Back to GetFilings.com

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

FORM 10-K

For the fiscal year ended December 31, 2004

or

For the transition period from                                

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, 2004, the last day of the Registrant's most recently completed fiscal second quarter, was approximately $40,000,000, 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 21, 2005, the Registrant had outstanding 2,959,674 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

        Certain portions of the Registrant's Definitive Proxy Statement for the 2005 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

PART I

Item 1.    Business

(a)    General Development of Business

        Strategic Distribution, Inc. (the "Company") is a Delaware corporation that was organized in 1968. In 1994, the Company acquired Industrial Systems Associates, Inc. ("ISA"). ISA changed its name to SDI, Inc. ("SDI") effective January 26, 2004. Through SDI and the Company's Mexican subsidiaries, the Company provides supply chain management services with respect to maintenance, repair and operating ("MRO") supplies for industrial and institutional customers in the United States and Mexico.

(b)    Financial Information About Industry Segments

        The Company operates in one reportable segment and substantially all of its revenues were from the provision of MRO supply chain management services and supplies for industrial and institutional customers. See Item 8, "Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements", Footnote No. 14.

(c)    Narrative Description of Business.

        The Company's programs permit organizations to outsource all aspects of their MRO supplies procurement; with most of its existing customer base 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. The Company also offers solutions that enable customers to efficiently manage MRO supplies procurement using Company tools and systems applications.

Service Offerings

        The Company provides proprietary MRO supply chain management services through programs tailored to meet customer needs. 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 programs substantially mitigate these inefficiencies by reducing both the process and product costs associated with MRO supply management. The Company's programs also help 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 programs are superior to both traditional and alternative methods of MRO supply distribution in that the Company's programs allow customers to outsource MRO supply distribution and handling activities and concentrate on their core businesses.

        Another benefit of the Company's services is the identification and reduction of redundant and inactive inventory in the customer's legacy inventory of MRO supplies. The Company uses its software to systematically describe all MRO parts. Redundancies are identified and the Company is able to consolidate and reduce inventories and standardize costs, 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.

2

        The Company operates a proprietary Information Technology platform, In-Site®, which includes a flexible Enterprise Reporting Package ("ERP") system for budgetary controls, sophisticated inventory management, spend analysis, mobile work order management and consolidated transaction processing.

        Traditionally, the Company has provided MRO supply chain management services through its In-Plant® Store program. This 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 thousands of MRO supplies from hundreds of traditional industrial distributors. The Company's In-Plant Store program allows the customer to procure its MRO supplies through one vendor. Through the In-Plant Store program, the Company 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.

        In addition to its full service offering, the Company has created a technology based solution for small sites (sites with an MRO spend under $2 million) that incorporates the Company's sophisticated In-Site® Online inventory management tool with a Company hosted ERP tool. In-Site Online is designed for small sites where it is not economically practical to deliver a solution at the client's site. This solution enables customers to access the Company's database directly from the customer's desktop via Internet access. In-Site Online provides item search and requisitioning capabilities in an e-business environment.

        In marketing to prospective customers, the Company has modified its offering to place more emphasis upon the value added supply chain management services it provides and a decreased emphasis upon MRO supply sales. In this connection, the Company has enhanced its service offering by adding additional system capabilities and providing more flexible solutions, including In-Site Online designed for smaller sites where a comprehensive In-Plant Store is not economically justified. The Company's marketing efforts are focused on driving future business to a fee for services model. In addition, traditionally the Company carried inventory on behalf of its customers without adequate compensation. The Company is endeavoring to limit its obligations to carry inventory with new customers. The Company believes these changes in its offering combined with intensifying MRO supply pricing pressure have been primarily responsible for lengthening its sales cycle and limiting its success in securing new customers. The Company believes that its modified offerings will gain market acceptance as customers come to understand the Company's value proposition, but there is no guarantee concerning whether or when such market acceptance will occur.

        The Company believes that increased recognition of the inefficiencies associated with the traditional MRO supply distribution process has increased the demand for MRO supply chain management solutions such as those offered by the Company.

Customers

        During the year ended December 31, 2004, two customers comprised approximately 32.3% of the Company's revenues. Revenues from Coors Brewing Company and the New York City Department of Education comprised 16.6% and 15.7% of the Company's revenue for the year ended December 31, 2004, respectively. Loss of either of these customers would have a material adverse effect on the business.

3

        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 customers in the United States and Mexico. During the year ended December 31, 2004 and 2003, 19.2% and 19.4% of the Company's revenues were from customers in Mexico. The Company's operations in Mexico face unique risks, including foreign trade restrictions, changes in U.S. and Mexican governmental regulations, currency fluctuations, tariffs and other trade barriers, the potential for nationalization of enterprises, and political, economic and social instability.

        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 at the time. The Company transitioned all storerooms to EPC during July 2003. The Company's revenues from EPC for fiscal 2003 and 2002 were $16.0 million and $34.7 million, respectively. There were no accounts receivable or inventory related to the EPC services agreements at December 31, 2003.

        During 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 year ended December 31, 2002 were $77.0 million ($50.8 million excluding the Kraft inventory sale).

        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.

Products

        The Company 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 2004.

4

Suppliers

        The Company purchases products from manufacturers and distributors. The Company has 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 agreement or supply arrangement were canceled, the Company does not believe that the loss of any one supply agreement or distribution contract, or any small group of supply agreements or 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, but the Company also competes with MRO supply distributors that are larger and have significantly greater financial resources than the Company. 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. Some of the integrated supply providers with which the Company competes are also wholesale distributors that have access to more favorable MRO supply pricing than that available to the Company. Some of the Company's competitors sell identical MRO supplies for lower prices than those offered by 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 reasonably price-competitive, to deliver value-added supply chain management solutions to its customers 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 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, 2004, the Company had 365 employees, of whom 123 were employed in selling and administrative capacities and 242 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.

5

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 Bristol, Pennsylvania, a few small warehouses and offices located at or near In-Plant Store sites and an office for the Mexican operations located in El Paso, Texas. 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.

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 21, 2005, 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:

        The Company paid a cash distribution, which was 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 years ended December 31, 2004 and 2002. The Company has not made any decisions to declare any cash dividends in the foreseeable future. At the time of distribution in 2003, only shareholders who

6

converted shares during the 2001 reverse split received a distribution. During 2004, the Company paid out $51,000 relating to the fourth quarter 2003 distribution. As of December 31, 2004, $84,000 of the 2003 distribution remained unpaid and is recorded as a liability on the consolidated balance sheet. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources".

Item 6.    Selected Financial Data

(a)

Operating results include approximately $5,700,000 of revenue related to supplies shipped in 2003. This revenue was not recognized until all of the criteria of Staff Accounting Bulletin No. 104, Revenue Recognition ("SAB 104"), were met during the first quarter of 2004.

(b)

Operating results include a favorable resolution of a dispute of $400,000 and a favorable recovery of previously reserved receivables of $300,000.

(c)

A $1.1 million income tax benefit relating to the favorable resolution of a state tax issue was recorded.

(d)

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.

(e)

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 the termination of the Kraft contract and inventory sale to Kraft.

(f)

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.

(g)

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

(h)

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.

(i)

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

7

        Certain statements in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, 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, concentration of customers and ability to retain new customers, the Company's ability to enforce provisions of its contracts, termination of contracts, competition in the Company's business, the Company's dependence on key personnel and other risks described in this Form 10-K, and other filings made by the Company with the Securities and Exchange Commission ("SEC"). In the event of economic downturn, the Company could experience customer bankruptcies, reduced volume of business from its existing customers and lost volume due to plant shutdowns, or consolidations by the Company's customers.

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 supply chain management services with respect to maintenance, repair and operating ("MRO") supplies for industrial and institutional customers in the United States and Mexico. The Company conducts it U.S. operations primarily through its wholly-owned subsidiary, SDI, Inc. ("SDI").

        As a result of the termination of service agreements with customers during 2004 and 2003 and the slowdown of the introduction of new sites, the Company's revenues for the year ended December 31, 2004 were below those reported for the year ended December 31, 2003. The termination of contracts with customers throughout fiscal 2003 (10 customers) and 2004 (6 customers) was the primary cause of the revenue reduction. In marketing to prospective customers, the Company has modified its offering to place more emphasis upon the value added supply chain management services it provides and a decreased emphasis upon MRO supply sales. In this connection, the Company has enhanced its service offering by adding additional system capabilities and providing more flexible solutions, including In-Site Online designed for smaller sites where a comprehensive In-Plant Store is not economically justified. The Company's marketing efforts are focused on driving future business to a fee for services model. In addition, traditionally the Company carried inventory on behalf of its customers without adequate compensation. The Company is endeavoring to limit its obligations to carry inventory with new customers. The Company believes these changes in its offering combined with intensifying MRO supply pricing pressure have been primarily responsible for lengthening its sales cycle and limiting its success in securing new customers. The Company believes that its modified offerings will gain market acceptance as customers come to understand the Company's value proposition, but there is no guarantee concerning whether or when such market acceptance will occur.

        Revenue changes 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 dependent 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 the determination by the Company that certain costs are necessary to maintain and improve the Company's technology and service offerings.

8

Critical Accounting Policies

        The 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 and 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 accrued 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 an 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. 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, 2004 are reasonable, actual results could differ materially from estimated amounts recorded in the Company's consolidated financial statements.

Contract Terminations

        During 2004, the Company terminated contracts with 6 smaller customers, none of which ever totaled more than 10% of the Company's revenue in any given reporting period.

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

9

        During 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. The Company's Kraft revenues for the year ended December 31, 2002 were $77.0 million ($50.8 million excluding the Kraft inventory sale). There were no accounts receivable or inventory related to the Kraft services agreement at December 31, 2002.

        In connection with the termination of the Kraft agreement, the Company 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 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.

        As a result of the termination of the Kraft relationship, the Company evaluated the recoverability of its computer technology and determined that the carrying value was impaired from the expected underutilization. As a result, the Company recorded an impairment charge of $3.8 million 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").

Results of Operations

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

10

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Revenues

        Revenues for the year ended December 31, 2004 decreased $12.7 million, or 9.4%, to $121.9 million from $134.6 million for the year ended December 31, 2003. The termination of contracts with customers throughout fiscal 2003 and 2004 was the primary cause for the revenue reduction. The closing of EPC accounted for $16.0 million of the overall decrease. Other site closings and a reduction in revenue from our existing business resulted in an additional decrease of $16.5 million (including a $2.5 million inventory sale to a former customer) and a $0.8 million (including a $1.0 million inventory sale to a current customer during 2003). This decrease of $33.3 million was offset by revenues from new customers of $20.6 million. A portion of the revenues from new customers during 2004, $5.7 million, relates to supplies shipped during the third quarter of 2003 and other service fee revenue. This revenue was not recognized until all of the criteria of Staff Accounting Bulletin No. 104, Revenue Recognition ("SAB 104"), were met during the first quarter of 2004. As a result, the Company recognized revenue on two seasonal buys from the new customer during the year ended December 31, 2004. The Company categorizes "new" customers as those that generated revenue in the current period with no revenue during the comparable period of the prior year.

        Coors Brewing Company comprised 16.6% and 14.1% of the 2004 and 2003 revenue, respectively. Revenues from the New York City Department of Education comprised 15.7% of the Company's revenue for the year ended December 31, 2004. EPC, which terminated its contract with the Company during the third quarter of 2003, comprised 11.9% of the Company's revenue for the year ended December 31, 2003.

Cost of Materials / Gross Margin

        Cost of materials as a percentage of revenue increased 2.7% to 80.4% for the year ended December 31, 2004 from 77.7% in 2003. The increase in the cost of materials as a percentage of revenue was primarily attributable to a lower portion of management service fees (1.1%) in the revenue mix for the year ended December 31, 2004 as compared to the year ended December 31, 2003, lower gross margins from the Company's new business in 2004 (1.1%), and a reduction in the consolidated costs of goods sold during the fourth quarter of 2003 as a result of decreases in previously estimated liabilities for product purchases (0.7%), partially offset by the 2004 implementation revenue earned at one of the new customers which had no direct product costs. The new customers generated lower gross margins than the Company has historically reported, but they also, on average, report lower site operating expenses as a percentage of revenue compared to our continuing business.

11

Other

        NM — not meaningful

        Operating wages and benefits expense as a percentage of revenues decreased to 7.2% for the year ended December 31, 2004 from 8.6% in 2003. The reduction in operating wages and benefits expenses as a percentage of revenues was primarily attributable to the termination of the EPC services agreement. Operating wages and benefits expenses stated as a percentage of revenues were higher under the EPC services agreement than in our standard service agreements. Continued declines in business volume from existing customers may result in lower productivity and may negatively impact the Company's ability to maintain staff at optimal levels.

        Other operating expenses as a percentage of revenues increased 0.2% to 2.9% for the year ended December 31, 2004 from 2.7% in 2003. The increase in percentage is primarily related to the impact of certain fixed costs, such as depreciation of the Company's ERP system, on a declining revenue base. The Company's other operating expenses were reduced by $0.1 million for the year ended December 31, 2004 substantially as a result of contract terminations.

        Selling, general and administrative expenses as a percentage of revenues increased to 12.8% for the year ended December 31, 2004 from 11.6% in 2003. The increase in the selling, general and administrative costs as a percentage of revenue is primarily attributable to non-operational employee wages and benefits and other fixed costs as a percentage of the 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 each of the years ended December 31, 2004 and 2003, the Company recorded benefits of $0.7 million. The $0.7 million benefits for the year ended December 31, 2004 related to the favorable resolution of a dispute with a vendor of $0.4 million and a favorable recovery of previously reserved receivables of $0.3 million. The $0.7 million benefit for the year ended December 31, 2003 related to a legal settlement for more than anticipated. 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. Overall, SG&A expense in 2004 remained relatively consistent with 2003, decreasing $0.1 million.

        Interest income was $338,000 for the year ended December 31, 2004 compared to interest income of $496,000 for the comparable period in 2003. During 2004, the average monthly cash balance was approximately $12.4 million lower than the comparable period of 2003. The reduction of interest income was primarily attributable to the lower average cash balance. The decrease in the average cash balance during the period is primarily attributable to the $5.00 per common share cash distribution paid to the Company's shareholders in the fourth quarter of 2003, amounting to approximately

12

$14.8 million, and the timing difference between the cash outlay and receivable collections from the Company's seasonal business during the fourth quarter of 2004. During the year ended December 31, 2004 the Company sold short-term investments for approximately $5.1 million, and realized a $30,000 loss on an investment that was previously recorded in other comprehensive loss.

        Income tax expense of $23,000 was recorded on income earned from the Company's Mexican operations during the year ended December 31, 2004. During the fourth quarter of 2004, the Company recognized a benefit and received cash in the amount of approximately $1.1 million relating to the favorable resolution of a state tax issue. There was no tax benefit recorded for pretax losses of the Company's U.S. operations for the year ended December 31, 2004. 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.

        Net loss for the year ended December 31, 2004 was $2,621,000 compared to net loss of $724,000 in 2003, as a result of the operating results previously discussed.

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 was the primary cause for the revenue reduction. The termination 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 from 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.

        As a result of the termination of the In-Plant Store services agreements 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. The Company reduced its operating costs as a result of the revenue decline.

        Coors Brewing Company, comprised 14.1% of the 2003 revenue and less than 10% in fiscal 2002. EPC, which terminated its services agreement 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.

13

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 a result of decreases in previously estimated liabilities for product purchases.

Other

        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.

        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

14

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.

        During the year ended December 31, 2002, the Company recorded charges of $4.5 million, or 1.8% of revenues, in connection with the termination of the Kraft services agreement. The charges include $0.7 million of severance expense and $3.8 million 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, primarily due to the $5.00 per share cash distribution of $14.6 million in the fourth quarter of 2003.

        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 were not 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.

Liquidity and Capital Resources

        As of December 31, 2004, the Company had $26.8 million of cash and cash equivalents. The Company believes that cash on hand, cash generated from future operations 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 used in operating activities was $1.5 million for the year ended December 31, 2004 compared to net cash provided by operations of $1.8 million in 2003. The decrease in net cash from operating activities was primarily due to the weaker operational performance during the twelve months ended December 31, 2004 as well as an increase in accounts receivable of approximately $7.6 million,

15

offset by a decrease in inventories of approximately $6.1 million. During the fourth quarter of 2004, the Company resolved a state income tax issue and recognized a benefit of approximately $1.1 million.

        As of December 31, 2004 and December 31, 2003, accounts receivable, net on the consolidated balance sheet included outstanding balances of approximately $0.5 million and $0.7 million, respectively, for 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 provided by investing activities was $3.5 million for the year ended December 31, 2004 compared to net cash used of $5.3 million in 2003. During the year ended December 31, 2004 the Company sold short-term investments for approximately $5.0 million and realized a $30,000 loss on an investment that was previously recorded in other comprehensive loss. These short-term investments were purchased during 2003 for $5.1 million. The difference between the approximately $5.1 million realized on the sale of short-term investments and the $3.6 million net cash provided by investing activities consisted of approximately $1.5 of capital expenditures for computer systems and related equipment.

        Net cash used in financing activities was $11,000 for the year ended December 31, 2004 compared to $15.2 million in 2003. During the fourth quarter of 2003, the Company declared and paid a cash distribution, which was 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 $0.7 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, 2004, the Company issued 6,573 shares of common stock upon exercise of stock options.

        During the year ended 2004, the Company entered into a new lease for its corporate headquarters. Under this five year lease agreement, the Company's annual rent obligations are as follows: 2005—$316,000, 2006—$325,000, 2007—$334,000, 2008—$343,000 and 2009—$307,000. The minimum future rental payments for all operating leases with initial noncancellable lease terms in excess of one year as of December 31, 2004 are as follows: 2005—$410,000, 2006—$383,000, 2007—$344,000, 2008—$343,000 and 2009—$307,000.

        The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to the Company's 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 did not recognize 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

16

balance sheet. Due to meeting all of the criteria of SAB 104 during the first quarter of 2004, the Company recognized the revenue related to the $4.6 million of costs deferred as of December 31, 2003. The Company recognized 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 2004, the Financial Accounting Standards Board ("FASB") issued a revised Statement of Financial Accounting Standards No. 123 ("SFAS 123"), Share Based Payment. The revised SFAS No. 123 requires that the fair value of stock options be recorded in the results of operations beginning no later than July 1, 2005. Stock compensation expense under the prior rules would have reduced reported diluted earnings per share by 2 cents in 2004. Upon adoption of the revised standard, prior awards are charged to expense under the previous rules, and awards after adoption are charged to expense under the revised rules. The Company has not determined the impact of the adoption of the new standard; however the Company does not anticipate expense under the new standard to be higher than previously reported.

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, 2004, 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 or are reasonably likely to materially affect 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 Company's fourth fiscal quarter of 2004.

17

STRATEGIC DISTRIBUTION, INC. AND SUBSIDIARIES
Index to Financial Statements

F-1

Report of Independent Registered Public Accounting Firm

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

        We have audited the consolidated balance sheets of Strategic Distribution, Inc. and subsidiaries as of December 31, 2004 and 2003, 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, 2004. In connection with our audits of the consolidated financial statements, we also have audited the 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. 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 5 to the consolidated financial statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

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 supply chain management services with respect to maintenance, repair and operating ("MRO") supplies for industrial and institutional customers in the United States and Mexico. The Company conducts it U.S operations primarily through its wholly-owned subsidiary, SDI, Inc. ("SDI").

        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.

(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 in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. 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 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, 2004, are reasonable, actual results could differ from the estimated amounts recorded in the Company's financial statements.

        During 2003, the Company determined that certain other liabilities and reserves as of December 31, 2003, were overstated by approximately $1,374,000. The adjustments required to correct the liabilities and reserves were based on recent developments that lead 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 overstated liabilities to suppliers. The remaining adjustments of $444,000 were reflected as reductions in Selling, General and Administrative Expenses and Other Operating Expenses in 2003.

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, 2004 and 2003, the Company had investments in cash, cash equivalents and short-term investments of approximately $26,840,000 and $29,840,000, respectively. During the year ended December 31, 2003, the Company made a cash distribution, which

F-7

was deemed to be a return of capital for tax purposes, to stockholders totaling $14,765,000. (See Note 10, Stockholders' Equity). The Company's investment policy limits investments to highly rated and highly liquid instruments of U.S. Banks, the U.S. government or government agencies, and commercial money market funds.

        The Company accounted 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 classified their investments as available-for-sale. Available-for-sale securities 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, were all less than one year. In 2003, the Company had unrealized losses of $25,000 on its available-for-sale securities, which was realized at the time of sale during the second quarter of 2004.

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 consist 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 these 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 were included in inventory on the Company's consolidated balance sheet. The supplies shipped to this new customer were of a seasonal nature. The Company recognized 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 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 undiscounted 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 7, 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 exceeds the exercise price. As allowed by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, the amendment to SFAS No. 123, Accounting for Stock-Based Compensation, the Company has elected to continue to apply the intrinsic value-based method of accounting as described above, and have adopted only the disclosure requirements of SFAS No. 123.

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 12, 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 were 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, 2004 and 2002, the comprehensive loss equaled the net loss reported.

Reclassifications

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

(3)    Accounts Receivable

        Accounts receivable is stated net of an allowance for doubtful accounts of $1,905,000 and $2,588,000 at December 31, 2004 and 2003, respectively. As of December 31, 2004 and 2003, accounts receivable included outstanding balances' of approximately $500,000 and $700,000, respectively, related to terminated accounts with which the Company was involved in litigation.

F-10

(4)    Office Fixtures and Equipment

        For the years ended December 31, 2004, 2003 and 2002, depreciation and amortization expense were $1,578,000, $1,730,000 and $2,797,000, respectively.

        During the year ended December 31, 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 (see Note 7, Contract Terminations).

(5)    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 carrying 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.

(6)    Accounts Payable and Accrued Expenses

F-11

(7)    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 then largest customer. The Company transitioned all storerooms to EPC during July 2003. The Company's EPC revenues for the years ended December 31, 2003 and 2002 were $16.0 million and $34.7 million, respectively. There were no accounts receivable and inventory related to EPC at December 31, 2003.

        During 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 year ended December 31, 2002 were $77.0 million ($50.8 million excluding the Kraft inventory sale). There were no accounts receivable and inventory related to Kraft at December 31, 2002.

        In connection with the termination of the Kraft agreement, the Company and Kraft 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 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.

        As a result of the termination of the Kraft relationship, the Company evaluated the recoverability of its computer technology and determined that the carrying value was impaired from the expected underutilization. As a result, the Company recorded an impairment charge of $3.8 million in accordance with the provisions of SFAS 144. 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.

(8)    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 $170,000, $40,000 and $260,000 and for the years ended December 31, 2004, 2003 and 2002, respectively. The Company's expense for 2003 was reduced by approximately $175,000 of forfeitures from unvested balances of participants.

F-12

(9)    Income Taxes

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

        The Company received $1,081 during the fourth quarter of 2004 as a result of the favorable resolution of a state tax issue.

        A reconciliation of the expected Federal income tax benefit (expense) from operations at the statutory rate (34% in 2004, 2003 and 2002) to the Company's income tax expense follows:

F-13

        The components of the net deferred tax asset were as follows: