10-Q 1 frm10q2ndqtr2007.htm FORM 10-Q - 2ND QUARTER - 2007 Form 10-Q - 2nd Quarter - 2007


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

ý
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the quarterly period ended March 31, 2007
   
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TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-15789

STRATUS SERVICES GROUP, INC.
(Exact name of Registrant as specified in its charter)

Delaware
  
22-3499261
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)
     
149 Avenue at the Common, Shrewsbury, New Jersey 07702
(Address of principal executive offices)
     
(732) 866-0300
(Registrant’s telephone number, including area code)
     
Securities registered under Section 12(b) of the Exchange Act:   Not Applicable
     
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.04 par value
(Title of class)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One)

Large Accelerated Filer o
Accelerated Filer o
Non-Accelerated Filer T

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

The number of shares of Common Stock, $.04 par value, outstanding as of May 9, 2007 was 67,568,617.



STRATUS SERVICES GROUP, INC.
Condensed Consolidated Balance Sheets
(Unaudited)

   
March 31,
  
September 30,
  
Assets
  
2007
  
2006
  
           
Current assets
              
Cash
  
$
16,412
  
$
84,881
  
Accounts receivable-less allowance for doubtful accounts of $75,000
              
and $75,000
    
958,365
    
815,463
  
Unbilled receivables
    
126,552
    
126,191
  
Notes receivable
    
-
    
80,000
  
Due from related party
    
121,764
    
499,264
  
Prepaid insurance
    
35,427
    
12,244
  
Prepaid expenses and other current assets
    
275,852
    
244,662
  
     
1,534,372
    
1,862,705
  
               
Property and equipment, net of accumulated depreciation
    
190,099
    
145,727
  
Other assets
    
6,350
    
6,350
  
   
$
1,730,821
  
$
2,014,782
  
               
Liabilities and Stockholders’ Equity (Deficiency)
              
Current liabilities
              
Loans payable (current portion)
  
$
73,464
  
$
72,477
  
Loans payable - related parties
    
106,721
    
87,721
  
Notes payable - acquisitions (current portion)
    
237,335
    
203,663
  
Note payable - related party (current portion)
    
423,271
    
265,308
  
Line of credit
    
740,817
    
596,950
  
Insurance obligation payable
    
16,797
    
7,348
  
Accounts payable and accrued expenses
    
3,723,155
    
3,737,712
  
Accrued payroll and taxes
    
155,720
    
107,204
  
Payroll taxes payable
    
3,377,316
    
3,823,710
  
Series A redemption payable
    
300,000
    
300,000
  
     
9,154,596
    
9,202,093
  
               
Loans payable (net of current portion)
    
44,124
    
-
  
Notes payable - acquisitions (net of current portion)
    
366,366
    
476,017
  
Note payable - related party (net of current portion)
    
193,579
    
351,542
  
Convertible debt
    
40,000
    
40,000
  
     
9,798,665
    
10,069,652
  
Commitments and contingencies
              
               
Stockholders’ equity (deficiency)
              
Preferred stock, $.01 par value, 5,000,000 shares authorized
              
               





See notes to condensed consolidated financial statements


1


               
Series F voting convertible preferred stock, $.01 par value, 6,000
             
shares issued and outstanding, liquidation preference of $600,000
              
(including unpaid dividends of $112,000 and $91,000)
    
712,000
    
691,000
  
               
Common stock, $.04 par value, 500,000,000 shares authorized; 67,568,617
              
and 65,479,756 shares issued and outstanding
    
2,702,745
    
2,619,190
  
               
Additional paid-in capital
    
9,343,215
    
9,407,238
  
Accumulated deficit
    
(20,825,804
)
  
(20,772,298
)
Total stockholders’ equity (deficiency)
    
(8,067,844
)
  
(8,054,870
)
   
$
1,730,821
  
$
2,014,782
  




See notes to condensed consolidated financial statements


2

STRATUS SERVICES GROUP, INC.
Condensed Consolidated Statements of Operations
(Unaudited)

   
Three Months Ended
  
Six Months Ended
  
   
March 31,
  
March 31,
  
     
2007
    
2006
    
2007
    
2006
  
                           
                           
Revenues
 
$
1,810,705
  
$
1,190,086
  
$
3,673,559
  
$
2,423,944
  
                           
Cost of revenues ($-0-, $90,138, $-0-and $90,138 to related parties)
    
1,251,101 
    
871,568 
    
2,524,904 
    
1,693,824 
  
 
    
 
    
 
          
Gross profit
    
559,604
    
318,518
    
1,148,655
    
730,120
  
                           
Selling, general and administrative expenses
    
726,358
    
761,471
    
1,374,561
    
2,007,504
  
                           
Operating (loss) from continuing operations
    
(166,754
)
  
(442,953
)
  
(225,906
)
  
(1,277,384
)
                           
Interest expense
    
(56,249
)
  
(84,457
)
  
(118,672
)
  
(383,808
)
Other income (expense)
    
36,386
    
38,572
    
14,578
    
(18,737
)
(Loss) from continuing operations
    
(186,617
)
  
(488,838
)
  
(330,000
)
  
(1,679,929
)
Discontinued operations - (loss) from discontinued operations
    
-
    
(200,000
)
  
-
    
(307,044
)
Gain on sale of discontinued operations (net)
    
100,635
    
220,284
    
276,494
    
3,376,726
  
                           
Net earnings (loss)
    
(85,982
)
  
(468,554
)
  
(53,506
)
  
1,389,753
  
Dividends on preferred stock
    
(10,500
)
  
(10,500
)
  
(21,000
)
  
(21,000
)
                           
Net earnings (loss) attributable to common stockholders
  
$
(96,482
)
$
(479,054
)
$
(74,506
)
$
1,368,753
  
                           
Net earnings (loss) per share attributable to common stockholders
                          
                           
Basic:
                          
(Loss) from continuing operations
  
$
-
  
$
(.01
)
$
-
  
$
(.06
)
Earnings (loss) from discontinued operations
    
-
    
-
    
-
    
.11
  
Net earnings (loss)
  
$
-
  
$
(.01
)
$
-
  
$
.05
  
                           
Diluted:
                          
(Loss) from continuing operations
  
$
-
  
$
(.01
)
$
-
  
$
(.06
)
Earnings (loss) from discontinued operations
    
-
    
-
    
-
    
.11
  
Net earnings (loss)
  
$
-
  
$
(.01
)
$
-
  
$
.05
  
                           
Weighted average shares outstanding per common share
                          
Basic
    
65,573,033
    
36,055,682
    
65,526,870
    
28,158,364
  
Diluted
    
65,573,033
    
36,055,682
    
65,526,870
    
28,689,714
  
                           
                           


See notes to condensed consolidated financial statements


3

STRATUS SERVICES GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 

 
  
Six Months Ended 
 
March 31,
     
2007
    
2006
  
               
Cash flows from (used in) operating activities
              
Net earnings (loss)
  
$
(53,506
)
$
1,389,753
  
Adjustments to reconcile net earnings to net cash used by operating activities
              
Depreciation
    
38,799
    
73,340
  
Amortization
    
-
    
41,902
  
Stock compensation
    
-
    
92,000
  
Gain on sale of discontinued operations
    
(276,494
)
  
(3,376,726
)
Imputed interest
    
21,654
    
15,254
  
Dividends on preferred stock 
    
-
    
163,625
  
Intrinsic value of beneficial conversion feature of convertible preferred stock
    
-
    
1,674
  
Changes in operating assets and liabilities
              
Accounts receivable
    
(143,263
)
  
10,262,020
  
Prepaid insurance
    
(23,183
)
  
185,639
  
Prepaid expenses and other current assets
    
2,303
    
238,930
  
Other assets
    
-
    
23,825
  
Insurance obligation payable 
    
9,449
    
(99,903
)
Accrued payroll and taxes
    
48,516
    
(194,962
)
Payroll taxes payable
    
(446,394
)
  
(437,725
)
Accounts payable and accrued expenses
    
(46,499
)
  
(1,508,853
)
Accrued interest
    
22,099
    
20,578
  
Total adjustments
    
(793,013
)
  
5,300,618
  
     
(846,519
)
  
6,890,371
  
Cash flows from investing activities
              
Purchase of property and equipment
    
(29,689
)
  
(27,582
)
Cash received in connection with sale of discontinued operations
              
(including $377,500 and $460,736 from a related party) (net of $10,000
              
in costs in 2006)
    
650,901
    
702,581
  
Collection of notes receivable
    
-
    
6,609
  
     
621,212
    
681,608
  
Cash flows from (used in) financing activities
              
Net proceeds from (repayments of) line of credit
    
143,867
    
(6,071,490
)
Payments of loans payable
    
(8,371
)
  
-
  
Proceeds from loans payable - related parties
    
120,000
    
-
  
Payments of loans payable - related parties
    
(101,000
)
  
(9,002
)
Payments of note payable - related party
    
-
    
(1,425,000
)
Payments of notes payable - acquisitions
    
(7,033
)
  
(38,999
)
Proceeds from exercise of warrants
    
9,375
    
-
  
Cash overdraft
    
-
    
(14,731
)
     
156,838
    
(7,559,222
)
Net change in cash
    
(68,469
)
  
12,757
  
Cash - beginning
    
84,881
    
40,784
  
Cash - ending
  
$
16,412
  
$
53,541
  



See notes to condensed consolidated financial statements


4


               
Supplemental disclosure of cash paid
              
Interest
  
$
96,573
  
$
342,987
  
Schedule of noncash investing and financing activities
              
Sale of discontinued operations:
              
Gain on sale
  
$
276,494
  
$
3,156,442
  
Net assets sold
    
-
    
1,683,783
  
Cancellation of accounts payable - related parties (net)
    
-
    
(3,541,364
)
Due from related party
    
377,500
    
(1,250,000
)
Accrued earn-out
    
(3,093
)
  
-
  
Accrued expenses
    
-
    
50,000
  
Net cash received
  
$
650,901
  
$
98,861
  
               
Issuance of common stock upon conversion of convertible preferred stock
  
$
-
  
$
24,366
  
Cumulative dividends on preferred stock
  
$
21,000
  
$
21,000
  
               
Assignment of note receivable in exchange for notes payable - acquisitions
  
$
80,000
  
$
-
  




See notes to condensed consolidated financial statements




5

STRATUS SERVICES GROUP, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1 - BASIS OF PRESENTATION

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

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

Until December 2005, Stratus Services Group, Inc. together with its 51%-owned consolidated joint venture, (the “Company”) was a national provider of staffing and productivity consulting services. Prior to December 2005, the Company operated a network of 29 offices in 7 states. In December 2005, the Company completed a series of asset sales transactions pursuant to which it sold substantially all of the assets that it used to conduct its staffing services business (see Note 5). Since such time, the Company has been focused on expanding its information technology staffing solutions business, which is conducted through its 51% owned consolidated joint venture, Stratus Technology Services, LLC (“STS”) through offices located in New Jersey and Florida (see Note 10).

NOTE 2 - LIQUIDITY

At March 31, 2007, the Company had limited liquid resources. Current liabilities were $9,154,596 and current assets were $1,534,372. The difference of $7,620,224 is a working capital deficit, which is primarily the result of losses incurred during the last several years. These factors, among others, indicate that the Company may be unable to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Management recognizes that the Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to allow it to satisfy its obligations on a timely basis, to fund the operation and capital needs, and to obtain additional financing as may be necessary.

Management of the Company has taken steps to revise and reduce its operating requirements, which it believes will be sufficient to assure continued operations and implementation of the Company’s plans. The steps included closing branches that were not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expense, and most significantly, the asset sales transactions that were completed in December 2005 (see Note 5).

The Company continues to pursue other sources of equity or long-term debt financings. The Company also continues to negotiate payment plans and other accommodations with its creditors.

NOTE 3 - NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”. FIN 48 provides guidance for the recognition, measurement, classification and disclosure of the financial statement effects of a position taken or expected to be taken in a tax return (“tax position”). The financial statement effects of a tax position must be recognized when there is a likelihood of more than 50 percent that based on the technical merits, the position will be sustained upon examination and resolution of the related appeals or litigation processes, if any. A tax position that meets the recognition threshold must be measured initially and subsequently as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not expect its adoption of FIN 48 to have a material impact on its consolidated financial portion, results of operations or cash flows.

6
 
In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. The Statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, or the Company’s fiscal year ending September 30, 2009. The Company does not expect the adoption of this new standard to have a material impact on its consolidated financial position, results of operations or cash flow.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”. This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The effective date to initially recognize the funded status and to provide the required disclosures is for fiscal years ending after December 15, 2006, or the Company’s fiscal year ending September 30, 2007. The requirement to measure plan assets and benefit obligations is effective for fiscal years ending after December 15, 2008, or the Company’s fiscal year ending September 30, 2009. The Company does not expect the adoption of this new standard to have a material impact on its consolidated financial position, results of operations or cash flows.

In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” and is effective for fiscal years beginning after November 15, 2007. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company is currently assessing the impact the adoption of this pronouncement will have on the financial statements.

NOTE 4 - EARNINGS/LOSS PER SHARE

Basic “Earnings Per Share” (“EPS”) excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS assumes conversion of dilutive options and warrants, and the issuance of common stock for all other potentially dilutive equivalent shares outstanding. There were no dilutive shares for the three months ended March 31, 2007 and 2006. There were -0- and 531,350 dilutive shares for the six months ended March 31, 2007 and 2006, respectively. Outstanding common stock options and warrants not included in the computation of earnings per share for the three and six months ended March 31, 2007 and 2006, totaled 17,221,153 and 18,611,403, respectively. These options and warrants were excluded because their inclusion would have an anti-dilutive effect on earnings per share.

NOTE 5 - DISCONTINUED OPERATIONS

In December 2005, the Company completed the following series of transactions pursuant to which it sold substantially all of the assets used to conduct its staffing services business, other then the IT staffing solutions business that is conducted through the Company’s 51% owned joint venture, STS.

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

 
•
$250,000 was payable over the 60 days following December 2, 2005, at a rate no faster than $125,000 per 30 days;
 
 
•
$1,000,000 payable by ALS will be paid directly to certain taxing authorities to reduce the Company’s tax obligations; and
 
 
•
$3,537,000 which was paid by means of the cancellation of all net indebtedness owed by the Company to ALS outstanding as of the close of business on December 2, 2005.
 
In addition to the foregoing amounts, ALS also assumed the Company’s obligation to pay $798,626 due under a certain promissory note issued by the Company in connection with an acquisition to Provisional Employment Solutions, Inc. As a result of the sale of the ALS Purchased Assets to ALS, all sums due and owing to ALS by the Company were deemed paid in full and no further obligations remain.

7
(ii)   On December 5, 2005, the Company completed the sale, effective as of November 28, 2005 (the “AI Effective Date”), of substantially all of the tangible and intangible assets, excluding accounts receivable and other certain items, as described below, of three of its California offices (the “AI Purchased Assets”) to Accountabilities, Inc. (AI”). The offices sold were the following: Culver City, California; Lawndale, California and Orange, California (the “Other California Offices”). Pursuant to the terms of an Asset Purchase Agreement between the Company and AI dated December 5, 2005 (the “AI Asset Purchase Agreement”), AI has agreed to pay to the Company an earnout amount equal to two percent of the sales of the Other California Offices for the first twelve month period after the AI Effective Date; one percent of the sales of the Other California Offices for the second twelve month period after the AI Effective Date; and one percent of the sales of the Other California Offices for the third twelve month period from the AI Effective Date. In addition, a Demand Subordinated Promissory Note between the Company and AI dated September 15, 2005, which had an outstanding principal balance of $125,000 at the time of closing was deemed paid and marked canceled.

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

(iii)
On December 7, 2005, the Company completed the sale, effective as of November 28, 2005 (the “SOP Effective Date”), of substantially all of the tangible and intangible assets, excluding accounts receivable and other assets as described below, of several of its Northeastern offices (the “SOP Purchased Assets”) to Source One Personnel, Inc. (“SOP”). The offices sold were the following: Cherry Hill, New Jersey; New Brunswick, New Jersey; Mount Royal/Paulsboro, New Jersey (soon to be Woodbury Heights, New Jersey); Pennsauken, New Jersey; Norristown, Pennsylvania; Fairless Hills, Pennsylvania; New Castle, Delaware and the former Freehold, New Jersey profit center (the “NJ/PA/DE Offices”). The assets of Deer Park, New York, Leominster, Massachusetts, Lowell, Massachusetts and Athol, Massachusetts (the “Earn Out Offices”) were also purchased (collectively the “NJ/PA/DE Offices” and the “Earn Out Offices” shall be referred to as the “Purchased Offices”). In addition to the foregoing, the SOP Purchased Assets also included substantially all of the tangible and intangible assets, excluding accounts receivable and other assets as described below, used by the Company in the operation of its business at certain facilities of certain customers including the following: the Setco facility in Cranbury, New Jersey, the Record facility in Hackensack, New Jersey, the UPS-MI (formerly RMX) facility in Long Island, New York, the UPS-MI (formerly RMX) facility in the State of Connecticut, the UPS-MI (formerly RMX) facility in the State of Ohio, the APX facility in Clifton, New Jersey (the “Earn Out On-Site Business”) and the Burlington Coat Factory in Burlington, New Jersey, the Burlington Coat Factory facility in Edgewater Park, New Jersey and the UPS-MI (formerly RMX) facility in Paulsboro, New Jersey (the foregoing business and the “Earn Out On-Site Businesses” shall be referred to herein collectively as the “On-Site Businesses”). Pursuant to the SOP Asset Purchase Agreement between the Company and SOP dated December 7, 2005 (the “SOP Asset Purchase Agreement:), the purchase price for the SOP Purchased Assets was payable as follows (the “SOP Purchase Price”):

 
•
An aggregate of $974,031 of indebtedness owed by the Company to SOP (i) under certain promissory notes previously issued by the Company to SOP and (ii) in connection with a put right previously exercised by SOP with respect to 400,000 shares of our common stock was cancelled.
 
 
•
SOP is required to make the following earn out payments to the Company during the three year period commencing on the SOP Effective Date (the “Earn Out Period”):
 
 
•
Two percent of sales (excluding taxes on sales) from the Earn Out Offices and the Earn Out On-Site Businesses for the initial twelve months of the Earn Out Period.
 
 
•
One percent of sales (excluding taxes on sales) from the Earn Out Offices and the Earn Out On-Site Businesses for the second twelve months of the Earn Out Period.
 
 
•
One percent of sales (excluding taxes on sales) from the Earn Out Offices and the Earn Out On-Site Businesses for the third twelve months of the Earn Out Period.
 
Certain assets held by the Purchased Businesses were excluded from the sale, including cash and cash equivalents, accounts receivable, and the Company’s rights to receive payments from any source.

(iv)
On December 7, 2005 (the “Closing Date”), the Company completed the sale of substantially all of the tangible and intangible assets, excluding cash and cash equivalents, of two of its California branch offices (the “TES Purchased Assets”) to Tri-State Employment Service, Inc. (“TES”). The offices sold were the following: Bellflower, California and West Covina, California (the “California Branch Offices”). Pursuant to the terms of an Asset Purchase Agreement between the Company and TES dated December 7, 2005 (the “TES Asset Purchase Agreement”), TES has agreed to pay to the Company an earnout amount as follows:
 
 
8
 
•
two percent of sales of the California Branch Offices to existing clients for the first twelve month period after the Closing Date;
 
 
•
one percent of sales of the California Branch Offices to existing clients for the second twelve month period after the Closing Date; and
 
 
•
one percent of sales of the California Branch Offices to existing clients for the third twelve month period after the Closing Date.
 
For purposes of calculating the amount owed by TES to the Company, in no event shall the aggregate annual sales to such clients exceed $25,000,000.

On the Closing Date, TES made a payment of $1,972,521 to the Company’s lender (see Note 6) and acquired the lender’s rights to certain of the Company’s accounts receivable that collateralize its obligation to the lender. As a result of this transaction, the Company’s obligations to the lender were reduced by $1,972,521.

The operating results of discontinued operations are summarized as follows:

   
Three Months Ended
  
Six Months Ended
  
   
March 31,
  
March 31,
  
   
2007
  
2006
  
2007
  
2006
  
                   
Revenues
  
$
-
    $    
$
-
  
$
18,265,587
  
Cost of revenues
    
-
          
-
    
16,215,630
  
Gross profit
    
-
          
-
    
2,046,957
  
Selling, general and administrative expenses
    
-
          
-
    
1,950,622
  
Operating income
    
-
          
-
    
96,335
  
Interest expense
    
-
          
-
    
(205,056
)
Other income (expense)
    
-
    
(200,000
)
  
-
    
(198,323
)
Net income (loss)
  
$
-
  
$
(200,000
)
$
-
  
$
(307,044
)

The gain on sale of discontinued operations is summarized as follows:

   
Three Months Ended
  
Six Months Ended
  
   
March 31,
 
March 31,
  
   
2007
  
2006
  
2007
  
2006
  
Sold to:
                          
ALS
  
$
-
  
$
-
  
$
-
  
$
4,340,459
  
AI
    
36,041
    
92,836
    
112,614
    
(204,601
)
SOP
    
32,967
    
46,681
    
72,313
    
(284,584
)
TES
    
31,627
    
80,767
    
91,567
    
(414,548
)
     
100,635
    
220,284
    
276,494
    
3,436,726
  
                           
Other costs of sales
    
-
    
-
    
-
    
(60,000
)
Gain on sale of discontinued operations
  
$
100,635
  
$
220,284
  
$
276,494
  
$
3,376,726
  

The above gain is comprised of earnout payments in the three and six months ended March 31, 2007 and three months ended March 31, 2006, and includes earnout payments of $294,145 in the six months ended March 31, 2006.

NOTE 6 - LINE OF CREDIT

The Company had a loan and security agreement (the “Loan Agreement”) with Capital Temp Funds, Inc. (the “Lender”) which provided for a line of credit up to 85% of eligible accounts receivable, as defined, not to exceed $12,000,000. The Loan Agreement restricted the Company’s ability to incur other indebtedness, pay dividends and repurchase stock. Borrowings under the Loan Agreement bore interest at 3% above the prime rate. Borrowings under the Loan Agreement were collateralized by substantially all of the Company’s assets.

On January 15, 2005, the Company entered into a Forbearance Agreement (the “Forbearance Agreement”) pursuant to which Lender agreed to forebear from accelerating obligations and/or enforcing existing defaults.
 
9
 
The Forbearance Agreement amended the Loan Agreement to reduce the maximum credit line to $12,000,000, which, after March 1, 2005 was further reduced by $250,000 per month.
 
On August 11, 2005, the Company and the Lender entered into an Amended and Restated Forbearance Agreement (the “Amended Forbearance Agreement”) whereby the Lender had again agreed to forbear from accelerating obligations and/or enforcing existing defaults until the earlier to occur of (a) August 26, 2005 or (b) the date of any Forbearance Default, as defined (the “Forbearance Period”).
 
The Amended Forbearance Agreement provided that during the Forbearance Period, the maximum credit line would be $10,500,000.
 
Between August 25, 2005 and December 21, 2005, the Lender granted the Company a series of extensions of the Amended Forbearance Agreement. An extension granted in November 2005 was conditioned upon, among other things, the Company and ALS entering into a binding agreement providing for a sale to ALS of certain assets of the Company. The Company and ALS entered into such an agreement on November 3, 2005. As a condition to obtaining an extension granted in December 2005, the Company was required to represent that it had closed the sale of assets to ALS and to acknowledge and agree that any loans and advances made by the Lender during the extension period would be the last requested advances under the Loan Agreement. The final extension of the Amended Forbearance Agreement expired on December 21, 2005. As of January 31, 2006, the Company repaid all of the indebtedness under the Loan Agreement.
 
The Lender charged the Company $350,000 of fees in connection with the Forbearance Agreement, the Amended Forbearance Agreement and the various extensions thereof during the three months ended December 31, 2005.
 
In connection with the Company and the Lender entering into the Amended Forbearance Agreement, the Company, the Lender and ALS also entered into the ALS Forbearance, whereby ALS agreed to forbear, through August 25, 2005, from enforcing payment defaults under the Company’s Outsourcing Agreement (see Note 10). All of the Company’s obligations under the Company’s Outsourcing Agreement with ALS were satisfied in connection with the sale of assets to ALS which occurred in December 2005 (see Note 5).
 
On January 3, 2006, the Company’s consolidated 50% owned joint venture, STS (see Notes 1 and 10), entered into a factoring and security agreement (the “Factoring Agreement”) with Action Capital Corporation (“Action”). The Factoring Agreement provides for the sale of up to $1,500,000 of acceptable accounts receivable of STS to Action. Action reserves and withholds an amount in a reserve account equal to 10% of the face amount of accounts receivable purchased under the Factoring Agreement. Action has full recourse against STS including, without limitation, the right to charge-back or sell back any accounts receivable, if not paid within 90 days of the date of purchase. The Factoring Agreement provides for STS to pay interest of prime plus 1% plus a monthly fee of .6% on the daily average of unpaid advances.
 
The prime rate at March 31, 2007 was 8.25%.
 
NOTE 7 - PAYROLL TAX LIABILITIES

During fiscal 2003, the Company was notified by both the New Jersey Department of Labor and the California Employment Development Department (the “EDD”) that, if certain payroll delinquencies were not cured, judgment would be entered against the Company. As of March 31, 2007, there was still an aggregate of $3.4 million in delinquent payroll taxes outstanding which are included in “Payroll taxes payable” on the balance sheet. Judgment has not been entered against the Company in California. While judgment has been entered against the Company in New Jersey, no actions have been taken to enforce same.

On January 7, 2005, the Company entered into a payment plan agreement with the EDD with regard to the Company’s past due and unpaid unemployment taxes. The Company is to continue to pay $12,500 per week to be first applied to its unpaid employment tax liability of $284,046 (as of December 31, 2006) for periods prior to the second quarter 2004; then to second quarter 2004 and third quarter 2004 employment taxes to the extent not already paid, then to interest and then to penalties. The weekly payment of $12,500 is to increase for a three month period following any quarter in which the Company’s reported income is above $200,000 based on a percentage increase tied to the amount in excess of $200,000. The Company believes that consistent with the parties’ intentions when entering into the Plan, the gain on sale of discontinued operations, which resulted in no cash to the Company, would be excluded from reported income.

NOTE 8 - INCOME TAXES

No income tax expense was recorded in the six months ended March 31, 2006, because the Company recognized a deferred tax benefit resulting from the utilization of the Company’s net operating loss carryforwards.

10

NOTE 9 - PREFERRED STOCK

a. Series F

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

The holder of the Series F Preferred Stock is entitled to receive, from assets legally available therefore, cumulative dividends at a rate of 7% per year, accrued daily, payable monthly, in preference and priority to any payment of any dividend on the Common Stock and on the Series F Preferred Stock. Dividends may be paid, at the Company’s option, either in cash or in shares of Common Stock, valued at the Series F Conversion Price (as defined below). Holders of Series F Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends.

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

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

The Company may redeem the shares of the Series F Preferred Stock at any time prior to conversion at a redemption price of 115% of the purchase price paid for the Series F Preferred Shares plus any accrued but unpaid dividends.

b. Series I

The Company was required to redeem each share of the Series I Preferred Stock for an amount equal to the stated value of $100 per share plus all accrued and unpaid dividends on August 5, 2005, the one year anniversary date of the issuance of the Series I Preferred Stock to the extent permitted by applicable law; provided, however, that the Company had the right to extend the required redemption date for an additional one year, in which case the Company was required to pay all dividends accrued through the first year of issuance in cash and issue to each holder of Series I Preferred Stock a number of shares of its common stock which then have a value equal to 10% of the stated value of the Series I Preferred Stock held. In addition, because the Company extended the redemption date, it was required to pay dividends quarterly and pay an advisory fee to an advisor designated by the holders of the Series I Preferred Stock in an amount equal to 10% of the aggregate stated value of the outstanding shares of Series I Preferred Stock, 80% of which was payable in cash and 20% of which will be paid in shares of the Company’s common stock, valued at the then current market value. If the Company did not redeem the Series I Preferred Stock by the extended redemption date, the dividend rate of the Series I Preferred Stock would have increased to 24% per year and the Series I Preferred Stock would have been convertible, at the option of the holder, into either common stock at a conversion price equal to 80% of the average closing bid price of the common stock during the five trading days preceding the conversion or common stock and warrants at a rate of 125 shares of common stock and 250 warrants for each $100 of stated value and accrued and unpaid dividends represented by the Series I Preferred Stock. Holders of Series I Preferred Stock had no voting rights, except as provided by law and with respect to certain limited matters.

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

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

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

11

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

• $1,800,000 was due and payable in cash upon the earlier of the Company’s receipt of $1,800,000 of accounts receivable or March 15, 2006. During the year ended September 30, 2006, the Company issued 5,000,000 shares of its common stock, valued at the then market value, to Pinnacle as payment of $45,000 against this portion of the Convertible Note. At March 31, 2007, $210,000 remains unpaid.

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

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

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

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

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

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

NOTE 10 - RELATED PARTY TRANSACTIONS

Consulting Fees
An entity which employs the son of the Chief Executive Officer of the Company (the “CEO”) provided consulting services to the Company. Consulting expense was $-0- and $44,000 for the six months ended March 31, 2007 and 2006, respectively. Included in the $44,000 is a charge of $16,000 in connection with the issuance of 2,000,000 shares of the Company’s common stock to the entity.

Joint Venture
The Company provides information technology staffing services through a joint venture, STS (see Note 1), in which the Company has a 51% interest. Prior to February 13, 2007, the Company had a 50% interest. On February 13, 2007, the Company acquired from Fusion Business Services, LLC (“Fusion”) an additional 1% interest in STS in exchange for the issuance to the members of Fusion of 70,111 shares of the Company’s common stock. As a result of the transfer, which was effective as of January 1, 2007, the Company owns a 51% interest in STS and Fusion owns 49% interest. Fusion has a right to re-acquire the 1% interest transferred to the Company upon the occurrence of certain events, including the institution of bankruptcy or insolvency proceedings against the Company, a sale of all or substantially all of the Company’s assets, a merger or consolidation of the Company with another entity, or the liquidation or dissolution of the Company. The purchase price payable by Fusion in connection with any such re-acquisition shall be a return of the shares issued to it for the 1% interest or a cash payment of $1,262. A son of the CEO of the Company has a majority interest in Fusion.

Payroll Outsourcing
The Company was a party to an Outsourcing Agreement with ALS pursuant to which ALS and its affiliate, Advantage Services Group, LLC (“Advantage”), were to provide payroll outsourcing services for all of the Company’s in-house staff, except for its corporate employees, and customer staffing requirements. As a result of this arrangement, all of the Company’s field personnel were employees of ALS. The Company paid agreed upon pay rates, plus burden (payroll taxes and workers’ compensation insurance) plus a fee ranging between 2% and 3% (0% - 1 ½% effective June 10, 2005) of pay rates. On June 10, 2005, the Company entered into a Second Addendum to Outsourcing Agreement with ALS, which, among other things, reduced certain rates charged by ALS to the Company. The total amount charged by ALS under this agreement and similar agreements previously in effect between the parties was $17,326,000 and $48,245,000 in the six months ended March 31, 2006.

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

12
Due from Related Party
The amount due from related party in the condensed consolidated balance sheet is the remaining balance due from ALS in connection with the sale of the ALS Purchased Assets (see Note 5).

Loans Payable
During the six months ended March 31, 2007, the CEO loaned $100,000 to the Company which was repaid in January 2007. In addition, during the six months ended March 31, 2007, a significant shareholder loaned $20,000 to the Company, which is still outstanding at March 31, 2007.

Other
An entity through which the son of the CEO is employed is a consultant to AI (see Note 5).

The nephew of the CEO of the Company is affiliated with Pinnacle Investment Partners, LP, the holder of the shares of the convertible note issued in exchange for shares of the Company’s Series I Preferred Stock (see Note 9). The Company believes that PIP Management Inc., which has been designated as the advisor to the Series I holders (see Note 9), is also affiliated with Pinnacle Investment Partners, LP.

NOTE 11 - DERIVATIVE INSTRUMENTS

The Company evaluated the application of SFAS No. 133 and EITF 00-19 for its financial instruments and determined that certain warrants to purchase the Company’s Common Stock are derivatives that are required to be accounted for as free-standing liability instruments in the Company’s financial statement. As a result, the Company reports the value of those warrants as current liabilities on its balance sheet and reports changes in the value of these warrants as non-operating gains or losses on its statements of operations. The value of the warrants is required to be remeasured on a quarterly basis, and is based on the Black Scholes Pricing Model.

Variables used in the Black Scholes option pricing model include (1) 4% risk-free interest rate, (2) expected warrant life is the actual remaining life of the warrants as of each period end, (3) expected volatility is 100%, and (4) zero expected dividends.

Due to the nature of the required calculations and the large number of shares of the Company’s common stock involved in such calculations, changes in the Company’s common stock price may result in significant changes in the value of the warrants and resulting non-cash gains and losses on the Company’s statement of operations.


13

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

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

Our critical accounting policies and estimates are described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2006.

Introduction

Through December 2005, we provided a wide range of staffing services and productivity consulting services associated with such staffing services nationally through a network of offices located throughout the United States. Regardless of the type of temporary service offering we provided, we recognized revenues based on hours worked by assigned personnel. Generally, we billed our customers a pre-negotiated, fixed rate per hour for the hours worked by our temporary employees. Therefore, we did not separate our various service offerings into separate offering segments. We did not routinely provide discrete financial information about any particular service offering. We also did not conduct any regular reviews of, nor make decisions about, allocating any particular resources to a particular service offering to assess its performance. As set forth below, certain of our service offerings targeted specific markets, but we did not necessarily conduct separate marketing campaigns for such services. Pursuant to the Outsourcing Agreement that was in place with ALS, LLC ("ALS"), ALS was responsible for paying wages, workers’ compensation, unemployment compensation insurance, Medicare and Social Security taxes and other general payroll related expenses for all of the temporary employees we placed, and we were billed for such expenses plus a fee by ALS. These expenses are included in the cost of revenue. Because we paid our temporary employees only for the hours they actually worked, wages for our temporary personnel were a variable cost that increased or decreased in proportion to revenues. Gross profit margin varied depending on the type of services offered. In some instances, temporary employees placed by us may have decided to accept an offer of permanent employment from the customer and thereby “convert” the temporary position to a permanent position. Fees received from such conversions were included in our revenues. Selling, general and administrative expenses include payroll for management and administrative employees, office occupancy costs, sales and marketing expenses and other general and administrative costs.

In December 2005, we completed a series of asset sale transactions pursuant to which we sold our staffing operations. As a result of such sales, we no longer actively conduct any staffing services business, other than IT staffing solutions services conducted through our 51% owned joint venture, STS.

14

Results of Operations
Discontinued Operations/Acquisition on Disposition of Assets

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

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

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

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

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

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

In connection with the transaction, we entered into Non-Compete and Non-Solicitation Agreements with ALS pursuant to which we agreed not to compete with ALS with the customers of and in the geographic area of the Western Offices, and ALS agreed not to compete with us with respect to certain customers and accounts, including, accounts serviced by our remaining offices, for a period of two years.
 
(b)
On December 5, 2005, we completed the sale, effective as of November 28, 2005 (the “AI Effective Date”), of substantially all of the tangible and intangible assets, excluding accounts receivable and other certain items, as described below, of three of our California offices (the “AI Purchased Assets”) to Accountabilities, Inc. (“AI”) The offices sold were the following: Culver City, California; Lawndale, California and Orange, California (the “Other California Offices”). Pursuant to the terms of an Asset Purchase Agreement between the Company and AI dated December 5, 2005 (the “AI Asset Purchase Agreement”), AI has agreed to pay to us an earnout amount equal to two percent of the sales of the Other California Offices for the first twelve month period after the AI Effective Date; one percent of the sales of the Other California Offices for the second twelve month period after the AI Effective Date; and one percent of the sales of the Other California Offices for the third twelve month period from the AI Effective Date. In addition, a Demand Subordinated Promissory Note between us and AI dated September 15, 2005 which had an outstanding principal balance of $125,000 at the time of closing was deemed paid and marked canceled.
 
Certain assets held by the Other California Offices were excluded from the sale, including cash and cash equivalents, accounts receivable, and our rights to receive payments from any source.
 
In connection with the AI transaction, we entered into Non-Compete and Non-Solicitation Agreements with AI pursuant to which we agreed not to compete with AI with the customers of and in the geographic area of the Other California Offices, and AI agreed not to compete with us with respect to certain customers and accounts, including, accounts serviced by our remaining offices, for a period of three years.
 
(c)
On December 7, 2005, we completed the sale, effective as of November 28, 2005 (the “SOP Effective Date”), of substantially all of the tangible and intangible assets, excluding accounts receivable and other assets as described below, of several of our Northeastern offices (the “SOP Purchased Assets”) to Source One Personnel, Inc. (“SOP”). The offices sold were the following: Cherry Hill, New Jersey; New Brunswick, New Jersey; Mount Royal/Paulsboro, New Jersey (soon to be Woodbury Heights, New Jersey); Pennsauken, New Jersey; Norristown,
 

15

Pennsylvania; Fairless Hills, Pennsylvania; New Castle Delaware and the former Freehold, New Jersey profit center (the “NJ/PA/DE Offices”). The assets of Deer Park, New York, Leominster, Massachusetts, Lowell, Massachusetts and Athol, Massachusetts (the “Earn Out Offices”) were also purchased (collectively the “NJ/PA/DE Offices” and the “Earn Out Offices” shall be referred to as the “Purchased Offices”). In addition to the foregoing, the SOP Purchased Assets also included substantially all of the tangible and intangible assets, excluding accounts receivable and other assets as described below, used by us in the operation of our business at certain facilities of certain customers including the following: the Setco facility in Cranbury New Jersey, the Record facility in Hackensack, New Jersey, the UPS-MI (formerly RMX) facility in Long Island, New York, the UPS-MI (formerly RMX) facility in the State of Connecticut, the UPS-MI (formerly RMX) facility in the State of Ohio, the APX facility in Clifton, New Jersey (the “Earn Out On-Site Business”) and the Burlington Coat Factory in Burlington, New Jersey, the Burlington Coat Factory facility in Edgewater Park, New Jersey and the UPS-MI (formerly RMX) facility in Paulsboro, New Jersey (the foregoing business and the “Earn-Out On-Site Businesses” shall be referred to herein collectively as the “On-Site Businesses”). Pursuant to the SOP Asset Purchase Agreement between us and SOP dated December 7, 2005 (the “SOP Asset Purchase Agreement”), the purchase price for the SOP Purchased Assets was payable as follows (the “SOP Purchase Price”):
 
• An aggregate of $974,031 of indebtedness owed by us to SOP (i) under certain promissory notes previously issued by us to SOP and (ii) in connection with a put right previously exercised by SOP with respect to 400,000 shares of our common stock was cancelled.
 
• SOP is required to make the following earn out payments to us during the three year period commencing on the SOP Effective Date (the “Earn Out Period”):
 
 
•
Two percent of sales (excluding taxes on sales) from the Earn Out Offices and the Earn Out On-Site Businesses for the initial twelve months of the Earn Out Period.
 
 
•
One percent of sales (excluding taxes on sales) from the Earn Out Offices and the Earn Out On-Site Businesses for the second twelve months of the Earn Out Period.
 
 
•
One percent of sales (excluding taxes on sales) from the Earn Out Offices and the Earn Out On-Site Businesses for the third twelve months of the Earn Out Period.
 
Certain assets held by the Purchased Offices were excluded from the sale, including cash and cash equivalents, accounts receivable, our rights to receive payments from any source.
 
In connection with the SOP transaction, we entered into Non-Compete and Non-Solicitation Agreements with SOP pursuant to which we agreed not to compete with SOP with respect to the business acquired from us by SOP for a period of two years.
 
(d)
On December 7, 2005 (the “Closing Date”), we completed the sale of substantially all of the tangible and intangible assets, excluding cash and cash equivalents, of two of our California branch offices (the “TES Purchased Assets”) to Tri-State Employment Service, Inc. (“TES”). The offices sold were the following: Bellflower, California and West Covina, California (the “California Branch Offices”). Pursuant to the terms of an Asset Purchase Agreement between the Registrant and TES dated December 7, 2005 (the “TES Asset Purchase Agreement”), TES has agreed to pay to us as follows:
 
• two percent of sales of the California Branch Offices to existing clients for the first twelve month period after the Closing Date;
 
• one percent of sales of the California Branch Offices to existing clients for the second twelve month period after the Closing Date; and
 
• one percent of sales of the California Branch Offices to existing clients for the third twelve month period after the Closing Date.
 
For purposes of calculating the amount owed by TES to us, in no event shall the aggregate annual sales to such clients exceed $25,000,000.
 
On the Closing Date, TES made a payment of $1,972,521 to our lender and acquired the lender’s rights to certain of our accounts receivable that collateralize our obligation to the lender. As a result of this transaction, our obligations to the lender were reduced by $1,972,521.
 

16

In connection with the TES transaction, we entered in Non-Compete and Non-Solicitation Agreements pursuant to which we agreed not to compete with TES with the customers of and in the geographic area of the California Branch Offices, and TES agreed not to compete with Stratus with respect to certain customers and accounts, including, accounts serviced by Stratus’ remaining offices, for a period of three years.
 
The foregoing transactions resulted in a net gain on sale of discontinued operations which is summarized as follows:
 
   
Three Months Ended
  
Six Months Ended
  
   
March 31,
  
March 31,
  
   
2007
  
2006
  
2007
  
2006
  
Sold to:
                  
ALS
  
$
-
  
$
-
  
$
-
  
$
4,340,459
  
AI
    
36,041
    
92,836
    
112,614
    
(204,601
)
SOP
    
32,967
    
46,681
    
72,313
    
(284,584
)
TES
    
31,627
    
80,767
    
91,567
    
(414,548
)
     
100,635
    
220,284
    
276,494
    
3,436,726
  
                           
Other costs of sales
    
-
    
-
    
-
    
(60,000
)
Gain on sale of discontinued operations
  
$
100,635
  
$
220,284
  
$
276,494
  
$
3,376,726
  

The above gain is comprised of earnout payments in the three and six months ended March 31, 2007 and three months ended March 31, 2006, and includes earnout payments of $294,145 in the six months ended March 31, 2006.
 
Continuing Operations
Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006

Revenues. Revenues increased 34.3% to $1,810,705 for the three months ended March 31, 2007 from $1,190,086 for the three months ended March 31, 2006. This increase was primarily a result of an increase in billable hours and permanent placements and expansion of our customer base.

Gross Profit. Gross profit increased 75.7% to $559,604 for the three months ended March 31, 2007 from $318,518 for the three months ended March 31, 2006, primarily as a result of increased revenues. Gross profit as a percentage of revenues increased to 30.9% for the three months ended March 31, 2007 from 26.8% for the three months ended March 31, 2006. This increase was a result of increased permanent placements.

Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) decreased 4.6% to $726,358 for the three months ended March 31, 2007 from $761,471 for the three months ended March 31, 2006. Selling, general and administrative expenses as a percentage of revenues decreased to 40.1% for the three months ended March 31, 2007 from 64.0% for the three months ended March 31, 2006.

Interest Expense. Interest expense decreased 33.4% to $56,249 for the three months ended March 31, 2007 from $84,457 for the three months ended March 31, 2006. Interest expense as a percentage of revenues decreased to 3.1% for the three months ended March 31, 2007 from 7.1% for the three months ended March 31. 2006.
 
Net Loss Attributable to Common Stockholders. As a result of the foregoing, we had a net loss attributable to common stockholders of $197,117, for the three months ended March 31, 2007 compared to a net loss attributable to common stockholders of $699,338 for the three months ended March 31, 2006.

Six Months Ended March 31, 2007 Compared to Six Months Ended March 31, 2006

Revenues. Revenues increased 51.6% to $3,673,559 for the six months ended March 31, 2007 from $2,423,944 for the six months ended March 31, 2006. This increase was primarily a result of an increase in billable hours and permanent placements and expansion of our customer base.

Gross Profit. Gross profit increased 57.3% to $1,148,655 for the six months ended March 31, 2007 from $730,120 for the six months ended March 31, 2006, primarily as a result of increased revenues. Gross profit as a percentage of revenues increased to 31.3% for the six months ended March 31, 2007 from 30.1% for the six months ended March 31, 2006. This increase was a result of increased permanent placements.

Selling, General and Administrative Expenses. SG&A decreased 31.5% to $1,374,561 for the six months ended March 31, 2007 from $2,007,504 for the six months ended March 31, 2006. Selling, general and administrative expenses as a

17

percentage of revenues decreased to 37.4% for the six months ended March 31, 2007 from 82.8% for the six months ended March 31, 2006.

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

Interest Expense. Interest expense decreased 69.1% to $118,672 for the six months ended March 31, 2007 from $383,808 for the six months ended March 31, 2006. Interest expense as a percentage of revenues decreased to 3.2% for the six months ended March 31, 2007 from 15.8% for the six months ended March 31, 2006. The decrease was a result of the decrease in outstanding debt. Interest expense in the six months ended March 31, 2006 includes $100,000 of the principal amount of the Convertible Note issued in exchange for our Series I Preferred Stock that was attributable to the settlement of our obligation to pay certain advisory fees and dividend payments under the terms of the Series I Preferred Stock. (see Note 9 to the Condensed Consolidated Financial Statements).
 
Net Loss Attributable to Common Stockholders. As a result of the foregoing, we had a net loss attributable to common stockholders of $351,000 for the six months ended March 31, 2007 compared to a net loss attributable to common stockholders of $1,700,929 for the six months ended March 31, 2006.

Liquidity and Capital Resources

Cash flows have not been segregated between continuing operations and discontinued operations in the accompanying condensed consolidated statements of cash flows. Cash provided to us from discontinued operations (included in the consolidated cash flow discussions below) during the six months ended March 31, 2007 and 2006 was comprised of the following:

   
Six Months Ended
  
   
March 31,
  
   
2007
  
2006
  
           
Cash provided by (used in) operating activities
  
$
(498,184
)
$
8,280,378
  
Cash provided by investing activities
    
650,901
    
689,535
  
Cash used in financing activities
    
-
    
(7,865,389
)
Net
  
$
157,217
  
$
1,104,524
  
               

Although there is no assurance we will continue to receive earnout payments in connection with discontinued operations, we estimate that we will receive approximately $35,000 per month, through November 2008.

At March 31, 2007, we had limited liquid resources. Current liabilities were $9,154,596 and current assets were $1,534,372. The difference of $7,620,224 is a working capital deficit, which is primarily the result of losses incurred during the last several years. This condition raises substantial doubts about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

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

We have taken steps to revise and reduce our operating requirements, which we believe will be sufficient to assure continued operations and implementation of our plans. The steps included closing branches that are not profitable, reductions in staffing, and other selling, general and administrative expenses, and most significantly, the asset sales transactions that were completed in December 2005. We continue to pursue other sources of equity or long-term debt financings. We also continue to negotiate payments plans and other accommodations with our creditors. We believe that the collection of receivables that we retained after completion of the asset sale transactions and earnout payments to which we are entitled in connection with the Asset Sales will provide us with sufficient cash flow to support our operations in the next twelve months.

Net cash provided by (used in) operating activities was $(846,519) and $6,890,371 in the six months ended March 31, 2007 and 2006, respectively.

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Net cash provided by investing activities was $621,212 and $681,608 in the six months ended March 31, 2007 and 2006, respectively. Net cash received in connection with the sale of discontinued operations was $650,901 (comprised of earnout payments) and $702,581 (including earnout payments of $294,145), in the six months ended March 31, 2007 and 2006, respectively. Cash used for capital expenditures was $29,689 and $27,582 in the six months ended March 31, 2007 and 2006, respectively.

Net cash provided by (used in) financing activities was $156,838 and $(7,559,222) in the six months ended March 31, 2007 and 2006, respectively. We had net borrowings (repayments) of $143,867 and $(6,071,490) under our line of credit in the six months ended March 31, 2007 and 2006, respectively. Net short-term borrowings (repayments) were $10,629 and $(9,002) in the six months ended March 31, 2007 and 2006, respectively. Net short-term borrowings in the six months ended March 31, 2007, includes $100,000 loaned to us by our Chief Executive Officer, which was repaid in January 2007 and $20,000 which was loaned to us by a significant shareholder. Payments of notes payable - acquisitions was $7,033 and $38,999 in the six months ended March 31, 2007 and 2006, respectively. We paid $1,425,000 in the six months ended March 31, 2006, against a note payable to Pinnacle Investment Partners, L.P., a related party.

Our principal uses of cash are to fund temporary employee payroll expense and employer related payroll taxes, investment in capital equipment, expansion of services offered, workers’ compensation, general liability and other insurance coverages, and debt service.

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

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

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

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

On January 15, 2005, we entered into a Forbearance Agreement (the “Forbearance Agreement”) pursuant to which the Lender agreed to forebear from accelerating obligations and/or enforcing existing defaults. The Forbearance Agreement amended the Loan Agreement to reduce the maximum credit line to $12,000,000, which, after March 1, 2005 was further reduced by $250,000 per month.
 
On August 11, 2005, we entered into an Amended and Restated Forbearance Agreement (the “Amended Forbearance Agreement”) whereby the Lender had again agreed to forbear from accelerating obligations and/or enforcing existing defaults until the earlier to occur of (a) August 26, 2005 or (b) the date of any Forbearance Default, as defined (the “Forbearance Period”).
 
The Amended Forbearance Agreement provided that during the Forbearance Period, the maximum credit line would be $10,500,000.
 
Between August 25, 2005 and December 21, 2005, the Lender granted us a series of extensions of the Amended Forbearance Agreement. An extension granted in November 2005 was conditioned upon, among other things, our entry into a binding agreement providing for a sale to ALS of the assets of our offices in Southern California, the Phoenix region and its Dallas Morning News account. We entered into such an agreement with ALS on November 3, 2005. As a condition to obtaining an extension granted in December 2005, we were required to represent that we had closed the sale of assets to ALS and to acknowledge and agree that any loans and advances made by the Lender during the extension period would be the last requested advances under the Loan Agreement. The final extension of the Amended Forbearance Agreement expired on December 21, 2005. At such time, $2,431,808 of indebtedness remained outstanding under the Loan Agreement. As of January 31, 2006, we had repaid all of the indebtedness.
 

19

The Lender charged us $412,500 of fees in connection with the Forbearance Agreement, the Amended Forbearance Agreement and the various extensions thereof during the fiscal year ended September 30, 2005 and $350,000 during the three months ended December 31, 2005.
 
In connection with us and the Lender entering into the Amended Forbearance Agreement, we, the Lender and ALS also entered into the ALS Forbearance, whereby ALS agreed to forbear, through August 25, 2005, from enforcing payment defaults under our Outsourcing Agreement with ALS subject to certain conditions. All of our obligations under our Outsourcing Agreement with ALS were satisfied in connection with the sale of assets to ALS which occurred in December 2005.
 
In January 2006, STS entered into a Factoring and Security Agreement (the “Factoring Agreement”) with Action Capital Corporation (“Action”) which provides for the sale of up to $1,500,000 of accounts receivable of STS to Action. Action reserves and withholds in a reserve account, an amount equal to 10% of the face amount of accounts receivable purchased under the Factoring Agreement. Action has full recourse against STS, including the right to charge-back or sell back any accounts receivable if not paid within 90 days of the date of purchase. The Factoring Agreement provides for interest at an annual rate of prime plus 1% plus a monthly fee of .6% on the daily average of unpaid balances.
 
During fiscal 2003, we were notified by both the New Jersey Department of Labor and the California Employment Development Department (the “EDD”) that, if certain payroll delinquencies were not cured, judgment would be entered against us. As of March 31, 2007, there was still an aggregate of $3.4 million in delinquent payroll taxes outstanding, including interest and penalties, which are included in “Payroll taxes payable” on the balance sheet as of March 31, 2007. Judgment has not been entered against us in California. While judgment has been entered against us in New Jersey, no actions have been taken to enforce same. On January 7, 2005, we entered into a payment plan agreement with the EDD, which requires us to pay $12,500 per week to the EDD. The $12,500 weekly payment is subject to increase for a three month period following any quarter in which our reported income exceeds $200,000, based upon a percentage related to the amount of increase above $200,000.
 
In July 2003, we entered into an agreement with the holder of our Series A Preferred Stock pursuant to which we agreed to redeem the aggregate 1,458,933 shares of Series A Preferred Stock then outstanding. The agreement, as amended in March 2004, provided that our obligation to redeem the Series A Preferred Stock was contingent upon the sale of not less than $1,000,000 units in our “best efforts” public offering of units. This condition was satisfied in July 2004. As a result, we paid $500,000 and issued 1,750,000 shares of common stock to the Series A holder and redeemed all of the Series A Preferred Stock following the initial closing of the offering. We were obliged to pay the Series A holder an additional $250,000 by January 31, 2005, at our option, issue to the Series A holder shares of common stock having an aggregate market value of $250,000, based upon the average closing bid prices of the common stock for the 30 days preceding January 31, 2005. We failed to make the $250,000 payment in cash or stock. Accordingly, we are required to pay $300,000 in cash, plus accrued interest at the rate of 18% per year from the date of default until the date the default is cured, to the former holder of the Series A Preferred Stock. The former holder of the Series A Preferred Stock has threatened to institute litigation against us related to this matter and the Asset Sales. We are currently in discussions with the former holder of the Series A Preferred Stock to try to resolve all issues.

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

As of March 31, 2007, there were no off-balance sheet arrangements, unconsolidated subsidiaries, commitments or guarantees of other parties, except as disclosed in the notes to financial statements. Stockholders’ (deficiency) at that date was $8,037,444.

We engaged in various transactions with related parties during the six months ended March 31, 2007 including the following:


20


•
 
At March 31, 2007, we owed: $41,000 under a demand note bearing interest at 10% per annum to a corporation owned by the son of Joseph J. Raymond, our Chairman, President and CEO; $4,123 to a trust formed for the benefit of a family member of a former member of our Board of Directors under a promissory note bearing interest at 12% per annum which became due in full in August 2005; $41,598 to a former member of our Board of Directors under a promissory note bearing interest at 12% per annum which becomes due in full in May 2006. We borrowed $100,000 from Joseph J. Raymond in December 2006 and repaid it in January 2007. We also borrowed $20,000 from a significant shareholder in January 2007, which is still outstanding at March 31, 2007.
 
•
 
The nephew of our Chairman, President and CEO is affiliated with Pinnacle Investment Partners, LP (“Pinnacle”), which is the holder of the Convertible Note issued in exchange for our Series I Preferred Stock. As of March 31, 2007, $616,850 was outstanding on the Convertible Note.
 
•
 
On February 13, 2007, we acquired from Fusion Business Services, LLC (“Fusion”) an additional 1% interest in STS in exchange for the issuance to the members of Fusion of 70,111 shares of our common stock. As a result of the transfer, which was effective as of January 1, 2007, we own a 51% interest in STS and Fusion owns a 49% interest. Fusion has a right to re-acquire the 1% interest transferred to the Company upon the occurrence of certain events, including the institution of bankruptcy or insolvency proceedings against us, a sale of all or substantially all of our assets, a merger or consolidation of us with another entity, or the liquidation or dissolution of us. The purchase price payable by Fusion in connection with any such re-acquisition shall be a return of the shares issued to it for the 1% interest or a cash payment of $1,262. A son of our CEO has a majority interest in Fusion.
 

Contractual Obligations

Our aggregate contractual obligations are as follows:

       
Payments Due by Fiscal Period (in Thousands)
  
           
2009 -
  
2011 -
      
   
Total
  
2008
  
2010
  
2012
  
Thereafter
  
                       
Contractual Obligations:
                      
Long-term debt obligations
  
$
1,445
  
$
841
  
$
445
  
$
159
  
$
-
  
Operating lease obligations
    
219
    
60
    
119
    
40
    
-
  
Series A redemption payable
    
300
    
300
    
-
    
-
    
-
  
Payroll tax liability (a)
    
122
    
122
    
-
    
-
    
-
  
Workers’ compensation insurance liability (b)
    
287
    
41
    
144
    
102
    
-
  
TOTAL
  
$
2,373
  
$
1,364
  
$
708
  
$
301
  
$
-
  

(a)
Exclusive of interest and penalties. Payments may be accelerated based upon future operating result benchmarks.
(b)
In December 2006, we entered into an agreement with the California Compensation Insurance Fund (“the Fund”) whereby the Fund agreed to reduce our then liability of $2,023,000 to $300,000 provided that we make certain monthly payments aggregating $300,000 over 56 months. At March 31, 2007, $2,005,000 is included in accounts payable and accrued expenses on the attached condensed consolidated balance sheet. The difference of $1,723,000 has not been recognized in earnings at this time since it is contingent upon our paying the $300,000 in accordance with the terms of the agreement.

Impact of Inflation

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

Impact of Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”. FIN 48 provides guidance for the recognition, measurement, classification and disclosure of the financial statement effects of a position taken or expected to be taken in a tax return (“tax position”). The financial statement effects of a tax position must be recognized when there is a likelihood of more than 50 percent that based on the technical merits, the position will be sustained upon examination and resolution of the related appeals or litigation processes, if any. A tax position that meets the recognition threshold must be measured initially and subsequently as the largest amount of tax benefit that is greater than 50 percent likely of being

21

realized upon ultimate settlement with a taxing authority. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not expect its adoption of FIN 48 to have a material impact on its consolidated financial portion, results of operations or cash flows.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157 (“SFAS”) No. 157, “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. The Statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, or the Company’s fiscal year ending September 30, 2009. The Company does not expect the adoption of this new standard to have a material impact on its consolidated financial position, results of operations or cash flow.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”. This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The effective date to initially recognize the funded status and to provide the required disclosures is for fiscal years ending after December 15, 2006, or the Company’s fiscal year ending September 30, 2007. The requirement to measure plan assets and benefit obligations is effective for fiscal years ending after December 15, 2008, or the Company’s fiscal year ending September 30, 2009. The Company does not expect the adoption of this new standard to have a material impact on its consolidated financial position, results of operations or cash flows.

In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” and is effective for fiscal years beginning after November 15, 2007. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. We are currently assessing the impact the adoption of this pronouncement will have on our financial statements.

Sensitive Accounting Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. Significant estimates include management’s estimate of the carrying value of accounts receivable, the impairment of goodwill and the establishment of valuation reserves offsetting deferred tax assets. Actual results could differ from those estimates. The Company’s critical accounting policies relating to these items are described in the Company’s Annual Report on Form 10-K for the year ended September 30, 2006. As of March 31, 2007, there have been no material changes to any of the critical accounting policies contained therein.
 
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

We are subject to the risk of fluctuating interest rates in the ordinary course of business for borrowings under our Factoring Agreement, which provides for the sale of up to $1,500,000 of accounts receivable to Action Capital. Advances under this agreement bear interest at an annual rate of prime plus 1%, plus a monthly management fee of.6% on the dail average of unpaid balances.

We believe that our business operations are not exposed to market risk relating to foreign currency exchange risk or commodity price risk.
 
Item 4 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our internal control over financial reporting discussed below, our disclosure controls and procedures were effective as of the end of the period covered by this report.

22

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

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

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

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

Other than the continued implementation of the improvements in our internal controls described above, there were no significant changes in our internal controls during the quarter ended March 31, 2007, that have materially affected, or are reasonably likely to have materially affected, our internal controls subsequent to the date we carried out our evaluation.



23


Part II
Other Information
Item 1.
Legal Proceedings

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

Item 1A.
Risk Factors

There have been no material changes with respect to the risk factors disclosed in our Report on Form 10-K for the fiscal year ended September 30, 2006.

Item 3.
Defaults Upon Senior Securities

Dividends on our Series F Preferred Stock accrue at a rate of 7% per annum, payable monthly. As of the date of the filing of this report, $116,718 is in arrears on the Series F Preferred Stock.

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

There were no matters submitted to a vote of our security holders during the three months ended March 31, 2006.

Item 5.
Other Information

Not applicable.

Item 6
Exhibits

Number
Description
   
31.1
Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
   
31.2
Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
   
32.1
Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
   
32.2
Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
   
   


24

SIGNATURES

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

     
  STRATUS SERVICES GROUP, INC.
 
 		  
 		  
 
Date: May 10, 2007 By:   /s/ Joseph J. Raymond
 
 
Chairman of the Board of Directors,
President and Chief Executive Officer

 
     
   
 
 		  
 		  
 
Date: May 10, 2007 By:   /s/ Michael A. Maltzman
 
 
Vice President and Chief Financial Officer
Principal Financial and Accounting Officer

25