10-Q 1 a4455604.txt IBSS 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2003 [_] Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the transition period from ____________ to ___________ Commission file number: 0-24031 INTEGRATED BUSINESS SYSTEMS AND SERVICES, INC. ---------------------------------------------- (Exact Name of Small Business Issuer as Specified in Its Charter) South Carolina 57-0910139 ------------------------------------------- -------------------------- (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 1601 Shop Road, Suite E Columbia, South Carolina 29201 ------------------------------------------- -------------------------- (Address of Principal Executive Offices) (Zip Code) -------------------------------------------------------------------------------- (Former Address, if Changed Since Last Report) Small Business Issuer's Telephone Number, Including Area Code: 803-736-5595 ------------ APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the small business issuer's classes of common equity, as of the latest practicable date: 22,307,923 shares of no par value common stock outstanding at August 7, 2003. Transitional Small Business Disclosure Format (check one) ( ) Yes (X) No Integrated Business Systems and Services, Inc. Form 10-QSB Quarter Ended June 30, 2003 Table of Contents

Advisory Note Regarding Forward-Looking Statements Some of the statements contained in this report on Form 10-QSB constitute forward-looking statements. We caution readers of this report that these statements involve a number of known and unknown risks and uncertainties that may cause our actual results to be materially different from those contemplated by these statements. Factors that might cause such a difference include, but are not limited to, those discussed in this report under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors That May Affect Our Financial Condition and Operating Results," both of which are contained in Item 2 of Part I of this report, as well as those factors set forth in other periodic reports and filings that we make with the Securities and Exchange Commission. Copies of these filings may be obtained from the Securities and Exchange Commission at its principal office in Washington, DC at prescribed rates by calling 1-800-SEC-0330. These filings are also available electronically through the Internet web site maintained by the Securities and Exchange Commission at the Internet address: http://www.sec.gov. 2 PART I - FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements Integrated Business Systems and Services, Inc. Consolidated Condensed Balance Sheets

The accompanying notes are an integral part of these consolidated condensed financial statements. 3 Integrated Business Systems and Services, Inc. Consolidated Condensed Statements of Operations (Unaudited)

The accompanying notes are an integral part of these consolidated condensed financial statements. 4 Integrated Business Systems and Services, Inc. Consolidated Condensed Statements of Cash Flows (Unaudited)

The accompanying notes are an integral part of these consolidated condensed financial statements. 5 Integrated Business Systems and Services, Inc. Notes To Consolidated Condensed Financial Statements (Unaudited) 1. Basis of Presentation The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles for consolidated condensed interim financial information and with the instructions to Form 10-QSB and Item 310 of Regulation S-B promulgated by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of those of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the three-month and six-month period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2003. For further information, please refer to the audited financial statements and footnotes thereto included in the company's Form 10-KSB for the year ended December 31, 2002, as filed with the Securities and Exchange Commission. 2. Basis of Consolidation In 2002 and 2003, the consolidated financial statements include the accounts of Integrated Business Systems and Services, Inc. and its majority-owned subsidiary, Synamco, LLC (collectively, the "company"). 3. Earnings Per Share Net loss per share of common stock amounts presented on the face of the consolidated statements of operations have been computed based on the weighted average number of shares of common stock outstanding in accordance with the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 128, "Earnings Per Share." Stock warrants and stock options were not included in the calculation of diluted loss per share because the company has experienced operating losses in all periods presented, and therefore, the effect would be anti-dilutive. 4. Going Concern The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated condensed financial statements, at June 30, 2003, the company had a working capital deficiency of approximately $4.5 million and an accumulated deficit of approximately $23.8 million. Ultimately, the company's viability as a going concern is dependent upon its ability to continue to generate positive cash flows from operations, maintain adequate working capital and obtain satisfactory long-term financing. However, there can be no assurances that the company will be successful in each or any of the above endeavors. 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. The company's plans include the measures described in the following paragraphs, although it is not possible to predict the ultimate outcome of the company's efforts. The measures described below are also addressed elsewhere in this report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Cost Control Program - During September of 2001, in connection with the company's executive managements' restructuring of internal operations and in response to the need to reduce costs in connection with lower than expected year-to-date revenues, the company commenced a comprehensive cost control program. The implementation of that program is continuing. By the end of June 2003, the monthly cash payments necessary to fund continuing operational expenses had decreased by over 70% as compared to the monthly cash required for operations prior to the commencement of the cost control program. 6 Included in the cost control program are measures that have resulted in substantial reductions in the largest cash expenditure categories of human resource and payroll-related expenses. Through June of 2003, these measures have included the reduction of over 50% in the number of employees; the deferral of up to 61% in the compensation rates of executive officers; reductions of up to 50% in the compensation rates for the company's remaining non-executive personnel; reductions of approximately 13% in the rates paid for employee health insurance; scale-backs in employee benefit programs; and substantial reductions in employee travel, accommodation and hiring costs. In addition, the company has achieved significant cash flow relief through the discontinuance of non-essential third party consulting and service arrangements and the renegotiation of other third party contracts, including those in the areas of public relations, investor relations, financial advisory services, financial printing and industry research. During the remainder of 2003, in addition to the reductions outlined above, the company intends to pursue additional reductions in operating expenses where appropriate. In addition to the cost reductions summarized above, in the first quarter of 2003, the company reduced its annual lease and facilities costs by approximately 80%. During February of 2003, the company moved to newly up-fitted offices closer to downtown Columbia. Under its former lease, which did not expire until October 31, 2004, the company leased approximately 19,500 square feet at an annual gross rent of approximately $345,000. The new facilities comprise approximately 7,200 square feet at an annual gross rent of approximately $36,000, with an annual up-fit cost of $20,400. The gross rent under the new lease remains fixed during the entire ten-year term that expires in 2013. If the need to expand should arise, the company has an option with its current landlord to rent contiguous office space of approximately 4,775 square feet at an annual gross rent of $19,100. In March 2003, the company successfully terminated its former lease under which had already accrued past due obligations of approximately $166,000. Under the termination and settlement agreement with the company's former landlord, the entire payment obligation to its former landlord, including obligations for past due rents and costs, is $160,000. This amount is being paid down, without interest, in 24 monthly installments ending in February 2005. The move to its new facilities and the termination of the former lease has reduced facilities costs by over $435,000 through the 19 months that remained under the term of the former lease. Capital Expenditures - The company currently does not have any commitments or budgeted needs during the remainder of 2003 for any material capital expenditures, including purchases of furniture, fixtures or equipment. In the absence of any substantial infusion of growth capital or an unexpected increase in its expected gross margin for 2003, the company does not expect its capital expenditure plans for the next twelve months to change. Debt and Other Payables - On December 31, 2001, the company achieved almost complete debt service relief for 2002 and 2003 through the restructuring of substantially all of its short-term and long-term debt into convertible debentures and notes. Under the restructured debt instruments as originally in effect, approximately 80% of the entire principal balance of the restructured debt was not payable until January 1, 2004. Substantially all of the remaining 20% was payable during January of 2003. Effective January 1, 2003, the holders of substantially all of that remaining 20% agreed to extend the January 2003 maturity date until January of 2004. In addition, the holders of the debt scheduled to mature in January 2003 agreed to extend until May 31, 2003 the due date for the first of the two annual interest installments that earlier had been extended to April 30, 2003. In the months since the issuance of the currently outstanding convertible debt, a portion of the principal and accrued interest on the debt has been converted by its holders into shares of the company's common stock. These and other holders of the convertible debt may elect to convert additional amounts of this debt into common stock prior to the maturity date in January of 2004. These debt conversions have reduced, and if continued in 2003, will continue to reduce the company's short-term debt obligations. For additional information regarding the company's outstanding investor debt, please refer to the matters described above under the caption "Sources of Operating Capital" and the matters described elsewhere in this report under the caption "Risk Factors That May Affect Our Financial Condition and Operating Results." With respect to its trade accounts payable, the company has established long-term payout arrangements with respect to substantially all of its unsecured creditors. In addition, where permitted under securities laws, the company has satisfied and expects to continue to satisfy certain of its unsecured obligations to third parties through restricted stock grants. 7 Additional Capital - During 2002, the company raised approximately $984,000 through the private placement of common stock, two-year convertible debentures and common stock purchase warrants. It may seek to raise additional funds in 2003 from the private placement of additional debt, equity or equity-linked securities. Because of several factors, including the operating, market and industry risks associated with an investment in its common stock; the inclusion of a going concern paragraph in its annual and quarterly financial reports; the fact that its common stock is traded on the Over-the-Counter Bulletin Board maintained by the NASD; the continued weakness in the capital markets in general and the technology sectors in particular; and the other factors described in this report under the heading "Risk Factors That May Affect Our Financial Condition and Operating Results," the company believes it will experience difficulty in obtaining additional financing until its operating results or overall market conditions reflect sustained improvement. As a consequence of its comprehensive restructuring and cost control program described above, the company has achieved substantial cash flow relief during the past twelve months. In the absence of any substantial infusion of growth capital or a significant increase in customer revenues over the amounts included in its budget for the remainder of 2003, the company has not budgeted for any material increase in these monthly cash payments, and as noted above, the company will continue in 2003 to pursue further reductions in its monthly cash payment obligations. The company expects that the proceeds from revenues generated from its operations will be adequate to meet its projected working capital and other cash requirements for at least the next twelve months. Management intends to closely monitor the company's progress and to further reduce its expenses if its marketing and sales strategies do not result in sufficient new revenues within a reasonable period of time. Any such reduction will involve scaling back, delaying or postponing any development activities that are not essential at that time in order for the company to achieve its stated objectives. In any event, the company's working capital deficit may continue to grow unless it is able to sustain revenues sufficient to meet expenditure levels, or its expenditure levels are further reduced. 5. New Accounting Standards In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123" ("SFAS No. 148"). SFAS No. 148 amends SFAS No. 123, "Accounting for Stock Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require in both annual and interim financial statements prominent disclosures about the method of accounting for stock based employee compensation and the effect of the method used on reported results. The company is required to follow the prescribed disclosure format and has provided the additional disclosures required by SFAS No. 148 for the quarterly period ended June 30, 2003. On January 1, 2003, the company adopted Financial Accounting Standards Board No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 provides guidance on the recognition and measurement of an asset retirement obligation and its associated retirement cost. It also provides accounting guidance for legal obligations associated with the retirement of tangible long-lived assets. The adoption of SFAS No. 143 did not materially impact the company's consolidated financial statements. In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, "Consolidation of Variable Interest Entities and Interpretation of ARB No. 51" ("Fin 46"). Many variable interest entities have been commonly referred to as special-purpose entities or off-balance sheet structures, but this interpretation applies to a larger population of entities. In general, a variable interest entity ("VIE") is any legal structure used for business purposes that either: (1) does not have equity investors with voting rights, or (2) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Under Fin 46, the VIE is required to be consolidated by the company if it is subject to a majority of the risk of loss from the VIE's activities or entitled to receive a majority of the entity's residual returns. The consolidation requirements of FIN 46 apply to VIEs created after January 31, 2003 and apply to existing VIEs in the first year or interim period beginning after June 15, 2003. The company has adopted FIN 46, and it did not have a material impact of the company's consolidated financial statements. 8 In April 2003, the Financial Accounting Standards Board issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this statement (1) clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative as defined by SFAS No. 133, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to the language used in FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others", and (4) amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. In May 2003, the Financial Accounting Standards Board issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("SFAS 150"). This statement specifies that instruments within its scope embody obligations of the issuer and that, therefore, the issuer must classify them as liabilities. 6. Stock Based Compensation The company accounts for stock options in accordance with APB Opinion No.25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, no compensation expense is recognized for stock or stock options issued at fair value. For stock options granted at exercise prices below the estimated fair value, the company records deferred compensation expense for the difference between the exercise price of the shares and the estimated fair value. The deferred compensation expense is amortized ratably over the vesting period of the individual options. For performance based stock options, the company records compensation expense related to these options over the performance period. Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123" as amended by FASB Statements No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" ("SFAS 148")), provides an alternative to APB 25 in accounting for stock based compensation issued to employees. SFAS 123 provides for a fair value based method of accounting for employee stock options and similar equity instruments. However, for companies that continue to account for stock based compensation arrangements under APB 25, SFAS 123 requires disclosure of the pro forma effect on net income and earnings per share as if the fair value based method prescribed by SFAS 123 had been applied. The company intends to continue to account for stock based compensation arrangements under APB No. 25 and has adopted the pro forma disclosure requirements of SFAS 123. Had compensation cost for options granted under the company's stock-based compensation plans been determined based on the fair value at the grant dates consistent with SFAS 123, the company's net income and earnings per share would have changed to the pro forma amounts listed below:

9 The pro forma disclosures required by SFAS 123 regarding net loss and net loss per share are stated as if the company had accounted for stock options using fair values. Compensation expense is recognized on a straight-line basis over the vesting period of each option installment. Using the Black-Scholes option-pricing model the fair value at the date of grant for these options was estimated using the following assumptions:

The weighted average fair value for options granted under the Option Plans during the six months ended June 30, 2003 was $0.20. The weighted average fair value for options granted under the Option Plans during the six months ended June 30, 2002 was $0.68. The Black-Scholes and other option pricing models were developed for use in estimating fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions. The company's employee stock options have characteristics significantly different than those of traded options, and changes in the subjective assumptions can materially affect the fair value estimate. Accordingly, in management's opinion, these existing models may not necessarily provide a reliable single measure of the fair value of employee stock options. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations and financial condition. This discussion should be read in conjunction with the consolidated condensed financial statements and related notes set forth in this quarterly report on Form 10-QSB under the caption "Part I - Financial Information - Consolidated Condensed Financial Statements." Results of Operations Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002 Revenues. Our total operating revenues increased by $1,016 (or approximately .1%) to $773,963 in the three months ended June 30, 2003, from $772,947 in the comparable prior year period. This increase was primarily attributable to the increase of $123,625 in our service revenue associated with Fruit of the Loom, offset by a decrease of $105,000 in license revenue. Cost of Revenues. Our total cost of revenues decreased $30,585 (or approximately 10%) to $288,364 in the three months ended June 30, 2003, from $318,949 in the comparable prior year period. This decrease was attributable to several factors, including staff reductions and lower labor costs of personnel necessary for project implementations, as well as the decrease in the human resource costs necessary to support the maintenance obligations associated with our license agreements. The reduction of these human resource costs was primarily attributable to the increase in efficiencies in our overall customer support operations and the successful execution during 2002 and in the second quarter of 2003 of our comprehensive cost control program described below under the heading "Liquidity and Capital Resources." Gross Profit and Margins. Our gross profit increased $31,601 (or approximately 7%) to $485,599 in the three months ended June 30, 2003, from $453,998 in the comparable prior year period. We experienced a corresponding gross margin increase to approximately 63% for the three months ended June 30, 2003 from approximately 59% for the comparable prior year period. This increase was attributable to the increase in the second quarter of 2003, both in absolute dollars and as a proportion of gross revenues, in our service revenues, where we generate some of our highest margins; the decrease in the second quarter of 2003 in our third party hardware sales, where we generate our lowest margins; and the successful execution of our comprehensive cost control program described below under the heading "Liquidity and Capital Resources." Sales and Marketing Expenses. Our sales and marketing expenses decreased $63,559 (or approximately 44%) to $82,006 in the three months ended June 30, 2003, from $145,565 in the comparable prior year period. As a percentage of our quarterly revenues, sales and marketing expenses in the second quarter of this year decreased to 11% from 19% in the comparable quarter of last year. Sales and marketing expenses decreased primarily as a result of decreases in marketing salaries associated with staff reductions, as well as decreases in third party professional fees and public relations expenses realized as a consequence of our comprehensive restructuring and cost control program described below under the heading "Liquidity and Capital Resources." Research and Development Expenses. Our research and development expenses decreased $77,990 (or approximately 64%) to $43,873 in the three months ended June 30, 2003, from $121,863 in the comparable prior year period. As a percentage of our total quarterly revenues, research and development expenses in the second quarter of 2003 decreased to 6% from 16% in the comparable quarter of last year. The decrease for the second quarter of this year was primarily attributable to the relatively larger allocation of human resources in the second quarter of last year to research and development, as well as to the reductions in these expenses realized as a consequence of our comprehensive restructuring and cost control program described below under the heading "Liquidity and Capital Resources." Although our research and development expenses in the second quarter of this year decreased both in dollar amount and as a percentage of revenues from those incurred in the comparable quarter of last year, we anticipate that these expenses may increase in actual dollars on a quarterly basis. We expect, however, that they will continue to decrease as a percentage of our quarterly revenues, although not at the same rate as that was experienced from 2002 to 2003. 11 General and Administrative Expenses. Our general and administrative expenses, excluding interest expense, decreased $262,656 (or approximately 41%) to $374,482 in the three months ended June 30, 2003, from $637,138 in the comparable prior year period. As a percentage of our quarterly revenues, general and administrative expenses in the second quarter of this year decreased to 48% from 82% in the comparable quarter of last year. The decrease for the second quarter of this year was primarily attributable to our comprehensive restructuring and cost control program described below under the heading "Liquidity and Capital Resources - Cost Control Program." Non-Operating Items. Other income and expenses decreased $5,226 (or approximately 3%) to $175,668 in the three months ended June 30, 2003, from $180,894 in the comparable prior year period. The largest expense in this category is Interest expense. Interest expense decreased approximately 1% (or approximately $1,365) to $183,285 in the three months ended June 30, 2003 as compared to $181,920 in the comparable prior year period. Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002 Revenues. Our total operating revenues increased by $230,957 (or approximately 17%) to $1,574,177 in the six months ended June 30, 2003, from $1,343,220 in the comparable prior year period. This increase was primarily attributable to the increase of $579,546 in our service revenue associated with Fruit of the Loom, offset by a decrease of $256,590 in license revenue. Cost of Revenues. Our total cost of revenues decreased $221,013 (or approximately 29%) to $549,817 in the six months ended June 30, 2003, from $770,830 in the comparable prior year period. This decrease was attributable to several factors, including staff reductions and lower labor costs of personnel necessary for project implementations, as well as the decrease in the human resource costs necessary to support the maintenance obligations associated with our license agreements. The reduction of these human resource costs was primarily attributable to the increase in efficiencies in our overall customer support operations and the successful execution during 2002 and in the first quarter of 2003 of our comprehensive cost control program described below under the heading "Liquidity and Capital Resources." Gross Profit and Margins. Our gross profit increased $451,970 (or approximately 79%) to $1,024,360 in the six months ended June 30, 2003, from $572,390 in the comparable prior year period. We experienced a corresponding gross margin increase to approximately 65% for the Six months ended June 30, 2003 from approximately 43% for the comparable prior year period. This increase was attributable to the increase in both quarters of 2003, both in absolute dollars and as a proportion of gross revenues, in our service revenues, where we generate some of our highest margins; the decrease in the first quarter of 2003 in our third party hardware sales, where we generate our lowest margins; and the successful execution of our comprehensive cost control program described below under the heading "Liquidity and Capital Resources." Sales and Marketing Expenses. Our sales and marketing expenses decreased $144,611 (or approximately 44%) to $184,434 in the six months ended June 30, 2003, from $328,045 in the comparable prior year period. As a percentage of our quarterly revenues, sales and marketing expenses in the first and second quarters of this year decreased to 12% from 24% in the comparable quarters of last year. Sales and marketing expenses decreased primarily as a result of decreases in marketing salaries associated with staff reductions, as well as decreases in third party professional fees and public relations expenses realized as a consequence of our comprehensive restructuring and cost control program described below under the heading "Liquidity and Capital Resources." Research and Development Expenses. Our research and development expenses decreased $151,427 (or approximately 60%) to $101,618 in the six months ended June 30, 2003, from $253,045 in the comparable prior year period. As a percentage of our total quarterly revenues, research and development expenses in the first and second quarter of 2003 decreased to 6% from 19% in the comparable quarters of last year. The decrease for the first two quarters of this year was primarily attributable to the relatively larger allocation of human resources in the first two quarters of last year to research and development, as well as to the reductions in these expenses realized as a consequence of our comprehensive restructuring and cost control program described below under the heading "Liquidity and Capital Resources." Although our research and development expenses in the first quarter of this year decreased both in dollar amount and as a percentage of revenues from those incurred in the comparable quarter of last year, we anticipate that these expenses may increase in actual dollars on a quarterly basis. We expect, however, that they will continue to decrease as a percentage of our quarterly revenues, although not at the same rate as that was experienced from 2002 to 2003. 12 General and Administrative Expenses. Our general and administrative expenses, excluding interest expense, decreased $347,597 (or approximately 27%) to $917,483 in the six months ended June 30, 2003, from $1,265,080 in the comparable prior year period. As a percentage of our quarterly revenues, general and administrative expenses in the first and second quarters of this year decreased to 58% from 94% in the comparable quarters of last year. The decrease for the first quarter of this year was primarily attributable to our comprehensive restructuring and cost control program described below under the heading "Liquidity and Capital Resources - Cost Control Program." Non-Operating Items. Other income and expenses decreased $234,961 (or approximately 37%) to $399,543 in the Six months ended June 30, 2003, from $634,504 in the comparable prior year period, primarily as a consequence of a decrease in interest expense. Interest expense decreased 37% (or approximately $239,000) to $400,444 in the Six months ended June 30, 2003 as compared to $639,305 in the comparable prior year period. The decrease in interest expense is attributable in part to the lower amount of our outstanding debt in 2003 as compared to 2002. The greatest portion ($307,292) of the decrease, however, is solely attributable to the intrinsic value approach that was applied to both the common stock purchase warrants and the conversion features of our private placements of convertible debt in 2001 and 2002, all as required by the application of Accounting Principles Board Opinion No. 14, Emerging Issues Task Force ("EITF") Issue No. 98-5 and EITF Issue No. 00-27. The directive of these accounting policies is to attribute an appropriate value to the conversion feature imbedded in convertible debt where the conversion price is either below the market price of the common stock at the commitment date, or where such price may adjust during the life of the debt to a price that is below the market price of the common stock at the time of the adjustment. The entire value of the imbedded conversion feature is charged to interest expense and credited to additional paid in capital at the time of the commitment. These accounting policies also require recognition of the fair value of any warrants issued in connection with debt financing. The fair value is charged to a debt discount that is amortized to interest expense over the life of the related debt instrument, and an equal amount is credited to additional paid in capital. Cash Flow Analysis Net cash provided by operating activities was $188,869 during the six months ended June 30, 2003, representing an increase of $951,807 from the $762,936 of net cash used in operating activities during the comparable prior year period. This significant turn-around to net cash provided by operations this quarter from net cash used in operations the first six months of last year was primarily a consequence of the cost control program implemented by executive management, as described in greater detail below under the caption "Liquidity and Capital Resources." Net cash used in investing activities was $134,605 during the six months ended June 30, 2003, representing an increase of $140,540 from net cash provided by investing activities of $5,935 during the comparable prior year period. This increase was associated with cash used in purchases of capital equipment and leasehold improvements in the first quarter of 2003 that were required for our recent office move described below under the caption "Liquidity and Capital Resources." 13 Net cash provided by financing activities was $17,606 during the three months ended June 30, 2003, representing a decrease in cash provided by financing activities of $797,593 from the $815,199 of net cash provided by financing activities during the comparable prior year period. This decrease in cash provided by financing activities was attributable to the relatively larger amount of private financing in the form of convertible debentures and sales of common stock that took place during the second quarter of 2002 as compared to the second quarter of this year and the increase in cash used in the second quarter of 2003 to pay down certain notes payable. Liquidity and Capital Resources Sources of Operating Capital. Prior to 1997, we financed our operations primarily through our revenues from operations, including funded research and development revenues, and occasional short-term loans from our principals, their families and other individuals and entities. Since the middle of 1997, we have financed our operations primarily through private and public offerings of common stock and convertible debt, and to a lesser extent from operating revenues and through borrowings from third parties. We raised net proceeds of approximately $1.22 million in our November 1997 initial public offering. Since that time, we have raised additional equity of approximately $12.3 million through several private placements of common stock and stock purchase warrants and the conversion of approximately $2.1 million of convertible debt into equity. During 2001, we raised an aggregate of approximately $5.1 million in additional capital, consisting of approximately $1.03 million from the exercise of common stock options and warrants, approximately $409,000 from the private placement of common stock, and approximately $3.66 million from the issuance of convertible debt. During 2002, we raised approximately $984,000 through the private placement of common stock, two-year convertible debentures, and common stock purchase warrants. Although we may seek to raise additional funds in 2003 from the private placement of additional debt, equity or equity-linked securities, we expect that we will experience difficulty in obtaining additional financing until our operating results or overall market conditions reflect sustained improvement. Cost Control Program. During September of 2001, in connection with executive managements' restructuring of our internal operations and in response to the need to reduce costs in connection with lower than expected year-to-date revenues, we commenced a comprehensive cost control program. The implementation of that program is continuing. By the end of March 2003, our monthly cash payments necessary to fund continuing operational expenses had decreased by over 70% as compared to the monthly cash required for operations prior to the commencement of our cost control program. Included in our cost control program are measures that have resulted in substantial reductions in our largest cash expenditure categories of human resource and payroll-related expenses. Through March of 2003, these measures have included the reduction of over 50% in the number of our employees; the deferral of up to 61% in the compensation rates of our executive officers; reductions of up to 50% in the compensation rates for our remaining non-executive personnel; reductions of approximately 13% in the rates we pay for employee health insurance; scale-backs in our employee benefit programs; and substantial reductions in employee travel, accommodation and hiring costs. In addition, we have achieved significant cash flow relief through the discontinuance of non-essential third party consulting and service arrangements and the renegotiation of other third party contracts, including those in the areas of public relations, investor relations, financial advisory services, financial printing and industry research. During the remainder of 2003, in addition to the reductions outlined above, we intend to pursue additional reductions in operating expenses where appropriate. In addition to the cost reductions summarized above, in the first quarter of 2003, we reduced our annual lease and facilities costs by approximately 80%. During February of 2003, we moved to newly up-fitted offices closer to downtown Columbia. Under our former lease, which did not expire until October 31, 2004, we leased approximately 19,500 square feet at an annual gross rent of approximately $345,000. Our new facilities comprise approximately 7,200 square feet at an annual gross rent of approximately $36,000, with an annual up-fit cost of $30,000. Our gross rent under our new lease remains fixed during the entire ten-year term that expires in 2013. If the need to expand should arise, we have an option with our current landlord to rent contiguous office space of approximately 4,775 square feet at an annual gross rent of $19,100. In March 2003, we successfully terminated our former lease under which we had already accrued past due obligations of approximately $166,000. Under our termination and settlement agreement with our former landlord, our entire payment obligation to our former landlord, including obligations for past due rents and costs, is $160,000. This amount is being paid down, without interest, in 24 monthly installments ending in February 2005. The move to our new facilities and the termination of our former lease has reduced our facilities costs by over $435,000 through the 19 months that remained under the term of our former lease. 14 Capital Expenditures. During the first quarter of 2003, we signed a $130,000 note payable for the leasehold improvements associated with our new office space described below. This note is amortized over 10 years and carries an annual interest rate of 10%. We currently do not have any commitments or budgeted needs during the remainder of 2003 for any material capital expenditures, including purchases of furniture, fixtures or equipment. In the absence of any substantial infusion of growth capital or an unexpected increase in our expected gross margin for 2003, we do not expect our capital expenditure plans for the next twelve months to change. Debt and Other Payables. On December 31, 2001, we achieved almost complete debt service relief for 2002 and 2003 through the restructuring of substantially all of our short-term and long-term debt into convertible debentures and notes. Under the restructured debt instruments as originally in effect, approximately 80% of the entire principal balance of the restructured debt was not payable until January 1, 2004. Substantially all of the remaining 20% was payable during January of 2003. Effective January 1, 2003, the holders of substantially all of that remaining 20% agreed to extend the January 2003 maturity date until January of 2004. In addition, the holders of the debt scheduled to mature in January 2003 agreed to extend until May 31, 2003 the due date for the first of the two annual interest installments that earlier had been extended to April 30, 2003. In the months since the issuance of the company's currently outstanding convertible debt, a portion of the principal and accrued interest on the debt has been converted, by its holders, into shares of our common stock. These and other holders of the convertible debt may elect to convert additional amounts of this debt into common stock prior to the maturity date in January of 2004. These debt conversions have reduced, and if continued in 2003, will continue to reduce the company's short-term debt obligations. For additional information regarding our outstanding investor debt, please refer to the matters described above under the caption "Sources of Operating Capital" and the matters described elsewhere in this report under the caption "Risk Factors That May Affect Our Financial Condition and Operating Results." With respect to our trade accounts payable, we have established long-term payout arrangements with respect to substantially all of our unsecured creditors. In addition, where permitted under securities laws, we have satisfied and expect to continue to satisfy certain of our unsecured obligations to third parties through restricted stock grants. 15 Additional Capital. As noted above, during 2002, we raised approximately $984,000 through the private placement of common stock, two-year convertible debentures and common stock purchase warrants. We may seek to raise additional funds in 2003 from the private placement of additional debt, equity or equity-linked securities. Because of several factors, including the operating, market and industry risks associated with an investment in our common stock; the inclusion of a going concern paragraph in our annual and quarterly financial reports; the fact that our common stock is traded on the Over-the-Counter Bulletin Board maintained by the NASD; the continued weakness in the capital markets in general and the technology sectors in particular; and the other factors described in this report under the heading "Risk Factors That May Affect Our Financial Condition and Operating Results," we believe we will experience difficulty in obtaining additional financing until our operating results or overall market conditions reflect sustained improvement. As a consequence of our comprehensive restructuring and cost control program described above under the caption "Cost Control Program," we have achieved substantial cash flow relief during the past twelve months. In the absence of any substantial infusion of growth capital or a significant increase in customer revenues over the amounts included in our budget for the remainder of 2003, we have not budgeted for any material increase in these monthly cash payments, and as noted above, we will continue in 2003 to pursue further reductions in our monthly cash payment obligations. We expect that the proceeds from revenues generated from our operations will be adequate to meet our projected working capital and other cash requirements for at least the next twelve months. Management intends to closely monitor the company's progress and to further reduce our expenses if our marketing and sales strategies do not result in sufficient new revenues within a reasonable period of time. Any such reduction will involve scaling back, delaying or postponing any development activities that are not essential at that time in order for the company to achieve its stated objectives. In any event, our working capital deficit may continue to grow unless we are able to sustain revenues sufficient to meet expenditure levels, or our expenditure levels are further reduced. Critical Accounting Policies We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the consolidated financial statements included in our annual report on Form 10-KSB for the year ended December 31, 2002. We consider these accounting policies to be critical accounting policies. Certain accounting policies require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and in the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. The judgments and assumptions we use are based on historical experience and other factors that we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and from estimates that could have a material impact on our reported results. Regulatory Matters We are not aware of any current recommendations by regulatory authorities, which, if they were to be implemented, would have a material adverse effect on our liquidity, capital resources or operations. 16 Controls Evaluation Limitations on the Effectiveness of Controls. The company's management, including the Chief Executive Officer, does not expect that our Disclosure Controls or our Internal Controls (each, as defined below in Part I of this report under the caption "Item 3. Controls and Procedures") will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Furthermore, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. 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. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Scope of the Controls Evaluation. The Chief Executive Officer's evaluation of our Disclosure Controls and our Internal Controls included a review of the controls' objectives and design, the controls' implementation by the company, and the effect of the controls on the information generated for use in this report. In the course of the controls evaluation, we sought to identify data errors, controls problems, or acts of fraud, and to confirm that appropriate corrective actions, including process improvements, were being undertaken. This kind of evaluation is performed on a quarterly basis so that the conclusions concerning controls effectiveness can be reported in our quarterly reports on Form 10-QSB and in our annual reports on Form 10-KSB that we will file with the Securities and Exchange Commission. Our Internal Controls are also evaluated on an ongoing basis by other personnel in our company and by our independent auditors in connection with their audit and review activities. The overall goals of these various evaluation activities are to monitor our Disclosure Controls and our Internal Controls and to make modifications as necessary. Our intent in this regard is that the Disclosure Controls and the Internal Controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant. Among other matters, we sought in our controls evaluation to determine whether there were any "significant deficiencies" or "material weaknesses" in the company's Internal Controls, or whether the company had identified any acts of fraud involving personnel who have a significant role in the company's Internal Controls. This information was important, both for the controls evaluation generally, and because Items 5 and 6 in the Section 302 Certification of the Chief Executive Officer (included elsewhere in this report) requires that the Chief Executive Officer disclose that information to our Board's Audit Committee and to our independent auditors and to report on related matters in this section of this report. In the professional auditing literature, "significant deficiencies" are referred to as "reportable conditions." These are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A "material weakness" is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions. We also sought to deal with other controls matters in the controls evaluation, and in each case, we considered what revision, improvement and/or correction, if any, were necessary to make in accord with our on-going procedures. In accord with requirements of the Securities and Exchange Commission, the Chief Executive Officer notes that, since the date of the controls evaluation to the filing date of this report, there have been no significant changes in Internal Controls or in other factors that could significantly affect Internal Controls, including any corrective actions with regard to significant deficiencies and material weaknesses. 17 Conclusions. Based upon the controls evaluation, our Chief Executive Officer has concluded that, subject to the limitations noted above, our Disclosure Controls are effective to ensure that material information relating to the company is made known to management, including the Chief Executive Officer, particularly during the period when our periodic reports are being prepared, and that our Internal Controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with generally accepted accounting principles. RISK FACTORS THAT MAY AFFECT OUR FINANCIAL CONDITION AND OPERATING RESULTS In addition to other information contained in this report on Form 10-QSB, the following risk factors should be carefully considered in evaluating our company and its business. These factors may have a significant impact on our business, operating results and financial condition. As a consequence of these risk factors, the other information contained in this report, and the risks discussed in our other periodic filings with the Securities and Exchange Commission, our actual results could differ materially from those contemplated by any forward-looking statements contained in this report. RISKS RELATED TO OUR COMPANY All of our assets are pledged as collateral under all of our investor and other debt. The Internal Revenue Service has placed a lien on all of our assets until our second quarter 2002 payroll tax obligation to them is satisfied. A default by us under our secured debt or the failure to satisfy our obligation to the Internal Revenue Service could result in a foreclosure on all of our assets and the discontinuation of our operations. Funds from any resulting liquidation of all of our assets would not be sufficient to fully repay our secured creditors. In such event, our unsecured creditors and our shareholders would receive nothing. At June 30, 2003, we had approximately $2.8 million in outstanding debt under convertible debentures and notes that we issued in 2001 and in 2002. This debt has a security interest in all of our assets, including our proprietary technologies. Of this amount, approximately $300,000 in principal and interest is due during the remainder of 2003, and the remainder is due during the first quarter of 2004. In the months since the issuance of the company's currently outstanding convertible debt, holders of a portion of this debt have converted the principal and accrued interest on all or a portion of their debt into common stock. These and other holders of the convertible debt may indicate their desire to convert additional amounts of their debt into common stock during the current year. Although these conversions have reduced and will continue to reduce the company's principal and interest obligations, we expect that in the first quarter of 2004 we may still be faced with principle and interest obligations on the remaining convertible debt that we will not be able to satisfy from currently projected cash flows from operations. Accordingly, unless our cash flow is substantially greater than currently projected, we will need to renegotiate the amount and timing of payments on any substantial amount of this debt that is not converted into equity prior to January 2004. While we believe we will be able to restructure such debt under terms that are reasonable to the company, we cannot provide any assurance that we will be able to finalize any definitive agreement with the holders of any significant portion of this debt that remains outstanding at the end of this year. At June 30, 2003, we owed $164,903 in federal payroll taxes and $5,730 in state payroll taxes, including interest and penalties. These taxes relate to payrolls in the second and third quarters of 2002. Our tax obligations have continued to decline since August of last year through the periodic tax payments we have made and are continuing to make under arrangements with both federal and state tax authorities. We expect to have all past due state payroll tax obligations fully satisfied by the middle of 2003, and we expect to have all past due federal tax obligations fully satisfied by the middle of 2004. In the meantime, the Internal Revenue Service has placed a lien on all of our assets until our second quarter 2002 payroll tax obligation (currently $70,676) to them is satisfied. 18 In the event that we are unable to satisfy our prior payroll tax obligations, or our repayment obligations under our secured debt, or we otherwise default under the terms of such debt, the holders of this debt may seek to foreclose their security interests and liens on our assets. In such event, if we are unable to reach a pay out arrangement satisfactory to the holders of this secured debt or seek satisfactory debt relief under federal bankruptcy laws, we believe that our company would no longer be able to operate. In that event, we believe that it is most likely that our company's assets would be sold and that the proceeds from such sale would not be sufficient to satisfy the liens of our secured creditors. This would leave no funds for the payment of any of our unsecured obligations to third parties, including any judgment creditors that might arise, and would leave no funds or assets available for distribution to our shareholders. Our most recent financial statements include a going concern paragraph. Our independent accountants' report for our most recent year-end audit and the notes to our year-end 2002 audited financial statements included in our report on Form 10-KSB for the year ended December 31, 2002 identify factors that, in the opinion of our independent accountants, raise substantial doubts about our ability to continue as a going concern. For additional information regarding this report, please refer to Note 4 to our unaudited condensed consolidated financial statements included in this report on Form 10-QSB and to Note 1 to our audited financial statements included in our annual report on Form 10-KSB filed with the Securities and Exchange Commission for the year ended December 31, 2002. Substantially all of our revenue over the past eighteen months has been associated with only one customer, the loss of whom would severely jeopardize our ability to maintain our operations. In 2002, our largest customer accounted for more than 88% of our revenue, and our second largest customer accounted for more than 10% of our revenue. Consequently, the loss of our largest customer would have a material adverse effect on our revenue and would likely result in the cessation of our operations if we are not otherwise able to expand our revenue base. Even if we are successful in growing the size and depth of our customer base, we have historically generated substantially all of our revenue from a limited number of customers, substantially all of which are in the manufacturing industry. We remain focused on expanding our sales and marketing efforts toward companies in other industries and other vertical markets, particularly for business-to-business integration. Nevertheless, we expect that a small number of customers in the manufacturing industry will continue to account for a substantial portion of our revenue for the foreseeable future. Any significant decline in the demand for, and market acceptance of, our software in the manufacturing industry would hurt our ability to execute our business plan in the short-term. Even if we expand our customer base, we believe that our current customers will continue to provide a substantial portion of our revenue through additional license, implementation services and maintenance fees. Moreover, if we successfully market our products in new vertical markets, we expect that customers in some of those new vertical markets are likely to have different requirements and may require us to change our product design or features, sales methods, support capabilities or pricing policies. Any failure by us to successfully address any new vertical markets will have an adverse effect on our results of operations. We have a large accumulated deficit, we expect future losses, and we may never achieve or maintain profitability. Excluding the third quarter of last year, we have experienced operating losses in each of our fiscal years since January 1, 1995. As of December 31, 2002, we had an accumulated deficit of approximately $23.29 million. In addition, since 1997, we have continued to allocate a substantial proportion of our internal resources to activities associated with the development, marketing and sale of our current suite of new software products. During the last three years, we have also undertaken a complete restructuring of our sales and marketing organization and have commenced several new customer acquisition strategies. This strategy of increased emphasis on new product development and the suspension of much of our traditional sales activities while we began implementing our sales team reorganization resulted in a substantial reduction in our traditional service revenues during the affected periods. Despite our history of losses, we believe it is vital to our future success that we continue to allocate working capital toward our sales and marketing strategies, although at a lower percentage of revenue than our allocation of working capital in this area during our most recent fiscal years. 19 If expenditures related to our sales and marketing activities are not accompanied or shortly followed by increased revenue, our quarterly and annual operating losses could be greater than expected until we are able to delay or reduce expenditures. While we achieved profitability during the third quarter of 2002, many factors, including the factors described in this report, may result in our incurring losses in 2003. We need to significantly increase our quarterly revenues or significantly reduce our quarterly expenses from their historical levels in order for us to sustain the profitability achieved during the third quarter of 2002. The recent restructuring of our operations has strained our existing resources and may cause our business to suffer. Our ability to successfully offer products and services and implement our business plan in our rapidly evolving markets requires an effective planning and management process. During the latter part of 2001 and the first eight months of 2002, we restructured our entire executive, administrative and operating teams in order to achieve greater efficiencies in execution, better allocation of skills across departments and better project tracking. In connection with that restructuring, we have reduced by over 50% the number of our employees from a high of approximately 60 employees during 2001 to 25 at the end of June 2003. We anticipate that if we are able to achieve our anticipated growth in our customer base during 2003, we will need to increase the number of our employees in some areas later this year. In the meantime, the staffing requirements necessary to support our existing business and our growth strategies have placed a significant strain on our currently reduced management systems, infrastructure and resources. If we are able to achieve our anticipated growth in our customer base, concurrently with the need to expand, train and manage our workforce, we expect that we will also be required to manage an increasing number of relationships with these new customers, various strategic alliance partners and other third parties. Failure to expand any of the foregoing areas efficiently and effectively could interfere with and possibly limit our ability to expand our business as a whole. If we do not retain our key management personnel and attract and retain other highly skilled employees, our business will suffer. Our future success depends on the skills, experience and performance of our senior management team, other key personnel and advisors, and their ability to operate effectively, both individually and as a group. Each of our key employees is bound by an employment agreement with the company. Although we maintain "key man" insurance in the amount of $1 million on the lives of each of George E. Mendenhall, Chairman and Chief Executive Officer, and Stuart E. Massey, Executive Vice President, recovery under such insurance may not be adequate to compensate us for the full impact resulting from the death of either of these officers. If any of our existing senior management or other key research, engineering and development or sales and marketing personnel were to leave the company, it would be difficult to replace them, and our business would be materially harmed. If we are able to achieve our anticipated sales growth, our success will also depend on our ability to recruit, retain and motivate additional highly skilled sales, marketing and engineering personnel. We believe we will face significant competition for individuals with the skills required to develop, market and support our products and services. We believe that attracting and retaining these personnel is particularly difficult for us because: -- the market for connectivity infrastructure software is still emerging -- our company and our products are not yet widely known in the marketplace -- the relative scarcity of qualified technical personnel in the Columbia, South Carolina metropolitan area makes it difficult to attract and retain technical personnel If we fail to recruit and retain sufficient numbers of these highly skilled employees our ability to compete will be significantly harmed, and our business will suffer. 20 We must expand our network of distribution partners in order to successfully sell our products. We have recently implemented a sales model under which we are focusing more efforts toward the sale of our products through indirect sales channels such as resellers, system integrators, application software vendors and infrastructure technology companies. We plan to continue to invest resources toward the development of our relationships with these third parties. We may not be successful in the implementation of our sales strategies, and even if we are, such strategies may not result in an increase in our revenues. If we fail to maintain our existing relationships with indirect sales channel arrangements or fail to establish new ones, or if our revenue does not increase correspondingly with the expenses we incur in pursuing such relationships, our business will suffer. If we do not effectively compete with new and existing competitors, our revenues and operating margins will decline. The market for our products is intensely competitive, evolving, and subject to rapid technological change. We expect the intensity of competition to increase in the future. As a result of increased competition, we may have to reduce the prices of our products and services, and we may experience reduced gross margins and loss of market share, any one of which could significantly reduce our future revenues and operating results. Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, as well as better name recognition and larger customer bases than we do. These competitors may be able to develop products comparable or superior to those offered by us, or adapt more quickly than we can to new technologies, evolving industry trends or customer requirements. They are also positioned to devote greater resources to the development, promotion and sale of their products than we are. Accordingly, we may not be able to compete effectively in our markets, and competition may intensify and harm our business and its operating results. If we are not successful in developing enhancements to existing products and new products in a timely manner, garnering customer acceptance or generating average licensing prices, our gross margins may decline and cause our business and operating results to suffer. For additional information on our competitive posture in our industry, please refer to the description set forth in our annual report on Form 10-KSB for the year ended December 31, 2002, under the caption "Item 1 - Description of Business - Competition and Markets." Variations in the time it takes us to sell our products may cause fluctuations in our operating results. Our customers generally consider a wide range of factors before committing to purchase our products, including product benefits, the ability to operate with existing and future computer systems, the ability to accommodate increased transaction volumes, and product reliability. Some of our customers are addressing these factors for the first time when they consider whether to buy our products and services. As a result, we or other parties must educate potential customers on the use and benefits of our products and services. In addition, the purchase of our products generally involves a significant commitment of capital and other resources by a customer. This commitment often requires significant technical review, assessment of competitive products, and approval at a number of management levels within a customer's organization. The length of our sales cycles may vary based on the industry in which the potential customer operates, and is difficult to predict for any particular license transaction. Because of the number of factors influencing our sales process, the period between our initial contact with a new customer and the time when we are able to recognize revenue from that customer varies widely in length. Our sales cycles typically range from two to six months. For larger opportunities with new customers, however, these cycles may be longer. The length and variability of our sales cycles makes it difficult to predict whether particular sales will be concluded in any given quarter. If one or more of our license transactions are not consummated in a given quarter, our results of operations for that quarter may be below our expectations and the expectations of analysts and investors which would be likely to cause a decline in our stock price. 21 Significant unanticipated fluctuations in our actual or anticipated quarterly revenues and operating results may cause us not to meet securities analysts' or investors' expectations and may result in a decline in our stock price. Our quarterly operating results have fluctuated significantly in the past and may vary significantly in the future. Moreover, as a result of our limited operating history with our new suite of Synapse-based software products and the evolving nature of the markets in which we compete, it is difficult to accurately forecast our revenue in any given period. Accordingly, we believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful and should not be relied upon as indications of sustainable trends or other future performance. If our revenues, operating results or earnings are below the levels expected by investors or securities analysts, our stock price is likely to decline. In addition, we expect to experience significant fluctuations in our future quarterly revenues and operating results as a result of many factors specific to our operations, including: -- the difficulty in predicting the size and timing of our customer orders -- the mix of our products and services sold and the mix of our distribution channels -- the lengthy sales cycle for some of our products -- the market acceptance of our products -- the terms and timing of our financing activities -- whether we are able to successfully expand our sales and marketing programs -- the possible loss of any of our key personnel -- the difficulty in predicting the amount and timing of employee stock option exercises Our revenues and operating results depend upon the volume and timing of customer orders and payments, and the date of product delivery. New software licensing, service and maintenance contracts may not result in revenues in the quarter in which the contracts are signed, and we may not be able to predict accurately when revenues from these contracts will be recognized. A substantial portion of our revenues has been and will continue to be derived from large licensing and software implementation orders. We expect this trend to continue for the foreseeable future. We also expect that increases in the dollar size of individual license transactions will increase the risk of fluctuation in future quarterly results. We realize substantially higher gross margins on our license revenues as compared to our services and maintenance revenues. Consequently, our margins for any particular quarter will be highly dependent on the mix of license, service and maintenance revenues in that quarter. If we cannot generate large customer orders, or our customers delay or cancel their orders in a particular quarter, these factors will have a material adverse effect on our revenues, and more significantly on a percentage basis, on our net income or loss in that quarter. Defects in, or slow performance of, our software products could diminish demand for our products and expose us to costly liability that would adversely affect our operating results. The Synapse software products we offer are internally complex. Complex software may contain errors or defects, particularly when first introduced or when new versions or enhancements are released. Although we conduct extensive testing, we may not discover software defects that affect our current or new products or enhancements until after they are sold. Although we have not experienced any material software defects to date, any errors, defects or slow performance that may be discovered could result in: -- loss of revenue -- product returns or order cancellations -- delay in market acceptance of our products -- diversion of our development resources -- distraction of our management -- damage to our customer relationships and our reputation -- increased service and warranty costs -- costly litigation defense 22 Our license and service agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in our license and service agreements may not be effective as a result of existing or future federal, state or local laws, ordinances or judicial decisions. Although we have not experienced any product liability claims to date, sale and support of our products entails the risk of such claims, which could be substantial in light of our customers' use of many of our products in mission-critical applications. We do not maintain product liability insurance. If a claimant brings a product liability claim against us, it could have a material adverse effect on our business, results of operations and financial condition. RISKS RELATED TO OUR INDUSTRY If we fail to adapt to the rapid technological change that characterizes our markets, we could lose market share, or our products could become obsolete. The market for our current suite of software products is characterized by: -- rapid technological change -- frequent new product introductions and enhancements -- uncertain product life cycles -- changing customer requirements -- evolving industry standards The introduction of products embodying new technologies, the emergence of new industry standards, or changes in customer requirements could render some or all of our existing products obsolete and unmarketable. Moreover, decreases in the cost of existing competing products or services could enable our current or potential customers to fulfill their own needs for transaction processing and integration systems and services in a more cost-efficient manner than through the purchase of our products and services. As a result, our success depends upon our ability to respond to changing customer requirements and to enhance existing products and services to keep pace with technological developments and emerging industry standards. We have invested significantly in technology, and we anticipate that it will be necessary for us to continue to do so. Failure to develop and introduce enhancements to our existing products and services in a timely manner in response to changing market conditions or customer requirements will materially and adversely affect our business, results of operations and financial condition. Because our products could interfere with our customers' other software applications and hardware, we may be subject to claims by these customers, which may be costly and may not be adequately covered by insurance. Our products inter-operate with many parts of complicated computer systems of our customers, such as mainframes, servers, personal computers, application software, databases, operating systems and data transformation software. Failure of any one of these parts could cause all or large parts of our customers' computer systems to fail. In such circumstances, it may be difficult to determine which part failed, and it is likely that customers will bring lawsuits against several suppliers. Even if our software is not at fault, we could suffer material expenses and material diversion of management time in defending any such lawsuits, causing our business to suffer. 23 If we fail to adequately protect our proprietary rights, we may lose these rights and our business may be seriously harmed. Our success depends upon our proprietary technology. To establish and protect our proprietary rights, we rely primarily on a combination of: -- patent law -- copyright law -- trademark and trade secret laws -- confidentiality procedures and agreements -- licensing arrangements -- the complex nature of our technologies As part of our confidentiality procedures, we enter into non-disclosure agreements with our employees upon hiring them, and with our customers and strategic partners when we enter into license, service and maintenance agreements with respect to our software, documentation and other proprietary information. Despite these precautions, third parties could copy or otherwise obtain and use our products or technologies without authorization, or develop similar technologies independently. It is difficult for us to police unauthorized use of our products. Because of this difficulty in determining the extent to which piracy of our software products may exist, software piracy remains a persistent problem. Expensive litigation may be necessary in the future to enforce our intellectual property rights. Moreover, effective protection of intellectual property rights is unavailable or limited in certain foreign countries. While we believe that our products and technologies are protected against infringement, as a practical matter, existing laws may afford only limited protection. Consequently, the protection of our proprietary rights may not be adequate, and our competitors could independently develop similar technologies, duplicate our products, reverse-engineer, or design around the intellectual property rights we hold. Our products may infringe upon the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products. The commercial success of our business depends upon our products not infringing any intellectual property rights of others and upon no claims for infringement being made against us. We have conducted periodic patent searches to determine whether or not we may be infringing the patent or trademark rights of any third parties. We have also applied for patent protection of our proprietary Synapse software. Because patent applications in the United States are not publicly disclosed until the patent is issued, applications of which we are not aware may have been filed which are similar to our software products. Consequently, we may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us or our licensees in connection with their use of our products. Intellectual property litigation is expensive and time-consuming, and could divert our management's attention away from running our business. If we were to discover that any of our products violated the intellectual property rights of others, we would have to obtain licenses from these parties in order to continue marketing our products without substantial re-engineering. We might not be able to obtain the necessary licenses on acceptable terms or at all. If we could not obtain such licenses, we might not be able to re-engineer our products successfully or in a timely manner. We believe that we are not infringing any intellectual property rights of third parties, but there can be no assurance that such infringement will not occur. If we fail to address any infringement issues successfully, we will be forced to incur significant costs and could be prevented from selling our products. OTHER RISKS The price of our common stock may fluctuate significantly and may be negatively affected by factors beyond our ability to control or predict. The price of our common stock is subject to the volatility generally associated with Internet, middleware, software and technology stocks in general, and may also be affected by broader market trends unrelated to our or our competitors' operating performances. Our stock price and the stock prices of many other companies in the technology and emerging growth sectors have historically experienced wide fluctuations, including rapid rises and declines in stock prices that have often been unrelated to the operating performance of such companies. In this connection, we note that since 2001, a substantial downward trend, especially during the most recent year, has been experienced in the markets for stocks across substantially all market sectors, and particularly in the technology sectors in which our stock may be included by various market analysts. These downward trends and fluctuations are typically the result of the combination of general economic, political and market conditions, most recently including recessions, the threat of terrorist activities, and concerns over the accuracy of financial reporting by several large publicly traded corporations. These factors are beyond our ability to control or predict. We believe that the downward trends in the securities trading markets as a whole have had and will continue to have a comparable adverse impact on the trading market for our common stock. We can provide no assurance that these downward trends and the events giving rise to them will not continue for the foreseeable future, or that they will not materially adversely affect the market price of our common stock. 24 The number of our shares of common stock that are or may become eligible for sale in the near future may cause the market price for our common stock to decline significantly, even if our business is doing well. Trading in our common stock has historically been very limited and has made the market price of our common stock vulnerable to significant fluctuations. At June 30, 2003, we had 22,303,672 outstanding shares of common stock, with an approximate additional 8.1 million shares of common stock issuable upon the exercise of employee stock options and common stock purchase warrants and an approximate additional 32 million shares issuable upon conversion of debt which would total an approximate 62 million shares at June 30, 2003, if all of the outstanding options and warrants were exercised and all of the outstanding debt was converted. Of the outstanding shares, 2,604,877 were held by members of management and may be publicly sold only pursuant to the volume and manner of sale restrictions of Rule 144 under the Securities Act of 1933. Approximately 7,464,995 of the remaining outstanding shares are restricted securities issued under federal and state exemptions from registration and may not be publicly sold. Once these restricted shares, or the shares issuable pursuant to outstanding options, warrants and convertible debt, become eligible for resale under Rule 144, or their resale is otherwise registered by us with the Securities and Exchange Commission, if the holders of these shares sell substantial amounts of their shares into the public market during a short period of time, or if those shareholders are perceived by the market as intending to sell them, our stock price may decline significantly. The issuance of these shares will also result in dilution to our shareholders, and may make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we deem appropriate. Failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in new products could reduce our ability to compete and result in lower revenues. We expect that our current cash balance and cash from expected sales of our products and services should be sufficient to meet our working capital and capital expenditure needs for at least the next twelve months. Nevertheless, even if we are successful in realizing our expected 2003 sales objectives, we expect that we will still require additional third party financing in the future to implement our growth strategies and achieve our long-term objectives. In light of the recent downward trends experienced by the capital markets, we cannot be certain that we will be able to obtain additional debt or equity financing on favorable terms, or at all. If we obtain additional equity financing, our shareholders may experience significant dilution of their ownership interests and the per share value of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness or that force us to maintain specified liquidity or other ratios, any of which could harm our business. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things: -- develop or enhance our products and services -- continue to implement our sales and marketing strategies -- acquire complementary technologies, products or businesses -- expand operations, in the United States or internationally -- hire, train and retain employees -- respond to competitive pressures or unanticipated working capital requirements 25 Our failure to do any of these things could result in lower revenues and could seriously harm or result in the discontinuation of our operations. Anti-takeover provisions in our articles of incorporation and state corporate laws could discourage or prevent a takeover, even if an acquisition of our company would be beneficial to our shareholders. In many cases, shareholders receive a premium for their shares when a company is purchased by another enterprise. Various provisions in our articles of incorporation, our bylaws and South Carolina corporate laws could deter and make it more difficult for a third party to bring about a merger, sale of control, or similar transaction without approval of our board of directors, even if the transaction would be beneficial to our shareholders. These provisions tend to perpetuate existing management. As a result, our shareholders may be deprived of opportunities to sell some or all of their shares at prices that represent a premium over market prices. These provisions, which could make it less likely that a change in control will occur, include: -- provisions in our articles of incorporation establishing three classes of directors with staggered terms, which means that only one-third of the members of the board of directors is elected each year, and each director serves for a term of three years. -- provisions in our articles of incorporation authorizing the board of directors to issue a series of preferred stock without shareholder action, which issuance could discourage a third party from attempting to acquire, or make it more difficult for a third party to acquire, a controlling interest in us. -- provisions in our articles of incorporation prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of shareholders to elect director candidates. -- provisions in our bylaws relating to meetings of shareholders which limit who may call a meeting and what matters may be voted upon. -- provisions in our bylaws establishing advance notice requirements for nominations for election to the board of directors and for proposing matters that can be acted upon by shareholders at shareholder meetings. -- state law provisions that require two-thirds of the shareholders to approve mergers and similar transactions, and amendments to our articles of incorporation. In addition, the South Carolina Business Combination Act, the South Carolina Control Share Acquisition Act and the vesting terms of our stock option plans may discourage, delay or prevent a change in control of our company. Item 3. Controls and Procedures Quarterly Evaluation of the Company's Disclosure Controls and Internal Controls Within the 90 days prior to the filing date of this report on Form 10-QSB, the company evaluated the effectiveness of the design and operation of its "disclosure controls and procedures" ("Disclosure Controls"), and its "internal controls and procedures for financial reporting" ("Internal Controls"). This evaluation (the "Controls Evaluation") was done under the supervision and with the participation of management, including our Chief Executive Office. Rules adopted by the Securities and Exchange Commission require that in this section of this report we present the conclusions of the Chief Executive Officer about the effectiveness of our Disclosure Controls and Internal Controls based on and as of the date of the Controls Evaluation. 26 Officer Certifications Appearing immediately following the "Signatures" section of this report there is a form of certification by our Chief Executive Officer. The form of certification is required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section 302 Certification"). This section of the report that you are currently reading is the information concerning the Controls Evaluation referred to in the Section 302 Certifications, and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented. Disclosure Controls and Internal Controls Disclosure Controls are procedures that are designed with the objective of ensuring that the information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosure. Internal Controls are procedures that are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with generally accepted accounting principles. PART II - OTHER INFORMATION Item 1. Legal Proceedings We are not currently a party to any material litigation. Item 2. Changes in Securities During the three months ended June 30, 2003, we did not issue any securities in a transaction that was not registered under the Securities Act of 1933 in reliance upon the exemption from registration contained in Section 4(2) and Rule 506 of Regulation D of that act. Those sections of the act exempt from registration any securities transactions that do not involve a general solicitation and in which recipients of the securities acquiring them solely for investment, provided the recipients also possess requisite financial sophistication and, subject to some limitations, are provided with certain information regarding the company. Item 3. Defaults Upon Senior Securities This item is not applicable. Item 4. Submission of Matters to Vote of Security Holders This item is not applicable. 27 Item 5. Other Information This item is not applicable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Please refer to the Exhibit Index that follows the "Signatures" and "Certifications" pages of this report. (b) Reports on Form 8-K. The company made the following filings on Form 8-K during the three months ended June 30, 2003: Current Report on Form 8-K, dated May 16, 2003, reporting, under Item 9, the Company's First Quarter Earnings. Signatures and Certifications of the Chief Executive Officer of the Company The following pages include the Signatures page for this report and separate Certifications of the Chief Executive Officer of the company as required by Rule 13a-14 under the Securities Exchange Act of 1934 in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the "Section 302 Certification"). The Section 302 Certification includes references to an evaluation of the effectiveness of the design and operation of the company's "disclosure controls and procedures" and its "internal controls and procedures for financial reporting". Item 3 of Part I of this report presents the conclusions of the Chief Executive Officer about the effectiveness of such controls based on and as of the date of such evaluation (relating to Item 4 of the Section 302 Certification), and contains additional information concerning disclosures to the company's Audit Committee and independent auditors with regard to deficiencies in internal controls and fraud (Item 5 of the Section 302 Certification) and related matters (Item 6 of the Section 302 Certification). 28 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. Date: August 15, 2003 INTEGRATED BUSINESS SYSTEMS AND SERVICES, INC. (Registrant) By: /s/ GEORGE E. MENDENHALL --------------------------- George E. Mendenhall Chief Executive Officer 29 SECTION 302 CERTIFICATION I, George E. Mendenhall, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of Integrated Business Systems and Services, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: August 15, 2003 /s/ GEORGE E. MENDENHALL --------------------------- George E. Mendenhall Chief Executive Officer 30 INTEGRATED BUSINESS SYSTEMS AND SERVICES, INC. FORM 10-QSB EXHIBIT INDEX Exhibit Number ------- 3.1 Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 2.1 to the Company's Form 1-A filed July 9, 1997). 3.2 Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 2.2 to the Company's Form 1-A filed July 9, 1997). 10.1 Employment Agreement dated as of January 1, 1997, as amended January 1, 1999, between the Company and George E. Mendenhall (incorporated by reference to Exhibit 6.3 to the Company's Form 1-A filed July 9, 1997). 10.2 Amendment No. 1 dated as of September 1, 1997, to Employment Agreement dated as of January 1, 1997, between the Company and George E. Mendenhall (incorporated by reference to Exhibit 6.22 to the Company's Amendment No. 1 to Form 1-A filed September 15, 1997). 10.3 Amendment No. 2 dated as of January 1, 1999 to Employment Agreement dated January 1, 1997, between the Company and George E. Mendenhall (incorporated by reference to Exhibit 6.17(b) to the Company's Amendment No. 1 to Form SB-1 filed April 6, 1999 (Registration No. 333-43437). 10.4 Employment Agreement dated as of December 31, 1996 between the Company and Stuart E. Massey (incorporated by reference to Exhibit 6.4 to the Company's Form 1-A filed July 9, 1997). 10.5 Amendment No. 1 dated as of September 1, 1997, to Employment Agreement dated as of December 31, 1996, between the Company and Stuart E. Massey (incorporated by reference to Exhibit 6.23 to the Company's Amendment No. 1 to Form 1-A filed September 15, 1997). 10.6 Employment Agreement effective as of January 1, 1999 between the Company and Donald R. Futch (incorporated by reference to Exhibit 6.20 to the Company's Amendment No. 1 to Form SB-1 filed April 6, 1999 (Registration No. 333-43437)). 10.7 Employment Agreement effective as of May 30, 2000 between the Company and William S. McMaster. (incorporated by reference to Exhibit 10.10 to the Company's 10-KSB for the year ended December 31, 2000). 10.8 Integrated Business Systems and Services, Inc. Stock Option Plan (incorporated by reference to Exhibit 6.18 to the Company's Form 1-A filed July 9, 1997). 10.9 Integrated Business Systems and Services, Inc. 2001 Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.11 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.10 Lease Agreement dated October 1, 2000 between the Company and Atrium Northeast Limited Partnership (incorporated by reference as Exhibit 10.16 of the Company's Form 10-QSB for the quarter ended September 30, 2000). 31 10.11 Escrow Agreement among Pacific Corporate Trust Company, the Company, Harry P. Langley, George E. Mendenhall and Stuart E. Massey (incorporated by reference to Exhibit 6.24 to the Company's Amendment No. 2 to Form 1-A filed October 8, 1997). 10.12 Nonqualified Stock Option Agreement dated as of May 30, 2000 between the Company and William S. McMaster (incorporated by reference to Exhibit 10.15 to the Company's Form 10-KSB for the year ended December 31, 2000). 10.13 Promissory Note dated March 15, 2002 between the Company and Fitz-John Creighton McMaster (incorporated by reference to Exhibit 10.13 to the Company's Form 10-QSB for the three month period ended September 30, 2002). 10.14 Promissory Note dated March 15, 2002 between the Company and Rice Street Associates, LLC (incorporated by reference to Exhibit 10.14 in the Company's Form 10-QSB for the three-month period ended September 30, 2002). 10.15 Second Amendment to and Restated Promissory Note dated August 15, 2001 between the Company and Kirkman Finlay III (incorporated by reference to Exhibit in the Company's Form 10-QSB for the three-month period ended September 30, 2002). 10.16 Letter Agreement between the Company and George E. Mendenhall effective September 1, 2001 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.16 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.17 Letter Agreement between the Company and Stuart E. Massey effective September 1, 2001 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.17 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.18 Letter Agreement between the Company and William S. McMaster effective September 1, 2001 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.18 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.19 Letter Agreement between the Company and Donald R. Futch effective September 1, 2001 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.19 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.20 Letter Agreement between the Company and James V. Hopkins effective September 1, 2001 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.20 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.21 Class A Secured Convertible Debenture dated December 31, 2001 between the Company and IBSS Class A Investors(incorporated by reference to Exhibit 10.21 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.22 Class B Secured Convertible Debenture dated December 31, 2001 between the Company and IBSS Class B Investors (incorporated by reference to Exhibit 10.22 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.23 Common Stock Purchase Warrant dated December 31, 2001 between the Company and IBSS Class A Investors (incorporated by reference to Exhibit 10.23 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 32 10.24 Common Stock Purchase Warrant dated December 31, 2001 between the Company and IBSS Class B Investors (incorporated by reference to Exhibit 10.24 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.25 Omnibus Security Agreement dated December 31, 2001 by and among the Company, IBSS Class A Investors and IBSS Class B Investors (incorporated by reference to Exhibit 10.25 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.26 Inter-Creditor Agreement dated December 31, 2001 by and among the Company, IBSS Class A Investors and IBSS Class B Investors (incorporated by reference to Exhibit 10.26 in the Company's Form 10-QSB for the three-month period ended June 30, 2002). 10.27 Security Agreement dated January 1, 2003 by and between the Company and Fitz-John Creighton McMaster. 10.28 Security Agreement dated January 1, 2003 by and between the Company and Rice Street Associates, LLC. 10.29 Security Agreement dated August 14, 2001 by and between the Company and Kirkman Finlay III (incorporated by reference to Exhibit 10.29 in the Company's Form 10-QSB for the three-month period ended September 30, 2002). 10.30 Integrated Business Systems and Services, Inc. 2002 Stock Option Plan (incorporated by reference to Exhibit 10.30 in the Company's Form 10-QSB for the three-month period ended September 30, 2002). 10.31 Letter Agreement between the Company and Donald R. Futch effective September 1, 2002 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.31 in the Company's Form 10-KSB for the twelve-month period ended December 31, 2002). 10.32 Letter Agreement between the Company and Stuart E. Massey effective September 1, 2002 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.32 in the Company's Form 10-KSB for the twelve-month period ended December 31, 2002). 10.33 Letter Agreement between the Company and William S. McMaster effective September 1, 2002 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.33 in the Company's Form 10-KSB for the twelve-month period ended December 31, 2002).. 10.34 Letter Agreement between the Company and George E. Mendenhall effective September 1, 2002 with respect to cash compensation deferral (incorporated by reference to Exhibit 10.34 in the Company's Form 10-KSB for the twelve-month period ended December 31, 2002). 10.50 Lease Agreement between the Company and Pinebelt, LLC dated October 8, 2002 with respect to property at 1602 Shop Road, Ste E, Columbia, S.C. (incorporated by reference to Exhibit 10.50 in the Company's Form 10-QSB for the three-month period ended March 31, 2003). 21.1 Subsidiaries of the Company (incorporated by reference to Exhibit 21 in the Company's Form 10-KSB for fiscal year ended December 31, 2001). 99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 33

INTEGRATED BUSINESS SYSTEMS & SERVICES INC 10-Q