PFSWEB INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly
Period Ended June 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _______ to _______

Commission File Number 000-28275

PFSWEB, INC.
------------
(Exact name of registrant as specified in its charter)

DELAWARE 75-2837058
- ------------------------------- ----------------------------------
(State of Incorporation) (I.R.S. Employer I.D. No.)

500 NORTH CENTRAL EXPRESSWAY, PLANO, TEXAS 75074
- -------------------------------------------- -------------------------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (972) 881-2900
---------------------------

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 X No
---- ----

At August 7, 2002 there were 18,268,154 shares of registrant's common stock
outstanding, excluding 86,300 shares of common stock in treasury.

PFSWEB, INC. AND SUBSIDIARIES
FORM 10-Q

JUNE 30, 2002

INDEX

2

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

PFSWEB, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE DATA)

The accompanying notes are an integral part of these unaudited interim
condensed consolidated financial statements.

3

PFSWEB, INC. AND SUBSIDIARIES

UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these unaudited interim
condensed consolidated financial statements.

4

PFSWEB, INC. AND SUBSIDIARIES

UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

Theaccompanying notes are an integral part of these unaudited interim
condensed consolidated financial statements.

5

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. OVERVIEW AND BASIS OF PRESENTATION

PFSweb, Inc. (the "Company" or "PFSweb") is an international provider
of integrated business process outsourcing services to major brand name
companies seeking to maximize their supply chain efficiencies and to extend
their traditional and e-commerce initiatives in the United States, Canada, and
Europe. The Company offers such services as professional consulting, technology
collaboration, managed hosting and creative web development, order management,
web-enabled customer contact centers, customer relationship management,
financial services including billing and collection services, information
management, option kitting and assembly services, and international fulfillment
and distribution services.

The unaudited interim condensed consolidated financial statements as of
June 30, 2002, and for the three and six months ended June 30, 2002 and 2001,
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and are unaudited. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to the rules and regulations promulgated
by the SEC. In the opinion of management and subject to the foregoing, the
unaudited interim condensed consolidated financial statements of the Company
include all adjustments, consisting of only normal recurring adjustments,
necessary for a fair presentation of the Company's financial position as of June
30, 2002, its results of operations for the three and six months ended June 30,
2002 and 2001 and its results of cash flows for the six months ended June 30,
2002 and 2001. Results of the Company's operations for interim periods may not
be indicative of results for the full fiscal year.

Certain prior period data has been reclassified to conform to the
current period presentation. These reclassifications had no effect on previously
reported net income or shareholders' equity. Included in selling, general and
administrative expenses in the three and six months ended June 30, 2002, are
approximately $0.8 and $1.5 million, respectively, of technology infrastructure
costs that were incurred in both periods but that were recorded as a component
of cost of net service fee revenue in the three and six months ended June 30,
2001. These technology costs were principally dedicated to the activities that
generated service fee revenue under the transaction management services contract
with Daisytek International Corporation ("Daisytek"), the Company's former
parent corporation, which was terminated in November 2001 (see Note 6).

2. SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

All intercompany accounts and transactions have been eliminated in
consolidation.

INVESTMENT IN AFFILIATE

In 2001 the Company paid $750,000 in cash for a 49% ownership interest
in Business Supplies Distributors Holdings, LLC, ("Holdings") (see Note 8). The
Company records its interest in Holdings' net income, which is allocated and
distributed to the owners pursuant to the terms of Holdings' operating
agreement, under the modified equity method, which results in the Company
recording its allocated earnings of Holdings or 100% of Holdings' losses and the
Company's proportionate share of Holdings' cumulative foreign currency
translation adjustments.

In addition to the equity investment, at June 30, 2002 the Company has
an $8.8 million outstanding loan to Supplies Distributors, a subsidiary of
Holdings, in the form of a Subordinated Demand Note (the "Note"). The Note can
be decreased to $6.5 million subject to Holdings' compliance with the covenants
of its senior loan facilities, as amended. Management believes that the Note,
which is due on demand, will not be repaid in its entirety within the upcoming
year and has therefore classified the entire balance as long-term.

6

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company evaluates each period whether the carrying value of the
Note from Supplies Distributors is impaired and whether it will be required to
perform under its primary guarantee obligation associated with the Supplies
Distributors debt obligations ($57.4 million at June 30, 2002) (See Note 8). As
of June 30, 2002, management believes the carrying value of the Note is
recoverable and that no liability should be recorded in the consolidated
financial statements of PFSweb associated with its guarantee obligation.

REVENUE AND COST RECOGNITION

The Company's service fee revenues primarily relate to its (1)
distribution services, (2) order management/customer care services and (3) the
reimbursement of out-of-pocket and third-party vendor expenses.

Distribution services relate primarily to inventory management, product
receiving, warehousing and fulfillment (i.e., picking, packing and shipping).
Revenue for these activities are either (i) earned on a per transaction basis or
(ii) earned at the time of product fulfillment which occurs at the completion of
the distribution services.

Order management/customer care services relate primarily to taking
customer orders for our client's products via various channels such as telephone
call-center, electronic or facsimile. These services also entail addressing
customer questions related to orders, as well as cross-selling/up-selling
activities. Revenue is recognized as the services are rendered. Fees charged to
the client are on a per transaction basis based on either (i) a pre-determined
fee per order or fee per telephone minutes incurred, or (ii) are included in the
product fulfillment service fees which are recognized on product shipment. The
Company's cost of service fee revenue, representing the cost to provide the
services described above, is recognized as incurred. Cost of service fee revenue
also includes certain costs associated with technology collaboration and ongoing
technology support which consist of creative website development and
maintenance, web hosting, technology interfacing, and other ongoing programming
activities. These activities are primarily performed to support the distribution
and order management/customer care services and are recognized as incurred.

The Company also performs billing services and information management
services for its clients. Billing services and information management services
are typically not billed separately to clients because the activities are
continually performed, and the costs are insignificant and are generally covered
by other fees described above. Therefore, any revenue attributable to these
services is often included in the distribution or order management fees which
are recognized as services are performed. The service fee revenue associated
with these activities is currently not significant and is incidental to the
above-mentioned services.

The Company's billings for reimbursement of out-of-pocket expenses,
such as travel, and certain third-party vendor expenses such as shipping and
handling costs and telecommunication charges are included in gross service fee
revenue. The related reimbursable costs are reflected as pass-through charges
and reduce total gross service fee revenue in computing net service fee revenue.

The Company recognizes revenue, and records trade accounts receivables,
pursuant to the methods described above when collectibility is reasonably
assured. Collectibility is evaluated on an individual customer basis taking into
consideration historical payment trends, current financial position, results of
independent credit evaluations and payment terms.

Other revenue of $0.1 million and $0.5 million for the three and six
months ended June 30, 2001, respectively, represents the fees charged to clients
in conjunction with early contract terminations. Cost of other revenue for the
three and six months ended June 30, 2001 includes approximately $0.1 million of
certain uncollectible amounts receivable from, and liabilities applicable to,
clients who terminated contracts.

The Company primarily performs its services under two to three year
contracts that can be terminated by either party. In conjunction with these
long-term contracts the Company generally receives start-up fees to

7

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

cover its implementation costs, including certain technology infrastructure and
development costs. The Company defers the fees received, and the related costs,
and amortizes them over the life of the contract. The amortization of deferred
revenue is included as a component of service fee revenue. The amortization of
deferred implementation costs is included as a cost of service fee revenue. To
the extent implementation costs exceed the fees received, excess costs are
expensed as incurred.

The following summarizes the deferred implementation costs and revenues
(in thousands):

Current and non-current deferred implementation costs are a component
of prepaid expenses and other assets, respectively. Current and non-current
deferred implementation revenues are a component of accrued expenses and
deferred income, respectively.

CONCENTRATION OF BUSINESS AND CREDIT RISK

The Company had three clients that each exceeded 10% of the Company's
net service fee revenues for the six months ended June 30, 2002. In total, these
clients represented approximately 63% of the Company's net service fee revenue,
with the Company's largest client representing 33% of net revenues, and Supplies
Distributors and its affiliates (see Note 8) representing 16% of net revenues.
Service fee revenue from Daisytek accounted for approximately 62% of the
Company's total revenues for the six months ended June 30, 2001, of which 20%
was from the Daisytek subsidiaries that were the predecessors to Supplies
Distributors. As of June 30, 2002, the Company's largest client accounted for
approximately 40% of accounts receivable. As of December 31, 2001, two clients
accounted for approximately 36% of accounts receivable, of which 12% was due
from Supplies Distributors and its affiliates.

As of June 30, 2002 and December 31, 2001, the Company had a note
receivable of $8.8 million and $11.7 million, respectively, outstanding from
Supplies Distributors.

RESTRICTED CASH

In conjunction with certain long-term debt and leases, as of June 30,
2002 and December 31, 2001, the Company had $2.9 million and $2.7 million of
cash restricted, respectively, as collateral for letters of credit that secure
these debt and lease obligations. The letters of credit expire at various dates
through July, 2004.

PROPERTY AND EQUIPMENT

The Company's property held under capital leases amounted to
approximately $5.3 million and $5.5 million, net of accumulated amortization of
approximately $3.4 million and $2.4 million at June 30, 2002 and December 31,
2001, respectively.

3. RECENTLY ISSUED ACCOUNTING PRINCIPLES

On January 1, 2002, the Company adopted the provisions of EITF D-103
"Income Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred." The Company's billings for out-of-pocket expenses, such as travel,
and certain third-party vendor expenses such as shipping and handling costs and
telecommunication charges are included in gross service fee revenue. The related
reimbursable costs are reflected as pass-through charges and reduce total gross
service fee revenue in computing net service fee revenues.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The Company is currently assessing the impact
on the

8

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

consolidated financial statements and will adopt the provisions of this standard
in the first quarter of 2003.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses the financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The Company is
currently assessing the impact on the consolidated financial statements and will
adopt the provisions of this standard by the first quarter of 2003.

4. COMPREHENSIVE INCOME (LOSS) (IN THOUSANDS)

Effective April 1, 2001, in response to a change to the Euro for
transaction activity previously conducted in the U.S. dollar by the Company's
largest European client, the Company adopted the Euro as its functional currency
for its European operations. As a result, beginning April 1, 2001, all assets
and liabilities are translated at exchange rates in effect at the end of the
period, and income and expense items are translated at the average exchange
rates for the period. Translation adjustments are reported as a separate
component of shareholders' equity. Gains and losses from foreign currency
transactions are included in net income (loss).

5. NET INCOME (LOSS) PER COMMON SHARE AND COMMON SHARE EQUIVALENT

Basic and diluted net loss per common share attributable to PFSweb
common stock were determined based on dividing the income or loss available to
common stockholders by the weighted-average number of common shares outstanding.
During the three and six months ended June 30, 2002 and 2001, all outstanding
options to purchase common shares were anti-dilutive and have been excluded from
the weighted diluted average share computation. As of June 30, 2002 and 2001
there were 6,007,797 and 1,934,983 options outstanding, respectively. There are
no other potentially dilutive securities outstanding.

6. TRANSACTIONS WITH DAISYTEK

As of June 30, 2002, the Company had no receivables from Daisytek. As
of December 31, 2001 the Company had receivables from Daisytek of approximately
$0.1 million.

In conjunction with the successful completion of an initial public
offering of PFSweb common stock, PFSweb entered into agreements with Daisytek,
including a tax sharing agreement, a transaction management services agreement,
a transition services agreement and a master separation agreement. In addition,
on a going forward basis, Daisytek continues to be an obligor and guarantor for
certain of the Company's facility and equipment leases.

On May 25, 2001, the Company completed the sale of certain assets to
Daisytek pursuant to an Asset Purchase Agreement (the "Purchase Agreement") (See
Note 7). The Purchase Agreement included a termination by the Company and
Daisytek of certain transaction management services agreements previously
entered into between the Company and Daisytek and a Daisytek subsidiary.
Concurrently with the closing of the asset sale, the Company and Daisytek also
entered into a six-month transition services agreement under which the Company
provided Daisytek with certain transitional and information

9

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

technology services that expired in November 2001.

For the three and six months ended June 30, 2001, the unaudited interim
condensed consolidated financial statements include service fee revenues and
cost of service fee revenues for certain services subcontracted to PFSweb by
Daisytek under Daisytek's contractual agreements.

Net service fee revenue charged to Daisytek under (i) the IBM Master
Distributor Agreements (See Note 8), entered into during the quarter ended
September 30, 1999, (ii) the transaction management services agreement with
Daisytek, and (iii) certain subcontracted services, were $5.7 million, net of
$0.1 million of pass-through charges, and $13.1 million, net of $0.1 million of
pass-through charges, for the three and six months ended June 30, 2001,
respectively.

Effective November 2001, the Company is no longer a party to any
agreement to provide services for Daisytek.

7. DISPOSITION OF ASSETS

On May 25, 2001, the Company completed the sale of certain assets to
Daisytek pursuant to the Purchase Agreement. Under the Purchase Agreement, the
Company transferred and sold to Daisytek certain distribution and fulfillment
assets, including equipment and fixtures, that were previously used by the
Company to provide outsourcing services to Daisytek. Daisytek also assumed
certain related equipment leases and a warehouse lease and hired certain
employees who were associated with the warehouse facility. The consideration
payable under the Purchase Agreement of $11.0 million included a termination by
the Company and Daisytek of certain transaction management services agreements
previously entered into between the Company, Daisytek and a Daisytek subsidiary.
Proceeds of $10.9 million were received for assets with an approximately $4.5
million net book value with a resulting $5.8 million gain, after closing costs
of $0.6 million. Concurrently with the closing of the asset sale, the Company
and Daisytek also entered into a six-month transition services agreement under
which the Company provided Daisytek with certain transitional and information
technology services.

Pro forma net revenues and pro forma loss from operations for the three
months ended June 30, 2001, assuming the transaction had occurred in January
2001, would have been $5.7 million and $(4.3) million, respectively. Pro forma
net revenues and pro forma loss from operations for the six months ended June
30, 2001, assuming the transaction had occurred in January 2001, would have been
$12.2 million and $(8.6) million, respectively. The pro forma data do not give
effect to any fees earned by PFSweb for services provided to Daisytek under a
six-month transition services agreement entered into on May 25, 2001 or the
effect of the $5.8 million gain on the sale of the assets. Additionally, these
pro forma adjustments do not consider certain infrastructure costs, such as
operating costs associated with the information technology function, salaries of
certain management and personnel, telephone and lease costs, and depreciation
expense which supported this business but that will continue in the future.
Because these ongoing costs were not considered, the pro forma adjustments to
the loss from operations are not indicative of the overall margin earned under
these transaction management services agreements.

8. SUPPLIES DISTRIBUTORS

The Company, Business Supplies Distributors (a Daisytek subsidiary --
"BSD"), Daisytek and IBM were parties to various Master Distributor Agreements
that had various scheduled expiration dates through September 2001. Under these
agreements, BSD and its affiliates Business Supplies Distributors Europe B.V.
("BSD Europe"), a Daisytek subsidiary, and BSD (Canada) Inc., a Daisytek
subsidiary ("BSD Canada" and together with BSD and BSD Europe, the "BSD
Companies"), acted as master distributors of various IBM products, Daisytek
provided financing and credit support to the BSD Companies and the Company
provided transaction management and fulfillment services to the BSD Companies.

On June 8, 2001, Daisytek notified the Company and IBM that it did not
intend to renew these agreements upon their scheduled expiration dates. In July
2001, the Company and Inventory Financing

10

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Partners, LLC ("IFP") formed Holdings, and Holdings formed a wholly-owned
subsidiary, Supplies Distributors ("Supplies Distributors"). Concurrently,
Supplies Distributors formed its wholly-owned subsidiaries Supplies Distributors
of Canada, Inc. ("SDC") and Supplies Distributors S.A. ("SDSA"), a Belgium
corporation. Supplies Distributors, SDSA, the Company and IBM entered into new
Master Distributor Agreements to replace the prior agreements. Under these
agreements, Supplies Distributors and SDSA act as master distributors of various
IBM products and, pursuant to a transaction management services agreement
between the Company and Supplies Distributors, the Company provides transaction
management and fulfillment services to Supplies Distributors.

The Company made an equity investment of $0.75 million in Holdings,
which is included in investment in affiliate in the accompanying consolidated
financial statements, for a 49% voting interest, and IFP made an equity
investment of $0.25 million in Holdings for a 51% voting interest. Certain
officers and a director of the Company collectively own a 49% non-voting
interest in IFP. In addition to its equity investment in Holdings, the Company
has also provided Supplies Distributors with a subordinated loan, evidenced by
the Note, which, as of June 30, 2002, had an outstanding balance of $8.8 million
(see Note 2). In June 2002, Supplies Distributors repaid $3.0 million to the
Company, reducing the outstanding balance of the Note. The Note, which is
classified as a note receivable from affiliate, accrues interest at a
fluctuating rate per annum equal to the Company's cost of funds, as determined
by the Company. For the three and six months ended June 30, 2002, the Company
charged interest at 10% and earned $0.3 and $0.6 million, respectively,
associated with the Note.

On September 26, 2001, Supplies Distributors purchased all of the stock
of the BSD Companies for a purchase price of $923,000. In conjunction with the
purchase, BSD and Supplies Distributors were merged with Supplies Distributors
being the surviving corporation. Effective December 31, 2001, BSD Canada and SDC
were amalgamated, with SDC being the surviving corporation. On September 27,
2001, Supplies Distributors entered into short-term credit facilities with IBM
Credit Corporation ("IBM Credit") and IBM Belgium Financial Services S.A. ("IBM
Belgium") for the purpose of financing its distribution of IBM products. The
facilities, which at inception included $40 million for the U.S. operations and
20 million Euros (approximately $19.8 million) for the European operations, were
subsequently increased to $45 million and 27 million Euros (approximately $26.8
million), respectively, and extended through March 25, 2002.

On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $26.8 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $21.8 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions, various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
other things, merge, consolidate, sell assets, incur indebtedness, make loans
and payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFSweb (See
Note 9). Additionally, the Company is required to maintain a subordinated loan
to Supplies Distributors of no less than $6.5 million and shareholders' equity
of at least $25.0 million.

Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such agreement. Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% or
Eurodollar

11

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

rate plus 3.0% or on an adjusted basis, as defined. In Europe, SDSA entered into
a two year factoring agreement with Fortis Commercial Finance N.V. ("Fortis") to
provide factoring for up to 10 million Euros (approximately $9.9 million) of
eligible accounts receivables. Borrowings under this agreement accrue interest
at 8.5%, or on an adjusted basis as defined. These credit facilities contain
cross default provisions, various restrictions upon the ability of Holdings,
Supplies Distributors and SDSA to, among other things, merge, consolidate, sell
assets, incur indebtedness, make loans and payments to related parties, provide
guarantees, make investments and loans, pledge assets, make changes to capital
stock ownership structure and pay dividends, as well as financial covenants,
such as minimum net worth, as defined, and are secured by all of the assets of
Supplies Distributors, as well as collateralized guaranties of Holdings and
PFSweb (See Note 9). Additionally, the Company is required to maintain a
subordinated loan to Supplies Distributors of no less than $6.5 million and may
not maintain restricted cash of more than $5.0 million as security for capital
leases, and is restricted with regard to transactions with related parties,
capital expenditures, indebtedness and changes to capital stock ownership
structure.

Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which are
reported as service fee revenue, affiliate in the accompanying unaudited interim
condensed consolidated financial statements, of approximately $1.5 million, net
of $0.1 million of pass-through charges, for the three months ended June 30,
2002 and $3.0 million, net of $0.1 million of pass-through charges, for the six
months ended June 30, 2002. Prior to becoming a related party, service fees
earned by PFSweb from BSD (the Daisytek subsidiary and predecessor to Supplies
Distributors), associated with the same business activities, were $2.0 million,
net of $0.1 million of pass-through charges, for the three months ended June 30,
2001 and $4.3 million, net of $0.3 million of pass-through charges, for the six
months ended June 30, 2001. As of June 30, 2002 and December 31, 2001, the
Company has trade accounts receivables of $0.7 million and $0.9 million due from
Supplies Distributors, respectively.

Pursuant to Holdings' operating agreement, Holdings allocates its
earning and distributes its cash flow, as defined, in the following order of
priority: first, to IFP until it has received a one-time amount equal to its
capital contribution of $0.25 million; second, to IFP until it has received an
amount equal to a 35% cumulative annual return on its capital contribution;
third, to PFSweb until it has received a one-time amount equal to its capital
contribution of $0.75 million; fourth, to PFSweb until it has received an amount
equal to a 35% cumulative annual return on its capital contribution; and fifth,
to PFSweb and IFP, pro rata, in accordance with their respective capital
accounts. Notwithstanding the foregoing, no distribution may be made if, after
giving effect thereto, the net worth of Holdings shall be less than $1.0
million. In May 2002, Holdings paid a $0.2 million dividend to IFP. Under the
terms of its credit agreements, Holdings is currently limited to annual cash
dividends of $0.6 million. The Company recorded $0.4 million and $0.9 million of
equity in the earnings of Holdings for the three and six months ended June 30,
2002, respectively. The Company's investment in Holdings includes the Company's
proportionate share of cumulative foreign currency translation adjustments
reflected in Holdings equity section, which, as of June 30, 2002, resulted in a
decrease of $0.3 million to the Company's accumulated other comprehensive loss.

12

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Summarized financial information for Holdings as of June 30, 2002 is as
follows (in thousands):

Cash and cash equivalents (including restricted
cash of $738) ................................... $ 1,443
Accounts receivable, net of allowance for
doubtful accounts of $312 ....................... 29,988
Inventories, net ..................................... 41,236
Prepaid expenses and other current assets ............ 3,408
Other assets, net (including restricted
cash of $875) ................................... 1,072
------------
Total assets .................................. $ 77,147
============

Trade accounts payable ............................... $ 2,895
Accrued expenses ..................................... 2,204
Debt (guaranteed by PFSweb) .......................... 57,445

Other debt ........................................... 3,256
Note payable to affiliate ............................ 8,800
Members' capital:
Capital contributions ............................ 1,000
Retained earnings ................................ 1,018
Unrealized gain on investment .................... 294
Accumulated other comprehensive loss ............. 235
------------
Total members' capital ........................ 2,547
------------
Total liabilities and members' capital ........ $ 77,147
============

Summarized operating information for Holdings for the three and six
months ending June 30, 2002 is as follows (in thousands):

13

9. COMMITMENTS AND CONTINGENCIES

The Company has provided collateralized guarantees to secure the
repayment of Supplies Distributors' credit facilities. As of June 30, 2002 the
outstanding balance of the credit facilities guaranteed by the Company was
approximately $57.4 million. These guarantees expire concurrently with the
expiration of the underlying credit agreements. To the extent Supplies
Distributors or its subsidiaries fails to comply with its covenants, including
its monthly financial covenant requirements, and the lenders accelerate the
repayment of the credit facility obligations, Supplies Distributors or its
subsidiaries would be required to repay all amounts outstanding thereunder. In
such event, the Company would be obligated to perform under those guarantees and
repay, to the extent Supplies Distributors or its subsidiaries was unable to,
Supplies Distributors' or its subsidiaries credit facility obligations.
Additionally, if the Company was unable to maintain the Company's required level
of stockholders' equity of $25.0 million or if the Company was to violate any of
the restricted transactions pursuant to the IBM Credit, IBM Belgium, or Congress
agreements (see Note 8), the Company could also be obligated to perform under
these guarantees. Any requirement to perform under the Company's guarantees
would have a material adverse impact on the Company's financial condition and
results of operations and no assurance can be given that the Company will have
the financial ability to repay all of such guaranteed obligations. In addition,
in the event Supplies Distributors or its subsidiaries is, or would be, in
default of its obligations under its credit facilities, the Company is
restricted from receiving any payment of its Note and such event would also have
a material adverse impact upon the Company's financial condition and results of
operations. Furthermore, the Company is obligated to repay any over-advance made
to Supplies Distributors or its subsidiaries by its lenders. An over-advance
would arise in the event borrowings exceeded the maximum amount available under
the eligible borrowing base, as defined. The Company has also provided a
guarantee of the obligations of Supplies Distributors and its subsidiaries to
IBM, excluding the trade payables that are financed by IBM Credit. No
liabilities have been recorded in the accompanying financial statements for
these guarantee obligations.

Although the parties to these credit facilities are currently in
compliance with all of the covenants and other provisions required thereunder,
the Company may seek the consent of the required lenders to modify, amend or
waive some of the restrictions and financial covenants thereunder prior to its
maturity in March 2003. No assurance can be given that the Company will be able
to obtain such modifications, amendments or waivers, and the failure to obtain
one or more of such modifications, amendments or waivers will have a material
adverse effect upon Holdings, Supplies Distributors and PFSweb and their
respective financial condition and operations.

14

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis of our results of operations and
financial condition should be read in conjunction with the unaudited interim
condensed consolidated financial statements and related notes appearing
elsewhere in this Form 10-Q.

FORWARD-LOOKING INFORMATION

We have made forward-looking statements in this Report on Form 10-Q.
These statements are subject to risks and uncertainties, and there can be no
guarantee that these statements will prove to be correct. Forward-looking
statements include assumptions as to how we may perform in the future. When we
use words like "seek," "strive," "believe," "expect," "anticipate," "predict,"
"potential," "continue," "will," "may," "could," "intend," "plan," "target" and
"estimate" or similar expressions, we are making forward-looking statements. You
should understand that the following important factors, in addition to those set
forth above or elsewhere in this Report on Form 10-Q and our Form 10-K for the
nine-month transition period ended December 31, 2001, could cause our results to
differ materially from those expressed in our forward-looking statements. These
factors include:

o our ability to retain and expand relationships with existing
clients and attract new clients;

o our reliance on the fees generated by the transaction volume
or product sales of our clients;

o our reliance on our clients' projections or transaction volume
or product sales;

o our client mix and the seasonality of their business;

o our ability to finalize pending contracts;

o the impact of strategic alliances and acquisitions;

o trends in the market for our services;

o trends in e-commerce;

o whether we can continue and manage growth;

o changes in the trend toward outsourcing;

o increased competition;

o our ability to generate more revenue and achieve sustainable
profitability;

o effects of changes in profit margins;

o the customer concentration of our business;

o the unknown effects of possible system failures and rapid
changes in technology;

o trends in government regulation both foreign and domestic;

o foreign currency risks and other risks of operating in foreign
countries;

o potential litigation involving our e-commerce intellectual
property rights;

o our dependency on key personnel;

15

o our ability to raise additional capital;

o our relationship with and our guarantees of the working
capital indebtedness of our affiliate, Supplies Distributors;

o the continued listing of our common stock on the NASDAQ
SmallCap Market; and

o our relationship with and separation from Daisytek, our former
parent corporation.

We have based these statements on our current expectations about future
events. Although we believe that the expectations reflected in our
forward-looking statements are reasonable, we cannot guarantee you that these
expectations actually will be achieved. In addition, some forward-looking
statements are based upon assumptions as to future events that may not prove to
be accurate. Therefore, actual outcomes and results may differ materially from
what is expected or forecasted in such forward-looking statements. We undertake
no obligation to update publicly any forward-looking statement for any reason,
even if new information becomes available or other events occur in the future.
There may be additional risks that we do not currently view as material or that
are not presently known.

OVERVIEW

We are an international outsourcing provider of integrated business
process outsourcing solutions to major brand name companies seeking to maximize
their supply chain efficiencies and to extend their e-commerce initiatives. We
derive our revenues from a broad range of services, including professional
consulting, technology collaboration, order management, managed web hosting and
web development, customer relationship management, financial services including
billing and collection services, options kitting and assembly services,
information management and international fulfillment and distribution services.
We offer our services as an integrated solution, which enables our clients to
outsource their complete infrastructure needs to a single source and to focus on
their core competencies. Our distribution services are conducted at our
warehouses and include real-time inventory management and customized picking,
packing and shipping of our clients' customer orders. We currently provide
infrastructure and distribution solutions to clients that operate in a range of
vertical markets, including technology manufacturing, computer products,
printers, cosmetics, fragile goods, high security collectibles, pharmaceuticals,
housewares, apparel, telecommunications and consumer electronics, among others.

Our service fee revenue is typically charged on a percent of shipped
revenue basis or on a per-transaction basis, such as a per-minute basis for
Web-enabled customer contact center services and a per-item basis for
fulfillment services. Additional fees are billed for other services. We price
our services based on a variety of factors, including the depth and complexity
of the services provided, the amount of capital expenditures or systems
customization required, the length of contract and other factors. Our billings
for reimbursements of out-of-pocket expenses, such as travel and certain
third-party vendor expenses such as shipping and handling costs and
telecommunication charges are included in gross service fee revenue. The related
reimbursable costs are reflected as pass-through charges and reduce total gross
service fee revenue in computing net service fee revenue.

Our expenses are comprised of (i) cost of service fee revenue, which
consists primarily of compensation and related expenses for our Web-enabled
customer contact center services, international fulfillment and distribution
services and professional consulting services, and other fixed and variable
expenses directly related to providing services under the terms of fee based
contracts, including certain occupancy and information technology costs and
depreciation and amortization expenses; and (ii) selling, general and
administrative expenses, which consist primarily of compensation and related
expenses for sales and marketing staff, executive, management and administrative
personnel and other overhead costs, including certain occupancy and information
technology costs and depreciation and amortization expenses.

16

RESULTS OF OPERATIONS

The following table sets forth certain historical financial information
from our unaudited interim condensed consolidated statements of operations
expressed as a percent of revenue.

RESULTS OF OPERATIONS FOR THE INTERIM PERIODS ENDED JUNE 30, 2002 AND 2001

Net Service Fee Revenue (including service fee revenue, affiliate). Net
service fee revenue was $10.3 million for the three months ended June 30, 2002
as compared to $9.4 million for the three months ended June 30, 2001, an
increase of $0.9 million or 9.8%. The increase in net service fee revenue over
the prior period was due to the impact of new service contract relationships of
$5.4 million and a seasonably high revenue period of our largest client. The
impact of such new contracts was partially offset by the impact of terminated
contracts in calendar year 2001 of $3.8 million, primarily the Daisytek
contracts. Net service fee revenue for the three months ended June 30, 2002,
included $0.4 million of contracts terminated in the current fiscal year. Net
service fee revenue was $18.7 million for the six months ended June 30, 2002 as
compared to $20.7 million for the six months ended June 30, 2001, a decrease of
$2.0 million or 9.7%. The decrease in net service fee revenue over the prior
period was due to the impact of certain client terminations in calendar year
2001 of $9.6 million, primarily the Daisytek contracts. This reduction was
partially offset by the impact of new service contract relationships of $8.6
million. Net service fee revenue for the six month period ended June 30, 2002
included $0.9 million of contracts terminated in the current fiscal year. For
the three and six month periods ended June 30, 2002, net service fee revenue
from existing clients declined $0.7 million and $1.0 million, respectively, from
the prior periods, primarily related to decreases in the net service fee
revenues earned from the business activity with Supplies Distributors versus its
predecessor company.

In conjunction with the $10.9 million sale of a distribution facility
to Daisytek in May 2001 (discussed below in "Liquidity and Capital Resources"),
we terminated certain of our transaction management services agreements entered
into between us, Daisytek and a Daisytek subsidiary. Concurrently with the
closing of the facility sale, we entered into a six-month transition services
agreement to provide Daisytek with certain transitional and information
technology services. The net impact of the changes in our services provided to
Daisytek, excluding the business activity previously provided to BSD, another
Daisytek subsidiary, was a

17

reduction in net service fee revenue of $3.8 million and $9.0 million for the
three and six months ended June 30, 2002, respectively. Such terminated
contracts do not include the business activity previously provided to BSD, a
Daisytek subsidiary, which now operates through Supplies Distributors, our
affiliate company.

Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which are
reported as service fee revenue, affiliate in the accompanying unaudited interim
condensed consolidated financial statements, of approximately $1.5 million, net
of $0.1 million of pass-through charges, for the three months ended June 30,
2002 and $3.0 million, net of $0.1 million of pass-through charges, for the six
months ended June 30, 2002. Prior to becoming a related party, service fees
earned by PFSweb from BSD (the Daisytek subsidiary and predecessor to Supplies
Distributors), associated with the same business activities, were $2.0 million,
net of $0.1 million of pass-through charges, for the three months ended June 30,
2001 and $4.3 million, net of $0.3 million of pass-through charges, for the six
months ended June 30, 2001.

Other Revenue. Other revenue of $0.1 million and $0.5 million for the
three and six months ended June 30, 2001, respectively, represents the fees
charged to clients in conjunction with early contract terminations.

Cost of Net Service Fee Revenue. Cost of net service fee revenue was
$6.4 million for the three months ended June 30, 2002, as compared to $6.1
million during the three months ended June 30, 2001, an increase of $0.3 million
or 4.7%. The resulting service fee gross profit was $4.0 million, or 38.3% of
net service fee revenue, during the three months ended June 30, 2002 as compared
to $3.3 million, or 35.4% of net service fee revenue for the three months ended
June 30, 2001. The increase in gross profit is primarily a result of the
increase in service fee revenue. Our gross profit as a percent of net service
fee revenue also increased in the current period because the gross profit
percentage earned on certain contracts terminated in calendar year 2001 was
lower than the contracts we currently operate. In addition, our net service fee
revenue with our new largest client is seasonally high during the June quarter,
which favorably impacts our gross margin percentage, as the fixed costs
represent a lower percentage of net service fee revenue. This was partially
offset by $0.3 million of costs in excess of start up fees incurred for a new
client implementation during the three months ended June 30, 2002. Cost of net
service fee revenue was $11.6 million for the six months ended June 30, 2002, as
compared to $13.7 million during the six months ended June 30, 2001, a decrease
of $2.1 million or 15.2%. The resulting service fee gross profit was $7.1
million or 37.8% of net service fee revenue, during the six months ended June
30, 2002 as compared to $7.0 million, or 33.8% of net service fee revenue for
the six months ended June 30, 2001. The reduction in gross profit is primarily a
result of the decrease in service fee revenue. However, our gross profit as a
percent of net service fee revenue increased in the current period because the
gross profit percentage earned on certain contracts terminated in calendar year
2001 was lower than the contracts we currently operate. This was partially
offset by $0.3 million of costs in excess of start up fees incurred for a new
client implementation during the six months ended June 30, 2002.

Cost of Other Net Revenue. Cost of other revenue for the three and six
months ended June 30, 2001 reflect approximately $0.1 million of certain
uncollectible amounts receivable from, and accrued expenses applicable to,
clients who terminated contracts.

Selling, General and Administrative Expenses. SG&A expenses were $7.0
million for the three months ended June 30, 2002, or 67.9% of revenues, as
compared to $6.0 million, or 62.8% of revenues, for the three months ended June
30, 2001. SG&A expenses were $14.1 million for the six months ended June 30,
2002, or 75.7% of revenues, as compared to $12.4 million, or 58.5% of revenues,
for the six months ended June 30, 2001. SG&A expenses increased over the prior
year due to approximately $0.8 million and $1.5 million for the three and six
months ended June 30, 2002, respectively, of technology infrastructure costs
that were incurred in both periods but that were recorded as a component of cost
of service fee revenue in the prior year. These technology costs were
principally dedicated to the activities that generated service fee revenue under
the transaction management services contract with Daisytek, which was terminated
in November 2001. Increases in sales and marketing costs in the current six
month period were offset by a net decrease in personnel compensation costs due
to head count reductions.

18

Equity in Earnings of Affiliate. For the three and six months ended
June 30, 2002, we recorded $0.4 million and $0.9 million, respectively, of
equity in earnings of affiliate that represents our allocation of Holdings
earnings.

Interest Income. Interest income was $0.3 million for the three months
ended June 30, 2002 as compared to interest income of $0.2 million for the three
months ended June 30, 2001. Interest income was $0.5 million for the six months
ended June 30, 2002 as compared to interest income of $0.4 million for the six
months ended June 30, 2001. The increase in interest income is attributable to
the impact of higher interest rates charged on our subordinated loan to Supplies
Distributors partially offset by lower interest rates earned by our cash and
cash equivalents and higher interest expense due to an increase in our long-term
debt and capital lease obligations. We anticipate that interest income will
decrease in the future due to the reduction of the outstanding balance on our
subordinated loan to Supplies Distributors.

Income Taxes. For the three and six months ended June 30, 2002, we did
not record any tax benefits associated with our net loss since we have not
established a sufficient history of earnings for our operations. A valuation
allowance has been provided for our net deferred tax assets as of June 30, 2002,
which are primarily related to our net operating loss carryforwards. For the six
months ended June 30, 2001, we recorded an income tax benefit associated with
the true-up of previously estimated tax attributes for fiscal 2000, which were
due to us since our prior results were included in Daisytek's consolidated tax
return, offset by an income tax provision associated with a pre-tax income from
our Canadian operations. We did not record an income tax benefit for our
European pre-tax losses in the current or prior period.

SUPPLIES DISTRIBUTORS

Business Supplies Distributors (a Daisytek subsidiary -- "BSD"),
Daisytek, IBM and us were parties to various Master Distributor Agreements that
had various scheduled expiration dates through September 2001. Under these
agreements, BSD and its affiliates Business Supplies Distributors Europe B.V.
("BSD Europe"), a Daisytek subsidiary, and BSD (Canada) Inc., a Daisytek
subsidiary ("BSD Canada" and together with BSD and BSD Europe, the "BSD
Companies"), acted as master distributors of various IBM products, Daisytek
provided financing and credit support to the BSD Companies and we provided
transaction management and fulfillment services to the BSD Companies.

On June 8, 2001, Daisytek notified us and IBM that it did not intend to
renew these agreements upon their scheduled expiration dates. In July 2001, we
and Inventory Financing Partners, LLC ("IFP") formed Business Supplies
Distributors Holdings, LLC ("Holdings"), and Holdings formed a wholly-owned
subsidiary, Supplies Distributors ("Supplies Distributors"). Concurrently,
Supplies Distributors formed its wholly-owned subsidiaries Supplies Distributors
of Canada, Inc. ("SDC") and Supplies Distributors S.A. ("SDSA"), a Belgium
corporation. Supplies Distributors, SDSA, IBM and PFSweb entered into new Master
Distributor Agreements to replace the prior agreements. Under the new
agreements, Supplies Distributors and SDSA act as master distributors of various
IBM products and, pursuant to a transaction management services agreement
between us and Supplies Distributors, we provide transaction management and
fulfillment services to Supplies Distributors.

We made an equity investment of $0.75 million in Holdings for a 49%
voting interest, and IFP made an equity investment of $0.25 million in Holdings
for a 51% voting interest. Certain officers and a director of PFSweb own a 49%
non-voting interest in IFP. In addition to its equity investment in Holdings, we
have also provided Supplies Distributors with a subordinated loan, which, as of
June 30, 2002, had an outstanding balance of $8.8 million and accrued interest
at approximately 10%. During June 2002, Supplies Distributors repaid us $3.0
million, reducing the balance of our subordinated loan. The balance can be
decreased to $6.5 million subject to Supplies Distributors' compliance with the
covenants of its senior loan facilities, as amended.

On September 26, 2001, Supplies Distributors purchased all of the stock
of the BSD Companies for a purchase price of $923,000. In conjunction with the
purchase, BSD and Supplies Distributors were merged with Supplies Distributors
being the surviving corporation. Effective December 31, 2001, BSD Canada and SDC
were amalgamated, with SDC being the surviving corporation. On September 27,
2001, Supplies Distributors entered into short-term credit facilities with IBM
Credit Corporation ("IBM Credit") and IBM Belgium Financial Services S.A. ("IBM
Belgium") for the purpose of financing its distribution of IBM

19

products. The facilities, which at inception included $40 million for the U.S.
operations and 20 million Euros (approximately $19.8 million) for the European
operations, were subsequently increased to $45 million and 27 million Euros
(approximately $26.8 million), respectively, and extended through March 25,
2002. The Company has provided a collateralized guaranty to secure the repayment
of these credit facilities.

On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $26.8 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $21.8 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions, various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
other things, merge, consolidate, sell assets, incur indebtedness, make loans
and payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFSweb.
Additionally, we are required to maintain a subordinated loan to Supplies
Distributors of no less than $6.5 million, and shareholders' equity of at least
$25.0 million. Furthermore, we are obligated to repay any over-advance made to
Supplies Distributors or SDSA under these facilities. An over-advance would
arise in the event borrowings exceeded the maximum amount available under the
eligible borrowing base, as defined.

Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such agreement. Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% or
Eurodollar rate plus 3.0% or on an adjusted basis, as defined. In Europe, SDSA
entered into a two year factoring agreement with Fortis Commercial Finance N.V.
("Fortis") to provide factoring for up to 10 million Euros (approximately $9.9
million) of eligible accounts receivables. Borrowings under this agreement
accrue interest at 8.5%, or on an adjusted basis as defined. These credit
facilities contain cross default provisions, various restrictions upon the
ability of Holdings, Supplies Distributors and SDSA to, among other things,
merge, consolidate, sell assets, incur indebtedness, make loans and payments to
related parties, provide guarantees, make investments and loans, pledge assets,
make changes to capital stock ownership structure and pay dividends, as well as
financial covenants, such as minimum net worth, as defined, and are secured by
all of the assets of Supplies Distributors, as well as collateralized guaranties
of Holdings and PFSweb. Additionally, we are required to maintain a subordinated
loan of no less than $6.5 million to Supplies Distributors and may not maintain
restricted cash of more than $5.0 million as security for capital leases, and
are restricted with regard to transactions with related parties, capital
expenditures, indebtedness and changes to capital stock ownership structure.
Furthermore, we are obligated to repay any over-advance made to Supplies
Distributors under the Congress facility. An over-advance would arise in the
event borrowings exceeded the maximum amount available under the eligible
borrowing base, as defined. PFS has also provided a guarantee of the obligations
of Supplies Distributors and SDSA to IBM, excluding the trade payables that are
financed by IBM credit.

Pursuant to the terms of our transaction management services agreement
with Supplies Distributors, we earned service fees, which are reported as gross
service fee revenue, affiliate in the accompanying unaudited interim condensed
consolidated financial statements, of approximately $1.5 million, net of $0.1
million of pass-through charges, for the three months ended June 30, 2002 and
$3.0 million, net of $0.1 million of pass-through charges, for the six months
ended June 30, 2002. Prior to becoming a related party, service fees earned by
PFSweb from BSD (the Daisytek subsidiary and predecessor to Supplies
Distributors), associated with the same business activities, were $2.0 million,
net of $0.1 million of pass-through charges, for the three months ended June 30,
2001 and $4.3 million, net of $0.3 million of pass-through charges, for the six
months ended June 30, 2001. As of June 30, 2002 and December 31, 2001 we had
trade accounts receivables of $0.7 million and $0.9 million due from Supplies
Distributors, respectively.

20

We record our interest in Holdings' net income, which is allocated and
distributed to the owners pursuant to the terms of Holdings' operating
agreement, under the modified equity method, which results in us recording our
allocated earnings of Holdings or 100% of Holdings' losses and our proportionate
share of Holdings' cumulative foreign currency translation adjustments. Pursuant
to Holdings' operating agreement, Holdings allocates its earning and distributes
its cash flow, as defined, in the following order of priority: first, to IFP
until it has received a one-time amount equal to its capital contribution of
$0.25 million; second, to IFP until it has received an amount equal to a 35%
cumulative annual return on its capital contribution; third, to PFSweb until it
has received a one-time amount equal to its capital contribution of $0.75
million; fourth, to PFSweb until it has received an amount equal to a 35%
cumulative annual return on its capital contribution; and fifth, to PFSweb and
IFP, pro rata, in accordance with their respective capital accounts.
Notwithstanding the foregoing, no distribution may be made if, after giving
effect thereto, the net worth of Holdings shall be less than $1.0 million. In
May 2002, Holdings paid a $0.2 million dividend to IFP. Under terms of the
credit agreements described above, Holdings is currently limited to annual cash
dividends of $0.6 million. We recorded $0.4 million and $0.9 million of equity
in the earnings of Holdings for the three and six months ended June 30, 2002,
respectively. Our investment in Holdings includes our proportionate share of
cumulative foreign currency translation adjustments reflected in Holdings equity
section, which, as of June 30, 2002, resulted in a decrease of $0.3 million to
our accumulated other comprehensive loss.

Summarized financial information for Holdings as of June 30, 2002 is as
follows (in thousands):

Cash and cash equivalents (including restricted
cash of $738) ..................................... $ 1,443
Accounts receivable, net of allowance for
doubtful accounts of $312 ......................... 29,988
Inventories, net ..................................... 41,236
Prepaid expenses and other current assets ............ 3,408
Other assets, net (including restricted
cash of $875) ..................................... 1,072
------------
Total assets ................................. $ 77,147
============

Trade accounts payable ............................... $ 2,895
Accrued expenses ..................................... 2,204
Debt (guaranteed by PFSweb) .......................... 57,445
Other debt ........................................... 3,256
Note payable to affiliate ............................ 8,800
Members' capital:
Capital contributions ............................ 1,000
Retained earnings ................................ 1,018
Unrealized loss on investment .................... 294
Accumulated other comprehensive loss ............. 235
------------
Total members' capital ........................ 2,547
------------
Total liabilities and members' capital ........ $ 77,147
============

Summarized operating information for Holdings for the three and six
months ended June 30, 2002 is as follows (in thousands):

21

LIQUIDITY AND CAPITAL RESOURCES

On May 25, 2001, we completed the sale of certain assets to Daisytek
pursuant to an Asset Purchase Agreement (the "Purchase Agreement"). Under the
Purchase Agreement, we transferred and sold to Daisytek certain distribution and
fulfillment assets, including equipment and fixtures, that were previously used
by us to provide outsourcing services to Daisytek. Daisytek also assumed certain
related equipment leases and a warehouse lease and hired certain employees who
were associated with the warehouse facility. The consideration payable under the
Purchase Agreement of $11.0 million included a termination by us and Daisytek of
certain transaction management services agreements previously entered into
between us and Daisytek and a Daisytek subsidiary. Proceeds of $10.9 million
were received for assets with an approximately $4.5 million net book value with
a resulting $5.8 million gain, after closing costs of $0.6 million. Concurrently
with the closing of the asset sale, we and Daisytek also entered into a
six-month transition services agreement, which terminated in November 2001,
under which we provided Daisytek with certain transitional and information
technology services.

Net cash used in operating activities was $3.2 million for the six
months ended June 30, 2002, and primarily resulted from cash used to fund
operating losses and the net impact of an increase in accounts receivable of
$1.6 million, partially offset by an increase in accounts payable and accrued
expenses of $0.2 million and a decrease in prepaid expenses and other current
assets of $1.5 million. The increase in accounts receivable is primarily due to
increased service fee billings for our largest client, which has a seasonally
high second quarter of business activity, and a $0.4 million increase in credit
card charges owed to us as part of the billing and collection services we
perform on behalf of our clients. Once collected, these funds are remitted to
our clients. The decrease in other current assets primarily relates to the
collection of VAT receivables associated with our European operations. Net cash
used in operating activities was $1.5 million for the six months ended June 30,
2001, and primarily resulted from cash used to fund operating losses and the net
impact of an increase in prepaid expenses and other current assets of $0.4
million and a decrease in accounts payable and accrued expenses of $2.8 million
partially offset a decrease in accounts receivable of $2.7 million.

Net cash provided by investing activities for the six months ended June
30, 2002 totaled $1.8 million, representing the net repayment of $2.9 million by
Supplies Distributors of our subordinated loan, which totaled $8.8 million at
June 30, 2002, offset by capital expenditures of $0.9 million and a $0.2 million
increase in our restricted cash balance to $2.9 million, which is to secure our
long-term debt and lease financing. Cash provided by investing activities
totaled $6.6 million for the six months ended June 30, 2001, which primarily
included $9.4 million in net proceeds from the sale of the distribution facility
offset by $2.2 million of capital expenditures. Capital expenditures have
historically consisted primarily of additions to upgrade our management
information systems, including our Internet-based customer tools, other methods
of e-commerce and general expansion of our facilities, both domestic and
foreign. We expect to incur capital expenditures in order to support new
contracts and anticipated future growth opportunities. We anticipate that our
total investment in upgrades and additions to facilities and information
technology services for the upcoming twelve months will be approximately $2 to
$4 million, although additional capital expenditures may be necessary to support
the infrastructure requirements of new clients. A portion of these expenditures
may be financed through operating or capital leases. We may elect to modify or
defer a portion of such anticipated investments in the event that we do not
achieve the revenue necessary to support such investments.

Net cash used in financing activities was approximately $0.3 million
for the six months ended June 30, 2002, representing the proceeds from debt and
from the issuance of common stock pursuant to our employee stock purchase plan
offset by payments on our long-term debt and capital lease obligations. Net cash
used in financing activities was approximately $0.1 million for the six months
ended June 30, 2001, representing payments on our capital lease obligations
offset by the proceeds from issuance of common stock.

During the six months ended June 30, 2002, our working capital
decreased to $9.0 million from $11.2 million at December 31, 2001, primarily due
to the funding of operations and capital expenditures, offset by the repayment
from Supplies Distributors of $2.9 million against our subordinated loan. In
order to obtain additional financing in the future, in addition to our current
cash position, we plan to evaluate various financing alternatives including
utilizing capital or operating leases, establishing our own credit facility,

22

entering into asset based lending or factoring programs, or transferring a
portion of our subordinated loan balances, due from Supplies Distributors, to
third-parties. In conjunction with certain of these alternatives, we may be
required to provide certain letters of credit to secure these arrangements. No
assurances can be given that we will be successful in obtaining any additional
financing or the terms thereof. We currently believe that our cash position and
funds generated from operations (including our anticipated revenue growth and/or
cost reductions to offset lower than anticipated revenue growth) will satisfy
our presently known operating cash needs, our working capital and capital
expenditure requirements and our lease obligations, and additional subordinated
loans to Supplies Distributors, if necessary, for at least the next twelve
months.

The following is a schedule of our total contractual cash obligations,
which is comprised of operating leases, long-term debt and capital leases,
including interest (in millions):

In support of certain debt instruments and leases, as of June 30, 2002,
we had $2.9 million of cash restricted in the form of letters of credit. The
letters of credit expire at various dates through July 2004. As described above,
we have provided collateralized guarantees to secure the repayment of Supplies
Distributors' credit facilities. As of June 30, 2002, the outstanding balance of
the credit facilities guaranteed by PFSweb was approximately $57.4 million.
These guarantees expire concurrently with the expiration of the underlying
credit agreements. To the extent Supplies Distributors or its subsidiaries fails
to comply with its covenants, including its monthly financial covenant
requirements, and the lenders accelerate the repayment of the credit facility
obligations, Supplies Distributors or its subsidiaries would be required to
repay all amounts outstanding thereunder. In such event, we would be obligated
to perform under those guarantees and repay, to the extent Supplies Distributors
or its subsidiaries was unable to, Supplies Distributors' or its subsidiaries
credit facility obligations. Additionally, if we were unable to maintain our
required level of stockholders' equity of $25.0 million or if we were to violate
any of the restricted transactions pursuant to the IBM Credit, IBM Belgium, or
Congress agreements, we could also be obligated to perform under these
guarantees. Any requirement to perform under our guarantees would have a
material adverse impact on our financial condition and results of operations and
no assurance can be given that we will have the financial ability to repay all
of such guaranteed obligations. In addition, in the event Supplies Distributors
or its subsidiaries is, or would be, in default of its obligations under its
credit facilities, we are restricted from receiving any payment of our
subordinated loans and such event would also have a material adverse impact upon
our financial condition and results of operations. Furthermore, we are obligated
to repay any over-advance made to Supplies Distributors or its subsidiaries by
its lenders. An over-advance would arise in the event borrowings exceeded the
maximum amount available under the eligible borrowing base, as defined. Although
the parties to these credit facilities are currently in compliance with all of
the covenants and other provisions required thereunder, we may seek the consent
of the required lenders to modify, amend or waive some of the restrictions and
financial covenants thereunder prior to its maturity in March 2003. No assurance
can be given that we will be able to obtain such modifications, amendments or
waivers, and the failure to obtain one or more of such modifications, amendments
or waivers will have a material adverse effect upon Holdings, Supplies
Distributors and PFSweb and their respective financial condition and operations.
PFS has also provided a guarantee of the obligations of Supplies Distributors
and SDSA to IBM, excluding the trade payables that are financed by IBM credit.
No liabilities have been recorded in the accompanying financial statements for
these guarantee obligations. We do not have any other material commercial
commitments.

Currently, we believe that we are operating with and incurring costs
applicable to excess capacity in both our North American and European
operations. We believe that as we add revenue, we will be able to cover our
existing infrastructure and public company costs and reach profitability. We
currently estimate that the net service fee revenue needed to leverage our
infrastructure and reach profitability is approximately $14 million per quarter.
No assurance can be given that we can achieve such operating levels, or that, if
achieved, we will be profitable in any particular fiscal period.

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In the future, we may attempt to acquire other businesses or seek an
equity or strategic partner to expand our services or capabilities in connection
with our efforts to grow our business. Acquisitions involve certain risks and
uncertainties and may require additional financing. Therefore, we can give no
assurance with respect to whether we will be successful in identifying
businesses to acquire or an equity or strategic partner, whether we or they will
be able to obtain financing to complete a transaction, or whether we or they
will be successful in operating the acquired business.

CONTINUED LISTING ON NASDAQ SMALLCAP MARKET

In June 2002, the NASDAQ approved our transition from the NASDAQ
National Market System to the NASDAQ SmallCap Market. Our securities began
trading on the NASDAQ SmallCap Market on June 10, 2002.

This transition occurred in response to NASDAQ Marketplace Rule
4450(a)(5), which requires a minimum bid price of $1.00 for continued listing on
the NASDAQ National Market. The SmallCap Market also has a minimum bid price of
$1.00 per share. However, as compared to the 90-day grace period provided by the
NASDAQ National Market, the SmallCap Market currently has a longer bid price
minimum grace period of 180 days from receipt of NASDAQ Delisting Notification
(February 14, 2002 for the Company). This grace period extended us through
August 13, 2002.

Due to our compliance with the initial listing requirements for the
NASDAQ SmallCap Market, on August 14, 2002 we have been provided an additional
180 day grace period, or until February 10, 2003 to regain compliance. We can,
however, provide no assurance as to our ability to maintain compliance with the
listing standards and our continued listing in the NASDAQ SmallCap Market.

SEASONALITY

The seasonality of our business is dependent upon the seasonality of
our clients' business and their sale of their products. Accordingly, our
management must rely upon the projections of our clients in assessing quarterly
variability. We believe that with our current client mix, our business activity
will be at it lowest in the quarter ended March 31 and at its highest in the
quarter ended June 30.

We believe that results of operations for a quarterly period may not be
indicative of the results for any other quarter or for the full year.

INFLATION

Management believes that inflation has not had a material effect on our
operations.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

On January 1, 2002, we adopted the provisions of EITF D-103 "Income
Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred." For the periods presented above, our billings for reimbursements of
'out-of-pocket' expenses, such as travel, and certain third-party vendor
expenses such as shipping and handling costs and telecommunication charges are
included in gross service fee revenue. The related reimbursable costs are
reflected as pass-through charges and reduce total gross service fee revenue in
computing net service fee revenue.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. We are currently assessing the impact on the
consolidated financial statements and will adopt the provisions of this standard
by the first quarter of 2003.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal

24

Activities," which addresses the financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." We are currently assessing the impact on
the consolidated financial statements and will adopt the provisions of this
standard by the first quarter of 2003.

CRITICAL ACCOUNTING POLICIES

A description of critical accounting policies is included in footnote 2
to the accompanying unaudited interim condensed consolidated financial
statements. For other significant accounting policies, see Note 2 to the
consolidated financial statements in our December 31, 2001 Annual Report on Form
10-K.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are exposed to various market risks including interest rates on its
financial instruments and foreign exchange rates.

Interest Rate Risk

The carrying value of our financial instruments, which include cash and
cash equivalents, accounts receivable, note receivable, accounts payable and
capital lease obligations, approximate their fair values based on short terms to
maturity or current market prices and rates. The impact of a 100 basis point
change in interest rates would not have a material impact on the Company's
results of operations or financial position.

Foreign Exchange Risk

Currently, our foreign currency exchange rate risk is primarily limited
to Canadian dollars and the Euro. In the future, we believe our foreign currency
exchange risk will also include other currencies applicable to certain of our
international operations. We may, from time to time, employ a small number of
derivative financial instruments to manage our exposure to fluctuations in
foreign currency rate risk. To hedge our net investment and long-term
intercompany payable balance we might enter into forward currency exchange
contracts. We do not hold or issue derivative financial instruments for trading
purposes or enter into foreign currency transactions for speculative purposes.

Effective April 1, 2001, in response to a change to the Euro for
transaction activity previously conducted in the U.S. dollar by our largest
European client, we adopted the Euro as our functional currency for our European
operations.

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PART II. OTHER INFORMATION

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

On June 7, 2002, the Company held its Annual Meeting of Stockholders.
The following matters were acted upon and votes cast or withheld:

1. Election of three Class III directors:

Mark C. Layton

For: 15,268,730 Withheld: 953,587

Timothy M. Murray

For: 15,644,386 Withheld: 577,931

Dr. Neil W. Jacobs

For: 15,650,814 Withheld: 571,503

2. Approval of the amendment to the Company's Certificate of
Incorporation:

For: 13,987,203 Against: 2,205,559 Abstained: 29,555

3. Appointment of KPMG LLP as auditors for the fiscal year ending
December 31, 2002:

For: 15,905,954 Against: 293,622 Abstained: 22,741

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a) Exhibits:

EXHIBIT

NO. DESCRIPTION OF EXHIBITS

3.1* Amended and Restated Certificate of Incorporation

3.2* Amended and Restated Bylaws

10.1 Form of Executive Severance Agreement between the
Company and each of its executive officers

99.1 Certification of Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

99.2 Certification of Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

- ----------

* Incorporated by reference from PFSweb, Inc. Registration Statement on
Form S-1 (Commission File No. 333-87657).

b) Reports on Form 8-K:

Form 8-K filed on May 20, 2002 reporting Item 5, Other Events, that
on May 16, 2002 PFSweb, Inc. (the "Company") received a letter from
The NASDAQ Stock Market indicating that the Company no longer
complied with the $1.00 minimum bid price requirement for continued
listing set forth in Marketplace Rule 4450 (c)(5), and that the
Company's stock is, therefore, subject to delisting from the Nasdaq
National Market. The Company announced that it had requested a
hearing from Nasdaq to appeal the Nasdaq stock determination.

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SIGNATURES

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

Date: August 14, 2002

PFSweb, Inc.

By: /s/ Thomas J. Madden
-------------------------------------
Thomas J. Madden
Chief Financial Officer,
Chief Accounting Officer,
Executive Vice President

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INDEX TO EXHIBITS

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* Incorporated by reference from PFSweb, Inc. Registration Statement on
Form S-1 (Commission File No. 333-87657).