Datatec Systems, Inc. and its subsidiaries (the "Company", "Datatec", or "we") are in the business of providing rapid and accurate technology services and licensing software tools designed to accelerate the delivery and management of complex Information Technology ("IT") solutions for technology providers, primarily large Original Equipment Manufacturers ("OEMs"), systems integrators, independent software vendors, telecommunications carriers and service providers (collectively, "Technology Providers"), as well as to a select number of "Fortune 2000" customers in the United States and Canada.

The Company's services include the following: (i) configuration: the process of "customizing" internetworking devices such as routers and switches, and computing devices such as servers and workstations to meet the specific needs of the user; (ii) integration: the process of integrating these hardware devices as well as integrating operational and application software on a network to ensure they are compatible with the topology of the network and all legacy systems; (iii) installation: the physical process of installing technology on networks; and (iv) service chain management: enabling product or service providers to jointly manage the customer support relationship between themselves and all vendors supplying technology or services. Also, the Company licenses its software tools through its Global Integration Services division to organizations with their own installation forces.

The Company utilizes internally developed Web-enabled implementation tools that differentiate its deployment services. These tools, together with its proprietary processes, allow the Company to rapidly and efficiently deliver high quality and cost effective large-scale technology deployment solutions to its clients, which it does primarily on a fixed time/fixed cost basis. The components of the Company's implementation model are made up of a combination of people, processes and technology that include:

The Company operates out of 10 offices and has a field deployment team of approximately 715 people, allowing it to conduct multiple, simultaneous large-scale deployments across the United States and Canada. The Company's services capabilities further enable Technology Providers to rapidly increase the "absorption" of their products in the marketplace.

The Company was incorporated in the State of Delaware on January 10, 1996 and its stock is traded on the NASDAQ National Market System under the symbol "DATC". The Company maintains its executive offices at 23 Madison Road, Fairfield, New Jersey 07004. Its telephone number is (973) 808-4000. The Company's Website can be located at www.datatec.com.

At the start of fiscal 2003, the Company changed its method of estimating progress toward completion of contracts. Under the Company's previous method, the percentage of direct labor incurred to date to total estimated direct labor to be incurred on a project was used to determine a contract's percentage of completion, while under the new method, the percentage of total costs incurred to date to total estimated costs to be incurred on a project is used to determine a contract's percentage of completion. The change was made to reflect the effect of non-labor charges and to more accurately measure a contract's progress towards completion. In accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes," paragraph 27, the financial statements of prior periods have been adjusted to apply the new method retroactively.

A summary of the significant effects of the accounting change applied to the Company's restated results can be found in the Company's Annual Report on Form 10-K for the period ended April 30, 2002.

Technology Providers need to improve the "absorption" or "time to market" of their products in order to maximize return on sales, as well as return on product development costs. In addition, end users need to maximize their return on technology investments especially when one considers the rapid obsolescence factor, which has a negative impact on returns if the time to deploy new technology is not minimized. The speed and accuracy of deployment are critical factors in improving these fundamental ratios.

The dynamics that are driving increasing demand for the Company's software-enabled deployment offerings include the following:

Technology companies continue to launch new products at an ever-faster rate. Due to the speed of change there is currently a lack of trained personnel to assimilate these new products rapidly and efficiently in the market. The Company believes that the use of its tools better aligns the current speed of technology introductions with the absorption of that technology in the marketplace.

The Company has created the following distinct branded solutions targeted towards specific market needs: (i) Network Device Deployment; (ii) Computing Device Deployment; (iii) Technology Refresh & Migration; (iv) Site Readiness & Infrastructure; and (v) Consolidated Support Center.

Network Device Deployment ("NDD"). NDD is the software-enabled process for staging, configuring, integrating and installing new communication devices such as routers and switches. Clients can elect to outsource one or all of the above functions. They can also choose to carry out the first three processes within their own manufacturing, staging or integration facilities using Datatec's IW2000.

Computing Device Deployment ("CDD"). CDD is the software-enabled process for staging, configuring, integrating and installing new computing devices such as servers, workstations and laptops. Clients ship products to one of the Company's configuration centers for processing. However, before the deployment process can commence, significant pre-deployment time is spent in engineering, designing, software customization and data collection to ensure rapid and error-free deployment. The Company has identified CDD as a major opportunity for growth.

Technology Refresh & Migration ("TRM"). TRM projects apply the Company's methodology and configuration automation tools to decrease the time and complexity of upgrading a client's existing IT infrastructure and equipment on-site. Typical TRM projects may include one or in some cases all of the following:

Site Readiness and Infrastructure ("SRI"). A major technology migration or upgrade within an organization often requires an overhaul of a company's physical infrastructure before the start of the migration or upgrade. Datatec has significant experience and expertise in ensuring that a site is fully capable of accepting new technology. Infrastructure improvement could include one or all of the following:

Consolidated Support Center. Consolidated Support Center is the software-enabled process for allowing the customer and all related vendors to utilize the Company as a Single Point of Contact (SPOC) for all service related requests. This could include one or all of the following services: deployment support, Level 0 and Level 1 technical support (classic help desk services) or on complete service chain management. The Company has identified the Consolidated Support Center as a major opportunity for continued growth.

The Company's mission is to see its processes and methodologies, which are encapsulated in its software tools, become the defacto standard for technology deployment. The Company's strategy is to achieve this by providing full end-to-end software-enabled deployment services and by licensing its software tools to large Technology Providers and certain "Fortune 2000" companies. The Company is engaged in the following activities in support of this strategy:

The Company's marketing efforts are focused on projects requiring more complex solutions from a technical, geographic dispersion, or time-sensitive point of view. In the Company's experience, more complex, multi-site deployments have significantly less competitive pressures and generate higher proposal close rates and gross margins than deployments with less complexity and/or less geographic dispersion.

Given the growth of the Internet economy, the Company has over the past several years focused on creating relationships with OEMs and Technology Providers. These market segments are in need of resources and processes to facilitate the assimilation of new technologies in their respective markets. By accelerating the absorption of technologies, the Company believes that it improves the return on sales for these partners and the return on new technology investment for their partners and customers.

This strategy has helped establish a new "Indirect" identity for the Company as it forms significant relationships with global OEMs and major integrators. These relationships have in turn provided new and additional leverage for access to and identity in the Company's targeted market segments.

The Company has created alliances with non-competitive service providers in order to provide seamless solutions to end users. Any major technology deployment comprises four major phases:

Datatec focuses on the Implementation phase and, through its consolidated support center, the Operations phase, by creating a post sales support function. Datatec continues to create relationships with companies that address the other two phases in order to provide greater asset lifecycle support to its clients. Collaboration in resource allocation, planning and project execution by the various partners is being enabled through eDeploy, allowing end users to benefit from the expertise of "best of breed" providers without the disadvantages of having to manage the "agendas" of several and disparate IT providers.

Backlog for the Company's services as of June 30, 2001, 2002 and 2003 was approximately $58 million, $52 million and $62 million, respectively. Backlog consists of purchase orders and written agreements with customers for which a customer has scheduled the provision of services within the next 12 months. Orders included in backlog may be canceled or rescheduled by customers without penalty. A variety of conditions, both specific to the individual customer and generally affecting the customer's industry, may cause customers to cancel, reduce or delay orders that were previously made or anticipated. The Company cannot assure the timely replacement of canceled, delayed or reduced orders. Significant or numerous cancellations, reductions or delays in orders by a customer or group of customers could have a material adverse effect on the Company's business, consolidated financial position or consolidated results of operations. Backlog should not be relied upon as indicative of the Company' s revenues for any future period.

The Company performs deployment services directly to a variety of enterprise clients. The major industry segments to which Datatec sells are Retail, Financial Services, Insurance and Hospitality, which typically have a large number of geographically dispersed sites and deploy complex technology. Also, the Company delivers its services to end users through Technology Providers that utilize the Company's deployment services on a project-by-project basis. The Company's clients include:

During each of the past three fiscal years, revenue from the Company's services to a limited number of customers has accounted for a substantial percentage of the Company's total revenue. For the years ended April 30, 2001, 2002 and 2003 the Company's 15 largest customers accounted for approximately 82%, 83% and 96% of the Company's revenue, respectively. For the year ended April 30, 2001, IBM Global Services and Lowe's Companies, Inc. accounted for approximately 27% and 21% of the Company's revenue, respectively. For the year ended April 30, 2002, Lowe's Companies, Inc. accounted for approximately 33% of the Company's revenue. For the year ended April 30, 2003, Lowe's Companies, Inc. and IBM Global Services accounted for approximately 37% and 28% of the Company's revenue, respectively. This concentration of customers can cause the Company's revenue and earnings to fluctuate from quarter-to-quarter, based on customer requirements and the timing of service delivery.

The Company encounters vigorous competition in its business from a variety of sources. Datatec competes with other companies involved in the design, sale, installation, integration and servicing of computer and networking technologies, as well as companies that develop software tools to automate the technology implementation process. The IT deployment market is highly fragmented and characterized by a small number of very large organizations that carry out a significant amount of deployment services and a large number of small companies that in turn carry out small amounts of deployment. Although no one company dominates the deployment market, many of the Company's competitors are larger and have substantially more resources than the Company. In addition to direct competition, the Company faces indirect competition from end users, many of whom internally design, integrate and deploy their own technologies. The Company, however, knows of no other company that offers rapid IT deployment services or software tools designed to support the delivery of complex IT solutions as their primary business focus.

The Company relies on a combination of trade secrets, copyright and trademark laws and contractual restrictions to establish and protect proprietary rights in its technology. The eDeploy trademark is protected for ten years from February 1, 2000 under United States Trademark laws.

The Company has entered into confidentiality and invention assignment agreements with its software developers, and, when obtainable, enters into non-disclosure agreements with its suppliers, distributors and others so as to limit access to and disclosure of its proprietary information. There can be no assurance that these statutory and contractual arrangements will prove sufficient to deter misappropriation of the Company's technologies or that the Company's competitors will not independently develop non-infringing technologies that are substantially similar to or superior to the Company's technology. The Company invested $1.4 million, $0.5 million and $0.6 million in product related research and development activities during the fiscal years ended April 30, 2001, 2002 and 2003, respectively. The Company did not engage in any customer sponsored research and development activities during these fiscal years.

On November 2, 2001, the Company acquired 100,000 shares of Series A Preferred Stock of eDeploy.com, Inc. (the "Shares"), a wholly owned subsidiary ("eDeploy.com"), held by Cisco Systems, Inc. ("Cisco") through an exchange of 1,021,382 shares of Datatec's common stock. Dividends payable to Cisco during the period it held the 100,000 shares of Series A Preferred Stock of eDeploy.com, Inc. are included in accrued and other liabilities and annual dividends, recorded prior to the exchange, are reflected as minority interest in the Company's consolidated statements of operations.

As of April 30, 2003, the Company had 1,099 full-time employees, 715 of whom are employed under contracts managed by the International Brotherhood of Electrical Workers and the International Brotherhood of Electrical Workers Local 3. The current contracts with the union expire on December 31, 2004.

The Company's success depends in large part upon its ability to attract and retain qualified employees, particularly senior management, systems engineering personnel and sales personnel. The competition for such employees is intense. There can be no assurance that the Company will be successful in attracting or retaining any employees. Any failure by the Company to retain qualified senior management, systems engineering personnel or sales personnel could materially adversely affect the Company's business, operating results, and financial condition. The Company believes that its relationship with its employees is satisfactory.

The Company's corporate headquarters is located in leased facilities aggregating 42,675 square feet located at 23 Madison Road, Fairfield, New Jersey 07004. This facility is comprised of the Company's headquarters as well as one of the Company's two Configuration Centers. In addition to its headquarters building, the Company leases, throughout the United States, approximately 156,703 square feet of space in nine locations for its sales and field operations and configuration centers. The Company believes that it has sufficient space to meet its operating needs.

The Company, from time to time, is involved in routine litigation and various legal matters in the ordinary course of business. The Company does not expect that the ultimate outcome of this litigation will have a material adverse effect on its results of operations or financial position. Other than as described below, the Company is not a party to legal proceedings that individually or in the aggregate are believed to be material to the Company's results of operations or financial condition.

On September 22, 2000, Petsmart, Inc. filed a complaint against the Company in the Superior Court of Maricopa County, Arizona. Petsmart has alleged that it has been damaged by the Company's failure to satisfactorily complete work contemplated by an agreement between the parties. Damages were unspecified. At a settlement meeting held on April 17, 2002, discussions were held in which Petsmart proposed a series of settlement offers under which we would pay damages ranging between $7,000,000 and $8,000,000. In a letter to us dated May 3, 2002, Petsmart proposed settlement offers under which we would pay damages ranging between $5,000,000 and $7,000,000. On March 7, 2003, Petsmart filed an Offer of Judgment offering to settle the litigation for a payment of $2,300,000. We believe that we have meritorious defenses to the claims and we intend to defend this vigorously. We have further counter-claimed against Petsmart for amounts owing to us under the contract. These amounts have been reserved as part of the allowance for uncollectable accounts. A trial date has been set for August 2003.

On April 30, 2003, the Company held its Annual Meeting of Stockholders for the year ended April 30, 2002 whereby the Company's stockholders (a) elected seven (7) directors (b) approved an amendment to the 2000 Stock Option Plan to increase the number of shares available for issuance under the 2000 Stock Option Plan from three million shares of Common Stock to five million shares of Common Stock and (c) ratified the appointment of Deloitte & Touche LLP as the Company's independent public accountants for the fiscal year ended April 30, 2003. The vote on such matters was as follows:

(a) Election of Directors:

The Company intends to hold its next annual meeting of stockholders for the fiscal year ended April 30, 2003 on October 21, 2003. Stockholder proposals made in accordance with Rule 14a-8 under the Exchange Act and intended to be presented at the Company's annual meeting of stockholders, must be received by the Company at the Company's principal office no later than August 25, 2003 for possible inclusion in the proxy statement for that annual meeting of stockholders.

(A) Market Information

The Company's Common Stock is currently traded on the Nasdaq National SmallCap System ("NASDAQ") under the symbol "DATC". The following table sets forth the high and low sale prices on NASDAQ for the periods indicated.

(B) Holders

As of June 30, 2003, there were approximately 340 holders of record of the Company's Common Stock.

The Company has not paid any cash dividends on its Common Stock since its inception, other than distributions to shareholders in amounts sufficient to reimburse Datatec Industries, Inc. shareholders for Federal (and some state) income tax liabilities arising from Datatec Industries, Inc.'s former status as an "S" Corporation. The Company currently intends to retain any earnings for use in the business and does not anticipate paying any dividends to its shareholders in the foreseeable future. The Company's loan agreements with its primary lender includes a restriction prohibiting the payment of dividends.

For the "Equity Compensation Plan Information" table, please refer to Item 12, which begins on page 80 .

(D) Securities Authorized for Issuance and Recent Sales of Unregistered Securities

On April 23, 2003, the Company raised gross proceeds of $5.0 million in a private placement (the "Offering") of 2,000,000 million units comprised of 4,000,000 shares of its Common Stock, and warrants to purchase 2,000,000 shares of Common Stock. These warrants have an exercise price of $1.625 and expire on April 23, 2007.

The placement agent for the Offering was Fahnestock & Co., Inc. As part of its fee for the Offering, the Company issued to Fahnestock warrants to purchase 480,000 shares of Common Stock at an exercise price of $1.75 and an expiration date of April 23, 2007. In addition, the Company paid Fahnestock placement agent commissions of $325,000.

The Company has also agreed to file a registration statement for the resale of the shares of Common Stock issued in the Offering and the shares of Common Stock underlying the warrants, and to use its commercially reasonable efforts to cause the registration statement to be declared effective within 90 days of the closing. The Company filed such registration statement on May 29, 2003.

The issuance of these shares of Common Stock and the warrants were not registered under the Securities Act of 1933. The Company believes that the issuance of these shares of Common Stock and Warrants are exempt from registration under Section 4(2) of the Securities Act of 1933 as a transaction not involving a public offering.

The following table sets forth the selected financial data of the Company for the years ended and at April 30, 1999, 2000, 2001, 2002 and 2003.

The data presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and the notes thereto appearing elsewhere herein.

The Company is in the business of providing rapid and accurate technology deployment services and licensing software tools to support Technology Providers and Enterprises in the delivery of complex IT solutions. Utilizing two (2) regional staging and configuration centers and its own field deployment team of approximately 715 people operating out of 9 offices, the Company conducts multiple simultaneous large-scale deployments for organizations throughout the United States and Canada. The Company believes its consistent, rapid deployment model enables its Enterprise customers to accelerate the assimilation of networking technologies into their organizations and allows its Technology Providers to enhance the absorption of their products in the marketplace.

The Company began utilizing software tools as the main driver of its configuration and integration services when it acquired Computer Aided Software Integration, Inc. ("CASI") in 1996. This acquisition brought with it IW2000, a suite of software tools used in the configuration and integration processes. During fiscal 1999 the Company began expanding its development of software tools to incorporate several new applications in addition to IW2000 and has incorporated them into a new product, eDeploy®. These applications include: Preparation and Design, Configuration and Integration, Deployment Management and Transition and Maintenance. During that year the Company merged the activities of developing, marketing, selling and managing the licensing of its software into its CASI subsidiary. The Company then changed the name of CASI to eDeploy.com, Inc. ("eDeploy.com"). Subsequently, the Company realized that it was more efficient to manage all of its activities under one operatin g unit. As a result, the activities of eDeploy.com was integrated into the operations of Datatec. The Company fully integrated the application of eDeploy into its operations during the later part of the fiscal year ended April 30, 2001.

At the start of fiscal 2003, the Company changed its method of estimating progress toward completion of contracts. Under the Company's previous method, the percentage of direct labor incurred to date to total estimated direct labor to be incurred on a project was used to determine a contract's percentage of completion, while under the new method, the percentage of total costs incurred to date to total estimated costs to be incurred on a project is used to determine a contract's percentage of completion. The change was made to reflect the effect of non-labor charges and to more accurately measure a contract's progress towards completion. In accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes," paragraph 27, the financial statements of prior periods have been adjusted to apply the new method retroactively.

A summary of the significant effects of the accounting change applied retroactively are shown below:

A summary of the significant effects of the accounting change applied to the Company's restated results can be found in the Company's Annual Report on Form 10-K for the period ended April 30, 2002.

Subordinated Secured Convertible Debentures. On April 3, 2002, the Company raised $2.0 million (less transaction costs of $0.170 million) which was used for working capital purposes by issuing an aggregate of $2.0 million principal amount of Subordinated Secured Convertible Debentures and Warrants to purchase an aggregate of 270,000 shares of Common Stock at $1.416 per share. At April 30, 2003, $0.6 million of the debentures had been converted into shares of the Company's Common Stock. Subsequent to April 30, 2003, all of the debentures, together with interest, were converted into shares of the Company's Common Stock. The debentures have been converted into a total of 1,755,288 shares of Common Stock. In connection with the issuance of the debentures, the Company was required to register the shares of Common Stock underlying the debentures with the SEC. Although the Company filed the required registration statement with the SEC within the required time period, such registr ation statement was not declared effective within the required time period and as such, the Company was in default of its registration rights agreement and incurred certain penalties. Consequently, the Company issued an aggregate of 669,794 shares of Common Stock to the investors in exchange for the full cancellation of penalties. On April 1, 2003, the SEC declared the registration statement covering the shares issued to the holders of the debentures effective.

The Company recorded a discount of $582,000 in connection with the issuance of the debentures. The warrants have been valued at approximately $291,000, based on the Black Scholes Pricing Model utilizing the following assumptions: expected life of 5.0 years; volatility of 119%, and risk free borrowing rate of 4.405%. This amount has been recorded as a discount against the debt and will be accreted as interest expense over the remaining life of the debt. In addition, in accordance with Emerging Issues Task Force Issue No. 98-5, an embedded beneficial conversion feature of approximately $291,000 has been recognized as additional paid-in-capital and will be accreted as additional interest expense over the remaining life of the debt. Through April 30, 2003, $504,000 of the above discounts has been accreted. The debentures were secured by all of the Company's assets.

The warrants are exercisable at any time from April 3, 2002 to April 3, 2007 and are not redeemable by the Company. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price.

Private Placement of Common Stock. On April 28, 2003, we raised $5.0 million in private equity financing (less out-of-pocket transaction costs of approximately $0.425 million) for working capital purposes by selling 4 million shares of our common stock and warrants to purchase an additional 2 million shares of common stock at an exercise price of $1.625 per share. The warrants are exercisable at any time from April 28, 2003 to April 28, 2007. We may redeem the warrants at any time after April 28, 2004 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. We also issued a four-year warrant to purchase 480,000 shares of common stock at an exercise price of $1.75 per share to the placement agent for the financing. These warrants are exercisable at any time from April 28, 2003 to April 28, 2007 and are not redeemable by us. The exercise price on both the warrants issued to investors in the private placement and the warrants issued to the placement agent is subject to adjustment upon certain events, including stock dividends, reclassifications, recapitalizations, reorganizations and mergers. In addition, the exercise price of the warrants issued to the investors in the private placement is subject to adjustment upon issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price. The agreement with the investors in the private placement requires us to file a registration statement for the resale of the shares of the common stock issued, as well as the shares underlying the warrants, with the SEC within 45 days of April 28, 2003 and have such registration statement be declared effective within 90 days of April 28, 2003.

Acquisition of Millennium Care. On May 1, 2003, we acquired all of the outstanding equity of Millennium Care Inc., a privately-held help-desk outsourcing company. In connection with the acquisition, we issued 1,546,247 shares of common stock, warrants to purchase an additional 200,000 shares of common stock and employee stock options to purchase 56,490 shares of common stock. The warrants are exercisable at $1.82 per share and are not exercisable before January 31, 2004 or after May 1, 2008. These warrants also require Millennium to achieve a revenue target of CDN$5.4 million for calendar year 2003 in order to become exercisable. We may redeem the warrants at any time after January 31, 2005 at a price of $0.10 per warrant if the closing price of the common stock is at least 180% of the exercise price for 20 out of 30 consecutive trading days and the average daily trading volume during this period is greater than 100,000 shares per day. The exercise price of the warrants is sub ject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets. The stock options are exercisable at $1.40 per share and were issued to replace Millennium employee options, which were canceled as a result of the acquisition. We have also agreed to issue to the sellers of Millennium additional shares of common stock in the event certain revenue targets are met by Millennium during calendar year 2003 and 2004. If Millennium achieves qualified revenue of over $6 million (Canadian) in calendar year 2003 or $10 million (Canadian) in calendar year 2004, we would be required to issue additional shares of our common stock in an amount equal to 40% of any such excess for calendar year 2003 and 35% of any such excess or calendar year 2004.

Issuance of Subordinated Secured Convertible Notes and Warrants. On July 3, 2003, we issued an aggregate of $4.9 million principal amount of subordinated secured convertible notes and warrants to purchase an aggregate of 875,000 shares of our common stock, pursuant to a Note Purchase Agreement by and among the Company and the investors signatory thereto. The investors are six funds managed by the Palladin Group L.P., which also manages two funds that were among our current lenders. The notes are to be repaid by us in ten equal monthly installments beginning on January 1, 2004 and ending on October 1, 2004 and bear interest at a rate of 2% per annum. The monthly installments of principal and interest are payable in cash or common stock at our option, subject to certain listing and registration requirements relating to the common stock. If we elect to pay the monthly installments in common stock, the conversion rate is the lower of: (a) $1.40 or (b) a 10% discount to the then fai r market value of the common stock. The holder of each note is entitled, at its option, to convert at any time the principal amount of the note or any portion thereof, together with accrued but unpaid interest, into shares of our common stock at a conversion price for each share of common stock equal to $1.40. In connection with the financing, we issued to the investors four-year warrants to purchase an aggregate of 875,000 shares of common stock at an exercise price of $1.3224 per share. The warrants are exercisable at any time from July 3, 2003 to July 3, 2007 and are not redeemable by us. The exercise price of the warrants is subject to adjustment upon certain events, including stock splits, stock dividends, reorganizations, reclassifications, mergers, consolidations and dispositions of assets and issuances, other than certain permitted issuances, of common stock and securities convertible into common stock at prices less than the exercise price.

We agreed to prepare and file a registration statement covering the resale of the shares of common stock issuable upon the conversion of the notes and the exercise of the warrants. The registration statement is to be filed with the Securities and Exchange Commission not later than August 3, 2003.

Senior Credit Facility. The Company maintains a credit facility with IBM Credit. At the beginning of fiscal 2003, the credit facility consisted of: (i) a $16 million, three-year revolving credit facility and (ii) a $3 million, three-year term loan, payable in monthly installments of principal and interest. Since the beginning of fiscal 2003, the credit facility has been amended several times.

On April 14, 2003, the credit facility was amended to: (i) extend the credit facility to August 1, 2004 from August 1, 2003; (ii) provide for a maximum availability of $29 million until May 31, 2003, $25 million from June 1, 2003 until December 31, 2003, $20 million from January 1, 2004 until March 31, 2004 and $15 million from April 1, 2004 until August 1, 2004; (iii) lower the interest rate on the facility from prime rate plus 4.25% to prime rate plus 1.75% effective May 1, 2003; (iv) amend certain finance charges and financial covenants (described below); and (v) require the Company to pay off the remaining balance of the $3 million term loan with IBM Credit after the closing of an equity financing. The Company repaid the term loan in full after closing on the $5 million private equity placement in April 2003.

On June 3, 2003, the credit facility was further amended to provide for maximum availability as follows: (i) $25 million from June 1, 2003 until January 14, 2004; (ii) $23 million from January 15, 2004 until March 31, 2004; and (iii) $20 million from April 1, 2004 until August 1, 2004. In addition, IBM Credit agreed to increase the Company's maximum availability from $25,000,000 to $28,000,000 until August 31, 2003, at which time the maximum borrowings under the credit facility available must be reduced to $25,000,000. The Company is required to pay interest at the rate of prime rate plus 4% on any amounts borrowed over $25 million, instead of prime rate plus 1.75%.

The borrowings under the revolving line of credit are based on a formula of 85% of eligible receivables and 25-35% of eligible inventory. The amounts outstanding under the credit facility as of April 30, 2002 and April 30, 2003 were $14.5 million and $28.8 million, respectively, while the amounts outstanding under the term loan as of April 30, 2002 and April 30, 2003 were $3.0 million and $0.0 million, respectively. At times, IBM Credit has allowed the Company to borrow amounts in excess of the maximum allowable. At June 30, 2003, the Company had approximately $27.8 million outstanding under the credit facility.

The following is a summary of the financial covenants currently required by the agreement with IBM Credit as of the last day of the relevant fiscal period:

As set forth in the table below, the Company has failed to comply with one or more of the financial covenants of its credit facility for each fiscal quarter beginning in the fiscal quarter ended as of January 31, 2001, through and including the fiscal quarter ended as of April 30, 2003. Consequently, the amounts outstanding under the revolving credit facility and term loan as of April 30, 2002 and 2003 have been classified as current in the Company's consolidated balance sheets. The Company and IBM Credit entered into an Acknowledgment, Waiver and Amendment to the Inventory and Working Capital Financing Agreement as of the end of each quarter since January 31, 2001 by which IBM Credit has waived the Company's defaults. The following is a summary of the defaults for each of the quarters referred to above.

The Company's deployment services are generally provided at a fixed contract price pursuant to purchase orders or other agreements with its customers, while its software licensing is done on a "per seat" basis over a specified period of time. Application Service Provider ("ASP") activities are based on usage. Revenue from licensing activity remains immaterial in amount.

Services from deployment activities are performed primarily under long-term contracts, but may be performed under short-term workorders or time and material arrangements. The Company's typical long-term contract contains multiple elements designed to track the various services required under the arrangement with the customer. These elements are used to identify components of progress billings, but are combined for revenue recognition purposes. The Company recognizes revenue earned under long-term contracts utilizing the percentage of completion method of accounting by measuring a contract's percentage of completion as determined by the percentage of total costs incurred to date to total estimated costs.

Contracts are reviewed at least quarterly and if necessary, revenue, costs and gross margin are adjusted prospectively for revisions in estimated total contract value and total estimated contract costs. Estimated losses are recognized when identified.

Payment milestones differ according to the customer and the type of work performed. Generally, the Company invoices customers and payments are received throughout the deployment process and, in certain cases, in advance of work performed if a substantial amount of up front costs are required. In certain cases payments are received from customers after the completion of site installation. However, revenue and costs are only recognized on long-term contracts to the extent of the contracts' percentage of completion. Costs and estimated earnings in excess of billings, which is classified as a current asset, is recorded for the amount of revenue earned in excess of billings to customers. Deferred revenue is recorded as a current liability for the amount of billings in excess of revenue earned.

The Company records payments received in advance and services to be supplied in the future under contractual agreements as billings in excess of costs and estimated earnings until such related services are supplied.

The Company's cost of deployment services consists of four main categories: labor, materials, project expenses and allocated indirect costs. The Company estimates progress toward completion of its contracts by applying the percentage of total costs incurred to total estimated costs. Direct costs (labor, materials, and project expenses) are charged directly to projects as they are incurred. Indirect costs are then applied to projects, to determine the projects total costs, and a gross margin is then determined. This process enables management to track all costs associated with delivering services to its customers. Project managers and other field supervisors manage and are evaluated, in part, on how projects' actual direct costs compare to their estimated direct costs. Operations management manages and is evaluated, in part, on how projects' actual gross margins compare to targeted gross margins.

Labor consists of salaries and benefits of the Company's field installation force as well as staging and configuration personnel. The materials category includes all materials used in the installation process such as connectors, wall plates, conduits, and data and electrical cable. Project expenses include travel and living expenses for the implementation teams, equipment rentals and other costs that are not labor or materials costs. In addition, indirect costs, such as software amortization, warehouse expense, material handling costs, etc., are allocated to projects on bases, generally direct labor hours, which reflect management's best estimate of absorption of these indirect costs.

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The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates underlying the accompanying consolidated financial statements include estimated revenues under long-term contracts, estimated costs to complete long-term contracts, recoverability of intangibles and other long-lived assets, allowance for doubtful accounts and inventory carrying values.

Actual results could differ from those estimates.

The Company elected to early adopt the provisions of SFAS 142, "Goodwill and Other Intangible Assets" (See Note 1 of Notes to the Consolidated Financial Statements). These provisions require that goodwill no longer be subject to amortization but rather be reviewed periodically for impairment and that other identifiable intangibles be separated and those with finite lives be amortized over their useful lives. Goodwill and intangible assets with indefinite lives must be assessed once a year for impairment, and more frequently if circumstances indicate a possible impairment. Based on its evaluation, which, in part, was based on certain fair value assumptions, the Company determined that there is no impairment to its goodwill and other intangible assets.

The Company capitalizes certain computer software costs incurred in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". Also, the Company capitalizes certain costs of computer software developed or obtained for internal use in accordance with Statement of Position No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Once technological feasibility has been established, software development costs are captured in the Company's job costing system under specific projects related to the development effort. Costs related to software developed for external use are amortized using the greater of the ratio that current gross revenue for a product bears to the total of current and anticipated future gross revenues for the product, or a maximum of three years using the straight-line method beginning when the products are available for general rel ease to customers. Costs related to internal use software are amortized over a period not to exceed three years.

As of April 30, 2003, the Company had net operating loss carryforwards for Federal tax purposes of approximately $50 million, of which approximately $10 million is subject to separate return year limitations. United States tax rules limit the amount of net operating losses that companies may utilize in any one year in the event of a 5% shareholder having cumulative changes in ownership over a three-year period in excess of 50%. The Company does not believe that it incurred a change of ownership that limits its ability to utilize its net operating loss carryforwards as of April 30, 2003, although ownership changes in future periods may pose limitations on the Company's use of net operating loss carryforwards. No federal tax provision has been recorded against 2003 net income since net operating loss carryforwards will be utilized to reduce any tax obligation to zero. At April 30, 2003 and 2002, the Company determined that it was unlikely that it would realize remaining net operating loss carryforwards, and as such, has provided a full valuation allowance offsetting these carryforwards. The Company's net operating loss carryforwards expire beginning in 2009 through 2022.

The following discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto appearing elsewhere herein.

The consolidated statements of operations for the Company (as retroactively adjusted) are summarized below (dollar amounts in thousands):

Datatec has a direct and indirect sales strategy. Its direct sales are mainly to "Fortune 2000" customers who have significant numbers of geographically dispersed sites and where the technology being implemented is complex. As such, Retail, Insurance, Hospitality and Financial Services are Datatec's target market segments. These market segments are highly challenging for most small sized integrators, but Datatec's software tools, processes and national operations allow it to operate successfully within these segments. When Datatec adopted an indirect model in 1998 by selling its service offerings through Technology Partners to their clients that fall within Datatec's target market segments, Datatec decided to reduce channel conflict by adopting a "preservation" strategy with its direct accounts and opted to grow its operations primarily through its indirect channel.

Revenue for the year ended April 30, 2003 was $125.1 million compared to $75.3 million for the year ended April 30, 2002, representing an increase of approximately 66.1%. The increase in revenue for the fiscal year ended April 30, 2003 is attributable primarily to: (i) an increase in the work performed for the Company's existing customer base; (ii) long term contract work commencing for several new customers during the first two quarters of 2003; and (iii) the related increases in materials sold, which comprised a greater portion of the Company's total revenue value than in the comparable prior period.

Gross margin. Gross margin for the years ended April 30, 2002 and 2003 were as follows (in thousands):

Gross margin as a percentage of revenue decreased for the year ended April 30, 2003 from the year ended April 30, 2002 to 22% from 32% while the gross margin dollars increased to $27.2 million from $23.9 million. The Company's gross margins were adversely affected because of the increase in materials sales as a percentage of total sales for the fiscal 2003. Materials typically are sold at gross margins that are lower than the gross margins realized on the service component of revenue. Additionally, the rapid expansion of the Company's field service personnel (715 field personnel at April 30, 2003 compared to 250 field personnel at April 30, 2002), resulted in increased marginal job costs, decreased operating efficiencies and decreased gross profits, while such new employees were being trained prior to being utilized in the field.

Labor costs as a percent of revenue for the years ended April 30, 2003 and 2002 were approximately 41% and 30%, respectively. The increase in direct labor during fiscal 2003 was the result of significant increased hiring that resulted from the Company's additional workload. Materials costs as a percentage of revenue over the same period were approximately 18% and 16%, respectively. The increase in materials costs was directly related to the increase in project revenue attributable to one customer. Project expense costs as a percentage of revenue over the same period were approximately 14% for both years. These costs remained relatively constant as a percentage of revenue generated as the overall components of a typical deployment contract remained unchanged. Occasionally, the materials component of a contract may vary depending upon the deployment requirements.

Selling, general and administrative expenses. Selling, general and administrative expenses for the years ended April 30, 2003 and 2002 were $22.1 million and $24.1 million, respectively, representing a decrease of 8.3%. As a percentage of revenue, selling, general and administrative expenses represented 17.6% of revenue for the year ended April 30, 2003 compared to 32% for the year ended April 30, 2002. The decreases in selling, general and administrative expenses as a percentage of revenue are attributable to cost reduction and austerity programs initiated by the Company in conjunction with its plan to return to sustainable profitability.

Interest expense. Interest expense for the year ended April 30, 2003 was $3.7 million, including $465,000 of non-cash interest relating to the accretion of deferred interest and the beneficial conversion feature related to the Subordinated Secured Convertible Debentures and Warrants, compared to $2.1 million for the year ended April 30, 2002. The increase in interest expense is primarily attributable to the accreted interest in addition to higher average borrowings and borrowing costs.

Revenue for the year ended April 30, 2002 was $75.3 million compared to $96.1 million for the year ended April 30, 2001, representing a decrease of approximately 21.7%. Deployment Services revenue decreased to $68.3 million in fiscal 2002 from $92.5 million in fiscal 2001, a decrease of 26.2%, while software licensing revenue increased to $2.0 million from $1.9 million for the same period. The decrease in revenue was attributed to the continued slowdown in technology deployment across industries through the quarter ended January 31, 2002, which delayed business decisions until the Company's fourth fiscal quarter. Revenue from Technology Providers decreased 50.9%, going from $47.5 million in 2001 to $23.3 million in 2002, as these companies were severely impacted by the slowdown in technology spending. Revenue from Enterprise customers increased by $0.1 million, going from $46.9 million in 2001 to $47.0 million in fiscal 2002, as the slowdown in technology spending had less of an im pact on the retailing sector than on other sectors.

Gross margin. Gross margin for the years ended April 30, 2001 and 2002 were as follows (in thousands):

Gross margin as a percentage of revenue increased for the year ended April 30, 2002 from the year ended April 30, 2001 to 32% from 17% while the amount of gross margin increased to $23.9 million from $16.2 million. The increase in gross margin amount was primarily due to an approximate 50% reduction in indirect salary costs during fiscal 2002, a more efficient delivery of services and lower materials costs. These costs were partially offset by a decrease in revenue of approximately $20.9 million for the year ended April 30, 2002 compared to April 20, 2001.

Labor costs as a percent of revenue for the years ended April 30, 2002 and 2001 were approximately 30% and 36%, respectively. The decrease in direct labor during fiscal 2002 was the result of personnel cutbacks started during fiscal 2001 caused by lower revenue. Materials costs as a percentage of revenue over the same periods were approximately 16% and 19%, respectively. The decrease in materials costs was directly related to the decrease in overall revenue. Project expense costs, as a percentage of revenue, remained constant at 14% over the same periods. These costs remained relatively constant as a percentage of revenue generated as the overall components of a typical deployment contract remained unchanged. Occasionally, the materials component of a contract may vary depending upon the deployment requirements.

Selling, general and administrative expenses. Selling, general and administrative expenses for the years ended April 30, 2002 and 2001 were $24.1 million and $33.2 million, respectively, representing a decrease of 27.4%. As a percentage of revenue, selling, general and administrative expenses represented 32% of revenue for the year ended April 30, 2002 compared to 35% for the year ended April 30, 2001. The decrease in selling, general and administrative expenses was due to cost savings programs, primarily personnel reductions, initiated during the fiscal year ended April 30, 2001 but fully realized in the fiscal year ended April 30, 2002.

Interest expense. Interest expense for the year ended April 30, 2002 was $2.1 million, including $38,793 of interest accreted in connection with the Subordinated Secured Convertible Debentures and Warrants, compared to $1.7 million for the year ended April 30, 2001. The increase in interest expense is attributable to higher average borrowings and borrowing costs.

Backlog for the Company's services as of June 30, 2001, 2002 and 2003 was approximately $58 million, $52 million and $62 million, respectively. Backlog consists of purchase orders and written agreements with customers for which a customer has scheduled the provision of services within the next 12 months. Orders included in backlog may be canceled or rescheduled by customers without penalty. A variety of conditions, both specific to the individual customer and generally affecting the customer's industry, may cause customers to cancel, reduce or delay orders that were previously made or anticipated. The Company cannot assure the timely replacement of canceled, delayed or reduced orders. Significant or numerous cancellations, reductions or delays in orders by a customer or group of customers could have a material adverse effect on the Company's business, financial condition and results of operations. Backlog should not be relied upon as indicative of the Company's revenues for any futur e period.

Current Assets: Current assets for the years ended April 30, 2003 and 2002 amounted to approximately $55.8 million and $25.8 million, respectively. The increase of approximately $30.0 million is the result of a significant increase in accounts receivable and costs and estimated earnings in excess of billings from increased service revenues and an increase of approximately $3.0 million in cash resulting from the Company's April 2003 private placement.

Property and Equipment: Property and equipment for the years ended April 30, 2003 and 2002 amounted to approximately $3.2 million and $3.3 million, respectively. The decrease of approximately $0.1 million reflects purchases of equipment of approximately $2.0 million offset by depreciation and amortization.

Other Assets: Other assets for the years ended April 30, 2003 and 2002 amounted to approximately $3.1 million and $4.2 million, respectively. The decrease of approximately $1.1 million represents the net difference resulting from annual amortization charges that exceed current investments and reflects the decrease in the continued investment in software development as the Company adjusted its spending levels to reflect current business activity.

Current Liabilities: Current liabilities for the years ended April 30, 2003 and 2002 amounted to approximately $53.8 million and $29.0 million, respectively. The increase of approximately $24.8 million is attributable primarily to an increase in short-term borrowings of approximately $11.3 million, an increase in accounts payable of approximately $8.8 million, an increase in accrued liabilities of approximately $2.0 million, and the reclassification of the $1.3 million of Debentures to current liabilities. The increases in short-term borrowings and accounts payable are related to funding requirements for expenditures related to the Company's growth in operating costs resulting from increased revenue arising from scope increases to existing contracts, while the increase in accrued and other liabilities is related to an increase in billings in excess of costs and estimated earnings related to billings on contracts in progress.

Minority Interest: As previously described, minority interest was eliminated during the year ended April 30, 2002 due to the conversion of Cisco's investment in eDeploy.com, Inc. into Common Stock of the Company.

Cash Flow: Cash used in operating activities increased to $9.8 million for the fiscal year ended April 30, 2003 from $4.9 million for the fiscal year ended April 30, 2002. Cash used in operating activities for fiscal 2003 is primarily attributable to increases in costs and estimated earnings in excess of billings and accounts receivable offset by increases in accounts payable and accrued liabilities, while cash used in operating activities for fiscal 2002 is primarily attributable to the net loss for the period and an increase in costs and estimated earnings in excess of billings and a decrease in accounts payable and accrued liabilities.

Cash used in investing activities increased to $3.1 million from $1.0 million for the fiscal year ended April 30, 2003 compared to the fiscal year ended April 30, 2002. The increase resulted from additional investments in equipment for field service personnel and software development costs incurred during fiscal 2003.

Cash provided from financing activities increased by approximately $10.4 million for the fiscal year ended April 30, 2003 to $15.8 million from $5.4 million for the fiscal year ended April 30, 2002. Cash was generated primarily from the sale of Common Stock ($4.4 million, net) and short-term borrowings ($11.3 million) for the fiscal year ended April 30, 2003, while cash generated during the year ended April 30, 2002 primarily arose from the sale of Subordinated Secured Convertible Debentures ($1.8 million, net) and short-term borrowings ($3.6 million).

The net loss of $19.4 million for the fiscal year ended April 30, 2001 and the net loss of $2.7 million for the fiscal year ended April 30, 2002 resulted in a strain on the Company's cash resources. Although the Company took dramatic measures to cut costs, the Company's working capital line is at its maximum allowable level and the average days outstanding of its trade payables have extended beyond normal credit terms granted by vendors.

Although the Company realized net income of $1.4 million for fiscal year ended April 30, 2003 and took dramatic measures to cut costs and to manage cash, it is still experiencing a significant strain on cash resources. The primary reason for the strain on resources is the increased requirements for expenditures for field personnel, job expenses and materials related to the increased revenue. As a result, the working capital financing line regularly remains at or close to its maximum allowable levels and the average days outstanding on trade payables have extended beyond normal credit terms granted by vendors.

Achievement of the Company's fiscal 2004 operating plan, including maintaining adequate capital resources, depends upon the timing of work performed by us on existing projects, our ability to gain and perform work on new projects, our ability to maintain positive relations with our key vendors and our ability to raise permanent capital and replace our current working capital financing line within the timeframe required to meet our spending requirements. Multiple project cancellations, job performance related losses, delays in the timing of work performed by us on existing projects, our inability to gain and perform work on new projects, or our inability to raise permanent capital and replace our current working capital financing line in a timely fashion could have an adverse impact on our liquidity and on our ability to execute our operating plan.

The Company has taken a variety of actions to ensure our continuation as a going concern. A summary of recent events and our completed or planned actions are as follows:

IBM Credit, the Company's working capital lender, has notified the Company that it does not intend to renew its working capital line beyond August 2004 (see Note 7 of the Notes to the Consolidated Financial Statements). As a result, the company is seeking replacement financing for its credit facility.

Seasonality: The Company's business is affected on a seasonal basis to the extent of its activity with the retail sector. As a result, the Company generally generates lower revenue in its third fiscal quarter (November 1 through January 31).

Quarterly fluctuations: The Company's ability to generate revenue is dependent upon obtaining many new projects each year. Period-to-period comparisons between years may not be meaningful or indicative of operating results over a longer period.

On September 22, 2000, Petsmart, Inc. filed a complaint against us in the Superior Court of Maricopa County, Arizona. Petsmart has alleged that it has been damaged by our failure to satisfactorily complete work contemplated by an agreement between the parties. Damages were unspecified. At a settlement meeting held on April 17, 2002, discussions were held in which Petsmart proposed a series of settlement offers under which we would pay damages ranging between $7,000,000 and $8,000,000. In a letter to us dated May 3, 2002, Petsmart proposed settlement offers under which we would pay damages ranging between $5,000,000 and $7,000,000. On March 7, 2003, Petsmart filed an Offer of Judgment offering to settle the litigation for a payment of $2,300,000. We believe that we have meritorious defenses to the claims and we intend to defend this vigorously. We have further counter-claimed against Petsmart for amounts owing to us under the contract. These amounts have been reserved as part of the allowance for uncollectable accounts. A trial date has been set for August 2003.

The following is a summary of obligations and commitments to make future payments under short-term borrowings, note due to related party, operating leases and subordinated secured convertible notes (see Notes 7, 10, 13 and 15 to the Consolidated Financial Statements).

In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supercedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. This Statement also amends ARB No. 51, "Consolidated Financial Statements", to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The provisions of this Statement are required to be applied starting wi th fiscal years beginning after December 15, 2001. The Company adopted the provisions of SFAS No. 144 on May 1, 2002 and based on its evaluation of the carrying value of its long-lived assets, determined that there is no impairment.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement eliminates the automatic classification of gain or loss on extinguishments of debt as an extraordinary item of income and requires that such gain or loss be evaluated for extraordinary classification under the criteria of APB No. 30. This Statement also requires sales-leaseback accounting for certain lease modifications that have economic effects that are similar to sales-leaseback transactions, and makes various other technical corrections to existing pronouncements. This Statement will be effective for the Company for the fiscal year ending April 30, 2004. The Company does not believe that the adoption of this Statement will not have a material effect on the Company's consolidated financial position or consolidated results of operations.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 will supersede Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated with an exit or disposal plan be recognized when incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." Such interpretation elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair market value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation apply to guarantees issued or modified after December 31, 2002. The Company adopted the provisions of this interpretation on January 1, 2003. The disclosure provisions of this interpretation are effective for financial statements with annual periods ending after December 15, 2002. The Company adopted the required disclosure provisions of this interpretation as of April 30, 2003. The adoption of the recognition and meas urement provisions of this statement did not have a material impact on the Company's consolidated financial position or consolidated results of operations.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure". 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 prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results. The provisions of SFAS No. 148 are effective for financial statements for fiscal years and interim periods ending after December 15, 2002. The disclosure provisions of SFAS No. 148 have been adopted by the Company. SFAS No. 148 did not require the Company to change to the fair value based method of accounting for stock based compensation.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This standard 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, "Accounting for Derivative Instruments and Hedging Relationships." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships after June 30, 2003. The Company does not believe that the implementation of this standard will materially impact its consolidated financial position or consolidated results of operations.

As of April 30, 2003, the Company had cash and cash equivalents of $3.0 million. The Company has had a history of limited working capital. The Company anticipates, based on currently proposed plans and assumptions relating to operations, that its existing capital resources will not be sufficient to satisfy our anticipated August 2004 debt payments. As of June 30, 2003, the Company had borrowed the maximum available under its credit facility with IBM Credit. IBM Credit has informed the Company that it is not prepared to extend the credit facility beyond August 2004. There can be no assurance that any additional financing will be available to the Company on acceptable terms, if at all. The Company's inability to secure the necessary financing could result in the Company defaulting under its credit facility with IBM Credit. If the Company is unable to raise additional capital or is unable to further renegotiate our credit facility with IBM Credit it may not be able to continue as a going concern.

The Company achieved a net profit of $1.4 million for the fiscal year ended April 30, 2003. However, during the prior five fiscal years we achieved net losses in each year. For fiscal 2002, we recorded a net loss of $2.7 million. We may not generate sufficient revenues to meet our expenses or to operate profitably in the future.

On April 14, 2003 IBM agreed to amend the credit facility to: (i) extend the expiration date of the facility to August 2004 from August 2003; (ii) provide a maximum availability of (a) $29 million until May 31, 2003; (b) $25 million until December 31, 2003; (c) $20 million until March 31, 2004; and (d) $15 million until August 1, 2004; (iii) lower the interest charges to prime plus 1.75% from prime plus 4.25% and (iv) alter certain financial covenants. Finally, on June 11, 2003, IBM agreed to increase borrowings under the credit facility from $25 million to $28 million beginning on June 1, 2003 and ending on August 31, 2003. On August 31, 2003, the maximum borrowings allowable under the credit facility may not exceed $25 million.

On June 3, 2003, the credit facility was further amended to provide for maximum availability as follows: (i) $25 million from June 1, 2003 until January 14, 2004; (ii) $23 million from January 15, 2004 until March 31, 2004; and (iii) $20 million from April 1, 2004 until August 1, 2004. In addition, IBM Credit agreed to increase the Company's maximum availability from $25,000,000 to $28,000,000 until August 31, 2003, at which time the maximum borrowings under the credit facility available must be reduced to $25,000,000. The Company is required to pay interest at the rate of prime rate plus 4% on any amounts borrowed over $25 million, instead of prime rate plus 1.75%.

In view of Datatec Industries' continued failure to comply with the covenants in its credit facility arrangement, no assurance can be given that Datatec Industries will be able to comply with the revised loan covenants in the future. In the event there is a default under the credit facility, the Company may not be able to continue as a going concern.

The Company currently has outstanding warrants to purchase an aggregate of 4,298,750 shares of common stock at exercise prices ranging from $0.98 to $1.75. The exercise of any of these warrants may have a dilutive effect on existing stockholders. In addition, in the event the Company raises additional capital, a further dilutive effect may be incurred by stockholders.

As of April 30, 2003, the Company had outstanding debt of approximately $31.6 million. The Company's level of debt and the limitations imposed on the Company by our existing or future debt agreements could have significant consequences on the business and the Company's future prospects, including the following:

The Company's quarterly operating results have varied in the past, and may vary significantly in the future, depending on factors that include the following:

Any unfavorable change in these or other factors could have a material adverse effect on the Company's operating results for a particular quarter. Changes in such factors also make the prediction of revenue and results of operations on a quarterly basis difficult, and performance forecasts derived from such predictions unreliable.

The Company has also experienced large fluctuations in sales from quarter-to-quarter due to substantial sales to customers in the retailing industry. Typically, these customers delay improvements and enhancements during the fourth quarter of the calendar year to avoid costly interruptions during the holiday sales season.

Due to the complex nature and large size of implementation projects that the Company is now pursuing, there is a longer lead-time between the initiation of prospective business and the consummation of a transaction, if any. The lead-time between the initiation of a prospective client and the consummation of a transaction is typically approximately nine to twelve months. As such, there are likely to be substantial fluctuations in sales volume from month-to-month and quarter-to-quarter. The fluctuations in the Company's operating results increase the Company's risk of failure, especially given its present level of working capital. As a result, if the Company experiences lower than expected sales volume for an extended period of time, it may have a material adverse effect on our business, financial condition and results of operations.

The Company may not be able to successfully compete against current and future competitors, causing it to lose market share. The Company competes with a number of other companies involved in the design, configuration, installation, integration, deployment and servicing of computer networking technologies. The market for such services is highly fragmented, intensely competitive and rapidly changing. Some of the Company's competitors have significantly greater resources and better brand-name recognition than Datatec. In addition, there are relatively low barriers to entry in these markets and new competition may arise either from expansion by established companies or from new emerging companies. Increased competition may result in pressure for price reductions and related reductions in gross margins and market share. In addition to direct competition, we face indirect competition from existing and potential future customers, many of which internally design, integrate and deploy the ir own technologies for their particular needs, and therefore may be reluctant to use services offered by independent providers such as the Company.

The following are the competitive factors that the Company believes will have a significant effect on its ability to compete successfully:

A major part of the Company's growth strategy is to market its services in part through indirect customers and strategic alliances with systems manufacturers, systems integrators, independent software developers/distributors and telecommunications carriers that utilize the Company's services to provide joint solutions to customers. Services marketed through strategic alliances and indirect customers accounted for approximately $44 million of the Company's revenues during the fiscal year ended April 30, 2003. The loss of these strategic alliances and indirect customers would result in a significant decline in revenues. The Company has entered into a non-exclusive agreement with Cisco Systems, Inc., pursuant to which it has agreed to provide implementation services to customers of Cisco. Cisco may terminate its agreement with the Company at any time, with or without cause. Termination of the Cisco agreement, or any similar agreement, may have a material adverse effect on the Company 's business, financial condition and results of operations. Because we utilize and will continue to utilize indirect customers and strategic alliances as a significant distribution channel, the Company is subject to the risk that indirect customers or strategic partners will discontinue or decrease their use of the Company's services for reasons unrelated to the quality or price of, or demand for, our services. The Company is also subject to the risk that the demand for products and services sold by indirect customers or strategic partners will decline, which could have a material adverse effect on results of operations.

During each of the past two fiscal years, sales of our services to a limited number of customers have accounted for a substantial percentage of our total net sales. Our 10 largest customers accounted for approximately 93% of our revenues for the year ended April 30, 2003 and approximately 77% of our revenues for the year ended April 30, 2002. For the years ended April 30, 2003 and April 30, 2002, respectively, one customer accounted for approximately 37% and 30% of revenues. This concentration of customers can cause our net sales and earnings to fluctuate from quarter-to-quarter, based on the requirements of these customers and the timing of delivery of services. Although the particular customers are likely to change from period to period, we believe that large orders from a limited number of customers will continue to account for a substantial portion of our revenues in any fiscal period. In any period, the unexpected loss of or decline in net sales from a major customer, or the f ailure to generate significant revenues from other customers, could have a material adverse effect on our financial results.

From time to time, the Company discloses an amount of backlog for its services, which typically consists of purchase orders, written agreements and other oral agreements with customers for which a customer has scheduled the provision of services within the next 12 months. Orders included in backlog may be canceled or rescheduled by customers without penalty. A variety of conditions, both specific to the individual customer and generally affecting the customer's industry, may cause customers to cancel, reduce or delay orders that were previously made or anticipated. The Company cannot assure the timely replacement of canceled, delayed or reduced orders. Significant or numerous cancellations, reductions or delays in orders by a customer or group of customers could materially adversely affect the Company's business, financial condition and results of operations. Backlog should not be relied upon as indicative of the Company's revenues for any future period.

The Company's success depends in large part upon the abilities of its senior management, including, Isaac Gaon, our Chairman of the Board and Chief Executive Officer. The loss of the services of Mr. Gaon or any other member of senior management could have a material adverse effect on the Company's business. Datatec has an employment agreement with Mr. Gaon, which expires on April 30, 2006. The employment agreement may be terminated by Datatec for cause or by Mr. Gaon for good reason. The Company's future success and growth also depends on its ability to continue to attract, motivate and retain highly qualified employees, including those with the technical, managerial, sales and marketing expertise necessary to operate the Company's business. Competition for personnel in the configuration, integration and deployment services industry is intense, and the Company cannot assure you that it will be successful in attracting and retaining such personnel. Departures and additions of key personnel may be disruptive to the Company's business and could have a material adverse effect on its business, financial condition and results of operations.

A significant percentage of the Company's deployment force is employed under contracts with the International Brotherhood of Electrical Workers and the International Brotherhood of Electrical Workers Local 3 that expire on December 31, 2004. The Company's union employees are responsible for the deployment of services. Any work stoppages or other labor disturbances could harm our business.

Most of the Company's intellectual property consists of proprietary or confidential information that is not subject to patent protection. Existing trade secret laws offer only limited protection. The steps that the Company has taken to protect these proprietary rights may not be adequate to deter misappropriation.

Although the Company does not believe that it is infringing the intellectual property rights of others, there can be no assurance that such claims will not be asserted. Any such litigation could be costly and divert management's attention, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject it to significant liabilities, require it to seek licenses from third parties or prevent it from selling the Company's services, any one of which would hinder the Company's financial performance and its ability to compete.

The market price of our Common Stock is very volatile, with per share closing bids ranging from a low of approximately $.46 to a high of approximately $9.13 over the period from May 1, 2000 to the date of the filing of this Annual Report on Form 10-K. Announcements by the Company or by its competitors of technological or other innovations for new commercial products or services developments concerning propriety rights or governmental regulations, changes in financial estimates by securities analysts, or general conditions in the economy or the market for the Company's services, some of which may be unrelated to the Company's performance and beyond its control, may have a significant effect on the Company's business and on the market price of the Common Stock. Sales of a substantial number of shares by existing security holders could also have an adverse effect on the market price of the Company's Common Stock. The shares of equity of many technology companies have experienced extrem e price and volume fluctuations unrelated to the operating performance of those companies.

If the Company does not prevail in a lawsuit commenced by Petsmart, Inc. or if it does not enter into a settlement with Petsmart on terms favorable to the Company, its business could be harmed as well as its liquidity. On September 22, 2000, Petsmart filed a complaint against the Company in the Superior Court of Maricopa County, Arizona. Petsmart has alleged that it has been damaged by the Company's failure to satisfactorily complete work contemplated by an agreement between the parties. Damages were unspecified. At a settlement meeting held on April 17, 2002, discussions were held in which Petsmart proposed a series of settlement offers under which the Company would pay damages ranging between $7,000,000 and $8,000,000. In a letter to the Company dated May 3, 2002, Petsmart proposed settlement offers under which the Company would pay damages ranging between $5,000,000 and $7,000,000. On March 7, 2003, Petsmart filed an Offer of Judgment offering to settle the litigation for a pa yment of $2,300,000. The Company believes that it has meritorious defenses to the claims and the Company intends to defend itself vigorously. The Company has further counter-claimed against Petsmart for amounts owing to it under the contract. These amounts have been reserved as part of the allowance for uncollectable accounts. A trial date has been set for August 2003.

The Company's Charter, Rights Agreement (commonly referred to as a "poison pill") and Delaware law contain certain provisions that may have anti-takeover effects which may have a negative effect on the price investors are willing to pay for the Company's Common Stock. The Company's Charter, among other things,

Moreover, the Company's Charter authorizes the issuance of a maximum of 4,000,000 shares of preferred stock. Therefore, the rights of the holders of the Common Stock are subject to, and may be adversely affected by, the rights of the holders of the Company's preferred stock that may be issued in the future. In addition, the issuance of preferred stock could have a dilutive effect on the holdings of the Company's current stockholders.

The Company is subject to the provisions of Section 203 of the Delaware General Corporation Law, as amended, which restricts certain business combinations with interested stockholders even if such a combination would be beneficial to all stockholders. In general, Section 203 would require a two-thirds vote of stockholders for any business combination (such as a merger or sale of all or substantially all of the Company's assets) between the Company and an "interested stockholder" unless such transaction is approved by a majority of the disinterested directors or meets certain other requirements. These provisions could deprive stockholders of an opportunity to receive a premium for their Common Stock as part of a sale of the Company or may otherwise discourage a potential acquirer from attempting to obtain control of the Company.

The Company has adopted a "poison pill" that grants holders of the Common Stock preferential rights in the event of an unsolicited takeover attempt. These rights are denied to any stockholder involved in the takeover attempt and this has the effect of requiring cooperation with the Company's Board of Directors. This may also prevent an increase in the market price of the Company's Common Stock resulting from actual or rumored takeover attempts. The poison pill could also discourage potential acquirers from making unsolicited acquisition bids.

Fair Value of Financial Instruments - The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.

The Company has not entered into, and does not expect to enter into, financial instruments for trading or hedging purposes.

The Company is currently exposed to material future earnings or cash flow exposures from changes in interest rates on short-term debt obligations since the majority of the Company's short-term debt obligations are at variable rates. The Company does not currently anticipate entering into interest rate swap and/or similar instruments.

The following methods and assumptions were used to estimate the fair value of the financial instruments:

1. Fair Market value is calculated by discounting the scheduled cash payments at the market or adjusted rate.

2. Market rate increased by 10%.

3. Commercial and industrial loan rate of 6.81% for moderate risk, 31 to 365-day loans (Federal Reserve Survey of Terms of Business Lending, May 5-9, 2003).

On April 11, 2002, the Board of Directors of the Company rescinded its earlier decision to engage Arthur Andersen LLP ("Andersen") and dismissed Andersen as independent public accountants for the fiscal year ended April 30, 2002.

The audit reports of Andersen on the consolidated financial statements of the Company and its subsidiaries for each of the fiscal years ended April 30, 2001 and 2000 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles.

The decision to dismiss Andersen as independent public accountants was made by the Board of Directors following the recommendation of its Audit Committee.

During the fiscal years ended April 30, 2001 and 2000 and the subsequent interim period through April 11, 2002, there were no disagreements between the Company and Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to Andersen's satisfaction would have caused them to make reference to the subject matter of the disagreement in connection with their reports.

During the fiscal year ended April 30, 2001 and 2000 and the subsequent interim period through April 11, 2002, there were no "reportable events" as defined by Item 304(a)(1)(v) of Regulation S-K.

The Company engaged Deloitte & Touche LLP ("Deloitte") as its new principal independent accountants on April 11, 2002.

Neither the Company nor anyone on its behalf has consulted Deloitte during the Company's two most recent fiscal years, or any subsequent interim period, prior to the engagement of Deloitte.

Index to Consolidated Financial Statements and Financial Statements Schedules

Schedules other than the one listed above have been omitted since they are either not required, are not applicable, or the required information is shown in the consolidated financial statements or related notes.

To the Board of Directors and Stockholders

of Datatec Systems, Inc. and Subsidiaries

Fairfield, New Jersey

We have audited the accompanying consolidated balance sheets of Datatec Systems, Inc. and Subsidiaries (the "Company") as of April 30, 2003 and 2002, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders' equity (deficit), and cash flows for each of the three years in the period ended April 30, 2003. Our audits also include the financial statement schedule listed in the Index at Item 15(a) (2). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of April 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, in 2003 the Company changed its method of accounting for estimating progress towards completion of contracts and retroactively adjusted the 2001 and 2002 consolidated financial statements for the change.

New York, New York

July 22, 2003