UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2003

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

For the transition period from to

Commission file number 001-15789

STRATUS SERVICES GROUP, INC.

(Exact name of Registrant as specified in its charter)

Delaware		22-3499261
(State of other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

500 Craig Road, Suite 201, Manalapan, New Jersey 07726
(Address of principal executive offices)

(732) 866-0300
(Issuer’s telephone number)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of May 16, 2003, 18,901,478 shares of the Registrant’s common stock were outstanding.

Part I – Financial Information

Item 1. – Financial Statements

STRATUS SERVICES GROUP, INC.

Condensed Balance Sheets

	March 31, 2003			September 30, 2002
	(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	234,803		$	162,646
Accounts receivable – less allowance for doubtful accounts of $1,555,000 and $1,742,000	12,418,719			9,179,543
Unbilled receivables	2,716,342			2,065,972
Other receivables	—			250,000
Prepaid insurance	2,474,746			2,709,331
Prepaid expenses and other current assets	320,068			333,601
	18,164,678			14,701,093

Property and equipment, net of accumulated depreciation	1,272,098			1,281,817
Intangible assets, net of accumulated amortization	1,568,607			802,145
Goodwill	7,085,582			7,085,582
Deferred financing costs, net of accumulated amortization	4,964			5,768
Other assets	180,899			154,991
	$	28,276,828		$	24,031,396
Liabilities and Stockholders’ Equity
Current liabilities
Loans payable (current portion)	$	750,695		$	464,830
Loans payable – related parties	341,000			116,000
Notes payable – acquisitions (current portion)	624,887			578,040
Line of credit	10,359,108			7,739,117
Cash overdraft	1,044,629			731,501
Insurance obligation payable	—			128,075
Accounts payable and accrued expenses	6,938,700			5,472,696
Accrued payroll and taxes	2,475,733			1,828,629
Payroll taxes payable	1,585,145			929,328
	24,119,897			17,988,216

Loans payable (net of current portion)	105,287			217,965
Notes payable – acquisitions (net of current portion)	2,388,818			1,919,532
Convertible debt	40,000			40,000
	26,654,002			20,165,713

Temporary equity – put options	823,000			823,000
Commitments and contingencies

Stockholders’ equity
Preferred stock, $.01 par value, 5,000,000 shares authorized

Series A voting redeemable convertible preferred stock, $.01 par value, 1,458,933 shares issued and outstanding, liquidation preference of $4,376,799 (including unpaid dividends of $498,564 and $345,376)	3,549,564			3,293,376

Series E non-voting convertible preferred stock, $.01 par value, 18,046 and 16,683 shares issued and outstanding, liquidation preference of $1,804,600 (including unpaid dividends of $64,059 and $20,000)	1,868,659			1,485,947

Series F voting convertible preferred stock, $.01 par value, 8,000 shares issued and outstanding, liquidation preference of $800,000	800,000			1,000,000

Series H non-voting convertible preferred stock, $.01 par value, 5,000 shares issued and outstanding, liquidation preference of $500,000	500,000			500,000

Common stock, $.01 par value, 100,000,000 shares authorized; 18,491,478 and 11,522,567 shares issued and outstanding	184,915			115,226
Additional paid-in capital	12,394,387			12,626,733
Accumulated deficit	(18,497,699		)	(15,978,599		)
Total stockholders’ equity	799,826			3,042,683
	$	28,276,828		$	24,031,396

See notes to condensed financial statements.

STRATUS SERVICES GROUP, INC.

Condensed Statements of Operations

(Unaudited)

	Three Months Ended March 31,						Six Months Ended March 31,
	2003			2002			2003			2002

Revenues	$	25,607,094		$	17,505,428		$	47,754,822		$	32,298,652

Cost of revenues	22,365,491			14,836,750			41,154,491			26,956,072

Gross Profit	3,241,603			2,668,678			6,600,331			5,342,580

Selling, general and administrative expenses	4,023,143			3,305,380			7,579,652			6,206,867

Other charges	523,000			—			523,000			—

Operating (loss) from continuing operations	(1,304,540		)	(636,702		)	(1,502,321		)	(864,287		)

Other income (expenses)
Interest and financing costs	(546,808		)	(451,564		)	(1,045,719		)	(963,607		)
Other income	22,653			35,825			28,940			41,510
	(524,155		)	(415,739		)	(1,016,779		)	(922,097		)
(Loss) from continuing operations	(1,828,695		)	(1,052,441		)	(2,519,100		)	(1,786,384		)

Discontinued operations – (loss) from discontinued Engineering Division	—			(312,059		)	—			(238,793		)
Gain on sale of Engineering Division	—			1,759,056			—			1,759,056
Net earnings (loss)	(1,828,695		)	394,556			(2,519,100		)	(266,121		)
Dividends and accretion on preferred stock	(407,663		)	(166,000		)	(773,757		)	(290,000		)
Net earnings (loss) attributable to common stockholders	$	(2,236,358	)	$	228,556		$	(3,292,857	)	$	(556,121	)

Net earnings (loss) per share attributable to common stockholders
Basic:
(Loss) from continuing operations	$	(.13	)	$	(.12	)	$	(.21	)	$	(.22	)
Earnings from discontinued operations	—			.14			—			.16
Net earnings (loss)	$	(.13	)	$	.02		$	(.21	)	$	(.06	)

Diluted:
(Loss) from continuing operations	$	(.13	)	$	(.12	)	$	(.21	)	$	(.22	)
Earnings from discontinued operations	—			.14			—			.16
Net earnings (loss)	$	(.13	)	$	.02		$	(.21	)	$	(.06	)

Weighted average shares, outstanding per common share
Basic	17,599,034			10,382,034			15,950,320			9,583,750
Diluted	17,599,034			10,382,034			15,950,320			9,583,750

See notes to condensed financial statements.

STRATUS SERVICES GROUP, INC.

Condensed Statements of Cash Flows

(Unaudited)

	Six Months Ended
	March 31, 2003			March 31, 2002
Cash flows from operating activities
Net (loss) from continuing operations	$	(2,519,100	)	$	(1,547,591	)
Net (loss) from discontinued operations	¾			(238,793		)
Adjustments to reconcile net earnings (loss) to net cash used by operating activities
Depreciation	273,069			265,971
Amortization	181,057			272,024
Provision for doubtful accounts	50,000			208,000
Deferred financing costs amortization	804			388,978
Loss on sales of shares of investment	¾			9,550
Gain on extinguishment of convertible debt	¾			(3,277		)
Gain on sale of Engineering Division	¾			(1,759,056		)
Interest expense amortization for the intrinsic value of the beneficial conversion feature of convertible debentures				104,535
Accrued interest	(7,388		)	92,021
Imputed interest	22,747			¾
Changes in operating assets and liabilities
Accounts receivable	(3,939,546		)	(1,745,285		)
Prepaid insurance	234,585			207,304
Prepaid expenses and other current assets	13,533			(58,480		)
Other assets	(25,908		)	12,836
Insurance obligation payable	(128,075		)	(475,356		)
Accrued payroll and taxes	647,104			75,916
Payroll taxes payable	655,817			238,819
Accounts payable and accrued expenses	1,645,892			943,141
Total adjustments	(376,309		)	(1,222,359		)
	(2,895,409		)	(1,488,480		)
Cash flows (used in) investing activities
Purchase of property and equipment	(188,350		)	(246,399		)
Proceeds from sales of shares of investment	¾			5,466
Payments for business acquisitions	(61,644		)	(181,920		)
Net proceeds from sale of Engineering Division	¾			1,459,079
	(249,994		)	1,036,226
Cash flows from financing activities
Proceeds from issuance of Common Stock	¾			222,083
Proceeds from issuance of Preferred Stock	186,400			282,500
Proceeds from loans payable	380,000			271,195
Payments of loans payable	(106,813		)	(11,566		)
Proceeds from loans payable – related parties	300,000			50,000
Payments of loans payable – related parties	(75,000		)	(50,000		)
Payments of notes payable – acquisitions	(352,489		)	(142,769		)
Net proceeds from line of credit	2,619,991			723,529
Cash overdraft	313,128			¾
Cost in connection with common stock issued for acquisition	¾			(2,000		)
Net proceeds from convertible debt	¾			326,871
Redemption of convertible debt	¾			(301,992		)
Dividends paid	(47,657		)	¾
	3,217,560			1,367,851
Net change in cash and cash equivalents	72,157			915,597
Cash and cash equivalents – beginning	162,646			171,822
Cash and cash equivalents – ending	$	234,803		$	1,087,419

Supplemental disclosure of cash paid
Interest	$	1,047,762		$	437,693
Schedule of noncash investing and financing activities
Fair value of assets acquired	$	1,022,519		$	1,814,355
Less: cash paid	(176,644		)	(334,355		)
Less: common stock and put options issued	¾			(380,000		)
Liabilities assumed	$	845,875		$	1,100,000

Issuance of Series B Preferred Stock in exchange for convertible and other debt (including $160,000 loans payable – related parties)	$	—		$	1,106,499
Issuance of common stock upon conversion of convertible preferred stock	$	754,200		¾
Issuance of common stock in exchange for accounts payable and accrued expenses	$	37,500		$	59,000
Issuance of common stock upon conversion of convertible debt	¾			$	736,003
Issuance of warrants for fees	¾			$	55,000
Cumulative dividends and accretion on preferred stock	$	493,100		$	290,000

STRATUS SERVICES GROUP, INC.

Notes to Condensed Financial Statements

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying condensed financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These condensed financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the financial position, the results of operations and cash flows of the Company for the periods presented. It is suggested that these condensed financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K.

The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

NOTE 2 – LIQUIDITY

At March 31, 2003, the Company had limited liquid resources. Current liabilities were $24,119,897 and current assets were $18,164,678. The difference of $5,955,219 is a working capital deficit, which is primarily the result of losses continuously incurred beginning the year ended September 30, 2001. Current liabilities include a cash overdraft of $1,044,629, which is represented by outstanding checks. These conditions raise substantial doubts about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

The Company’s continuation of existence is dependent upon the continued cooperation of its creditors, its ability to generate sufficient cash flow to meet its continuing obligations on a timely basis, to fund the operating and capital needs, and to obtain additional financing as may be necessary.

Management of the Company has taken steps to revise and reduce its operating requirements, which it believes will be sufficient to assure continued operations and implementation of the Company’s plans. The steps include closing branches that are not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expenses.

The Company continues to pursue other sources of equity or long-term debt financings. The Company also continues to negotiate payment plans and other accommodations with its creditors.

NOTE 3 – EARNINGS/LOSS PER SHARE

Basic “Earnings Per Share” (“EPS”) excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS assumes conversion of dilutive options and warrants, and the issuance of common stock for all other potentially dilutive equivalent shares outstanding. There were no dilutive shares for the three and six months ended March 31, 2003 and 2002.

NOTE 4 – INTANGIBLE ASSETS

At the beginning of fiscal year ended September 30, 2003, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. The provisions of SFAS No. 142 prohibit the amortization of goodwill and certain intangible assets that are deemed to have indefinite lives and require that such assets be tested for impairment annually, or more frequently if events or

changes in circumstances indicate that the asset might be impaired and written down to fair value. In order to assess the fair value of its goodwill and indefinite-lived intangible assets as of the adoption date, the Company engaged an independent valuation firm to assist in determining the fair value. The valuation process appraised the Company’s assets and liabilities using a combination of present value and multiple of earnings valuation techniques. Based upon the results of the valuation it was determined that there was no impairment of goodwill.

As of March 31, 2003 and September 30, 2002, intangible assets consisted of the following:

	March 31, 2003			September 30, 2002

Covenant-not-to-compete	$	232,680		$	213,180
Customer list	1,819,735			891,716
	2,052,415			1,104,896
Less: accumulated amortization	(483,808		)	(302,751		)
	$	1,568,607		$	802,145

For the three and six months ended March 31, 2002, the Company recorded goodwill amortization of $72,294 and $144,588, respectively. Excluding this amortization expense net (loss) attributable to common stockholders from continuing operations for the three and six months ended March 31, 2002, would have been $(1,146,147) and $(1,931,796) or $(.11) and $(.20) per basic and diluted share, respectively.

Estimated amortization expense for each of the next five years is as follows:

For the Year Ending March 31,
2004		$225,000
2005		192,000
2006		169,000
2007		97,000
2008		95,000

NOTE 5 – LINE OF CREDIT

The Company has a loan and security agreement (the “Agreement”) with a lending institution whereby the Company can borrow up to 85% of eligible accounts receivable, as defined, not to exceed the lesser of $12 million or six times the Company’s tangible net worth (as defined). Borrowings under the Agreement bore interest at 1 1/2% above the prime rate (see below) and are collateralized by substantially all of the Company’s assets. The Agreement expires on June 12, 2004.

At March 31, 2003, the Company was in violation of the following covenants under the Agreement:

(i) Failing to meet the tangible net worth requirement, and;

(ii) The Company’s Common Stock being delisted from the Nasdaq SmallCap Market

The Company has received a waiver from the lender on the above violations and, in December 2002, entered into a modification of the Agreement. The modification provided that borrowings under the Agreement bore interest at 1 ¾% above the prime rate, as long as the Company was in violation of any of the covenants under the Agreement.

Effective April 10, 2003, the Company entered into another modification of the Agreement which provides that borrowings under the Agreement bear interest at 3% above the prime rate.

The prime rate at March 31, 2003 was 4.25%.

NOTE 6 – CONVERTIBLE DEBT

At various times during the six months ended March 31, 2002, the Company issued convertible debentures through private placements. The debentures bore interest at 6% a year, payable quarterly and had a maturity date of five years from issuance. Each debenture was convertible after 120 days from issuance into the number of shares of the Company’s common stock determined by dividing the principal amount of the debenture by the lesser of (a) 120% of the closing bid price of the common stock on the trading day immediately preceding the issuance date or (b) 75% of the average closing bid price of the common stock for the five trading days immediately preceding the date of the conversion. The Company had the right to prepay any of the debentures at any time at a prepayment rate that varied from 115% to 125% of the amount of the debenture depending on when the prepayment is made.

The discount arising from the 75% beneficial conversion feature was charged to interest expense during the period from the issuance of the debenture to the earliest time at which the debenture becomes convertible.

During the six months ended March 31, 2002, the Company redeemed $258,394 of debentures resulting in a gain of approximately $3,000, which is included in “Other income (expense)” in the condensed statement of operations.

In March 2002, the Company entered into an agreement with the holder (the “Debenture Holder”) of all but $40,000 of the outstanding debentures pursuant to which it issued to the Debenture Holder 231,300 shares of Series B Convertible Preferred Stock (see Note 7) in exchange for (i) $456,499 aggregate principal amount of Debentures, (ii) the cancellation of a $400,000 promissory note previously issued by the Company to the Debenture Holder and (iii) $300,000 in cash. As a result, only $40,000 of Debentures remains outstanding.

NOTE 7 – PREFERRED STOCK

a. Series A

The shares of Series A Preferred Stock have a stated value of $3.00 per share. The difference between the carrying value and redemption value of the Series A Preferred Stock is being accreted through a charge to additional paid-in-capital through the June 30, 2008 redemption date.

The Series A Preferred Stock entitles the holders thereof to cumulative dividends at $.21 per share per year, payable semi-annually, commencing on December 31, 2001, when and if declared by the Board of Directors. The shares of Series A Preferred Stock are convertible at the option of the holder into shares of the Company’s Common Stock on a one-for-one basis. On June 30, 2008, the Company will be required to redeem any shares of Series A Preferred Stock outstanding at a redemption price of $3.00 per share together with accrued and unpaid dividends, payable at the Company’s option, either in cash or in shares of common stock. For purposes of determining the number of shares which the Company will be required to issue if it chooses to pay the redemption price in shares of Common Stock, the Common Stock will have a value equal to the average closing price of the Common Stock during the five trading days immediately preceding the date of redemption.

b. Series E

The shares of Series E Preferred Stock have a stated value of $100 per share. The holders of the Series E Preferred stock are entitled to cumulative dividends at a rate of 6% of the stated value per year, payable every 120 days, in preference and priority to any payment of any dividend on the Company’s Common Stock. Dividends may be paid, at the Company’s option, either in cash or in shares of Common Stock, valued at the Series E Conversion Price (as defined below). Holders of Series E Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends.

The Series E Preferred Stock is convertible into Common Stock at a conversion price equal to 75% of the average of the closing bid prices, for the five trading days preceding the conversion date, for the Common Stock. The number of shares issuable upon conversion is determined by multiplying the number of shares of Series E Preferred Stock to be converted by $100, and dividing the result by the Series E Conversion Price then in effect.

Holders of Series E Preferred Stock do not have any voting rights, except as required by law.

The Company may redeem the shares of the Series E Preferred Stock at any time prior to conversion, at a redemption price of 115% of the purchase price paid for the Series E Preferred Shares, plus any accrued but unpaid dividends.

The discount arising from the beneficial conversion feature was treated as a dividend from the date of issuance to the earliest conversion date.

During the six months ended March 31, 2003, holders of Series E Preferred Stock converted 5,637 shares into 4,718,911 shares of Common Stock at conversion prices between $.108 and $.186.

c. Series F

In July 2002, the Company’s Chief Executive Officer invested $1,000,000 in the Company in exchange for 10,000 shares of newly created Series F Convertible Preferred Stock (the “Series F Preferred Stock”), which has a stated value of $100 per share.

The holder of the Series F Preferred Stock is entitled to receive, from assets legally available therefore, cumulative dividends at a rate of 7% per year, accrued daily, payable monthly, in preference and priority to any payment of any dividend on the Common Stock and on the Series F Preferred Stock. Dividends may be paid, at the Company’s option, either in cash or in shares of Common Stock, valued at the Series F Conversion Price (as defined below). Holders of Series F Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends.

The Series F Preferred Stock is convertible into Common Stock at a conversion price (the “Series F Conversion Price”) equal to $.10 per share which was the market price at date of issuance. The number of shares issuable upon conversion is determined by multiplying the number of shares of Series F Preferred Stock to be converted by $100, and dividing the result by the Series F Conversion Price.

Except as otherwise required by law, holders of Series F Preferred Stock and holders of Common Stock shall vote together as a single class on each matter submitted to a vote of stockholders. Each outstanding share of Series F Preferred Stock shall be entitled to the number of votes equal to the number of full shares of Common Stock into which each such share of Series F Preferred Stock is then convertible on the date for determination of stockholders entitled to vote at the meeting. Holders of the Series F Preferred Stock are entitled to vote at the meeting. Holders of the Series F Preferred Stock are entitled to vote as a separate class on any proposed amendment to the terms of the Series F Preferred Stock which would increase or decrease the number of authorized shares of Series F Preferred Stock or have an adverse impact on the Series F Preferred Stock and on any proposal to create a new class of shares having rights or preferences equal to or having priority to the Series F Preferred Stock.

The Company may redeem the shares of the Series F Preferred Stock at any time prior to conversion at a redemption price of 115% of the purchase price paid for the Series F Preferred Shares plus any accrued but unpaid dividends.

During the six months ended March 31, 2003, the Company’s Chief Executive Officer converted 2,000 shares of the Series F Preferred Stock into 2,000,000 shares of Common Stock.

d. Series H

The holders of the Series H Preferred Stock are entitled to cumulative dividends at a rate of 6% per year, payable quarterly, commencing on March 30, 2004, in preference and priority to any payment of any dividend on the Company’s Common Stock. Dividends may be paid, at the Company’s option, either in cash or in shares of Common Stock, valued at the Series H Conversion Price (as defined below). Holders of Series H Preferred Stock are entitled to a liquidation preference of $100 per share, plus accrued and unpaid dividends before any liquidation payment may be made to holders of the Company’s Common Stock.

The Series H Preferred Stock is convertible into Common Stock at a conversion price (the “Series H Conversion Price”) equal to the lower of $.20 per share, which was the market price at date of issuance, or the average market price of the Common Stock for the five trading days immediately preceding the conversion date. The number of shares

issuable upon conversion is determined by multiplying the number of shares of Series H Preferred Stock to be converted by $100 and dividing the result by the Series H Conversion Price then in effect.

Holders of Series H Preferred Stock do not have any voting rights, except as required by law.

The Company has the right, but not the obligation, to redeem the shares of Series H Preferred Stock at any time prior to conversion at a redemption price of 115% of the purchase price paid for the Series H Preferred Shares plus any accrued but unpaid dividends.

NOTE 8 – OTHER CHARGES

During the period May 1, 2001 through May 20, 2002, the Company maintained workers’ compensation insurance with an insurance company, with a deductible of $150,000 per incident. The Company had established reserves based upon its evaluation of the status of claims still open in conjunction with claims reserve information provided to the Company by the insurance company. The Company believes that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although the Company believes it can recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance the Company will prevail, the Company recorded $523,000 of additional payments made and reserves in the three and six months ended March 31, 2003.

NOTE 9 – STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation plans using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. Accordingly, no stock-based employee compensation cost has been recognized in the financial statements as all options granted under the Company’s stock option plan, had an exercise price at least equal to the market value of the underlying common stock on the date of grant. The pro forma information below is based on provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”, issued in December 2002.

	Three Months Ended March 31,						Six Months Ended March 31,
	2003			2002			2003			2002

Net (loss) from continuing operations attributable to common stockholders, as reported	$	(2,236,358	)	$	(1,218,441	)	$	(3,292,857	)	$	(2,076,384	)
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(827,908		)	(618,989		)	(1,419,238		)	(1,171,917		)

Pro forma net (loss) from continuing operations attributable to common stockholders	$	(3,064,266	)	$	(1,837,430	)	$	(4,712,095	)	$	(3,248,301	)

(Loss) from continuing operations per common share attributable to common stockholders:
Basic - as reported	$	(.13	)	$	(.12	)	$	(.21	)	$	(.22	)
Basic - pro forma	$	(.17	)	$	(.18	)	$	(.30	)	$	(.34	)

Diluted - as reported	$	(.13	)	$	(.12	)	$	(.21	)	$	(.22	)
Basic - pro forma	$	(.17	)	$	(.18	)	$	(.30	)	$	(.34	)

NOTE 10 – DISCONTINUED OPERATIONS – SALE OF ENGINEERING DIVISION

On March 28, 2002, the Company completed the sale of the assets of its Engineering Services Division (the “Division”) to SEA Consulting Services Corporation (“SEA”) pursuant to the Asset Purchase Agreement dated

as of January 24, 2002, among the Company, SEP, LLC (“SEP”), Charles Sahyoun, Sahyoun Holders LLC and SEA.

The assets of the Division had been transferred to SEP, a limited liability company in which the Company owns a 70% interest, at the time of the execution of the Asset Purchase Agreement. Sahyoun Holders, LLC, a company wholly-owned by Charles Sahyoun, the President of the Division, owns the remaining 30% interest in SEP.

Under the terms of the Asset Purchase Agreement, the Company received an initial cash payment of $1,560,000, which represented 80% of the initial $2,200,000 installment of the purchase price payable to SEP after the satisfaction of certain liabilities and expenses of SEP. Sahyoun Holdings, LLC received the other 20% of the initial net installment of the purchase price, or $440,000.

The Asset Purchase Agreement requires SEA to make the following additional payments to SEP:

(i) A payment of $1 million, plus or minus the amount by which SEA’s profit for the six months ended June 30, 2002, as determined pursuant to the Asset Purchase Agreement, is greater or less than $600,000 (the “Second Payment”);

(ii) A payment of $1 million, plus or minus the amount by which SEA’s profit for the six months ended December 31, 2002, as determined pursuant to the Asset Purchase Agreement, is greater or less than $600,000 (the “Third Payment”);

(iii) Five subsequent annual payments (the “Subsequent Payments”) which will be based upon a multiple of the annual successive increases, if any, in SEA’s profit during the five year period beginning on January 1, 2003 and ending December 31, 2007.

Pursuant to an allocation and indemnity agreement entered into by the Company, Sahyoun Holdings, LLC and Charles Sahyoun (the “Allocation and Indemnity Agreement”), the Company was entitled to $250,000 of the Second Payment and $250,000 of the Third Payment. On April 15, 2002, by letter agreement between the Company, Sahyoun Holdings, LLC and Joseph J. Raymond, Sr., the Chairman and Chief Executive Officer of the Company, the parties agreed to a modification of the Allocation and Indemnity Agreement. Per that letter agreement, Sahyoun Holdings, LLC provided the Company with $200,000 cash in exchange for the Company’s short-term, 90-day demand note, due and payable by August 1, 2002 in the amount of $250,000. Such $250,000 was repaid by the Company from its $250,000 share of the Second Payment which was received in June 2002. Sahyoun Holdings, LLC and Charles Sahyoun have guaranteed the $250,000 payment to be made to the Company from the Third Payment, regardless of the operating results of SEA. Upon its receipt of all of the payments required under the Allocation and Indemnity Agreement, the Company’s interest in SEP will terminate and the Company will not be entitled to any additional payments under the Asset Purchase Agreement, including the Subsequent Payments. Sahyoun Holdings, LLC is entitled to all amounts paid to SEP under the Asset Purchase Agreement other than $500,000 of payments made or payable to the Company pursuant to the Allocation and Indemnity Agreement and guaranteed by Charles Sahyoun and Sahyoun Holdings, LLC, as described above.

The transaction resulted in a gain, which was calculated as follows:

Initial cash payment	$	2,200,000
Guaranteed additional payments	500,000
Less costs of sale:
Allocation to Charles Sahyoun	(440,000		)
Broker’s fee	(200,000		)
Other costs	(100,921		)
Balance	1,959,079
Net assets sold	200,023
Gain	$	1,759,056

In December 2002, the Company and Charles Sahyoun agreed to offset the $250,000 of the Third Payment due to the Company against $250,000 of accrued commissions due Charles Sahyoun. As a result, the Company is not entitled to any additional payments under the Asset Purchase Agreement.

Revenues from the Division were $1,135,000 and $2,730,000 for the three and six months ended March 31, 2002, respectively.

NOTE 11 – ACQUISITION

Effective as of December 1, 2002, (the “Effective Date”), the Company purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of six offices of Elite Personnel Services (“Elite”), a California corporation. The Elite branches provide temporary light industrial and clerical staffing in six business locations in California and Nevada. The Company also took over Elite’s Downey, California office, from which Elite serviced no accounts but which it utilized as a corporate office. The company will continue to utilize the Downey office as a regional corporate facility. The acquisition of Elite furthers the Company’s expansion into the California staffing market. Pursuant to the terms of an Asset Purchase Agreement between the Registrant and Elite dated November 19, 2002 (the “Asset Purchase Agreement”), the purchase price payable at closing (the “Base Purchase Price”) for the assets was $1,264,000, all of which was represented by an unsecured promissory note. In addition to the Base Purchase Price, Elite will also receive as a deferred purchase price, an amount equal to 10% of the annual “Gross Profits” as defined in the Asset Purchase Agreement of the acquired business between $2,500,000 and $3,200,000, and 15% of the annual Gross Profits of the acquired business in excess of $3,200,000 for a minimum period of one year from the Effective Date and for a period of two years from the Effective Date, if Gross Profits during the first year reach specified levels. Any additional payments due will increase the value initially assigned to the customer list and be amortized over the remaining useful life of the customer list. The note includes imputed interest at 4% per year and is payable over an eight-year period in equal monthly payments beginning 30 days after the Effective Date. In connection with the transaction, Elite, its President and other key management members entered into Non-Competition and Non-Solicitation Agreements pursuant to which they agreed not to compete with the Registrant in the territories of the acquired business for periods ranging from twelve months to five years, and to not solicit the employees or customers of the acquired business for periods ranging from twelve months to five years. Additionally, Elite’s President has also entered into an Employment Agreement, as of the Effective Date, with the Company for a minimum of a one year term. This term can be extended if certain targeted Gross Profit levels are attained.

For financial accounting purposes, interest on the note has been imputed at a rate of 11% per year. Accordingly, the note and Base Purchase Price has been recorded at $845,875. There was an additional $176,644 of costs paid to third parties in connection with the acquisition.

The following summarizes the fair value of the assets acquired at the date of acquisition based upon a third-party valuation of certain intangible assets:

Property and equipment	$	75,000
Covenant-not-to-compete	19,500
Customer list	928,019
Total assets acquired	$	1,022,519

The covenant-not-to-compete and customer list are being amortized over their estimated useful life of five and ten years, respectively.

The unaudited pro forma results of operations presented below assume that the acquisition and another acquisition that occurred effective January 1, 2002, had occurred at the beginning of fiscal 2002. This information is presented for informational purposes only and includes certain adjustments such as amortization of intangibles resulting from the acquisitions and interest expense related to acquisition debt.

	Unaudited Six Months Ended March 31,
	2003			2002
Revenues	$	53,332,822		$	48,849,652
Net (loss) from continuing operations attributable to common stockholders	(3,192,883		)	(2,160,384		)

Net (loss) per share attributable to common stockholders
Basic	$	(.20	)	$	(.23	)
Diluted	$	(.20	)	$	(.23	)

NOTE 12 – RELATED PARTY TRANSACTIONS

During the six months ended March 31, 2003, a son and the brother of the Chief Executive Officer of the Company (the “CEO”) each loaned $100,000 to the Company. In addition, one of the members of the Board of Directors of the Company loaned $100,000 to the Company. Each of the aforementioned loans is unsecured and is due on demand. The loans bear interest at various rates. The loans are outstanding at March 31, 2003 and included in loans payable on the condensed balance sheet.

During the six months ended March 31, 2003, the CEO was repaid $75,000 for a previous loan to the Company. In addition, the CEO loaned the Company $50,000, which was repaid prior to March 31, 2003.

NOTE 13 - SUBSEQUENT EVENT

In April 2003, holders of Series E Preferred Stock converted 1,015 shares into 410,000 shares of common stock at a conversion price of $.2475.

Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to future economic performance, plans and objectives of management for future operations and projections of revenue and other financial items that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. The words “expect”, “estimate”, “anticipate”, “believe”, “intend”, and similar expressions are intended to identify forward-looking statements. Such statements involve assumptions, uncertainties and risks. If one or more of these risks or uncertainties materialize or underlying assumptions prove incorrect, actual outcomes may vary materially from those anticipated, estimated or expected. Among the key factors that may have a direct bearing on our expected operating results, performance or financial condition are economic conditions facing the staffing industry generally; uncertainties related to the job market and our ability to attract qualified candidates; uncertainties associated with our brief operating history; our continued operating losses and their effect on liquidity; our ability to raise additional capital; the continued cooperation of our creditors; our ability to achieve and manage growth; our ability to successfully identify suitable acquisition candidates, complete acquisitions or integrate the acquired business into our operations; our ability to attract and retain qualified personnel; our ability to develop new services; our ability to cross-sell our services to existing clients; our ability to enhance and expand existing offices; our ability to open new offices; general economic conditions; and other factors discussed from time to time in our filings with the Securities and Exchange Commission. These factors are not intended to represent a complete list of all risks and uncertainties inherent in our business. The following discussion and analysis should be read in conjunction with the Condensed Financial Statements and notes appearing elsewhere in this report.

Our critical accounting policies and estimates are described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2002.

Introduction

We provide a wide range of staffing, engineering and productivity consulting services nationally through a network of offices located throughout the United States. We recognize revenues based on hours worked by assigned personnel. Generally, we bill our customers a pre-negotiated, fixed rate per hour for the hours worked by our temporary employees. We are responsible for workers’ compensation, unemployment compensation insurance, Medicare and Social Security taxes and other general payroll related expenses for all of the temporary employees we place. These expenses are included in the cost of revenue. Because we pay our temporary employees only for the hours they actually work, wages for our temporary personnel are a variable cost that increases or decreases in proportion to revenues. Gross profit margin varies depending on the type of services offered. In some instances, temporary employees placed by us may decide to accept an offer of permanent employment from the customer and thereby “convert” the temporary position to a permanent position. Fees received from such conversions are included in our revenues. Selling, general and administrative expenses include payroll for management and administrative employees, office occupancy costs, sales and marketing expenses and other general and administrative costs.

Results of Operations

Discontinued Operations/Acquisition or Disposition of Assets

On January 24, 2002, we entered into an agreement to sell the assets of our Engineering Services Division (the “Division”) to SEA Consulting Services Corporation (“SEA”). Closing of the sale was contingent upon shareholder approval and the receipt of a fairness opinion by us.

On March 28, 2002, we completed the sale of the assets of the Division to SEA pursuant to the Asset Purchase Agreement dated as of January 24, 2002 among us, SEP, LLC (“SEP”), Charles Sahyoun, Sahyoun Holdings LLC and SEA. The transaction was approved by a vote of our stockholders at the annual meeting of stockholders held on March 28, 2002.

The assets of the Division had been transferred to SEP, a limited liability company in which we owned a 70% interest, at the time of the execution of the Asset Purchase Agreement. Sahyoun Holdings, LLC, a company wholly owned by Charles Sahyoun, the President of the Division, owns the remaining 30% interest in SEP.

Under the terms of the Asset Purchase Agreement, we received an initial cash payment of $1,560,000, which represented 80% of the initial $2,200,000 installment of the purchase price payable to SEP after the satisfaction of certain liabilities and expenses of SEP. Sahyoun Holdings, LLC received the other 20% of the initial net installment of the purchase price, or $440,000.

The Asset Purchase Agreement requires the purchaser to make the following additional payments to SEP:

(a) A payment of $1 million, plus or minus the amount by which SEA’s profit for the six months ended June 30, 2002, as determined pursuant to the Asset Purchase Agreement, is greater or less than $600,000 (the “Second Payment”);

(b) A payment of $1 million, plus or minus the amount by which the SEA’s profit for the six months ended December 31, 2002, as determined pursuant to the Asset Purchase Agreement, is greater or less than $600,000 (the “Third Payment”);

(c) Five subsequent annual payments (the “Subsequent Payments”) which will be based upon a multiple of the annual successive increases, if any, in the SEA’s profit during the five year period beginning on January 1, 2003 and ending December 31, 2007.

Pursuant to an allocation and indemnity agreement entered into by us, Sahyoun Holdings, LLC and Mr. Sahyoun (the “Allocation and Indemnity Agreement”), we were entitled to $250,000 of the Second Payment and $250,000 of the Third Payment. On April 15, 2002, by letter agreement between us, Sahyoun Holdings, LLC and Joseph J. Raymond, Sr., our Chairman and Chief Executive Officer, the parties agreed to a modification of the Allocation and Indemnity Agreement. Per that letter agreement, Sahyoun Holdings, LLC provided us with $200,000 cash in exchange for our short-term, 90-day demand note, due and payable by August 1, 2002 in the amount of $250,000. The $250,000 was paid by us from our share of the Second Payment which was received by us in June 2002.

Sahyoun Holdings LLC and Mr. Sahyoun have guaranteed the $250,000 payment to be made to us from the Third Payment, regardless of the operating results of SEA. In December 2002, Mr. Sahyoun and we agreed to offset the $250,000 against $250,000 of accrued commissions due Mr. Sahyoun. As a result, we will not be entitled to any additional payments under the Asset Purchase Agreement, including the Subsequent Payments. Sahyoun Holdings LLC is entitled to all amounts paid to SEP under the Asset Purchase Agreement other than $500,000 of payments made or payable to us pursuant to the Allocation and Indemnity Agreement and guaranteed by Charles Sahyoun and Sahyoun Holdings, LLC as described above. Under the terms of the Asset Purchase Agreement, Sahyoun Holdings LLC will not be entitled to any Subsequent Payments or its allocable share of the Second and Third Payments if Mr. Sahyoun’s employment with SEA ceases for any reason other than death or permanent disability prior to December 31, 2003.

Effective January 1, 2002, we purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of seven offices of PES. The initial purchase price was $1,480,000, represented by a $1,100,000 promissory note and 400,000 shares of our common stock. There was an additional $334,355 of costs incurred in connection with the acquisitions. In addition, PES is entitled to earnout payments of 15% of pretax profit of the acquired business up to a total of $1.25 million or the expiration of ten years, whichever occurs first. The note bears interest at 6% a year and is payable over a ten-year period in equal quarterly payments.

Effective December 1, 2002, we purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of six offices of Elite Personnel Services, Inc. We also took over Elite’s Downey, California office, from which Elite serviced no accounts, but which it utilized as a corporate office. We will continue to utilize the Downey office as a regional corporate facility. Pursuant to a Asset Purchase Agreement dated November 19, 2002 between us and Elite (the “Asset Purchase Agreement”), the purchase price paid at closing (the “Base Purchase Price”) was $1,264,000, all of which was represented by a promissory note (the “Note”) payable over eight years, in equal monthly installments. Imputed interest at the rate of 4% per year is included in the Note amount. For financial accounting purposes, interest on the note has been imputed at a rate of 11% per year. Accordingly, the net Base Purchase Price was recorded as $845,875.

In addition to the Base Purchase Price, Elite may also receive as deferred purchase price an amount equal to 10% of “Gross Profits” as defined in the Asset Purchase Agreement, of the acquired business between $2,500,000 and $3,200,000 per year, plus 15% of Gross Profits of the acquired business in excess of $3,200,000 per year, for a minimum of one year from the Effective Date, and for a period of two years from the Effective Date if Gross Profits for the first year reach specified levels.

In connection with this acquisition, we also entered into an employment and non-compete agreement for a five-year period with the President and sole stockholder of Elite.

Continuing Operations

Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

Revenues. Revenues increased 46.3% to $25,607,094 for the three months ended March 31, 2003 from $17,505,428 for the three months ended March 31, 2002. Approximately $7.4 million of the increase was attributable to the acquisition in December 2002. Excluding acquisitions, revenues increased 4.1%. This increase was a result of an increase in billable hours.

Gross Profit. Gross profit increased 21.5% to $3,241,603 for the three months ended March 31, 2003 from $2,668,678 for the three months ended March 31, 2002, primarily as a result of increased revenues. Gross profit as a percentage of revenues decreased to 12.7% for the three months ended March 31, 2003 from 15.2% for the three months ended March 31, 2002. This decrease was a result of increased pricing competition of staffing services and increases in the cost of workers’ compensation insurance and state unemployment taxes. In addition, we have been assessed the penalty rate by the New Jersey Department of Labor for state unemployment taxes because of payment delinquencies (see Part II – Item 5 of this report). The estimated additional expense in the three months ended March 31, 2003 is $250,000.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, not including depreciation and amortization, increased 22.1% to $3,782,308 for the three months ended March 31, 2003 from $3,084,964 for the three months ended March 31, 2002. Selling, general and administrative expenses, not including depreciation and amortization, as a percentage of revenues decreased to 14.8% for the three months ended March 31, 2003 from 17.6% for the three months ended March 31, 2002. The increase in the dollar amount is primarily a result of the acquisitions in January and December 2002, whereas the percentage of revenue decrease is attributable to significant cost reductions implemented by us and the increase in revenues with no proportionate increase in selling, general and administrative expenses.

Depreciation and Amortization. Depreciation and amortization expenses, not including amortization of goodwill of $72,294 in the three months ended March 31, 2002, increased to $240,835 for the three months

ended March 31, 2003 from $148,122 for the three months ended March 31, 2002. Depreciation and amortization, not including the amortization of goodwill, as a percentage of revenues increased to 0.9% for the three months ended March 31, 2003 from 0.8% for the three months ended March 31, 2002. The increase was due to capital expenditures and amortization of intangibles in connection with the acquisition in December 2002.

Other Charges. During the period May 1, 2001 through May 20, 2002, we maintained workers’ compensation insurance with an insurance company, with a deductible of $150,000 per incident. We had established reserves based upon our evaluation of the status of claims still open in conjunction with claims reserve information provided to us by the insurance company. We believe that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although we believe we can recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance we will prevail, we recorded $523,000 of additional payments made and reserves in the three months ended March 31, 2003.

Interest and Financing Costs. Interest and financing costs increased 21.1% to $546,808 for the three months ended March 31, 2003 from $451,564 for the three months ended March 31, 2002. Included in the amounts for the three months ended March 31, 2002 was $68,000, which is the portion of the discount on the beneficial conversion feature of convertible debt. The increase is attributable to the increase in borrowings under our line of credit because of increased revenues and additional loans required to provide funding for our operations.

Net Loss Attributable to Common Stockholders. As a result of the foregoing, we had a net loss and net loss attributable to common stockholders of ($1,828,695) and ($2,236,358), respectively for the three months ended March 31, 2003 compared to a net loss and net loss attributable to common stockholders of ($1,052,441) and ($1,218,441) for the three months ended March 31, 2002, respectively.

Continuing Operations

Six Months Ended March 31, 2003 Compared to Six Months Ended March 31, 2002

Revenues. Revenues increased 47.9% to $47,754,822 for the six months ended March 31, 2003 from $32,298,652 for the six months ended March 31, 2002. Approximately $13.8 million of the increase was attributable to the acquisitions in January and December 2002. Excluding acquisitions, revenues increased 5.1%. This increase was the result of an increase in billable hours.

Gross Profit. Gross profit increased 23.5% to $6,600,311 for the six months ended March 31, 2003 from $5,342,580 for the six months ended March 31, 2002, primarily as a result of increased revenues. Gross profit as a percentage of revenues decreased to 13.8% for the six months ended March 31, 2003 from 16.5% for the six months ended March 31, 2002. This decrease was a result of increased pricing competition of staffing services and increases in the cost of workers’ compensation insurance and state unemployment taxes. In addition, we have been assessed the penalty rate by the New Jersey Department of Labor for state unemployment taxes because of payment delinquencies (see Part II – Item 5 of this report). The estimated additional expense in the six months ended March 31, 2003 is $476,000.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, not including depreciation and amortization, increased 23.7% to $7,125,526 for the six months ended March 31, 2003 from $5,761,360 for the six months ended March 31, 2002. Selling, general and administrative expenses, not including depreciation and amortization, as a percentage or revenues decreased to 14.9% for the six months ended March 31, 2003 from 17.8% for the six months ended March 31, 2002. The increase in the dollar amount is primarily a result of the acquisitions in January and December 2002, whereas the percentage of revenue decrease is attributable to significant cost reductions implemented by us and the increase in revenues with no proportionate increase in selling, general and administrative expenses.

Depreciation and Amortization. Depreciation and amortization expenses, not including amortization of goodwill of $144,588 in the six months ended March 31, 2002, increased to $454,127 for the six months ended March 31, 2003 from $300,919 for the six months ended March 31, 2002. Depreciation and amortization, not including the amortization of goodwill, as a percentage of revenues increased to 1.0% for the six months ended

March 31, 2003 from 0.9% for the six months ended March 31, 2002. The increase was due to capital expenditures and amortization of intangibles in connection with the acquisition in December 2002.

Interest and Financing Costs. Interest and financing costs increased 8.5% to $1,045,719 for the six months ended March 31, 2003 from $963,607 for the six months ended March 31, 2002. Included in the amounts for the six months ended March 31, 2002 was $68,000, which is the portion of the discount on the beneficial conversion feature of convertible debt. Also included in the amounts for the six months ended March 31, 2002 was approximately $224,000 of amortization of deferred financing costs related to the convertible debt. The increase is attributable to the increase in borrowings under our line of credit because of increased revenues and additional loans required to provide funding for our operations.

Net Loss Attributable to Common Stockholders. As a result of the foregoing, we had a net loss and net loss attributable to common stockholders of ($2,519,100) and ($3,292,857), respectively for the six months ended March 31, 2003 compared to a net loss and net loss attributable to common stockholders of ($1,786,384) and ($2,076,384) for the six months ended March 31, 2002, respectively.

Liquidity and Capital Resources

At March 31, 2003, we had limited liquid resources. Current liabilities were $24,119,897 and current assets were $18,164,678. The difference of $5,955,219 is a working capital deficit, which is primarily the result of losses incurred during the last two years. These conditions raise substantial doubts about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

Our continuation of existence is dependent upon the continued cooperation of our creditors, our ability to generate sufficient cash flow to meet our continuing obligations on a timely basis, to fund the operating and capital needs, and to obtain additional financing as may be necessary.

We have taken steps to revise and reduce our operating requirements, which we believe will be sufficient to assure continued operations and implementation of our plans. The steps include closing branches that are not profitable, consolidating branches and reductions in staffing and other selling, general and administrative expenses. We continue to pursue other sources of equity or long-term debt financings. We also continue to negotiate payments plans and other accommodations with our creditors.

Net cash used in operating activities was $2,895,409 and $1,488,480 in the six months ended March 31, 2003 and 2002, respectively.

Net cash provided by (used in) investing activities was ($249,994) and $1,036,226 in the six months ended March 31, 2003 and 2002, respectively. The sale of our Engineering Division in the six months ended March 31, 2002 generated net cash proceeds of $1,459,079 which was used to fund operating activities. Cash used for acquisitions for the six months ended March 31, 2003 and 2002 was $61,644 and $181,920, respectively. The balance in both periods was primarily for capital expenditures.

Net cash provided by financing activities was $3,217,500 and $1,367,851 in the six months ended March 31, 2003 and 2002, respectively. We had net borrowings of $2,619,991 and $723,529 under our line of credit in the

six months ended March 31, 2003 and 2002, respectively. We also received net proceeds less redemptions of $24,879 from the issuance of convertible debt in the six months ended March 31, 2002. During the six months ended March 31, 2003 and 2002, we received $186,400 and $504,583, respectively, in proceeds from the issuance of our Common Stock and Preferred Stock. Net short-term borrowings were $498,187 and $259,629 in the six months ended March 31, 2003 and 2002, respectively. Payments of notes payable-acquisitions was $352,489 and $142,769 in the six months ended March 31, 2003 and 2002, respectively.

Our principal uses of cash are to fund temporary employee payroll expense and employer related payroll taxes, investment in capital equipment, start-up expenses of new offices, expansion of services offered, workers’ compensation, general liability and other insurance coverages, debt service and costs relating to other transactions such as acquisitions. Temporary employees are paid weekly.

At various times during the years ended September 30, 2002 and 2001, we issued convertible debentures through private placements. The debentures bore interest at 6% a year, payable quarterly and had a maturity date of five years from issuance. Each debenture was convertible after 120 days from issuance into the number of shares of our common stock determined by dividing the principal amount of the debenture by the lesser of (a) 120% of the closing bid price of the common stock on the trading day immediately preceding the issuance date or (b) 75% of the average closing bid price of the common stock for the five trading days immediately preceding the date of the conversion. We had the right to prepay any of the debentures at any time at a prepayment rate that varied from 115% to 125% of the amount of the debenture depending on when the prepayment was made.

As a result of conversions of the debentures and certain transactions with the debenture holders, only $40,000 of debentures remained outstanding at September 30, 2002 and December 31, 2002.

We have a loan and security agreement (the “Agreement”) with a lending institution which provides for a line of credit up to 85% of eligible accounts receivable, as defined, not to exceed $12,000,000. Advances under the Agreement bore interest at a rate of prime plus 1 1/2% (see below). The credit agreement restricts our ability to incur other indebtedness, pay dividends and repurchase stock. Borrowings under the agreement are collateralized by substantially all of our assets. As of March 31, 2003, $10,359,108 was outstanding under the credit agreement.

At March 31, 2003, we were in violation of the following covenants under the loan and security agreement:

i) Failing to meet the tangible net worth requirement;

ii) Our common stock being delisted from the Nasdaq SmallCap Market.

We have received a waiver from the lender on all of the above violations and in December 2002, entered into a modification of the Agreement. The modification provided that borrowings under the Agreement bore interest at a rate of prime plus 1 3/4% as long as we are in violation of any of the covenants under the Agreement.

Effective April 10, 2003, the Company entered into another modification of the Agreement which provides that borrowings under the Agreement bear interest at 3% above the prime rate.

Holders of the 1,458,933 outstanding shares of our Series A Preferred Stock are entitled to dividends at a rate of $.21 per share per annum when and if declared by our Board of Directors in preference and priority to any payment of dividends on our common stock or any other series of our capital stock. Dividends on the Series A Preferred Stock may be paid in additional shares of Preferred Stock if the shares of common stock issuable upon the conversion of the Series A Preferred Stock have been registered for resale under the Securities Act of 1933. We are obligated to pay quarterly dividends to holders of our Series E Preferred Stock and, commencing March 2004, holders of our Series H Preferred Stock, at a rate of 6% per annum of the stated value of the stock in preference and priority to any payment of dividends on our common stock. We are obligated to pay monthly

dividends on our Series F Preferred Stock at a rate of 7% per annum of the stated value of the stock in preference and priority to any payment of dividends on our common stock. The aggregate stated value of the Series E, Series F and Series H Preferred Stock was $1,804,600, $800,000 and $500,000, respectively, as of March 31, 2003. Dividends on the Series E, Series F and Series H Preferred Stock may be paid at the Company’s option in shares of common stock (valued at the conversion price of the applicable class of preferred stock) if such shares have been registered for resale under the Securities Act of 1933.

We are obligated to redeem any shares of Series A Preferred Stock outstanding on June 30, 2008 at a redemption price of $3.00 per share together with accrued and unpaid dividends. We have the option to pay the redemption price through the issuance of shares of common stock. For purposes of determining the number of shares we will be required to issue if we pay the redemption price in shares of common stock, the common stock will have a value equal to the average closing price of the common stock during the five trading days preceding the date of redemption.

Other fixed obligations that we had as of March 31, 2003 include:

• $1,189,686 under a promissory note bearing interest at 7% per annum which was issued in connection with our acquisition of Source One and which is payable in equal quarterly installments of $130,717 until its maturity date in August 2005.

• $995,565 under a promissory note bearing interest at 6% per annum which was issued in connection with our acquisition of certain assets of PES and which is payable in equal quarterly installments of $36,770 until its maturity date in December 2011.

• $1,211,332, including $395,378 of imputed interest, under a promissory note which was issued in connection with our acquisition of Elite and which is payable in equal monthly installments of $13,167 until its maturity in November 2010.

• $80,000 under a promissory note that was due in April 2002 which bears interest at 18% per annum.

• $12,500 due under promissory notes bearing interest at 6% per annum which were issued in connection with an acquisition transaction completed in January 2001 and which is payable in monthly installments of $5,000 through June 2003.

• $131,837 under a promissory note which bears interest at 15% per annum and which requires us to make payments of principal and interest of $8,000 per month until its maturity date in October 2004.

• $130,162 under a non-interest bearing promissory note which requires us to make monthly payments of principal and interest of $13,437 and which is due in full upon the demand of the holder.

• $41,000 under a demand note bearing interest at 10% per annum issued to a corporation wholly owned by the son of Joseph J. Raymond, our Chief Executive Officer.

• $725,000 under demand loans which bear interest at various rates, including $100,000 owed to a son of Joseph J. Raymond, our Chief Executive Officer.

• $88,983 under promissory notes used to acquire, and secured by, motor vehicles which require aggregate monthly payments of principal and interest of $3,453 and which become due in full at various dates between July and August, 2005.

All of our offices are leased through operating leases that are not included on the balance sheet. As of March 31, 2003, future minimum lease payments under lease agreements having initial terms in excess of one year were: 2004- $543,000, 2005-$328,000, 2006-$167,000, 2007-$137,000 and 2008 - $11,000.

We may be required to make certain “earnout” payments to sellers of businesses that we have acquired in recent years, including Source One, PES and Elite. The amount of these payments, if any, will depend upon the results of the acquired businesses. There were no earnout payments made in fiscal 2002 or the six months ended March 31, 2003.

Source One has the right to require us to repurchase 400,000 shares of our common stock at a price of $2.00 per share at any time after July 27, 2003 and before the later of July 27, 2005 and the full payment of the

outstanding note that we issued to it in connection with the acquisition transaction completed with Source One in July 2001. In addition, the holder of the $80,000 note which was due in April 2002 has the right to require us to repurchase 20,000 shares of common stock at a price of $1.00 per share plus interest at a rate of 15% per annum until the note is paid in full.

In January 2003, a $367,216 judgment was awarded against us to an insurance carrier. As of February 13, 2003, the judgment was unpaid; however, we have entered into an agreement with the plaintiff which permits us to satisfy the judgment over a three year period. The unpaid balance of $342,216 at March 31, 2003 is included in “Accounts payable and accrued expenses” on the balance sheet.

In April 2003, we were served with a Complaint and named as one of several Defendants in the matter of Lopez v. RSI Home Products, Inc. et al, (“RSI”), in the Superior Court of California, Orange County. RSI is one of our customers. The case is a class action proceeding alleging failure to pay hourly wages and overtime wages, failure to provide rest periods and meal periods or compensation in lieu thereof, failure to pay wages of terminated or resigned employees, knowing and intentional failure to comply with itemized employee wage statement provisions, violation of the unfair competition law, and breach of fiduciary duty. Stratus has engaged California counsel to represent it in such proceedings; the time to file an Answer has been extended to June 6, 2003 for all Defendants. The amount of Plaintiff’s claim against all Defendants is not yet reasonably determinable or quantifiable.

In February 2003, the New Jersey Department of Labor notified us that approximately $2,100,000 of payroll taxes are delinquent. We dispute that the entire amount is owed and have recently begun discussion with the New Jersey Department of Labor to determine the actual amount owed and arrange for payment of that amount over a period of time. As of December 31, 2002, a substantial portion of such payroll tax liabilities had been accrued.

As of March 31, 2003, there were no off-balance sheet arrangements, unconsolidated subsidiaries, commitments or guarantees of other parties, except as disclosed in the notes to financial statements. Stockholders’ equity at that date was $799,826 which represented 7% of total assets.

Seasonality

Our business follows the seasonal trends of our customer’s business. Historically, we have experienced lower revenues in the first calendar quarter with revenues accelerating during the second and third calendar quarters and then staring to slow again during the fourth calendar quarter.

Impact of Inflation

We believe that since our inception, inflation has not had a significant impact on our results of operations.

Impact of Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 142, which must be applied to fiscal years beginning after December 15, 2001, modifies the accounting and reporting of goodwill and intangible assets. The pronouncement requires entities to discontinue the amortization of goodwill; reallocate all existing goodwill among its reporting segments based on criteria set by SFAS No. 142, and perform initial impairment tests by applying a fair-value-based analysis on the goodwill in each reporting segment. Any impairment at the initial adoption date shall be recognized as the effect of a change in accounting principle. Subsequent to the initial adoption, goodwill shall be tested for impairment annually or more frequently if circumstances indicate a possible impairment.

Under SFAS No. 142, entities are required to determine the useful life of other intangible assets and amortize the value over the useful life. If the useful life is determined to be indefinite, no amortization will be recorded. For intangible assets recognized prior to the adoption of SFAS No. 142, the useful life should be reassessed. Other intangible assets are required to be tested for impairment in a manner similar to goodwill. We adopted SFAS No. 142 and completed a transitional impairment test, as required by SFAS No. 142, and determined that there was no impairment of goodwill as of October 1, 2002.

In August 2001, the FASB issued SFAS No. 144, “Impairment of Long-Lived Assets”. SFAS No. 144 supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of”. SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and the fair value of the asset. SFAS No. 144 removes goodwill from its scope. SFAS No. 144 is applicable to financial statements issued for fiscal years beginning after December 15, 2001, or for our fiscal year ending September 30, 2003. The adoption of SFAS No. 144 did not have any material adverse impact on our financial position or results of our operations.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” which nullifies EITF 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 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred.

Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 may affect the timing of the recognition of future exit and disposal costs.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” Interpretation 46 changes the criteria by which one company includes another entity in its consolidated financial statements. Previously, the criteria were based on control through voting interest. Interpretation 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A company that consolidates a variable interest entity is called the primary beneficiary of that entity. The consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not expect the adoption to have a material impact to the Company’s financial position or results of operations.

SENSITIVE ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. Significant estimates include management’s estimate of the carrying value of accounts receivable, the impairment of goodwill and the establishment of valuation reserves offsetting deferred tax assets. Actual results could differ from those estimates. The Company’s critical accounting policies relating to these items are described in the Company’s Annual Report on Form 10-K for the year ended September 30, 2002. As of March 31, 2003, there have been no material changes to any of the critical accounting policies contained therein.

Item 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

We are subject to the risk of fluctuating interest rates in the ordinary course of business for borrowings under our Loan and Security Agreement with Capital Tempfunds, Inc. This credit agreement provides for a line of credit up to 85% of eligible accounts receivable, not to exceed $12,000,000. Advances under this credit agreement bear interest at a rate of prime plus 3%.

We believe that our business operations are not exposed to market risk relating to foreign currency exchange risk or commodity price risk.

Item 4. – CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Securities Exchange Act of 1934, within the 90 days prior to the filing date of this report, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer along with our Chief Financial Officer, who concluded that our disclosure controls and procedures are effective. Their have been no significant changes in our internal controls or in other factors, which could significantly affect internal controls subsequent to the date we carried out its evaluation.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported with the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.

Part II – Other Information

Item 1 – Legal Proceedings

In January 2003, a $367,216 judgment was awarded against us to the plaintiff in Ace American Insurance Company v. Stratus Services Group, Inc., a contract/tort action in which the plaintiff alleged that we had failed to pay certain insurance premiums. As of the date of the filing of this Report the judgment was unpaid; however, we have entered into an agreement with the plaintiff which permits us to satisfy the judgment over a three year period. The unpaid balance of $342,216 at March 31, 2003 is included in “Accounts payable and accrued expenses” on the balance sheet.

In April 2003, we were served with a Complaint and were named as one of several Defendants in the matter of Lopez v. RSI Home Products, Inc. et al. (“RSI”), in the Superior Court of California, Orange County. RSI is one of our customers. The case is a class action claim alleging failure to pay hourly wages and overtime wages, failure to provide rest periods and meal periods or compensation in lieu thereof, failure to pay wages of terminated or resigned employees, knowing and intentional failure to comply with itemized employee wage statement provisions, violation of the unfair competition law, and breach of fiduciary duty. Stratus has engaged California counsel to represent it in such proceedings; the time to file an Answer has been extended to June 6, 2003 for all Defendants. The amount of Plaintiff’s claim against all Defendants is not yet reasonably determinable or quantifiable.

Item 2 – Changes in Securities and Use of Proceeds

Conversion of Series E Preferred Stock and Series F Preferred Stock

In March and April 2003, holders of Series E Preferred Stock converted an additional 1,445 shares into 642,000 shares of our Common Stock at conversion prices between $.185 and $.248. The issuances of the Common Stock upon such conversions were made in reliance upon the exemptions from registration provided under Rule 506 and Section 4(2) of the Securities Act of 1933.

In February 2003, Joseph J. Raymond, our President and Chief Executive Officer, the holder of the Series F Preferred Stock, converted 1,000 shares into 1,000,000 shares of our Common Stock at a conversion price of $.10 per share. The issuance of the Common Stock upon such conversion was made in reliance upon the exemptions from registration by Rule 506 and Section 4(2) of the Securities Act of 1933.

We did not receive any proceeds as a result of such conversions.

Item 3 – Defaults Upon Senior Securities

Dividends on our Series A Preferred Stock accrue at a rate of 7% per annum and are payable semi-annually when and if declared by our Board of Directors. No such dividends have been declared and, as of the date of the filing of this report, $535,497 of dividends is in arrears on the Series A Preferred Stock.

Dividends on our Series E Preferred Stock accrue at a rate of 6% of the stated value per year, payable every 120 days. As of the date of the filing of this report, $77,112 is in arrears on the Series E Preferred Stock.

Dividends on our Series H Preferred Stock accrue at a rate of 6% per year, payable quarterly, commencing on March 30, 2004. As of the date of the filing of this report, $3,616 of such dividends have accrued, but are not yet in arrears.

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

There were no matters submitted to a vote of our security holders during the three months ended March 31, 2003.

Item 5 – Other Information

In February 2003, the New Jersey Department of Labor notified us that approximately $2,100,000 of payroll taxes are delinquent. We dispute that the entire amount is owed and have recently begun discussions with the New Jersey Department of Labor to determine the actual amount owed and to arrange for payment of that amount over a period of time. As of March 31, 2003, such payroll tax liabilities had been accrued.

Item 6 - Exhibits and Reports on Form 8-K

(a) Exhibits

Number		Description

99.1		Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002

99.2		Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K

On January 30, 2003, we filed a Form 8-K/A to amend our Form 8-k filed on November 26, 2002 to include pro forma financial information related to our acquisition of certain assets of Elite Personnel Services and certain historical financial information of the acquired business.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	STRATUS SERVICES GROUP, INC.


Date: May 15, 2003	By:	/s/ Joseph J. Raymond
		Joseph J. Raymond
		Chairman of the Board of Directors,
		President and Chief Executive Officer


Date: May 15, 2003	By:	/s/ Michael A. Maltzman
		Michael A. Maltzman
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

CERTIFICATION

I, Joseph J. Raymond, certify that:

1. I have reviewed this quarterly report on Form 10-Q for the quarterly period ended March 31, 2003 of Stratus Services Group, 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 Exchange Act 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.

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: May 15, 2003	By:	/s/ Joseph J. Raymond
		Joseph J. Raymond
		Chairman and Chief Executive Officer

CERTIFICATION

I, Michael A. Maltzman, certify that:

1. I have reviewed this quarterly report on Form 10-Q for the quarterly period ended March 31, 2003 of Stratus Services Group, Inc.;

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.

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

Date: May 15, 2003	By:	/s/ Michael A. Maltzman
		Michael A. Maltzman
		Vice President and Chief Financial Officer