UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB/A
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 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.
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(Exact Name of Small Business Issuer as Specified in Its Charter)
South Carolina 57-0910139
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(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
1601 Shop Road, Suite E
Columbia, South Carolina 29201
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(Address of Principal Executive Offices) (Zip Code)
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(Former Address, if Changed Since Last Report)
Small Business Issuer's Telephone Number, Including Area Code: 803-736-5595
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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:
23,724,392 shares of no par value common stock outstanding at November 3, 2003.
Transitional Small Business Disclosure Format (check one) ( ) Yes (X) No
Integrated Business Systems and Services, Inc.
Form 10-QSB
Quarter Ended September 30, 2003
Table of Contents
Page Number
PART I FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements:
Consolidated Condensed Balance Sheets as of September 30, 2003 and December 31, 2002 3
Consolidated Condensed Statements of Operations for the three months and nine months
ended September 30, 2003 and 2002, respectively 4
Consolidated Condensed Statements of Cash Flows for the nine months ended September 30,
2003 and 2002, respectively 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Risk Factors That May Affect Our Financial Condition and Operating Results 16
Item 3. Controls and Procedures 24
PART II OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to Vote of Security Holders 25
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
Section 302 Certifications 28
Exhibit Index 30
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
September 30, 2003 December 31, 2002
ASSETS: (unaudited) (audited)
------------------------------------------
Current assets:
Cash and cash equivalents $147,409 $55,874
Accounts receivable, trade, net 168,024 202,970
Interest receivable 30,506 26,539
Other prepaid expenses 6,751 63,809
------------------------------------------
Total current assets 352,690 349,192
Capitalized software costs, net 107,703 241,294
Property and equipment, net 413,397 399,849
Related party receivable 13,200 18,200
Other assets 44,500 11,479
------------------------------------------
Total assets $931,490 $1,020,014
==========================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY):
Current liabilities:
Notes payable $517,500 $696,000
Current portion of long-term debt 2,294,665 150,000
Accounts payable 108,025 190,423
Accrued liabilities:
Compensation and benefits 657,917 519,576
Payroll taxes 85,368 241,726
Professional fees 98,249 170,920
Interest payable 698,758 377,857
Other 116,982 133,614
Deferred revenue 17,087 73,327
------------------------------------------
Total current liabilities 4,594,551 2,553,443
Long-term debt, net of current portion 116,994 2,051,488
------------------------------------------
Total liabilities 4,711,545 4,604,931
------------------------------------------
Shareholders' equity (deficiency):
Common stock, no par value per share, 100,000,000
shares authorized, 23,656,051 and 22,230,258 shares
outstanding at September 30, 2003 and December 31,
2002, respectively 20,195,520 19,877,678
Notes receivable officers/directors (131,080) (131,080)
Unearned compensation - (42,581)
Accumulated deficit (23,844,495) (23,288,934)
------------------------------------------
Total shareholders' equity (deficiency) (3,780,055) (3,584,917)
------------------------------------------
Total liabilities and shareholders' equity
(deficiency) $931,490 $1,020,014
==========================================
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)
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------------------------------
2003 2002 2003 2002
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Revenues:
Services $806,491 $857,568 $2,338,592 $1,810,123
Licenses 48,438 250,000 48,438 506,590
Maintenance and support 47,902 5,718 64,953 54,521
Hardware - third party - 1,855 25,025 84,802
Other - - - 2,325
---------------------------------------------------
Total revenues 902,831 1,115,141 2,477,008 2,458,361
Cost of revenues 324,185 282,117 874,002 1,052,947
---------------------------------------------------
Gross profit 578,646 833,024 1,603,006 1,405,414
---------------------------------------------------
Operating expenses:
Sales and marketing 81,794 102,557 266,228 430,602
Research and development 17,958 77,963 119,575 331,008
General and administrative 298,691 457,663 1,216,139 1,722,742
---------------------------------------------------
Total operating expenses 398,443 638,183 1,601,942 2,484,352
---------------------------------------------------
Income (Loss) from operations 180,203 194,841 1,064 (1,078,938)
---------------------------------------------------
Interest and miscellaneous income 32,845 168,754 49,210 173,554
Interest expense (189,891) (346,582) (590,334) (985,887)
Loss on sale of assets - - (15,501) -
---------------------------------------------------
Total other expenses (157,046) (177,828) (556,625) (812,333)
---------------------------------------------------
Net Income (Loss) $23,157 $17,013 $(555,561) $(1,891,271)
===================================================
Basic loss per share $0.00 $0.00 $(0.02) $(0.10)
Basic weighted average shares outstanding 22,382,100 18,816,267 22,305,095 18,190,537
Diluted loss per share $0.00 $0.00 $(0.02) $(0.10)
4
Integrated Business Systems and Services, Inc.
Consolidated Condensed Statements of Cash Flows
(Unaudited)
Nine months ended
-----------------
September 30,
------------
2003 2002
---- ----
Operating activities
Net loss $(555,561) $(1,891,272)
Adjustments to reconcile net loss to cash provided by (used in)
Operating activities:
Depreciation/amortizaton 109,856 114,016
Amortization of software costs 133,591 134,412
Non-cash interest expense 229,725 695,093
Issuance of stock in payment of accounts payable
and accrued liabilities 13,254 104,446
Loss on disposition of fixed assets 15,500 -
Non-cash compensation 168,790 -
Gain on long term compensation - (83,219)
Changes in operating assets and liabilities:
Accounts receivable 34,946 109,843
Interest receivable (3,967) (4,515)
Unbilled revenue - 38,856
Prepaid expenses and other assets 24,037 (71,004)
Accounts payable (69,898) (185,650)
Accrued expenses 228,704 261,689
Deferred revenue (56,240) (6,772)
----------------------------------
Cash provided by (used in) in operating activities 272,737 (784,077)
----------------------------------
Investing activities
Purchases of property and equipment (138,904) (560)
Related party receivables, net 5,000 7,726
----------------------------------
Cash (used in) provided by investing activities (133,904) 7,166
----------------------------------
Financing activities
Proceeds on notes payable, net - 839,000
Payments on notes payable (178,500) (136,221)
Payments on long term debt (3,917) -
Proceeds from issuance of long-term debt 134,363 -
Proceeds from sale of common stock - 100,000
Proceeds from exercise of common stock options
and warrants 756 11,097
----------------------------------
Cash (used in) provided by financing activities (47,298) 813,876
----------------------------------
Net increase in cash 91,535 36,965
Cash and cash equivalents at beginning of period 55,874 6,100
----------------------------------
Cash and cash equivalents at end of period $147,409 $43,065
==================================
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 nine-month period ended September 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
The computations of basic earnings (loss) per share and diluted
earnings (loss) per share are in conformity with the provisions of Statement of
Financial Accounting Standards No. 128.
Basic income (loss) per share is calculated as income available to
common stockholders divided by the weighted average common shares outstanding.
Diluted earnings per share is calculated as diluted income (loss) available to
common stockholders divided by the diluted weighted average number of common
shares. Diluted weighted average number of common shares has been calculated
using the treasury stock method for Common Stock equivalents, which includes
common stock issuable pursuant to stock options and common stock warrants and,
the if-converted method for convertible debt. The following is provided to
reconcile the earnings per share calculations:
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------------ ---------------------------------
2003 2002 2003 2002
---------------- ---------------- -------------- ---------------
Income (loss) applicable to common shares $ 23,157 $ 17,013 $ (555,561) $ (1,891,278)
Effect of dilution:
Convertible debt -- -- -- --
Stock options -- -- -- --
---------------- ---------------- -------------- ---------------
Loss applicable to shares outstanding,
diluted $ 23,157 $ 17,013 $ (555,561) $ (1,891,272)
================ ================ ============== ===============
Weighted average common shares outstanding,
basic 22,382,100 18,816,267 22,305,095 18,190,537
Effect of dilution:
Convertible debt -- -- -- --
Stock options 877,103 102,381 -- --
---------------- ---------------- -------------- ---------------
Weighted average common shares outstanding,
diluted 23,259,203 18,918,648 22,305,095 18,190,537
================ ================ ============== ===============
6
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 September 30, 2003, the company had a working
capital deficiency of approximately $4.2 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.
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. The Company is currently in default under
all of the remaining 20% short-term notes due January 1, 2004. Under these
principal and interest due total approximately $648,000 as of September 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 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.
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.
7
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 periods ended September 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.
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 FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
statement establishes standards for how an issuer classifies and measures in its
financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with this standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. SFAS No. 150 is effective for all financial instruments entered
into on or modified after May 31, 2003. For existing financial instruments, SFAS
No. 150 is effective at the beginning of the first interim period beginning
after June 15, 2003. The Company adopted SFAS No. 150 and there was no material
impact on its financial position, results of operations or cash flows from
adoption.
8
In November 2002, the FASB's Emerging Issues Task Force ("EITF")
reached a final consensus on Issue No. 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables, which is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. Under
EITF Issue No. 00-21, revenue arrangements with multiple deliverables are
required to be divided into separate units of accounting under certain
circumstances. The company adopted EITF Issue No. 00-21 on July 1, 2003, and
such adoption did not have a material effect on its condensed consolidated
financial statements for the three and nine months ended September 30, 2003.
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:
Nine Months Ended September 30,
2003 2002
------------------- -------------------
Net loss:
As reported $ (555,561) $ (1,891,271)
Add: stock-based compensation expense
included in reported net income
168,790 -
Deduct: stock-based compensation expense
determined under the fair value based
method for all awards (240,464) (576,577)
------------------- -------------------
Pro forma net loss $ (627,235) $ (2,467,848)
=================== ===================
Net loss per common share:
As reported:
Basic and diluted $ (0.02) $ (0.10)
Pro forma:
Basic and diluted $ (0.03) $ (0.13)
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:
9
Nine Months Ended September 30,
2003 2002
------------ ------------
Dividend yield - -
Expected volatility 122-141% 122-141%
Risk-free rate of return 2.61-6.04% 4.53-6.04%
Expected option life, years 5 5
The weighted average fair value for options granted under the Option
Plans during the nine months ended September 30, 2003 was $0.20. The weighted
average fair value for options granted under the Option Plans during the six
months ended September 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.
7. Debt Restructure
On October 27, 2003 the Company signed a letter of intent to
restructure the majority (80%) of its short-term debt. The new convertible notes
will be non-interest bearing and not be due until the end of 2005.
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 September 30, 2003 Compared to Three Months Ended
September 30, 2002
Revenues. Our total operating revenues decreased by $212,310 (or
approximately 19%) to $902,831 in the three months ended September 30, 2003,
from $1,115,141 in the comparable prior year period. This decrease was primarily
attributable to the decrease of license revenues from the sales of our Synapse
Manufacturing (MES) software.
Cost of Revenues. Our total cost of revenues increased $42,068 (or
approximately 15%) to $324,185 in the three months ended September 30, 2003,
from $282,117 in the comparable prior year period.
Gross Profit and Margins. Our gross profit decreased $254,378 (or
approximately 31%) to $578,646 in the three months ended September 30, 2003,
from $833,024 in the comparable prior year period. We experienced a
corresponding gross margin decrease to approximately 64% for the three months
ended September 30, 2003 from approximately 75% for the comparable prior year
period. This decrease was attributable to the decrease in the third quarter of
2003 in license sales where we generate our highest margins.
Sales and Marketing Expenses. Our sales and marketing expenses
decreased $20,763 (or approximately 20%) to $81,794 in the three months ended
September 30, 2003, from $102,557 in the comparable prior year period. As a
percentage of our quarterly revenues, sales and marketing expenses in the third
quarter of this year remained at 9% the same as in the comparable quarter of
last year.
Research and Development Expenses. Our research and development
expenses decreased $60,005 (or approximately 77%) to $17,958 in the three months
ended September 30, 2003, from $77,963 in the comparable prior year period. As a
percentage of our total quarterly revenues, research and development expenses in
the third quarter of 2003 decreased to 2% from 7% in the comparable quarter of
last year. The decrease for the third quarter of this year was primarily
attributable to the relatively larger allocation of human resources in the third
quarter of last year to research and development. Although our research and
development expenses in the third 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 was experienced from 2002 to 2003.
General and Administrative Expenses. Our general and administrative
expenses decreased $158,972 (or approximately 35%) to $298,691 in the three
months ended September 30, 2003, from $457,663 in the comparable prior year
period. As a percentage of our quarterly revenues, general and administrative
expenses in the third quarter of this year decreased to 33% from 41% in the
comparable quarter of last year. The decrease for the third 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 $20,782 (or
approximately 12%) to $157,046 in the three months ended September 30, 2003,
from $177,828 in the comparable prior year period. The largest expense in this
category is interest expense. Interest expense decreased approximately 45% (or
approximately $156,691) to $189,891 in the three months ended September 30, 2003
as compared to $346,582 in the comparable prior year period.
11
Nine Months Ended September 30, 2003 Compared to Nine Months Ended
September 30, 2002
Revenues. Our total operating revenues increased by $18,647 (or
approximately 1%) to $2,477,008 in the nine months ended September 30, 2003,
from $2,458,361 in the comparable prior year period. This increase was primarily
attributable to the increase of $528,469 in our service revenue associated with
Fruit of the Loom, offset by a decrease of $458,152 in license revenue.
Cost of Revenues. Our total cost of revenues decreased $178,945 (or
approximately 17%) to $874,002 in the nine months ended September 30, 2003, from
$1,052,947 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.
Gross Profit and Margins. Our gross profit increased $197,592 (or
approximately 14%) to $1,603,006 in the nine months ended September 30, 2003,
from $1,405,414 in the comparable prior year period. We experienced a
corresponding gross margin increase to approximately 65% for the nine months
ended September 30, 2003 from approximately 57% for the comparable prior year
period. This increase was attributable to the increase, both absolute dollars
and as a proportion of gross revenues, in our service revenues, where we
generate some of our highest 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 $164,374 (or approximately 38%) to $266,228 in the nine months ended
September 30, 2003, from $430,602 in the comparable prior year period. As a
percentage of our quarterly revenues, sales and marketing expenses in the first,
second and third quarters of this year decreased to 11% from 18% 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 $211,433 (or approximately 64%) to $119,575 in the nine
months ended September 30, 2003, from $331,008 in the comparable prior year
period. As a percentage of our total quarterly revenues, research and
development expenses in the first, second and third quarter of 2003 decreased to
5% from 13% in the comparable quarters of last year. The decrease for the first
three quarters of this year was primarily attributable to the relatively larger
allocation of human resources in the first three 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 nine months 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.
General and Administrative Expenses. Our general and administrative
expenses decreased $506,603 (or approximately 29%) to $1,216,139 in the nine
months ended September 30, 2003, from $1,722,742 in the comparable prior year
period. As a percentage of our quarterly revenues, general and administrative
expenses in the first, second and third quarters of this year decreased to 49%
from 70% 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."
12
Non-Operating Items. Other income and expenses decreased $255,708 (or
approximately 31%) to $556,625 in the Nine months ended September 30, 2003, from
$812,333 in the comparable prior year period, primarily as a consequence of a
decrease in interest expense.
Interest expense decreased 395,553(or approximately 40%) to $590,334 in
the nine months ended September 30, 2003 as compared to $985,887 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.
Cash Flow Analysis
Net cash provided by operating activities was $272,737 during the nine
months ended September 30, 2003, representing an increase of $1,056,744 from the
$784,077 of net cash used in operating activities during the comparable prior
year period. This significant turn-around to net cash provided by operations
this year from net cash used in operations the first nine 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 $133,904 during the nine
months ended September 30, 2003, representing an increase of $141,070 from net
cash provided by investing activities of $7,166 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."
Net cash used in financing activities was $47,298 during the three
months ended September 30, 2003, representing a decrease in cash provided by
financing activities of $861,174 from the $813,876 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 third quarter of 2002 as compared to the
third quarter of this year and the increase in cash used in the third 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.
13
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 above.
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, 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. The Company is currently in default under all of the remaining 20%
short-term notes due January 1, 2004. Under these principal and interest due
total approximately $648,000 as of September 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.
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 the
remainder of 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.
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.
14
We believe that the accounting policies described below are critical to
understanding our business, results of operations and financial condition
because they involve more significant judgments and estimates used in the
preparation of our consolidated financial statements. We have discussed the
development, selection and application of our critical accounting policies with
the audit committee of our board of directors, and our audit committee has
reviewed our disclosure relating to our critical accounting policies in this
"Management and Analysis of Financial Condition and Results of Operations."
Deferred Tax Asset Recoverability - We have recorded a full valuation allowance
against our deferred tax assets as a result of our losses over the recent
history. We considered future taxable income versus the cumulative losses
incurred during previous years and determined that, in light of the cumulative
losses over our recent history, we could not support a conclusion that
realization of the existing deferred tax assets was more likely than not.
Likewise, should we determine that we would be able to realize our deferred tax
assets in the future, an adjustment will be made to the balance of the valuation
allowance.
Revenue Recognition - We generate our revenues primarily by licensing to
customers standardized manufacturing software systems and providing integration
services, automation and administrative support and information services to the
manufacturing industry. We recognize revenues related to software licenses and
software maintenance in compliance with the American Institute of Certified
Public Accountants Statement of Position No. 97-2, "Software Revenue
Recognition," as amended. Revenue is generally recognized when all of the
following criteria are met as set forth in paragraph 8 of SOP 97-2: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the
fee is fixed or determinable; and (4) collectibility is probable. Each of these
four criteria above is defined as follows:
Persuasive evidence of an arrangement exists. Our customary practice is to have
a written contract, which is signed by both the customer and us or, in
situations where a contract is not required; a customer purchase order has been
received by us.
Delivery has occurred. Our software may be either physically or electronically
delivered to our customers. Delivery is deemed to have occurred upon the
delivery of the electronic code or the shipment of the physical product based on
standard contractual committed shipping terms, whereby risk of loss passes to
the customer when the shipment is picked up by the carrier. If undelivered
products or services exist in an arrangement that are essential to the
functionality of the delivered product, delivery is not considered to have
occurred until these products or services are delivered as described above.
The fee is fixed or determinable. Our customers generally pay a per-license fee
that is based on the number of servers on which the software is installed, the
size of the application that they will develop for the software, the options
provided for those servers, and the number of client workstations that access
the server. Additional license fees are due when the total number of subscribers
increases beyond the specified number for which a license was purchased or when
additional options are added. License fees are generally due within 30-45 days
from product delivery.
Collectibility is probable. We assess collectibility on a customer-by-customer
basis. We typically sell to customers with high credit ratings and solid payment
practices. New customers are subjected to a credit review process in which we
evaluate the customers' financial position and ultimately their ability to pay.
If we determine, from the outset of an arrangement that collectibility is not
probable based upon the credit review process, we recognize revenue as we
receive cash payments.
15
Our agreements with our customers and resellers do not contain product return
rights. Revenues from maintenance, which consist of fees for ongoing support and
product updates, are recognized ratably over the term of the contract, typically
one year. Consulting revenues are primarily related to implementation services
performed on a time and materials basis under separate service arrangements.
Software Development Costs - Under the provisions of SFAS No. 86, "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
issued by the Financial Accounting Standards Board ("FASB"), certain costs
incurred in the internal development of computer software, which is to be
licensed to customers, are capitalized. Amortization of capitalized software
costs is provided upon commercial release of the products at the greater of the
amount using (i) the ratio that current gross revenues for a product bear to the
total of current and anticipated future gross revenues of that product or (ii)
the straight-line method over the remaining estimated economic life of the
product including the period being reported on. Capitalized software costs are
generally amortized on a straight-line basis over five years.
Costs that are capitalized as part of internally developed software primarily
include direct and indirect costs associated with payroll, computer time and
allocable depreciation and other direct allocable costs, among others. All costs
incurred prior to the establishment of technological feasibility, which is
defined as the earlier to occur of (1) establishment of a detail program design
or (2) the development of a working model, have been expensed as research and
development costs during the periods in which they were incurred. Once
technological feasibility has been achieved, costs of producing the product
master are capitalized. Capitalization stops when the product is available for
general release. The amount, by which unamortized software costs exceed the
estimated net realizable value, if any, is charged to income in the period it is
determined. We evaluate the net realizable value of capitalized computer
software costs and intangible assets on an ongoing basis relying on a number of
factors, including operating results, business plans, budgets and economic
projections.
Accounting for Stock-Based Compensation - SFAS No. 123, Accounting for
Stock-Based Compensation defines a fair value method of accounting for issuance
of stock options and other equity instruments. Under the fair value method,
compensation cost is measured at the grant date base on the fair value of the
award and is recognized over the service period, which is usually the vesting
period. Pursuant to SFAS No. 123, companies are not required to adopt the fair
value method of accounting for employee stock-based transactions. Companies are
permitted to account for such transactions under APB Opinion No. 25, Accounting
for Stock Issues to Employees, but are required to disclose in a note to the
consolidated financial statements pro forma net income and per share amounts as
if a company had applied the methods prescribed by SFAS No. 123.
We apply APB Opinion No. 25 and related interpretations, which do not require us
to recognize compensation cost, in accounting for stock options granted to
employees and non-employee directors, and we have compiled with the disclosure
requirements of SFAS No. 123.
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.
17
In accordance 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.
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.
At September 30, 2003, we had approximately $2.9 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 $648,000 in principal
and interest is due during the remainder of 2003, and the remainder is due
during the first quarter of 2004. The company is currently in default on a
portion of its outstanding debt. Principal and internal amounts totalling
approximately $648,000 at September 30, 2003. Funds from any resulting
liquidation of all our assets would not be sufficient to fully repay our secured
creditors. In such event, our unsecured creditors and our shareholders would
receive nothing.
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 principal 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.
18
At September 30, 2003, we owed $113,822 in federal 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.
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.
19
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 and third quarter of this
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.
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 quarters
of 2002 and 2003, many factors, including the factors described in this report,
may result in our incurring losses for the remainder of 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 quarters of 2002 and 2003.
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.
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.
20
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.
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.
21
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
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.
22
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.
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.
23
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.
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 September 30, 2003, we had 23,656,051 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
September 30, 2003, if all of the outstanding options and warrants were
exercised and all of the outstanding debt was converted.
24
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
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.
25
2
-- 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.
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.
26
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 September 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.
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 September 30, 2003:
Current Report on Form 8-K, dated August 18, 2003, reporting, under
Item 9, the Company's Second Quarter Earnings.
Signatures and Certifications of the Chief Executive Officer and the Executive
Secretary of the Company
The following pages include the Signatures pages for this report and
separate Certifications of the Chief Executive Officer and the Executive
Secretary 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).
27
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: November 14, 2003 INTEGRATED BUSINESS SYSTEMS AND SERVICES, INC.
(Registrant)
By: /s/ GEORGE E. MENDENHALL
---------------------------
George E. Mendenhall
Chief Executive Officer
By: /s/ STUART E. MASSEY
---------------------------
Stuart E. Massey
Executive Secretary
28
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: November 14, 2003 /s/ GEORGE E. MENDENHALL
---------------------------
George E. Mendenhall
Chief Executive Officer
29
SECTION 302 CERTIFICATION
I, Stuart E. Massey, certify that:
5. I have reviewed this quarterly report on Form 10-QSB of Integrated Business
Systems and Services, Inc.;
6. 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;
7. 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;
8. 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: November 14, 2003 /s/ STUART E. MASSEY
---------------------------
Stuart E. Massey
Executive Secretary
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 (incorporated by reference to Exhibit
10.27 in the Company's Form 10-QSB for the three-month period ended
June 30, 2003).
10.28 Security Agreement dated January 1, 2003 by and between the Company and
Rice Street Associates, LLC (incorporated by reference to Exhibit 10.28
in the Company's Form 10-QSB for the three-month period ended June 30,
2003).
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