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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission file number 001-15789

STRATUS SERVICES GROUP, INC.
(Exact name of Registrant as specified in its charter)

        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 ý    No o

        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. o

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

        The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the last sale price of such stock as reported by the OTC Bulletin Board, as of the last business day of the Registrant's most recently completed second fiscal quarter, was $6,412,762 based upon 20,686,329 shares held by non-affiliates.

        The number of shares of Common Stock, $.01 par value, outstanding as of December 23, 2003 was 23,648,576.

        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; our ability to continue to maintain workers' compensation, general liability and other insurance coverages; the continued cooperation of our creditors; 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.

        In this Annual Report on Form 10-K, references to "Stratus", "the Company", "we", "us" and "our" refer to Stratus Services Group, Inc.

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FORM 10-K

STRATUS SERVICES GROUP, INC.
Form 10-K for the Fiscal Year Ended September 30, 2003

Table of Contents

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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 its 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 offer different groups of staffing services comprised of Staffing Services, SMARTSolutions™ and Information Technology Services. Our Staffing Services offering 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™ 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. 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 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 December 2003, we completed ten acquisitions of staffing businesses, representing thirty offices in seven states. In March 2002, we sold our Engineering Division and in fiscal 2003 we sold the assets of eight of our offices located in Nevada, New Jersey, Florida and Colorado. As of December 23, 2003 we were providing services from 27 locations in 7 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.

Financial Information About Industry Segments

        We disclose segment information in accordance with SFAS NO. 131, "Disclosure about Segments of an Enterprise and Related Information." We operate as one business segment which provides different types of staffing services. In accordance with SFAS 131, in concluding that our operations comprise a single operating segment, we have taken into account that we do not compile discrete financial information, other than revenue information, by service offering. As a result, in assessing our performance and making decisions regarding resources to be allocated within our company, our Chief Executive Officer and other members of management review consolidated financial information as well as discrete financial information compiled for each of our branch offices.

Principal Services & Markets

        Our business operations are classified as one segment of different types of staffing services that consists of Staffing Services, SMARTSolutions™ and Information Technology Services service offerings, each service offering having a particular specialty niche within our broad array of targeted markets for all our staffing services.

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        Staffing Services includes both personnel placement and employer services such as payrolling, outsourcing, on-site management and administrative services. Payrolling typically involves the placement of individuals identified by a customer as short-term seasonal or special use workers on our payroll for a designated period. 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 one of our employees 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 our customers include cognitive, personality and psychological evaluation and drug testing that is confirmed through an independent, certified laboratory.

        Staffing Services can also be separated into 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™.    SMARTSolutions™ is a customized staffing program provided through our staffing services offices designed to reduce labor and management costs and increase workplace efficiency. While we assist the client in attempting to reach certain targets and milestones, our billings do not depend on the success or failure of the client achieving or not achieving such milestones.

        While SMARTSolutions™ 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™ is a more sophisticated offering of our 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™ program. Once identified, the team assumes full responsibility for the sales process. A significant portion of our SMARTSolutions™ clients have been obtained through this process or from "word of mouth" recommendations from current SMARTSolutions™ customers.

        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 for staffing services. See "Part III-Item 13 Certain Relationships and Related Party Transactions". 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 which 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.

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Business Strategy

        Our objective is to become a leading provider of staffing services throughout the United States. Key elements of our business strategy include:

        FOCUS ON SALES WITHIN THE CLERICAL, LIGHT INDUSTRIAL AND LIGHT TECHNICAL SECTOR. We focus on placing support personnel in markets for clerical, light industrial and light technical temporary staffing. We believe that these services are the foundation of the temporary staffing industry, will remain so for the foreseeable future and best leverage our assets and expertise. We also believe 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. We believe that we are well-positioned to capitalize on these business segments because of our ability to attract and retain qualified personnel and our knowledge of the staffing needs of customers.

        ENHANCE RECRUITING OF QUALIFIED PERSONNEL. We believe that a key component of our success is our ability to recruit and maintain a pool of qualified personnel and regularly place them into desirable positions. We use comprehensive methods to assess, select and, when appropriate, train our temporary employees in order to maintain a pool of qualified personnel to satisfy ongoing customer demand. We offer our temporary employees comprehensive benefit, retention and recognition packages, including bonuses, vacation pay and holiday pay.

        EMPHASIZE BUSINESS CORRIDORS. Our strategy is to capitalize on our presence along the I-95 business corridor from New York to Delaware, to grow our presence in the California West Coast markets, and to build market share by targeting small to mid-sized customers, including divisions of Fortune 500 companies. We believe 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, we believe that business corridor markets are more likely to provide the opportunity to sell recurring business that is characterized by relatively higher gross margins. We focus on this type of business while also selectively servicing strategic national and regional contracts. While we have, in fiscal 2003, made our growth through acquisitions a secondary focus to our internal growth, we are continuously evaluating other potential acquisition opportunities.

        MAINTAIN ENTREPRENEURIAL AND DECENTRALIZED OFFICES WITH STRONG CORPORATE SUPPORT. We seek 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. We have designed programs to encourage a "team" approach in all aspects of sales and recruiting, to improve productivity and to maximize profits. We believe that this structure allows us 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. We believe our management information systems are instrumental to the success of our operations. Our business depends on our ability to store, retrieve, process and manage significant amounts of data. We continually evaluate the quality, functionality and performance of our systems in an effort to ensure that these systems meet our operation needs. During fiscal 2001, we 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.

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        In addition, we have fully upgraded both our hardware and software at our corporate headquarters to accommodate potential future growth. We have implemented a nationwide area network based upon a reliable, secure, inexpensive, and high performance Virtual Private Network, or VPN. Our VPN integrates all of our offices onto one large area network, capable of multiple changes in a LIVE environment. Through our VPN, all of our locations can share common data through various servers and a mid-range system which runs our Keynote application. All VPN access includes, but is not limited to, all back office software systems, internet access and real time e-mail access.

        We believe that our investments in information technology will increase our management's ability to store, retrieve, process and manage information. As a result, we believe we will be able to improve service to our 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. We have a dedicated risk management department that has developed risk management programs and loss control strategies that we believe 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. We believe that its emphasis on controlling employee-related costs enables branch office managers to price services more competitively and improve profitability.

Growth Strategy

        Our current strategy for growing our business and improving our financial performance focuses evenly on a combination of internal growth, sales of underperforming offices and strategic external and complementary acquisitions.

        INTERNAL GROWTH. A significant element of our growth strategy has been, and continues to be, our focus on internal growth. Our internal growth strategy consists of the following:

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Increase Sales and Profitability at Existing Offices. We believe that a substantial opportunity exists to increase sales of services and profitability in existing offices. We have 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, we have maintained our corporate-level branch management function to establish and monitor branch office performance targets and develop programs to support branch operations.



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Expand SMARTSolutions™ and Vendor-on-Premise Programs. We have taken advantage of industry trends by continuing to promote our SMARTSolutions™ program and "vendor-on-premises" programs. As of December 23, 2003, we had 4 SMARTSolutions™ sites and 10 vendor-on-premises programs. Under these programs, we assume administrative responsibility for coordinating all essential staffing services throughout a customer's location, including skills testing and training.



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Pursue Expansion by Establishment of New Offices. Subject to the availability of resources, we seek to open new offices primarily in existing markets to benefit from common area management, cross-marketing opportunities and leveraging of administrative expenses. Our 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 our current geographic network.

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SALES OF UNDER-PERFORMING OFFICES. In order to improve our financial performance and generate cash for operations, we sold the assets of seven of our offices which were not performing up to management's expectations in fiscal 2003. The offices sold were located in Elizabeth, New Jersey; New Brunswick, New Jersey; Paterson, New Jersey; Perth Amboy, New Jersey; Trenton, New Jersey; Miami Springs, Florida and Colorado Springs, Colorado. The terms of these sales are described in this report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Discontinued Operations/Acquisition or Disposition of Assets."

PURSUIT OF COMPLEMENTARY AND STRATEGIC ACQUISITIONS. We intend to focus on opportunities for growth through acquisitions in existing as well as new markets. While we have, in Fiscal 2003, made our growth through acquisitions a secondary focus to our internal growth, we are continuously evaluating other potential acquisition opportunities.

        In evaluating potential acquisition candidates, we focus 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. We have 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 contracts 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 ours. Acquired companies typically are brought under our 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 our existing operations.

        Between September 1997 and December 2003, we completed eleven acquisitions of primarily staffing companies or divisions of staffing companies. These acquisitions included forty offices located in nine states and collectively generated over $90 million in revenue for the twelve months preceding such acquisitions. Pursuant to our acquisition strategy we made the following purchases:

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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.



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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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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.



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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.



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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.

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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.



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



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In August 2001, we acquired certain assets of the light industrial and clerical businesses of Source One Personnel, Inc., a $15 million (in annual revenues) 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.



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



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In March 2002, we acquired certain assets (the "Sale Assets") of Eden Health Employment Services ("Eden"), a temporary staffing firm located in Union City, New Jersey from Wells Fargo Credit, Inc. ("Wells Fargo"). Pursuant to the terms and conditions of the transaction, Wells Fargo transferred its rights, title and interest in the Sale Assets free and clear of any liens of Wells Fargo and any liens subordinated thereto. The purchase price for the Sale Assets is a royalty payable monthly through October 20, 2004. The royalty is an amount based on a percentage derived from sales/placements attributable to Eden. Any invoices billed by Eden on or after March 4, 2002 are our property, from which we will deduct any royalties due.



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In December 2002, we acquired the assets of six California and Nevada branches of Elite Personnel Services, Inc., a $30 million (in annual revenues), Downey, California based provider of light industrial and clerical staffing services. This acquisition expands the already-existing California region for continued West Coast 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 forty in nine states at December 17, 2002. As a result of the sale in Fiscal 2003 of under-performing offices, these numbers are now 27 in 7 states as of December 23, 2003.

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. According to the American Staffing Association (formerly the National Association of Temporary and Staffing Services), 2002 staffing industry revenues were approximately $61.8 billion. Although staffing industry revenues declined in 2001 and 2002, temporary help sales, which constitute the largest share of staffing industry revenues, increased more than 300% from 1990 through 2000, according to the American Staffing Association. During the first quarter of 2003, revenues of U.S. staffing firms totaled $13.1 billion, an increase of five percent over the same period of 2002. According to the American Staffing Association, over 90% of businesses use staffing companies for temporary help. We believe that the U.S. staffing industry is highly fragmented and has been experiencing

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consolidation in recent years, particularly with respect to temporary staffing companies. We believe that the industry is consolidating in response to:

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



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Increased competition from larger, better capitalized competitors; and



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Owner's desires for liquidity.

        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 also use 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 MPS Group, Manpower, Inc., Kelly Services, Inc., 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

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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, 2003, we provided services to 1900 customers in 21 states. Our five largest customers represented 27% of our revenue from continuing operations but no one customer exceeded 10% and only one customer exceeded 8%.

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 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 not obtained federal registration of any of the trademarks we use in our business, including SMARTSolutions, SMARTReport, and SMARTTraining, our slogan, name or logo. 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 any of our marks 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.

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Employees

        As of September 30, 2003, we were employing 5,158 total employees. Of that amount, 311 were classified as staff employees and 4,847 were classified as field or "temp" employees, those employees placed at client facilities.

        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. Management Personnel are targeted and recruited for specific engagements. We usually advertise for professionals who possess specialized education, training or work experience.

        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 and disability coverage. 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 our future programs, products, expenses, revenue, liquidity and cash needs as well as our 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.

        Our auditors have qualified their opinion on our financial statements for the year ended September 30, 2003, with a qualification which raises substantial doubt about our ability to continue as a going concern. Our ability to continue in business depends upon the continued cooperation of our creditors, our ability to generate sufficient cash flow to meet our continuing obligations on a timely basis and our ability to obtain additional financing. At September 30, 2003, we had limited liquid resources and owed $1,056,812 under promissory notes that were past due or due upon demand. In addition, approximately $4,400,000 of payroll taxes was delinquent and we had a cash overdraft, representing outstanding checks of $699,057. Current liabilities at September 30, 2003 were $24,112,324 and current assets were $16,132,990. The difference of $7,979,334 is a working capital deficit, which is primarily the result of losses incurred during the last two years. While we have plans to use the funds raised from a proposed offering of securities to reduce our indebtedness, we can give no assurance that we will raise sufficient capital to eliminate our working capital deficit or that our creditors will not seek to enforce their remedies against us, which could include the imposition of insolvency proceedings.

Fluctuations in the general economy could have an adverse impact on our business.

        Demand for our 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

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reduce their utilization of temporary employees before releasing full-time employees. In addition, we may experience less demand for our services and more competitive pricing pressure during periods of economic downturn. Therefore, any significant economic downturn could have a material adverse effect on our business, results of operations, cash flows or financial condition.

We may be unable to continue and manage our growth.

        Our ability to continue growth will depend on a number of factors, including: the strength of demand for temporary employees in our markets; the availability of capital to fund acquisitions; the ability to maintain or increase profit margins despite pricing pressures; and existing and emerging competition. We must also adapt our infrastructure and systems to accommodate growth and recruit and train additional qualified personnel. Furthermore, the United States economy is continuing to show signs of an economic slowdown. Should the economic slowdown or a recession continue for an extended period, competition for customers in the staffing industry would increase and may adversely impact management's allocation of our resources and result in declining revenues.

We rely heavily on executive management and could be adversely affected if our executive management team was not available.

        We are highly dependent on our senior executives, including Joseph J. Raymond, our 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 our senior management team. We 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 our 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 our business, results of operations, cash flows or financial condition.

We rely heavily on our management information systems and our business would suffer if our systems fail or cannot be upgraded or replaced on a timely basis.

        We believe our management information systems are instrumental to the success of our operations. Our business depends on our ability to store, retrieve, process and manage significant amounts of data. We continually evaluate the quality, functionality and performance of our systems in an effort to ensure that these systems meet our operational needs. We have, 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 we 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 our 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 our business, results of operations, cash flows or financial condition.

Increases in employee-related costs would have an adverse effect on our business.

        Our employee-related costs fluctuate and an increase in these costs could have a significant effect on our ability to achieve profitability. We are 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. We maintain workers' compensation insurance on a fully-insured, guaranteed cost basis with various private carriers and state insurance funds. We accrue 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

13

employee. Unemployment insurance premiums are set by the states in which our employees render their services. A significant increase in these premiums or in workers' compensation-related costs or our inability to continue to maintain workers' compensation coverage could have a material adverse effect on our business, results of operations, cash flows or financial condition.

Our financial results will suffer if we lose any of our significant customers.

        As is common in the temporary staffing industry, certain of our engagements to provide services to our customers are of a non-exclusive, short-term nature and subject to termination by the customer with little or no notice. During fiscal 2002 and 2003, no single customer of ours accounted for more than 10% of our sales or services. Nonetheless, the loss of any of our significant customers could have an adverse effect on our business, results of operations, cash flows or financial condition. We are also subject to credit risks associated with our trade receivables. During fiscal 2002 and fiscal 2003, we incurred costs of $1,650,000 and $875,000, respectively, for bad debts. Should any of our principal customers default on their large receivables, our business results of operations, cash flows or financial condition could be adversely affected.

We have experienced significant fluctuations in our operating results and anticipate that these fluctuations may continue.

        Fluctuations in our operating results could have a material adverse effect on the price of our common stock. Operating results may fluctuate due to a number of factors, including the demand for our services, the level of competition within our markets, our ability to increase the productivity of our existing offices, control costs and expand operations, the timing and integration of acquisitions and the availability of qualified temporary personnel. In addition, our results of operations could be, and have in the past been, adversely affected by severe weather conditions. Moreover, our results of operations have also historically been subject to seasonal fluctuations. Demand for temporary staffing historically has been greatest during our fourth fiscal quarter due largely to the planning cycles of many of our 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 us, particularly in the light industrial sector. Due to the foregoing factors, we have experienced in the past, and may possibly experience in the future, results of operations below the expectations of public market analysts and investors.

If we are not able to attract and retain the services of qualified temporary personnel, our business will suffer.

        Our success depends upon our ability to attract and retain qualified personnel who possess the skills and experience necessary to meet the staffing requirements of our customers. We have experienced and may continue to experience significant difficulties in hiring and retaining sufficient numbers of qualified personnel to satisfy the needs of our customers. During periods of increased economic activity and low unemployment, the competition among temporary staffing firms for qualified personnel increases. Many regions in which we operate have in the past, and may continue to experience, historically low rates of unemployment and we have experienced, and may continue to experience, significant difficulties in hiring and retaining sufficient numbers of qualified personnel to satisfy the needs of our customers. Furthermore, we 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 us in sufficient numbers and on terms of employment acceptable to us. We must continually evaluate and upgrade our base of available qualified personnel to keep pace with changing customer needs and emerging technologies. Furthermore, a substantial number of our temporary employees during any given year will terminate their employment with us to accept regular staff employment with our customers. The inability to

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attract and retain qualified personnel could have a material adverse effect on the business, results of operations, cash flows or financial condition.

Our success depends upon the performance of our field management.

        We are dependent on the performance and productivity of our local managers, particularly branch and regional managers. This loss of some of our key managers could have an adverse effect on our operations, including our ability to establish and maintain customer relationships. Our 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 we are unable to attract and retain key employees to perform these services, our business, results of operations, cash flows or financial condition could be adversely affected. Furthermore, we may be dependent on the senior management of companies that may be acquired in the future. If any of these individuals do not continue in their management roles, there could be material adverse effects on our business, results of operations, cash flows or financial condition.

We may be subject to claims as a result of actions taken by our temporary staffing personnel.

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

Future acquisitions could increase the risk of our business.

        While we intend to pursue acquisitions in the future, there can be no assurance that we will be able to expand our 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 us, seek to increase their market share through acquisitions. In addition, we are subject to certain limitations on the incurrence of additional indebtedness under our credit facilities, which may restrict our ability to finance acquisitions. Further, there can be no assurance that we will be able to identify suitable acquisition candidates or, if identified, complete such acquisitions or successfully integrate such acquired businesses into our 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 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 our existing locations. In addition, to the extent that we consummate 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 our operations could have a material adverse effect on our business, results of operations, cash flows or financial condition.

Short sales of our common stock could place downward pressure on the price of our common stock.

        Selling stockholders and others may engage in short sales of our common stock. Short sales could place downward pressure on the price of our common stock. In that case, we could be required to issue

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an increasingly greater number of shares of our common stock upon future conversions of our Series E Preferred Stock, sales of which could further depress the price of our common stock. The downward pressure on the price of our common stock resulting from conversions of the Series E Preferred Stock could encourage additional short sales by selling stockholders and others.

There is no limit on the number of shares which are issuable upon conversion of our Series E Preferred Stock and if the price of our common stock decreases, the number of shares issuable upon conversion will continue to increase.

        The number of shares issuable upon conversion of our Series E Preferred Stock depends upon the market price of our common stock. The conversion price of the Series E Preferred Stock is equal to 75% of the average of the closing bid prices of the common stock for the five trading days preceding the conversion. As a result, the lower the price of our common stock at the time of conversion, the greater the number of shares the converting holder will receive and the more the interests of our existing stockholders will be diluted. For example, assuming that the market value of our common stock is $.25 per share after giving effect to our proposed one-for-four reverse stock split, the number of shares of common stock that we would be required to issue upon conversion of the outstanding shares of Series E Preferred Stock, would increase from an aggregate of approximately 20,323,733 shares, based upon a conversion price of $.1875, to approximately:

•

27,098,311 shares (or 60.2% of our currently outstanding common shares) if the conversion price decreased by 25%;



•

40,647,466 shares (or 69.4% of our outstanding common shares) if the conversion price decreased by 50%; and



•

81,294,933 shares (or 81.9% of our outstanding common shares) if the conversion price decreased by 75%.

Potential conversions of our convertible preferred stock will reduce the percentage ownership interest of existing stockholders and may cause a reduction in our share price.

        As of December 23, 2003 we had outstanding 1,458,933 shares of Series A Preferred Stock, 38,107 shares of Series E Preferred Stock and 6,000 shares of Series F Preferred stock. If all of the holders of preferred stock convert their preferred stock into shares of common stock, we will be required to issue no less than 27,782,666 shares of common stock based on an assumed conversion price of $.1875 per share for the Series E Preferred Stock. If the trading price of the common stock is low when the conversion price of the Series E Preferred Stock 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 interests in our company. In addition, if a holder of preferred stock converts our preferred stock and sells the common stock, it 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 more the conversion price of our Series E Preferred Stock will fall and the greater the number of shares we will have to issue upon conversion.

Regulatory and legal uncertainties could harm our business.

        The implementation of unfavorable governmental regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs, cause the development of the affected markets to become impractical or otherwise adversely affect our financial performance. If we are determined to be a "Professional Employer Organization," we cannot assure you that we will be able to satisfy licensing requirements or other applicable regulations. Certain states have enacted laws which govern the activities of Professional Employer Organizations, which generally provide payroll administration, risk management and benefits administration to client

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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 which govern such organizations; however, the definition of Professional Employer Organization varies from state to state and in some states the term is broadly defined. In addition, we can give no assurance that the states in which we operate will not adopt licensing or other regulations affecting companies which provide commercial and professional staffing services.

We are controlled by our Chairman, who is our principal stockholder, and our management.

        As of December 23, 2003, our Chairman of the Board, Joseph J. Raymond, owned or had the right to vote shares representing approximately 36.6% of the outstanding voting power of our capital stock. Our directors and executive officers, as a group, own or have the right to vote shares representing approximately 38.0% of the outstanding voting power of our capital stock. As a result, Mr. Raymond and, if they should determine to act together, our directors and executive officers as a group, will be able to exercise significant influence over the outcome of any matters which might be submitted to our stockholders for approval, including the election of directors and the authorization of other corporate actions requiring stockholder approval.

ITEM 2. PROPERTIES

        We own no real property. We lease approximately 6,841 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, 2007. As of September 30, 2003, we leased 27 additional facilities, primarily flexible staffing offices, in 7 states. 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.

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

        During the fourth quarter of fiscal 2003, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.

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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 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. On February 27, 2002, our common stock was delisted from the Nasdaq SmallCap Market and is currently trading on the NASD OTC Bulletin Board under the symbol "SERV.OB". There were approximately 229 holders of record of common stock as of December 23, 2003. This number does not include the number of shareholders whose shares were held in "nominee" or "street name". 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 and by the NASD OTC Bulletin Board.

        On December 18, 2003, the closing price of our common stock as reported by the NASD OTC Bulletin Board was $.21 per share. We have never paid cash 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 cash dividends on our common stock in the foreseeable future. Any future payment of dividends on our common stock will depend upon our financial condition, capital requirements and earnings as well as other factors that the Board of Directors deems relevant.

        See "Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management" for information regarding securities authorized for issuance under equity compensation plans.

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ITEM 6. SELECTED FINANCIAL DATA.

        (In thousands except per share)

        The selected financial data that follows should be read in conjunction with our financial statements and the related notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this report. The financial results for prior years have been reclassified to present the operations of certain sold branches as discontinued operations.

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

Introduction

        We provide a wide range of staffing services and productivity consulting services associated with such staffing services nationally through a network of offices located throughout the United States. Regardless of the type of temporary service offering we provide, 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. Therefore we do not separate our various service offerings into separate offering segments. We do not routinely provide discrete financial information about any particular service offering. We also do not conduct any regular reviews of, nor make decisions about, allocating any particular resources to a particular service offering to assess its performance. As set forth below, certain of our service offerings target specific markets, but we do not necessarily conduct separate marketing campaigns for such services. We are responsible for workers' compensation, unemployment compensation insurance, Medicare and Social Security taxes and other general payroll related expenses for all of the temporary employees we place. These expenses are included in the cost of revenue. Because we pay our temporary employees only for the hours they actually work, wages for our temporary personnel are a variable cost that increases or decreases in proportion to revenues. Gross profit margin varies depending on the type of services offered. In some instances, temporary employees placed by us may decide to accept an offer of permanent employment from the customer and thereby "convert" the temporary position to a permanent position. Fees received from such conversions are included in our revenues. Selling, general and administrative expenses include payroll for management and administrative employees, office occupancy costs, sales and marketing expenses and other general and administrative costs.

Critical Accounting Policies and Estimates

        The following accounting policies are considered by us to be "critical" because of the judgments and uncertainties affecting the application of these policies and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.

Revenue Recognition

        We recognize revenue as the services are performed by our workforce. Our customers are billed weekly. At balance sheet dates, there are accruals for unbilled receivables and related compensation costs.

        During fiscal 2003, we changed our method of reporting the revenues for payrolling services from gross billing to a net revenue basis. Unlike traditional staffing services, under a payrolling arrangement, our customer recruits and identifies individuals for us to hire to provide services to the customer. We become the statutory employer although the customer maintains substantially all control over those employees. Accordingly, Emerging Issues Task Force ("EITF") 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent" requires that we do not reflect the direct payroll costs paid to such employees in revenues and cost of revenue.

Allowance for Doubtful Accounts Receivable

        We provide customary credit terms to our customers and generally do not require collateral. We perform ongoing credit evaluations of the financial condition of our customers and maintain an allowance for doubtful accounts receivable based upon historical collection experience and expected collectibility of accounts. As of September 30, 2003, we had recorded an allowance for doubtful

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accounts of approximately $1,733,000. The actual bad debts may differ from estimates and the difference could be significant.

Goodwill and Intangible Assets

        Effective October 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and other Intangible Assets". The provisions of SFAS No. 142 require that intangible assets not subject to amortization and goodwill be tested for impairment annually, or more frequently, if events or changes in circumstances indicate that the carrying value may not be recoverable. Amortization of goodwill and intangible assets with indefinite lives, including such assets recorded in past business combinations, ceased upon adoption. Thus no amortization for such goodwill was recognized in the accompanying statement of operations for the year ended September 30, 2003, compared to $289,177 and $332,636 for the years ended September 30, 2002 and 2001, respectively.

        In order to assess the fair value of our goodwill as of the adoption date, we engaged an independent valuation firm to assist in determining the fair value. The valuation process appraised our assets and liabilities using a combination of present value and multiple of earnings valuation techniques. Based upon the results of the valuations, it was determined that there was no impairment of goodwill.

Valuation Allowance Against Deferred Income Tax Assets

        Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse. We have recorded a valuation allowance of approximately $8.0 million to offset the entire balance of the deferred tax asset as of September 30, 2003. The valuation allowance was recorded as a result of the losses incurred by us and our belief that it is more likely than not that we will be unable to recover the net deferred tax assets.

Results of Operations

Discontinued Operations/Acquisition or Disposition of Assets

        In March 2002, we completed the sale of the assets of our Engineering Services Division (the "Division") to SEA Consulting Services Corporation (the "Purchaser"). Prior to the sale, the assets of the Division had been transferred to SEP, LLC ("SEP"), a limited liability company in which we held a 70% interest and Sahyoun Holdings LLC, a company wholly owned by Charles Sahyoun, the President of the Division, owned the remaining 30% interest.

        Under the terms of the Asset Purchase Agreement executed in connection with the transaction, we received an initial cash payment of $1,560,000, which represented 80% of the initial $2,200,000 installment of the purchase price payable to SEP after the satisfaction of certain liabilities and expenses of SEP. Sahyoun Holdings, LLC received the other 20% of the initial net installment of the purchase price, or $440,000. The Asset Purchase Agreement required the Purchaser to make certain additional payments to SEP based upon the operating results of the acquired business through December 31, 2007.

        Pursuant to an allocation and indemnity agreement entered into by us, Sahyoun Holdings, LLC and Mr. Sahyoun (the "Allocation and Indemnity Agreement"), we were entitled to $250,000 of a payment due in 2002 and $250,000 of a payment due in 2003. On April 15, 2002, by letter agreement between us, Sahyoun Holdings, LLC and Joseph J. Raymond, Sr., our Chairman and Chief Executive Officer, the parties agreed to a modification of the Allocation and Indemnity Agreement. Per that letter agreement, Sahyoun Holdings, LLC provided us with $200,000 cash in exchange for our

21

short-term, 90-day demand note, due and payable by August 1, 2002 in the amount of $250,000. The $250,000 was paid by us from our share of the payment which was received by us in June 2002.

        Sahyoun Holdings LLC and Mr. Sahyoun guaranteed the $250,000 payment due to us in 2003, regardless of the operating results of SEA. In December 2002, Mr. Sahyoun and we agreed to offset the $250,000 against $250,000 of accrued commissions due Mr. Sahyoun. As a result, we will not be entitled to any additional payments under the Asset Purchase Agreement.

        Effective January 1, 2002, we purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of seven offices of PES. The initial purchase price was $1,480,000, represented by a $1,100,000 promissory note and 400,000 shares of our common stock. There was an additional $334,355 of costs incurred in connection with the acquisitions. In addition, PES is entitled to earnout payments of 15% of pretax profit of the acquired business up to a total of $1.25 million or the expiration of ten years, whichever occurs first. The note bears interest at 6% a year and is payable over a ten-year period in equal quarterly payments. See Note 3 to the Financial Statements included with this Report.

        Effective December 1, 2002, we purchased substantially all of the tangible and intangible assets, excluding accounts receivable, of six offices of Elite Personnel Services, Inc. Pursuant to a Asset Purchase Agreement dated November 19, 2002 between us and Elite (the "Elite Purchase Agreement"), the purchase price paid at closing (the "Base Purchase Price") was $1,264,000, all of which was represented by a promissory note (the "Note") payable over eight years, in equal monthly installments. Imputed interest at the rate of 4% per year is included in the Note amount. Accordingly, the net Base Purchase Price was $1,083,813.

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

        On September 29, 2003, we completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Las Vegas, Nevada office. Pursuant to the terms of an Asset Purchase Agreement between us and US Temp Services, Inc. ("US Temps") dated September 29, 2003, the purchase price for the purchased assets was $105,000, all of which was paid by means of a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $2,029.94, over a 5 year period. The note is secured by a security interest on all of the purchased assets. The purchase price for the assets acquired by US Temps was arrived at through arms-length negotiations between the parties.

        On September 10, 2003, we completed the sale, effective as of September 15, 2003 (the "Effective Date"), of substantially all of the tangible and intangible assets, excluding accounts receivable, of five of our New Jersey offices to D/O Staffing LLC ("D/O"). The offices sold are the following: Elizabeth, New Jersey; New Brunswick, New Jersey; Paterson, New Jersey; Perth Amboy, New Jersey and Trenton, New Jersey. Pursuant to the terms of an asset purchase agreement between D/O and us dated September 10, 2003 (the "D/O Purchase Agreement"), the base purchase price for the purchased assets was $1,250,000 payable as follows:

(i)

$1,150,000 payable in certified funds at the closing; and



(ii)

$100,000 payable in certified funds into escrow at the closing to be held in escrow by attorneys for the Buyer pursuant to the terms of an escrow agreement, to account for certain post-closing adjustments.

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        Additionally, we may be entitled to receive as a deferred purchase price (the "Bonus"), an amount equal to $125,000 if, for the one year period measured from the Effective Date, the purchased assets generate for D/O at least $18,000,000 in actual billings by client accounts serviced by us as of the closing and transferred by us to D/O pursuant to the D/O Purchase Agreement. The Bonus, if any, is payable by way of a promissory note, payable over a 24 month period and bearing interest at an interest rate of 6% per year.

        The purchase price for the assets was arrived at through arms-length negotiations between the parties.

        On August 22, 2003, we completed the sale, effective as of August 18, 2003 (the "ALS Effective Date") of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Miami Springs, Florida office. Pursuant to the terms of the Asset Purchase Agreement between us and ALS, LLC, a Florida limited liability company ("ALS") dated August 22, 2003 (the "Purchase Agreement"), the purchase price for the purchased assets was $128,000, all of which was paid by means of a promissory note, which bears interest at the rate of 7% per annum, with payments over a 60 month period. The amount of the monthly payments due under the note will be the greater of $10 per month or 20% of the monthly net profits generated by the staffing business originating from the purchased assets, commencing October 31, 2003. However, until such time as all outstanding receivables due and owing by us to ALS, as of the date of the Purchase Agreement in the amount of $289,635.30, have been paid in full, these monthly payments shall be deducted from any and all amounts due from us to ALS. The note is secured by a security interest in all of the purchased assets.

        The purchase price for the assets acquired by ALS was arrived at through negotiations with a related party purchaser. The son of our President and Chief Executive Officer is a 50% member in ALS, LLC. We believe that the terms of the transaction are comparable to those which would have been obtained in a transaction with an unrelated party. Proceeds from the Note will be used to pay down existing debt and for working capital purposes.

        On March 9, 2003, we completed the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Colorado Springs, Colorado office. Pursuant to the terms of an asset purchase agreement between us and US Temps dated March 9, 2003, the purchase price for the purchased assets was $20,000, all which was paid by means of a promissory note, which bears interest at the rate of 6% per year and is payable in monthly installments of $608.44, over a three year period. The note is secured by a security interest on all of the purchased assets.

Continuing Operations

Year Ended September 30, 2003 Compared to the Year Ended September 30, 2002

        Revenues.    Revenues increased 67.0% to $76,592,209 for the year ended September 30, 2003 from $45,859,801 for the year ended September 30, 2002. Approximately $28.6 million of the increase was attributable to the acquisitions in January and December, 2002. Excluding acquisitions revenues increased 4.6%. This increase was a result of an increase in billable hours.

        Gross Profit.    Gross profit increased 38.5% to $11,405,778 for the year ended September 30, 2003 from $8,235,085 for the year ended September 30, 2002, primarily as a result of increased revenues. Gross profit as a percentage of revenues decreased to 14.9% for the year ended September 30, 2003, from 18.0% for the year ended September 30, 2002. This decrease was a result of increased pricing competition for staffing services and increases in the cost of workers' compensation insurance and state unemployment taxes. In addition, we have been assessed the penalty rate by the New Jersey Department of Labor for state unemployment taxes because of payment delinquencies (see "Liquidity and Capital Resources"). The estimated additional expense in the year ended September 30, 2003 is $700,000.

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        Selling, General and Administrative Expenses.    Selling, general and administrative expenses, not including depreciation and amortization and provision for doubtful accounts, increased 19.8% to $11,611,826 for the year ended September 30, 2003 from $9,314,927 for the year ended September 30, 2002. Selling, general and administrative expenses, not including depreciation and amortization and provision for doubtful accounts, as a percentage of revenues decreased to 15.2% for the year ended September 30, 2003 from 20.3% for the year ended September 30, 2002. The increase in the dollar amount is primarily a result of the acquisitions in January and December 2002, whereas the percentage of revenue decrease is attributable to significant cost reductions implemented by us and the increase in revenues with no proportionate increase in selling, general and administrative expenses.

        Loss on Impairment of Goodwill.    As a result of the steady decline in revenue and earnings of certain previously acquired business units, we determined that there was a permanent impairment of goodwill and accordingly, recorded an impairment loss of $300,000 in the year ended September 30, 2002.

        Depreciation and Amortization.    Depreciation and amortization expenses not including amortization of goodwill of $169,849 in the year ended September 30, 2002, increased 20.5% to $922,246 for the year ended September 30, 2003 from $595,744 for the year ended September 30, 2002. Depreciation and amortization as a percentage of revenues decreased to 1.2% for the year ended September 30, 2003 from 1.3% for the year ended September 30, 2002. The increase in the dollar amount was due to capital expenditures and the amortization of intangibles associated with the acquisition in December 2002.

        Provision for Doubtful Accounts.    Provision for doubtful accounts decreased 25.0% to $775,000 for the year ended September 30, 2003 from $1,033,820 for the year ended September 30, 2002. Provision for doubtful accounts as a percentage of revenues decreased to 1.0% for the year ended September 30, 2003 from 2.3% for the year ended September 30, 2002. The greater amount in 2002 was due to a change in estimate in light of the downturn in the economy at that time and our evaluation of the recoverability of certain of our accounts.

        Other Charges.    During the period May 1, 2001 through May 20, 2002, we maintained workers' compensation insurance with an insurance company, with a deductible of $150,000 per incident. We had established reserves based upon our evaluation of the status of claims still open in conjunction with claims reserve information provided to us by the insurance company. We believe that the insurance company has paid and reserved claims in excess of what should have been paid or reserved. Although we believe we can recover some of the amounts already paid, this can only be pursued through litigation against the insurance company. Since there is no assurance we will prevail, we recorded $753,000 of additional payments made and reserves in the year ended September 30, 2003.

        Interest and Financing Costs.    Interest and financing costs increased to $1,887,900 for the year ended September 30, 2003 from $1,689,635 for the year ended September 30, 2002. Included in the amounts for the year September 30, 2002, is $104,535, which is the portion of the discount on the beneficial conversion feature of convertible debt and $291,755 of costs we incurred in connection with the issuance of the convertible debt. Interest and financing costs, not including these convertible debt costs, as a percentage of revenue decreased to 2.5% for the year ended September 30, 2003, from 2.8% for the year ended September 30, 2002. The increase in the dollar amount is attributable to the increase in borrowings under our line of credit because of increased revenues and additional loans required to provide funding for our operations.

        Net (Loss) Attributable to Common Stockholders.    As a result of the foregoing, we had a net loss and net loss attributable to common stockholders of $(4,433,132) and $(6,063,006), respectively, for the year ended September 30, 2003, compared to a net loss and net loss attributable to common stockholders of $(7,085,633) and $(8,127,443) for the year ended September 30, 2002.

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Year Ended September 30, 2002 Compared to the Year Ended September 30, 2001

        Revenues.    Revenues increased 56.7% to $45,859,801 for the year ended September 30, 2002 from $29,274,041 for the year ended September 30, 2001. Approximately $15.4 million of the increase was attributable to acquisitions. Excluding acquisitions revenues increased 3.8%. This increase was a result of an increase in billable hours.

        Gross Profit.    Gross profit increased 15.1% to $8,235,085 for the year ended September 30, 2002 from $7,151,723 for the year ended September 30, 2001. Gross profit as a percentage of revenues decreased to 18.0% for the year ended September 30, 2002 from 24.4% for the year ended September 30, 2001. This decrease was a result of increased pricing competition of staffing services. We also saw a deterioration in margins as a result of the downturn in the economy.

        Selling, General and Administrative Expenses.    Selling, general and administrative expenses, not including depreciation and amortization and provision for doubtful accounts, decreased 4.6% to $9,314,927 for the year ended September 30, 2002 from $8,902,660 for the year ended September 30, 2001. Selling, general and administrative expenses, not including depreciation and amortization and provision for doubtful accounts, as a percentage of revenues decreased to 20.3% for the year ended September 30, 2002 from 30.4% for the year ended September 30, 2001. The decrease is attributable to significant cost reductions implemented by us, which were offset in part by additional costs associated with the expansion of our business.

        Loss on Impairment of Goodwill.    As a result of the steady decline in revenue and earnings of certain previously acquired business units, and in the case of one business unit, the loss of a major customer, we determined that there was a permanent impairment of goodwill and accordingly, recorded an impairment loss of $302,000 and $700,000 in the year ended September 30, 2002 and 2001, respectively.

        Depreciation and Amortization.    Depreciation and amortization expenses increased 78.5% to $765,593 for the year ended September 30, 2002 from $428,845 for the year ended September 30, 2001. Depreciation and amortization as a percentage of revenues increased to 1.7% for the year ended September 30, 2002 from 1.5% for the year ended September 30, 2001. The increase was primarily due to the amortization of goodwill and other intangibles associated with acquisitions and the impact of increased capital expenditures.

        Provision for Doubtful Accounts.    Provision for doubtful accounts increased 93.2% to $1,033,820 for the year ended September 30, 2002 from $535,000 for the year ended September 30, 2001. Provision for doubtful accounts as a percentage of revenues increased to 2.3% for the year ended September 30, 2002 from 1.8% for the year ended September 30, 2001. The increase was due to a change in estimate in light of the downturn in the economy and our evaluation of the recoverability of certain of our accounts.

        Finance Charges.    Finance charges for the year ended September 30, 2001 were the amounts charged under an agreement with a factor, which was terminated on December 12, 2000.

        Loss on Sale of Investment.    In the year ended September 30, 2002, we sold 63,025,000 shares, representing our entire 26.3% investment in a publicly-traded foreign company for net proceeds of $206,631 and realized a loss of $2,159,415.

        Interest and Financing Costs.    Interest and financing costs decreased to $1,689,635 for the year ended September 30, 2002 from $1,707,730 for the year ended September 30, 2001. Included in the amounts for the years ended September 30, 2002 and 2001, is $104,535 and $1,213,747, respectively, which is the portion of the discount on the beneficial conversion feature of convertible debt and $291,755 and $135,374, respectively, of costs we incurred in connection with the issuance of the

25

convertible debt. Interest and financing costs, not including these convertible debt costs, as a percentage of revenue increased to 2.8% for the year ended September 30, 2002, from 1.2% for the year ended September 30, 2001. This increase was primarily the result of debt incurred by us in connection with acquisitions.

        Income Taxes.    Income tax expense for the year ended September 30, 2001, is the result of a change in judgment about the reliability of deferred tax assets.

        Net (Loss) Attributable to Common Stockholders.    As a result of the foregoing, we had a net loss and net loss attributable to common stockholders of ($7,085,633) and ($8,127,443), respectively, for the year ended September 30, 2002, compared to a net loss and net loss attributable to common stockholders of ($5,940,772) and ($6,003,772) for the year ended September 30, 2001.

Liquidity and Capital Resources

        At September 30, 2003, we had limited liquid resources. Current liabilities were $24,112,324 and current assets were $16,132,990. The difference of $7,979,334 is a working capital deficit, which is primarily the result of losses incurred during the last two years. These conditions raise substantial doubts about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

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

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

        In order to raise capital to sustain our operations, we have filed a Registration Statement on Form S-1 with respect to a proposed offering of securities (the "Offering"). We are seeking to raise a minimum of $1,000,000 and a maximum of $10,000,000 through the sale of units consisting of common stock and warrants to purchase common stock. The Offering is being underwritten on a best efforts basis and we can give no assurance that we will be successful in raising any funds in the Offering. The Registration Statement filed in connection with the proposed Offering has not yet become effective. The securities may not be sold nor may offers to buy the securities be accepted prior to the time the Registration Statement becomes effective.

        Net cash used in operating activities was $2,432,131 and $3,679,332 in the years ended September 30, 2003 and 2002, respectively.

        Net cash provided by investing activities was $819,725 and $1,256,236 in the years ended September 30, 2003 and 2002, respectively. The sale of certain branches in the year ended September 30, 2003 generated net cash proceeds of $1,120,770, which was used to fund operating activities. The sale of our Engineering Division and sale of an investment in the year ended September 30, 2002 generated net cash proceeds of $1,709,079 and $206,631, respectively, which was used to fund operating activities. Cash used for acquisitions for the year ended September 30, 2003 and 2002, was $61,644 and $336,726, respectively. The balance in both periods was primarily for capital expenditures.

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        Net cash provided by financing activities was $1,503,313 and $2,413,920 in the years ended September 30, 2003 and 2002, respectively. We had net borrowings of $573,158 and $432,536 under our line of credit in the years ended September 30, 2003 and 2002, respectively. We also received net proceeds, less redemptions, of $24,879 from the issuance of convertible debt in the year ended September 30, 2002. During the years ended September 30, 2003 and 2002, we received $1,442,650 and $2,154,214, respectively, in proceeds from the issuance of our Common Stock and Preferred Stock and we redeemed $455,000 of Series B Preferred Stock in the year ended September 30, 2002. Net borrowings during the year ended September 30, 2002 include $200,000 advanced to us by Source One Personnel, Inc. ("Source One"). This loan was represented by a promissory note bearing interest at a rate of 7% per year and was made in connection with a modification of Source One's agreement to forbear from exercising remedies under promissory notes we issued to it in connection with an acquisition transaction completed in July 2001 in the principal amounts of $600,000 and $1,800,000, respectively. The $200,000 note and the $600,000 note were repaid in full on July 31, 2002 from the proceeds we received from the issuance of the Series E Preferred Stock. The $1,800,000 note is payable quarterly over a four year period which commenced in November 2001.

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

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

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

        As a result of conversions of the debentures and certain transactions with the debenture holders, only $40,000 of debentures remained outstanding at September 30, 2002 and 2003.

        We have a loan and security agreement (the "Loan Agreement") with Capital Temp Funds, Inc. which provides for a line of credit up to 85% of eligible accounts receivable, as defined, not to exceed $12,000,000. Until December 2000, advances under the Loan Agreement bore interest at a rate of prime plus 1¹/2%. (See below) The Loan Agreement restricts our ability to incur other indebtedness, pay dividends and repurchase stock. Borrowings under the Loan Agreement are collateralized by substantially all of our assets. As of September 30, 2003, $8,312,275 was outstanding under the credit agreement.

        At September 30, 2003, we were in violation of the following covenants under the Loan Agreement:

(i)

Failing to meet the tangible net worth requirement;



(ii)

Our common stock being delisted from the Nasdaq SmallCap Market

        We have received a waiver from the lender on all of the above violations. In December 2002 we entered into a modification of the Loan Agreement. The modification provided that borrowings under

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the Loan Agreement bear interest at a rate of prime plus 1³/4% as long as we are in violation of any of the covenants under the Loan Agreement. Effective April 10, 2003, we entered into another modification of the Loan Agreement which provides that borrowings under the Loan Agreement bear interest at 3% above the prime rate.

        Holders of the 1,458,933 outstanding shares of our Series A Preferred Stock are entitled to dividends at a rate of $.21 per share per annum when and if declared by our Board of Directors in preference and priority to any payment of dividends on our common stock or any other series of our capital stock. Dividends on the Series A Preferred Stock may be paid in additional shares of Preferred Stock if the shares of common stock issuable upon the conversion of the Series A Preferred Stock have been registered for resale under the Securities Act of 1933. We are obligated to pay quarterly dividends to holders of our Series E Preferred Stock at a rate of 6% per annum of the stated value of the stock in preference and priority to any payment of dividends on our common stock. We are obligated to pay monthly dividends on our Series F Preferred Stock at a rate of 7% per annum of the stated value of the stock in preference and priority to any payment of dividends on our common stock. The aggregate stated values of the Series E and Series F Preferred Stock was $4,025,835 and $800,000, respectively, as of September 30, 2003. At June 30, 2003, we had 5,000 shares of Series H Preferred Stock outstanding with an aggregate stated value of $500,000; however, in July 2003, the holder of all outstanding shares of Series H Preferred Stock exchanged such shares for 5,087 shares of Series E Preferred Stock. Dividends on the Series E and Series F Preferred Stock may be paid at the Company's option in shares of common stock (valued at the conversion price of the applicable class of preferred stock) if such shares have been registered for resale under the Securities Act of 1933.

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

        In July 2003, we entered into an agreement with Artisan (UK) plc, the parent company of Artisan.com Limited, pursuant to which we have agreed to redeem the aggregate 1,458,933 shares of our Series A Preferred Stock owned by Artisan.com Limited and Cater Barnard (USA) plc, an affiliate of Artisan. These shares represent all of the shares of Series A Preferred Stock currently outstanding. Our obligation to redeem the Series A Preferred Stock is contingent upon our sale of not less than $4,000,000 of units in our proposed best efforts offering of units ("Units"). If we sell at least $4,000,000 of Units in the Offering, we will be obligated to pay $500,000 to Artisan within 15 days after the $4,000,000 of Units are sold. In addition, we will be obligated to pay Artisan an additional $250,000 by January 31, 2005 or, at our option, issue to Artisan shares of our common stock having an aggregate market value of $250,000, based upon the average closing bid prices of the common stock for the 30 trading days preceding January 31, 2005. If we fail to make the $250,000 payment in cash or stock, we will be required to pay Artisan $300,000 in cash, plus interest calculated on a daily basis at a rate of 18% from the date of the default to the date the default is cured. We have also agreed to issue to Artisan a number of shares of our common stock which will represent 5.5% of our outstanding common stock, subject to certain adjustments, upon completion of our sale of $4 million of Units in the Offering. Further, upon final completion of the Offering, we will be required to issue additional shares of common stock so that the total number of shares of common stock issued to Artisan will equal 5.5% of our common stock after giving effect to the assumed exercise of all warrants and options that then have exercise prices equal to or less than the then current market price of our common stock and the conversion of all convertible securities that then have conversion prices equal to or less than the then current market price of our common stock.

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        Other fixed obligations that we had as of September 30, 2003 include:

•

$967,968 under a promissory note bearing interest at 7% per year which was issued in connection with our acquisition of Source One and which is payable in equal quarterly installments of $130,717 until its maturity date in August 2005.



•

$973,498 under a promissory note bearing interest at 6% per year which was issued in connection with our acquisition of certain assets of PES and which is payable in equal quarterly installments of $36,770 until its maturity date in December 2011.



•

$1,132,330, including $351,292 of imputed interest, under a promissory note which was issued in connection with our acquisition of Elite and which is payable in equal monthly installments of $13,167 until its maturity in November 2010.



•

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



•

$76,246 under a promissory note which bears interest at 15% per year and which requires us to make payments of principal and interest of $8,000 per month until its maturity date in October 2004.



•

$52,975 under a non-interest bearing promissory note which requires us to make monthly payments of principal and interest of $13,437 and which is due in full upon the demand of the holder.



•

$69,460 under a promissory note which bears interest at 8% per year and which requires us to make monthly payments of principal and interest of $7,500 until it is paid in full.



•

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



•

$882,837 under demand loans which bear interest at various rates, including $40,000 owed to Joseph J. Raymond, $106,000 owed to sons of Joseph J. Raymond, $100,000 owned to the brother of Joseph J. Raymond and $100,000 and $116,337 owed to a member of the Board of Directors and a trust formed for the benefit of the family of another member of the Board of Directors, respectively.



•

$76,223 under promissory notes used to acquire and secured by motor vehicles which require aggregate monthly payments of principal and interest of $3,453 and which become due in full at various dates between July and August, 2005.

        All of our offices are leased through operating leases that are not included on the balance sheet. As of September 30, 2003, future minimum lease payments under lease agreements having initial terms in excess of one year were: 2004—$547,000, 2005 -$295,000, 2006—$185,000 and 2007—$169,000.

        We may be required to make certain "earnout" payments to sellers of businesses that we have acquired in recent years, including Source One, PES and Elite. The amount of these payments, if any, will depend upon the results of the acquired businesses. There were no earnout payments made in fiscal 2003. There is $244,000 included in "Accounts payable and accrued expenses" on the balance sheet as of September 30, 2003 for estimated earnout payments that we recorded as part of the acquisition of Elite.

        Source One has the right to require us to repurchase 400,000 shares of our common stock at a price of $2.00 per share at any time after July 27, 2003 and before the later of July 27, 2005 and the full payment of the outstanding note that we issued to it in connection with the acquisition transaction completed with Source One in July 2001. Source One notified us that it was exercising this right on July 29, 2003. We are attempting to negotiate an arrangement which would permit us to pay this

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amount over an extended period of time or upon receipt of financing. No assurance can be given that Source One will agree to such an arrangement. In addition, the holder of the $80,000 note which was due in April 2002 has the right to require us to repurchase 20,000 shares of common stock at a price of $1.00 per share plus interest at a rate of 15% per year until the note is paid in full.

        In January 2003, a $367,216 judgment was awarded against us to an insurance carrier. As of September 30, 2003, the judgment has not yet been paid in full; however, we have entered into an agreement with the plaintiff which permits us to satisfy the judgment by making payments of $25,000 per month through April 15, 2004 with a final payment of $30,000 due on May 15, 2004. The unpaid balance of $192,216 at September 30, 2003 is included in "Accounts payable and accrued expenses" on the balance sheet.

        During fiscal 2003, we were notified by both the New Jersey Department of Labor and the California Department of Industrial Relations that, if certain payroll delinquencies were not cured, judgment would be entered against us. As of September 30, 2003, there was still an aggregate of $4.4 million in delinquent payroll taxes outstanding which are included in liabilities in the September 30, 2003 balance sheet set forth herein at Pages F-3 and F-4. Judgment has not been entered against us, as we continue to work with these state agencies to pay down outstanding delinquencies.

        In April 2003, we were served with a Complaint and named as one of several Defendants in the matter of Lopez v. RSI Home Products, Inc., et al., ("RSI"), in the Superior Court of California, Orange County. RSI is one of our former customers. The case is a class action proceeding alleging failure to pay hourly wages and overtime wages, failure to provide rest periods and meal periods or compensation in lieu thereof, failure to pay wages of terminated or resigned employees, knowing and intentional failure to comply with itemized employee wage statement provisions, violation of the unfair competition law, and breach of fiduciary duty. The matter has been settled among the parties and the parties await Court approval of the settlement. However, the settlement will not have any adverse effect on our financial condition or results of operations.

        As of September 30, 2003, there were no off-balance sheet arrangements, unconsolidated subsidiaries, commitments or guarantees of other parties, except as disclosed in the notes to financial statements. Stockholders' equity (deficiency) at that date was $(4,914,685).

        We engaged in various transactions with related parties during fiscal 2003 including the following:

•

We paid $53,000 to Jeffrey J. Raymond and $86,000 to an entity owned by Joseph J. Raymond, Jr., each of whom is the son of Joseph J. Raymond, our Chairman, President and Chief Executive Officer, in fiscal 2003 for consulting services. These amounts were included in selling, general and administrative expense. The services provided included the identification of acquisition candidates, acquisition advisory services, due diligence, post-acquisition transition services, customer relations, accounts receivable collection and strategic planning advice.



•

During the fiscal year ended September 30, 2003, we borrowed $215,000 from Joseph J. Raymond, our Chairman and Chief Executive Officer, to support our operations. We repaid $175,000 of this amount plus $75,000 that was due Mr. Raymond at September 30, 2002 during the year ended September 30, 2003.



•

During the fiscal year ended September 30, 2003, a son, the brother and the brother-in-law of Joseph J. Raymond, our Chairman and Chief Executive Officer each loaned $100,000 to us. The loans are unsecured and due on demand.



•

We borrowed $116,337 from the Kingston Family Revocable Trust under a promissory note that was issued in May 2003 and due upon demand and which bears interest, only in the event of default, at a rate equal to the lesser of 18% per annum or the maximum interest rate permitted

30

by law. The Kingston Family Revocable Trust is a trust formed for the benefit of the family of H. Robert Kingston, one of our directors.

•

In August 2003, we sold substantially all of the assets of our Miami Springs, Florida office to ALS, LLC, a limited liability company in which Joseph J. Raymond, Jr., the son of our President and Chief Executive Officer, holds a 50% interest. Terms of the transaction are described above under the caption "Discontinued Operations/Acquisition or Disposition of Assets." ALS, LLC is the holding company for Advantage Services Group, LLC ("Advantage").



•

During fiscal 2003, Advantage, a company in which Joseph J. Raymond, Jr., the son of our President and Chief Executive Officer, holds a 50% interest, provided payrolling services to certain of our customers under an arrangement pursuant to which we paid Advantage a fee equal to the cost of providing such services plus a specified percentage above Advantage's cost. The total amount paid to Advantage under this arrangement in fiscal 2003 was $1,224,131. In November 2003, we agreed to pay Advantage $20,000 per month until we have paid Advantage $225,000 owed to it in connection with this arrangement. Our obligation to pay this amount is secured by a warrant to purchase 2,000,000 shares of our common stock. The warrant, which is exercisable only if we default on our payment obligations to Advantage, has an exercise price equal to the lower of $.15 per share or 75% of the then current market price of the common stock.

In November 2003, we entered into payrolling agreements with Advantage with respect to four of our accounts that require that we pay Advantage a fee ranging between 2% to 3% above its cost. We have pledged our accounts with these customers as security for our obligations to Advantage under these agreements. In addition, if the aggregate payroll of employees provided under these agreements does not equal at least $8 million by November 30, 2004, we will be required to pay Advantage an amount equal to 8% of the shortfall.

        We believe that all transactions with related parties have been on terms no less favorable to us than those that could have been obtained from unaffiliated third parties.

Seasonality

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

Impact of Inflation

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

Impact of Recent Accounting Pronouncements

        In June 2001, the Financial Accounting Standards Board (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

31

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 test 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. The Company adopted SFAS No. 142 and completed a transitional impairment test, as required by SFAS No. 142, and determined that there was no impairment of goodwill as of October 1, 2002.

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

        In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" which nullifies EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a material impact on the Company's financial position and results of operations.

        In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities". Interpretation 46 changes the criteria by which one company includes another entity in its consolidated financial statements. Previously, the criteria were based on control through voting interest. Interpretation 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. A company that consolidates a variable interest entity is called the primary beneficiary of that entity. The consolidation requirements apply to older entities in the first fiscal year or interim period ending after December 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the

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variable interest entity was established. The Company does not expect the adoption to have a material impact to the Company's financial position or results of operations.

        In April 2003, the FASB Issued SFAS No. 149, "Amendment of SFAS 33 on Derivative Instruments and Hedging Activities". SFAS No. 149 is intended to result in more consistent reporting of contracts as either freestanding derivative instruments subject to SFAS No. 33 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative features. In addition, SFAS 149 clarifies the definition of a derivative by providing guidance on the meaning of initial net investments related to derivatives. SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company does not expect that the adoption of SFAS No. 149 will have an impact on its financial position, results of operations or cash flows.

        In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) in statements of financial position. This statement affects the issuer's accounting for three types of freestanding financial instruments including (1) mandatorily redeemable shares that are required to be redeemed at a specified or determinable date or upon an event certain to occur, (2) put options and forward purchase contracts, which involves financial instruments embodying an obligation that the issuer must or could choose to settle by issuing a variable number of its shares or other equity instruments based solely on something other than the issuer's own equity shares and (3) certain obligations that can be settled with shares, the monetary value of which is (i) fixed, tied solely or predominantly to a variable such as a market index, or (ii) varies inversely with the value of the issuers' shares. For public companies, SFAS No. 150 became effective at the beginning of the first interim period beginning after June 15, 2003. As a result of SFAS No. 150, we have classified put options that were previously classified as "Temporary equity" and our Series A redeemable convertible preferred stock as liabilities at September 30, 2003.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

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

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

ITEM 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.

ITEM 9A. CONTROLS AND PROCEDURES

        At the end of the period covered by this report, we carried out an evaluation of the effectiveness of the design and operations of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our Chairman and

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Chief Executive Officer along with our Chief Financial Officer, who concluded that our disclosure controls and procedures were effective as of the date of the evaluation. Their were no significant changes in our internal controls during the quarter ended September 30, 2003 that have materially affected, or are reasonably likely to have materially affected, our internal controls subsequent to the date we carried out our evaluation.

        Disclosure controls and procedures are controls and other procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported with the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.

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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 directors and the executive officers follows the table.

        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.

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        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.

        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 Industries, Inc., 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 Secretary of the Company since September 1997 and as General Counsel from September 1997 until March 2002. He currently serves as Secretary, Controller and General Counsel of Telx Group, Inc., a telecommunications company. 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.

Code of Ethics and Business Conduct

        We have adopted a Code of Ethics and Business Conduct that applies to all of our directors, officers and employees, including our Chief Executive Officer, our Chief Financial Officer and other senior financial officers. Our Code of Ethics and Business Conduct is posted on our website, www.stratusservices.com, under the "Employee Information-Legal" caption. We intend to disclose on our website any amendment to, or waiver of, a provision of the Code of Ethics and Business Conduct that applies to our Chief Executive Officer, our Chief Financial Officer or our other senior financial officers.

Audit Committee Financial Expert

        Our Board of Directors has determined that Michael Rutkin is the Audit Committee's financial expert. Mr. Rutkin is the brother-in-law of Joseph J. Raymond, our Chairman, President and Chief Executive Officer, and thus is not considered "independent" under NASD Rule 4200(a)(15).

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 2003, except that each of Joseph J. Raymond, Michael A. Maltzman, J. Todd Raymond, Sanford I. Feld and Donald W. Feidt were late in filing their Forms 4, which were due in connection with the grant of options made to such individuals in March, 2003.

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ITEM 11. EXECUTIVE COMPENSATION

        The following table provides certain summary information regarding compensation paid by the Company during the fiscal years ended September 30, 2001, 2002 and 2003 to the Chief Executive Officer of the Company and to the Company's only other executive officer who earned compensation of $100,000 or more in fiscal 2003 (together with the Chief Executive Officer, the "Named Executive Officers"):

Directors' Compensation

        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 30, 2007. 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 fiscal 2002 and 2003, Mr. Raymond voluntarily did not take a substantial portion of his minimum annual base salary.

        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:

•

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



•

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;



•

has committed any act which constitutes fraud or gross negligence;



•

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



•

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

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

•

the assignment to him of 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;



•

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;



•

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



•

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.

        The Company has entered into an employment agreement with Mr. Maltzman which provides for a base salary of $165,000 per annum. Mr. Maltzman is entitled to profit sharing awards based upon the Company's overall profitability. The agreement with Mr. Maltzman is terminable by either party at any time without cause. However, in the event that this agreement is terminated by the Company without cause or by Mr. Maltzman with good reason, Mr. Maltzman 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 Mr. Maltzman any earned but unused vacation time and any accrued but unpaid profit sharing. The Company is also required to maintain insurance and benefits for Mr. Maltzman during the severance period.

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Option Grants

        Shown below is further information with respect to grants of stock options in fiscal 2003 to the Named Officers by the Company which are reflected in the Summary Compensation Table set forth under the caption "Executive Compensation."

(1)

Exercisable immediately.

Option Exercises and Fiscal Year-End Values

        Shown below is information with respect to options exercised by the Named Executive Officers during fiscal 2003 and the value of unexercised options to purchase the Company's Common Stock held by the Named Executive Officers at September 30, 2003.

        No options were exercised by the Named Executive Officers during the fiscal year ended September 30, 2003.

(1)

Represents market value of shares covered by in-the-money options on September 30, 2003. The closing price of the Common Stock on such date was $.31. Options are in-the-money if the market value of shares covered thereby is greater than the option exercise price.

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ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        The following table sets forth information, as of December 23, 2003 with respect to (a) each person who is known by the Company to be the beneficial owner (as defined in Rule 13d-3 ("Rule 13d-3") of the Securities and Exchange Act of 1934) of more than five percent (5%) of the Company's Common Stock, Series A Preferred Stock and Series F Preferred Stock and (b) the beneficial ownership of Common Stock, Series A Preferred Stock and Series F Preferred Stock by each director and each of the Company's current Executive Officers who earned in excess of $100,000 in fiscal 2003 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 900,000 shares of Common Stock owned by Artisan.com Limited, 1,375,933 shares of Common Stock issuable upon the conversion, at the holder's option, of an equal number of shares of Series A Preferred Stock owned by Artisan.com Limited and 83,000 shares of Common Stock issuable upon the conversion, at the holder's option, of an equal number of shares of Series A Preferred Stock owned by Cater Barnard (U.S.A.) plc. All of such shares are subject to proxies granted by Artisan.com Limited and Cater Barnard (U.S.A.) which give Joseph J. Raymond the right to vote these shares until July 2004, provided that he remains Chairman of the Company's Board of Directors. Also includes (i) 6,000,000 shares of Common Stock issuable as of December 23, 2003, upon conversion of 6,000 shares of Series F Preferred Stock held by a corporation of which Mr. Raymond is sole owner; (ii) 853,333 shares of Common Stock issuable as of December 23, 2003, upon conversion of 1,600 shares of Series E Preferred Stock, assuming a conversion price of $.1875; and (iii) 2,827,116 shares of Common Stock subject to options which are currently exercisable or may become exercisable within 60 days of December 23, 2003.

(2)

These shares are held by Artisan.com Limited (1,375,933 shares) and Cater Barnard (83,000 shares). Each of Artisan.com Limited and Cater Barnard has granted Mr. Raymond a proxy to vote these shares as described in Note 1 above.

(3)

These shares are owned directly by Mr. Raymond.

(4)

Includes 1,375,933 shares of Common Stock issuable upon conversion, at the holder's option, of an equal number of shares of Series A Preferred Stock. Artisan.com Limited has granted Joseph J. Raymond a proxy to vote these shares as described in Note 1 above.

(5)

Artisan.com Limited has granted Joseph J. Raymond a proxy to vote these shares as described in Note 1 above.

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(6)

Represents 83,000 shares of Common Stock issuable upon the conversion, at the holder's option, of an equal number of shares of Series A Preferred Stock. Cater Barnard (USA) plc has granted Joseph J. Raymond a proxy to vote these shares as described in Note 1 above.

(7)

Shares beneficially owned do not exceed 1% of the Company's outstanding Common Stock.

(8)

Cater Barnard (USA) plc has granted Joseph J. Raymond a proxy to vote these shares as described in Note 1 above.

(9)

Includes 685,448 shares subject to currently exercisable stock options.

(10)

Includes 30,000 shares held by the children of Michael Rutkin, living in his household and 10,000 shares held by his wife.

(11)

Includes 101,164 shares subject to currently exercisable stock options and warrants.

(12)

Includes 60,000 shares subject to currently exercisable options.

(13)

Includes 60,000 shares subject to currently exercisable options.

(14)

Includes 104,262 shares of Common Stock that are beneficially owned by J. Todd Raymond, the Company's Corporate Secretary, and includes 368,782 shares subject to currently exercisable options.

Agreement with holder of Series A Preferred Stock

        In July 2003, we entered into an agreement with Artisan (UK) plc, the parent company of Artisan.com Limited, pursuant to which we have agreed to redeem the aggregate 1,458,933 shares of our Series A Preferred Stock owned by Artisan.com Limited and Cater Barnard (USA) plc, an affiliate of Artisan. These shares represent all of the shares of Series A Preferred Stock currently outstanding. Our obligation to redeem the Series A Preferred Stock is contingent upon our sale of not less than $4,000,000 of units in our proposed best efforts Offering. If we sell at least $4,000,000 of units in the Offering, we will be obligated to pay $500,000 to Artisan within 15 days after the $4,000,000 of units are sold. In addition, we will be obligated to pay Artisan an additional $250,000 by January 31, 2005 or, at our option, issue to Artisan shares of our common stock having an aggregate market value of $250,000, based upon the average closing bid prices of the common stock for the 30 trading days preceding January 31, 2005. If we fail to make the $250,000 payment in cash or stock, we will be required to pay Artisan $300,000 in cash, plus interest calculated on a daily basis at a rate of 18% from the date of the default to the date the default is cured. We have also agreed to issue to Artisan a number of shares of our common stock which will represent 5.5% of our outstanding common stock, subject to certain adjustments, upon completion of our sale of $4 million of units in the Offering. Further, upon final completion of the Offering, we will be required to issue additional shares of common stock so that the total number of shares of common stock issued to Artisan will equal 5.5% of our common stock after giving effect to the assumed exercise of all warrants and options that then have exercise prices equal to or less than the then current market price of our common stock and the conversion of all convertible securities that then have conversion prices equal to or less than the then current market price of our common stock.

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Securities Authorized for Issuance under Equity Compensation Plans

        The number of stock options outstanding under our equity compensation plans, the weighted average exercise price of outstanding options, and the number of securities remaining available for issuance, as of September 30, 2003, was as follows:

(1)

Our equity incentive plans provide for the issuance of incentive awards to officers, directors, employees and consultants in the form of stock options, stock appreciation rights, restricted stock and deferred stock, and in lieu of cash compensation.

(2)

Represents shares subject to options granted to certain officers pursuant to employment agreements and individual stock option agreements, including (a) options with respect to 1,000,000 shares granted to Joseph J. Raymond which expire in January 2010 and which become exercisable only if we achieve earnings of $1.00 per share in a fiscal year, options with respect to 500,000 shares granted to Joseph J. Raymond which expire in March 2013, and options with respect to 50,000 shares granted to Joseph J. Raymond which expire in April, 2010, and (b) options with respect to 83,333 shares granted to Michael A Maltzman which expire in September, 2007, options with respect to 83,333 shares granted to Michael A. Maltzman which expire in March 2013, options with respect to 26,667 shares granted to J. Todd Raymond, which expire in September, 2007, options with respect to 26,667 shares granted to J. Todd Raymond which expire in March, 2013, and options with respect to 50,000 shares granted to Charles Sahyoun which expire in March, 2012.

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ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.

        Jeffrey J. Raymond, the son of Joseph J. Raymond, our Chairman and Chief Executive Officer, serves as a consultant to us 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 $53,000 in fiscal 2003.

        During the fiscal year 2003, we paid consulting fees of $86,000 to RVR Consulting, Inc., a corporation of which Joseph J. Raymond, Jr., the son of Joseph J. Raymond, our Chairman and Chief Executive Officer is an officer and 100% stockholder.

        In November 2000, we formed the Stratus Technology Services, LLC joint venture ("STS") with Fusion Business Services, LLC. Jamie Raymond, son of Joseph J. Raymond, Chairman and CEO, is the managing member of STS and Fusion, which owns a 50% interest in Stratus Technology Services, LLC.

        At various times throughout our history, we have borrowed funds from Joseph J. Raymond, our Chairman and CEO. As of September 30, 2003, we owed $75,000 to Mr. Raymond pursuant to a non-interest bearing promissory note which is due on demand.

        In fiscal 2003, a son, brother and brother-in-law of Joseph J. Raymond Sr., our Chairman, President and Chief Executive Officer, each loaned $100,000 to us. The loans are unsecured and due on demand. In fiscal 2003, we borrowed $116,337 from the Kingston Family Revocable Trust under a promissory note that was issued in May 2003 and due upon demand and which bears interest only in the event of default, at a rate equal to the lesser of 18% per year or the maximum interest rate permitted by law. The Kingston Family Revocable Trust is a trust formed for the benefit of the family of H. Robert Kingston, one of our directors.

        During fiscal 2003, Advantage Services Group, LLC ("Advantage"), a company in which Joseph J. Raymond, Jr., the son of our President and Chief Executive Officer, holds a 50% interest, provided payrolling services to certain of our customers under an arrangement pursuant to which we paid Advantage a fee equal to the cost of providing such services plus a specified percentage above Advantage's cost. The total amount paid to Advantage under this arrangement in fiscal 2003 was $1,224,131. In November 2003, we agreed to pay Advantage $20,000 per month until we have paid Advantage $225,000 owed to it in connection with this arrangement. Our obligation to pay this amount is secured by a warrant to purchase 2,000,000 shares of our common stock. The warrant, which is exercisable only if we default on our payment obligations to Advantage, has an exercise price equal to the lower of $.15 per share or 75% of the then current market price of the common stock.

        In November 2003, we entered into payrolling agreements with Advantage with respect to four of our accounts that require that we pay Advantage a fee ranging between 2% to 3% above its cost. We have pledged our accounts with these customers as security for our obligations to Advantage under these agreements. In addition, if the aggregate payroll of employees provided under these agreements does not equal at least $8 million by November 30, 2004, we will be required to pay Advantage an amount equal to 8% of the shortfall.

        On August 22, 2003, we completed the sale, effective as of August 18, 2003 of substantially all of the tangible and intangible assets, excluding accounts receivable, of our Miami Springs, Florida office to ALS, LLC. Pursuant to the terms of the Asset Purchase Agreement between us and ALS, the purchase price for the purchased assets was $128,000, which was paid by a promissory note which bears interest at the rate of 7% per year, with payments over a 60 month period. The amount of the monthly payments due under the note will be the greater of $10 per month or 20% of the monthly net profits generated by the staffing business originating from the purchased assets, commencing October 31, 2003. However, until such time as all outstanding amounts due and owing by us to ALS, as of the date of the Purchase Agreement in the amount of $289,635, have been paid in full, these monthly payments shall

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be deducted from any and all amounts due from us to ALS. The note is secured by a security interest in all of the purchased assets.

        Joseph J. Raymond, Jr., the son of our President and Chief Executive Officer is a 50% member in ALS, LLC. ALS, LLC is the holding Company for Advantage.

        In February 2003, Pinnacle Investment Partners, L.P. ("Pinnacle") converted a $100,000 short-term note that we previously issued to it into 1,000 shares of Series E Preferred Stock. In addition, Pinnacle purchased 6,000 shares of Series E Preferred Stock from us for an aggregate purchase price of $60,000. Because the Series E Preferred Stock was convertible into our common stock, Pinnacle may have been the beneficial owner of 5% or more of our common stock during fiscal 2003. The terms of the Series E Preferred Stock have been amended to restrict conversions which would result in a holder of the Series E Preferred Stock becoming the beneficial owner of 5% or more of our common stock.

        We believe that all transactions with related parties have been on terms no less favorable to us than those that could have been obtained from unaffiliated third parties.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

        The following table set forth the aggregate fees billed to us for the year ended September 30, 2003 by Amper, Politziner & Mattia, P.C., our independent auditors:

        Audit fees represent amounts billed for professional services rendered for the audit of our annual financial statements and the reviews of the financial statements included in our Forms 10-Q and Forms 8-K for the fiscal year. Audit Related Fees represent amounts charged for reviewing various registration statements filed by us with the Securities and Exchange Commission during the year and audits of 401K plans. Before Amper, Politziner & Mattia, P.C. was engaged by us to render audit or non-audit services, the engagement was approved by our Audit Committee. Our Board of Directors is of the opinion that the Audit Related Fees charged by Amper, Politziner & Mattia, P.C. are consistent with Amper, Politziner & Mattia, P.C. maintaining its independence from us.

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)

Financial statements and financial statement schedules. Reference is made to Index of Financial Statements and Financial Statement Schedules hereinafter contained.

(b)

Reports on Form 8-K

        On September 25, 2003, the Company filed a report on Form 8-K to report on (i) the completion on September 10, 2003, effective September 15, 2003, of the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of five of the Company's New Jersey offices to D/O Staffing, LLC, a New Jersey limited liability company; and (ii) the completion, on August 18, 2003, of the sale of substantially all of the tangible and intangible assets, excluding accounts receivable, of the Company's Miami Springs, Florida office to ALS, LLC, a Florida limited liability company.

(c)

Exhibits

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46

47

48

49

50

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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.

POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS that each individual whose signature appears below constitutes and appoints Joseph J. Raymond and each of them, as his true lawful attorney-in-fact and agent, with full power of substitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K/A, and to file the same, together with all the exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and being requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, of his or her or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

        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.

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STRATUS SERVICES GROUP, INC.

INDEX TO FINANCIAL STATEMENTS

As of September 30, 2003 and 2002
and for the Years Ended September 30, 2003, 2002 and 2001

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, 2003 and 2002, 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, 2003. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Stratus Services Group, Inc. as of September 30, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America.

        The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

        In connection with our audits of the financial statements referred to above, we audited the financial Schedule II. 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.

Edison, New Jersey
December 19, 2003

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STRATUS SERVICES GROUP, INC.

Balance Sheets

See accompanying summary of accounting policies and notes to financial statements.

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STRATUS SERVICES GROUP, INC.

Statements of Operations

See accompanying summary of accounting policies and notes to financial statements.

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STRATUS SERVICES GROUP, INC.

Statements of Cash Flows