Stratus Services (SSVG) 10-Q 2008 Q3 Quarterly report

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-15789

STRATUS SERVICES GROUP, INC.

(Exact name of Registrant as specified in its charter)

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

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

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

Large Accelerated Filer  o	Accelerated Filer  o	Non-Accelerated Filer  o	Smaller Reporting Company  T
		(Do not check if a smaller reporting company)

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 September 16, 2008 was 71,318,617.

STRATUS SERVICES GROUP, INC.

Condensed Consolidated Balance Sheets

(Unaudited)

	June 30,			September 30,
Assets	2008			2007
Current assets
Cash	$	12,702		$	144,849
Accounts receivable–less allowance for doubtful accounts of  $200,000 and $75,000		1,820,517			1,104,650
Unbilled receivables		51,353			176,690
Inventory		201,407			-
Prepaid insurance		36,910			53,351
Prepaid expenses and other current assets		122,094			269,988
		2,444,983			1,749,528
Property and equipment, net of accumulated depreciation		209,099			186,279
Intangible assets, net of accumulated amortization		69,444			94,444
Goodwill		1,766,336			1,766,336
Other assets		20,996			8,820
	$	4,310,858		$	3,805,407
Liabilities and Stockholders’ Equity (Deficiency)
Current liabilities
Loans payable (current portion)	$	130,142		$	130,983
Loans payable – related parties		473,736			85,721
Notes payable – acquisitions (current portion) (including $55,103 and $52,859 to related  party)		427,665			349,673
Note payable – related party (current portion)		616,850			506,233
Line of credit		967,680			642,570
Insurance obligation payable		15,989			13,154
Accounts payable and accrued expenses		4,754,796			4,349,523
Accrued payroll and taxes		429,615			190,969
Payroll taxes payable		3,126,509			3,218,455
Series A redemption payable		300,000			300,000
		11,242,982			9,787,281
Loans payable (net of current portion)		21,197			35,013
Notes payable – acquisitions (net of current portion) (including $67,860 and $109,664 to related party)		330,869			430,241
Note payable – related party (net of current portion)		-			110,617
Notes payable – minority interest investors		750,000			675,000
		12,345,048			11,038,152
Commitments and contingencies
Minority interest		332,648			547,135
Stockholders’ equity (deficiency)
Preferred stock, $.01 par value, 5,000,000 shares authorized
Series F voting convertible preferred stock, $.01 par value, 6,000
shares issued and outstanding, liquidation preference of $600,000
(including unpaid dividends of $164,500 and $133,000)		764,500			733,000
Common stock, $.04 par value, 500,000,000 shares authorized; 71,318,615
and 69,568,615 shares issued and outstanding		2,852,745			2,782,745
Additional paid-in capital		9,724,616			9,760,516
Accumulated deficit		(21,708,699	)		(21,056,141	)
Total stockholders’ equity (deficiency)		(8,366,838	)		(7,779,880	)
	$	4,310,858		$	3,805,407

See notes to condensed consolidated financial statements

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STRATUS SERVICES GROUP, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Revenues	$	3,394,571		$	2,079,589		$	9,031,505		$	5,753,148
Cost of revenues		2,240,760			1,480,205			6,217,262			4,005,109
Gross profit		1,153,811			559,384			2,814,243			1,748,039
Selling, general and administrative expenses		1,286,004			673,542			3,493,345			2,048,103
Operating (loss) from continuing operations		(132,193	)		(74,158	)		(679,102	)		(300,064	)
Interest expense		(71,532	)		(58,555	)		(205,385	)		(177,227	)
Loss from continuing operations before minority interests		(203,725	)		(137,213	)		(884,487	)		(477,291	)
Minority interests in net (income) loss of consolidated subsidiaries		69,604			(10,925	)		243,887			3,653
Earnings (loss) from continuing operations		(134,121	)		(143,638	)		(640,600	)		(473,638	)
Discontinued operations – income (loss) from discontinued operations		(163,108)			-			(186,108	)		-
Gain on sale of discontinued operations (net)		53,435			183,653			174,150			460,147
Net earnings (loss)		(243,794	)		40,015			(652,558	)		(13,491	)
Dividends on preferred stock		(10,500	)		(10,500	)		(31,500	)		(31,500	)
Net earnings (loss) attributable to common stockholders	$	(254,294	)	$	29,515		$	(684,058	)	$	(44,991	)
Net earnings (loss) per share attributable to common stockholders
Basic:
(Loss) from continuing operations	$	-		$	-		$	(.01	)	$	-
Earnings (loss) from discontinued operations		-			-			-			-
Net earnings (loss)	$	-		$	-		$	(.01	)	$	-
Diluted:
(Loss) from continuing operations	$	-		$	-		$	(.01	)	$	-
Earnings (loss) from discontinued operations		-			-			-			-
Net earnings (loss)	$	-		$	-		$	(.01	)	$	-
Weighted average shares outstanding per common share
Basic		71,318,615			69,568,615			70,794,892			66,874,118
Diluted		71,318,615			85,516,115			70,794,892			66,874,118

See notes to condensed consolidated financial statements

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STRATUS SERVICES GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended
	June 30,
	2008			2007
Cash flows from (used in) operating activities
Net (loss)	$	(652,558	)	$	(13,491	)
Adjustments to reconcile net earnings to net cash used by operating activities
Depreciation		64,112			59,119
Amortization		25,000			-
Stock compensation		20,000			-
Gain on sale of discontinued operations		(174,150	)		(460,147	)
Imputed interest		18,181			28,652
Accrued interest		66,767			33,373
Changes in operating assets and liabilities
Accounts receivable		(590,530	)		(286,712	)
Inventory		(201,407	)		-
Prepaid insurance		16,441			(18,798	)
Prepaid expenses and other current assets		202,223			(16,693	)
Other assets		(12,176	)		-
Minority interest		(243,887	)		(3,653	)
Insurance obligation payable		2,835			(5,429	)
Accrued payroll and taxes		238,646			195,159
Payroll taxes payable		(91,946	)		(605,292	)
Accounts payable and accrued expenses		338,506			20,196
Total adjustments		(321,385	)		(1,060,225	)
		(973,943	)		(1,073,716	)
Cash flows from investing activities
Purchase of property and equipment		(86,932	)		(31,297	)
Cash received in connection with sale of discontinued operations (including $499,264 from a related party in 2007)		119,821			953,772
		32,889			922,475
Cash flows from (used in) financing activities
Net proceeds from line of credit		325,110			67,541
Proceeds from loans payable		-			50,000
Payments of loans payable		(14,656	)		(8,371	)
Proceeds from loans payable – related parties		486,195			120,000
Payments of loans payable – related parties		(98,181	)		(106,000	)
Payments of notes payable – acquisitions		(39,561	)		(7,033	)
Proceeds from exercise of warrants		-			9,375
Proceeds from minority interest investors		150,000			-
		808,907			125,512
Net change in cash		(132,147	)		(25,729	)
Cash – beginning		144,849			84,881
Cash – ending	$	12,702		$	59,152

See notes to condensed consolidated financial statements

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Supplemental disclosure of cash paid
Interest	$	244,152		$	255,354
Schedule of noncash investing and financing activities
Sale of discontinued operations:
Gain on sale	$	174,150		$	460,147
Net assets sold		-			-
Due from related party		-			499,264
Accrued earn-out		(54,329	)		(5,639	)
Net cash received	$	119,821		$	953,772
Cumulative dividends on preferred stock	$	31,500		$	31,500
Assignment of note receivable in exchange for notes payable - acquisitions	$	-		$	80,000

See notes to condensed consolidated financial statements

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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.

Certain prior period financial statement amounts have been reclassified to be consistent with the presentation for the current period.

NOTE 2 - DESCRIPTION OF BUSINESS AND SEGMENT INFORMATION

Description of Business

Until December 2005, Stratus Services Group, Inc. (“Stratus”) , together with its 51%-owned joint venture, Stratus Technology Services, LLC (“STS”), was a national provider of staffing and productivity consulting services.  In December 2005, Stratus completed a series of asset sales transactions pursuant to which it sold substantially all of the assets it used to conduct its staffing services (see Note 7).  In August 2007, Stratus’ newly formed subsidiary, Transworld Assets, LLC (“Transworld”) (see Note 4) acquired substantially all of the assets used by Green-Tech Assets, Inc. and its affiliate, CC Laurel, Inc. in their technology asset disposal business (see Notes 4 and 8).  Following the transaction, Transworld Assets, LLC changed its named to Green-Tech Assets, LLC (“GTA”).  Stratus, STS and GTA are herein referred to as the “Company”.

Segment Information

The operating segments reported below are the segments for which operating results are evaluated regularly by management in deciding how to allocate resources and in assessing performance.  The Company’s reportable segments are strategic divisions that offer different services and are managed separately as each division requires different resources and marketing strategies.  Intersegment sales are not significant.

Prior to the acquisition of the technology asset disposal business in August 2007, the Company operated as one business segment.

Net revenues and operating income (loss) by segments for the three and nine months ended June 30, 2008 were as follows:

	Three Months Ended June 30, 2008			Nine Months Ended June 30, 2008
Revenues:
Information technology services	$	2,302,014		$	6,391,315
Technology asset disposal business		1,092,557			2,640,190
Consolidated revenues	$	3,394,571			9,031,505
Operating (loss):
Information technology services	$	24,627		$	(65,471	)
Technology asset disposal business		(112,402	)		(280,769	)
Corporate expenses		(44,418	)		(332,862	)
Consolidated operating (loss)		(132,193	)	$	(679,102	)

Management reviews the Company’s assets on a consolidated basis because it is not meaningful to allocate assets to the various segments.  Management evaluates segment performance based on revenues and operating income.  The Company

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does not allocate income taxes or charges determined to be non-recurring in nature.  Unallocated amounts of operating (loss) consist of corporate expenses.

The Company primarily operates in the United States.

NOTE 3 – LIQUIDITY

At June 30, 2008, the Company had limited liquid resources.  Current liabilities were $11,242,982 and current assets were $2,244,983.  The difference of $8,997,999 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 the continued cooperation of its creditors, 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 include closing branches that are 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 7) and the acquisition of the technology asset disposition business that took place in August 2007 (See Notes 4 and 8).

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.  If the Company is not successful in raising additional capital or obtaining additional accommodations from its creditors, no assurances can be given that its creditors will not seek to pursue all remedies available to them, which could result in a voluntary or involuntary bankruptcy proceeding.

NOTE 4 - NEWLY-FORMED SUBSIDIARY

In July 2007, Stratus, in exchange for 5,000,000 shares of its common stock received a 51% interest in an entity created to acquire substantially all of the assets of Green-Tech Assets, Inc. and its affiliate, CC Laurel, Inc.  Following the acquisition, Transworld changed its name to Green-Tech Assets, LLC.  Minority interest investors in GTA, through a private offering, purchased units at the price of $100,000 which was comprised of a pro-rata share of the minority interest and a $50,000 note bearing interest at 6% per year and due July 31, 2012.  In addition, each unit owner received 50,000 shares of Stratus’ common stock which was held by GTA.  The private offering was closed in October 2007 with 15 units sold, representing $750,000 in contributed capital and $750,000 in notes payable.

NOTE 5– NEW ACCOUNTING STANDARDS

In September 2006, the FASB issued 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 is currently assessing the impact the adoption of this pronouncement will have on the financial statements.

In February 2007, the FASB issued SFAS 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.

In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51” and is effective for fiscal years beginning after December 5, 2008.  This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  The Company is currently assessing the impact the adoption of this pronouncement will have on the Company’s financial statements.

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In December 2007, the FASB issued SFAS No. 141 (Revised) “Business Combinations”.  SFAS 141 (Revised) is effective for fiscal years beginning after December 13, 2008.  This Statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.  The Statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  The Company is currently assessing the impact the adoption of this pronouncement will have on the Company’s financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”  SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements which are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States.  SFAS No. 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.”  The Company does not expect the adoption of SFAS No. 162 to have a material impact on its consolidated financial statements.

NOTE 6 – 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 and nine months ended June 30, 2008 and 2007.  Outstanding common stock options and warrants not included in the computation of earnings per share for the three and nine months ended June 30, 2008 and 2007, totaled 17,963,653 and 17,213,653, respectively.  These options and warrants were excluded because their inclusion would have an anti-dilutive effect on earnings per share.

NOTE 7 – DISCONTINUED OPERATIONS

The gain on sale of discontinued operations is comprised of earnout payments in connection with the sales of substantially all of the Company’s then assets in December 2005.  The earnout payments, which are based on sales of certain of the sold branches, continue through November 2008.  The loss from discontinued operations is comprised primarily of write-offs of certain assets.

NOTE 8 – ACQUISITION

Effective as of August 2, 2007, the Company’s newly formed subsidiary, Transworld (see Note 4), purchased substantially all of the assets used by Green-Tech Assets, Inc. and its affiliate, CC Laurel, Inc. (the “Seller”) in their technology asset disposal business located in Providence, Rhode Island. The purpose of the acquisition was to generate future cash flow for the Company and provide cross-selling opportunities between the Company’s subsidiaries.

The purchase price was comprised of $600,000 in cash, a promissory note in the principal amount of $166,828 bearing interest at 5% per year payable in equal installments of $5,000 over 36 months, and 2,000,000 shares of Stratus’ common stock held by Transworld.  Transworld guaranteed the Seller that the market price of Stratus’ common stock would be $.20 per share on the third anniversary date of the transaction.  Additionally, Transworld assumed approximately $817,000 of specified liabilities.  The aggregate cost of the acquisition, including finders’ fees and other costs aggregated $2,163,745, which was allocated as follows:

Accounts receivable	$	245,484
Property and equipment		35,000
Other assets		16,925
Intangible assets		100,000
Goodwill		1,766,336
Total	$	2,163,745

The intangible assets represent a covenant not to compete which is being amortized over three years.

The unaudited proforma consolidated results of operations presented below assume that the acquisition had occurred at the beginning of fiscal 2007.  This information is presented for informational purposes only and includes certain adjustments such as amortization of intangible assets resulting from the acquisition and interest expense related to the acquisition debt.

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	Unaudited Three Months Ended June 30, 2007			Unaudited Nine Months Ended June 30, 2007
Revenues	$	3,352,306		$	8,852,997
Net (loss) from continuing operations attributable to common stockholders		(158,021	)		(475,149	)
Net (loss) per share attributable to common stockholders basic and diluted		-			(.01	)

NOTE 9 - LINE OF CREDIT

On January 3, 2006, the Company’s consolidated 51% owned joint venture, STS (see Notes 1 and 15), entered into a factoring and security agreement (the “Factoring Agreement”) with Action Capital Corporation (“Action”).  The Factoring Agreement provides for the sale of up to $1,500,000 of acceptable accounts receivable of STS to Action.  Action reserves and withholds an amount in a reserve account equal to 10% of the face amount of accounts receivable purchased under the Factoring Agreement.  Action has full recourse against STS including, without limitation, the right to charge-back or sell back any accounts receivable, if not paid within 90 days of the date of purchase.  The Factoring Agreement provides for STS to pay interest of prime plus 1% plus a monthly fee of .6% on the daily average of unpaid advances.  The prime rate at June 30, 2008 was 5.00%.

NOTE 10 - GOODWILL AND OTHER INTANGIBLE ASSETS

Intangible assets with definite lives are amortized over their estimated useful lives.

Intangible assets consist of the following as of June 30, 2008 and September 30, 2007:

	June 30, 2008			September 30, 2007
Covenant-not-to-compete	$	100,000		$	100,000
Accumulated amortization		(30,556	)		(5,556	)
	$	69,444		$	94,444

Covenant not to compete is being amortized over three years.

Estimated amortization expense related to intangible assets with definite lives is as follows:

For the Twelve Months Ending June 30,
2009	$	33,333
2010		33,333
2011		2,778

Amortization expense of amortizable intangible assets was $8,333 and $-0-, for the three months ended June 30, 2008 and 2007, respectively, and $25,000 and $-0-, for the nine months ended June 30, 2008 and 2007, respectively.

The net carrying amount of goodwill at June 30, 2008 and September 30, 2007 is comprised of goodwill recorded during the year ended September 30, 2007 (See Note 8).

NOTE 11 – PAYROLL TAX LIABILITIES

During fiscal 2003, the Company was notified by both the New Jersey Department of Labor and the California Employment Development Department (the “EDD”) that, if certain payroll delinquencies were not cured, judgment would be entered against the Company.  As of June 30, 2008, there was still an aggregate of $3.1 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; however, the EDD has issued notices of levy to two parties that have payment obligations to the Company which, in one case, directs the party to remit amounts owed to the Company to the EDD, and, in the other case, directs the party to hold funds owed to the Company and provide certain information to the EDD pending

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further instruction. 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.  Under the terms of the agreement, the Company is required to pay $12,500 per week to be first applied to its unpaid employment tax liability, then to interest and then to penalties until all amounts are fully paid.  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.

The Company paid $12,500 per week to the EDD until July 2007 when it satisfied the outstanding employment tax liability (exclusive of interest and penalties) in full.  In August 2007, the Company unilaterally reduced its payments with respect to accrued interest and penalties to $1,000 per week.  The Company discontinued making any payments upon issuance of the notices of levy in April 2008.

NOTE 12 – SERIES F PREFERRED STOCK

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.

NOTE 13 - NOTE PAYABLE – RELATED PARTY

On January 13, 2006, the Company entered into an agreement with Pinnacle Investment Partners, LP (“Pinnacle”) (See Note 16), the holder of all of the outstanding shares of the Company’s Series I Preferred Stock, 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 all of the shares of the Company’s Series I Preferred Stock held by Pinnacle  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.  At June 30, 2008, $210,000 of this has not been paid.

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

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•      $225,000 and accrued interest thereon at the rate of 6% per annum became due and payable on December 28, 2007; and remains outstanding; 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 of principal was converted into 20,833,331 shares of the Company’s Common Stock.

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

NOTE 14 - 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.

NOTE 15 - COMMITMENTS AND CONTINGENCIES

The Company is subject to legal claims and litigation in the ordinary course of business, including but not limited to, the matters described below.  A negative result in one or more of such matters could have an adverse effect on the Company’s financial condition and results of operations.  As of June 30, 2008, the Company was a party to the following actions:

Tymatt Associates, LLC v. Stratus Services Group, Inc.  On October 15, 2007, Tymatt Associates, LLC (“Tymatt”) filed suit against the Company for breach of contract in the Supreme Court of the State of New York, County of New York, seeking damages of $300,000 plus accrued interest at a rate of 18% per annum from January 31, 2005, as well as costs and expenses, including accountant’s fees and attorney’s fees, in connection with the Company’s failure to either pay to Tymatt the sum of $250,000 or to deliver to Tymatt a number of shares of Stratus common stock with a value of $250,000 by January 31, 2005 as required by the terms of a redemption agreement pertaining to the Company’s Series A Preferred Stock.  The Company has been in discussions with Tymatt in an attempt to resolve this matter; however, no assurance can be given that it will be able to resolve this matter on terms that are satisfactory to it.

Teamone Personnel Solutions, LLC vs. Stratus Services Group, Inc.  On October 19, 2007, Teamone Personnel Solutions, LLC (“Teamone”) filed a Request for Entry of Default and Court Judgment in the amount of $157,004 in the Superior Court of California, County of Solano.  Teamone had filed in July 2007 suit seeking enforcement of an acceleration provision of a promissory note executed by the Company in favor of Teamone on March 2, 2005 in the principal amount of $160,000.  The Company has been discussions with Teamone to arrange for a deferred payment schedule for the amount owed; however, no assurance can be given that Teamone will agree to deferring payment and will not seek to enforce its judgment.

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In re APX Holdings, LLC, et al.  In August 2007, the Trustee in a Chapter 7 bankruptcy proceeding in the United States Bankruptcy Court for the Central District of California involving APX Holding, LLC, one of the Company’s former customers, brought an action against the Company and several other parties, including the Company’s former lender and ALS, LLC seeking to recover $860,184 of preference payments that were allegedly made by APX and its affiliates.  The Company settled this matter in April 2008 by agreeing to pay $23,000 to the Trustee in four equal monthly installments; however, the company failed to make the payment due in June 2008 and the Trustee has advised the Company that it is requesting that the Bankruptcy Court enter a judgment in the amount of approximately $40,000 against the Company.

Temporary Services Insurance Ltd. V. Stratus Services Group, Inc., ALS, LLC, U.S. Temps, Inc., et al.  In September 2007, Temporary Services Insurance Ltd. (“TSIL”) instituted an action in the United States District Court, Middle District of Florida, Orlando Division, against us, ALS, LLC, certain principals and affiliates of ALS, LLC and certain other parties alleging that the Company participated in a fraudulent scheme to obtain workers compensation insurance through TSIL at a cost substantially lower than the cost of workers compensation insurance that it could have otherwise obtained through its own carriers.  In its complaint, TSIL, which seeks unspecified damages, alleges that ALS, LLC failed to disclose certain outsourcing agreements with its clients, including the outsourcing agreements between the Company and ALS, LLC, that the employees provided by ALS, LLC  to perform services for the Company and its clients were actually the Company’s employees, and that the Company was unjustly enriched by ALS LLC’s misrepresentations and failure to disclose material facts pertaining to its relationship with the Company.  The Company intends to vigorously defend this matter.

State Compensation Insurance Fund vs. Stratus Services Group, Inc.  In December 2006, the Company entered into an agreement with the California State Compensation Insurance Fund (the “Fund”) whereby the Fund agreed to reduce the Company’s then liability of $2,023,000 to $300,000 provided that the Company make certain monthly payments aggregating $300,000 over 56 months.  The Company failed to make the payments due in July, August and September 2008 and has been notified that the Fund intends to enter judgment against the Company in the amount of $2,023,419.

Liberty Mutual Fire Insurance Company vs. Stratus Services Group, Inc.  In May 2006, Liberty Mutual Fire Insurance Company (“Liberty”) instituted an action in the Superior Court of New Jersey alleging that the Company owed it approximately $250,000 of unpaid workers’ compensation insurance premiums.  A default judgment was subsequently entered against the Company.  The Company subsequently entered into a series of Tolling Agreements with Liberty pursuant to which Liberty agreed to dismiss its action against the Company without prejudice, and the Company agreed to make periodic payments to Liberty commencing in September 2006.  Liberty agreed that these payments would be deducted from the Company’s outstanding balance to Liberty.  Liberty reserved the right to reinstate its lawsuit against the Company in the event of a default by the Company under the Tolling Agreements.  The Company failed to make a $5,500 payment due to Liberty in June 2008 and Liberty has advised the Company that it is reinstating its lawsuit.

NOTE 16 - RELATED PARTY TRANSACTIONS

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 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 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.

Loans Payable

During the nine months ended June 30, 2008, the brother of the Company’s CEO loaned $151,195 to STS of which $13,181 was repaid during the nine months ended June 30, 2008.  In addition, during the nine months ended June 30, 2008, a significant shareholder of the Company loaned $40,000 to STS and $295,000 to GTA of which $85,000 was repaid during the nine months ended June 30, 2008.

During the nine months ended June 30, 2007, the Company’s CEO loaned $100,000 to the Company which was repaid in January 2007.  In addition, during the nine months ended June 30, 2007, a significant shareholder loaned $20,000 to the Company which was repaid subsequently to June 30, 2007.

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Other

The nephew of the CEO of the Company is affiliated with Pinnacle Investment Partners, LP, the holder of the convertible note issued in exchange for shares of the Company’s Series I Preferred Stock (see Note 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 diversify our client base; 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, 2007.

Introduction

From inception until 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.  In December 2005, we completed a series of asset sale transactions (the “Asset Sales”) 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.  In August 2007, we entered the technology asset disposition business through our acquisition of the operations now conducted by our 51% subsidiary, GTA.

Continuing Operations

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

Revenues.  Revenues increased 63.2% to $3,394,571 for the three months ended June 30, 2008 from $2,079,589 for the three months ended June 30, 2007.  Approximately $1,093,000 of the increase was attributable to the acquisition of our technology asset disposition operations in August 2007.  Excluding the acquisition, revenues increased 10.7%.  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 106.2% to $1,153,811 for the three months ended June 30, 2008 from $559,384 for the three months ended June 30, 2007.  Approximately $434,000 of the increase was attributable to the acquisition in August 2007.  Excluding the acquisition, gross profits increased 28.6%.  Gross profit as a percentage of revenues, exclusive of the gross profit attributable to the acquisition, increased to 31.3% for the three months ended June 30, 2008 from 28.8% for the three months ended June 30, 2007, primarily as a result of an increase in permanent placements.

Selling, General and Administrative Expenses.  Selling, General and Administrative expenses (“SGA”) increased 90.9% to $1,286,004 for the three months ended June 30, 2008 from $673,542 for the three months ended June 30, 2007.  Exclusive of approximately $418,000 attributable to the acquisition in August 2007, SG&A increased 28.8%.  SG&A as a percentage of revenues increased to 37.9% for the three months ended June 30, 2008 from 32.4% for the three months ended June 30, 2007.  The increase in SG&A for the three months ended June 30, 2008, is primarily a result of additions to our sales and recruiting staff.

Interest Expense.  Interest expense increased 22.1% to $71,532 for the three months ended June 30, 2008 from $58,555 for the three months ended June 30, 2007.  Interest expense as a percentage of revenues decreased to 2.1% for the three months ended June 30, 2008 from 3.1% for the three months ended June 30, 2007.

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Minority Interest in Net (income) Loss of Consolidated Subsidiaries.  The minority interest in net (income) loss of consolidated subsidiaries for the three months ended June 30, 2008 and 2007 represents the minority venturers’ proportionate share of the net (income) loss of our consolidated subsidiaries.

Net Loss Attributable to Common Stockholders.As a result of the foregoing, we had a net loss attributable to common stockholders of $144,621, for the three months ended June 30, 2008 compared to a net loss attributable to common stockholders of $154,138 for the three months ended June 30, 2007.

Nine Months Ended June 30, 2008 Compared to Nine Months Ended June 30, 2007

Revenues.   Revenues increased 57.0% to $9,031,505 for the nine months ended June 30, 2008 from $5,753,148 for the nine months ended June 30, 2007.  Approximately $2,603,000 of the increase is attributable to the acquisition in August 2007.  Excluding the acquisition, revenues increased 11.7%.  This increase was primarily a result of an increase in billable hours and expansion of our customer base, net of a decrease in permanent placements.

Gross Profit.  Gross profit increased 61.0% to $2,814,243 for the nine months ended June 30, 2008 from $1,748,039 for the nine months ended June 30, 2007.  Approximately $884,000 of the increase was attributable to the acquisition in August 2007.  Excluding the acquisition, gross profits increased 10.4%.  Gross profit as a percentage of revenues, exclusive of the gross profit attributable to the acquisition, decreased to 30.0% for the nine months ended June 30, 2008 from 30.4% for the nine months ended June 30, 2007, primarily as a result of a decrease in permanent placements and a small reduction in our markup percentages.

Selling, General and Administrative Expenses.  Selling, General and Administrative expenses (“SGA”) increased 70.6% to $3,493,345 for the nine months ended June 30, 2008 from $2,048,103 for the nine months ended June 30, 2007.  Exclusive of approximately $985,000 attributable to the acquisition in August 2007, SG&A increased 22.5%.  SG&A as a percentage of revenues increased to 38.7% for the nine months ended June 30, 2008 from 35.6% for the nine months ended June 30, 2007.  The increase in SG&A for the nine months ended June 30, 2008 is primarily a result of additions to our sales and recruiting staff.

Interest Expense.  Interest expense increased 15.9% to $205,385 for the nine months ended June 30, 2008 from $177,227 for the nine months ended June 30, 2007.  Interest expense as a percentage of revenues decreased to 2.3% for the nine months ended June 30, 2008 from 3.1% for the nine months ended June 30, 2007.

Minority Interest in Net (income) Loss of Consolidated Subsidiaries.  The minority interest in net (income) loss of consolidated subsidiaries for the nine months ended June 30, 2008 and 2007 represents the minority venturers’ proportionate share of the net (income) loss of our consolidated subsidiaries.

Net Loss Attributable to Common Stockholders.As a result of the foregoing, we had a net loss attributable to common stockholders of $672,100, for the nine months ended June 30, 2008 compared to a net loss attributable to common stockholders of $(505,138) for the nine months ended June 30, 2007.

Liquidity and Capital Resources

Cash flows have not been segregated between continuing operations and discontinued operations in the accompanying condensed consolidated statements of cash flows.  Cash provided to us from discontinued operations (included in the consolidated cash flow discussions below) during the nine months ended June 30, 2008 and 2007 was comprised of the following:

	Nine Months Ended
	June 30,
	2008			2007
Cash used in operating activities	$	(21,500	)	$	(700,184	)
Cash provided by investing activities		119,821			946,543
Cash used in financing activities		-			-
Net	$	98,321		$	246,359

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At June 30, 2008, we had limited liquid resources.  Current liabilities were $11,242,982 and current assets were $2,244,983.  The difference of $8,997,999 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 the continued cooperation of our creditors, 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 include 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 cash flow from operations and earnout payments to which we are entitled in connection with the Asset Sales will provide us with sufficient cash flow to support our operations in the next twelve months provided that we continue to receive cooperation and accommodations from our creditors.  No assurance can be given that we will be able to raise additional capital or that our creditors will not seek to pursue all remedies available to them, which could result in a voluntary or involuntary bankruptcy proceeding.

Net cash used in operating activities was $1,028,272nd $1,073,716 in the nine months ended June 30, 2008 and 2007, respectively.

Net cash provided by investing activities was $87,218 and $922,475 in the nine months ended June 30, 2008 and 2007, respectively.  Net cash received in connection with the sale of discontinued operations (comprised of earnout payments) was $119,821 and $953,772, in the nine months ended June 30, 2008 and 2007, respectively.  Cash used for capital expenditures was $86,932 and $31,297 in the nine months ended June 30, 2008 and 2007, respectively.

Net cash provided by financing activities was $808,907 and $125,512 in the nine months ended June 30, 2008 and 2007, respectively.  We had net borrowings of $325,110 and $67,541 under our line of credit in the nine months ended June 30, 2008 and 2007, respectively.  Net short-term borrowings were $373,358 and $55,629 in the nine months ended June 30, 2008 and 2007, respectively.  Net short-term borrowings in the nine months ended June 30, 2008 includes $138,014 (net of repayments of $13,181) loaned to us by the brother of our Chief Executive Officer (“CEO”) and $250,000 (net of repayments of $85,000) loaned to us by a significant shareholder.  Net short-term borrowings in the nine months ended June 30, 2007 includes $100,000 loaned to us by our CEO, which was repaid in January 2007 and $20,000 which was loaned to us by a significant shareholder of which $4,000 was repaid through June 30, 2007.  Payments of notes payable - acquisitions was $39,561 and $7,033 in the nine months ended June 30, 2008 and 2007, respectively.  During the nine months ended June 30, 2008, we received net proceeds of $150,000 from the minority investors in Green-Tech Assets, LLC of which $75,000 is represented by notes payable and the balance is contributed equity.

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.

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.  The prime rate at June 30, 2008 was 5.00%.  As of June 30, 2008, $835,005 was outstanding under the Factoring Agreement.

During fiscal 2003, we were notified by both the New Jersey Department of Labor and the California Employment Development Department (the “EDD”) that, if certain payroll delinquencies were not cured, judgment would be entered against us.  As of June 30, 2008, there was still an aggregate of $3.1 million in delinquent payroll taxes outstanding, including interest and penalties, which are included in “Payroll taxes payable” in the June 30, 2008 balance sheet.  Judgment has not been entered against us in California; however, the EDD has issued notices of levy to two parties that have payment obligations to us which, in one case, directs the party to remit amounts owed to us to the EDD, and, in the other case, directs the party to hold funds owed to us and provide certain information to the EDD pending further

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instruction.  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.  We paid $12,500 per week to the EDD until July 2007 when we satisfied the outstanding employment tax liability (exclusive of interest and penalties) in full.  In August 2007, we unilaterally reduced our payments with respect to accrued interest and penalties to $1,000 per week and discontinued payments in April 2008.

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, or 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 instituted 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 13 to the Condensed Consolidated Financial Statements.

In December 2006, we entered into an agreement with the California State 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.  We failed to make the payments due in July, August and September 2008 and have been notified that the Fund intends to enter judgment against us in the amount of $2,023,419.

In May 2006, Liberty Mutual Fire Insurance Company (“Liberty”) instituted an action in the Superior Court of New Jersey alleging that we owed it approximately $250,000 of unpaid workers’ compensation insurance premiums.  A default judgment was subsequently entered against us.  We subsequently entered into a series of Tolling Agreements with Liberty pursuant to which Liberty agreed to dismiss its action against us without prejudice, and we agreed to make periodic payments to Liberty commencing in September 2006.  Liberty agreed that these payments would be deducted from our outstanding balance to Liberty.  Liberty reserved the right to reinstate its lawsuit against us in the event we defaulted under the Tolling Agreement.  We failed to make a $5,500 payment due to Liberty in June 2008 and Liberty has advised us that it is reinstating its lawsuit.

In August 2007, the Trustee in a Chapter 7 bankruptcy proceeding in the United States Bankruptcy Court for the Central District of California involving APX Holding, LLC, one of our former customers, brought an action against us and several other parties, including our former lender and ALS, seeking to recover $860,184 of preference payments that were allegedly made by APX and its affiliates.  We settled this matter in April 2008 by agreeing to pay$23,000 to the Trustee in four equal monthly payments; however, we failed to make the payment due in June 2008 and the Trustee has advised us that it is requesting the Bankruptcy Court to enter judgment against us in the amount of approximately $40,000.

As of June 30, 2008, 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 $(8,123,044).

We engaged in various transactions with related parties during the nine months ended June 30, 2008 including the following:

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• During the nine months, the brother of our CEO and a significant shareholder loaned us $151,195and $335,000, respectively.  We repaid $13,181 and $85,000 to them, respectively, during the nine months.

• In addition, at June 30, 2008, 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; $3,123 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 became due in full in May 2006.

• 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 June 30, 2008, $616,850 was outstanding on the Convertible Note.

Contractual Obligations

Our aggregate contractual obligations as of June 30, 2008 are as follows:

			Payments Due by Fiscal Period (in Thousands)
						2010 -		2012 -
	Total		2009		2011		2013		Thereafter
Contractual Obligations:
Long-term debt obligations	$	2,750	$	1,648	$	306	$	796	$	-
Operating lease obligations		491		219		272				-
Series A redemption payable		300		300						-
TOTAL	$	3,541	$	2,167	$	578	$	796	$	-

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 September 2006, the FASB issued 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.  We are currently assessing the impact the adoption of this pronouncement will have on our financial statements.

In February 2007, the FASB issued SFAS 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.

In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51” and is effective for fiscal years beginning after December 5, 2008.  This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  We are currently assessing the impact the adoption of this pronouncement will have on our financial statements.

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In December 2007, the FASB issued SFAS No. 141 (Revised) “Business Combinations”.  SFAS 141 (Revised) is effective for fiscal years beginning after December 13, 2008.  This Statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.  The Statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  We currently assessing the impact the adoption of this pronouncement will have on our financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”  SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements which are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States.  SFAS No. 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.”  The Company does not expect the adoption of SFAS No. 162 to have a material impact on its consolidated 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, 2007.  As of June 30, 2008, 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 daily 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 disclosure controls and procedures were effective as of the end of the period covered by this report.  There were no changes in our internal controls during the quarter ended June 30, 2008 that have materially affected, or are reasonably likely to have materially affected our internal controls over financial reporting.

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.

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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, including the matters described in our Report on Form 10-K for the fiscal year ended September 30, 2007 (the “2007 10-K”) and Note 16 to the financial statements included with this report.  There have been no material changes in the status of such matters since the filing of the 2007 10-K, except as described below.

We settled the matter captioned In re APX Holdings, LLC, et al. in which the Trustee in a Chapter 7 bankruptcy proceeding alleged that we had received $860,184 of preference payments by agreeing to pay $23,000 to the Trustee in four monthly installments; however, we failed to make the payment due in June 2008 and the Trustee has advised us that it is requesting that the Bankruptcy Court enter a judgment against us in the amount of approximately $40,000.

In December 2006, we entered into an agreement with the California State Compensation Insurance 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.  We failed to make the payments due in July, August and September 2008 and have been notified that the Fund intends to enter judgment against us in the amount of $2,023,419.

In May 2006, Liberty Mutual Fire Insurance Company instituted an action in the Superior Court of New Jersey alleging that we owed it approximately $250,000 of unpaid workers’ compensation insurance premiums.  A default judgment was subsequently entered against us.  We subsequently entered into a series of Tolling Agreements with Liberty pursuant to which Liberty agreed to dismiss its action against us without prejudice, and we agreed to make periodic payments to Liberty commencing in September 2006.  Liberty agreed that these payments would be deducted from our outstanding balance to Liberty.  Liberty reserved the right to reinstate its lawsuit against us in the event we defaulted under the Tolling Agreement.  We failed to make a $5,500 payment due to Liberty in June 2008 and Liberty has advised us that it is reinstating its lawsuit.

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, 2007.

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, $173,821 is in arrears on the Series F Preferred Stock.

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

There were no matters submitted to a vote of our security holders during the three months ended June 30, 2008.

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

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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:  September 18, 2008	By:	/s/ Joseph J. Raymond
		Name: Joseph J. Raymond
		Title:  Chairman of the Board of Directors,
		President and Chief Executive Officer

	Company Name
Date:  September 18, 2008	By:	/s/ Michael A. Maltzman
		Name: Michael A. Maltzman
		Title:  Vice President and Chief Financial Officer
		Principal Financial and Accounting Officer

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