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

FORM 10-K

Commission file Number 0-5228

Strategic Distribution, Inc.
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (215) 633-1900

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $.10 Per Share
(Title of class)

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

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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 10-K or any amendment to this Form 10-K. ý

        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 Registrant's Common Stock, par value $.10 per share (the "Common Stock"), held by non-affiliates on June 30, 2003, the last day of the Registrant's most recently completed fiscal second quarter, was approximately $34,000,000, based upon the last sale price of the Common Stock on such date as reported on the Nasdaq National Market. For purposes of this calculation, the Registrant has defined "affiliate" to include persons who are directors or executive officers of the Registrant and persons who singly, or as a group, beneficially own 10% or more of the issued and outstanding Common Stock.

        As of March 23, 2004, the Registrant had outstanding 2,953,308 shares of Common Stock, which were registered pursuant to Section 12(g) of the Securities Exchange Act of 1934 (the "1934 Act"). The Common Stock is sometimes referred to herein as the "Voting Stock" of the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

        The Registrant's Proxy Statement for the 2004 Annual Meeting of Shareholders is incorporated by reference in Part III of this Annual Report on Form 10-K.

Explanatory Note

        As part of the year-end closing process, the Company determined that certain liabilities to its materials suppliers, which were accrued prior to 2001, were overstated by $827,000. As a result, the Consolidated Financial Statements were restated to reflect a decrease of $827,000 to the accumulated deficit account as of December 31, 2000, for the correction of errors that arose in periods prior to 2001. See Item 8, "Financial Statements and Supplementary Data—Notes to the Consolidated Financial Statements", Footnote No. 3.

PART I

Item 1. Business

        (a)    General Development of Business    

        Strategic Distribution, Inc. (the "Company") is a Delaware corporation which was organized in 1968. In 1994, the Company acquired Industrial Systems Associates, Inc. ("ISA"). ISA changed its name to SDI, Inc. effective January 26, 2004. ISA is a provider of In-Plant Store® programs for the procurement, handling and data management of maintenance, repair and operating ("MRO") supplies for industrial and institutional customers in North America.

        (b)    Financial Information About Industry Segments    

        The Company operates in one reportable segment and substantially all of its revenues were from the procurement, handling and data management of MRO supplies for industrial and institutional customers. See Item 8, "Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements", Footnote No. 15.

        (c)    Narrative Description of Business.    

        The Company's In-Plant Store program permits an organization to outsource all aspects of their MRO procurement, storage and internal distribution; the Company takes responsibility for purchasing, receiving, stocking, issuing and delivering MRO supplies at the customer site. The Company also efficiently manages customers' MRO inventory using its proprietary information system.

Service Offerings

        The Company provides proprietary MRO supply procurement, handling, data management solutions and related services to organizations, through its In-Plant Store program. The Company sells a broad range of MRO supplies, replacement parts and selected classes of production materials, which are described collectively as MRO supplies. MRO supplies are frequently inexpensive but critical items, with high associated procurement costs due to inherent inefficiencies in traditional MRO supply distribution methods. The Company's In-Plant Store program, in which organizations outsource the procurement, handling and data management of MRO supplies to the Company, substantially mitigates these inefficiencies by reducing both the process and product costs associated with MRO supply procurement and handling. The Company's In-Plant Store program also helps customers achieve operational improvements, such as reduced plant down-time resulting from unavailable parts, and manufacturing process improvements due to better tracking of critical parts. The Company believes that its In-Plant Store program is superior to both traditional and alternative methods of MRO supply distribution in that the In-Plant Store program allows customers to outsource MRO supply distribution and handling activities and concentrate on their core businesses.

        The In-Plant Store program is a comprehensive outsourcing service through which the Company manages all aspects of MRO supply procurement and handling at a customer's site. Prior to the implementation of the In-Plant Store program, a customer would typically obtain MRO supplies from as many as 500 traditional industrial distributors. Through the In-Plant Store program, the Company

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services many of its customers' MRO supply needs by establishing a dedicated, fully integrated store at the customer's site. The customer, in turn, generally purchases all of its MRO supplies from SDI. The Company operates the In-Plant Store program with its own trained MRO procurement professionals, installs its proprietary information system designed specifically for industrial procurement and identifies appropriate inventory levels based on the supply needs of each site. Upon implementation of services the Company sometimes purchases, receives, inventories and issues MRO supplies directly to plant personnel, delivers ongoing technical support and provides the customer with a comprehensive invoice twice per month, thereby reducing the administrative burden of traditional MRO supply.

        A benefit of the Company's services is the identification and reduction of redundant and obsolete inventory in the customer's legacy inventory of MRO supplies. For example, the same MRO item may be used in several different departments at a manufacturing site; each department describes the part differently and, therefore, the different departments do not realize that they are using the same part. The Company uses its software to systematically describe all MRO parts. Redundancies are identified and the Company is able to consolidate and reduce inventories, thereby reducing its own and the customer's capital investment. The Company can also reduce handling and other expenses related to MRO procurement and gain better pricing by consolidating purchases. In addition, over time, the Company can provide its customers value by (i) more quickly and easily identifying and locating MRO items needed by different departments at a site, or by different sites operated by the same company, and (ii) helping locate alternative sources for different MRO items.

        The Company believes that increased recognition of the inefficiencies associated with the traditional MRO supply distribution process has increased the demand for integrated supply solutions such as the Company's In-Plant Store program.

Customers

        In May 2003, the Company announced that it agreed to terminate the In-Plant Store services agreements with El Paso Corporation ("EPC"), its largest customer. The Company transitioned all storerooms to EPC during July 2003. The Company's revenues from EPC for fiscal 2003, 2002 and 2001 were $16.0 million, $34.7 million, and $36.5, respectively. There were no accounts receivable or inventory related to the EPC services agreements at December 31, 2003.

        During 2001 and early 2002, the Company and Kraft Foods North America, Inc. ("Kraft") discussed certain changes to the In-Plant Store services agreement that would have made the Kraft agreement profitable and reduced the Company's working capital commitment. As a result of the inability of the parties to reach a revised agreement, on March 27, 2002 the Company and Kraft agreed to terminate the relationship prior to the contract expiration of August 2003. During the second quarter of 2002, the Company sold its Kraft inventory to Kraft at normal selling prices. The value of the sale was $26.2 million and the related gross margin was $1.7 million. During the second and third quarters of 2002, the Company substantially completed the transition of all storerooms to Kraft and reduced its operating costs. The Company provided inventory procurement and management services to Kraft during the transition. The Company's Kraft revenues for the years ended December 31, 2002 and 2001 were $77.0 million ($50.8 million excluding the Kraft inventory sale) and $86.1 million, respectively. There were no accounts receivable or inventory related to the Kraft services agreement at December 31, 2002.

        During the year ended December 31, 2003, three customers comprised approximately 35.3% of the Company's revenues. Although EPC terminated its contract with the Company during the third quarter of 2003, it comprised 11.9% of the Company's revenues for the year ended December 31, 2003. The Company operated one In-Plant Store site for another customer, Coors Brewing Company, which comprised 14.1% of the Company's revenues for the year ended December 31, 2003.

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        The Company periodically reviews the financial condition of its customers and seeks to reduce asset exposure and program costs when appropriate.

        The Company provides its services to its In-Plant Store customers in the United States and Mexico. During the year ended December 31, 2003, 19.4% of the Company's revenues were from customers in Mexico.

Products

        The Company, through the In-Plant Store program, provides a broad range of MRO supplies, replacement parts and selected classes of production materials, including the following:

        Because of the broad range of products sold by the Company, no single product or class of products accounted for more than 10% of the Company's revenues in 2003.

Suppliers

        The Company purchases products for its In-Plant Store program from manufacturers and specialty distributors. The Company has distribution agreements with manufacturers and suppliers, all of which can be canceled by the respective manufacturers and suppliers upon notice of one year or less. Because no manufacturer or supplier provides products that account for more than 10% of the Company's revenues and because the Company believes that it could quickly find alternative sources of supply if any distribution contract were canceled, the Company does not believe that the loss of any one distribution contract, or any small group of distribution contracts, would have a material adverse impact on the Company's business.

Competition

        The Company's business is highly competitive. The Company competes with a wide variety of traditional MRO supply distributors. Most of such distributors are small enterprises selling to customers in a limited geographic area. The Company also competes with several integrated supply providers, direct mail suppliers, internet suppliers and large warehouse stores, some of which have significantly greater financial resources than the Company. The primary areas of competition include price, breadth and quality of product lines distributed, ability to fill orders promptly, technical knowledge of sales personnel and, in certain product lines, service and repair capability. The Company believes that its ability to compete effectively is dependent upon its ability to be price-competitive, to deliver value-added procurement solutions to its customers through its In-Plant Store program and to respond to the needs of its customers with high quality of service. The Company believes that certain of its competitors have developed and implemented programs which offer services similar to, and which compete with, the Company's In-Plant Store program.

        The Company also competes, to some extent, with the manufacturers of MRO supplies. The Company believes, however, that most of such manufacturers sell their products through traditional industrial distributors, because the limited range of products that a manufacturer offers cannot compete

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effectively with the broad product lines and additional services offered by traditional industrial distributors and MRO supply service providers such as the Company.

Government Regulation

        In recent years, governmental and regulatory bodies have promulgated numerous standards and regulations designed, among other things, to ensure the quality of certain classes of MRO items, to protect workers' well-being and to make the work place safer. The Company has increased sales in the past as a result of its customers' compliance with this increasing level of regulation. The Company cannot predict the level or direction of future regulation.

Employees

        As of December 31, 2003, the Company had approximately 375 employees, of whom approximately 120 were employed in selling and administrative capacities and approximately 255 were involved in operations. None of the Company's employees were covered under collective bargaining agreements. The Company considers its employee relations to be good.

Insurance

        The Company maintains liability and other insurance that it believes to be customary and generally consistent with industry practice. The Company is also named as an additional insured under the products liability policies of certain of its suppliers and, with respect to In-Plant Store facilities, so names certain of its customers. The Company believes that such insurance is adequate to cover potential claims relating to its existing business activities.

Item 2. Properties

        The Company leases its corporate headquarters located in Bensalem, Pennsylvania, as well as several small warehouses and offices located at or near In-Plant Store sites. The Company has the right to renew some of these leases. The Company believes the properties that are currently under lease are adequate to serve the Company's business operations for the foreseeable future. The Company believes that if it were unable to renew its lease at any of these facilities, it could find other suitable facilities with no adverse effect on the Company's business. The Company does not own or lease the space occupied by its In-Plant Store facilities.

Item 3. Legal Proceedings

        The Company is currently involved in certain legal proceedings incidental to the conduct of its business, including collection matters with several terminated accounts. The Company does not believe that the outcomes of such proceedings are likely to have a material adverse effect, individually or in the aggregate, on its consolidated financial position or results of operations.

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

        Not applicable.

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PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters

        The Common Stock is quoted on the Nasdaq National Market ("NNM") under the symbol "STRD". As of March 23, 2004, there were approximately 1,400 holders of record of the Common Stock. The following table sets forth the high and low sale prices of the Common Stock on the NNM for the periods indicated:

        Effective May 17, 2001, the Company's shareholders approved a one-for-ten reverse split of its common stock (the "Reverse Split"). The shareholders also approved a decrease in the number of authorized shares of common stock from 50,000,000 shares to 20,000,000 shares. All references in this to number of shares issued and per share amounts have been restated to reflect the effect of the Reverse Split for the periods presented.

        The Company paid a cash distribution, which is deemed to be a return of capital for tax purposes, of $5.00 per common share to its shareholders during the fourth quarter of 2003. The distribution was paid on October 6, 2003 to stockholders of record on September 8, 2003 and amounted to $14,765,000. The Company paid no cash dividends on the Common Stock for the year ended December 31, 2002. The Company does not intend to declare any cash dividends in the foreseeable future. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources".

        The information regarding shares authorized for issuance under equity compensation plans is contained in the Proxy Statement under the caption "Description of Outstanding Stock" and is incorporated herein by reference.

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Item 6. Selected Financial Data

(a)

Operating results include a benefit of $700,000 from a legal settlement for less than amounts previously accrued, a $930,000 reduction in cost of materials related to changes in previously recorded estimates of liabilities for products purchased, a charge of $232,000 for the repricing of outstanding stock options and a charge of $250,000 related to changes in the Company's vacation benefits.

(b)

Operating results include revenues of $26,200,000, gross margin of $1,700,000, a charge of $3,800,000 for the write-down of certain fixed assets and severance expense of $700,000, all related to termination of the Kraft contract and inventory sale to Kraft.

(c)

Operating loss is net of operating income of $900,000 related to an increase in the recoverable value of accounts receivable and inventories in connection with the termination of services agreements and $300,000 from an insurance recovery.

(d)

Operating loss includes charges amounting to $5,800,000 related to the bankruptcies of two large In-Plant Store customers.

(e)

Operating loss includes a charge of $1,514,000 for settlement of an employment contract and a charge of $1,584,000 related to the write-off of certain impaired assets.

(f)

Income before income taxes includes a pretax gain of $43,185,000 from the sale of the Company's INTERMAT, Inc. subsidiary ("INTERMAT").

(g)

Certain liabilities were restated due to a correction of an error related to periods prior to 2001. See Note 3 to the consolidated financial statements.

(h)

An income tax benefit of $8,641,000 was recorded related primarily to the Company's recognition of net operating loss carryforwards.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of our results of operations and financial position for the periods described below. This discussion should be read in conjunction with the consolidated financial statements included in this report.

General

        Strategic Distribution, Inc. and subsidiaries (the "Company") provides proprietary maintenance, repair and operating ("MRO") supply procurement, handling and data management solutions to industrial and institutional customers, primarily through its In-Plant Store® program. The Company became a provider of the In-Plant Store program in 1994 and conducts its U.S. operations primarily through its wholly-owned subsidiary, Industrial Systems Associates, Inc. ("ISA"). ISA changed its name to SDI, Inc. effective January 26, 2004.

        As part of the year-end closing process, the Company determined that certain liabilities to its materials suppliers, which were accrued prior to 2001, were overstated by $827,000. As a result, the consolidated financial statements were restated to reflect a decrease of $827,000 to the accumulated deficit account as of December 31, 2000 for the correction of errors that arose in periods prior to 2001. See Note 3 to the consolidated financial statements included in this report.

        The Company experienced a decline of 46.9% in revenues from 2002 to 2003. The majority of the decline in revenues was attributable to the loss of two large customers: (1) El Paso Corporation ("EPC") in July of 2003 and (2) Kraft in September of 2002. The remainder of the decline in sales was attributable to the loss of nine other customers and to a decline in continuing business of $5.8 million. The returns attributable to these customers were less than the Company prefers today. The Company anticipates the loss of five customers during the first two quarters of 2004. Many of the Company's customers experienced business downturns over the last two years and a number of the lost customers, including EPC and Kraft, were due to customers' decisions to reduce outside services and manage their indirect materials programs with their own resources. The Company has recently entered into agreements with six new customers including two large customers. The Company has actively increased its marketing efforts to expand the business in the direction of fee for services, rather than product focused. The Company has enhanced this service offering through enhanced systems capabilities and by providing more flexible solutions, including the needs of smaller sites that do not require an In-Plant Store program onsite. These new contracts deliver a more favorable return than historical contracts. Termination of contracts and economic downturn affecting the Company's customers, negatively impacts the Company's revenues and earnings, and its ability to effectively implement improvements in the In-Plant Store program. The Company periodically reviews the financial condition of its customers and seeks to reduce asset exposure and program costs when appropriate. There can be no assurance, however, that the Company will not experience further reductions in business or asset losses.

        Certain statements in this Item 7 constitute forward-looking statements which involve risks and uncertainties. The Company's actual results in the future could differ significantly from the results discussed or implied in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those related to the Company's ability to obtain new customers and manage growth, the Company's ability to enforce provisions of its contracts, termination of contracts by the Company's customers, competition in the Company's business, the Company's dependence on key personnel and the effects of recession on the Company and its customers. In the event of continued economic downturn, the Company could experience additional customer bankruptcies, reduced volume of business from its existing customers and lost volume due to plant shutdowns or consolidations by the Company's customers.

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Critical Accounting Policies

        The Securities and Exchange Commission ("SEC") has issued cautionary advice regarding disclosure about critical accounting policies. The SEC defines critical accounting policies as those that are both most important to the portrayal of a company's financial condition and results and that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain and may change materially in subsequent periods. The preparation of the Company's consolidated financial statements requires estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Significant estimates made by the Company include the following:

•

Reserves and Accrued Liabilities:  The Company provides reserves or accrued liabilities in accordance with generally accepted accounting principles for events such as site closures, to record assets at estimated net realizable values and to record probable contingent liabilities. In addition, in the ordinary course of business, management makes estimates of accrued liabilities to suppliers and other service providers. The amounts of such reserves and liabilities are based on information and assumptions that the Company deems reasonable and probable at the time. The matters that give rise to such provisions are inherently uncertain and require complex and subjective judgments.



•

Allowance for doubtful accounts:  The Company maintains allowances for doubtful accounts for estimated losses resulting from the Company's review and assessment of its customers' ability to make required payments. If the financial condition of the Company's customers were to deteriorate, additional allowances might be required.



•

Deferred tax asset valuation allowance:  The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance, future realization of these assets in excess of the net amount recorded would increase income during that period. Likewise, should the Company determine a greater possibility exists that it would not be able to realize part of or the entire net deferred tax asset in the future; a charge to income would result at the time the determination was made.



•

Recoverability of assets:  The Company makes significant estimates relating to the recoverability of assets, such as inventory and long-lived assets and the assessment of litigation and other contingencies. The Company's ability to recover the value of its inventory depends on a number of factors, including the financial condition of its customers, the effect of changes in economic conditions and its ability to enforce provisions of its contracts in the event of disputes, through litigation if necessary. The recoverability of long-lived assets is highly dependant on the Company's business volume and application of the applicable accounting standards requires significant judgments and estimates.

        Although the Company believes the estimates and assumptions used in determining the recorded amounts of net assets and liabilities at December 31, 2003 are reasonable, actual results could differ materially from estimated amounts recorded in the Company's consolidated financial statements.

Contract Terminations

        In May 2003, the Company announced that it agreed to terminate its In-Plant Store services agreements with EPC, its largest customer. The Company transitioned all storerooms to EPC during July 2003. The Company's revenues from EPC for fiscal 2003, 2002 and 2001 were $16.0 million, $34.7 million, and $36.5 million, respectively. There were no accounts receivable or inventory related to EPC at December 31, 2003.

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        During 2001 and early 2002, the Company and Kraft discussed certain changes to the In-Plant Store services agreement that would have made the Kraft agreement profitable and reduced the Company's working capital commitment. As a result of the inability of the parties to reach a revised agreement, on March 27, 2002 the Company and Kraft agreed to terminate the relationship prior to the contract expiration of August 2003. During the second quarter of 2002, the Company sold its Kraft inventory to Kraft at normal selling prices. The value of the sale was $26.2 million and the related gross margin was $1.7 million. During the second and third quarters of 2002, the Company substantially completed the transition of all storerooms to Kraft and reduced its operating costs. The Company provided inventory procurement and management services to Kraft during the transition. During the second quarter of 2002, the Company and Kraft finalized a transition plan, provided the affected workforce with information concerning employment opportunities with either the Company or Kraft and provided severance benefits to those employees whose positions were being eliminated in the workforce reduction. In connection therewith, the Company recorded severance expense of $700,000 during the second quarter of 2002, which was paid prior to December 31, 2002. The Company's Kraft revenues for fiscal 2002 and 2001 were $77.0 million ($50.8 million excluding the Kraft inventory sale) and $86.1 million, respectively. There were no accounts receivable or inventory related to Kraft at December 31, 2002. There are no significant additional Kraft revenues, expenses or cash flows expected in the future.

        During the second quarter of 2002, the Company recorded a charge of $3,800,000 related to the write-down of certain fixed assets in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). The Company provides its MRO procurement, handling and data management services through the In-Plant Store® program utilizing the In-Site® operating system, the Company's proprietary information system. The Company's primary investment in long-lived assets is in its In-Site technology, including supporting equipment or systems such as personal computers and network communications. As a result of the termination of the Kraft services agreement, the Company evaluated, in accordance with SFAS 144, the recoverability of its computer technology and determined that the value was impaired from the expected underutilization. The Company measured the fair value of the long-lived assets in accordance with SFAS 144 and determined the amount of impairment to be $3,800,000, including $200,000 related to personal computers removed from use and sold or disposed.

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Results of Operations

        The following table of revenues and percentages sets forth selected items of the results of operations:

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Revenues

        Revenues for the year ended December 31, 2003 decreased $119.0 million or 46.9% to $134.6 million from $253.6 million for the year ended December 31, 2002. The termination of contracts with customers throughout fiscal 2002 and 2003 is the primary cause for the revenue reduction. The closing of two customers, Kraft ($77.0 million) and EPC ($18.7 million) accounted for $95.7 million of the overall decrease. Revenues for the year ended December 31, 2002 included $26.2 million related to the sale of Kraft inventory in connection with the termination of the Kraft services agreement. The remaining decrease of $23.3 million was due to the termination of other customer contracts of $19.7 million and the reduction in our continuing business of $5.6 million, partially offset by increases in revenue in our Mexican operations of $1.0 million and an increase in revenue relating to a one-time $1.0 million inventory sale to an existing customer that reduced its In-Plant Store program during the third quarter of 2003.

        During 2003, the Company incurred $4.6 million of costs for supplies shipped to a new customer. The Company did not recognize revenue on the shipment of supplies as a result of not meeting all of the criteria required by Staff Accounting Bulletin No. 104, Revenue Recognition ("SAB 104"). As of December 31, 2003, the $4.6 million of costs relating to the supplies shipped to the new customer were included in inventory on the Company's consolidated balance sheet. The supplies shipped to this customer were of a seasonal nature.

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        As a result of the termination of the In-Plant Store services agreement with EPC, Kraft and other customers and the slowdown of the introduction of new sites, the Company did not achieve historic levels of revenue during 2003. Additional contract terminations and revenue declines in the Company's remaining business may cause future operating results to differ significantly from historical results reported. Future growth in the Company's business is highly dependant on its ability to attract new customers. The Company has reduced and may continue to reduce its operating costs as a result of the revenue declines. Such cost reductions will likely be lower than the relative sales declines because of the fixed nature of certain costs and determinations by the Company that certain costs are necessary to improve the Company's technology and service offerings and to obtain new business.

        Coors Brewing Company, comprised 14.1% of the 2003 revenue and less than 10% in fiscal 2002. EPC, which terminated its contract with the Company during the third quarter of 2003, comprised 11.9% and 13.7% of the Company's revenue for the years ended December 31, 2003 and 2002, respectively. Kraft comprised approximately 30.4% (20.0% excluding the Kraft inventory sale) of the Company's revenues during the year ended December 31, 2002.

Cost of Materials / Gross Margin

        Cost of materials as a percentage of revenues decreased to 77.7% for the year ended December 31, 2003 from 80.9% in 2002. During the year ended December 31, 2002, the high dollar/low margin sale of Kraft inventory produced $1.7 million of gross margin, which accounted for 1.4% of higher cost of material percentage for the period. Excluding the aforementioned sale, the Company's overall gross margin increased 1.8% for the year ended December 31, 2003 as compared to 2002. Approximately 1.1% of this increase was due to a greater portion of management service fees in the revenue mix during fiscal 2003. Management service fees have no direct material costs. The remainder of the change of approximately $0.9 million or 0.7% is attributable to reductions in the consolidated cost of goods sold during the fourth quarter of 2003 as result of decreases in previously estimated liabilities for product purchases. Further explanation of this benefit is discussed in Footnote 3 to the consolidated financial statements.

Other

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        Operating wages and benefits expense as a percentage of revenues increased to 8.6% for the year ended December 31, 2003 from 7.3% in 2002. Excluding revenue from the Kraft inventory sale, the percentage for the year ended December 31, 2002 was 8.1%. The Company's operating wages and benefits were reduced by $6.9 million or 37.4% during 2003 in conjunction with contract terminations. However, as a percentage of revenue these expenses increased, excluding the impact of the Kraft inventory sale, by approximately 0.5%. The comparable year over year percentage reflects the Company's effort to reduce costs commensurate with declines in the Company's revenue base. These efforts were offset by increases in the cost of medical and dental benefits and pay rate increases on a lower revenue base. Continued declines in business volume from existing customers may result in lower productivity and negatively impact the Company's ability to maintain staff at optimum levels.

        Other operating expenses as a percentage of revenues increased 0.1% to 2.7% for the year ended December 31, 2003 from 2.6% in 2002. The Company's operating expenses were reduced by $2.9 million during 2003 in conjunction with contract terminations. These expense reductions were primarily due to decreased depreciation and amortization of approximately $0.9 million, temporary labor of $0.6 million and data / telecommunications of $0.5 million. The reduction in depreciation and amortization is due in large part to the asset impairment charge recorded in the second quarter of 2002. Other operating expenses from continuing sites remained approximately the same as the prior year.

        Selling, general and administrative expenses as a percentage of revenues increased to 11.6% for the year ended December 31, 2003 from 8.1% in 2002. When revenue from the Kraft inventory sale is excluded, the percentage for the year ended December 31, 2002 was 9.0%. The Company's selling, general and administrative expenses were reduced by $4.9 million during 2003 in conjunction with contract terminations. This decrease was primarily from reductions in wages and benefits of non-operational employees of $2.6 million, bad debt expense of $1.1 million, legal fees of $0.5 million and travel and travel related expenses of $0.5 million. The primary reason for these decreases is due to the reduction in the Company's overall business and a legal settlement for outstanding accounts receivable balances that was settled more favorably than estimated by $0.7 million. Offsetting these decreases, during the fourth quarter of 2003, the Company recorded approximately $0.5 million in expense as a result of repricing the Company's outstanding stock options and changing the methodology for administering the Company's vacation policy. The increase in the selling, general and administrative costs as a percentage of revenue, excluding the impact of the Kraft inventory sale, from 9.0% to 11.6% is primarily attributable to non-operational employee wages and benefits and other fixed costs as a percentage of a much lower revenue base. The Company's ability to maintain or decrease the selling, general and administrative expenses as a percentage of revenue is highly dependent upon the Company's ability to expand its revenue base. Management believes the current cost structure of the Company will enable future growth. Potential cost reductions, if taken, could potentially inhibit that growth.

        During the year ended December 31, 2002, the Company recorded charges of $4,500,000, or 1.8% of revenues, in connection with the termination of the Kraft services agreement. The charges include $700,000 of severance expense and $3,800,000 of long-lived asset impairment expense. See "Contract Terminations," above.

        Interest income was $496,000 for the year ended December 31, 2003 compared to interest income of $437,000 for the comparable period in 2002. During 2003, the average monthly cash balance was approximately $8.6 million higher than in 2002. The large increase in the Company's cash balance occurred in May of 2002 as a result of the inventory sale to Kraft. Fiscal 2003 had a full year of benefit of this larger balance. As of December 31, 2003, the total cash, cash equivalent and short term investments had decreased by $13.8 million to $29.8 million as compared to December 31, 2002.

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        Income tax expense of $367,000 was recorded on income earned from the Company's Mexican operations during the year ended December 31, 2003. There was no tax benefit recorded for pretax losses of the Company's U.S. operations for the year ended December 31, 2003. The realization of income tax benefits from such losses is dependent on future events that cannot currently be deemed more likely than not to occur.

        During the first quarter of 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), and recorded a one-time non-cash charge of $1.9 million to write-off the carrying value of its goodwill. Such charge is non-recurring in nature and is reflected as a cumulative effect of accounting change in the accompanying consolidated statement of operations.

        Net loss for the year ended December 31, 2003 was $724,000, compared to net loss of $3,418,000 in 2002, as a result of the operating results previously discussed and the cumulative effect of the accounting change to write-off the Company's goodwill.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Revenues

        Revenues for the year ended December 31, 2002 decreased 20.7% to $253.6 million from $319.6 million for the year ended December 31, 2001. Revenues for the year ended December 31, 2002 include $26.2 million related to the sale of Kraft inventory in connection with the termination of the Kraft services agreement. Excluding the one-time sale of Kraft inventory, revenues for the year ended December 31, 2002 declined 28.9% from the comparable period in 2001. Termination of the Kraft services agreement accounted for $35.3 million (11.0%) of the revenue decline for the year ended December 31, 2002 as compared to the respective period in 2001. The weakened U.S. economy reduced mature store revenues by approximately $10.0 million (3.1%) for the year ended December 31, 2002 as compared to 2001. Revenue declines related to other site closings, including unprofitable contracts, partially offset by increased revenues from maturing sites during the year ended December 31, 2002, accounted for the remaining 14.8% of the net decline for the year.

        As a result of the termination of the In-Plant Store services agreement with Kraft, the slowdown of the introduction of new sites and the closing of unprofitable sites, the Company did not achieve historic levels of revenue during 2002. Kraft comprised approximately 30.4% (20.0% excluding the Kraft inventory sale) and 26.9% of the Company's revenues during the years ended December 31, 2002 and 2001. The Company's second largest customer, El Paso Corporation, comprised approximately 13.7% and 11.4% of the Company's revenues during the years ended December 31, 2002 and 2001. As noted previously, the Company lost EPC as a customer during fiscal 2003.

Cost of Materials / Gross Margin

        Cost of materials as a percentage of revenues decreased to 80.9% for the year ended December 31, 2002 from 82.0% in 2001. During the year ended December 31, 2002, the high dollar/low margin sale of Kraft inventory produced $1.7 million of gross margin, which accounted for 1.4% of higher cost of material percentage for the period. Excluding the aforementioned sale, the Company's

14

overall gross margins improved 2.5% for the year ended December 31, 2002 as compared to 2001. Approximately 1.3% of this improvement reflects the Company's efforts to close unprofitable sites and improve profit margins at both new and existing sites, partially offset by the slowdown in implementation of new In-Plant Store sites and the associated decline in implementation revenues, which have no material costs. Approximately 0.4% of the improvement relates to an increase in revenues, with no associated direct material costs, in connection with the termination of services agreements and an insurance recovery. The remaining 0.8% reflects a greater proportion of management service fees in the revenue mix. Management service fees have no direct material costs.

Other

        Operating wages and benefits expense as a percentage of revenues decreased to 7.3% for the year ended December 31, 2002 from 8.2% in 2001. When revenue from the Kraft inventory sale is excluded, the percentage for the year ended December 31, 2002 was 8.1%. The Company's operating wages and benefits were reduced significantly during 2002 in conjunction with contract terminations. The comparable year over year percentage reflects the Company's effort to reduce costs commensurate with declines in the Company's revenue base.

        Other operating expenses as a percentage of revenues decreased to 2.6% for the year ended December 31, 2002 from 3.0% in 2001. When revenue from the Kraft inventory sale is excluded, the percentage for the year ended December 31, 2002 was 2.9%. The Company's operating expenses were reduced significantly during 2002 in conjunction with contract terminations. The slightly lower adjusted percentage for the year ended December 31, 2002 reflects lower temporary labor and travel costs related to efficiency improvement projects initiated during 2001, partially offset by a higher percentage of fixed systems costs due to the lower revenue base.

        Selling, general and administrative expenses as a percentage of revenues decreased to 8.1% for the year ended December 31, 2002 from 10.8% in 2001. When revenue from the Kraft inventory sale is excluded, the percentage for the year ended December 31, 2002 was 9.0%. The Company's selling, general and administrative expenses were reduced significantly during 2002 in conjunction with contract terminations. The decreased percentage for the year ended December 31, 2002 reflects a 1.6% period over period reduction of charges for certain uncollectible accounts, including the 2001 write-off of uncollectible accounts in connection with the bankruptcies of two In-Plant Store customers. The remaining percentage decline resulted primarily from lower wages and travel costs, reflecting the Company's efforts to improve efficiency and reduce headcount in its administrative operations.

        During the year ended December 31, 2002, the Company recorded charges of $4,500,000, or 1.8% of revenues, in connection with the termination of the Kraft services agreement. The charges included

15

$700,000 of severance expense and $3,800,000 of long-lived asset impairment expense. See "Contract Terminations", above.

        Interest income, net was $437,000 for the year ended December 31, 2002 compared to interest expense, net of $348,000 for the comparable period in 2001. The Company had no borrowings against its credit facility during 2002, and invested its available cash, including cash received from the sale of Kraft inventory.

        Income tax expense of $164,000 was recorded on income earned from the Company's Mexican operations during the year ended December 31, 2002. There was no tax benefit recorded for pretax losses of the Company's U.S. operations for the year ended December 31, 2002. The realization of income tax benefits from such losses is dependent on future events that cannot currently be deemed more likely than not to occur. The Company's net loss for 2002 includes the write-off of $1.9 million of goodwill that was not deductible for federal income tax purposes.

        During the first quarter of 2002, the Company adopted SFAS 142 and recorded a one-time, non-cash charge of $1.9 million to write-off the carrying value of its goodwill. Such charge was non-recurring in nature and was reflected as cumulative effect of accounting change in the accompanying consolidated statement of operations.

        Net loss for the year ended December 31, 2002 was $3,418,000, compared to net loss of $13,125,000 in 2001, as a result of the operating results previously discussed and the cumulative effect of the accounting change to write-off the Company's goodwill.

Liquidity and Capital Resources

        As of December 31, 2003, the Company had $29.8 million of cash, cash equivalents and short term investments. The Company is currently evaluating strategic alternatives for the use of its cash balances. The Company believes that cash on hand and the ability to enter into a new credit facility, if deemed appropriate, will generate sufficient funds to permit the Company to support its operations.

        Net cash provided by operating activities was $1.8 million for the year ended December 31, 2003 compared to $40.6 million in 2002. As previously mentioned, the Company did not recognize revenue on approximately $4.6 million of costs for supplies shipped to a new customer as a result of not meeting all of the requirements of SAB 104. This amount is reflected as cash used from operations during 2003. The Company anticipates recognizing the revenue related to these costs plus gross margin during the first quarter of 2004. During 2002, the Company received $26.2 million from the one-time sale of inventory to Kraft in connection with the termination of the Kraft services agreement. The Company completed the transition of all storerooms to Kraft during 2002 and reduced Kraft accounts receivable by $12.2 million during the year. Also during 2002, the Company received federal income tax refunds of $4.1 million related to the filing of its year end 2000 and 2001 income tax returns. The remaining change in cash provided was primarily due to increased cash generated from the Company's operations and accounts receivable collections offset by reduction of amounts due to suppliers.

        As of December 31, 2003, accounts receivable, net on the consolidated balance sheet included outstanding balances of approximately $0.7 million with three terminated accounts with which the Company is involved in litigation. Although there can be no assurance, the Company does not believe, based upon its evaluation of information currently available, that the outcomes of such proceedings are likely to have a material adverse effect, individually or in the aggregate, on its consolidated financial position or results of operations.

        Net cash used in investing activities was $5.3 million for the year ended December 31, 2003 compared to $0.1 million in 2002. During 2003, the Company invested $5.1 million in short-term investments and purchases approximated $0.2 million of computer systems and related equipment.

16

        Net cash used in financing activities was $15.2 million for the year ended December 31, 2003 compared to $0.5 million in 2002. During the fourth quarter of 2003, the Company declared and paid a cash distribution, which is deemed to be a return of capital for tax purposes, of $5.00 per share to shareholders. The total cash outflow for this dividend was approximately $14.6 million. In addition, during 2003, the Company used $0.6 million to repurchase 45,476 shares of its common stock under a stock repurchase program, of which 876 of the shares were cancelled, partially offset by the issuance of 3,572 shares of common stock upon exercise of stock options. During the year ended December 31, 2002, the Company repurchased 42,400 shares of its common stock under a stock repurchase program for $0.5 million.

        The Company's revolving Loan and Security Agreement (the "credit facility"), which provided maximum borrowings of $50.0 million, expired on May 8, 2002. After completing the sale of Kraft inventory during the second quarter of 2002, the Company determined that it had sufficient cash and cash equivalents to support its operations and elected not to enter into a new credit facility at that time. Although there can be no assurance, in the event a credit facility is required in the future, the Company expects to be able to obtain a financing commitment, with terms and conditions appropriate for the Company's needs.

        We have no off-balance sheet arrangements that have or are reasonably likely to have current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.

Inflation

        The Company believes that any impact of general inflation has not had a material effect on its results of operations. The Company's current policy is to attempt to reduce any impact of inflation through price increases and cost reductions.

Seasonality

        During 2003, the Company entered into an agreement with a new institutional customer. Due to anticipated concentration of a portion of this customer's annual sales, the Company expects a spike in sales during the third quarter of each fiscal year the customer continues business with the Company. During the third quarter of 2003, the Company incurred $4.6 million of costs for supplies to this customer. The Company has not recognized revenue on the shipment of supplies as a result of not meeting all of the criteria required by SAB 104. As of December 31, 2003, the $4.6 million of costs relating to the supplies shipped to the new customer were included in inventory on the Company's balance sheet. Due to meeting all of the criteria of SAB 104 during the first quarter of 2004, the Company will recognize the revenue related to the $4.6 million of costs deferred as of December 31, 2003. The Company anticipates that it will recognize revenue on two seasonal buys during 2004 due to the recognition of the revenue associated with the aforementioned deferred costs in fiscal 2004. The Company does not expect to recognize revenue associated with two seasonal buys in fiscal 2005.

Recently Issued Accounting Standards

        In December 2003 the SEC issued Staff Accounting Bulletin No. 104 "Revenue Recognition" ("SAB No. 104") effective December 17, 2003. SAB 104 updates portions of the interpretive guidance included in Topic 13 of the codification of SABs to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations related to revenue recognition. We believe our revenue recognition policies are in compliance with SAB 104.

        In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on issue No. 00-21, Accounting for Revenue Arrangements with Multiple Arrangements with Multiple Deliverables, on a model to be used to determine when a revenue arrangement with multiple deliverables should be

17

divided into separate units of accounting and, if separation is appropriate, how the arrangement consideration should be allocated to the identified accounting units. The EITF also reached a consensus that this guidance should be reflective for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003. To date, the Company has not experienced an impact from the adoption of this consensus; however, management will evaluate its impact on future arrangements as they occur.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

        The Company's exposure to market risk is generally limited to changes in interest rates related to funds available for investment, which are tied to variable market rates. The Company does not have any material exposure to market risk associated with activities in derivative financial instruments, other financial instruments and derivative commodity instruments. If market interest rates were to increase by 10% from rates as of December 31, 2003, the effect would not be material to the Company.

        The Company provides the In-Plant Store program in Mexico through two subsidiaries (collectively "Mexico"). Mexico's operations are conducted primarily in U.S. dollars, its functional currency, and therefore the Company is not exposed to any significant foreign currency fluctuations and has no foreign currency translation adjustments.

Item 8. Financial Statements and Supplementary Data

        Financial statements of the Company are listed on the accompanying Index to Financial Statements.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        Not Applicable.

Item 9A. Controls and Procedures

(a)

Evaluation of Disclosure Controls and Procedures

        The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the "Exchange Act") as of the end of the period covered by this report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company, including its consolidated subsidiaries, that is required to be included in reports filed or submitted under the Exchange Act.

(b)

Changes in Internal Control Over Financial Reporting

        There have not been any changes that have materially affected the Company's internal controls over financial reporting in connection with the evaluation required by paragraph (d) of Rule 13a-15 or 15d-15 that occurred during the last fiscal quarter.

18

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES

Index to Financial Statements

F-1

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
Strategic Distribution, Inc.:

        We have audited the accompanying consolidated balance sheets of Strategic Distribution, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2003. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Strategic Distribution, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        As discussed in Note 3 of the Notes to Consolidated Financial Statements, the Company has restated its consolidated balance sheet as of December 31, 2002 and the consolidated statements of stockholders' equity for the years ended December 31, 2002 and 2001.

        As discussed in Note 6 of the Notes to Consolidated Financial Statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

Philadelphia, Pennsylvania
March 29, 2004

F-2

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except share data)

See accompanying notes to consolidated financial statements.

F-3

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(in thousands, except share data)

See accompanying notes to consolidated financial statements.

F-4

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

(in thousands, except share data)

See accompanying notes to consolidated financial statements.

F-5

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes to consolidated financial statements.

F-6

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Description of Business

        Strategic Distribution, Inc. and subsidiaries (the "Company") provides proprietary maintenance, repair and operating ("MRO") supply procurement, handling and data management solutions to industrial and institutional customers, primarily through its In-Plant Store® program. The Company became a provider of the In-Plant Store program in 1994 and conducts its U.S. operations primarily through a wholly-owned subsidiary, Industrial Systems Associates, Inc. ("ISA"). ISA changed its name to SDI, Inc. effective January 26, 2004.

        The Company provides the In-Plant Store program in Mexico through two subsidiaries (collectively "Mexico"). Mexico's operations are conducted primarily in U.S. dollars, its functional currency, and therefore the Company is not exposed to any significant foreign currency fluctuations and has no foreign currency translation adjustments.

        Effective May 17, 2001, the Company's shareholders approved a one-for-ten reverse split of its common stock (the "Reverse Split"). The shareholders also approved a decrease in the number of authorized shares of common stock from 50,000,000 shares to 20,000,000 shares. The effect of the Reverse Split has been retroactively reflected as of January 1, 2001 in the consolidated financial statements.

(2) Significant Accounting Policies

Principles of Consolidation

        The consolidated financial statements include the accounts of Strategic Distribution, Inc. and subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

        The preparation of the consolidated financial statements requires estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Significant estimates made by the Company include evaluation of the recoverability of assets, such as accounts receivable, inventories and income tax assets, and the assessment of litigation and other contingencies. The Company's ability to collect accounts receivable and recover the value of its inventories depends on a number of factors, including the financial condition of its customers, the effect of changes in economic conditions and the Company's ability to enforce provisions of its contracts in the event of disputes. The Company provides reserves or accrues liabilities in accordance with generally accepted accounting principles, to record assets at estimated net realizable values and to record probable contingent liabilities. The matters that give rise to such provisions are inherently uncertain and may require complex and subjective judgments.

        Although the Company believes the estimates and assumptions used in determining the recorded amounts of net assets and liabilities at December 31, 2003, are reasonable, actual results could differ materially from the estimated amounts recorded in the Company's financial statements.

Cash Equivalents and Short-Term Investments

        All highly liquid investments with a maturity of three months or less when purchased, are considered to be cash equivalents. As of December 31, 2003 and 2002, the Company had investments in cash equivalents and short-term investments of approximately $29,840,000 and $43,622,000, respectively. During the year ended December 31, 2003, the Company made a cash distribution, which is deemed to

F-7

be a return of capital for tax purposes, to stockholders totaling $14,765,000. (See Note 11, Stockholders' Equity).

        The Company accounts for investments in debt and equity securities under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities. Management determines the appropriate classification of debt securities at the time of purchase, and reevaluates such designation as of each balance sheet date. The Company has classified their investments as available-for-sale. Available-for-sale securities represent mortgage backed securities and are reported at fair value, with the unrealized gains and losses reported as a separate component of stockholders' equity. Realized gains and losses, declines in value judged to be other-than-temporary, and interest and dividends earned on available-for-sale securities are included in investment income. The contractual maturities of the Company's available-for-sale securities at December 31, 2003, are all less than one year. In 2003, the Company had unrealized losses of $25,000 on its available-for-sale securities.

Fair Value of Financial Instruments

        The carrying amounts of the Company's financial instruments, principally accounts receivable and accounts payable, approximate fair value.

Inventories

        Inventories, which consisted solely of goods purchased for resale, are stated at the lower of cost (determined on the first-in, first-out basis) or market.

        During 2003, the Company incurred $4,568,000 of costs for supplies shipped to a new customer. The Company did not recognize revenue on the shipment of supplies as a result of not meeting all of the criteria required by Staff Accounting Bulletin No. 104, Revenue Recognition ("SAB 104"). As of December 31, 2003, the $4,568,000 of costs relating to the supplies shipped to the new customer are included in inventory on the Company's balance sheet. The supplies shipped to this new customer were of a seasonal nature. The Company anticipates recognizing the revenue related to these costs plus gross margin during the first quarter of 2004.

Office Fixtures and Equipment

        Office fixtures and equipment are recorded at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the remaining life of the asset or the lease term. Maintenance and repairs are charged to expense. Major renewals and improvements are capitalized and depreciated over the remaining useful lives of the assets. Estimated useful lives of depreciable assets are as follows:

F-8

Impairment of Long-Lived Assets

        SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144") requires that long-lived assets, such as office fixtures and equipment and purchased intangibles subject to amortization, be tested for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. (See Note 8, Contract Terminations).

Deferred Income Taxes

        Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance may be established to reduce deferred tax assets to amounts deemed more likely than not to be realized.

Revenue Recognition

        Revenue is recognized when persuasive evidence of an arrangement exists, products are delivered or services are provided to customers, selling prices are fixed or determinable and collection is reasonably assured.

Stock-Based Compensation

        The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"), and related interpretations including Financial Accounting Standards Board ("FASB") Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation ("FIN 44"), to account for its stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123, as amended.

F-9

        The following table illustrates the effect on net loss of each period if the fair value based method of determining stock-based employee compensation under SFAS No. 123 had been applied to all outstanding awards. (See Note 13, Stock Compensation Plans).

Comprehensive Loss

        For the year ended December 31, 2003, the Company had unrealized losses of $25,000 on available-for-sale securities. Such losses are reflected as other comprehensive loss in stockholders' equity. Comprehensive loss was $749,000 for the year ended December 31, 2003. For the years ended December 31, 2002 and 2001, the comprehensive loss equaled the net loss reported.

Reclassifications

        Certain prior year amounts have been reclassified to conform to the current year presentation.

(3) Restatement and Changes in Estimates

        As part of the year end closing process, the Company determined that certain liabilities were overstated. The adjustments required to correct the liabilities caused a decrease of $827,000 in accumulated deficit effective December 31, 2000, for errors that arose in periods prior to 2001 related primarily to material supplies. As a result, the consolidated balance sheet as of December 31, 2002 and the consolidated statements of stockholders' equity for the years ended December 31, 2002 and 2001 were restated to reflect these changes. The consolidated statements of operations and cash flows for the years ended December 31, 2002 and 2001 were not affected by these restatements.

        In addition, the Company determined that certain other liabilities and reserves were overstated by approximately $1,374,000. The adjustments required to correct the liabilities and reserves were based on recent developments that led management to refine estimates related to certain liabilities and reserves. Of these adjustments, $930,000 was reflected as a reduction to cost of materials in 2003 due to overestimated liabilities to suppliers. The remaining adjustments of $444,000 were reflected as

F-10

reductions in Selling, General and Administrative Expenses and Other Operating Expenses in 2003. (See Note 16, Quarterly Data).

(4) Accounts Receivable

        Accounts receivable is stated net of an allowance for doubtful accounts of $2,588,000 and $3,750,000 at December 31, 2003 and 2002, respectively. For the years ended December 31, 2003, 2002 and 2001, charge-offs against the allowance were $2,235,000, $7,297,000 and $1,482,000, respectively. As of December 31, 2003 and 2002, accounts receivable included outstanding balances of approximately $700,000 and $3,000,000, respectively, with several terminated accounts with which the Company was involved in litigation.

(5) Office Fixtures and Equipment

        For the years ended December 31, 2003, 2002 and 2001, depreciation and amortization expense amounted to $1,730,000, $2,797,000 and $4,029,000.

        During the year ended December 31, 2002, the Company recorded a charge of $3,800,000 related to the write-down of certain fixed assets in accordance with the provisions of SFAS 144 (see Note 8, Contract Terminations).

(6) Intangible Assets

        SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142") requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. Under SFAS 142, goodwill impairment is deemed to exist if the net book value of the Company's goodwill exceeds its estimated fair value.

        During the year ended December 31, 2002, the Company adopted SFAS 142 and recorded a one-time, non-cash charge of $1,939,000 to write-off the carrying value of its goodwill as of January 1, 2002. The fair value used in determining the amount of impairment was estimated based on quoted market prices for the Company's common stock. This charge was non-recurring in nature and was reflected as "cumulative effect of accounting change" in the accompanying consolidated statements of operations. For the year ended December 31, 2001, amortization of intangible assets was $116,000 ($0.04 per share—basic and diluted).

F-11

(7) Accounts Payable and Accrued Expenses

(8) Contract Terminations

        In May 2003, the Company announced that it agreed to terminate the In-Plant Store services agreements with El Paso Corporation ("EPC"), its largest customer. The Company transitioned all storerooms to EPC during July 2003. The Company's EPC revenues for the years ended December 31, 2003, 2002 and 2001 were $16.0 million, $34.7 million and $36.5 million, respectively. There were no accounts receivable and inventory related to EPC at December 31, 2003.

        During 2001 and early 2002, the Company and its then largest customer, Kraft Foods North America, Inc. ("Kraft") discussed certain changes to the In-Plant Store services agreement that would have made the Kraft agreement profitable and reduced the Company's working capital commitment. As a result of the inability of the parties to reach a revised agreement, on March 27, 2002 the Company and Kraft agreed to terminate the relationship prior to the contract expiration of August 2003. During the second quarter of 2002, the Company sold its Kraft inventory to Kraft at normal selling prices. The value of the sale was $26.2 million and the related gross margin was $1.7 million. During the second and third quarters of 2002, the Company substantially completed the transition of all storerooms to Kraft and reduced its operating costs. The Company provided inventory procurement and management services to Kraft during the transition. The Company's Kraft revenues for the years ended December 31, 2002 and 2001 were $77.0 million ($50.8 million excluding the Kraft inventory sale) and $86.1 million. There were no accounts receivable and inventory related to Kraft at December 31, 2002.

        During the second quarter of 2002, the Company and Kraft finalized a transition plan, provided the affected workforce with information concerning employment opportunities with either the Company or Kraft and provided severance benefits to those employees whose positions were being eliminated in the workforce reduction. In connection therewith, the Company recorded severance expense of $700,000 during the second quarter of 2002, which was paid prior to December 31, 2002.

        During the second quarter of 2002, the Company recorded an impairment charge of $3,800,000 related to the write-down of certain fixed assets in accordance with the provisions of SFAS 144. The Company provides its MRO procurement, handling and data management services through the In-Plant Store® program utilizing the In-Site® operating system, the Company's proprietary information system. The Company's primary investment in long-lived assets is in the In-Site technology, including supporting equipment or systems such as personal computers and network communications. As a result of the termination of the Kraft services agreement, the Company evaluated, in accordance with SFAS 144, the recoverability of its computer technology over its expected useful life and determined that the value was impaired from the expected underutilization. The Company measured the fair value

F-12

of the long-lived assets in accordance with SFAS 144 and determined the amount of impairment to be $3,800,000, including $200,000 related to personal computers removed from use and sold or disposed. The Company used an expected present value method with multiple cash flow scenarios and a risk free interest rate as the basis for measuring the fair value of the assets.

(9) Retirement Plan

        The Company has a qualified defined contribution plan (the "Retirement Savings Plan") for employees who meet certain eligibility requirements. Contributions to the Retirement Savings Plan are at the discretion of the Board of Directors of the Company (the "Board") and are limited to the amount deductible for Federal income tax purposes. The expense for the Retirement Savings Plan was approximately $40,000, $260,000 and $400,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company's expense for 2003 was reduced by approximately $175,000 of forfeitures from unvested balances of participants.

(10) Income Taxes

        Income tax benefit (expense) from operations is as follows:

F-13

        A reconciliation of the expected Federal income tax benefit (expense) from operations at the statutory rate (34% in 2003, 2002 and 2001) to the Company's income tax expense follows: