NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of Dalrada Financial Corporation ("DFCO" or the "Company"), incorporated under the laws of the state of California in March 1982 and subsequently reincorporated under the laws of the state of Delaware in May 1983, and its following active subsidiaries (there are ten inactive subsidiaries not listed):

a) SourceOne Group, Inc., - 100% owned by DFCO;

b) The Christianson Group - 100% owned by DFCO;

c) Heritage Staffing Group, Inc. - 100% owned by DFCO;

d) Strategic Alternative Staffing, LLC - 100% owned by DFCO and

e) Quik Pix, Inc. - 85% owned by DFCO.

All significant intercompany accounts and transactions have been eliminated.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. For the year ended June 30, 2006, the Company experienced a loss from continuing operations of $4,739 and as of June 30, 2006, the Company had a negative working capital deficit of $24,916 and had a negative stockholders' deficit of $21,620. In addition, the Company is in default on certain note payable obligations, delinquent on payroll tax obligations and is being sued by numerous trade creditors for nonpayment of amounts due. The Company is also delinquent in its payments relating to payroll tax liabilities. These conditions raise substantial doubt about its ability to continue as a going concern. Management believes that it can continue to raise debt and equity financing to support its operations.

STOCK SPLITS

On September 15, 2006, the Company authorized a one for two hundred (1 for 200) reverse stock split of its common stock. All share information for common shares has been retroactively restated for this reverse stock split.

NATURE OF BUSINESS

The Company provides a variety of financial, staffing, professional employer organization outsourcing (PEO) and human resources services to small and medium-size businesses. These services allow the Company's customers to outsource many human resources tasks, including payroll processing, workers' compensation insurance, employee benefits administration, risk management and human resource administration. These financial services relieve existing and potential customers of the burdens associated with personnel management and control.

DFCO provides services through its subsidiaries and divisions: SourceOne Group, Inc. ("SOG") and Heritage Staffing; in addition, through The Solvis Group, Inc., ("Solvis") an 85% owned subsidiary that includes the operating units:
CallCenterHR (TM), Solvis Financial Services, Solvis Medical Staffing and Solvis home Health Care. These companies and business units provide a broad range of financial services, including: benefits and payroll administration, health and workers' compensation insurance programs, personnel records management, employer liability management, risk management and safety, and temporary staffing services, to small and medium-sized businesses. Solvis' services cover a broad range of services including payroll debit cards, health insurance, 401(k) and 125-Flex plans, supplemental insurance, payroll advances, and other value-added benefits.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

Staffing services include on-demand or short-term staffing assignments, long-term or indefinite-term contract staffing and on-site management. In a PEO contract arrangement, the Company becomes a co-employer of the client's existing workforce and assumes some or all of the client's human resource management responsibilities.

As a human resource department and strategic business partner for the Company's clients, its service offerings allow its clients to:
o comply with ever evolving complex employment related regulatory and tax issues;
o increase productivity by improving employee satisfaction and retention;
o reduce payroll expenses with lower workers' compensation costs; and
o focus on core business activities instead of human resource matters.

In January 2003, the Company completed the acquisition of a controlling in the shares of Quik Pix, Inc. ("QPI"), located in Anaheim, California. At the time of acquisition, QPI's principal business was providing products and services associated with visual marketing support. QPI revenues consist primarily of developing and mounting photographic and digital images for use in display advertising for tradeshows and customer building interiors. QPI also has a proprietary product PhotoMotion Images(TM), ("Photomotion") which is a patented color medium of multi-image transparencies. DFCO moved its ColorBlind(TM) software business into QPI. The business is in the process of being sold to another company, which will be concluded by the end of October 2006.

In July 2005, QPI acquired The Solvis Group, Inc. ("Solvis") from DFCO and changed its name to The Solvis Group and its trading symbol to SLVG. Solvis current trades on the Pink Sheets(R). As of June 30, 2006, Solvis is a wholly-owned subsidiary of QPI.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. Significant estimates made by the Company's management include but are not limited to recoverability of property and equipment, payroll tax liabilities, reserves for contingent liabilities and deferred taxes. Actual results could materially differ from those estimates.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

REVENUE RECOGNITION

PEO SERVICE FEES AND WORKSITE EMPLOYEE PAYROLL COSTS

The Company recognizes its revenues associated with its PEO business pursuant to EITF 99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent." The Company's revenues are reported net of worksite employee payroll cost (net method). Pursuant to discussions with the Securities and Exchange Commission staff, the Company changed its presentation of revenues from the gross method to an approach that presents its revenues net of worksite employee payroll costs (net method) primarily because the Company is not generally responsible for the output and quality of work performed by the worksite employees.

In determining the pricing of the markup component of the gross billings, the Company takes into consideration its estimates of the costs directly associated with its worksite employees, including payroll taxes, benefits and workers' compensation costs, plus an acceptable gross profit margin. As a result, the Company's operating results are significantly impacted by the Company's ability to accurately estimate, control and manage its direct costs relative to the revenues derived from the markup component of the Company's gross billings.

Consistent with its revenue recognition policy, the Company's direct costs do not include the payroll cost of its worksite employees. The Company's direct costs associated with its revenue generating activities are comprised of all other costs related to its worksite employees, such as the employer portion of payroll-related taxes, employee benefit plan premiums and workers' compensation insurance premiums.

SALES OF PRODUCTS

Revenue is recognized when earned. The Company's revenue recognition policies are in compliance with all applicable accounting regulations, including American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, With Respect to Certain Transactions. Revenue from products licensed to original equipment manufacturers is recorded when OEMs ship licensed products while revenue from certain license programs is recorded when the software has been delivered and the customer is invoiced. Revenue from packaged product sales to and through distributors and resellers is recorded when related products are shipped. Maintenance and subscription revenue is recognized ratably over the contract period. When the revenue recognition criteria required for distributor and reseller arrangements are not met, revenue is recognized as payments are received. Provisions are recorded for returns and bad debts. The Company's software arrangements do not contain multiple elements, and the Company does not offer post contract support.

TEMPORARY STAFFING

The Company records gross revenue for temporary staffing. The Company has concluded that gross reporting is appropriate because the Company (i) has the risk and responsibility of identifying and hiring qualified employees, (ii) has the discretion to select the employees and establish their price and duties and
(iii) bears the risk for services that are not fully paid for by customers. Temporary staffing revenues are recognized when the services are rendered by the Company's temporary employees. Temporary employees placed by the Company are the Company's legal employees while they are working on assignments. The Company pays all related costs of employment, including workers' compensation insurance, state and federal unemployment taxes, social security and certain fringe benefits. The Company assumes the risk of acceptability of its employees to its customers.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

WORKER'S COMPENSATION

In April 2005, the Company obtained a high deductible policy with an A rated national carrier in order to manage its financial exposure from catastrophic injuries and fatalities. Regulations governing self-insured employers often require the employer to maintain surety deposits of government securities, letters of credit or other financial instruments to cover workers' claims in the event the employer is unable to pay for such claims. The Company's excess workers' compensation insurance annual policy provided coverage for single occurrences exceeding $250 with an aggregate stop loss provision of $4,000. The Company was required to post a $2,625 reserve with the carrier from which claims would be paid until all claims are settled. As of the end of the policy year, ending April 30, 2006, based upon an independent actuary report, the Company reserved $615 in pending claims against the remaining collateral fund; producing an approximate $1,800 in excess reserves. For the next policy year beginning May 2006, the carrier raised the Company's stop loss rates, but required the Company to deposit only $1,600 in the claims collateral fund as the result of the Company's low claims experience in the prior year.

CONTINGENT LIABILITIES

The Company accrues and discloses contingent liabilities in its consolidated financial statements in accordance with Statement of Financial Accounting Standards ("SFAS") No. 5, Accounting for Contingencies. SFAS No. 5 requires accrual of contingent liabilities that are considered probable to occur and that can be reasonably estimated. For contingent liabilities that are considered reasonably possible to occur, financial statement disclosure is required, including the range of possible loss if it can be reasonably determined. The Company has disclosed in its audited financial statements several issues that it believes are reasonably possible to occur, although it cannot determine the range of possible loss in all cases. As these issues develop, the Company will continue to evaluate the probability of future loss and the potential range of such losses. If such evaluation were to determine that a loss was probable and the loss could be reasonably estimated, the Company would be required to accrue its estimated loss, which would reduce net income in the period that such determination was made.

RECLASSIFICATIONS

Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year's presentation. These reclassifications had no effect on previously reported results of operations or retained earnings.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

CONCENTRATION OF CREDIT RISK

The Company places its cash in what it believes to be credit-worthy financial institutions. However, cash balances may exceed FDIC and SPIC insured levels at various times during the year.

Financial instruments that could potentially subject the Company to concentration of credit risk include accounts receivable. The Company generally requires clients to pay invoices for service fees no later than one day prior to the applicable payroll date. As such, the Company generally does not require collateral.

Additionally, during 2005, 96% of revenue derived from temporary staffing was from two clients and during 2006 47% of revenue derived from temporary staffing was from two clients.

ALLOWANCE METHOD USED TO RECORD BAD DEBTS

The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company's estimate is based on historical collection experience and a review of the current status of trade accounts receivable. It is reasonably possible that the Company's estimate of the allowance for doubtful accounts will change. Accounts receivable are presented net of an allowance for doubtful accounts of $639 at June 30, 2006. Accounts deemed uncollectible are written off against the allowance.

LONG-LIVED ASSETS AND INTANGIBLE ASSETS

In accordance with SFAS Nos. 142 and 144, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS No. 142 relates to assets with an indefinite life where as SFAS 144 relates to assets that can be amortized and the life determinable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value of asset less the cost to sell.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Depreciation, including amortization of assets recorded under capitalized leases, is generally computed on a straight-line basis over the estimated useful lives of assets ranging from three to seven years. Amortization of leasehold improvements is provided over the initial term of the lease, on a straight-line basis. Maintenance, repairs, and minor renewals and betterments are charged to expense.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

The Company reviews the carrying value of property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends and prospects, and the effects of obsolescence, demand, competition, and other economic factors.

CUSTOMER LISTS

Customer lists includes customer purchased with the acquisition of certain assets of Heritage and SSL. The customer lists for Heritage and SSL are being amortized over their estimated useful life of 36 and 48 months, respectively, using the straight-line method. Amortization expense for the fiscal years 2007, 2008, 2009 and 2010 is expected to be $166, $160, $142 and $118, respectively.

PATENT COSTS

Patent costs include direct costs of obtaining the patent. Costs for new patents are capitalized and amortized over the estimated useful life of the patent, generally over the life of the patent on a straight-line method. The cost of patents in process is not amortized until issuance. During the year ended June 30, 2005, the Company determined that the cost of the patent was not recoverable and took a write-off related to the patent of $1,348.

ADVERTISING COSTS

The Company expenses advertising and promotion costs as incurred. During fiscal 2006 and 2005, the Company incurred advertising and promotion costs of approximately $84 and $135, respectively.

RESEARCH AND DEVELOPMENT

Research and development costs are charged to expense as incurred.

EARNINGS (LOSS) PER COMMON SHARE

The Company reports earnings (loss) per share in accordance with SFAS No. 128, "Earnings per Share." Basic earnings (loss) per share are computed by dividing income (loss) available to common shareholders by the weighted average number of common shares available. Diluted earnings (loss) per share is computed similar to basic earnings (loss) per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. The Company had the following potential common shares for the years ended June 30, 2006 and 2005, respectively: warrants - 7,330,000 and 157,817; stock options - 135,000 and 195,750; and convertible securities of 15,237,774 and 2,078,758. For the year ended June 30, 2005, all of the above diluted shares were considered anti-dilutive since the Company incurred a net loss. For the year ended June 30, 2006, the warrants and options were considered anti-dilutive since the average stock price for the year was less than the exercise price of the warrants and options.

Below is a computation of earning (loss) per share:

                                                                         YEAR ENDED JUNE 30,
                                                ----------------------------------------------------------------------
                                                               2006                                2005
                                                ----------------------------------  ----------------------------------
                                                  INCOME/                   PER       INCOME/                   PER
                                                  (LOSS)       SHARES      SHARE      (LOSS)       SHARES      SHARE

BASIC EARNINGS (LOSS) PER SHARE

Net income (loss) from continuing operations     $  2,679                             $ (4,042)
Preferred stock dividends                             (21)                                 (21)
                                                ----------                           ----------
                                                    2,658                               (4,063)
Discontinued operations                              (363)                                (176)
                                                ----------                           ----------
Net income (loss) attributed to common
   stockholders                                  $  2,295                             $ (4,239)
                                                ==========                           ==========

Weighed shares outstanding                                   4,100,203                           3,292,181

   Continuing operations                                                   $ 0.65                             $(1.23)
   Discontinued operations                                                  (0.09)                             (0.05)
                                                                          --------                           --------
                                                                           $ 0.56                              (1.29)
                                                                          ========                           ========

DILUTED EARNINGS  PER SHARE                                                                         N/A

Net income from continuing operations            $  2,679
Preferred stock dividends                             (21)
Interest on convertible debentures                    476
Amortization of discounts on convertible
   debentures                                       1,137
                                                ----------
                                                    4,271
Discontinued operations                              (363)
                                                ----------
Net income (loss) attributed to common
   stockholders                                  $  3,908
                                                ==========

Weighed shares outstanding                                   4,110,203

Conversion of convertible debentures into common stock      15,237,774
                                                           -----------
                                                            19,347,977
                                                           ===========

   Continuing operations                                                   $ 0.22
   Discontinued operations                                                 $(0.02)
                                                                          --------
                                                                           $ 0.20
                                                                          ========

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

DEBT DISCOUNTS

Debt discounts costs are principally the values attributed to the detachable warrants issued in connection with the convertible debentures and the value of the preferential conversion feature associated with the convertible debentures. These debt issuance costs are accounted for in accordance with Emerging Issues Task Force ("EITF") 00-27 issued by the Financial Accounting Standards Board ("FASB").

MINORITY INTEREST

On April 1, 2005, the Company contributed its wholly-owned subsidiary, Solvis Group, Inc. a Michigan corporation, to QPI, an 85%-owned subsidiary of the Company. QPI subsequently changed its name to The Solvis Group, Inc., a Nevada corporation ("Solvis"). At that date, Solvis had a stockholders' equity of $393. As a result of this transaction, the Company recognized minority interest on its consolidated balance sheet in the amount of $59. During the year ended June 30, 2005, Solvis incurred a net loss of which 15% or $251 is attributed to the minority interest. In the consolidated statement of operations for the year ended June 30, 2005, the Company has only recognized the minority interests' share of the net loss to the extent of the minority interest recorded on the consolidated balance sheet. Solvis had net income for the year ended June 30, 2006 of which 15% or $81 is attributed to minority interest. The net income attributed to minority interest for the year ended June 30, 2006 of $0 that has been separately designated in the accompanying statement of operations is the current year net income related to minority interest of $81 offset by the unrecorded loss of $192 from the year ended June 30, 2005. The Company has an unrecorded loss of $111 going into the year ended June 30, 2007.

INCOME TAXES

The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The Company recognizes the amount of taxes payable or refundable for the current year and recognizes deferred tax liabilities and assets for the expected future tax consequences of events and transactions that have been recognized in the Company's financial statements or tax returns. The Company currently has substantial net operating loss carryforwards. The Company has recorded a 100% valuation allowance against net deferred tax assets due to uncertainty of their ultimate realization.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

STOCK BASED COMPENSATION

The Company adopted SFAS No. 123 (Revised 2004), SHARE BASED PAYMENT ("SFAS No. 123R"), under the modified-prospective transition method on January 1, 2006. SFAS No. 123R requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. Share-based compensation recognized under the modified-prospective transition method of SFAS No. 123R includes share-based compensation based on the grant-date fair value determined in accordance with the original provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, for all share-based payments granted prior to and not yet vested as of January 1, 2006 and share-based compensation based on the grant-date fair-value determined in accordance with SFAS No. 123R for all share-based payments granted after January 1, 2006. SFAS No. 123R eliminates the ability to account for the award of these instruments under the intrinsic value method prescribed by Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and allowed under the original provisions of SFAS No.
123. Prior to the adoption of SFAS No. 123R, the Company accounted for our stock option plans using the intrinsic value method in accordance with the provisions of APB Opinion No. 25 and related interpretations.

For periods presented prior to the adoption of SFAS No. 123R, pro forma information regarding net loss and loss per share as required by SFAS No. 123R has been determined as if the Company had accounted for its employee stock options under the original provisions of SFAS No. 123. The fair value of these options was estimated using the Black-Scholes option pricing model. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the option's vesting period. The pro forma information regarding the effect on operations that is required by SFAS 123 has not been presented since there is no pro forma expense to be shown for the six months ended December 31, 2005 or the year ended June 30, 2005.

FAIR VALUE OF FINANCIAL INSTRUMENTS

For certain of the Company's financial instruments, including accounts receivable, inventories, accounts payable, and accrued expenses, the carrying amounts approximate fair value, due to their relatively short maturities. The amounts owed for long-term debt also approximate fair value because current interest rates and terms offered to the Company are at current market rates.

COMPREHENSIVE INCOME

The Company adopted SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting other comprehensive income and its components in a financial statement. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. Comprehensive income is not presented in the Company's financial statements since the Company did not have any of the items of other comprehensive income in any period presented.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

SEGMENT DISCLOSURE

SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," was issued, which changes the way public companies report information about segments. SFAS No. 131, which is based on the selected segment information, requires quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. The Company has four segments.

RECENT ACCOUNTING PRONOUNCEMENTS

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods' financial statements of changes in accounting principle, unless this would be impracticable. This statement also makes a distinction between "retrospective application" of an accounting principle and the "restatement" of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS No. 154 is not expected to have a material effect on the financial position or results of operations of the Company.

In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments". SFAS No. 155 amends SFAS No 133, "Accounting for Derivative Instruments and Hedging Activities", and SFAF No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 155, permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interest in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on the qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of the Company's first fiscal year that begins after September 15, 2006. SFAS No. 155 may have a material effect on the financial position or results of operations of the Company depending upon management's plans to fund operations.

In March 2006 the FASB issued SFAS 156 `Accounting for Servicing of Financial Assets' this Statement amends FASB Statement No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement:

1. Requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract.
2. Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable.
3. Permits an entity to choose `Amortization method' or Fair value measurement method' for each class of separately recognized servicing assets and servicing liabilities:

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

4. At its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity's exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value.
5. Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.

This Statement is effective as of the beginning of the Company's first fiscal year that begins after September 15, 2006. Management believes that this statement will not have a significant impact on the financial statements.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Management has not determined the effect, if any, the adoption of this statement will have on the financial statements.

Computer and other equipment                             $        611
Office furniture and fixtures                                     112
Leasehold improvements                                              -
                                                         -------------
                                                                  723
Less accumulated depreciation and amortization                   (368)
                                                         -------------

                                                         $        355
                                                         =============

Depreciation expense for the years ended June 30, 2006 and 2005 was $103 and $77, respectively.

NOTE 3 - RELATED PARTY TRANSACTIONS

TRANSACTIONS WITH OFFICERS AND KEY EXECUTIVES

During the years ended June 30, 2006 and 2005, the Company issued 252,625 and 36,361 shares of common stock to the Company's CEO as payment for compensation valued at $253 and $109, respectively.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

WARNING MANAGEMENT SERVICES, INC.

The Company's CEO and Chairman, Mr. Brian Bonar, is also the CEO and Chairman of Warning Management Services, Inc. In addition, the Company's former CFO, Mr. Randall A. Jones, is also the CFO of Warning Management Services, Inc. Warning a public company, located in Southern California. Warning's operations consist of a modeling agency and providing temporary staffing services to government agencies and private companies. Mr. Jones resigned from the Company effective April 15, 2006.

GUARANTEE OF INDEBTEDNESS OF WARNING

As of September 8, 2004, Warning Management Services, Inc. ("Warning") purchased all of the issued and outstanding shares of Employment Systems, Inc. ("ESI") for $1,500. The purchase was $750 cash paid at the closing and a $750 note payable by Warning. In connection with this transaction, the Company agreed to be a guarantor of the $750 note payable. As inducement to enter into this guarantee, the Company was given a non-cancelable 2-year payroll processing contract with ESI. The ESI note payable has been settled, paid, and released.

WARNING HAS A MONTH-TO-MONTH LEASE WITH THE COMPANY

Warning leases offices for its ESI subsidiary, on a month-to-month basis from the Company that started in October 2004. Monthly rental expense will be approximately $3 per month.

PEO SERVICES AGREEMENT WITH WARNING PROVIDES FOR A FEE AT PREVAILING MARKET RATE

In April 2004, the Company entered into an Agreement to provide PEO services for Warning. The Company receives from Warning a monthly administrative fee. During the year ended June 30, 2006, the Company invoiced Warning for $87 and Warning's ESI subsidiary for $520 for management services. During the year ended June 30, 2005, the Company invoiced Warning $390 for management services and $45 for reimbursement of costs. Warning also paid expenses of $38 on behalf of the Company during the year ended June 30, 2005. As of June 30, 2006, the Company has an amount due to Warning of $3 that is included in current liabilities.

NOTE 4 - ACQUISITIONS

STRATEGIC ALTERNATIVE STAFFING, LLC.

On May 1, 2006, DFCO completed its acquisition of Strategic Alternative Staffing LLC ("SSL"). The purchase price was $558 consisting of a $550 note payable to the owner of SSL and 50,000 warrants to purchase shares of DFCO common stock valued at $8. SSL is a professional employer organization and a broker of certain employee benefits. The Company acquired SSL as part of its strategic growth plan.

The operating results of SSL beginning May 1, 2006 are included in the accompanying consolidated statements of operations.

Cash                                           $            122
Accounts receivable                                         415
Customer list                                               567
Accounts payable and accrued expenses                      (546)

                                               ----------------
Purchase price                                 $            558
                                               ================

The customer list is being amortized over 48 months.

The pro forma financial information that the consolidated operations of the Company as if the SSL acquisition had occurred as of the beginning of the periods presented is not presented since the operations of SSL prior to the acquisition by DFCO were immaterial.

HERITAGE STAFFING GROUP, INC.

On April 4, 2005, DFCO completed its acquisition of certain assets of Heritage Staffing Group, Inc. ("Heritage"). The purchase price was $79 consisting of $20 in cash, a $45 note payable to the owner of Heritage and 25,000 warrants to purchase shares of DFCO common stock valued at $14. These warrants expired on March 31, 2006. Heritage is in the temporary staffing business and the Company acquired certain assets of Heritage to complement it other temporary staffing business.

The operating results of Heritage beginning April 4, 2005 are included in the accompanying consolidated statements of operations.

The total purchase price was valued at $80 and is summarized as follows in accordance with SFAS No. 141 and 142:

Computer equipment                             $              4
Furniture and fixtures                                        3
Customer list                                                72
                                               ----------------
Purchase price                                 $             79
                                               ================

The customer list is being amortized over 36 months.

The pro forma financial information that the consolidated operations of the Company as if the Heritage acquisition had occurred as of the beginning of the periods presented is not presented since the operations of Heritage prior to the acquisition by DFCO were immaterial.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

NOTE 5 - INVESTMENT IN ALLIANCE INSURANCE GROUP

On February 3, 2006, Solvis, a subsidiary of DFCO and Employment Systems, Inc., ("ESI") a wholly owned subsidiary of Warning Management Services, a related party, purchased an eighteen (18%) percent interest in Alliance Insurance Group for $2,800. The purpose of the investment was to obtain access to a low cost worker's compensation insurance policy for both companies.

The $2,800 purchase price is being financed through Bank Direct at 7.25% over 23 months. Both Solvis and ESI are co-signatories on the note. As Solvis is a co-guarantor of the note, the Company recorded the whole note of $2,800 on its books and recorded a $1,400 related party receivable from ESI. Additionally, the Company recorded a $1,400 investment in the insurance company. Solvis' $1,400 investment represents a 9% interest in the insurance company. ESI's $1,400 payable to Solvis is secured by ESI's 9% investment interest in the insurance company. The Company has accounted for this investment in Alliance Insurance Group using the cost method.

Accrued interest and penalties                 $            270
Accrued judgments                                         2,268
Taxes payable                                                63
Deposits                                                    293
Other                                                       626
                                               ----------------
                                                          3,520
                                               ================

NOTE 7 - BORROWINGS UNDER BANKS NOTES PAYABLE

The Company had outstanding two notes payable to Imperial Bank and Export-Import Bank in the amounts of $1,490 and $1,730, respectively. In December 2005, the Company entered into an agreement with these two banks whereby the Company paid a total of $483 as full satisfaction of all outstanding principal ($3,220) and accrued interest ($1,383) relating to these two notes payable. The Company recognized a gain on the settlement of debt related to this transaction of $4,120.

NOTE 8 - FACTORING LINES OF CREDIT

The Company's temporary staffing division entered into a factoring agreement that expires in January 2007 and is renewable for successive periods of 12 months assuming certain conditions are met. The agreement provides for the Company to borrow against factored accounts receivables at a discount of approximately 2% for each 30 day period the balances remain unpaid. Customer payments are made directly to the factoring company and there is full recourse for uncollected accounts. In February 2006, we paid off the factoring line with the proceeds of the February 13, 2006 notes payable refinancing.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

NOTE 9 - CONVERTIBLE DEBT FINANCING AND DERIVATIVE LIABILITIES

In accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended ("SFAS 133"), the holder's conversion right provision, interest rate adjustment provision, liquidated damages clause, cash premium option, and the redemption option (collectively, the debt features) contained in the terms governing the Notes are not clearly and closely related to the characteristics of the Notes. Accordingly, the features qualified as embedded derivative instruments at issuance and, because they do not qualify for any scope exceptions within SFAS 133, they were required by SFAS 123 to be accounted for separately from the debt instrument and recorded as derivative financial instruments.

During the year ended June 30, 2006, we recorded an other income item of $1,234 and $754, which relates to the debt features and warrants, respectively, to reflect the change in fair value of the derivative liability.

At each balance sheet date, we adjust the derivative financial instruments to their estimated fair value and analyze the instruments to determine their classification as a liability or equity. As of June 30, 2006, the estimated fair value of our derivative liability was $1,483, as well as a warrant liability of $3,138. The estimated fair value of the debt features was determined using the probability weighted averaged expected cash flows / Lattice Model. The model uses several assumptions, including: historical stock price volatility (utilizing a rolling 120-day period), risk-free interest rate (3.50%), remaining maturity, and the closing price of the Company's common stock to determine estimated fair value of the derivative asset. In valuing the debt features at June 30, 2006 the Company used the closing price of $0.15 and the respective conversion and exercise prices for the warrants.

DATE OF NOTE                    AMOUNT OF NOTES      CONVERSION PRICE(1)           TERM OF NOTE
------------                    ---------------      -------------------           ------------
January 27, 2006 (1)            $           112      $             0.452                2 years
February 9, 2006 (1)            $           246      $             0.452                2 years
February 13, 2006               $         7,545                  75% (3)                2 years


DATE OF WARRANTS ISSUED      NUMBER OF WARRANTS          EXERCISE PRICE        TERM OF WARRANTS
-----------------------      ------------------          --------------        ----------------

February 13, 2006                     6,760,000          $         1.00                 7 years
February 13, 2006 (2)                   520,000          $         1.00                 7 years
May 1, 2006 (4)                          50,000          $        20.00                 7 years

(1) = no warrants issued with this financing transaction.
(2) = no debt associated with these warrants.
(3) = 75% of 20-day pre-conversion market-based price.
(4) = warrants issued in connection with SSL acquisition

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

The notes contain provisions on interest accrual at the "prime rate" published in The Wall Street Journal from time to time, plus three percent (3%). The Interest Rate shall not be less than fifteen percent (15%). Interest shall be calculated on a 360 day year. Interest on the Principal Amount shall be payable monthly, commencing 120 days from the closing and on the first day of each consecutive calendar month thereafter (each, a "Repayment Date") and on the Maturity Date.

Following the occurrence and during the continuance of an Event of Default (as discussed in the Note), the annual interest rate on the Note shall automatically be increased by two percent (2%) per month until such Event of Default is cured.

The Notes also provide for liquidated damages on the occurrence of several events. As of June 30, 2006, no liquidating damages have been incurred by the Company.

Debt features. The Holder shall have the right, but not the obligation, to convert all or any portion of the then aggregate outstanding Principal Amount of this Note, together with interest and fees due hereon, into shares of Common Stock.

The proceeds from the financing transactions were allocated to the debt features and to the warrants based upon their fair values. After the latter allocations, the remaining value, if any, is allocated to the Note on the financial statements.

The debt discount is being accreted using the effective interest method over the term of the note.

The value of the discount on the converted notes on the books is being accreted over the term of the note (two years). For the year ended June 30, 2006, the Company accreted $884, of debt discount related to the Notes.

DATE OF WARRANTS ISSUED     NUMBER OF WARRANTS     VALUE AT ISSUANCE     VOLATILITY FACTOR
-----------------------     ------------------     -----------------     -----------------
February 13, 2006                    6,760,000     $           3,582                   72%
February 13, 2006                      520,000     $             302                   72%

These amounts have been classified as a derivative instrument and recorded as a liability on the Company's balance sheet in accordance with current authoritative guidance. The estimated fair value of the warrants was determined using the Black-Scholes option-pricing model with a closing price of on the date of issuance and the respective exercise price, a 7.0 year term, and the volatility factor relative to the date of issuance. The model uses several assumptions including: historical stock price volatility (utilizing a rolling 120 day period), risk-free interest rate (3.50%), remaining time till maturity, and the closing price of the Company's common stock to determine estimated fair value of the derivative liability. In valuing the warrants at June 30, 2006, the Company used the closing price of $0.15, the respective exercise price, as well as the remaining term on each warrant, as well as a volatility of 90%. In accordance with the provisions of SFAS No. 133, Accounting for Derivative Instruments, the Company is required to adjust the carrying value of the instrument to its fair value at each balance sheet date and recognize any change since the prior balance sheet date as a component of Other Income (Expense). The warrant derivative liability at June 30, 2006, had decreased to a fair value of $3,138, due in part to a decrease in the market value of the Company's common stock to $0.15 from $0.20 at issuance of the February 13, 2006 amount, as well as an increase in the volatility from 72% to 90% which resulted in an "other income" item of $754 on the Company's books.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

The recorded value of such warrants can fluctuate significantly based on fluctuations in the market value of the underlying securities of the issuer of the warrants, as well as in the volatility of the stock price during the term used for observation and the term remaining for the warrants.

DEBT FEATURES

In accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended ("SFAS 133"), the debt features provision (collectively, the features) contained in the terms governing the Notes are not clearly and closely related to the characteristics of the Notes. Accordingly, the features qualified as embedded derivative instruments at issuance and, because they do not qualify for any scope exception within SFAS 133, they were required by SFAS 133 to be accounted for separately from the debt instrument and recorded as derivative financial instruments.

Pursuant to the terms of the Notes, these notes are convertible at the option of the holder, at anytime on or prior to maturity. There is an additional interest rate adjustment feature, a liquidated damages clause, a cash premium option, as well as the redemption option. The debt features represents an embedded derivative that is required to be accounted for apart from the underlying Notes. At issuance of the Notes, the debt features had an estimated initial fair value as follows, which was recorded as a discount to the Notes and a derivative liability on the consolidated balance sheet.

                                             DEBT FEATURES
DATE OF NOTE            AMOUNT OF NOTES    VALUE AT ISSUANCE    CARRYING VALUE
------------            ---------------    -----------------    --------------

January 27, 2006        $           112    $              69    $           43
February 9, 2006        $           246    $             133    $          113
February 13, 2006       $         7,545    $           2,515    $        1,448

In subsequent periods, if the price of the security changes, the embedded derivative financial instrument related to the debt features will be adjusted to the fair value with the corresponding charge or credit to other expense or income. The estimated fair value of the debt features was determined using the probability weighted averaged expected cash flows / Lattice Model with the closing price on original date of issuance, a conversion price based on the terms of the respective contract, a period based on the terms of the notes, and a volatility factor on the date of issuance. The model uses several assumptions including: historical stock price volatility (utilizing a rolling 120 day period), risk-free interest rate (3.50%), remaining maturity, and the closing price of the Company's common stock to determine estimated fair value of the derivative liability. In valuing the debt features at June 30, 2006, the company used the closing price of $0.21 and the respective conversion price, a remaining term coinciding with each contract, and a volatility of 90%. For the year ended June 30, 2006, due in part to a decrease in the market value of the Company's common stock to $0.15 the Company recorded an "other income" on the consolidated statement of operations for the change in fair value of the debt features of approximately $1,234. At June 30, 2006, the estimated fair value of the debt features was approximately $1,483.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

The recorded value of the debt features related to the Notes can fluctuate significantly based on fluctuations in the fair value of the Company's common stock, as well as in the volatility of the stock price during the term used for observation and the term remaining for the warrants.

The significant fluctuations can create significant income and expense items on the financial statements of the Company.

Because the terms of the convertible notes ("notes") require such classification, the accounting rules required additional convertible notes and non-employee warrants to also be classified as liabilities, regardless of the terms of the new notes and / or warrants. This presumption has been made due to the company no longer having the control to physical or net share settle subsequent convertible instruments because it is tainted by the terms of the notes. Were the notes to not have contained those terms or even if the transactions were not entered into, it could have altered the treatment of the other notes and the conversion features of the latter agreement may have resulted in a different accounting treatment from the liability classification. The notes and warrants, as well as any subsequent convertible notes or warrants, will be treated as derivative liabilities until all such provisions are settled.

For the year ended June 30, 2006, we recorded an other income item of $1,234 and $754, related to the decrease in value of the debt features and warrants. A tabular reconciliation of this adjustment follows:

For the year ended June 30, 2006:

$    754   income, decrease in value of warrant liability
$  1,234   income, decrease in value of derivative liability
--------
$  1,988   other income related to convertible debt

For the year ended June 30, 2006, the Company recorded $884 of interest expense related to the accretion of debt related to the convertible financing.

For the year ended June 30, 2006:

$  1,605   original carrying value on convertible debt
$   (228)  converted to equity
$    884   accretion of convertible debt
--------
$  2,261   June 30, 2006 carrying value of debt

$  2,717   original value of derivative liability
$ (1,234)  income, decrease in value of derivative liability
--------
$  1,483   June 30, 2006 value of derivative liability

The balance of the carrying value of the warrant liability as of June 30, 2006 is:

$  3,892   original carrying value of warrant liability
$   (754)  income, decrease in value of warrant liability
--------
$  3,138   June 30, 2006 value of warrant liability

During the year ended June 30, 2006, the Company discussed with the lead investor the refinancing of certain convertible notes, including disputed amounts for accrued interest, penalties and note balances. As part of the funding described above we recognized an additional settlement of accrued interest, penalties and balances for $908.

NOTE 10 - NOTES PAYABLE, INCLUDING AMOUNTS DUE TO RELATED PARTIES

On August 9, 2005, the Company issued two secured promissory notes to two investors totaling $221. The notes are due on October 9, 2005 and accrue interest at a rate of 12% per annum. These two notes have not been repaid and are currently in default. In addition, on December 22, 2005, the Company issued a promissory note to an investor for $600. The note was due on January 6, 2006 and accrued interest at a rate of 15% per annum through February 1, 2006 and 24% per annum thereafter until the note is paid in full. This note was repaid from the proceeds of the February 13, 2006 funding.

During the year ended June 30, 2006 a subordinated non-convertible note payable of $1,500 plus accrued interest of $1,390 to a former director was reduced to $750 and recognized as a gain on extinguishment of debt of $2,140. The former director indicated that he would be filling to accept $750 as payment in full on his outstanding obligation including accrued interest.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

The following summarizes notes payable (including amounts due to a related party) at June 30, 2006:

Note payable in connection with SSL acquisition, payable from net profits $ 202

Note payable to two investors, interest at 8% per annum, payable upon demand 49

Notes payable to related party, interest at 8%, ranging from payable upon demand to due in 2008 458

Note payable to investor, interest at 10% per quarter, payable upon demand 70

Note payable to bank related to financing of worker's compensation deposit, interest at 7.5%, payable over 10 months through March 2007 2,553

Note payable to Direct Bank related to purchase of Alliance Insurance Group, interest at 7.5%,

payable over 23 months with balance due in
February 2008                                                 2,340

Note payable to a former director                               750

Other                                                             4
                                                        -----------
                                                              6,426
Less current portion                                         (5,156)
                                                        -----------
Long-term portion                                       $     1,270
                                                        ===========

Notes payable mature as follows:

During the years ended June 30,

2007                                           $     5,156
2008                                                 1,270
                                               -----------
                                               $     6,426
                                               ===========

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

NOTE 11 - STOCKHOLDERS' DEFICIT

AMENDMENT TO THE CERTIFICATE OF INCORPORATION.

On May 14, 2004, the Company's shareholders approved a Board proposal to amend the Certificate of Incorporation to increase the number of shares of common stock that the Company is authorized to issue from 500,000,000 to 1,000,000,000 shares.

5% SERIES A CONVERTIBLE, REDEEMABLE PREFERRED STOCK

Holders of the 5% convertible preferred stock ("Series A") are entitled to receive, when and as declared by the Board of Directors, but only out of amounts legally available for the payment thereof, cumulative cash dividends at the annual rate of $50.00 per share, payable semi-annually.

The 5% convertible preferred stock is convertible, at any time, into shares of the Company's common stock, at a price of $3.5 per common share. This conversion price is subject to certain anti-dilution adjustments, in the event of certain future stock splits or dividends, mergers, consolidations or other similar events. In addition, the Company shall reserve, and keep reserved, out of its authorized but un-issued shares of common stock, sufficient shares to effect the conversion of all shares of the 5% convertible preferred stock.

In the event of any involuntary or voluntary liquidation, dissolution or winding up of the affairs of the Company, the 5% convertible preferred shareholders shall be entitled to receive $1 per share, together with accrued dividends, to the date of distribution or payment, whether or not earned or declared.

The 5% convertible preferred stock is callable, at the Company's option, at call prices ranging from $210 to $220 per share. No call on the 5% convertible preferred stock was made during fiscal 2006 and 2005. As of June 30, 2006, the accumulated dividend in arrears was approximately $474 on the Series A.

                                                             UNDERLYING
                                          PRICE PER            COMMON
                                            SHARE              SHARES
                                       ----------------    ---------------

                                                           ---------------

JUNE 30, 2004                           $4.00 - $300.00            107,817
     Granted                            $0.60 - $1.00               50,000
     Exercised                                -                          -
     Canceled                                 -                          -
                                                           ---------------

JUNE 30, 2005                           $0.60 - $300.00            157,817
     Granted                            $1.00 - $20.00           7,330,000
     Exercised                                -                          -
     Canceled                           $0.60 - $300.00           (157,817)
                                                           ---------------
EXERCISABLE AT JUNE 30, 2006                                     7,330,000
                                                           ---------------

    NUMBER
      OF                   EXERCISE
   WARRANTS                 PRICE
--------------          --------------

     7,280,000                   $1.00
        50,000                  $20.00
--------------

2001 STOCK OPTION AND STOCK PURCHASE PLANS

The Company's shareholders approved the 2001 Stock Option Plan, pursuant to which 1,000,000 shares of common stock are reserved for issuance to eligible employees and directors of, and consultants to, the Company or any of its subsidiaries. Upon expiration, cancellation or termination of unexercised options, the shares of the Company's Common Stock subject to such options will again be available for the grant of options under the 2001 Stock Option Plan. Options granted under the 2001 Stock Option Plan may either be incentive or nonqualified stock options.

The Company's shareholders approved the 2001 Stock Purchase Plan, as amended, which enables eligible employees to purchase in the aggregate up to 50,000 shares of common stock.

                                             STOCK OPTION PLANS
                                                             UNDERLYING
                                          PRICE PER            COMMON
                                            SHARE              SHARES
                                       ----------------    ---------------

                                                           ---------------

JUNE 30, 2004                            $2.00 - $5.00             195,750
     Granted                                   -                         -
     Exercised                                 -                         -
     Canceled                                  -                         -
                                                           ---------------

JUNE 30, 2005                            $2.00 - $5.00             195,750
     Granted                                   -                         -
     Exercised                                 -                         -
     Canceled/Expired                    $2.00 - $3.00             (60,750)
                                                           ---------------
EXERCISABLE AT JUNE 30, 2006             $2.00 - $5.00             135,000
                                                           ---------------

    NUMBER
      OF                   EXERCISE
   WARRANTS                 PRICE
--------------          --------------

         7,500                   $2.00
       127,500                   $5.00
--------------

The Company has implemented SFAS 123R for future grants of options to employees. No unvested option grants to employees were outstanding at June 30, 2006.

COMMON STOCK ISSUED FOR SERVICES AND COMPENSATION

The table below shows all the issuances of common stock for services during the year ended June 30, 2006 and 2005. The value of the services was derived by multiplying the market value of the Company's common stock at the date a transaction for services was entered into by the number of shares issued.

ISSUE                                          SHARES
 DATE           DESCRIPTION                    ISSUED           AMOUNT

9/16/05  Professional Services                    25,000     $          15
3/13/06  Compensation to officer                  50,000                50
6/30/06  Compensation to officer                 252,625               253
                                            ------------     -------------
                                                 327,625     $         318
                                            ============     =============

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

ISSUE                                          SHARES
 DATE           DESCRIPTION                    ISSUED           AMOUNT

 7/26/04  Strategic planning/marketing             2,250     $           2
 9/28/04  Strategic planning/marketing             7,500                 8
10/19/04  Strategic planning/marketing             8,365                 8
10/25/05  Strategic planning/marketing            25,000                25
 6/13/05  Professional services                   30,000                30
                                            ------------     -------------
                                                  73,115     $          73
                                            ============     =============

NOTE 12 - SEGMENT AND GEOGRAPHIC INFORMATION

During fiscal 2006 and 2005, the Company managed and internally reported the Company's business as four (4) reportable segments as follows:

(1) professional employer organization
(2) temporary staffing
(3) products;
(4) corporate;

Segment information for the fiscal year ended June 30, 2006 and 2005, was as follows:

                                                PEO          TEMPORARY
                                              BUSINESS        STAFFING      PRODUCTS      CORPORATE       TOTAL
SELECTED STATEMENT OF OPERATIONS ACTIVITY:
Fiscal year ended June 30, 2006
  Revenues                                       1,382         68,226           772             -         70,380
  Cost of revenues                                 998         62,897            34             -         62,897
Gross profit                                       384          5,329           738             -          6,451
Total assets at June 30, 2006                    1,304         11,781           146         1,467         14,698

Fiscal year ended June 30, 2005
  Revenues                                       1,930         17,029           517             -         19,476
  Cost of revenues                               1,424         15,010            96             -         16,530
Gross profit                                       506          2,019           421             -          2,946
Impairment of patent                                 -              -         1,348             -          1,348

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

All sales were made in the United States of America

NOTE 13 - INCOME TAXES

The Company's provision for income taxes is accounted for in accordance with SFAS 109. SFAS 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under the SFAS 109 asset and liability method, deferred tax assets and liabilities are determined based upon the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is then provided for deferred tax assets that are more likely than not to not be realized.

The provision (benefit) for income taxes is as follows for the years ended June 30:

                                2006            2005
                            ------------    ------------

Current - State             $         40    $          -
Deferred benefit                       -               -
                            ------------    ------------
                            $         40    $          -
                            ============    ============

The components of deferred income taxes are as follows at June 30:

                                                  2006            2005
                                              ------------    ------------
Deferred tax assets
   Net operating loss carryforwards           $     37,493    $     38,927
   Other                                               475             524
                                              ------------    ------------
                                                    37,968          39,451
Valuation allowance                                (37,968)        (39,451)
                                              ------------    ------------
                                              $          -    $          -
                                              ============    ============

The Company's federal and state net operating loss carryforwards expire in various years through 2017. The Company has made numerous equity issuances that could result in limitations on the annual utilization of the Company's net operating loss carryforwards. The Company has not performed an analysis to determine the effect of such changes.

The provision for income taxes results in an effective rate that differs from the federal statutory rate. Reconciliation between the actual tax provision and taxes computed at the statutory rate is as follows for the year ended June 30, 2006:

                                                Tax           Percentage

Federal Tax                                 $        892             34.0%
State tax                                            157              6.0%
Penalties                                            374             14.3%
Reserves                                             200              7.6%
Other                                                (41)            (1.6%)
Net operating loss                                (1,542)           (58.8%)
                                            ------------     -------------
                                            $         40              1.5%
                                            ============     =============

Reconciliation between the actual tax provision and taxes computed at the statutory rate is as follows for the year ended June 30, 2005:

                                                Tax           Percentage

Federal Tax                                 $     (1,434)            34.0%
State tax                                           (253)             6.0%
Penalties                                            306             (7.3)
Other                                                 59             (1.4%)
Net operating loss                                 1,322            (31.3%)
                                            ------------     -------------
                                            $          -                0%
                                            ============     =============

At June 30, 2006, the Company had federal and state net operating loss ("NOL") carryforwards of approximately $90,000,000 and $69,000,000, respectively. Federal NOLs could, if unused, expire in varying amounts in the years 2010 through 2020.

NOTE 14 - COMMITMENTS AND CONTINGENCIES

LEASE COMMITMENT

The Company leases its operating facilities under lease agreements that expire through 2011.

Total rental expense was approximately $335 and $299 for the years ended June 30, 2006 and 2005, respectively.

Future minimum lease payments under non-cancelable capital and operating leases with initial or remaining terms of one year or more are as follows:

2007                                       $                432
2008                                                        347
2009                                                        192
2010                                                        195
2011                                                         17
                                           --------------------
Net Minimum Lease Payments                 $              1,183
                                           ====================

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

LEGAL MATTERS

The Company and its SourceOne Group ("SOG") subsidiary have been sued by the Arena Football 2 Operating Company, LLC ("Arena") in Wayne County Circuit Court, Michigan. In April 2006, Dalrada and SourceOne Group, Inc. entered into a settlement with AF2 Operating Company, LLC and other parties involved in the matter of AF2 Operating Company, LLC v. SourceOne Group Inc., et al. The net result of the settlement was that Dalrada and SourceOne Group, Inc. are obligated to make a net settlement payment of $ 203. In addition, the Company has filed claims against Arena and Arena's agent, Thilman and Filippini, based on, among other things, the representations made to SOG that let it to enter into the agreement with Arena. These claims are currently pending.

The Company and SOG have been sued by Liberty Mutual Insurance Company ("Liberty") in the United States District Court for the Northern District of Illinois. The nature of the specific claims made by Liberty against the Company and SOG are that the Company and SOG were and are obligated to make additional premium payments to Liberty for workers' compensation insurance, which is related to the Arena litigation described above. The initial claim by Liberty was estimated by Liberty to be $829 and is now claimed to exceed $1,000. In July 2007, the judge dismissed Dalrada from the litigation and dismissed many, but not all, of the claims against SourceOne Group. Management has vigorously contested the claims made by Liberty. Trial is scheduled for January 2007.

On April 25, 2006, a trial occurred in the matter of LM Insurance Corporation v. Brian Bonar pending in Superior Court of California for the County of San Diego. LM Insurance Corporation asserted that SourceOne Group, Inc. had entered into a policy for insurance coverage and that Brian Bonar had personally guaranteed the premium payments. The court found in favor of Brian Bonar.

On February 10, 2005, Berryman & Henigar Enterprises ("Plaintiff"), filed a complaint in the Superior Court of California, County of San Diego, Case No. GIC842610, against Warning Model Management, Inc. for breach of a promissory note issued pursuant to terms and conditions of a certain stock purchase and sale agreement dated September 9, 2004. The Company allegedly guaranteed payments on the underlying promissory note. Plaintiff seeks principal damages of $750 in that regard. Warning Model Management, Inc. has taken the position that Plaintiff failed to disclose certain material information in the underlying transaction which thereby negates the promissory note. Warning Model Management, Inc. reached a settlement, effective as of September 30, 2005 with the Plaintiff, which requires defendants, collectively, to pay Plaintiff the aggregate sum of $380. Defendants have made the initial two payments due under the settlement and the final payment in the sum of $80 was paid in April 2006. Accordingly, the matter has been settled and all claims satisfied.

On March 17, 2005, Greenland Corporation ("Plaintiff"), filed an amended complaint in the Superior Court of California, County of San Diego, Case No. GIC842605, against the Company and multiple other individuals and entities resulting from a transaction as evidenced by the "Agreement to Acquire Shares" dated August 9, 2002, whereby the Company obtained a controlling equity interest in Plaintiff. Plaintiff contends that the Company engaged in various forms of wrongdoing including breach of fiduciary duty, conversion, conspiracy and aiding and abetting. The Company has filed a cross-complaint alleging various causes of action against Plaintiff and its officers, directors and/or managing agents including Thomas J. Beener, Gene Cross, George Godwin, and Edward Sano. The subject cross-complaint seeks pecuniary and punitive damages resulting from various fraudulent transactions as well as legal malpractice against Mr. Beener. In July 2006, the matter was settled with Dalrada paying $150 of legal fees incurred by Greenland.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

On August 29, 2005, United Bank & Trust filed suit against the Company and other parties. The allegations of the lawsuit are that the Company guaranteed certain debt owed by InfoServices, Inc. and is liable in the amount of $678. The case is in its early stages and discovery has not yet commenced. However, the Company intends to vigorously defend itself against the claims asserted.

Throughout fiscal 2004 and 2005, trade creditors have made claims and/or filed actions alleging the failure of the Company to pay its obligations to them in a total amount exceeding $3,000. These actions are in various stages of litigation, with many resulting in judgments being entered against the Company. Several of those who have obtained judgments have filed judgment liens on the Company's assets. These claims range in value from less than $1 to just over $1,000, with the great majority being less than $20.

On September 7, 2005, the arbitrator from the American Arbitration Association awarded to Accord Human Resources a judgment against Greenland Corporation and the Company as the guarantor, an amount equaling $168. Legal counsel has estimated that the claim could amount to as much as $214. The Company has reserved $200 for the claim.

The Company was in a dispute with former creditors regarding the amount of debt converted into common stock. These creditors were seeking damages totaling $316. The Company proposed a settlement in the amount of $316, based on the advice of the Company's legal counsel. Consequently, $316 was charged to operations in the accompanying financial statements for the year ended June 30, 2006. The plaintiffs have accepted the settlement offer.

NOTE 15 - GAIN ON SETTLEMENT OF DEBT

During the year ended June 30, 2006 and 2005, the Company recognized a gain on settlement of debt of $8,546 and $829, respectively. For the year ended June 30, 2006, the recognized a gain of $4,120 related to the settlement of two notes payable to banks. (See Note 7) and a gain of $2,140 related to the settlement of notes payable and accrued interest with a former director (See Note 10). The remaining gain of $2,286 for the year ended June 30, 2006 and the gain of $829 for the year ended June 30, 2005 resulted primarily from the write off of stale accounts payable and judgments. The Company, based upon an opinion provided by independent legal counsel, has been released as the obligator of these liabilities. Accordingly, management has elected to adjust its accounts payable and to classify such adjustments as settlement of debt.

NOTE 16 - GAIN RESULTING FROM RECONCILIATION OF PAYROLL TAX LIABILITIES TO TAXING AUTHORITIES

During the years ended June 30, 2006 and 2005, the Company recorded an adjustment to earnings of $1,924 and $1,895, respectively, resulting from a reconciliation with the Internal Revenue Service and certain State taxing authorities of the amounts due for delinquent payment of payroll tax liabilities. The Company continually updates its estimate of the amount due related to delinquent payroll taxes and penalties as it receives correspondence or settlement agreements with the Internal Revenue Service and State taxing authorities.

DALRADA FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2006 AND 2005
(in thousands, except for share information)

The Company is delinquent in filing its payroll tax returns and owes $8,451 in delinquent payroll tax payments, interest and penalties.

NOTE 17 - DISCONTINUED OPERATIONS

In November 2005, the Company determined to discontinue operations of Master Staffing, its executive recruiting division. The decision was based on the Master Staffing lack of ability to generate sufficient revenue and the Company's lack of expertise in the executive recruiting business. The Company is completely exiting the executive recruiting business. The Company plans to wind down the operations of Master Staffing and close its only office over the next few months.

For the year ended June 30, 2006 and 2005, Master Staffing's revenues were $11 and $0, respectively, and losses from operations were $363 and $176, respectively. The results of operations of Master Staffing have been reported separately as discontinued operations.

Master Staffing's net assets at June 30, 2006 were $22, which consisted of furniture and equipment of $19 and other assets of $3.