STRATUS SERVICES GROUP INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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(Mark One)

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended September 30, 2001
-----------------------

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _______ to ________

Commission file number 001-15789
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STRATUS SERVICES GROUP, INC.
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(Exact name of Registrant as specified in its charter)

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

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

(732) 866-0300
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(Registrant's telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act: Not Applicable

Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.01 par value
(Title of class)

Indicate by check mark whether the registrant has (1) filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act 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 [X] No [ ]

Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of the voting stock held by non-affiliates, computed
by reference to the last sale price of such stock as reported by the Nasdaq
SmallCap Market, as of January 24, 2002, was $6,616,006, based upon 7,351,118
shares held by non-affiliates.

The number of shares of Common Stock, $.01 par value, outstanding as of January
24, 2002 was 9,637,549.

FORM 10-K
STRATUS SERVICES GROUP, INC.
FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2001

THIS ANNUAL REPORT ON FORM 10-K 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 ABILITY TO RAISE ADDITIONAL CAPITAL; 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 IN ITEM 1 OF THIS ANNUAL REPORT UNDER THE CAPTION "FACTORS AFFECTING
FUTURE OPERATING RESULTS" AND 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
FINANCIAL STATEMENTS AND NOTES APPEARING ELSEWHERE IN THIS ANNUAL REPORT.

PART I

ITEM 1. BUSINESS

GENERAL

We are a national business services company engaged in providing outsourced
labor and operational resources on a long-term, contractual basis. We were
incorporated in Delaware in March 1997 and began operations in August 1997 with
the purchase of certain assets of Royalpar Industries, Inc. and it subsidiaries.
This purchase provided us with a foundation to become a national provider of
comprehensive staffing services. We believe that as businesses increasingly
outsource a wider range of human resource functions in order to focus on their
core operations, they will require more sophisticated and diverse services from
their staffing providers.

We are functionally divided into three "service lines": Staffing Services,
Engineering Services and Information Technology Services. Our Staffing Services
Division provides temporary workers for short-term needs, extended-term
temporary employees, temporary-to-permanent placements, recruiting, permanent
placements, payroll processing, on-site supervising and human resource
consulting. Our SMARTSolutions(TM) technology, available through our Staffing
Services branch offices, provides a comprehensive, customized staffing program
designed to reduce labor and management costs and increase workforce efficiency.
Our Engineering Services Division provides a full range of technical engineering
services including on-site staff augmentation and in-house project work. Stratus
Technology Services ("STS") provides information technology ("IT") staffing
solutions to Fortune 1000, middle market and emerging companies. STS offers
expertise in a wide variety of technology practices and disciplines ranging from
networking professionals to internet development specialists and application
programmers. All three service groups seek to act as business partners to our
clients rather than merely a vendor. In doing so, they seek to systematically
enhance client productivity and positively impact our and our clients' financial
results. We are headquartered at 500 Craig Road, Suite 201, Manalapan, New
Jersey 07726 and our telephone number is (800) 777-1557.

Between September 1997 and January 2002 we completed nine acquisitions of
staffing businesses, representing twenty-nine offices in six states. As of
January 24, 2002 we were providing services from thirty-two locations in eight
states. We also maintain a presence on the Internet with our website at
WWW.STRATUSSERVICES.COM, an informational site designed to give prospective
customers and employees additional information regarding our operations.

MATERIAL RECENT EVENTS

On January 24, 2002 the Company entered into an agreement to sell the assets of
its Engineering Services Division ("SED") to SEA Consulting Services
Corporation. Concurrent with the execution of the agreement the Company
transferred 30% interest in SED to Sahyoun, LLC, a company controlled by the
President of SED in exchange for a combination of bonuses due the SED
management, options owned by the SED management and Company shares owned by
the SED management. The agreement provides for a purchase price of $2,200,000
of which the Company will receive 80% ($1,760,000). In addition, the Company
will receive additional payments of $250,000 each on June 30, 2002 and
December 31, 2002. Closing of the sale is contingent upon shareholder
approval and receipt of a fairness opinion by the Company. The pro forma
effect of this transaction on the September 30, 2001 balance sheet can be
found in the Financial Statements on page F-3.

PRINCIPAL SERVICES & MARKETS

Our business operations are classified as one segment that consists of Staffing
Services, Engineering Services and Information Technology Services, each
reporting to a Division President who reports directly to the Chief Executive
Officer and each with its own target market.

STAFFING SERVICES includes both personnel placement and employer services
such as payrolling, outsourcing, on-site management and administrative
services. Payrolling, which is also referred to as employee leasing,
typically involves the transfer of a customer's employees to our payroll.
Outsourcing represents a growing trend among businesses to contract with
third parties to provide a particular function or business department for
an agreed price over a designated period. On-site services involve the
placement of a Company employee at the customer's place of business to
manage all of the customer's temporary staffing requirements.
Administrative services include skills testing, drug testing and risk
management services. Skills testing available to the Company's customers
include cognitive, personality and psychological evaluation and drug
testing that is confirmed through an independent, certified laboratory.

Staffing Services can also be segmented by assignment types into
supplemental staffing, long-term staffing and project staffing.
Supplemental staffing provides workers to meet variability in employee
cycles, and assignments typically range from days to months. Long-term
staffing provides employees for assignments that typically last three to
six months but can sometimes last for years. Project staffing provides
companies with workers for a time specific project and may include
providing management, training and benefits.

Staffing services are marketed through our on-site sales professionals
throughout our nationwide network of offices. Generally, new customers are
obtained through customer referrals, telemarketing, advertising and
participating in numerous community and trade organizations.

SMARTSOLUTIONS(TM). SMARTSolutions(TM) is a customized staffing program
provided through our staffing services offices designed to reduce labor and
management costs and increase workforce efficiency. The programs typically
require an eight-week implementation process beginning with an operational
assessment of the client's tasks and

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processes conducted by the SMARTSolutions(TM) implementation team. The team
compiles and analyzes the data and then presents its recommendations to the
client's senior management. Together they establish an implementation
timeline with target dates and responsibility checklists. Once the timeline
is approved, a workforce-training curriculum or SMARTTraining(TM) Program
is developed and implemented by a team of associates headed by the On-site
Manager provided by Stratus. Monthly performance is reported to the client
through SMARTReports(TM) that track workforce performance, analyze that
performance against the pre-determined goals and adjust programs to meet
evolving customer needs.

While SMARTSolutions(TM) is designed to be most effective in manufacturing,
distribution and telemarketing operations, it is marketed to all companies
that have at least 50 people dedicated to specific work functions that
involve repetitive tasks measurable through worker output and could benefit
from proactive workforce management. Since SMARTSolutions(TM) differs
greatly from traditional staffing services, we have developed a national
marketing team dedicated strictly to marketing these programs. However, the
team utilizes our Staffing Services branch staff to identify companies
within their geographic regions that could potentially benefit from a
SMARTSolutions(TM) program. Once identified, the team assumes full
responsibility for the sales process. A significant portion of our
SMARTSolutions(TM) clients have been obtained through this process or from
"word of mouth" recommendations from current SMARTSolutions(TM) customers.

ENGINEERING SERVICES require highly specialized and technically skilled
employees that demand significantly higher hourly rates than traditional
temporary staffing services. Engineering Services augments customers'
in-house engineering capability by supplying our engineers as contract
labor. We will also take the lead role as the project manager on specific
engagements and provide a full range of services that include design
requirements, scheduling, drawing and specification management, field
supervision and quality assurance. On large engagements, we may take
responsibility for specific areas of the engagement only, or supply staff
to the project manager.

In addition to staff augmentation, we provide a broad range of project
support to Fortune 100 companies, government agencies and educational
institutions in electrical engineering, instrumentation and controls,
mechanical engineering, piping and pipe support analysis, civil, structural
and architectural engineering. We have developed an expertise providing
services to utilities and cogeneration facility operators and are qualified
to provide staffing services to nuclear power plants. Projects typically
last six months to one year and may require the services of several
specialized professionals.

The marketing of engineering services is focused primarily on addressing
the requirements typical of specific customers. In marketing to potential
customers, the engineering sales team identifies the requirements of the
customer and promotes services offerings designed to meet those
requirements. In addition to personal sales calls, targeted mailings and
telephone solicitations, the entire management team promotes our services
through cross-selling complementary services to existing customers,
submitting bids on "competitive bid" projects and networking through
industry trade associations. As is the case with SMARTSolutions(TM), we
anticipate that with the extensive experience of the Engineering Services
management team, word of mouth and personal contacts will provide the
majority of sales leads.

STRATUS TECHNOLOGY SERVICES, LLC. We provide Information Technology ("IT")
services throughout our branch network through our affiliate, Stratus
Technology Services, LLC ("STS"). STS was formed in November 2000 as a
50/50 joint venture between us and Fusion Business Services, LLC, a New
Jersey based technology project management firm, to consolidate and manage
the company-wide technology services business into a single entity focused
on establishing market share in the IT market. STS markets its services to
client companies seeking staff for project staffing, system maintenance,
upgrades, conversions, installations, relocations, etc. STS provides
broad-based professionals in such disciplines as finance, pharmaceuticals,
manufacturing and media and include such job specifications as Desktop
Support Administrators, Server Engineers, Programmers, Mainframe IS
Programmers, System Analysts, Software Engineers and Programmer Analysts.
In addition, STS, through its roster of professionals, can initiate and
manage turnkey IT projects and provide outsourced IT support on a
twenty-four hour, seven day per week basis.

BUSINESS STRATEGY

The Company's objective is to become a leading provider of staffing services
throughout the United States. Key elements of the Company's business strategy
include:

FOCUS ON SALES WITHIN THE CLERICAL, LIGHT INDUSTRIAL AND LIGHT TECHNICAL
SECTOR. The Company focuses on placing support personnel in markets for
clerical, light industrial and light technical temporary

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staffing. The Company believes that these services are the foundation of
the temporary staffing industry, will remain so for the foreseeable future
and best leverages the assets and expertise of our Company. The Company
also believes that employees performing these functions are, and will
remain, an integral part of the labor market in local, regional and
national economies around the world. The Company believes that it is
well-positioned to capitalize on these business segments because of its
ability to attract and retain qualified personnel and its knowledge of the
staffing needs of customers.

ENHANCE RECRUITING OF QUALIFIED PERSONNEL. The Company believes that a key
component of the Company's success is its ability to recruit and maintain a
pool of qualified personnel and regularly place them into desirable
positions. The Company uses comprehensive methods to assess, select and,
when appropriate, train its temporary employees in order to maintain a pool
of qualified personnel to satisfy ongoing customer demand. The Company
offers its temporary employees comprehensive benefit, retention and
recognition packages, including bonuses, vacation pay, holiday pay and
opportunities to participate in the Company's contributory 401(k) plan and
is considering a discounted employee stock purchase plan.

EMPHASIZE BUSINESS CORRIDORS. The Company's strategy is to capitalize on
its presence along the I-95 business corridor from New York to Delaware and
to build market share by targeting small to mid-sized customers, including
divisions of Fortune 500 companies. The Company believes that in many
cases, such markets are less competitive and less costly in which to
operate than the more central areas of metropolitan markets, where a large
number of staffing services companies frequently compete for business and
occupancy costs are relatively high. In addition, the Company believes that
business corridor markets are more likely to provide the opportunity to
sell recurring business that is characterized by relatively higher gross
margins. The Company focuses on this type of business while also
selectively servicing strategic national and regional contracts.

MAINTAIN ENTREPRENEURIAL AND DECENTRALIZED OFFICES WITH STRONG CORPORATE
SUPPORT. The Company seeks to foster an entrepreneurial environment by
operating each office as a separate profit center, by giving managers and
staff considerable operational autonomy and financial incentives. The
Company has designed programs to encourage a "team" approach in all aspects
of sales and recruiting, to improve productivity and to maximize profits.
The Company believes that this structure allows it to recruit and retain
highly motivated managers who have demonstrated the ability to succeed in a
competitive environment. This structure also allows managers and staff to
focus on branch operations while relying on corporate headquarters for
support in back-office operations, such as risk management programs and
unemployment insurance, credit, collections, advice on legal and regulatory
matters, quality standards and marketing.

ENHANCE INFORMATION SYSTEMS. The Company believes its management
information systems are instrumental to the success of its operations. The
Company's business depends on its ability to store, retrieve, process and
manage significant amounts of data. The Company continually evaluates the
quality, functionality and performance of its systems in an effort to
ensure that these systems meet the operation needs of the Company. During
fiscal 2001, the Company completed the implementation and rollout of the
Keynote Staffing Business Software System. This AS/400 based system comes
complete with a rich automated skill search capability, quality and
performance measurement reporting capabilities and user friendly, proactive
tools that we believe will improve the level of service our branch offices
are capable of delivering.

In addition, we have fully upgraded both our hardware and software at
corporate headquarters. Our AS/400 based system is capable of sustaining
the user demand with the exponential growth that we are currently
experiencing for the next 2-3 years. We are currently implementing a
nationwide area network based upon a reliable, secure, inexpensive, and
high performance Frame Relay network that has integrated all of our offices
onto one internal network linked through our servers at corporate. Once
fully completed, all of our branches will share a common server for
critical operating data utilized with the Keynote and other back office
software systems, as well as having access to other less critical but,
mission essential applications, i.e., real-time e-mail and internet access.

The Company believes that its investments in information technology will
increase management's ability to store, retrieve, process and manage
information. As a result, the Company believes it will be able to improve
service to its customers and employees by reducing errors and speeding the
resolution of inquiries, while more efficiently allocating resources
devoted to developing and maintaining the Company's information technology
infrastructure.

CONTROL COSTS THROUGH EMPHASIS ON RISK MANAGEMENT. Workers' compensation
and unemployment insurance premiums are significant expenses in the
temporary staffing industry. Workers' compensation costs are particularly
high in the light industrial sector. Furthermore, there can be significant
volatility in these costs. The Company has a dedicated risk management
department that has developed risk management programs

5

and loss control strategies that the Company believes will improve
management's ability to control these employee-related costs through
pre-employment safety training, safety assessment and precautions in the
workplace, post-accident procedures and return to work programs. The
Company believes that its emphasis on controlling employee-related costs
enables branch office managers to price services more competitively and
improve profitability.

GROWTH STRATEGY

The Company's current growth strategy focuses evenly on a combination of
internal growth and strategic external and complementary acquisitions.

INTERNAL GROWTH. A significant element of the Company's growth strategy has
been, and continues to be, its focus on internal growth. The Company's
internal growth strategy consists of the following:

o INCREASE SALES AND PROFITABILITY AT EXISTING OFFICES. The Company
believes that a substantial opportunity exists to increase sales of
services and profitability in existing offices. The Company has
incentive compensation plans to encourage branch office managers and
staff to increase productivity and profits at the branch level while
maintaining accountability for costs and collections of accounts
receivable. In addition, the Company has maintained its
corporate-level branch management function to establish and monitor
branch office performance targets and develop programs to support
branch operations.

o EXPAND SMARTSOLUTIONS(TM) AND VENDOR-ON-PREMISE PROGRAMS. The Company
has taken advantage of industry trends by continuing to promote its
SMARTSolutions(TM) program and "vendor-on-premises" programs. As of
January 18, 2002, the Company had four SMARTSolutions(TM) sites and
vendor-on-premises programs. Under these programs, the Company assumes
administrative responsibility for coordinating all essential staffing
services throughout a customer's location, including skills testing
and training.

o PURSUE EXPANSION BY ESTABLISHMENT OF NEW OFFICES. The Company seeks to
open new offices primarily in existing markets to benefit from common
area management, cross-marketing opportunities and leveraging of
administrative expenses. The Company's corporate and operating
management jointly develop expansion plans for new offices based upon
various criteria, including market demand, availability of qualified
personnel, the regulatory environment in the relevant market and
whether a new office would complement or broaden the Company's current
geographic network.

PURSUIT OF COMPLEMENTARY AND STRATEGIC ACQUISITIONS. The Company intends to
focus on opportunities for growth through acquisitions in existing as well
as new markets. The Company made three strategic external acquisitions in
fiscal 2001 and is continuously evaluating other potential acquisition
opportunities.

In evaluating potential acquisition candidates, the Company focuses on
independent staffing companies with a history of profitable operations, a
strong management team, a recognized presence in secondary markets and
compatible corporate philosophies and culture. The Company has used, and
may continue to use, a team approach by making select corporate officers
and outside consultants responsible for identifying prospective
acquisitions, performing due diligence, negotiating contacts and
subsequently integrating the acquired companies. The integration of newly
acquired companies generally involves standardizing each company's
accounting and financial procedures with those of the Company. Acquired
companies typically are brought under the Company's uniform risk management
program and key personnel of acquired companies often become part of field
management. Marketing, sales, field operations and personnel programs must
be reviewed and, where appropriate, conformed to the practices of the
Company's existing operations.

Between September 1997 and January 2002 we completed nine acquisitions of
primarily staffing companies or divisions of staffing companies. These
acquisitions included twenty-nine offices located in six states and
collectively generated over $60 million in revenue for the twelve months
preceding such acquisitions. Pursuant to our acquisition strategy we made
the following purchases:

o In August 1998, we acquired the assets of J.P. Industrial, LLC, a $1
million (in annual revenues) Canby, Oregon based Engineering Services
firm. We made this acquisition to expand our presence in the
engineering services intensive power generation and paper/wood product
industries in the Pacific Northwest.

o In January 1999, we completed the acquisition of the assets of B & R
Employment, Inc. ("B & R"), a $4 million (in annual revenues)
Wilmington, Delaware based provider of traditional temporary staffing
services. This acquisition gave us an immediate presence in the
industrial and banking center of Delaware.

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o In April 1999, we acquired certain assets of Adapta Services Group,
Inc., a single location, $2 million (in annual revenues) New Castle,
Delaware based provider of traditional staffing services. This
acquisition was an excellent complement to our acquisition of B&R
Employment, Inc., gave us full coverage of all of the major Delaware
metropolitan areas and provided us with additional quality customers.

o In June 2000, we acquired the assets of the eight New Jersey and
Pennsylvania branches of Tandem, a $25 million (in annual revenues)
division of Outsource International, Inc. This acquisition greatly
expanded our presence in our home state of New Jersey and continued
our Mid-Atlantic regional expansion.

o In July 2000, we acquired certain assets of Apoxiforce, Inc., a $1
million (in annual revenues) Elizabeth, New Jersey based provider of
traditional staffing services. This acquisition provided us with a
strong presence in the commercial food service industry and an
excellent customer list. These operations were incorporated into our
existing Elizabeth, New Jersey office and the personnel assimilated
throughout our New Jersey operations.

o In October 2000 we acquired the assets of seven New Hampshire and
Massachusetts branches of Tandem, a $9 million (in annual revenues)
division of Outsource International, Inc. This acquisition further
continued our East Coast expansion plan and provided us with a
platform to further expand our New England presence.

o In January 2001, we acquired certain assets of Cura Staffing Inc. and
WorkGroup Professional Services, Inc. sister companies, producing $4.8
million in revenues from offices in Coral Gables and Miami Springs,
Florida. This acquisition further expanded our South Florida presence
and provided SMARTSolutions(TM) opportunities.

o In August 2001, we acquired certain assets of the light industrial and
clerical businesses of Source One Personnel, Inc., a $15 million
Lawrenceville, New Jersey based, closely-held corporation. This
acquisition significantly expanded our I-95 corridor coverage in New
Jersey and provided inroads into the lucrative Philadelphia suburb
market.

o In January 2002, we acquired the assets of the seven Southern
California branches of Provisional Employment Services, Inc. a $23
million (in annual revenues) Orange, California based provider of
light industrial and clerical staffing services. This acquisition
establishes a strong base in Southern California for regional
expansion.

Due to these acquisitions, as well as new offices we opened, the number of
our offices increased from five in five states after the Royalpar, Inc.
acquisition in August 1997 to thirty-two in eight states at January 24,
2002.

COMPETITIVE BUSINESS CONDITIONS

Staffing companies provide one or more of four basic services to clients: (i)
flexible staffing; (ii) Professional Employer Organization ("PEO") services;
(iii) placement and search; and (iv) outplacement. Based on information provided
by the American Staffing Association (formerly the National Association of
Temporary and Staffing Services), the National Association of Professional
Employer Organizations and Staffing Industry Analysts, Inc., 2000 staffing
industry revenues were approximately $77 billion. Over the past seven years, the
staffing industry has experienced significant growth, growing at an average rate
of 10% per year largely due to the utilization of temporary help across a
broader range of industries, as well as the emergence of the PEO sector.
Currently, over 90% of the companies surveyed by the American Staffing
Association reported using temporary personnel.

The U.S. staffing industry is highly fragmented and has been experiencing
consolidation in recent years, particularly with respect to temporary staffing
companies. Recent industry statistics indicate that approximately 7,000
companies provide temporary staffing services in the United States. Many of
these companies are small, owner-operated businesses with limited access to
capital for development and expansion. We believe that the industry is
consolidating in response to:

o The increased demands of companies for a single supplier of a full
range of staffing and human resource services;

o Increased competition from larger, better capitalized competitors; and

o Owner's desires for liquidity.

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Although some consolidation activity has already occurred, we believe that
consolidation in the U.S. staffing industry will continue and that there will be
numerous available acquisition candidates.

Historically, the demand for temporary staffing employees has been driven by a
need to temporarily replace regular employees. More recently, competitive
pressures have forced businesses to focus on reducing costs, including
converting fixed labor costs to variable and flexible costs. Increasingly, the
use of temporary staffing employees has become widely accepted as a valuable
tool for managing personnel costs and for meeting specialized or fluctuating
employment requirements. Organizations have also begun using temporary staffing
to reduce administrative overhead by outsourcing operations that are not part of
their core business operations, such as recruiting, training and benefits
administration. By utilizing staffing services companies, businesses are able to
avoid the management and administrative costs that would be incurred if full
time employees were employed. An ancillary benefit, particularly for smaller
business, is that the use of temporary personnel reduces certain employment
costs and risks, such as, workers' compensation and medical and unemployment
insurance, that a temporary personnel provider can spread over a much larger
pool of employees.

In the past decade, the staffing industry has seen an evolution of services move
away from "temp help" or supplemental staffing to more permanent staffing
relationships. The industry has developed specialization among various sectors
and can be classified into four categories: integrated staffing service
providers, professional services providers, information technology providers and
commodity providers. Integrated staffing services provide a vendor-on-premise,
acting as the general contractor managing the workforce and maintaining the
payroll. Through this arrangement, providers are able to establish long-term
relationships with their customers, reduce cyclicality of employees, and
maintain relationships with customers that are less price sensitive. The
professional services provider supplies employees in the fields of engineering,
finance, legal, accounting and other professions. In general, these services are
less cyclical than the light industrial and clerical segments and carry higher
margins. Information technology companies offer technical employees to maintain
and implement all forms of information systems. The commodity segment of the
staffing industry is the traditional temporary employer business in which an
employee of the service is placed at the customer for a short period. It is
characterized by intense competition and low margins. This sector is most
exposed to economic cycles and price competition to win market share. Growth in
this segment has been constrained over the past three years due to a competitive
labor market for low-end workers.

We compete with other companies in the recruitment of qualified personnel, the
development of client relationships and the acquisition of other staffing and
professional service companies. A large percentage of temporary staffing and
consulting companies are local operators with fewer than five offices and have
developed strong local customer relationships within local markets. These
operators actively compete with us for business and, in most of these markets,
no single company has a dominant share of the market. We also compete with
larger, full-service and specialized competitors in national, regional and local
markets. The principal national competitors include AccuStaff, Inc., Manpower,
Inc., Kelly Services, Inc., The Olsten Corporation, Interim Services, Inc., and
Norrell Corporation, all of which may have greater marketing, financial and
other resources than Stratus. We believe that the primary competitive factors in
obtaining and retaining clients are the number and location of offices, an
understanding of clients' specific job requirements, the ability to provide
temporary personnel in a timely manner, the monitoring of the quality of job
performance and the price of services. The primary competitive factors in
obtaining qualified candidates for temporary employment assignments are wages,
responsiveness to work schedules and number of hours of work available. We
believe our long-term client relationships and strong emphasis on providing
service and value to our clients and temporary staffing employees makes us
highly competitive.

CUSTOMERS

During the year ended September 30, 2001 we provided services to 1,917 customers
in 27 states. Our five largest customers represented 28% of our revenue but no
one customer exceeded 10%. At January 24, 2002 we were providing services to 919
customers in 21 states, with the five largest customers representing 41% of our
revenues and no one customer exceeding 10%.

GOVERNMENTAL REGULATION

Staffing services firms are generally subject to one or more of the following
types of government regulation: (1) regulation of the employer/employee
relationship between a firm and its temporary employees; and (2) registration,
licensing, record keeping and reporting requirements. Staffing services firms
are the legal employers of their temporary workers. Therefore, laws regulating
the employer/employee relationship, such as tax withholding and reporting,
social security or retirement, anti-discrimination and workers' compensation,
govern these firms. State mandated workers' compensation and unemployment
insurance premiums have increased in recent years and have directly increased
our cost of services. In addition, the extent and type of health insurance
benefits that employers are required to provide employees have been the subject
of intense scrutiny and debate in recent years at both the national and state
level. Proposals have been made to

8

mandate that employers provide health insurance benefits to staffing employees,
and some states could impose sales tax, or raise sales tax rates on staffing
services. Further increases in such premiums or rates, or the introduction of
new regulatory provisions, could substantially raise the costs associated with
hiring and employing staffing employees.

Certain states have enacted laws that govern the activities of "Professional
Employer Organizations," which generally provide payroll administration, risk
management and benefits administration to client companies. These laws vary from
state to state and generally impose licensing or registration requirements for
Professional Employer Organizations and provide for monitoring of the fiscal
responsibility of these organizations. We believe that Stratus is not a
Professional Employer Organization and not subject to the laws that govern such
organizations; however, the definition of "Professional Employer Organization"
varies from state to state and in some states the term is broadly defined. If we
are determined to be a Professional Employer Organization, we can give no
assurance that we will be able to satisfy licensing requirements or other
applicable regulations. In addition, we can give no assurance that the states in
which we operate will not adopt licensing or other regulations affecting
companies that provide commercial and professional staffing services.

TRADEMARKS

We have filed for Federal Trademark registration of SMARTSolutions, SMARTReport,
SMARTTraining, our slogan, name and logo. No assurance can be given that this
registration will be obtained or if obtained, will be effective to prevent
others from using the mark concurrently or in certain locations. Currently, we
are asserting Common Law protection by holding the marks out to the public as
the property of Stratus. However, no assurance can be given that this Common Law
assertion will be effective to prevent others from using the mark concurrently
or in other locations. In the event someone asserts ownership to a mark, we may
incur legal costs to enforce any unauthorized use of the marks or defend
ourselves against any claims.

EMPLOYEES

As of September 30, 2001 we were employing 3,044 total employees. Of that amount
186 were classified as Staff employees and 2,858 were classified as field or
"temp" employees, those employees placed at client facilities. As of January 24,
2002 those numbers had increased to 3,894; 228 and 3,666, respectively.

A key factor contributing to future growth and profitability will be the ability
to recruit and retain qualified personnel. To attract personnel, we employ
recruiters, called "Staffing Specialists" who regularly visit schools, churches
and professional associations and present career development programs to various
organizations. In addition, applicants are obtained from referrals by existing
staffing employees and from advertising on radio, television, in the Yellow
Pages, newspapers and through the Internet. Each applicant for a Staffing
Services position is interviewed with emphasis on past work experience, personal
characteristics and individual skills. We maintain software-testing and training
programs at our offices for applicants and employees who may be trained and
tested at no cost to the applicant or customer. Engineering Services and
Management Personnel are targeted and recruited for specific engagements. We
usually advertise for professionals who possess specialized education, training
or work experience. Engineering Services recruiting efforts also rely upon
industry contacts, personal networks and referrals from existing and former
Engineering Services personnel.

To promote loyalty and improve retention among our employees and to
differentiate ourselves from competing staffing firms, we offer a comprehensive
benefits package after only ninety days of employment instead of the industry
standard of one hundred eighty days. The benefits package includes paid time
off, holiday and vacation time, medical coverage, dental, vision, prescription,
mental health, life insurance, disability coverage and a 401(k) defined
contribution plan. The average length of assignment for employees ranges from
six months to five years depending on the client requirements.

FACTORS AFFECTING FUTURE OPERATING RESULTS

This Form 10-K contains forward-looking statements concerning the Company's
future programs, products, expenses, revenue, liquidity and cash needs as well
as the Company's plans and strategies. These forward-looking statements are
based on current expectations and the Company assumes no obligation to update
this information. Numerous factors could cause actual results to differ
significantly from the results described in these forward-looking statements,
including the following risk factors.

WE HAVE LIMITED LIQUID RESOURCES AND A HISTORY OF NET LOSSES. At September
30, 2001, current liabilities were approximately $14.5 million and current
assets were approximately $13.0 million. The difference of approximately
$1.5 million is a working capital deficit which is primarily the result of
the losses we had during the last three quarters. We have incurred net
losses in recent periods, including net losses of $409,069 in our inception
period from August 11, 1997 through September 30, 1997, $2,412,145 in the
year ended September 30, 1998, $1,527,043 in

9

the year ended September 30, 1999 and $5,910,457 in the year ended
September 30, 2001. Although we had net earnings in the year ended
September 30, 2000 of $1,045,910, we can provide no assurance that our
operations will be profitable in the future. This situation has also made
it difficult for us to make timely payments to our vendors and we can make
no assurances that vendors and creditors will not exercise remedies against
us. The working capital deficit will remain until additional capital is
raised.

POSSIBLE ADVERSE EFFECTS ON FLUCTUATIONS IN THE GENERAL ECONOMY. Demand for
the Company's staffing services is significantly affected by the general
level of economic activity and unemployment in the United States. Companies
use temporary staffing services to manage personnel costs and staffing
needs. When economic activity increases, temporary employees are often
added before full-time employees are hired. However, as economic activity
slows, many companies reduce their utilization of temporary employees
before releasing full-time employees. In addition, the Company may
experience less demand for its services and more competitive pricing
pressure during periods of economic downturn. Therefore, any significant
economic downturn could have a material adverse effect on the Company's
business, results of operations, cash flows or financial condition.

UNCERTAIN ABILITY TO CONTINUE AND MANAGE GROWTH. The Company's ability to
continue growth will depend on a number of factors, including: (i) the
strength of demand for temporary employees in the Company's markets; (ii)
the availability of capital to fund acquisitions; (iii) the ability to
maintain or increase profit margins despite pricing pressures; and (iv)
existing and emerging competition. The Company must also adapt its
infrastructure and systems to accommodate growth and recruit and train
additional qualified personnel. Furthermore, the United States economy is
currently showing signs of an economic slowdown. Should an extended
economic slowdown or recession continue, competition for customers in the
staffing industry would increase and may adversely impact management's
allocation of the Company's resources and result in declining revenues.

RELIANCE ON EXECUTIVE MANAGEMENT. The Company is highly dependent on its
senior executives, including Joseph J. Raymond, its Chairman, CEO and
President since September 1, 1997; Michael A. Maltzman, Executive Vice
President and Chief Financial Officer who has been serving in that capacity
since September 1, 1997; and on the other members of its senior management
team. The Company entered into an employment agreement with Mr. Raymond
effective September 1, 1997 for continuing employment until he chooses to
retire or until his death and that agreement remains in effect as written.
Employment arrangements with all of the Company's executive officers are
at-will. The loss of the services of either Mr. Raymond or Mr. Maltzman and
other senior executives or other key executive personnel could have a
material adverse effect on the Company's business, results of operations,
cash flows or financial condition.

RELIANCE ON MANAGEMENT INFORMATION SYSTEMS. The Company believes its
management information systems are instrumental to the success of its
operations. The Company's business depends on its ability to store,
retrieve, process and manage significant amounts of data. The Company
continually evaluates the quality, functionality and performance of its
systems in an effort to ensure that these systems meet the operational
needs of the Company. The Company has, in the past, encountered delays in
implementing, upgrading or enhancing systems and may, in the future,
experience delays or increased costs. There can be no assurance that the
Company will meet anticipated completion dates for system replacements,
upgrades or enhancements, that such work will be competed in the
cost-effective manner, or that such replacements, upgrades and enhancements
will support the Company's future growth or provide significant gains in
efficiency. The failure of the replacements, upgrades and enhancements to
meet these expected goals could result in increased system costs and could
have a material adverse effect on the Company's business, results of
operations, cash flows or financial condition.

VARIABILITY OF EMPLOYEE-RELATED COSTS. The Company is responsible for all
employee-related expenses for the temporary employees, including workers'
compensation, unemployment insurance, social security taxes, state and
local taxes and other general payroll expenses. The Company maintains
workers' compensation insurance for all claims in excess of a loss cap of
$150,000 per incident, except with respect to locations in states where
private insurance is to permitted and which are covered by state insurance
funds. The Company accrues for workers' compensation costs based upon
payroll dollars paid to temporary employees. The accrual rates vary based
upon the specific risks associated with the work performed by the temporary
employee. At the beginning of each policy year, the Company reviews the
overall accrual rates with its outside actuaries and makes changes to the
rates as necessary based primarily upon historical loss trends.
Periodically, the Company evaluates its historical accruals based on an
actuarially developed estimate of the ultimate cost for each open policy
year and adjusts such accruals as necessary. These adjustments can either
be increases or decreases to workers' compensation costs, depending upon
the actual loss experience of the Company. There can be no assurance that
the Company's programs to control workers' compensation and other
payroll-related expenses will be effective or that loss development trends
will not require a charge to costs of services in future periods to
increase workers' compensation accruals. Unemployment insurance

10

premiums are set by the states in which the Company's employees render
their services. A significant increase in these premiums or in workers'
compensation-related costs could have a material adverse effect on the
Company's business, results of operations, cash flows or financial
condition.

RISKS RELATED TO CUSTOMERS. As is common in the temporary staffing
industry, the Company's engagements to provide services to its customers
are generally of a non-exclusive, short-term nature and subject to
termination by the customer with little or no notice. During fiscal 2000
and 2001 no single customer of the Company accounted for more than 12% and
10%, respectively, of the Company's sales of services. Nonetheless, the
loss of any of the Company's significant customers could have an adverse
effect on the Company's business, results of operations, cash flows or
financial condition. The Company is also subject to credit risks associated
with its trade receivables. During fiscal 2000 and fiscal 2001, the Company
incurred costs of $122,500 and $661,000, respectively, for bad debts.
Should any of the Company's principal customers default on their large
receivables, the Company's business results of operations, cash flows or
financial condition could be adversely affected.

VARIABILITY OF OPERATING RESULTS; SEASONALITY. The Company has experienced
significant fluctuations in its operating results and anticipates that
these fluctuations may continue. Operating results may fluctuate due to a
number of factors, including the demand for the Company's services, the
level of competition within its markets, the Company's ability to increase
the productivity of its existing offices, control costs and expand
operations, the timing and integration of acquisitions and the availability
of qualified temporary personnel. In addition, the Company's results of
operations could be, and have in the past been, adversely affected by
severe weather conditions. Moreover, the Company's results of operations
have also historically been subject to seasonal fluctuations. Demand for
temporary staffing historically has been greatest during the Company's
fourth fiscal quarter due largely to the planning cycles of many of its
customers. Furthermore, sales for the first fiscal quarter are typically
lower due to national holidays as well as plant shutdowns during and after
holiday season. These shutdowns and post-holiday season declines negatively
impact job orders received by the Company, particularly in the light
industrial sector. Due to the foregoing factors, the Company has
experienced in the past, and may possibly experience in the future, results
of operations below the expectations of public market analysts and
investors. The occurrence of such an event could likely have a material
adverse effect on the price of the common stock.

ABILITY TO ATTRACT AND RETAIN THE SERVICES OF QUALIFIED TEMPORARY
PERSONNEL. The Company depends upon its ability to attract and retain
qualified personnel who possess the skills and experience necessary to meet
the staffing requirements of its customers. During periods of increased
economic activity and low unemployment, the competition among temporary
staffing firms for qualified personnel increases. Many regions in which the
Company operates have in the past and may continue to experience
historically low rates of unemployment and the Company has experienced, and
may continue experience, significant difficulties in hiring and retaining
sufficient numbers of qualified personnel to satisfy the needs of its
customers. Furthermore, the Company may face increased competitive pricing
pressures during such periods. While the current economic environment is
facing uncertainties, competition for individuals with the requisite skills
is expected to remain strong for the foreseeable future. There can be no
assurance that qualified personnel will continue to be available to the
Company in sufficient numbers and on terms of employment acceptable to the
Company. The Company must continually evaluate and upgrade its base of
available qualified personnel to keep pace with changing customer needs and
emerging technologies. Furthermore, a substantial number of the Company's
temporary employees during any given year will terminate their employment
with the Company to accept regular staff employment with customers of the
Company. The inability to attract and retain qualified personnel could have
a material adverse effect on the Company's business, results of operations,
cash flows or financial condition.

RELIANCE ON FIELD MANAGEMENT. The Company is dependent on the performance
and productivity of its local managers, particularly branch, and regional
managers. This loss of some of the Company's key managers could have an
adverse effect on the Company's operations, including the Company's ability
to establish and maintain customer relationships. The Company's ability to
attract and retain business is significantly affected by local
relationships and the quality of services rendered by branch, area,
regional and zone managerial personnel. If the Company is unable to attract
and retain key employees to perform these services, the Company's business,
results of operations, cash flows or financial condition could be adversely
affected. Furthermore, the Company may be dependent on the senior
management of companies that may be acquired in the future. If any of these
individuals do to continue in their management roles, there could be
material adverse effect on the Company's business, results of operations,
cash flows or financial condition.

EMPLOYER LIABILITY RISKS. Providers of temporary staffing services place
people in the workplaces of other businesses. An inherent risk of such
activity includes possible claims of errors and omissions, discrimination
or harassment, theft of customer property, misappropriation of funds,
misuse of customers' proprietary information,

11

employment of undocumented workers, other criminal activity or torts,
claims under health and safety regulations and other claims. There can be
no assurance that the Company will not be subject to these types of claims,
which may result in negative publicity and the payment by the Company of
monetary damages or fines which, if substantial, could have a material
adverse effect on the Company's business, results of operations, cash flows
or financial condition.

RISK OF NASDAQ DELISTING. There are several requirements for continued
listing on the Nasdaq SmallCap Market ("Nasdaq") including, but not limited
to, a minimum stock bid price of one dollar per share and $2.5 million in
stockholder's equity. As of September 30, 2001 our stockholder's equity was
below the Nasdaq requirement and, although management is actively seeking
to remedy the problem, the Company can make no assurance that it will be
resolved in a timely fashion or at all. Furthermore, if the Company's
common stock price closes below one dollar per share for 30 consecutive
days, the Company may receive notification from Nasdaq that its common
stock will be delisted from the Nasdaq unless the stock closes at or above
one dollar per share for at least ten consecutive days during the 90-day
period following such notification. If the Company fails to comply with the
listing requirements, the result will be that its common stock might be
delisted. If its common stock is delisted, the Company may list its common
stock for trading over-the-counter. Delisting from the Nasdaq could
adversely affect the liquidity and price of the Company's common stock and
it could have a long-term impact on the Company's ability to raise future
capital through a sale of its common stock. In addition, it could make it
more difficult for investors to obtain quotations or trade this stock.

On January 17, 2002 the Company received a Nasdq Staff Determination,
due to its failure to file its Form 10-K for the fiscal period ended
September 30, 2001, indicating the Company's noncompliance with the
requirement for continued listing set forth in Nasdaq's Marketplace Rule
4310(c)(14), and that its securities are, therefore subject to
delisting. On January 24, 2002, the Company submitted a request for a
hearing to review the Staff Determination, staying the delisting. There
is no assurance the Panel will grant Stratus' request for continued
listing.

RISKS RELATED TO ACQUISITIONS. While the Company intends to pursue
acquisitions in the future, there can be no assurance that the Company will
be able to expand its current market presence or successfully enter other
markets through acquisitions. Competition for acquisitions may increase to
the extent other temporary services firms, many of which have significantly
greater financial resources than the Company, seek to increase their market
share through acquisitions. In addition, the Company is subject to certain
limitations on the incurrence of additional indebtedness under its credit
facilities, which may restrict the Company's ability to finance
acquisitions. Further, there can be no assurance that the Company will be
able to identify suitable acquisition candidates or, if identified,
complete such acquisitions or successfully integrate such acquired
businesses into its operations. Acquisitions also involve special risks,
including risks associated with unanticipated problems, liabilities and
contingencies, diversion of management's attention and possible adverse
effects on earnings resulting from increased goodwill amortization,
interest costs and workers' compensation costs, as well as difficulties
related to the integration of the acquired businesses, such as retention of
management. Furthermore, once integrated, acquisitions may not achieve
comparable levels of revenue or profitability as the Company's existing
locations. In addition, to the extent that the Company consummates
acquisitions in which a portion of the consideration is in the form of
common stock, current shareholders may experience dilution. The failure to
identify suitable acquisitions, to complete such acquisitions or
successfully integrate such acquired businesses into its operations could
have a material adverse effect on the Company's business, results of
operations, cash flows or financial condition.

RISK RELATED TO CONVERTIBLE SECURITIES. In December 2000, we raised
$1,987,400 by issuing 6% debentures, which are convertible into shares
of our common stock. In July 2001, we issued 1,458,933 shares of Series
A preferred stock which are convertible into 1,458,933 shares of common
stock. If all of the debentureholders convert their debentures into
shares of common stock, we will be required to issue no less than
427,398 shares of common stock and, if all the Series A preferred
stockholders elect to convert into common stock, we will be required to
issue no less than 1,458,933 shares of common stock. If the trading
price of the common stock is low when the conversion price of the 6%
debentures is determined, we would be required to issue a higher number
of shares of common stock, which could cause a further reduction in each
of our stockholder's percentage ownership interest. In addition, if a
selling shareholder converts our 6% debentures or Series A preferred
stock and sells the common stock, this could result in an imbalance of
supply and demand for our common stock and a decrease in the market
price of our common stock. The further our stock price declines, the
further the conversion price of the 6% debentures will fall and the
greater the number of shares we will have to issue upon conversion.

ITEM 2. PROPERTIES

We own no real property. We lease approximately 6,300 square feet in a
professional office building in Manalapan, New Jersey as our corporate
headquarters. That facility houses all of our centralized corporate functions,
including the Executive management team, payroll processing, accounting, human
resources and legal departments. Our lease expires on September 30, 2002 and we
have begun discussions with realtors regarding locating sufficient space. As of
September 30, 2001 we leased 35 additional facilities, primarily flexible
staffing offices, in 10 states. With the exception of the corporate
headquarters, we believe that our facilities are generally adequate for our
needs and we do not anticipate any difficulty in replacing such facilities or
locating additional facilities, if needed.

12

ITEM 3. LEGAL PROCEEDINGS

We are involved, from time to time, in routine litigation arising in the
ordinary course of business. We do not believe that any currently pending
litigation will have a material adverse effect on our financial position or
results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

13

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

On April 11, 2000 our registration statement on Form SB-2 (Commission File No.
333-83255) for our initial public offering (the "IPO") of common stock, $.01 par
value, became effective and our shares commenced trading on the Nasdaq SmallCap
Market under the symbol "SERV" on April 26, 2000. There were approximately 197
holders of record of Common Stock as of January 24, 2002. This number does not
include the number of shareholders whose shares were held in "nominee" or
"street name", which we cannot determine until after we have held our annual
meeting. The table below sets forth, for the periods indicated, the high and low
sales prices of our Common Stock as reported by the Nasdaq Stock Market.

On January 24, 2002, the closing price of our Common Stock as reported by the
Nasdaq Stock Market, was $0.90 per share. We have never paid dividends on our
Common Stock and we intend to retain earnings, if any, to finance future
operations and expansion. In addition, our credit agreement restricts the
payment of dividends. Therefore, we do not anticipate paying any cash dividends
in the foreseeable future. Any future payment of dividends will depend upon the
financial condition, capital requirements and our earnings as well as other
factors that the Board of Directors deems relevant.

On August 7, 2001, we issued 400,000 shares of our common stock to Source One
Personnel, Inc. ("Source One") in connection with our acquisition of
substantially all of the assets, excluding accounts receivable, of Source One.
The issuance of the shares was made in reliance upon the exemption provided by
Section 4(2) of the Securities Act of 1933 as a transaction not involving a
public offering.

Between September 21, 2001 and October 8, 2001 we sold a total of 383,000
shares of our common stock for an aggregate of $410,000 to Charles A.
Sahyoun, Jeffrey J. Raymond, Jr., Nicole Raymond, Jake Raymond and Jamie
Raymond. The issuance of the shares was made in reliance upon the exemption
provided by Section 4(2) of Securities Act of 1933 as a transaction not
involving a public offering.

Between November 28, 2001 and December 20, 2001 we issued 266,670 shares of
our common stock to private investors in our private placement initiated in
June 2001. The issuance of the shares was made in reliance upon the exemption
provided by Section 4(2) of Securities Act of 1933 as a transaction not
involving a public offering.

On December 28, 2001, we issued 400,000 shares of our common stock to
Provisional Employment Solutions, Inc. ("PES") in connection with our
acquisition of substantially all of the assets, excluding accounts receivable,
of PES. The issuance of the shares was made in reliance upon the exemption
provided by Section 4(2) of the Securities Act of 1933 as a transaction not
involving a public offering.

During the period between December 2000 and September 30, 2001, we sold
$3,643,402 of 6% Convertible Debentures (the "Debentures") in private
offerings to accredited investors conducted under Rule 506 of Regulation D.
The Debentures mature in five years from issuance and into a number of shares
of Common Stock which is determined by dividing the principal amount by the
lesser of (a) 120% of the closing bid price of Common Stock on the trading
day immediately preceding the initial issue date of the Debentures or (b) 75%
of the average closing bid price of the Common Stock for the five trading
days immediately preceding the conversion. Interest on the Debentures is
payable, at the option of the Company, in Common Stock. A five-year warrant
to acquire 25,000 shares of Common Stock at an exercise price of $7.50 per
share was issued to one of the investors in the offerings.

14

ITEM 6. SELECTED FINANCIAL DATA.
(In thousands except per share)

(1) Pro forma adjustment reflects the sale of the assets of the Engineering
Division for net proceeds of $1,496,000 at closing plus additional proceeds
to be received of $250,000 on June 30, 2002 and $250,000 on December 31, 2002.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

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. Our Engineering Services division typically generates higher
margins while the Staffing Services division typically generates lower margins.
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

YEAR ENDED SEPTEMBER 30, 2001 COMPARED TO YEAR ENDED SEPTEMBER 30, 2000

REVENUES. Revenues increased 54.2% to $64,271,705 for the year ended September
30, 2001 from $41,676,587 for the year ended September 30, 2000. Revenues
increased primarily as a result of acquisitions.

GROSS PROFIT. Gross profit increased 26.3% to $13,250,092 for the year ended
September 30, 2001 from $10,493,909 for the year ended September 30, 2000
primarily as a result of increased revenues attributable to acquisitions. Gross
profit as a

15

percentage of revenues decreased to 20.6% for the year ended September 30, 2001
from 25.2% for the year ended September 30, 2000. This decrease was due to lower
gross profit percentages realized by the acquired businesses as compared to our
historical gross profit percentages.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses not including depreciation and amortization increased
69.0% to $14,442,893 for the year ended September 30, 2001 from $8,547,788 for
the year ended September 30, 2000. Selling, general and administrative expenses
as a percentage of revenues increased to 22.5% for the year ended September 30,
2001 from 20.5% for the year ended September 30, 2000. The increases are
primarily attributable to costs associated with the integration of the
acquisitions, an increase in credit losses and additional management and other
costs in anticipation of future growth and acquisitions.

LOSS ON IMPAIRMENT OF GOODWILL. We periodically determine if there has been a
permanent impairment of goodwill. In this connection, we recorded an impairment
loss of $700,000 in the year ended September 30, 2001.

OTHER CHARGES. During the year ended September 30, 2001, we wrote off costs
associated with discontinued negotiations to sell the Engineering Division and
discontinued efforts to make certain acquisitions. We also wrote off costs we
incurred in connection with various financing not obtained and costs associated
with closed offices. The total of all these costs was $519,801.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased
109.5% to $768,994 for the year ended September 30, 2001 from $367,129 for the
year ended September 30, 2000. Depreciation and amortization expenses as a
percentage of revenues increased to 1.2% for the year ended September 30, 2001
from 0.9% for the year ended September 30, 2000. These increases were primarily
due to the amortization of goodwill associated with acquisitions and the impact
of increased capital expenditures.

FINANCE CHARGES. Finance charges were the amounts charged under an agreement
with a factor, which was terminated on December 12, 2000. Finance charges
decreased 83.7% to $100,934 for the year ended September 30, 2001 from $618,134
for the year ended September 30, 2000. As a percentage of revenues, finance
charges decreased to 0.2% for the year ended September 30, 2001, from 1.5% for
the year ended September 30, 2000. This decrease was due to the agreement being
terminated December 12, 2000.

INTEREST AND FINANCING COSTS. Interest and financing costs increased to
$2,176,964 for the year ended September 30, 2001 from $300,892 for the year
ended September 30, 2000. Included in the amount for the year ended September
30, 2001 is $1,213,747, which is the portion of the discount on the beneficial
conversion feature of convertible debt issued during the year and $135,374 of
costs we incurred in connection with the issuance of the convertible debt.
Interest and financing costs, not including these debt costs, as a percentage of
revenue increased to 3.4% for the year ended September 30, 2001 from 0.7% for
the year ended September 30, 2000. The increase was primarily attributable to
the line of credit agreement which replaced the agreement with the factor (see
"Finance Changes" above) on December 12, 2000.

INCOME TAX (BENEFIT). Income tax benefit of $340,000 for the year ended
September 30, 2000 is the result of the utilization of a portion of the net
operating loss carryforwards. Income tax expense for the year ended September
30, 2001 is the result of a change in judgment about the realizability of
deferred tax assets.

NET EARNINGS (LOSS) AND NET EARNINGS (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS.
As a result of the foregoing, we had a net loss and net loss attributable to
common stockholders of ($5,847,457) and ($5,910,457), respectively, for the year
ended September 30, 2001 compared to net earnings and net earnings attributable
to common stockholders of $1,045,910 for the year ended September 30, 2000. The
net loss as a percentage of revenues was (9.1%) for the year ended September 30,
2001. The net earnings for the year ended September 30, 2000 as a percentage of
revenues was 2.5%.

YEAR ENDED SEPTEMBER 30, 2000 COMPARED TO YEAR ENDED SEPTEMBER 30, 1999

REVENUES. Revenues increased 38.7% to $41,676,587 for the year ended September
30, 2000 from $30,042,751 for the year ended September 30, 1999. A significant
portion of the increase was attributable to the growth of our SMARTSolutions(TM)
division where revenues increased 108.1% to $14,443,057 for the year ended
September 30, 2000 from $6,938,887 for the year ended September 30, 1999.

GROSS PROFIT. Gross profit increased 55.8% to $10,493,909 for the year ended
September 30, 2000 from $6,736,497 for the year ended September 30, 1999. Gross
profit as a percentage of revenues increased to 25.2% for the year ended
September 30, 2000 from 22.4% for the year ended September 30, 1999. This
increase was due to continuing our plan to seek higher gross margin business and
the higher margins generated by our SMARTSolutions(TM) and Engineering
divisions.

16

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses not including depreciation and amortization increased
21.1% to $8,547,788 for the year ended September 30, 2000 from $7,057,631 for
the year ended September 30, 1999. Selling, general and administrative expenses
as a percentage of revenues decreased to 20.5% for the year ended September 30,
2000 from 23.5% for the year ended September 30, 1999. The increased dollar
amount is due to the increase in costs, primarily for personnel, to support the
increase in revenues.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased
86.5% to $367,129 for the year ended September 30, 2000 from $196,818 for the
year ended September 30, 1999. Depreciation and amortization expenses as a
percentage of revenues increased to 0.9% for the year ended September 30, 2000
from 0.7% for the year ended September 30, 1999. This increase was primarily due
to the amortization of goodwill associated with the acquisition in June 2000 and
the impact of increased capital expenditures.

FINANCE CHARGES. Finance charges decreased 14.4% to $618,134 for the year ended
September 30, 2000 from $722,020 for the year ended September 30, 1999. As a
percentage of revenues, finance charges decreased to 1.5% for the year ended
September 30, 2000 from 2.4% for the year ended September 30, 1999. This
decrease was due to improved collections, which reduced the average days
outstanding of the accounts receivable sold.

INCOME TAX BENEFIT. Income tax benefit of $340,000 for the year ended September
30, 2000 is the result of the utilization of a portion of the net operating loss
carryforwards. As a percentage of revenue, income tax benefit was 0.8%.

NET EARNINGS (LOSS) AND NET EARNINGS (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS.
As a result of the foregoing, we had net earnings and net earnings attributable
to common stockholders of $1,045,910 for the year ended September 30, 2000
compared to a net loss and net loss attributable to common stockholders of
($1,527,043) for the year ended September 30, 1999. The net earnings as a
percentage of revenues was 2.5% for the year ended September 30, 2000. The net
loss for the year ended September 30, 1999 as a percentage of revenues was
(5.1%).

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2001, we had limited liquid resources. Current liabilities were
approximately $14.5 million and current assets were approximately $13.0 million.
The difference of approximately $1.5 million is a working capital deficit which
is primarily the result of the losses we had during the last three quarters.
This situation has also made it difficult for us to make timely payments to our
vendors.

On January 24, 2002 we entered into an agreement to sell the assets of our
Engineering Division. Approximately, $1,796,000 of working capital will be
received by us and be available to eliminate our working capital deficit.

We believe that our liquidity position is currently manageable, but the working
capital deficit will remain until additional capital is raised.

Net cash used in operating activities was $2,405,464 and $1,624,452 in the years
ended September 30, 2001 and 2000, respectively. The change in operating cash
flow was primarily a result of a net increase of $3,159,746 in net (loss)
adjusted by non-cash items, including depreciation, amortization and imputed
interest. This change was substantially offset by the increase in accounts
payable and accrued expenses which was attributable to insufficient cash to
reduce these balances. Approximately $1,200,000 of the net proceeds from the
initial public offering (IPO) in April 2000 was used to reduce trade and other
payables in the year ended September 30, 2000.

Net cash used in investing activities was $2,032,021 and $1,955,343 in the years
ended September 30, 2001 and 2000, respectively. Cash used for acquisitions was
$1,218,674 and $1,053,868 in the years ended September 30, 2001 and 2000,
respectively. The balance in both periods was primarily for capital
expenditures.

Net cash provided by financing activities was $3,578,585 and $4,187,445 in the
years ended September 30, 2001 and 2000, respectively. We had net borrowings of
$2,065,156 under the line of credit obtained on December 12, 2000. We also
received net proceeds less redemptions of $441,356 from the issuance of
convertible debt and $1,412,772 from the sale of our common stock in the year
ended September 30, 2001. We used $265,125 to purchase treasury stock and
$320,394 to reduce our notes payable acquisitions in the year ended September
30, 2001. Net proceeds of the IPO in the year ended September 30, 2000 were
$6,034,169, of which $1,125,000 was used to repay notes and loans payable and
$350,000 was used to purchase treasury stock.

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; and costs relating to
other transactions such as acquisitions. Temporary employees are paid weekly.

17

During the year ended September 30, 2001, we sold $3,643,402 of 6% convertible
debentures in private offerings. The debentures mature five years from issuance
and are convertible commencing 120 days from issuance into a number of shares,
which is determined by dividing the principal amount by the lesser of (a) $4.65
or (b) 75% of the average closing bid price of the common stock for the five
trading days immediately preceding the conversion. We recorded interest expenses
of approximately $1.2 million for the beneficial conversion feature of the
convertible debt in the year ended September 30, 2001. As of September 30, 2001,
$1,125,399 of the 6% convertible debentures were outstanding.

On December 12, 2000, we entered into a loan and security agreement with a
lending institution which replaced our prior factoring arrangement and provides
for a line of credit up to 90% of eligible accounts receivable, as defined, not
to exceed $12,000,000. Advances under the credit agreement bear interest at a
rate of prime plus one and one-half percent (1 1/2 %). 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 September 30, 2001, $7,306,581 was outstanding under the
credit agreement. The agreement expires June 12, 2002.

Because we have a working capital deficit, we need to raise additional capital
to continue our operations. We are currently seeking sources of capital to
eliminate the working capital deficit. There can be no assurance that we will be
able to obtain additional capital at acceptable rates. If we cannot raise
additional capital, we will seek other alternatives such as the sale of assets.

SEASONALITY

Our business follows the seasonal trends of our customers business.
Historically, Staffing Services has 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.

SMARTSolutions(TM) and Engineering Services do not experience the same level of
seasonality associated with Staffing Services.

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 Statement
of Financial Accounting Standard (SFAS) No. 141, "Business Combinations". SFAS
No. 141 establishes new standards for accounting and reporting requirements for
business combinations and requires that the purchase method of accounting be
used for all business combinations initiated after June 30, 2001. SFAS No. 141
also requires that acquired intangible assets be recognized as assets apart from
goodwill if they meet one of the two specified criteria. Additionally, the
statement adds certain disclosure requirements to those required by APB 16,
including disclosure of the primary reasons for the business combination and the
allocation of the purchase price paid to the assets acquired and liabilities
assumed by major balance sheet caption. This statement is required to be applied
to all business combinations initiated after June 30, 2001 and to all business
combinations accounted for using the purchase method for which the date of
acquisition is July 1, 2001 or later. Use of the pooling-of-interests method is
prohibited. The adoption of SFAS No. 141 did not have an impact on our financial
condition or results of operations.

In June 2001, the 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. At September 30, 2001, the Company's
goodwill was approximately $7,815,000, and annual amortization of such goodwill
was approximately $341,000. The Company expects to adopt SFAS No. 142 during its
first fiscal quarter of fiscal 2003. Because of the extensive effort required to
comply with

18

the remaining provisions of SFAS Nos. 141 and 142, we cannot reasonably estimate
the impact on its financial statements of these provisions beyond discontinuing
amortization.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

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 90% of
eligible accounts receivable, not to exceed $12,000,000. Advances under this
credit agreement bear interest at a rate of prime plus one and one-half percent
(1-1/2%).

We are also exposed to equity price risk on our investment in
enterpriseAsia.com, a publicly-traded foreign company. We do not attempt to
reduce or eliminate our market exposure on this investment.

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The response to this item is submitted in a separate section of this report
commencing on Page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

No change in accountants or disagreement requiring disclosure pursuant to
applicable regulations took place within the reporting period or in any
subsequent interim period.

19

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTIONS 16(C) OF THE EXCHANGE ACT.

THE BOARD OF DIRECTORS AND OFFICERS

The name and age of each the directors and the executive officers of the Company
and their respective positions with the Company are set forth below. Additional
biographical information concerning each of the nominees and the executive
officers follows the table.

Set forth below is certain biographical information with respect to the nominees
for election to the Board of Directors.

JOSEPH J. RAYMOND has served as Chairman of the Board and Chief Executive
Officer of Stratus since its inception in 1997. Prior thereto, he served as
Chairman of the Board, President and Chief Executive Officer of Transworld Home
Healthcare, Inc. (NASDAQ:TWHH), a provider of healthcare services and products,
from 1992 to 1996. From 1987 through 1997, he served as Chairman of the Board
and President of Transworld Nurses, Inc., a provider of nursing and
paraprofessional services, which was acquired by Transworld Home Healthcare,
Inc. in 1992.

MICHAEL J. RUTKIN has served as a Director of Stratus since November 1997 and
was Chief Operating Officer and President from March 1997 to October 1998. Since
November 1998, Mr. Rutkin has served as General Manager/Chief Executive Officer
of Battleground Country Club. From 1996 to 1998, Mr. Rutkin served as Vice
President of Transworld Management Services, Inc. From February 1993 to October
1996, he served as Chief Operating Officer of HealthCare Imaging Services, Inc.
Prior thereto, Mr. Rutkin was the Executive Vice President of Advanced
Diagnostic Imaging from February 1987 to February 1993. From March 1981 to
September 1984, he served as Director of New Business Development for the United
States Pharmaceutical Division of CIBA-Geigy. Mr. Rutkin is the brother-in-law
of Joseph J. Raymond.

HARRY ROBERT KINGSTON has served as a Director of Stratus since November 1997.
From 1977 until his retirement in 1989, he served as the President and Chief
Executive Officer of MainStream Engineering Company, Inc., an engineering
staffing firm located in California . From 1965 to 1968, he served as President
and Partner of VIP Engineering Company, a subsidiary of CDI Corporation, a
staffing and engineering services business. From 1968 to 1977, Mr. Kingston
served as Vice President for CDI Corporation.

DONALD W. FEIDT has served as a Director of Stratus since November 1997. From
1987 to December 1998, Mr. Feidt was a Managing Partner of Resource Management
Associates, an information technology consulting company. Since December 1998,
Mr. Feidt has served as a Vice President to the Chief Executive Officer of Skila
Inc., a global web-based business intelligence platform company providing
services to the medical industry.

SANFORD I. FELD has served as a Director of the Company since November 1997. Mr.
Feld is currently president of Leafland Associates, Inc., an advisor to Feld
Investment and Realty Management, a real estate development and management
company. He also serves as Chairman of Flavor and Food Ingredients, a private
savory and flavor company. From 1973 to 1979, he served as Director of the
Chelsea National Bank of New York City.

CHARLES A. SAHYOUN has served as President of Stratus' Engineering Services
Division since December 1997. From September 1988 to December 1997, he was
employed in various capacities with Day & Zimmerman Utilities Services Group,
Inc., an engineering and design services company, including Vice President of
Business Development. Mr. Sahyoun is a cousin of Joseph J. Raymond.

20

MICHAEL A. MALTZMAN has served as Treasurer and Chief Financial Officer of
Stratus since September 1997 when it acquired the assets of Royalpar Industries,
Inc. Mr. Maltzman served as a Chief Financial Officer of Royalpar, which filed
for protection under United States Bankruptcy Code in 1997, from April 1994 to
August 1997. From June 1988 to July 1993, he served as Vice President and Chief
Financial Officer of Pomerantz Staffing Services, Inc., a national staffing
company. Prior thereto, he was a Partner with Eisner & Lubin, a New York
accounting firm. Mr. Maltzman is a Certified Public Accountant.

J. TODD RAYMOND has served as General Counsel and Secretary of the Company since
September 1997. From December 1994 to January 1996, Mr. Raymond was an associate
and managing attorney for Pascarella & Oxley, a New Jersey general practice law
firm. Prior thereto, Mr. Raymond acted as in-house counsel for Raymond & Perri,
an accounting firm. From September 1993 to September 1994, Mr. Raymond was an
American Trade Policy Consultant for Sekhar-Tunku Imran Holdings Sdn Berhad, a
Malaysian multi-national firm. He is the nephew of Joseph J. Raymond.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Section 16(a) of the Exchange Act requires the Company's executive officers and
directors, and persons who own more than ten percent of a registered class of
the Company's equity securities, to file reports of ownership and changes in
ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission (the
"SEC"). Officers, directors and greater than ten percent stockholders are
required by SEC regulation to furnish the Company with copies of all Forms 3, 4
and 5 they file.

Based solely on the Company's review of the copies of such forms it has
received, the Company believes that all of its executive officers, directors and
greater than ten percent stockholders complied with all filing requirements
applicable to them with respect to events or transactions during fiscal 2001,
except that each of Joseph J. Raymond, Charles Sahyoun, Michael A. Maltzman, J.
Todd Raymond, Sanford I. Feld and Donald W. Feidt are late in filing the Forms
5 which were due for filing in November 2001.

ITEM 11. EXECUTIVE COMPENSATION.

The following table provides certain summary information regarding compensation
paid by the Company during the fiscal years ended September 30, 1999, 2000 and
2001 to the Chief Executive Officer of the Company and to each of the Company's
other two most highly paid executive officers (together with the Chief Executive
Officer, the "Named Executive Officers"):

DIRECTORS' COMPENSATION

21

Directors who are employees of the Company are not compensated for serving on
the Board of Directors. Non-employee directors are paid a fee of $1,000 per
Board of Directors or committee meeting attended in person and $500 for
telephonic attendance.

EMPLOYMENT AGREEMENTS

In September 1997, the Company entered into an employment agreement (the
"Raymond Agreement") with Joseph J. Raymond, Chairman and Chief Executive
Officer, which had an initial term that expired in September 2000. The Raymond
Agreement has been extended through September, 2002. Pursuant to the Raymond
Agreement and subsequent amendments, Mr. Raymond is entitled to a minimum annual
base salary of $175,000 which is reviewed periodically and subject to such
increases as the Board of Directors, in its sole discretion, may determine.
During the term of the Raymond Agreement, if Stratus is profitable, Mr. Raymond
is entitled to a bonus/profit sharing award equal to .4% of Stratus' gross
margin, but not in excess of 100% of his base salary. If Stratus is not
profitable, he is entitled to a $10,000 bonus. Mr. Raymond is eligible for all
benefits made available to senior executive employees, and is entitled to the
use of an automobile.

In the event Stratus terminates Mr. Raymond without "Good Cause", Mr. Raymond
will be entitled to severance compensation equal to 2.9 times his base salary
then in effect plus any accrued and unpaid bonuses and unreimbursed expenses. As
defined in the Raymond Agreement "Good Cause" shall exist only if Mr. Raymond:

o willfully or repeatedly fails in any material respect to perform his
obligations under the Raymond Agreement, subject to certain
opportunities to cure such failure;

o is convicted of a crime which constitutes a felony or misdemeanor or
has entered a plea of guilty or no contest with respect to a felony or
misdemeanor during his term of employment;

o has committed any act which constitutes fraud or gross negligence;

o is determined by the Board of Directors to be dependent upon alcohol
or drugs; or

o breaches confidentiality or non-competition provisions of the Raymond
Agreement.

Mr. Raymond is also entitled to severance compensation in the event that he
terminates the Raymond Agreement for "Good Reason" which includes:

o the assignment to him or any duties inconsistent in any material
respect with his position or any action which results in a significant
diminution in his position, authority, duties or responsibilities;

o a reduction in his base salary unless his base salary is, at the time
of the reduction, in excess of $200,000 and the percentage reduction
does not exceed the percentage reduction of gross sales of Stratus
over the prior twelve month period;

o Stratus requires Mr. Raymond to be based at any location other than
within 50 miles of Stratus' current executive office location; and

o a Change in Control of Stratus, which includes the acquisition by any
person or persons acting as a group of beneficial ownership of more
than 20% of the outstanding voting stock of Stratus, mergers or
consolidations of Stratus which result in the holders of Stratus'
voting stock immediately before the transaction holding less than 80%
of the voting stock of the surviving or resulting corporation, the
sale of all or substantially all of the assets of Stratus, and certain
changes in the Stratus Board of Directors.

In the event that the aggregate amount of compensation payable to Mr. Raymond
would constitute an "excess parachute payment" under the Internal Revenue Code
of 1986, as amended (the "Code"), then the amount payable to Mr. Raymond will be
reduced so as not to constitute an "excess parachute payment." All severance
payments are payable within 60 days after the termination of employment.

Mr. Raymond has agreed that during the term of the Raymond Agreement and for a
period of one year following the termination of his employment, he will not
engage in or have any financial interest in any business enterprise in
competition with Stratus that operates anywhere within a radius of 25 miles of
any offices maintained by the Company as of the date of the termination of
employment.

22

The Company entered into employment agreements with each of the other two (2)
officers named in the Executive Compensation table set forth above. The
agreements with Mr. Sahyoun and Mr. Maltzman provide for base salaries of
$165,000 and $146,000, respectively. The agreement with Mr. Sahyoun entitles him
to a profit sharing award equal to 10% of the Engineering Services Division's
pre-tax income, but not in excess of his base salary. Mr. Maltzman is entitled
to profit sharing awards based upon the Company's overall profitability. Each of
these agreements is terminable by any party at any time without cause. However,
in the event that either of these agreements are terminated by the Company
without cause or by the executive with good reason, the executive will be
entitled to a severance payment equal to the greater of one month's salary for
each year worked or three months salary. In addition, the Company will pay the
executive any earned but unused vacation time and any accrued but unpaid profit
sharing. The Company is also required to maintain insurance and benefits for a
terminated executive during the severance period.

OPTION GRANTS

Shown below is further information with respect to grants of stock options in
fiscal 2001 to the Named Officers by the Company which are reflected in the
Summary Compensation Table set forth under the caption "Executive Compensation."

- --------------------------------------------------------------------------------
(1) 500,000 of these options are exercisable cumulative in two (2) equal annual
installments, commencing on the date of the grant; 500,000 are exercisable
cumulatively in five (5) equal annual installments, commencing on the date
of the grant.

(2) These options are exercisable cumulative in two (2) equal annual
installments, commencing on the date of the grant.

OPTION EXERCISES AND FISCAL YEAR-END VALUES

Shown below is information with respect to options exercised by the Named
Executive Officers during fiscal 2001 and the value of unexercised options
to purchase the Company's Common Stock held by the Named Executive Officers
at September 30, 2001.

No options were exercised by the Named Executive Officers during the fiscal year
ended September 30, 2001.

(1) Represents market value of shares covered by in-the-money options on
September 30, 2001. The closing price of the Common Stock on such date was
$1.00. Options are in-the-money if the market value of shares covered
thereby is greater than the option exercise price.

23

ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following table sets forth information, as of January 18, 2001 with respect
to the beneficial ownership (as defined in Rule 13d-3) of the Company's Common
Stock by each director and nominee for director, each of the Named Executive
Officers (as defined in the section captioned "Executive Compensation") who is
currently an officer of the Company and by all directors and executive officers
as a group. Except as set forth in the footnotes to the table, the stockholders
have sole voting and investment power over such shares.

- ---------------
(1) Includes 1,458,933 shares of Series A Preferred Stock that are convertible
into 1,458,933 shares of common stock at the holder's option.
(2) Includes 693,782 shares subject to options to purchase that are currently
exercisable or may become exercisable within 60 days of January 18, 2001.
Excludes 1,575,000 shares subject to options that are not vested or
exercisable within 60 days of January 18, 2001.
(3) Includes 210,448 shares subject to currently exercisable stock options.
Excludes 175,000 shares subject to options that are not vested or
exercisable within 60 days of January 18, 2001.
(4) Includes 30,000 shares held by the children of Michael Rutkin living in his
household and 10,000 shares held by his wife.
(5) Includes 49,167 shares subject to currently exercisable stock options and
warrants.
(6) Shares beneficially owned do not exceed 1% of the Company's outstanding
Common Stock.
(7) Includes 10,000 shares subject to current exercisable options.
(8) Includes 114,782 shares that are beneficially owned by J. Todd Raymond, the
Company's General Counsel and Corporate Secretary, including 88,782 shares
subject to currently exercisable options.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.

Jeffrey J. Raymond, the son of the Company's Chairman and Chief Executive
Officer, serves as a consultant to the Company pursuant to an agreement which
requires him to supervise the collection of certain accounts receivable, to use
his best efforts to maintain relationships with certain clients and to assist in
due diligence investigations of acquisitions of other companies. Total
consulting fees paid to Jeffrey Raymond were $281,000 in fiscal 2001.

During fiscal 2000, the Company paid consulting fees of $119,000 to RVR
Consulting, Inc., a corporation of which Joseph J. Raymond, Jr., the son of
Joseph J. Raymond, the Company's Chairman and Chief Executive Officer, is an
officer and 50% shareholder.

In November 2000, the Company formed the Stratus Technology Services, LLC
joint venture with Fusion Business Services, LLC. Jamie Raymond, son of
Joseph J. Raymond, Chairman & CEO, is the managing member of both Fusion and
STS and J. Todd Raymond, Secretary and General Counsel, holds a minority
interest in Fusion.

Between September 21, 2001 and October 8, 2001 we sold a total of 383,000
shares of our common stock to Charles A. Sahyoun, Jeffrey J. Raymond, Jr.,
Nicole Raymond, Jake Raymond and Jamie Raymond. The issuance of the shares
was made in reliance upon the exemption provided by Section 4(2) of the
Securities Act of 1933 as a transaction not involving a public offering.

All prior and ongoing material transactions with related parties have been
reviewed and/or ratified by a majority of the Company's independent,
disinterested directors. The Company anticipates that from time to time it will
enter into additional transactions with related parties. However, all future
material transactions with related parties will be entered into on terms that
are no less favorable than those that can be obtained from unaffiliated third
parties. At all times, the Company's directors have access to the Company's
counsel to discuss Company related issues.

24

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

PAGE
----

(a) Financial statements and financial statement schedules. F-1
Reference is made to Index of Financial Statements and
Financial Statement Schedules hereinafter contained.

(b) Reports on Form 8-K

On June 30, 2000 we filed a Form 8-K announcing the purchase of
certain assets of the New Jersey and Pennsylvania Tandem Division of
Outsource International of America, Inc.

On October 27, 2000 we filed a Form 8-K announcing the purchase of
certain assets of the New England Tandem Division of Outsource
International of America, Inc.

On August 9, 2001 we filed a Form 8-K announcing the purchase of
certain assets of Source One Personnel, Inc.

On January 3, 2002 we filed a Form 8-K announcing the purchase of
certain assets of Provisional Employment Solutions, Inc.

(c) Exhibits

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

27

* Constitutes a Management Contract required to be filed pursuant
to Item 14(c) of Form 10-K.

** Constitutes a Compensatory Plan required to be filed pursuant to
Item 14(c) of Form 10-K.

Footnote 1 Incorporated by reference to similarly numbered Exhibits filed
with Amendment No. 1 to the Company's Registration Statement on
Form SB-2 (Registration Statement No. 333-83255) as filed with
the Securities and Exchange Commission on September 3, 1999.

Footnote 2 Incorporated by reference to similarly numbered Exhibits filed
with Amendment No. 6 to the Company's Registration Statement on
Form SB-2 (Registration Statement No. 333-83255) as filed with
the Securities and Exchange Commission on February 1, 2000.

Footnote 3 Incorporated by reference to similarly numbered Exhibits filed
with Amendment No. 3 to the Company's Registration Statement on
Form SB-2 (Registration Statement No. 333-83255) as filed with
the Securities and Exchange Commission on December 17, 1999.

Footnote 4 Incorporated by reference to similarly numbered Exhibits filed
with Amendment No. 7 to the Company's Registration Statement on
Form SB-2 (Registration Statement No. 333-83255) as filed with
the Securities and Exchange Commission on March 17, 2000.

Footnote 5 Incorporated by reference to the Exhibits to the Company's Form
8-K, as filed with the Securities and Exchange Commission on June
30, 2000.

Footnote 6 Incorporated by reference to the Exhibits to the Company's Form
8-K, as filed with the Securities and Exchange Commission on
November 3, 2000.

Footnote 7 Incorporated by reference to Exhibit 1.2 filed with Amendment
No. 5 to the Company's Registration Statement on Form SB-2
(Registration Statement No. 333-83255) as filed with the
Securities and Exchange Commission on February 11, 2000.

Footnote 8 Incorporated by reference to the Exhibits to the Company's Form
8-K, as filed with the Securities and Exchange Commission on
August 9, 2001.

Footnote 9 Incorporated by reference to the Exhibits to the Company's Form
8-K, as filed with the Securities and Exchange Commission on
January 2, 2002.

Footnote 10 Incorporated by reference to Exhibit 3 filed with Form 10-Q
for the Quarter ended June 30, 2001 as filed with the Securities
and Exchange Commission on August 14, 2001.

Footnote 11 Incorporated by reference to similarly number Exhibits to the
Company's Form 10-KSB, as filed with the Securities and Exchange
Commission on December 29, 2000.

Footnote 12 Incorporated by reference to similarly numbered Exhibits filed
with the Company's Registration Statement on Form S-1
(Registration Statement No. 333-55312) as filed with the
Securities and Exchange Commission on February 9, 2001.

Footnote 13 Incorporated by reference to the Exhibits to the Company's
Form S-1/A, as filed with the Securities and Exchange Commission
on April 11, 2001.

28

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
behalf of the undersigned, thereunto duly authorized.

STRATUS SERVICES GROUP, INC.

By: /s/ Joseph J. Raymond
-----------------------------------------
Joseph J. Raymond
Chairman of the Board of Directors,
President and Chief Executive Officer

Date: January 25, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

29

STRATUS SERVICES GROUP, INC.
INDEX TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999

F-1

Independent Auditors' Report

To the Stockholders of
Stratus Services Group, Inc.

We have audited the accompanying balance sheets of Stratus Services Group, Inc.
as of September 30, 2001 and 2000, and the related statements of operations,
stockholders' equity, cash flows and comprehensive income for each of the three
years in the period ended September 30, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards 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, the financial statements referred to above present fairly, in
all material respects, the financial position of Stratus Services Group, Inc. as
of September 30, 2001 and 2000, and the results of its operations and its cash
flows for each of the three years in the period ended September 30, 2001, in
conformity with generally accepted accounting principles in the United States of
America.

In connection with our audits of the financial statements referred to above, we
audited the financial schedule listed under Item 14. In our opinion, the
financial schedule, when considered in relation to the financial statements
taken as a whole, presents fairly, in all material respects, the information
stated therein.

/s/ AMPER, POLITZINER & MATTIA, P.A.
AMPER, POLITZINER & MATTIA, P.A.

January 24, 2002
- --------------------------------------------------------------------------------
Edison, New Jersey

F-2

STRATUS SERVICES GROUP, INC.
Balance Sheets
Assets

F-3

STRATUS SERVICES GROUP, INC.
Statements of Operations

F-4

STRATUS SERVICES GROUP, INC.
Statements of Cash Flows

F-5

STRATUS SERVICES GROUP, INC.
Statements of Cash Flows - Continued

F-6

STRATUS SERVICES GROUP, INC.
Statement of Stockholders' Equity

F-7

STRATUS SERVICES GROUP, INC.
Statement of Stockholders' Equity - Continued

F-8

STRATUS SERVICES GROUP, INC.
Statements of Comprehensive Income

F-9

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
----------------------------------------------------------
POLICIES
--------
OPERATIONS
----------
Stratus Services Group, Inc. (the "Company") is a national
provider of staffing and productivity consulting services. As
of September 30, 2001, the Company operated a network of
thirty-five offices in ten states.

The Company operates as one business segment. The one business
segment consists of its traditional staffing services,
engineering staffing services, and SMARTSolutions(TM), a
structured program to monitor and enhance the production of a
client's labor resources. The Company's customers are in
various industries and are located throughout the United
States. Credit is granted to substantially all customers. No
collateral is maintained.

LIQUIDITY
---------

At September 30, 2001, the Company had limited liquid
resources. Current liabilities were $14,503,820 and current
assets were $12,957,821. The difference of $1,545,999 is a
working capital deficit which is primarily the result of
losses incurred during each of the three quarters ended
September 30, 2001. Management believes that the liquidity
position is currently manageable, but the working capital
deficit will remain until additional capital is raised.

On January 24, 2002 the Company entered into an agreement
to sell the assets of its Engineering Division (see
Note 24). Approximately $1,796,000 of working capital will
be received by the Company from this transaction.

REVENUE RECOGNITION
-------------------
The Company recognizes revenue as the services are performed
by its workforce. The Company's customers are billed weekly.
At balance sheet dates, there are accruals for unbilled
receivables and related compensation costs. The Company
believes its revenue recognition policies do not significantly
differ from SAB 101.

USE OF ESTIMATES
----------------
The preparation of financial statements in conformity with
generally accepted accounting principles 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. Actual results could differ from those
estimates.

CASH EQUIVALENTS AND CONCENTRATION OF CASH
------------------------------------------
The Company considers all highly liquid investments with
original maturities of three months or less to be cash
equivalents. The Company maintains its cash in bank deposit
accounts, which, at times may exceed federally insured limits.
The Company has not experienced any losses in such accounts.

RECLASSIFICATION
----------------
Certain items in the Statements of Cash Flows for the years
ended September 30, 1999 and 2000 have been reclassified to
conform to the year ended September 30, 2001 presentation.

COMPREHENSIVE INCOME (LOSS)
---------------------------
Comprehensive income (loss) is the total of net income (loss)
and other non-owner changes in equity including unrealized
gains or losses on available-for-sale marketable securities.

EARNINGS/LOSS PER SHARE
-----------------------
The Company utilizes Statement of Financial Accounting
Standards No. 128 "Earnings Per Share", (SFAS 128), whereby
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.

F-10

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
----------------------------------------------------------
POLICIES - CONTINUED
--------
EARNINGS/LOSS PER SHARE
-----------------------
Following is a reconciliation of the numerator and denominator
of Basic EPS to the numerator and denominator of Diluted EPS
for all years presented.

INVESTMENT
----------
The investment represents securities available for sale which
are stated at fair value. Unrealized holding gains and losses
are reflected as a net amount in accumulated other
comprehensive loss until realized. There were no gross
realized gains and losses on sales of available-for-sale
securities for the years ended September 30, 2001, 2000 and
1999. At September 30, 2001, the Company's securities
available-for-sale consisted of an investment in a
publicly-traded foreign company (see note 4).

PROPERTY AND EQUIPMENT
----------------------
Property and equipment is stated at cost, less accumulated
depreciation. Depreciation is provided over the estimated
useful lives of the assets as follows:

GOODWILL
--------
Goodwill is amortized on a straight-line basis over fifteen
years except for acquisitions after June 30, 2001 where
goodwill is not being amortized.

Periodically, the Company will determine if there has been a
permanent impairment of goodwill by comparing anticipated
undiscounted cash flows for operating activities of acquired
businesses with

F-11

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
----------------------------------------------------------
POLICIES - CONTINUED
--------
GOODWILL
--------
the carrying value of the related goodwill. In this connection
the Company charged $700,000 to operations in the year ended
September 30, 2001.

FACTORING
---------
The Company's factoring agreement (see Note 5) with a
financing institution ("factor") has been accounted for as a
sale of receivables under Statement of Financial Accounting
Standards No. 125 "Accounting for Transfers and Services of
Financial Assets and Extinguishment of Liabilities". ("SFAS"
No. 125)

FAIR VALUES OF FINANCIAL INSTRUMENTS
------------------------------------
Fair values of cash and cash equivalents, accounts receivable,
due from factor, accounts payable and short-term borrowings
approximate cost due to the short period of time to maturity.
Fair values of long-term debt, which have been determined
based on borrowing rates currently available to the Company
for loans with similar terms or maturity, approximate the
carrying amounts in the financial statements.

STOCK - BASED COMPENSATION
--------------------------
Statement of Financial Accounting Standards No. 123
"Accounting for Stock Based Compensation" ("SFAS" 123") allows
a company to adopt a fair value based method of accounting for
its stock-based compensation plans or continue to follow the
intrinsic value method of accounting prescribed by Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees". The Company accounts for stock-based
compensation in accordance with the provisions of APB No. 25,
and complies with the disclosure provisions of SFAS No. 123.
Under APB No. 25, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of
the Company's stock at the date of the grant over the amount
an employee must pay to acquire the stock.

INCOME TAXES
------------
The Company recognizes deferred tax assets and liabilities
based on differences between the financial reporting and tax
bases of assets and liabilities using the enacted tax rates
and laws that are expected to be in effect when the
differences are expected to be recovered. The Company provides
a valuation allowance for deferred tax assets for which it
does not consider realization of such assets to be more likely
than not.

ADVERTISING COSTS
-----------------
Advertising costs are expensed as incurred. The expenses for
the years ended September 30, 2001, 2000 and 1999 were
$189,000, $185,000 and $133,000, respectively, and are
included in selling, general and administrative expenses.

IMPAIRMENT OF LONG-LIVED ASSETS
-------------------------------
The Company evaluates the recoverability of its long-lived
assets in accordance with Statement of Financial Accounting
Standards No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" ("SFAS No.
121"). SFAS No. 121 requires recognition of impairment of
long-lived assets in the event the net book value of such
assets exceeds the future undiscounted cash flows attributable
to such assets.

NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In June 1998, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and
Hedging Activities. As amended by SFAS 138, SFAS No. 133 is
effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities. This statement did not
have a material impact on the Company's financial position and
results of operations.

F-12

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
----------------------------------------------------------
POLICIES - CONTINUED
--------
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In December 1999, the Securities and Exchange Commission staff
released Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements (SAB 101), which provides
guidance on the recognition, presentation and disclosure of
revenue in financial statements. The Company believes its
revenue recognition policies do not significantly differ from
SAB 101.

In September 2000, the FASB issued SFAS No. 140 "Accounting
for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" which is a replacement of SFAS
No. 125. SFAS No. 140 is effective for transfers and servicing
of financial assets and extinguishment of liabilities
occurring after March 31, 2001. This statement did not have a
material impact on the Company's financial position and
results of operations.

In June 2001, the FASB issued SFAS No. 141, "Business
Combinations". SFAS No. 141 establishes new standards for
accounting and reporting requirements for business
combinations and requires that the purchase method of
accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also requires that acquired
intangible assets be recognized as assets apart from goodwill
if they meet one of the two specified criteria. Additionally,
the statement adds certain disclosure requirements to those
required by APB 16, including disclosure of the primary
reasons for the business combination and the allocation of the
purchase price paid to the assets acquired and liabilities
assumed by major balance sheet caption. This statement is
required to be applied to all business combinations initiated
after June 30, 2001 and to all business combinations accounted
for using the purchase method for which the date of
acquisition is July 1, 2001 or later. Use of the
pooling-of-interests method is prohibited. The adoption of
SFAS No. 141 did not have an impact on the Company's financial
condition or results of operations.

In June 2001, the 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. At September 30, 2001, the Company's net goodwill
was approximately $7,815,000, and annual amortization of such
goodwill was approximately $341,000. The Company expects to
adopt SFAS No. 142 during its first fiscal quarter of fiscal
2003. Because of the extensive effort required to comply with
the remaining provisions of SFAS Nos. 141 and 142, the Company
cannot reasonably estimate the impact on its financial
statements of these provisions beyond discontinuing
amortization.

In August 2001, the FASB issued SFAS No. 144, "Accounting for
the Impairment or Disposal 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 establishes a single accounting model for
long-lived assets to be disposed of by sale and requires that
those long-lived assets be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS No.
144 is effective for fiscal years beginning after December 15,
2001. The Company does not anticipate that this statement will
have a material impact on its financial position and results
of operations.

F-13

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 2 - INITIAL PUBLIC OFFERING
-----------------------
On May 5, 2000, the Company completed its initial public
offering ("IPO") of 1,300,000 shares of common stock at a
price of $6.00 per share, generating net proceeds of
approximately $5,930,000 after deducting underwriters
discounts and offering costs of approximately $1,870,000.

NOTE 3 - ACQUISITIONS
------------
On January 4, 1999, the Company entered into an asset purchase
agreement with B&R Employment, Inc. ("B&R"). The Company
purchased certain assets including office equipment, furniture
and fixtures, sales and operating records, customer contracts
and agreements, vendor lists, and seller's licenses and
certificates. The purchase price was $2,400,000, consisting of
notes for $1,880,000 and the issuance of 34,667 shares of the
Company's common stock. B&R had a put option to sell these
shares back to the Company at $15 per share, provided that the
Company did not conduct an initial public offering within
twenty-four months. As a result of the IPO, $520,000 of
"Temporary equity - put options" representing 34,667 shares in
connection with the acquisition was transferred to additional
paid-in capital. In February 2000, the Company entered into a
debt-equity conversion agreement with B&R whereby, B&R agreed
to convert, except for $666,000, the amounts due under the
notes payable-acquisition, including accrued interest, into
shares of the Company's common stock upon the Company's
initial public offering of securities. The number of shares to
be issued was based on the offering price in the initial
public offering. In April 2000, the agreement was amended to
provide that B&R would convert $500,000 into shares of the
Company's common stock. Accordingly, upon the completion of
the IPO, B&R was issued 83,333 shares of the Company's common
stock and the notes were paid in full.

In connection with this acquisition, the Company entered into
an employment and a non-compete agreement for a three-year
period with the sole stockholder of B&R. The excess of cost
paid over net assets acquired resulted in goodwill of
$2,414,903, computed as follows:

Net assets acquired
Office equipment $ 7,000
Amounts paid
Notes payable (net of $35,527 discount) 1,844,473
Issuance of common stock and put options 520,000
Finders' fees 57,430
-------------------
2,421,903

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

Excess of amounts paid over net assets acquired - goodwill $ 2,414,903
===================

On June 26, 2000, the Company purchased substantially all of
the tangible and intangible assets, excluding accounts
receivable, of eight offices of Tandem, a division of
Outsource International, Inc. ("Outsource"). The purchase
price was $1,300,000, of which $800,000 was paid in cash at
the closing and the remaining $500,000 was represented by two
promissory notes. The first note, representing $400,000 was
payable in two installments of $200,000 plus accrued interest
at 8.5% a year, within 90 days and 180 days after closing. The
second note, representing $100,000 bears interest at 8.5% a
year and is payable in twelve equal monthly installments
beginning January 1, 2001. As of September 30, 2001, the
Company paid only two installments on the second note and the
balance of approximately $83,000 is included in the current
portion of "Notes payable - acquisitions" on the attached
balance sheet as of September 30, 2001.

The excess of cost paid over net assets acquired resulted in
goodwill of $1,562,693, computed as follows:

F-14

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 3 - ACQUISITIONS - CONTINUED
------------

Net assets acquired
Furniture and equipment $ 38,175
Accrued holiday and vacation pay (47,000)
---------------------
(8,825)
---------------------
Amounts paid
Cash 800,000
Notes payable 500,000
Finder's fees and other costs 253,868
---------------------
1,553,868
---------------------

Excess of amounts paid over net assets acquired - goodwill $ 1,562,693
=====================

On October 27, 2000, the Company purchased substantially all
of the tangible and intangible assets, excluding accounts
receivable, of seven offices of Tandem, a division of
Outsource International, Inc. The initial purchase price for
the assets was $125,000; of which $50,000 was paid in cash at
the closing and the remaining $75,000 was represented by a
promissory note secured by the assets purchased by the
Company. The note was payable in twenty-four equal monthly
installments of principal and interest at a variable rate of
prime plus two percent beginning December 1, 2000. In January
2001, the Company exercised an option to repay the outstanding
balance of the note plus $175,000 in lieu of an earnout
payment of thirty percent of the Earnings Before Interest,
Taxes, Depreciation and Amortization ("EBITDA") of the
acquired business for a two year period. The excess of cost
paid over net assets acquired resulted in goodwill of
$855,718, computed as follows:

Net assets acquired
Furniture and equipment $ 31,650
Accrued holiday and vacation pay (21,758)
---------------------
9,892
---------------------
Amounts paid
Cash 50,000
Note payable 75,000
Earnout payable 175,000
Finder's fees and other costs 565,610
---------------------
865,610
---------------------

Excess of amounts paid over net assets acquired - goodwill $ 855,718
=====================

On January 2, 2001, the Company purchased substantially all of
the tangible and intangible assets of Cura Staffing, Inc. and
The WorkGroup Professional Services, Inc. The purchase price
was $175,000 of which $100,000 was paid in cash at the closing
and the remaining $75,000 was represented by a 90-day
promissory note for $50,000 and $25,000 payable $5,000 a month
beginning after the payment of the 90-day promissory note. The
promissory note bears interest at 6% a year. As of September
30, 2001, the Company has not paid a portion of the $50,000
note and the entire $25,000 note. The balance of approximately
$31,000 is included in the current portion of "Notes payable -
acquisitions" on the attached balance sheet as of September
30, 2001.

The excess of cost paid over net assets acquired resulted in
goodwill of $228,144, computed as follows:

F-15

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 3 - ACQUISITIONS - CONTINUED

Net assets acquired
Furniture and equipment $ 11,000
Accrued holiday and vacation pay (12,000)
---------------------
(1,000)
---------------------
Amounts paid
Cash 100,000
Note payable and other payables 75,000
Finder's fees and other costs 52,144
---------------------
227,144
---------------------

Excess of amounts paid over net assets acquired - goodwill $ 228,144
=====================

On July 27, 2001, the Company purchased substantially all of
the tangible and intangible assets, excluding accounts
receivable of the clerical and light industrial staffing
division of Source One Personnel, Inc. ("Source One"). As a
result of the acquisition, the Company will expand its
presence in the Philadelphia to New York corridor.

The initial purchase price for the assets was $3,400,000, of
which $200,000, in cash, and 400,000 shares of the Company's
restricted common stock were paid at the closing and the
remaining $2,400,000 was represented by two promissory notes.
In addition, Source One is entitled to earnout payments based
upon the acquired business achieving certain performance
levels during each of the three fiscal years beginning October
1, 2001. There was an additional $42,163 of costs incurred in
connection with the acquisition. The first note, representing
$600,000, is payable in one installment of $600,000 plus
accrued interest at 7% per year, at 180 days after the
closing. The second note, representing $1,800,000 bears
interest at 7% per year and is payable over a four-year period
in equal quarterly payments beginning 120 days after the
closing. Source One has agreed to allow the Company to
defer the payment of the first note and the February 2002
installment of the second note until the earlier of the
receipt of the proceeds from the sale of the Company's
Engineering Division (see Note 24) or April 30, 2002. Source
One has a put option to sell the shares back to the Company
at $2 per share between 24 months after the closing and final
payment of the second note, but not less than 48 months.

The following table 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 $ 105,000
Intangible assets 636,300
Goodwill 2,700,863
-------------

Total assets acquired $ 3,442,163
=============

Of the $636,300 of intangible assets, $127,300 was assigned to
a covenant-not-to-compete and $509,000 was assigned to the
customer list. The intangible assets are being amortized over
their estimated useful life of four years. Goodwill is not
being amortized under the provision of SFAS No. 142. All of
the goodwill is expected to be deductible for tax purposes.

The above acquisitions have been accounted for as purchases.
The results of operations are included in the Company's
statements of operations from the effective date of
acquisition.

The unaudited pro forma results of operations presented below
assume that the acquisitions had occurred at the beginning of
fiscal 2000. This information is presented for informational
purposes only and include certain adjustments such as goodwill
amortization resulting from the acquisitions and interest
expense related to acquisition debt.

F-16

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 3 - ACQUISITIONS - CONTINUED

NOTE 4 - TRANSACTIONS WITH ARTISAN (UK) PLC

On June 26, 2001, the Company entered into an agreement to
purchase 63,025,000 ordinary shares, representing 26.3% of the
outstanding shares of enterpriseAsia. com ("EPA"), a London
AIM listed company, from Artisan (UK) plc ("Artisan"). In
exchange, the Company agreed to issue to Artisan 850,837
shares of the Company's Series A preferred stock. The Series A
preferred stock pays cumulative dividends at $.21 per share
per year, payable semi-annually, commencing on December 31,
2001. Beginning on October 1, 2001 the preferred stock shares
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. This transaction was consummated, effective
August 15, 2001.

The cost of the investment in EPA and value assigned to the
preferred stock issued was based upon the market price per
share of EPA on the date the transaction was consummated.
Accordingly, the original cost of the investment was
$1,592,000 and, therefore, the 850,837 shares of preferred
stock were assigned a value of $1.87 per share.

On July 3, 2001, the Company received $900,000 from
Artisan.com Limited ("Artisan.com"), a company affiliated with
Artisan, in exchange for 900,000 shares of the Company's
common stock in a private placement. The transaction was in
accordance with an agreement dated June 26, 2001 between the
Company and Artisan.com. The agreement provides that the
Company may offer and Artisan.com may buy additional shares of
the Company's common stock not exceeding $2,200,000 between
August 15, 2001 and December 31, 2001. The price per share is
the average market price per share over the five trading days
immediately preceding the issuance of the shares.

In connection with the transactions with Artisan and
Artisan.com, the Company issued 608,096 shares of its Series A
preferred stock and 30,000 shares of its common stock for
finders' fees to third parties.

The value of the preferred stock and common stock issued for
finders' fees was allocated to the investment in EPA and a
reduction to additional paid-in capital based on the relative
value of the original investment of $1,592,000 and the
$900,000 received for the 900,000 shares of the

F-17

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 4 - TRANSACTIONS WITH ARTISAN (UK) PLC - CONTINUED

Company's common stock. Accordingly, the original cost of the
investment in EPA increased by $757,000 and additional paid-in
capital was reduced by $417,700.

The Company is unable to exercise significant influence over
EPA's operating and financial policies. Therefore, the
investment in EPA is classified as available-for-sale
securities and reported at fair value in the attached balance
sheet.

NOTE 5 - FACTORING AGREEMENT

The Company had a factoring agreement under which it was able
to sell up to $3,000,000 of qualified trade accounts
receivable, with limited recourse provisions. The Company was
required to repurchase or replace any receivable remaining
uncollected for more than 90 days. During the years ended
September 30, 2001, 2000 and 1999, gross proceeds from the
sale of receivables was $10,204,208, $34,179,692 and
$25,227,640, respectively.

On December 12, 2000, the Company terminated its agreement
with the factor. As part of the termination agreement, the
Company repurchased all accounts receivable from the factor
with proceeds from a new line of credit (See note 6).

NOTE 6 - LINE OF CREDIT

On December 12, 2000, the Company entered into a loan and
security agreement with a lending institution whereby the
Company can borrow up to 90% 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 bear interest at 1 1/2% above
the prime rate and are collateralized by substantially all of
the Company's assets. The agreement expires on June 12, 2002.
Approximately $5,100,000 of the initial borrowing under this
agreement was used to repurchase accounts receivable from the
factor (see Note 5). The prime rate at September 30, 2001 was
6%.

NOTE 7 - PROPERTY AND EQUIPMENT

Property and equipment consist of the following as of
September 30:

F-18

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 9 - JOINT VENTURE

The Company provides information technology staffing services
through a joint venture, Stratus Technology Services, LLC
("STS"), in which the Company has a 50% interest. A son of
the Chief Executive Officer of the Company and the
Secretary and General Counsel of the Company have a
minority interest in the other 50% venturer. STS commenced
operations during the year ended September 30, 2001. The
Company's loss from operations of STS of $6,933 for the
year ended September 30, 2001 is included in other revenue
(expense) on the statements of operations.

NOTE 10 - LOANS PAYABLE

Loans payable consist of the following as of September 30:

(i) Payable $3,453 per month, including interest at 9.25%
to 10% a year.
(ii) Due in April 2002 interest is payable monthly at 18%
a year. In addition, the Company issued 60,000 shares
of its common stock to the noteholders. The
noteholders have the right to demand the repurchase
by the Company of the shares issued, until the notes
are paid in full, at $1.00 per share plus 15%
interest. Accordingly, $9,000 was charged to interest
expense in the year ended September 30, 2001 and
$69,000, representing the put option plus interest,
is included in "Temporary equity - put options" on
the attached balance sheet as of September 30, 2001.
(iii) Promissory note issued in January 2001 in connection
with the purchase of treasury stock. Note is payable
$8,000 per month, including interest at 15% a year.

The maturities on loans payable are as follows:
Year Ending September 30
-------------------------------------------
2002 $ 347,289
2003 105,345
2004 120,317
2005 65,581
--------------------
$ 638,532
====================

Other loans aggregating $600,000 were settled by the issuance
of 160,000 shares of the Company's common stock at $3.75 per
share during the year ended September 30, 1999. Other loans
during the year ended September 30, 2000, aggregating
$100,000, $200,000 and $200,000, were settled by the issuance
of 26,667 shares at $3.75 per share and 50,000 shares at $4.00
per share and 33,333 shares at $6.00 per share, respectively.

NOTE 11 - RELATED PARTY TRANSACTIONS

CONSULTING AGREEMENT

The son of the Chief Executive Officer of the Company provides
consulting services to the Company. Consulting expense was
$281,000, $156,000 and $107,000 for the years ended September
30, 2001, 2000 and 1999, respectively.

The Company has paid consulting fees to an entity whose
stockholder is another son of the Chief Executive Officer of
the Company. Consulting fees amounted to $119,000, $9,000 and
$23,000 for the years ended September 30, 2001, 2000 and 1999,
respectively.

F-19

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 11 - RELATED PARTY TRANSACTIONS - CONTINUED

REVENUES

The Company provided payroll services to an entity whose Chief
Executive Officer is the son of the Chief Executive Officer of
the Company. Revenues related thereto for the years ended
September 30, 2001, 2000 and 1999, were $-0-, $364,000 and
$1,392,000, respectively. In August 1999, $663,000 of accounts
receivable from this related party was converted into a note
of $1,017,000. The difference was attributable to interest,
which has not been accrued by the Company since all of the
receivable had previously been reserved for as a doubtful
account. All of the doubtful accounts receivable arose prior
to the entity becoming a related party. The accounts
receivable were generated through December 1998 and the entity
became a related party in March 1999. In September 1999, the
Company had agreed to accept 500,000 shares of the related
party's common stock as full payment for the note. Although
the shares of the related party's common stock were publicly
traded, the 500,000 shares held by the Company were restricted
at the time of issuance. Accordingly, the investment was
valued at $-0-. Subsequent thereto, the related party filed
for bankruptcy and discontinued its operations.

The Company also provided payroll services to a non-public
entity whose common stock is owned 50% by the Chief Executive
Officer of the Company. For the years ended September 30,
2001, 2000 and 1999, revenues were $-0-, $-0- and $304,000,
respectively.

In August 1999, the Chief Executive Officer of the Company and
his son agreed to exchange, effective June 30, 1999, $440,000
of notes payable by the Company to them, plus accrued interest
of $52,762 for 131,403 shares of the Company's common stock.
The stock was valued at $3.75 per share, which represented
fair value based on the latest stock transactions and no gain
or loss was recorded on the transaction.

SALE OF COMMON STOCK

During the year ended September 30, 2001, the Company sold
382,999 shares of its common stock in private placements to
relatives of the Chief Executive Officer of the Company at
prices approximating the then current market of $.93 to $1.43
per share, for total gross proceeds of $410,000, less expenses
of $5,958.

NOTE 12 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

NOTE 13 - INCOME TAXES

Deferred tax attributes resulting from differences between
financial accounting amounts and tax bases of assets and
liabilities follow:

F-20

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 13 - INCOME TAXES - CONTINUED

Non-current assets and liabilities
Net operating loss carryforward $ 2,694,000 $ 462,000
Stock compensation -- 27,000
Depreciation -- (5,000)
Valuation allowance (2,694,000) (484,000)
------------------- ---------------------
Net non-current deferred tax asset (liability) $ -- $ --
=================== =====================

At September 30, 2001, the Company has available the following
federal net operating loss carryforwards for tax purposes:

Expiration Date
Year Ending
September 30,
----------------------------

2012 $ 123,000
2018 1,491,000
2019 392,000
2021 4,730,000

The utilization of the net operating loss carryforwards may be
limited due to changes in control.

The effective tax rate on net earnings (loss) varies from the
statutory federal income tax rate for periods ended September
30, 2001, 2000 and 1999.

NOTE 14 - CONVERTIBLE DEBT

At various times during the year ended September 30, 2001, the
Company issued, through private placements, a total of
$3,643,402 of convertible debentures. The debentures bear
interest at 6% a year, payable quarterly and have a maturity
date of five years from issuance. Each debenture is
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

F-21

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 14 - CONVERTIBLE DEBT - CONTINUED

immediately preceding the date of the conversion. The Company
has the right to prepay any of the debentures at any time at a
prepayment rate that varies 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 aggregated $1,213,747 and is charged to interest
expense during the period from the issuance of the debenture
to the earliest time at which the debenture becomes
convertible.

Deferred finance costs incurred in connection with the
issuance of the debentures aggregated approximately $738,000
and is being amortized over the five year term of the
debentures. Included in the $738,000 is $88,000 for 50,000
five-year $5.00 warrants and 100,000 five-year $7.50 warrants
issued as finders' fees. In addition, the Company paid
approximately $280,000 in exchange for extending the earliest
conversion date and the maturity date by an additional 120
days on approximately $1,048,500 of debentures. This amount
was charged to deferred finance costs and is being amortized
over 120 days. Included in interest expense for the year ended
September 30, 2001 is approximately $146,000 for amortization
of deferred finance costs in connection with the debentures.

During the year ended September 30, 2001, the Company redeemed
$1,897,220 of debentures resulting in a loss of approximately
$71,000 which is included in "Other income (expense)" in the
statement of operations. The loss is comprised of prepayment
premiums ($326,000), and the write-off of deferred finance
costs ($377,000), less the amount of the beneficial conversion
feature ($632,000).

During the year ended September 30, 2001, $542,500 of
debentures were converted into 628,060 shares of common stock
at prices ranging from $.85 to $.90 per share. The Company
issued 108,666 shares of treasury stock to a debenture holder
in connection with a conversion.

The balance of the convertible debt on the attached balance
sheet as of September 30, 2001 is net of unamortized discount
of $78,285 and is due at various dates in the year ended
September 30, 2006.

NOTE 15 - PREFERRED STOCK

The Company has authorized 5,000,000 shares of preferred stock
of which 1,458,933 shares have been designated as Series A
preferred stock and issued in connection with transactions
with Artisan (see Note 4).

The difference between the carrying value and redemption value
of the preferred stock is being accreted through a charge to
additional paid-in-capital through the June 30, 2008
redemption date.

NOTE 16 - OTHER CHARGES

During the year ended September 30, 2001, the Company
discontinued negotiations to sell the Engineering Division and
discontinued efforts to make certain acquisitions. In this
connection, costs associated with these activities were
charged to operations. The Company also charged operations for
costs incurred in connection with various financing not
obtained and costs associated with closed offices. The total
charged to operations for the foregoing was $460,800.

In September 2001, the Company placed 1,500,000 of
unregistered shares of its common stock into an escrow account
in anticipation of receiving a loan which was to be
collateralized by the shares of common stock. The loan
transaction was never consummated, but in October 2001 the
shares were illegally transferred out of the escrow account by
a third party. Subsequent thereto, all but 89,600 shares were
returned to the Company and cancelled. The Company recorded a
$59,000 charge to operations in the year ended September 30,
2001, representing the market value of the shares not
returned. The 89,600 shares will be recorded as issued shares
in the quarter ended December 31, 2001 and $59,000 will be
credited to stockholders' equity.

F-22

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 17 - COMMITMENTS AND CONTINGENCIES
OFFICE LEASES

The Company leases offices and equipment under various leases
expiring through 2006. Monthly payments under these leases are
$36,000.

The following is a schedule by years of approximate future
minimum rental payments required under operating leases that
have initial or remaining non-cancelable lease terms in excess
of one year, as of September 30, 2001.

For the Years Ending
September 30,
----------------------------------

2002 $ 548,000
2003 434,000
2004 298,000
2005 263,000
2006 224,000

Rent expense was $697,000, $356,000 and $342,000 for the years
ended September 30, 2001, 2000 and 1999, respectively.

OTHER

From time to time, the Company is involved in litigation
incidental to its business including employment practices
claims. There is currently no litigation that management
believes will have a material impact on the Company's
financial portion.

NOTE 18 - TEMPORARY EQUITY

Certain stockholders of the Company may have had a right to
pursue claims against the Company as a result of possible
technical violations of the laws and regulations governing the
private placement and issuance of securities. Accordingly, the
Company had recorded the original total proceeds of the sale
of the shares to these certain stockholders in the amount of
$1,618,060 as temporary equity - common shares in the balance
sheet. The Company made a rescission offer to stockholders
holding approximately 2.8 million shares, pursuant to which
the Company offered to repurchase the shares at their original
purchase price (plus applicable interest) which ranged from
$0.75 to $3.75 per share. As a result of no one accepting the
rescission offer during the rescission period and the
expiration, in certain cases, of applicable statutes of
limitation, the $1,618,060 of temporary equity - common shares
was transferred to additional paid-in capital during the year
ended September 30, 2000.

At September 30, 2001 "Temporary equity - put options" is
comprised of $800,000 for put options on 400,000 shares of the
Company's stock issued in connection with the acquisition of
Source One (see Note 3) and $69,000 for put options on 60,000
shares of the Company's stock (see Note 10).

NOTE 19 - STOCK OPTIONS AND WARRANTS

The Company has issued stock options to employees with terms
of five to ten years. The options may be exercised for
2,107,741 shares.

In addition, the Company has issued to the Chief Executive
Officer of the Company, options to acquire 1,000,000 shares at
$6.00 per share and 500,000 shares at $1.10 per share. These
options have a ten-year term and are exercisable at the
earlier of five years or when the Company achieves earnings of
$1.00 per share in a fiscal year. These options will be
forfeited if the Chief Executive Officer leaves the employment
of the Company.

Pro forma information regarding net income and earnings per
share is required by the Financial Accounting Standards Board
Statement ("FASB No. 123"), and has been determined as if the

F-23

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 19 - STOCK OPTIONS AND WARRANTS - CONTINUED

Company had accounted for its employee stock options under the
fair value method. The fair value for these options was
estimated at the date of grant using the Black-Scholes
option-pricing model.

The Black-Scholes method option-pricing model was developed
for use in estimating the fair value of traded options, which
have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly
subjective assumptions. Because the Company's employee stock
options have characteristics significantly different from
those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair
value of its employee stock options.

The following weighted-average assumptions were used:

For purposes of pro forma disclosures, the estimated fair
value of the options is amortized to expense over the options'
vesting period. The Company's pro forma information follows:

Compensation expense under APB 25 for the years ended
September 30, 2001, 2000 and 1999 was $67,900, $46,800 and
$46,800, respectively.

A summary of the Company's stock option activity and related
information for the years ended September 30 follows:

The exercise prices range from $1.10 to $6.00 per share.

In connection with the IPO, the Company issued 130,000
warrants to its underwriters to purchase shares at $8.70 per
share, expiring in 2004. The Company has also issued the
following warrants:

As of September 30, 2001, no stock options or warrants have
been exercised.

NOTE 20 - MAJOR CUSTOMERS

The Company had one customer who accounted for 10% and 12% of
total revenues for the years ended September 30, 2001 and
2000, respectively, and two customers who accounted for 30% of
total revenues for the year ended September 30, 1999. Major
customers are those who account for more than 10% of total
revenues.

NOTE 21 - RETIREMENT PLANS

The Company maintains two 401(k) savings plans for its
employees. The terms of the plan define qualified participants
as those with at least three months of service. Employee
contributions are discretionary up to a maximum of 15% of
compensation. The Company can match up to 20% of the
employees' first 5% contributions. The Company's 401(k)
expense for the years ended September 30, 2001, 2000 and 1999
was $50,000, $37,000 and $26,000, respectively.

F-25

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 22 - PRIVATE PLACEMENTS

In June 2001, the Company entered into an agreement with an
investment banker to raise $1,200,000 through the sale of the
Company's stock through private placements at a price per
share calculated at a 30% discount to the 20-day average of
the mean between the closing bid and asked prices. The
agreement provides that the Company pays a placement fee to
the investment banker of 10% of the gross proceeds received
from the private placements and also issues five-year warrants
equal to 10% of the number of shares sold at an exercise price
equal to the price per share of the private placement. In
addition, the Company is to pay the investment banker's
expenses in connection with the agreement, not to exceed
$50,000. During the year ended September 30, 2001, the Company
sold 166,667 shares at $.75 per share under this agreement. In
connection therewith, the Company paid $16,250 to the
investment banker and issued warrants to purchase 16,667
shares of the Company's common stock.

For the year ended September 30, 2001, private placements
resulted in the issuance of 1,449,666 shares of common stock
(see Notes 4 and 11 above).

The Company raised $1,000,000 in gross proceeds through a
private placement during the year ended September 30, 1999.
Each private placement "unit" was a combination of debt and
equity. For each $50,000 unit, the investor received a $50,000
promissory note from the Company and 3,333 shares of the
Company's common stock valued at $3.75 per share.

In August 1999, each private placement participant was offered
an additional 10,000 shares of the Company's common stock in
exchange for the original debt portion of the unit, thereby
exchanging each unit acquired by an investor accepting the
offer into 13,333 shares of common stock at $3.75 per share.
In connection with this offer, participants representing
sixteen units agreed to this offer.

As each private placement investor representing the remaining
$200,000 received both debt (in the form of a promissory note
payable by the Company) and equity (in the form of the
Company's common stock), a portion of the $200,000 face value
of the debt was allocated to equity based on the value of
$3.75 per share of common stock. As such, the Company had
allocated $133 and $49,867 to common stock and additional
paid-in capital, respectively. The remainder of $150,000 was
allocated to short-term debt. The difference between the face
value and the amount recorded in short-term debt was accrued
to interest expense. All private placement debt was paid in
full from proceeds of the IPO.

NOTE 23 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

F-26

STRATUS SERVICES GROUP, INC.
NOTES TO FINANCIAL STATEMENTS

NOTE 23 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - CONTINUED

Year ended September 30, 1999:
Revenues 5,912,643 7,007,582 8,343,592 8,778,934
Gross profit 1,262,905 1,441,052 1,933,089 2,099,451
Net earnings (loss) (997,849) (756,005) 75,049 151,762
Net earnings (loss) per share:

Basic (.27) (.20) .02 .05
Diluted (.27) (.20) .02 .05

(1) Includes a $700,000 charge for loss on impairment of goodwill.

NOTE 24 - SUBSEQUENT EVENTS

a. Effective January 1, 2002, the Company purchased substantially
all of the tangible and intangible assets, excluding accounts
receivable, of seven offices of Provisional Employment
Solutions, Inc. ("PES"). The initial purchase price was
$1,480,000, represented by a $1,100,000 promissory note and
400,000 shares of the Company's common stock. 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.

b. On January 24, 2002 the Company entered into an agreement
to sell the assets of its Engineering Services Division
("SED") to SEA Consulting Services Corporation. Concurrent
with the execution of the agreement the Company transferred
30% interest in SED to Sahyoun, LLC, a company controlled
by the President of SED. The agreement provides for a
purchase price of $2,200,000 of which the Company will
receive 80% ($1,760,000). In addition, the Company will
receive additional payments of $250,000 each on June 30, 2002
and December 31, 2002. Closing of the sale is contingent upon
shareholder approval and receipt of a fairness opinion by
the Company.

The pro forma adjustments to the unaudited pro forma
balance sheet includes an adjustment to record the
Company's 80% share of the cash proceeds of $2,200,000, net
of an estimated $330,000 professional fees and other costs
related to the transaction, and the additional proceeds to
the Company of $500,000 to be received, $250,000 on June
30, 2002 and $250,000 on December 31, 2002, net of $199,610
of asset sold, resulting in a gain of $1,796,390, which is
shown as an increase to stockholders' equity.

c. On January 17, 2002 the Company received a Nasdaq Staff
Determination, due to its failure to file its Form 10-K for
the fiscal period ended September 30, 2001, indicating the
Company's noncompliance with the requirement for continued
listing set forth in Nasdaq's Marketplace Rule 4310(c)(14),
and that its securities are, therefore subject to delisting.
On January 24, 2002 the Company submitted a request for a
hearing to review the Staff Determination, staying the
delisting. There is no assurance the Panel will grant Stratus'
request for continued listing.

F-27

STRATUS SERVICES GROUP, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

ALLOWANCE FOR DOUBTFUL ACCOUNTS

(1) Transfers between valuation accounts.

(2) Reflects the increase (decrease) in the valuation allowance associated
with net operating losses of the Company.

F-28