreased by approximately $1,902,000, from $7,045,000, or 9.2% of revenue in the year ended June 30, 2005, to $5,143,000, or 6.4% of revenue in the year ended June 30, 2006. During fiscal year 2006, corporate general and administrative expenses incurred a one-time charge of $514,000 during the first quarter for severance costs, an additional one-time restructuring and reorganization costs of $450,000 during the quarter ended March 2006, and a $71,000 expense for employee/director stock options that vested during the year. In fiscal year 2005, general and administrative expenses included approximately $850,000 in non-recurring severance and non-cash expenses, including $448,000 from the resignation of our former chief executive officer in June 2005, $201,000 in non-cash expenses for options and warrants.

Depreciation and amortization expense. Depreciation and amortization expense decreased from approximately $3,171,000 in fiscal 2005 to approximately $2,651,000 for the year ended June 30, 2006. The decrease is primarily due to reduced amortizations of customer lists from prior acquisitions that have now been fully amortized.

Interest expense. Interest expense increased from $2,138,000 in fiscal 2005 to $7,296,000 in fiscal 2006. This increase was due primarily to non-cash related interest charges of approximately $5,276,000, which was comprised of:

(i) $1,742,853 in non-cash interest charges resulting from the reduction in the conversion price of our 9% Senior Subordinated Convertible Notes originally issued in October 2004 and amended in October 2005 (the “9% Notes”), $168,768 in non-cash interest charges resulting from the reduction in warrant exercise prices under warrants issued to holders of our 9% Notes, $49,851 in non-cash interest charges resulting from the reduction in warrant exercise price of the warrant issued to Laurus Master Fund, Ltd. (“Laurus”), and $95,188 in non-cash interest charges resulting from the reduction of the exercise price on the Company’s outstanding Class A publicly-traded warrants;

(ii) year to date non-cash interest amortization on the debt discounts of $161,734 on the Amended and Restated Secured Convertible Term Note originally issued to Laurus in November 2004 and amended in October 2005 (the “Laurus Note”), $426,365 on the 9% Notes, $150,000 on the conversion of the Secured Promissory Notes issued in October 2005 (the “Bridge Notes”), $374,839 on the Secured Promissory Notes issued in March 2006 (the “Senior Notes”), and $207,143 on the Junior Secured Convertible Promissory Notes issued in March 2006 and June 2006, respectively (the “Junior Notes”);

(iii) the retirement of the balances on deferred financing costs of $508,940 on the 9% Notes, $526,421 on the Laurus Note, and $79,942 on the Bridge Notes, and additional deferred financing costs in the aggregate of approximately $158,000 on the Bridge Notes, the Senior Notes, and the Junior Notes.

(iv) $112,211 of non-cash interest converted to equity due on the Secured Promissory Notes issued in October 2005 in connection with our acquisition of ITI (the “ITI Notes”), $39,211 of non-cash interest converted to equity due on the 9% Notes, and $109,315, of non-cash interest converted to equity due on the Bridge Notes.

At our option, the interest payment of $230,186 due on June 30, 2006 on the Senior Notes was paid in kind and added to the principal portion of the Senior Notes. The aggregate interest payment of $136,932 due on June 30, 2006 on the Junior Notes was also paid in kind and added to the principal portion thereof. The increase also includes contractual interest due on notes that we entered into in January and October 2004, the Bridge Notes entered into in November 2005, and an increase in the average borrowings under our credit facility.

The following table sets forth operating expenses for the periods presented from information derived from our consolidated statements of operations (in thousands):

		For the Twelve Months ended June 30,
		Dollars					Percentage of Revenues
OPERATING EXPENSES		2006		2005			2006			2005
*DynTek, excluding*	*Selling(1)*	$	8,197	$	8,080			10	%		10	%
*Redrockand ITI*	*General & Administrative(1)*	5,085		6,793				6	%		9	%
	*Depreciation & Amortization(1)*	2,266		2,807				3	%		4	%
	*Goodwill impairment*	—		12,897		%			%		17	%
	*Total*	$	15,548	$	30,577			19	%		40	%
*Redrock and ITI(2)*	*Selling(2)*	4,229		3,613				5	%		5	%
	*General & Administrative(2)*	58		252				—			—
	*Depreciation & Amortization(2)*	385		364				—			—
	*Total*	$	4,672	$	4,229			6	%		5	%
	*Totals*	$	20,220	$	34,806			25	%		45	%

(1) Revenues from Redrock and ITI are excluded for comparative purposes

(2) Represents expenses generated by Redrock following its acquisition on August 1, 2004 and ITI following its acquisition on October 1, 2004. Redrock and ITI operations were combined on February 11, 2005. Therefore, Selling, General and Administrative expenses are now combined.

Impairment of Goodwill. At June 30, 2006, we performed our annual impairment tests of goodwill for each of our reporting units as required under SFAS 142. As a result of these tests and the analysis performed by an outside valuation specialist, we determined that the remaining amount of goodwill was reasonably valued and that no impairment charge was required for the year ended June 30, 2006.

For the year ended June 30, 2005, an impairment charge of $12,897,000 was recorded. This charge was primarily in connection with our acquisition of DMR in 2002 which was determined to be unrecoverable upon (1) receiving a definitive notice from certain of our customers that they would not renew existing contracts with us and (2) losing a key employee with significant customer relationships. These events had a material adverse impact on our ability to compete in this segment and recover our original investment and a recorded a goodwill impairment charge of $6,026,000 during the quarter ended December 31, 2004. We recorded an additional $6,837,000 during the quarter ended June 30, 2005 in connection with (1) our new management’s decision to limit our activities in the BPO segment to only fulfilling service obligations on our existing contracts and (2) reducing our expectation of future revenue with respect to a service contract that we have with the state of Virginia, as we believe that it is more likely than not that such contract will not be renewed.

We engaged an outside valuation specialist to evaluate the DynCorp Management Resources (DMR) goodwill at June 30, 2005. The results of the evaluation indicated that the fair value of the DMR reporting unit, using a discounted cash flow model, was approximately $6,000,000 less than its carrying value. In determining the impairment charge, we considered a variety of factors including the effects of increasing

competition, the non-renewal of several major government services contracts, the closing of certain offices and changes in our business strategy, which is to curtail our activities in the BPO segment.

Other Income (expense). During the year ended June 30, 2006, we recorded a net non-cash loss on the extinguishment of debt obligations in the aggregate of $13,720,000. We recorded a loss of $14,620,000 based on the difference between the fair value of the equity instruments received in connection with the execution of certain Conversion and Settlement Agreements dated as of March 8, 2006, and the conversion price per share for the ITI Notes (see Note 11), the 9% Notes (see Note 10), and the Bridge Notes (see Note 10) wherein the note holders irrevocably cancelled their notes in exchange for shares of our common stock at a conversion rate of $0.20 per share.

During the year ended June 30, 2006, we recorded a net gain of approximately $900,000 in connection with settling trade debts of approximately $1,947,000. Settlement of these debts in one time cash payments amounted to approximately $725,000, effectuating a one-time gain of $1,222,000. Such gain was offset by a $322,000 loss on the extinguishment of the debt as we also entered into Conversion and Settlement Agreements with certain trade payable creditors to convert outstanding debt balances in the aggregate of approximately $161,000 into 804,165 shares of common stock at the conversion price of $0.20 per share based on the difference between the (a) fair value of 804,165 shares of common stock issuable to such holders for the settlement of the debt and (b) the aggregate debt of $161,000 at the conversion price of $0.20 per share.

We maintain a minority interest in Tekinsight, a full-service network infrastructure and web application services company. We assessed the value for the investment in Tekinsight and took a one-time expense of $505,043 in March 2006.

We also completed the sale of our investment in Private Label Cosmetics (PLC) for a one time gain of $75,000 during the fourth quarter of fiscal year 2006.

The Company realized a gain on the sale of these securities in the amount of $54,000 and approximately $58,000 in interest income during the year ended June 30, 2006.

We completed the transition and sale of our BPO business on June 30, 2006 and $275,000 in proceeds were included as other income.

Net loss. Our net loss for the year ended June 30, 2006 was $28,262,000 compared to a net loss of $22,591,000 for the year ended June 30, 2005. The net loss in fiscal 2006 did not include a goodwill impairment charge compared to an impairment charge of $12,897,000 for the prior fiscal year. The net loss for fiscal 2006 also included a gain from discontinued operations of $513,000 compared to a gain in fiscal year 2005 of $1,846,000 primarily attributable to claims that we settled with transportation vendors under the Virginia non-emergency transportation service contracts.

The fiscal year 2006 net loss includes depreciation and amortization expense of $2,651,000, non-cash option expense of $275,000, interest expense of $7,296,000 (including a non-cash portion of $5,276,000), a valuation adjustment on the investment in Tekinsight of $505,000, and a $14,620,000 loss on the extinguishment of debt obligations under the ITI Notes, the 9% Notes, and the Bridge Notes; offset by a gain on extinguishment of trade payable debt of $900,000. The fiscal 2005 net loss includes depreciation and amortization expense of $3,171,000, interest expense of $2,138,000 (including a non-cash portion of approximately $899,000) and other non-operating expenses (net) of $1,141,000, which included a write-down of an investment in preferred stock of $1,104,000.

Fiscal years ended June 30, 2005 and June 30, 2004—Continuing Operations

Revenues. For the year ended June 30, 2005, revenues increased to approximately $76,559,000 from approximately $49,947,000 during the prior year, or a 53% increase from the year ended June 30, 2004.

This increase was primarily a result of increased revenues from businesses acquired in September and October 2004, which now comprise our Southwest Region. Product sales increased from $22,782,000 in fiscal 2004 to $45,490,000 in fiscal 2005. The increase resulted primarily from the increase in product sales of network communication equipment and software in the Southwest Region, and the sale of other networking and computer equipment and software in our other regions. Our services revenues increased from $27,165,000 in fiscal 2004 to $31,069,000 in fiscal 2005, resulting primarily from additional services in our Southwest Region, offset by lower business process outsourcing services and slightly lower state and local government services in our Northeast Region. The revenue mix from product and services sales was 59% and 41%, respectively, for the 2005 fiscal year, as compared to 46% and 54%, respectively, for the 2004 fiscal year.

The following table sets forth for the periods presented from information derived from our consolidated statements of operations (in thousands):

		For the Twelve Months
		ended June 30,						Percentage
REVENUES		2005			2004			change			Amount
*DynTek, excluding*	*Product*		$	26,313		22,782			15	%	$	3,531
*Redrock and ITI(1)*	*Service*		22,385			27,165			(18	)%	(4,780		)
	*Total*		48,698			49,947			(3	)%	(1,249		)
*Redrock and ITI(2)*	*Product*		19,177			n/a			100	%	19,177
	*Service*		8,684			n/a			100	%	8,684
	*Total*		27,861			n/a			100	%	27,861
	*Totals*		$	76,559		$	49,947		53	%	$	26,612

(1) Revenues from Redrock and ITI are excluded for comparative purposes.

For our year ended June 30, 2005, 53% of our revenues were derived from commercial clients, compared to 47% from government agencies and educational institutions. This represents a significant change in customer mix from fiscal 2004 when 21% of our customers were commercial clients and 79% of our customers were government agencies and educational institutions. The change in mix reflects our decision to reduce our dependence overall on state and local government agencies and to grow our commercial business, which was primarily effected by the creation of our Southwest Region through the acquisitions of Redrock and ITI. The State of New York and its agencies accounted for 21% of our total revenues in fiscal 2005.

Gross profit. Gross profit increased from $8,936,000 in fiscal 2004 to $13,893,000 in fiscal 2005, an increase of 55%. Gross margin increased slightly, from 17.9% to 18.1% during the same period. This increase was primarily the result of an increase in services gross margin from 19.1% in fiscal 2004 to 22.2% in fiscal 2005, partially offset by a decrease in product gross margin from 16.5% in fiscal 2004 to 15.4% in fiscal 2005. Services margin increased primarily due to an increase in the overall level of utilization with respect to in-house consultants, and a greater mix of higher-end services in the latter part of fiscal 2005. The decrease in overall product gross margin is primarily the result of having consummated several large, lower-margin product sales under contracts with certain state and local government clients. Although we have improved our service margins, and will seek opportunities to make further improvements, our product margins in particular are subject to competitive pricing pressures and fluctuate from quarter to quarter depending on the mix of products we provide. We intend to meet the challenges of aggressive price reductions and discount pricing by certain product suppliers by focusing our offerings around relatively

higher margin practice areas, including security solutions, VOIP, and access infrastructure. There can be no assurance, however, that we will be able to improve profit margins and compete profitably in all areas, given the intense competition that exists in the IT industry.

Depreciation and amortization expense. Depreciation and amortization expense increased to approximately $3,171,000 for the year ended June 30, 2005, from approximately $2,985,000 in our 2004 fiscal year. The increase is primarily due to additional amortization that we recorded as a result of having allocated a portion of the purchase consideration from business combinations that we consummated in fiscal 2005 to customer contracts.

Interest expense. Interest expense for the year ended June 30, 2005 increased to $2,138,000, as compared to $942,000 for the year ended June 30, 2004. The increase includes contractual interest due on notes that we entered into in January and October 2004, an increase in the average borrowings under our credit facility, and the amortization of deferred financing fees and debt discounts associated with warrants and beneficial conversion features we issued with debt during the year ended June 30, 2005.

Selling, general and administrative expenses. Selling, general and administrative expenses increased to approximately $18,738,000 for the year ended June 30, 2005, from approximately $12,175,000 for the year ended June 30, 2004. Selling costs increased by approximately $4,568,000 due to increased selling costs on a higher revenue base, the addition of sales and business development personnel, and additional costs incurred in the integration of the Redrock and ITI businesses. General and administrative expenses increased by approximately $1,995,000, including approximately $850,000 in non-recurring severance and non-cash expenses, which comprises $448,000 resulting from the resignation of our former chief executive officer in June 2005, and $201,000 in non-cash expenses for options and warrants. As a percentage of total revenues, the aggregate selling, general and administrative expenses were 24% during fiscal 2005, which equaled the 24% in the prior fiscal year. This resulted from additional expenses that were offset proportionally on a higher revenue base for the year ended June 30, 2005.

The following table sets forth operating expenses for the periods presented from information derived from our consolidated statements of operations (in thousands):

		For the Twelve Months ended June 30,
		Dollars				Percentage of Revenues
OPERATING EXPENSES		2005		2004		2005			2004
*DynTek, excluding*	*Selling(1)*	$	8,080	7,125			10	%		15	%
*Redrock and ITI(1)*	*General & Administrative(1)*	6,793		5,050			9	%		10	%
	*Depreciation & Amortization(1)*	2,807		2,985			4	%		6	%
	*Goodwill impairment*	12,897		11,600			17	%		23	%
	*Total*	$	30,577	26,760			40	%		54	%
*Redrock and ITI(2)*	*Selling(2)*	3,613		n/a			5	%		n/a
	*General & Administrative(2)*	252		n/a			—			n/a
	*Depreciation & Amortization(2)*	364		n/a			—			n/a
	*Total*	$	4,229	n/a			5	%		n/a
	*Totals*	$	34,806	$	26,760		45	%		54	%

(1) Expenses from Redrock and ITI are excluded for comparative purposes

Impairment of Goodwill. At June 30, 2005, we performed our annual impairment tests of goodwill for each of our reporting units as required under SFAS 142. As a result of these tests, we determined that the remaining amount of goodwill recorded in connection with our acquisition of DMR in 2002 is non-recoverable. Accordingly, we recorded a $6,837,000 impairment charge during the quarter ended June 30, 2005, which together with earlier impairment charges amounts to $12,897,000 for the year ended June 30, 2005.

We recorded approximately $6,026,000 of goodwill impairment charges during the quarter ended December 31, 2004 after (1) receiving a definitive notice from certain of our customers that they would not renew existing contracts with us and (2) losing a key employee with significant customer relationships, These events had a material adverse impact on our ability to compete in this segment and recover our original investment. We recorded an additional $6,837,000 during the quarter ended June 30, 2005 in connection with (1) our new management’s decision to limit our activities in the BPO segment to only fulfilling service obligations on our existing contracts and (2) reducing our expectation of future revenue with respect to a service contract that we have with the state of Virginia, as we believe that it is more likely than not that such contract will not be renewed.

We evaluated the DMR goodwill at June 30, 2005. The results of the evaluation indicated that the fair value of the DMR reporting unit, using a discounted cash flow model, was approximately $6,000,000 less than its carrying value. In determining the impairment charge, we considered a variety of factors including the effects of increasing competition, the non-renewal of several major government services contracts, the closing of certain offices and changes in our business strategy, which is to curtail our activities in the BPO segment.

For the year-ended June 30, 2004, we recorded goodwill impairment charges in aggregate amount of $11,600,000. Our determination of the charge includes the effects of lower expected government spending and a reduction of forecasted growth rates in BPO contracts. The 2004 impairment charge includes approximately $750,000 associated with the lower BPO business and approximately $7,500,000 specifically associated with lower expected revenues under a significant services contract with the State of Virginia. Our determination of the impairment charge was made based upon a comprehensive review and comparison of the fair values to the book (carrying) values of each of the reporting units at each of the balance sheet dates.

Net loss. Our net loss for the year ended June 30, 2005 was $22,591,000 compared to a net loss of $18,999,000 for the year ended June 30, 2004. The net loss in fiscal 2005 includes a goodwill impairment charge in the amount of $12,897,000, compared to an impairment charge of $11,600,000 for the prior fiscal year. The fiscal 2005 net loss also includes depreciation and amortization expense of $3,171,000, compared to $2,985,000 for the prior fiscal year, interest expense of $2,138,000, compared to interest expense of $942,000 for the prior fiscal year, and other non-operating expenses (net) of $1,141,000, which included a write-down of an investment in preferred stock of $1,104,000. We also had a gain of $1,846,000 from discontinued operations in fiscal 2005 primarily attributable to claims that we settled with transportation vendors under the Virginia non-emergency transportation service contracts.

Liquidity and Capital Resources

As of June 30, 2006, we had cash, cash equivalents and marketable securities of $1,190,000.

We measure our liquidity in a number of ways, as summarized in the following table:

	As of June 30, 2006			As of June 30, 2005
	(Dollars in thousands)
Cash and cash equivalents		$	1,190		$	1,297
Working capital		$	43		$	(5,221	)
Working capital without giving effect to acquisition liability		$	—		$	(1,545	)
Current ratio		1.01:1			.80:1
Current ratio without giving effect to acquisition liability		—			.93:1
Notes payable (current portion)		$	—		$	3,621

Cash and cash equivalents generally consist of cash and money market funds. We consider all highly liquid investments purchased with maturities of three months or less to be cash equivalents. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for purposes of reporting cash flows.

We incurred a net loss of $28,262,000 for the year ended June 30, 2006, which includes $22,427,000 of non-cash and/or non-recurring charges resulting from $5,276,000 in non-cash interest charges; $2,651,000 of depreciation and amortization; $275,000 in stock based compensation; a $505,000 valuation adjustment on the investment in Tekinsight; and a $14,620,000 loss on the extinguishment of debt obligations under the ITI Notes, the 9% Notes, and the Bridge Notes; offset by a gain on extinguishment of trade payable debt of $900,000. At June 30, 2006, the Company had a positive working capital of approximately $43,000.

In October 2005, we raised gross proceeds of $2,500,000, upon issuance of the Bridge Notes to certain investors. The proceeds were used to pay acquisition debt and for working capital. Interest on unpaid principal under the Bridge Notes was 12% per annum through March 1, 2006, 14% from March 1, 2006 to April 1, 2006. In March of 2006, we entered into a Conversion and Settlement Agreement with the holders of the Bridge Notes to convert the $2,609,315 in aggregate principal and accrued interest under the Bridge Notes into shares of our common stock at a conversion price of $0.20 per share. The conversion was effective and the debt obligation cancelled in June 2006 following the effective date of our 1-for-10 reverse stock split.

In July 2005, we began making principal payments of approximately $146,000 per month on our 9% Notes due to certain investors. In October 2005, we amended a majority of 9% Notes to defer all payments of principal due under such 9% Notes until January 2007. In connection with such amendment, we reduced the conversion price of such notes from $6.50 to $2.20, and issued the 9% Note holders warrants to purchase shares of our common stock at $2.20 per share. In March 2006, we entered into Conversion and Settlement Agreements with the holders of the 9% Notes to convert $2,665,112 in aggregate principle and accrued interest into shares of our common stock at a conversion price of $0.20 per share. These agreements effected a complete settlement of the debt outstanding under the 9% Notes and the shares were issued in June 2006 following the effective date of our 1-for-10 reverse stock split.

In October 2005, we amended the Laurus Note, and deferred principal payments under the Laurus Note from December 2005 until March 2006 in return for a reduction in the exercise price of warrants issued in connection with issuance of the Laurus Note from $6.50 per share to $2.50 per share. This transaction deferred aggregate payments of $831,249 in cash otherwise due and payable prior to March 2006. We incurred a non-cash interest expense of $49,851 in connection with the reduction in the exercise price of the warrants. In March 2006, the remaining principal balance of $6,649,999 along with accrued interest of $102,198 was paid in full and the Laurus Note was cancelled.

In August 2005, we terminated our credit facility agreement with an agency of Textron Financial Corporation (“Textron”). The Textron facility provided a full notification factoring facility for up to

$7,000,000 of working capital. Eligible accounts receivable expected to be collected within 90 days were purchased with recourse, with a holdback amount of 15%. Interest was charged on the outstanding balance at the prime rate plus 2.0% (8.25% at June 30, 2005). Additionally, a 0.15% discount fee was charged at the time of purchase. In August 2005, we terminated this agreement, and paid the entire balance then outstanding of approximately $4,800,000.

On August 8, 2005, we entered into a series of related agreements with New England Technology Finance, LLC (“NETF”), an affiliate of Global Technology Finance, which is a provider of structured financing solutions to technology companies that operates in partnership with Credit Suisse First Boston, CIT Group, Inc. and others, that together provided a new working capital credit facility.

The facility is comprised of two primary components: (1) an Asset Purchase and Liability Assumption Agreement (the “APLA”), under which NETF agreed to finance certain of our qualified product purchases under an arrangement that provides for us to sell accounts receivable (resulting from the sale of such products to our customers) and for NETF to assume the liability for payment to product vendors; and (2) an Asset Purchase Agreement (the “APA”), under which NETF purchased $7,500,000 of our qualified accounts receivables (services and products). The proceeds we received under the APA were used to repay in full the $4,800,000 balance on our credit line with Textron, for acquisition debt, and general corporate purposes. In addition to the accounts receivable purchased on August 8, 2005, NETF may purchase up to 80% of our additional qualified accounts receivable in the future on the same terms.

We believe that the NETF APLA facility has enabled us to more effectively manage our liquidity. The facility is structured to provide us with the flexibility of matching the timing of cash outflows for product purchases to cash amounts that we collect from our customers. The financing fee under the facility is calculated on a monthly basis depending on our gross margin on such products, and days sales outstanding, which fee we anticipate will be less than prior fees charged under our prior financing arrangement with Textron. We may also use the APA facility as a general financing arrangement for certain product and services receivables.

During fiscal year 2006, we have taken certain steps to conserve our capital resources, including the transition and sale of our BPO segment, and announcing during the first quarter of fiscal year 2006 a projected annualized reduction of our general and administrative expenses by approximately $1,600,000 from the year ended June 30, 2005. In March 2006, the company announced another $800,000 in projected annualized savings from cost reductions measures in selling and general and administrative expenses. Total G&A expenses for the year ended June 30, 2005 was approximately $7,045,000, inclusive of one-time restructuring costs of $850,000. For the twelve-month period ended June 30, 2006, G&A expenses were $5,143,000 inclusive of all one time restructuring and re-organization costs of $964,000. Thus, we believe that we met our projected G&A reduction target.

On March 8, 2006, we entered into a Note Purchase Agreement (the “Note Purchase Agreement”) with SACC Partners, L.P. and Lloyd I. Miller, III (the “Senior Lenders”), pursuant to which we issued Senior Secured Notes in the aggregate principal amount of $6.7 million (the “Senior Notes”). The interest rate for the Senior Notes is 8% per annum if paid in cash, or 11% per annum if paid in kind, which is at our election for the first three years. Principal will be amortized over three years and payable in monthly installments beginning March 31, 2009, with the balance payable on the maturity date of March 1, 2010, and interest will be payable quarterly in arrears beginning June 30, 2006, unless we choose payment in kind option, in which case interest will be added to the principal amount of the Senior Notes during the period that we continue such election. As a condition to the purchase of Senior Notes, we issued warrants pro rata, according to each Senior Lender’s proportion of the aggregate principal amount of the Senior Notes, to purchase 19.9% of its outstanding common stock at the time of exercise, exercisable at $0.01 per share of common stock, until December 31, 2016. Proceeds from the sale of the Senior Notes were used to pay indebtedness outstanding under the Laurus Notes.

On March 8, 2006, under the Note Purchase Agreement, we also issued a Junior Secured Convertible Note to Trust A-4—Lloyd I. Miller (the “Junior Lender” and together with the Senior Lenders, the “Lenders”) in the aggregate principal amount of $3.0 million (the “Junior Note”). On June 15, 2006, we amended the Note Purchase Agreement to provide that upon the request of Mr. Miller or an affiliate of Mr. Miller, and upon the consent of the Company, the Company shall issue up to an additional aggregate initial principal amount of $3.0 million, on the same terms and conditions as provided for the Junior Note. On June 15, 2006, we issued an additional junior secured convertible promissory note to the Junior Lender in the initial principal amount of $1.0 million, on the same terms and conditions as the Junior Note (together with the Junior Note, the “Junior Notes”). The interest rate for the Junior Notes is 10% per annum if paid in cash, or 14% per annum if paid in kind, which is at our election for the first three years. Principal will be payable at the maturity date of March 1, 2011 and interest will be payable quarterly in arrears beginning June 30, 2006, unless we choose the payment in kind option, in which case interest will be added to the principal amount of the Junior Notes during the period that we continue such election. The Junior Notes may be converted into shares of our common stock at any time at the election of the holder at a conversion price of $0.20 per share of common stock after giving effect to the reverse stock split. Thus, the Junior Notes issued to the Junior Lender are convertible into 30,212,952 shares of our common stock, assuming that interest thereon is paid in kind for the first three years.

On March 8, 2006, we entered into a Securities Purchase Agreement with certain accredited investors (the “Securities Purchase Agreement”), pursuant to which we raised approximately $683,226 in net proceeds through the initial closing of a private placement of an aggregate of 3,795,700 shares of common stock at a purchase price of $0.20 per share and warrants to purchase 759,140 shares of common stock. On May 15, 2006, we effected a second and final closing of this private placement and raised $1,145,904 in gross proceeds from the sale of 5,729,520 shares of common stock at $0.20 per share and issued warrants to purchase 1,145,904 shares of common stock at an exercise price of $0.20 per share. At the second closing Network 1 was paid a fee of $114,590 and issued a warrant to purchase 1,145,904 shares of common stock at an exercise price of $0.20 per share.

The Company believes that its strategy of streamlining the business around its core competency of providing IT solutions is enabling it to operate under a more efficient cost structure than it had in the past. The Company is also not required to make principal payments under any of note obligations until June 2009 and its accounts receivable and product financing arrangement with NETF is providing it with timely working capital resources. Accordingly, the Company believes (based on these initiatives) that it will have sufficient liquidity to sustain the business through June 30, 2007.

The Company is continuing its financial and operational restructuring initiatives and will continue to implement its strategic business plan. Although the Company believes that it has sufficient liquidity to sustain the business through June 30, 2007, there is no assurance that unforeseen circumstances will not have a material affect on the business that could require it to raise addition capital or take other measures to sustain operations in the event outside sources of capital are not available. The Company has not secured any commitments for new financing at this time nor can it guarantee that any will become available.

Contractual Obligations

	Payments due by period
	Total		Less than 1 year			1-3 years			3-5 years		More than 5 years
	(in thousands)
Contractual Obligations
Non-Convertible Debt Obligations	6,930			—			—		6,930
Convertible Debt Obligations	4,137			—			—		4,137			—
Acquisition Debt	—			—			—		—			—
Operating Lease Obligations	1,654			603			884		157			10
Total	$	12,721		$	603		$	884	$	11,224		$	10

Critical Accounting Policies and Estimates

Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of goodwill, and accounting for discontinued operations.

Revenue Recognition. We apply the revenue recognition principles set forth under SOP 97-2 and SAB 104 with respect to all of our revenue. We adhere strictly to the criteria set forth in paragraph .08 of SOP 97-2 and outlined in SAB 104 which provides for revenue to be recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the vendor’s fee is fixed or determinable, and (iv) collectability is probable. A summary of our revenue recognition policies, as they relate to our specific revenue streams, is as follows:

Computer Hardware Product Revenues

We require our hardware product sales to be supported by a written contract or other evidence of a sale transaction that clearly indicates the selling price to the customer, shipping terms, payment terms (generally 30 days) and refund policy, if any.

Since our hardware sales are supported by a contract or other document that clearly indicates the terms of the transaction, and our selling price is fixed at the time the sale is consummated, we record revenue on these sales at the time in which we receive a confirmation that the goods were tendered at their destination when shipped “FOB destination,” or upon confirmation that shipment has occurred when shipped “FOB shipping point.”

Software Product Revenues

We make substantially all of our software product sales as a reseller of licenses, which may include a post contract customer support arrangement and access to product and upgrades, and enhancements that are provided exclusively by the manufacturer following delivery and the customer’s acceptance of the software product. We do not presently sell any software that we develop internally. Any responsibility for technical support and access to upgrades and enhancements to these software products are solely the responsibility of the software manufacturer, which arrangement is known to the customer at the time the sale is consummated. With respect to delivery, we require that the customer has received transfer of the software or, at a minimum, an authorization code (“key”) to permit access to the product. If a software license is delivered to the customer, but the license term has not begun, we do not record the revenue prior to inception of the license term.

We require our software product sales to be supported by a written contract or other evidence of a sale transaction, which generally consists of a customer purchase order or on-line authorization. These forms of evidence clearly indicate the selling price to the customer, shipping terms, payment terms (generally 30 days) and refund policy, if any. The selling prices of these products are fixed at the time the sale is consummated.

For product sales, we apply the factors discussed in EITF 99-19 “Reporting Revenue Gross as a Principal versus Net as an Agent” in determining whether to recognize product revenues on a gross or net basis. In a substantial majority of our transactions, we (i) act as principal; (ii) take title to the products; and (iii) have the risks and rewards of ownership, including the risk of loss for collection, delivery or returns. For these transactions, we recognize revenues based on the gross amounts billed to our customers. In certain circumstances, based on an analysis of the factors set forth in EITF 99-19, we have determined that we were acting as an agent, and therefore recognize revenues on a net basis. During the nine months ended December 31, 2005, no revenues were recognized on a net basis.

IT Services Revenue

We generally bill our customers for professional IT services based on hours of time that we spend on any given assignment at our hourly billing rates. As it relates to delivery of these services, we recognize revenue under these arrangements as the work is completed and the customer has indicated their acceptance of our services by approving a work order milestone or completion order. For certain engagements, we enter fixed bid contracts, and we recognize revenue as phases of the project are completed and accepted by our client. For our seat management services, we enter unit-price contracts (e.g., price per user for seat management), and we recognize revenue based on number of units multiplied by the agreed-upon contract unit price per month.

BPO Services Revenue

For our BPO services, which primarily included our child support service contracts in the states of Kansas and Nebraska, we provided services under a fixed price (flat monthly fee) contract, and recognized revenue as the services are provided and billed. In the state of North Carolina, we had one contract subject to revenue-sharing related to child support services. Under that contract, a fee from amounts collected was shared with the county on a percentage basis, and revenue was recognized monthly in arrears as a percentage of the total amount of collections received.

Collectability of Receivables. A considerable amount of judgment is required to assess the ultimate realization of receivables, including assessing the probability of collection and the current credit worthiness of our clients. Probability of collection is based upon the assessment of the client’s financial condition through the review of its current financial statements or credit reports.

Goodwill. SFAS 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (June 30th for the company) and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit. We have recorded goodwill in connection with the company’s acquisitions, most recently the acquisitions of Redrock in September 2004 and ITI in October 2004, and recorded goodwill in the amount of $4,664,000 and $6,568,000, respectively. During fiscal year 2006, additional costs were incurred relating to the Redrock acquisition and goodwill was increased by approximately $153,000 per the

separation agreement of a third owner of Redrock (see Note 8). In these instances, goodwill was determined by comparing the purchase price and related transaction costs with the fair value of the net tangible assets and liabilities acquired.

Convertible Notes. The company accounts for conversion options embedded in convertible notes in accordance with Statement of Financial Accounting Standard (“SFAS) No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a company’s Own Stock” (“EITF 00-19”). SFAS 133 generally requires companies to bifurcate conversion options embedded in convertible notes from their host instruments and to account for them as free standing derivative financial instruments in accordance with EITF 00-19. SFAS 133 provides for an exception to this rule when convertible notes, as host instruments, are deemed to be conventional as that term is described in the implementation guidance under Appendix A to SFAS 133 and further clarified in EITF 05-2 “The Meaning of “Conventional Convertible Debt Instrument” in Issue No. 00-19. The company accounts for convertible notes (deemed conventional) in accordance with the provisions of EITF 98-5.

“Accounting for Convertible Securities with Beneficial Conversion Features,” (“EITF 98-5”), EITF 00-27 “Application of EITF 98-5 to Certain Convertible Instruments.” Accordingly, the company records, as a discount to convertible notes, the intrinsic value of such conversion options based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized over the term of the related debt to their earliest date of redemption.

Recent Accounting Standards

In December 2004, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 123R “Share Based Payment”. This statement is a revision of SFAS Statement No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R addresses all forms of share based payment (“SBP”) awards including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Under SFAS 123R, SBP awards result in a cost that will be measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest that will result in a charge to operations. This statement is effective for public entities that do not file as small business issuers—as of the beginning of the first annual reporting period that begins after June 15, 2005. The Company is currently in the process of evaluating the effect that the adoption of this pronouncement may have on its financial statements.

In December 2004, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 153 “Exchanges of Nonmonetary Assets”. This Statement amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this Statement, which is to be applied prospectively, are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2004. The adoption of this pronouncement is not expected to have material effect on the Company’s financial statements.

Emerging Issues Task Force (“EITF”) Issue 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share.” The EITF reached a consensus that contingently convertible instruments, such as contingently convertible debt, contingently convertible preferred stock, and other such securities should be included in diluted earnings per share (if dilutive) regardless of whether the market

price trigger has been met. The consensus is effective for reporting periods ending after December 15, 2004. The adoption of this pronouncement is not expected to have material effect on the Company’s financial statements.

In September 2005, the FASB ratified the Emerging Issues Task Force’s (“EITF”) Issue No. 05-7, “Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues,” which addresses whether a modification to a conversion option that changes its fair value affects the recognition of interest expense for the associated debt instrument after the modification and whether a borrower should recognize a beneficial conversion feature, not a debt extinguishment if a debt modification increases the intrinsic value of the debt (for example, the modification reduces the conversion price of the debt).

In September 2005, the FASB also ratified the EITF’s Issue No. 05-8, “Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature,” which discusses whether the issuance of convertible debt with a beneficial conversion feature results in a basis difference arising from the intrinsic value of the beneficial conversion feature on the commitment date (which is treated recorded in the shareholder’s equity for book purposes, but as a liability for income tax purposes), and, if so, whether that basis difference is a temporary difference under FASB Statement No. 109, “Accounting for Income Taxes.” The Company is currently in the process of evaluating the effect that the adoption of this pronouncement may have on its financial statements.

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 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk associated with adverse changes in financial and commodity market prices and rates could impact our financial position, operating results or cash flows. We do not have any variable rate debt instruments and we are not exposed to market risk due to changes in interest rates such as the prime rate and LIBOR.

We have operated primarily in the United States. Accordingly, we have not had any significant exposure to foreign currency rate fluctuations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

DYNTEK, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2006

	Page Number
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		32
CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2006 AND 2005		33
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED JUNE 30, 2006, 2005 AND 2004		34
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED JUNE 30, 2006, 2005 AND 2004		35
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, 2006, 2005 AND 2004		36-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		38-69

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Audit Committee of the
Board of Directors and Shareholders
of Dyntek, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Dyntek, Inc. and Subsidiaries (the “Company”) as of June 30, 2006 and 2005, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the three years in the period ended June 30, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Dyntek, Inc. and Subsidiaries, at June 30, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2006 in conformity with generally accepted accounting principles (United States).

Marcum & Kliegman LLP
New York, New York
October 10, 2006

DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

*ASSETS*	June 30, 2006			June 30, 2005
CURRENT ASSETS:
Cash	$	546		$	963
Cash—Restricted	644			334
Accounts receivable, net	1,881			17,894
Due from NETF	2,817			—
Inventory	193			1,666
Prepaid expenses and other current assets	101			75
Other receivables	118			125
TOTAL CURRENT ASSETS	6,300			21,057
RESTRICTED CASH—non current portion	559			231
PROPERTY AND EQUIPMENT, net	763			959
GOODWILL	18,767			18,579
ACQUIRED CUSTOMER LISTS, net	2,722			4,637
DEFERRED FINANCING COSTS, net	304			1,002
DEPOSITS AND OTHER ASSETS	273			871
	$	29,688		$	47,336
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Cash overdraft	$	168		$	1,274
Accounts payable	2,090			8,937
Line of credit	—			4,697
Acquisition indebtedness	—			3,676
Accrued expenses	2,705			2,564
Deferred revenue	1,036			996
Notes payable-accrued interest	—			184
Notes payable-current portion	—			3,621
Liabilities of discontinued operations	258			329
TOTAL CURRENT LIABILITIES	6,257			26,278
DEFERRED REVENUE—non current portion	529			588
ACQUISITION INDEBTEDNESS—non current portion	—			644
NOTES PAYABLE—non current portion	2,021			6,371
TOTAL LIABILITIES	8,807			33,881
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock, $.0001 par value, 10,000,000 shares authorized; 0 and 583,124 shares issued and outstanding as of June 30, 2006 and June 30, 2005, respectively	—			1
Class A Common stock, $.0001 par value, 450,000,000 shares authorized; 55,180,586 and 7,542,676 shares issued and outstanding as of June 30, 2006 and June 30, 2005, respectively	6			1
Additional paid-in capital	146,783			109,555
Common stock to be issued in connection with acquisition (428,000 shares)	—			1,544
Accumulated deficit	(125,908		)	(97,646		)
TOTAL STOCKHOLDERS’ EQUITY	20,881			13,455
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	29,688		$	47,336

See notes to consolidated financial statements.

DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data)

	Years Ended June 30,
	2006			2005			2004
REVENUES
Product Revenues	$	56,459		$	45,490		$	22,782
Service Revenues	24,372			31,069			27,165
TOTAL REVENUES	80,831			76,559			49,947
COST OF REVENUES
Cost of Products	49,972			38,499			19,031
Cost of Services	18,271			24,167			21,980
TOTAL COST OF REVENUES	68,243			62,666			41,011
GROSS PROFIT	12,588			13,893			8,936
OPERATING EXPENSES:
Selling	12,426			11,693			7,125
General and administrative	5,143			7,045			5,050
Depreciation and amortization	2,651			3,171			2,985
Impairment of goodwill	—			12,897			11,600
TOTAL OPERATING EXPENSES	20,220			34,806			26,760
LOSS FROM OPERATIONS	(7,632		)	(20,913		)	(17,824		)
OTHER INCOME (EXPENSE)
Gain (Loss) on marketable securities	54			(250		)	(207		)
Loss on extinguishment of debt	(13,720		)	—			—
Equity interest in loss of investee	—			—			(64		)
Interest expense	(7,296		)	(2,138		)	(942		)
Interest income	58			30			102
Other income (expense), net	(239		)	(1,141		)	—
TOTAL OTHER INCOME (EXPENSE)	(21,143		)	(3,499		)	(1,111		)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	(28,775		)	(24,412		)	(18,935		)
INCOME TAX	—			25			—
LOSS FROM CONTINUING OPERATIONS	(28,775		)	(24,437		)	(18,935		)
DISCONTINUED OPERATIONS
Gain on disposal of discontinued operations	—			—			392
Gain (loss) on discontinued operations	513			1,846			(456		)
TOTAL GAIN (LOSS) FROM DISCONTINUED OPERATIONS	513			1,846			(64		)
NET LOSS	$	(28,262	)	$	(22,591	)	$	(18,999	)
NET LOSS PER SHARE:
Continuing operations	$	(1.33	)	$	(3.78	)	$	(4.00	)
Discontinued operations	0.02			0.29			(0.01		)
NET LOSS PER SHARE—basic and diluted	$	(1.31	)	$	(3.49	)	$	(4.01	)
WEIGHTED AVERAGE NUMBER OF SHARES USED IN COMPUTATION-BASIC AND DILUTED	21,572,858			6,466,277			4,730,170
NET LOSS	$	(28,262	)	$	(22,591	)	$	(18,999	)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX Unrealized gain (loss) on available-for-sale securities	—			—			74
COMPREHENSIVE LOSS	$	(28,262	)	$	(22,591	)	$	(18,925	)

See notes to consolidated financial statements.

DYNTEK INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands)

								Class		A							Additional			Unrealized			Accum-		Stock-
	Preferred			Stock				Common		Stock			Acquisition				Paid-in			Gain (loss)			ulated		holders’
	Shares			Amount				Shares		Amount			Shares				Capital			Securities			Deficit		Equity
Balance—June 30, 2003		1,490			$	1			3,838		$	—		—				81,922			(244	)	(56,056	)		25,623
Conversion of Preferred Stock to Common Stock		(807	)						202
Shares issued in connection with private placement of common stock									1,582		1							11,000								11,001
Warrant exercise									138									1,041								1,041
Stock option exercise									—									4								4
Shares issued in connection with acquisition of Woda & Associates									26									200								200
Shares issued in connection with acquisition of Entellus									11									90								90
Cancellation of note payable																		5,625								5,625
Shares issued in connection with convertible debt repayment									25									225								225
Convertible debt warrant discount																		499								499
Shares issued to placement agent in connection with convertible debt									16									170								170
Shares issued for services									5									50								50
Changes in unrealized gain (loss) on securities available for sale																					74					74
Net loss																							(18,999	)		(18,999	)
Balance—June 30, 2004		683			$	1			5,843		$	1		—				100,826			(170	)	(75,055	)		25,603
Conversion of Preferred Stock to Common Stock		(100	)						25
Shares issued upon conversion of 9% notes									78									509								509
Warrants issued for services																		190								190
Shares issued in connection with Laurus Funds debt financing									6									40								40
Debt discount on 9% convertible notes																		569								569
Warrants issued to placement agent																		44								44
Shares issued in connection with private offering									1,481									6,877								6,877
Common stock held in escrow under AMR asset purchase									30
Shares issued in connection with acquisition of Redrock									79									500								500
Changes in unrealized gain (loss) on securities available for sale																					170					170
Shares to be issued in connection with acquisition of ITI (428,000 shares)														1,544												1,544
Net loss																							(22,591	)		(22,591	)
Balance—June 30, 2005		583			$	1			7,543		$	1		$	1,544			109,555			—		(97,646	)		13,455
Conversion of Preferred Stock to Common Stock		(583	)		(1		)		145																	(1	)
Shares to be issued in connection with acquisition of ITI (428,000 shares)									428					(1,544		)		1,544
Stock based compensation																		275								275
Capital financing fees																		(549	)							(549	)
Change in conversion price of 9% Notes																		1,743								1,743
Change in exercise priced of warrants issued to 9% note-holders																		169								169
Change in exercise priced of warrants issued to Laurus Master Funds																		50								50
Discounts recorded upon issuance of Bridge Notes																		150								150
Shares issued in private placement									3,796									683								683
Change in exercise price of warrants																		95								95
Shares issued upon settlement of 9% Notes									13,283		2							7,969								7,971
Shares issued in private placement									5,730		1							1,031								1,032
Shares issued upon exercise of warrants									189									—								—
Shares issued upon settlement Iof acquisition debt									10,216		1							6,130								6,131
Shares issued upon of Bridge Notes									13,047		1							7,828								7,829
Shares issued upon trade payables									804									482								482
Discounts recorded upon issuance of Senior Notes																		6,228								6,228
Discounts recorded upon issuance of Junior Notes																		3,400								3,400
Net loss																							(28,262	)		(28,262	)
Balance—June 30, 2006		—			—				55,181		$	6		—				146,783			—		(125,908	)		20,881

See notes to consolidated financial statements.

DYNTEK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

	Years Ended June 30,
	2006			2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss-Continuing operations	$	(28,775	)	$	(24,437	)	(18,935		)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	2,651			3,171			2,880
Non-cash interest	5,276			899			120
Stock based compensation	275			190			—
Amortization of capitalized software costs	—			—			—
Equity interest in loss of investee	—			—			64
Loss / (Gain) on marketable securities	(54		)	248			207
Impairment charges
Goodwill	—			12,897			11,600
Capitalized software	—			—			105
Loss on extinguishment of debt	13,720			—			—
Investment losses	—			1,104			—
Loss on note due from equity investee	—			448			—
Settlement of note due from former officer	—			100			—
Gain on sale of equipment	—			(14		)	—
Changes in operating assets and liabilities:
Accounts receivable	15,965			(2,847		)	(3,221		)
Due from NETF	(2,817		)
Inventory	1,473			(215		)	(1,048		)
Accrued interest on notes payable	(176		)	106			79
Accrued interest income on note	—			—			—
Prepaid expenses and other current assets	(19		)	30			97
Deposits and other assets	598			(561		)	89
Accounts payable	(5,625		)	1,039			(5,532		)
Deferred revenue	(19		)	786			(648		)
Accrued expenses	302			229			(810		)
Restricted cash	(638		)	5			685
Total adjustments	30,912			17,616			4,667
NET CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS	2,137			(6,821		)	(14,268		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash proceeds from sale of discontinued operations	—			—			392
Cash from disposition of marketable securities	54			—			—
Other notes receivable	—			(22		)	(12		)
Cash received from Redrock acquisition	—			405			—
Cash received from ITI acquisition	—			106			—
Cash paid for acquisitions	(457		)	(6,618		)	—
Cash proceeds from sale of securities	—			—			71
Cash proceeds from sale of equipment	—			50			—
Capital expenditures	(224		)	(370		)	(195		)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES	(627		)	(6,449		)	256
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft	(1,106		)	994			(243		)
Proceeds from debt financing, net of expenses	13,200			5,439			6,000
Deferred financing costs	(575		)	(662		)	(564		)
Net proceeds (repayments) under line of credit	(4,697		)	968			1,746
Exercise of options and warrants	—			—			1,045
Issuance of common stock, net of expenses	1,169			6,886			11,001
Principal payments	(10,360		)	(196		)	—
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES	(2,369		)	13,429			18,985
CASH FLOWS OF DISCONTINUED OPERATIONS:
Operating cash flows	442			(2,006		)	(2,163		)
NET CASH PROVIDED BY (USED IN) DISCONTINUED OPERATIONS	442			(2,006		)	(2,163		)
NET INCREASE (DECREASE) IN CASH	(417		)	(1,847		)	2,810
CASH AT BEGINNING OF YEAR	963			2,810			—
CASH AT END OF YEAR	$	546		$	963		$	2,810

See notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands, except share data)

	Years Ended June 30,
	2006		2005			2004
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$	1,916	$	1,164		$	681
Cash paid for income taxes	$	—	$	—		$	33
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES:
Conversion of notes into common stock	$	7,468	$	509		$	225
Note receivable converted to preferred stock	$	—	$	—		$	1,104
Issuance of common stock and warrants to agents in convertible debt transactions	$	—	$	84		$	170
Common stock issued/to be issued to sellers of acquired businesses	$	—	$	2,044		$	290
Issuance of common stock for services rendered	$	—	$	—		$	50
Reclassification of LaborSoft accounts receivable to notes receivable, net of reserve	$	—	$	—		$	436
Debt discount issued in connection with convertible debt	$	—	$	569		$	499
Cancellation of note payable and accrued interest by investors	$	—	$	—		$	5,625
Acquisitions of businesses:
Current tangible assets			$	3,631
Non current tangible assets			508
Current liabilities assumed			(4,566		)
Intangible assets acquired			1,802
Goodwill recognized			11,607
Less
Accrued purchase consideration			(4,320		)
Stock based purchase consideration			(2,044		)
Cash paid for acquisitions of businesses			$	6,618

See notes to consolidated financial statements.

DYNTEK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

DynTek, Inc. (the “Company”) was initially incorporated in Delaware on May 27, 1989 as Universal Self Care, Inc. In January 1998 the Company changed its name to Tadeo Holdings, Inc. In November 1999 the Company changed its name to TekInsight, Inc., and in December 2001 the Company changed its name to DynTek, Inc.

The Company provides professional information technology (“IT”) services and sales of related products to mid-market commercial businesses, state and local government agencies, and educational institutions.

Reverse Stock Split and Amendment to Certificate of Incorporation

As described in Note 14, the Company’s stockholders approved an amended to its certificate of incorporation to effectuate a 1-for-10 reverse stock split and certain other transactions intended to recapitalize the Company. The reverse split became effective on June 5, 2006. All share information included in the accompanying financial statements and notes thereto give retroactive effect to the reverse split.

2. LIQUIDITY AND FINANCIAL CONDITION

The Company incurred a net loss of $28,262,000 for the year ended June 30, 2006, which includes $22,427,000 of non-cash charges resulting from $2,651,000 of depreciation and amortization; $275,000 of stock-based compensation; $5,276,000 of non-cash interest; a $505,000 reduction in the carrying value of an investment and a $14,620,000 loss on the extinguishment of debt obligations (Note 11). These charges were offset by a $900,000 gain on the extinguishment of trade payables (Note 11). The Company has $43,000 of working capital at June 30, 2006.

The Company, beginning in the first quarter of its fiscal year ended June 30, 2006, undertook a financial and operating restructuring plan designed to reduce the amount of cash flows used in its operating activities. The Company’s operational restructuring initiatives include, among other things, streamlining operations by reducing employee headcount, cutting overhead expenses and focusing revenue generating activities on selling products that are intended to generate higher profit margins.

The Company’s financial restructuring initiatives have enabled it alleviate constraints on its liquidity from having to immediately service previously existing debt obligations. The Company entered into a new credit facility with New England Technology and Finance (“NETF”) on August 8, 2005 (Note 7), converted two major note obligations and certain trade payables into equity during the quarter ended March 31, 2006 (Note 11), restructured notes payable to sellers of acquired businesses that were ultimately converted into equity on March 8, 2006 (Note 12), and issued $6,700,000 of notes to a major investor/stockholder on March 8, 2006. The Company used the proceeds of its $6,700,000 note offering to repay notes due to the Laurus Master Funds (Note 11). In May and June of 2006, the Company issued an aggregate of $4,000,000 of additional notes to the same major investor. The proceeds of these notes were used to repay certain indebtedness and for general corporate purposes.

The Company also raised net proceeds of approximately $1,714,000 through issuances of common stock in a private placement transaction (Note 14).

Subsequent to June 30, 2006, the Company raised an additional $3,000,000 through its issuance of notes to the same major investor described above. These funds are available to the Company to complete

acquisitions of suitable target companies that the Company may identify. However, such funds will be available to the Company in the event that it does not identify a suitable acquisition candidate.

The Company believes that its strategy of streamlining the business around its core competency of providing IT solutions is enabling it to operate under a more efficient cost structure than it had in the past. The Company is also not required to make principal payments under any of its note obligations until June 2009 and its accounts receivable and product financing arrangement with NETF is providing it with timely working capital resources. Accordingly, the Company believes (based on these initiatives) that it will have sufficient liquidity to sustain the business through June 30, 2007.

3. SIGNIFICANT ACCOUNTING POLICIES

A. Principles of Consolidation—The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company transactions have been eliminated.

B. Revenue Recognition. The Company applies the revenue recognition principles set forth under SOP 97-2 and SAB 104 with respect to all of our revenue. We adhere strictly to the criteria set forth in paragraph.08 of SOP 97-2 and outlined in SAB 104 which provides for revenue to be recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the vendor’s fee is fixed or determinable, and (iv) collectability is probable.

Computer Hardware Product Revenues

The Company requires its hardware product sales to be supported by a written contract or other evidence of a sale transaction that clearly indicates the selling price to the customer, shipping terms, payment terms (generally 30 days) and refund policy, if any. Since the Company’s hardware sales are supported by a contract or other document that clearly indicates the terms of the transaction, and the selling price is fixed at the time the sale is consummated, the Company records revenue on these sales at the time in which it receives a confirmation that the goods were tendered at their destination when shipped “FOB destination,” or upon confirmation that shipment has occurred when shipped “FOB shipping point.”

Software Product Revenues

The Company makes substantially all of its software product sales as a reseller of licenses, which may include a post contract customer support arrangement and access to product and upgrades, and enhancements that are provided exclusively by the manufacturer following delivery and the customer’s acceptance of the software product. The Company does not presently sell any software that it develops internally. Any responsibility for technical support and access to upgrades and enhancements to these software products are solely the responsibility of the software manufacturer, which arrangement is known to the customer at the time the sale is consummated. With respect to delivery, the Company requires that the customer has received transfer of the software or, at a minimum, an authorization code (“key”) to permit access to the product. If a software license is delivered to the customer, but the

license term has not begun, the Company does not record the revenue prior to inception of the license term.

The Company requires its software product sales to be supported by a written contract or other evidence of a sale transaction, which generally consists of a customer purchase order or on-line authorization. These forms of evidence clearly indicate the selling price to the customer, shipping terms, payment terms (generally 30 days) and refund policy, if any. The selling prices of these products are fixed at the time the sale is consummated.

For product sales, the Company applies the factors discussed in Emerging Issues Task Force Issue “EITF” 99-19 in determining whether to recognize product revenues on a gross or net basis. In a substantial majority of transactions, the Company (i) acts as principal; (ii) takes title to the products; and (iii) has the risks and rewards of ownership, including the risk of loss for collection, delivery or returns. For these transactions, the Company recognizes revenues based on the gross amounts billed to customers. In certain circumstances, based on an analysis of the factors set forth in EITF 99-19, the Company has determined that it was acting as an agent, and therefore recognizes revenues on a net basis. For the year ended June 30, 2005, revenues recognized on a net basis totaled approximately $1,455,000, or 3% of total product revenues during the period.

IT Services Revenue

The Company generally bills its customers for professional IT services based on hours of time spent on any given assignment at its hourly billing rates. As it relates to delivery of these services, the Company recognizes revenue under these arrangements as the work is completed and the customer has indicated their acceptance of services by approving a work order milestone or completion order. For certain engagements, the Company enters fixed bid contracts, and recognizes revenue as phases of the project are completed and accepted by the client. For its seat management services, the Company enters unit-price contracts (e.g., price per user for seat management), and recognizes revenue based on number of units multiplied by the agreed-upon contract unit price per month.

BPO Services Revenue

For business process outsourcing (“BPO”) services, which primarily included the Company’s child support service contracts in the state of Nebraska, the Company provides services under a fixed price (flat monthly fee) contract, and recognizes revenue as the services are provided and billed. In the state of North Carolina, the Company has one contract subject to revenue-sharing related to child support services. Under that contract a fee from amounts collected is shared by the Company with the county on a percentage basis, and revenue is recognized monthly in arrears as a percentage of the total amount of collections received.

C. Cash and Cash Equivalents—The Company considers all highly liquid temporary cash investments with an original maturity of three months or less when purchased, to be cash equivalents.

D. Accounts Receivable—The Company generates accounts receivable from sales of services and products to its customers. The Company establishes reserves for uncollectible accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. The Company periodically reviews its accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Information with respect to the Company’s allowance for doubtful accounts is presented in Note 6.

The Company sells its eligible accounts receivable with limited recourse to NETF under each of an Asset Purchase and Liability Assumption Agreement and an Asset Purchase Agreement that it entered into with NETF during the year ended June 30, 2006. The Company retains certain servicing rights under a related Master Servicing Agreement that provides for the Company to manage collections and other ongoing interactions with customers for certain contractual fees. These agreements are more fully described in Note 7.

The Company accounts for its transfers of accounts receivable to NETF under each of these agreements in accordance with the provision of SFAS 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” as sales of such accounts receivable balances. The gain or loss on sales of receivables to NETF is determined at the date of transfer based upon the amount at which they are transferred to NETF less any fees, discounts and other charges provided under the agreements.

E. Property and Equipment—Property and equipment is stated at cost and is depreciated on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are amortized over the term of their respective leases or service lives of the improvements, whichever is shorter.

F. Loss Per Common Share—Basic earnings per share has been calculated based upon the weighted average number of common shares outstanding. Convertible preferred stock, convertible debt, options and warrants have been excluded as common stock equivalents in the diluted earnings per share because their effect would be anti-dilutive. The aggregate number of potential common stock equivalents outstanding as of June 30, 2006 and 2005 is as follows:

	As of June 30,
	2006	2005
Preferred Shares (convertible at 2.5 common shares)	—	145,781
Warrants	26,946,897	2,312,924
Options	231,166	355,300
Convertible debt	20,684,658	1,615,318
	47,862,721	4,429,323

G. Estimates—The Company’s financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of goodwill, and accounting for discontinued operations.

H. Stock Based Compensation—Prior to July 1, 2005, the Company accounted for employee stock transactions in accordance with Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees.” The Company applied the proforma disclosure requirements of SFAS No. 123 “Accounting for Stock-Based Compensation.”

Effective July 1, 2005, the Company adopted SFAS No. 123R “Share Based Payment.” This statement is a revision of SFAS Statement No. 123, and supersedes APB Opinion No. 25, and its related implementation guidance. SFAS 123R addresses all forms of share based payment (“SBP”) awards including shares issued under employee stock purchase plans, stock options restricted stock and stock appreciation rights. Under SFAS 123R, SBP awards result in a cost that will be measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest that will result in a charge to operations. The Company adopted the modified prospective method

with respect to accounting for its transition to SFAS 123(R) and measured unrecognized compensation cost as described in Note 15. Accordingly, the Company recognized in salaries and related expense in its statement of operations approximately $275,000 for the fair value of stock options vested and for options expected to vest during year ended June 30, 2006.

For the years ended June 30, 2005 and 2004, the Company applied APB Opinion No. 25, “Accounting for Stock Issued to Employees.” As required under SFAS No. 148, “Accounting for Stock-based Compensation—Transition and Disclosure,” the following table presents pro-forma net income and basic and diluted earnings per share as if the fair value-based method had been applied to all awards during that period.

	Year Ended June 30,
	2005				2004
	(in thousands except per share data)
Net Loss		$	(22,591	)		$	(18,999	)
Stock-based employee compensation cost, net of tax effect, under fair value accounting		(332		)		(151		)
Pro-forma net loss under Fair Value Method		$	(22,923	)		$	(19,150	)
Loss per share
Basic		$	(3.55	)		$	(4.05	)
Diluted		$	(3.55	)		$	(4.05	)
Per share stock-based employee compensation cost, net of tax effect, under fair value accounting:
Pro-forma loss share basic		$	(3.55	)		$	(4.05	)
Pro-forma loss share diluted		$	(3.55	)		$	(4.05	)

The fair value of all awards was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: risk fee interest rate: 3.44% to 4.05%; expected dividend yield: 0 %; expected option life: 3 to 4 years; volatility: 35% to 136%.

I. Fair Value of Financial Instruments—The carrying amounts reported in the balance sheet for cash, trade receivables, accounts payable and accrued expenses approximate fair value based on the short-term maturity of these instruments. The carrying amounts of notes receivable approximate fair value as such instruments feature contractual interest rates that are consistent with current market rates of interest. The carrying amounts of notes payable approximate fair value because the effective yields of such instruments, which includes the effect of contractual interest rates taken together with discounts resulting from the concurrent issuances the issuances of common stock purchase warrants, are consistent with current market rates of interest.

J. Goodwill—Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations (Note 4). SFAS 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (June 30th for the Company) and between annual tests when circumstances indicate that the recoverability of the carrying amount of goodwill may be in doubt. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and

assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit (Note 9).

K. Comprehensive Income (Loss)—Comprehensive income (loss) is comprised of net income (loss) and all changes to the statements of stockholders’ equity, except for changes that relate to investments made by stockholders, changes in paid-in capital and distributions.

L. Inventory—Inventory consist primarily of finished goods in transit, which are recorded at the lower of cost or market.

M. Advertising Costs—Costs related to advertising and promotions of services are charged to sales operating expense as incurred. Advertising expense amounted to $162,000, $59,000, and $32,000 for the years ended June 30, 2006, 2005 and 2004, respectively. These expenses are included in selling expenses in the accompanying statements of operations.

N. Shipping and Handling Costs—The Company accounts for shipping and handling costs as a component of “Cost of Product Revenues.” These costs are primarily the direct freight costs related to the “drop shipment” of products to the Company’s customers. Shipping and handling costs amounted to $218,000 in fiscal 2006, $134,000 in fiscal 2005, and $95,000 in fiscal 2004.

O. Convertible Notes

The Company accounts for conversion options embedded in convertible notes in accordance with Statement of Financial Accounting Standard (“SFAS) No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”). SFAS 133 generally requires Companies to bifurcate conversion options embedded in convertible notes from their host instruments and to account for them as free standing derivative financial instruments in accordance with EITF 00-19. SFAS 133 provides for an exception to this rule when convertible notes, as host instruments, are deemed to be conventional as that term is described in the implementation guidance under Appendix A to SFAS 133 and further clarified in EITF 05-2 “The Meaning of “Conventional Convertible Debt Instrument” in Issue No. 00-19.

The Company accounts for convertible notes (deemed conventional) in accordance with the provisions of Emerging Issues Task Force Issue (“EITF”) 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features,” (“EITF 98-5”), EITF 00-27 “Application of EITF 98-5 to Certain Convertible Instruments,” Accordingly, the Company records, as a discount to convertible notes, the intrinsic value of such conversion options based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized over the term of the related debt to their earliest date of redemption.

P. New Accounting Standards

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets” (SFAS 153). SFAS 153 amends APB Opinion No. 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of SFAS 153 are effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The provisions of this statement are intended be applied prospectively. The adoption of this pronouncement did not have a material effect on the Company’s financial statements.

In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). This Statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed.

APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this pronouncement did not have a material effect on the Company’s financial statements.

On June 29, 2005, the EITF ratified Issue No. 05-2, “The Meaning of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19, ‘Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.’” EITF Issue 05-2 provides guidance on determining whether a convertible debt instrument is “conventional” for the purpose of determining when an issuer is required to bifurcate a conversion option that is embedded in convertible debt in accordance with SFAS 133. Issue No. 05-2 is effective for new instruments entered into and instruments modified in reporting periods beginning after June 29, 2005. The adoption of this pronouncement did not have a material effect on the Company’s financial statements.

In September 2005, the EITF ratified Issue No. 05-4, “The Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF Issue No. 00-19, ‘Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.’” EITF 05-4 provides guidance to issuers as to how to account for registration rights agreements that require an issuer to use its “best efforts” to file a registration statement for the resale of equity instruments and have it declared effective by the end of a specified grace period and, if applicable, maintain the effectiveness of the registration statement for a period of time or pay a liquidated damage penalty to the investor. The Task Force did not reach a conclusion on this issue; however, the Company has adopted View C of this pronouncement and treats registration right agreements as a free standing derivative. The adoption of View C did not have a material affect on the Company’s financial statements.

modification and whether a borrower should recognize a beneficial conversion feature, not a debt extinguishment if a debt modification increases the intrinsic value of the debt (for example, the modification reduces the conversion price of the debt). This issue is effective for future modifications of debt instruments beginning in the first interim or annual reporting period beginning after December 15, 2005. The adoption of this pronouncement did not have a material effect on the Company’s financial statements.

In September 2005, the FASB also ratified the EITF’s Issue No. 05-8, “Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature,” which discusses whether the issuance of convertible debt with a beneficial conversion feature results in a basis difference arising from the intrinsic value of the beneficial conversion feature on the commitment date (which is recorded in the stockholders’ equity for book purposes, but as a liability for income tax purposes), and, if so, whether that basis difference is a temporary difference under FASB Statement No. 109, “Accounting for Income Taxes.” This Issue should be applied by retrospective application pursuant to Statement 154 to all instruments with a beneficial conversion feature accounted for under Issue 00-27 included in financial statements for reporting periods beginning after December 15, 2005. The adoption of this pronouncement did not have a material effect on the Company’s financial statements.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 150.” SFAS No. 155 (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (b) clarifies that certain instruments are not subject to the requirements of SFAS 133, (c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that may contain an embedded derivative requiring bifurcation, (d) clarifies what may be an embedded derivative for certain concentrations of credit risk and (e) amends SFAS 140 to eliminate certain prohibitions related to derivatives on a qualifying special-purpose entity. SFAS 155 is applicable to new or modified financial instruments in fiscal years beginning after September 15, 2006, though the provisions related to fair value accounting for hybrid financial instruments can also be applied to existing instruments. Early adoption, as of the beginning of an entity’s fiscal year, is also permitted, provided interim financial statements have not yet been issued. The Company will apply the provisions of this statement prospectively to new instruments.

In March 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 156, Accounting for Servicing of Financial Assets (SFAS No. 156). SFAS No. 156 amends SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to require all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. SFAS No. 156 also permits servicers to subsequently measure each separate class of servicing assets and liabilities at fair value rather than at the lower of cost or market. For those companies that elect to measure their servicing assets and liabilities at fair value, SFAS No. 156 requires the difference between the carrying value and fair value at the date of adoption to be recognized as a cumulative effect adjustment to retained earnings as of the beginning of the fiscal year in which the election is made. SFAS No. 156 is effective for the first fiscal year beginning after September 15, 2006. The Company is evaluating the potential impact, if any, that the adoption of SFAS 156 will have on its consolidated financial statements.

4. BUSINESS COMBINATIONS

Redrock Communications Solutions, Inc.

On September 29, 2004, the Company entered into a Stock Purchase Agreement (the “Agreement”) effective August 1, 2004 to acquire all of the outstanding Common Stock of Redrock Communication Solutions, Inc. (“Redrock) for purchase consideration (after giving effect to earn-outs) of $5,226,000. The purchase price included $4,726,000 in cash and $500,000 for the fair value of 793,000 shares of common stock.

The Company assumed net liabilities of approximately $383,000 with respect to this transaction and allocated the excess of the purchase price over the fair value of net liabilities assumed as follows: customer list for $755,000 and goodwill for $4,817,000.

Integration Technologies Inc.

On October 14, 2004, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”), by and among the Company, ITI Acquisition Corp., a California corporation and wholly owned subsidiary of the Company (“Merger Sub”), Integration Technologies, Inc., a California corporation (“ITI”), the shareholders of ITI (the “ITI Shareholders”) and Casper Zublin, Jr., in his capacity as the shareholder representative (the “Representative”). Pursuant to the terms of the agreement the Company acquired all of the outstanding common stock of ITI for aggregate purchase consideration (after giving effect to earn-outs and certain changes and amendments to the purchase price) amounting to $6,890,000. The purchase price, as adjusted included $5,346,000 in cash and $1,544,000 for the fair value of 428,000 shares of common stock.

The Company assumed net liabilities of approximately $78,000 with respect to this transaction and allocated the excess of the purchase price over the fair value of net liabilities assumed as follows: customer list for $400,000 and goodwill for $6,568,000.

In September 2005, the Company and certain sellers of ITI (including the Company’s current chief executive officer, Casper Zublin, Jr.) agreed to convert $2,574,735 of remaining payments into promissory notes bearing interest at 8.9% per annum. The Company paid $643,684 in principal due under the ITI Notes in September 2005, with a remaining aggregate principal balance of $1,931,051.

On March 8, 2006, the Company entered into Conversion and Settlement Agreements with the holders of ITI Notes providing for the surrender of the notes to the Company for their immediate and irrevocable cancellation in exchange for such number of shares of common stock derived by dividing the aggregate principal and interest of $2,043,273 by a conversion price of $.20 per share. As described in Note 11, the Company accounted for the extinguishment of these and other notes that were also settled on March 8, 2006 as a troubled debt restructuring in accordance with SFAS 15. The conversion was effective and the shares of common stock were issued in June 2006 following the effective date of the Company’s 1 for 10 reverse stock split.

5. RESTRICTED CASH

Restricted cash includes cash received in connection with maintenance agreements that is restricted and will become available to the Company as revenue is earned and recognized under the terms of the respective agreements, which are three years. The non-current portion, which amounts to approximately $559,000, is classified as a non-current asset.

6. ACCOUNTS RECEIVABLE

Accounts receivable as follows (in thousands of dollars):

	June 30,
	2006			2005
Accounts receivable	$	2,581		$	18,512
Less: allowance for doubtful accounts	(700		)	(618		)
	$	1,881		$	17,894

7. DUE FROM NETF

On August 8, 2005, the Company entered into a series of related agreements with NETF providing for NETF to purchase, eligible accounts receivable balances and to finance qualified purchases (as defined). This facility is comprised of three components: (1) an Asset Purchase and Liability Assumption Agreement (the “APLA”), under which NETF finances certain of the Company’s qualified product purchases in connection with consummating sales to customers and (2) an Asset Purchase Agreement (the “APA”), and (3) a Master Servicing Agreement (“MSA”).

Qualified product purchases financed by NETF under the APLA are repaid from collections of accounts receivable balances that the Company generates from its sales of such products to customers. The Company transfers title to the invoices to NETF at the time these sales are financed and delivery is made to the customer. The Company pays contractual financing and servicing fees to NETF for its financing of these purchases in an amount that is equal to a percentage of the gross profit margin on such sales. The percentages fees vary based on the (a) amount of gross profit on such sales and (b) number of days in which the receivables from such sales remain uncollected.

NETF remits periodically to the Company an amount equal to the monthly gross profit margin on the sales less the contractual fees. The APLA also provides for the Company to repurchase, after 150 days, any amounts that remain unpaid by the customer for reasons other than the customer’s inability to pay as a result of its financial condition or possible insolvency. NETF pre-approves all product purchases and the credit worthiness of the Company’s customers under this arrangement as a precondition to financing the sale.

Under the APA, the Company transfers eligible accounts receivable to NETF in exchange for advances of up to 80% of their gross amount. NEFT charges the Company fees (the “Discount Factor”) in an amount equal to the LIBOR rate plus 4% annum on advances made at the time of the transfer. The Company also retains servicing rights under the (“MSA”). Under the terms of the MSA, the Company manages collections and other ongoing interactions with its customers in exchange for fees amounting to approximately 20% of the gross invoice amount. NEFT settles fees payable to the Company under this arrangement net of the Discount Factor.

At the inception of the agreement, NETF funded $7,500,000 of qualified accounts receivable under the APA agreement. The proceeds received from NETF at the inception of the agreement were used (i) to repay $4,800,000 of the remaining balance due under a previously existing secured borrowing arrangement (Note 11), (ii) to repay acquisition debt, and (iii) for general corporate purposes. The APA also provides for the Company to repurchase, after 150 days, any amounts that remain unpaid by the customer for

reasons other than the customers’ inability to pay as a result of its financial condition or possible insolvency; however such repurchases are limited to 15% of all receivables transferred to NETF under this arrangement. In addition, NETF pre-approves the credit worthiness of the Company’s customers under this arrangement as a precondition to purchasing any invoice.

This facility contains customary affirmative and negative covenants as well as specific provisions related to the quality of the accounts receivables sold. The Company has also indemnified NETF for the risk of loss under any transferred balances except for loss incurred as a result of customer credit risk. The aggregate amount of fees incurred under this arrangement (under the APA and APLA) amounted to $1,164,830 and is included as a component of interest expense in the accompanying statement of operations for the year ended June 30, 2006.

8. PROPERTY AND EQUIPMENT

Furniture, fixtures and equipment are as follows (in thousands of dollars):

	June 30,
	2006			2005
Furniture and Fixtures	$	1,044		$	1,030
Vehicles	49			49
Computer equipment	3,280			3,074
Machinery and equipment	3			3
Leasehold improvements	41			36
	4,417			4,192
Less: accumulated depreciation	(3,654		)	(3,233		)
	$	763		$	959

Depreciation expense for the years ended June 30 2006, 2005, and 2004 amounted to approximately $420,000, $359,000, and $310,000 respectively.

9. GOODWILL

Goodwill represents the fair value of net assets acquired in excess of the aggregate of purchase consideration issued to sellers and transaction costs incurred in connection with completing business combinations. The Company’s remaining goodwill relates to its IT services segment which principally includes its Redrock, ITI and Data Systems components, which together constitute the IT Services Segment reporting unit. The Company performed its annual goodwill impairment test of the IT services segment at June 30, 2006, in accordance with SFAS 142. Based on the results of this test, the Company determined that an impairment charge is not required for the year ended June 30, 2006.

The Company recorded a $12,897,000 impairment charge for the year ended June 30, 2005 for goodwill recorded in connection with its acquisition of DMR in 2002. The Company determined such goodwill to be unrecoverable upon (1) receiving a definitive notice from certain of its customers that they would not renew existing contracts with the Company and (2) losing a key employee with significant customer relationships. These events had a material adverse affect on the Company’s ability to compete in this segment and recover its original investment. A portion of this charge ($6,026,000) was recorded during the quarter ended December 31, 2004 based on events described herein. The Company recorded an additional $6,837,000 charge during the quarter ended June 30, 2005 in connection with (1) new management’s decision to limit the activities of the BPO segment to only fulfilling service obligations on the its existing contracts and (2) reducing its expectation of future revenue with respect to a service contract with the state of Virginia.

10. INTANGIBLE ASSETS

At June 30, 2006, 2005, and 2004, the Company had the following intangible assets (in thousands):

	2006		2005		2004
Acquired customer lists	$	14,562	$	14,246	$	12,678
Less: accumulated amortization	11,840		9,609		7,136
Acquired customer lists, net	$

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